National Electricity Regulator: briefing

Meeting report

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MINERALS AND ENERGY PORTFOLIO COMMITTEE
9 April 2003
NATIONAL ELECTRICITY REGULATOR: BRIEFING

Chairperson: Mr M Goniwe (ANC)

Documents handed out:
National Electricity Regulator presentation: Tariff Approval Process

Relevant documents:
see: www.ner.org.za

SUMMARY
The National Electricity Regulator briefed the Committee on electricity price-setting methodologies in the context of plans for restructuring electricity distribution and supply industries. The trend towards above-inflation-rate price increases could be attributed almost entirely to plans for addressing the capacity problems likely to face South Africa from as early as 2007 as a result of increased demand. Whether 'mothballed' electricity generating plants were re-commissioned or new plants constructed, the high capital expenditure entailed would inevitably be passed onto consumers. The choice between a gradual, phased-in approach to price increases and sudden, sharper hikes would be a policy decision largely beyond the NER's control. The Committee heard that the NER remained committed to arriving at an economical price for domestic consumption. However, the special poverty tariff arrangements needed for very poor households were also beyond the scope of the NER mandate and required clear policy direction.

In the discussion that followed DA Members, in particular, expressed concern about the extent to which industry restructuring could be justified to consumers when, prior to restructuring, that industry had been renowned for supplying some of the cheapest electricity in the world. ANC Members repeatedly drew the NER's attention to the need for the poor quality of electricity supply in rural areas and other historically disadvantaged communities to be urgently addressed.

MINUTES
Introducing representatives of the National Energy Regulator (NER), the Chairman reminded Members that the briefing had been arranged in response to a request for a comprehensive explanation of the tariff approval process that had emerged from discussions during an earlier briefing on 26 March 2003. The confidential in-depth follow-up briefing requested by Petro SA would probably not take place until after the April recess.

Two bills already certified by the office of the State Law Advisor will be considered by the Committee when it reconvenes: the Mining Titles Bill and the Petroleum Pipelines Bill. Since both Bills had generated considerable industry and public interest, it was likely that public hearings would need to be arranged. The Committee programme for the second session of Parliament would be adapted accordingly.

National Electricity Regulator (NER): Tariff Approval Process
Professor A Eberhard, NER board member, advised Members that the NER's primary responsibility was to protect consumer interests without compromising Eskom's financial viability. Affordable electricity for low-income households presented an ongoing challenge to which a targeted regulatory policy and related mechanism appeared to be the most appropriate response. Although South Africans remained captive customers of a monopoly service, a political decision to supply electricity at less than the cost of generating and distributing it would undermine the reliability of supply. This was why an electricity regulator had been established in 1995 and continued to be necessary. A transparent, clearly understood basis for electricity price setting remained essential.

Power and functions of the NER as a key player in the South African electricity industry
Dr W Barnard: Executive Manager, Regulation, noted the Chairman's interest in the gender-representivity of visiting delegations, advising Members that fifty-four per cent of the NER's staff were women.

He outlined the relationship between role players in the electricity industry along the supply chain, from electricity generation to sales. While the price of electricity distributed by Eskom was set nationally by the NER according to international benchmarks, tariffs for municipal supply tended to differ within municipal boundaries according to customer mix, consumption patterns and municipal surplus.

Mr B Sechotla: Head of Department, Pricing and Tariffs, then presented a detailed explanation of tariff regulation methodologies, tariff structures and the customer categories underpinning these. Against this background he explained the year-by-year process followed each time Eskom applied to the NER, in July, for permission to increase the price of electricity the following January. Since 1994 price increases had consistently remained below increases in the consumer price index (CPI), except in 2000 when the increase in the price of electricity had been one per cent higher than CPI. In real terms, therefore, the price of electricity had actually decreased during the past ten years.

Dr Barnard advised Members that, pending completion of the electricity distribution industry (EDI) and electricity supply industry (ESI) restructuring processes, the rate of return (RoR) methodology for regulating Eskom prices would remain in force. The introduction of the six proposed regional electricity distributors (REDs) would inform the process of restructuring municipal electricity tariffs, which would seek to improve industry cost efficiency by formalising cross-subsidisation mechanisms both within existing municipal tariff structures and between electricity distributors and retailers. Municipal tariff structures developed under the interim national distribution tariff system (INDTS) would be improved and would incorporate the proposed poverty tariff to address the needs of poor households. Wholesale electricity pricing structures (WEPs) would be introduced following the unbundling of Eskom into separate entities and the emergence of a single transmission entity.

Economic growth would determine electricity demand. This, in turn, would drive future price increases since it was anticipated that South Africa could face capacity problems from as early as 2007. The high cost of constructing new generating plants to improve supply capacity would inevitably result in price increases, although demand-side management in respect of electricity consumption trends and patterns could mitigate these to some extent. Private sector involvement in improving South Africa's electricity generating capacity would be subject to a market-related return on the investment entailed. The challenge would therefore continue to be managing the process of increasing electricity prices without compromising consumer confidence.

Discussion
Mr J Nash (ANC) expressed dismay at the extent to which South Africans, as the captive customers of a monopoly industry, appeared to have no recourse in the face of ongoing Eskom price increases. He questioned the relevance of the NER in these circumstances. He questioned the rationale behind increasing electricity prices in order to recover costs when Eskom's high profit margins appeared to suggest that these costs could have been recovered from the profits themselves. Concerned that the NER might be protecting the interests of Eskom at the expense of consumers and justifying this with a plethora of excuses, he asked why it was deemed necessary to construct new generating plants when several existing ones had been 'mothballed' for some time. He also asked what proportion of its profits Eskom was obliged to reinvest in electricity provision for poor households.

Mr I Davidson (DA) observed that the RoR methodology for calculating tariff increases and the high level of investment entailed in improving generating capacity would inevitably mean passing Eskom costs onto consumers. He asked what steps had been taken to prepare consumers for ongoing electricity price increases. Referring to a similar question posed during an earlier briefing by the NER, he asked how restructuring an industry could be justified to consumers when, prior to restructuring, that industry had been renowned for supplying some of the cheapest electricity in the world. He also enquired whether, in calculating a rate of return on power plants that had been in use for decades, their written-down value was utilised. He suggested that this might be more realistic than calculating costs on the basis of replacement values.

The Chair enquired whether the NER had ever rejected a price increase application from Eskom.

Referring to the interim national distribution tariff system (INDTS), Mr N Ngcobo (ANC) asked how municipal electricity tariffs were calculated. He observed that perceived inconsistencies in the month-to-month billing of domestic consumers in some areas tended to suggest shortcomings in municipal tariff structures and the categorisation of customers. He also enquired what impact regional capacity had on the price of electricity in South Africa. Could new technologies in electricity generation lower electricity prices over time?

Ms F Mathibela (ANC) expressed concern about the high price of electricity, and especially pre-paid electricity, in rural areas.

Professor I Mohamed (ANC) commented that an explanation given by Eskom at an earlier briefing, that above-inflation price increases would be necessary to accommodate the high cost of improving generation capacity, appeared not to be consistent with RoR methodology. Referring to a proposed move towards incentive-based regulation (IBR), he asked for clarity on incentives for improved cost efficiency. He suggested that the formula concerned appeared rather nebulous. He also asked for comment on the relatively high cost of electricity generated by the Koeberg plant. He asked whether the possible introduction of pebble bed modular reactor (PBMR) technology would also increase the cost of generating electricity.

Mr J Kgarimetsa (ANC) observed that it was hard to justify price increases in the absence of improved service, citing the poor quality of electricity supply in historically disadvantaged communities where frequent interruptions continued to occur.

Noting rumours of an eight per cent increase in Eskom power, Mr J Nash (ANC) asked what percentage increase was likely to be charged by municipalities. He asked why, in the light of grants to municipalities from the Department of Local Government, cross-subsidisation of services continued to be practised. He reiterated an earlier request for clarity on the regulation of municipal tariffs, requesting comment on how the eight per cent Eskom price increase had itself been calculated.

In response, Professor Eberhard again explained the essential role of the NER in ensuring that South African consumers did not, in fact remain captives of the Eskom monopoly. He emphasised that Eskom applied for increases in but did not itself set electricity prices. Noting the importance of understanding the difference between before- and after-tax profit, he asserted that Eskom consistently reinvested in the industry by retiring old debt. Since corporatisation in 2001 and the concomitant responsibility to pay tax, Eskom had contributed significantly towards the national electricity programme through the fiscus.

He assured Members that the value of existing power plants was factored into the RoR formula at an historical, depreciating rate. Nevertheless, he questioned the appropriateness of this approach since the RoR methodology did not necessarily imply that the price of electricity would continue to increase. In real terms, electricity prices might even decrease over time. Nevertheless, in the short-to-medium-term, the price of electricity could be expected to increase to make provision for improved generating capacity.

Mr I Davidson again observed that a pre-requisite to private sector involvement in electricity generation would be a market-related return on the investment entailed.

Professor Eberhard replied that, however new capacity was created, the high cost of doing so would inevitably be passed onto consumers.

He emphasised that, since the NER's inception, Eskom had not once been granted the price increase for which it had applied, but that electricity prices were nevertheless set by the NER with a view to ensuring Eskom's ongoing financial viability and a reliable electricity supply. He noted that the NER did not regulate electricity retailers falling below the minimum kilowatt distribution level underpinning municipal tariff structures. This had obvious implications for the quality of service provision in deep rural areas. The cost of distributing electricity to scarcely populated areas and small communities with concomitantly low domestic consumption levels was approximately sixty-three cents per unit. Currently, Eskom was supplying electricity to the distributors concerned or supplying the areas directly at a cost of thirty cents per unit, using cross-subsidisation within its distribution entities to cover this loss.

In respect of pre-paid electricity, once the NER had set an economical price for domestic consumption special arrangements would need to be made for very poor households using the proposed poverty tariff. However, unreliable electricity supply remained unacceptable. The NER would welcome detailed information on instances of this in order to explore ways of addressing the problem.

The RoR methodology did not make provision for improved generating capacity. Nevertheless, the costs entailed would put pressure on electricity prices and were largely responsible for anticipated above-inflation price increases. Whether these costs would be passed onto consumers by way of a gradual, phased-in or rapid, sharp increase in the price of electricity would be a policy decision.

In response to a comment from Professor I Mohamed (ANC) that Eskom had indicated a preference for the phased-in approach, Professor Eberhard assured Members that the NER would make every possible effort to prepare consumers for this eventuality. The introduction of IBR methodology in setting electricity tariffs would encourage electricity generators and distributors to improve operational efficiency, thereby reducing costs. The formula concerned was complex as efficiency factors and unavoidable risks and costs were difficult to calculate. Only when the NER was confident that IBR would serve both consumer and industry interests more effectively then the RoR methodology would it be introduced.

Since bulk electricity remained the highest input cost for municipal distributors and retailers, above-inflation increases in the price of bulk electricity from Eskom would inevitably be passed onto consumers. However, any additional retail- or distribution-related costs incurred to municipalities should be met from fiscal grants. He advised Members that, currently, these grants were allocated to cover additional costs in respect of other services, and not electricity. However, the proposed poverty tariffs would be subsidised by way of fiscal grants to municipal retailers.

Noting this, Mr Nash commented that municipalities would need to stop using the cross-subsidisation of services as an excuse for electricity price hikes.

Professor Eberhard conceded that the generating technology in use at the Koeberg plant was more costly. He advised Members that the NER would only have formal access to information on the cost-effectiveness of PBMR technology once discussions on this issue had reached a point at which the NER could usefully contribute towards the decision-making processes concerned. New electricity generating technologies would only be factored into the planning process once they had reached commercial maturity. Among member states of the regional power pool, electricity prices were set by other regulating entities or by the utilities themselves. The cost of transporting energy from one state to another was determined by bi-lateral and multilateral agreements within the region.

Mr Ncgobo expressed doubt about the extent to which municipalities could realistically be expected to absorb the cost of new distribution infrastructure without passing this onto consumers. He asked for clarity on fluctuating month-by-month domestic billings and the possible pricing inconsistencies behind these. He commented that proposals for separating gas and energy regulation into separate entities appeared to entail unnecessary expense and might not be workable. Would there be a single regulator for both industries? He also asked whether income from supplying electricity to other Southern African Development Community (SADC) states could be utilised to reduce electricity prices in South Africa itself. On the issue of researching new electricity generating technologies such as PBMR, he expressed concern at the extent to which costly consulting fees might impact negatively on the price of utilising these technologies. Would these costs also be passed onto consumers?

Mr Davidson again referred to a public perception that industry restructuring and privatisation were responsible for successive and collectively dramatic increases in the price of electricity. He reiterated his reservations about the extent to which this perception could adequately be addressed or how the rationale concerned could reasonably be justified when the old system had worked so well for consumers. On the issue of cross-subsidisation within the distribution industry he observed that, to the best of his knowledge, neither the commercial or industrial sectors had complained about their tariffs and mechanisms for using income from these to subsidise domestic consumption. Formalising and rationalising cross-subsidisation across municipalities and between customer categories with a view to making the industry as a whole more competitive could, once again, hit consumers hardest.

Professor Mohamed endorsed Mr Davidson's comments on cross-subsidisation, suggesting that the way in which customers were categorised might need to be reviewed in order to balance revenue and costs across categories.

Ms Mathibela again pointed to poor service delivery in rural areas and, in particular, to intermittent supply in the greater Groblersdal district. Endorsing her concerns, Mr Kgarimetsa appealed for urgent attention to be given to the electrification of rural areas and, in particular, to the quality of services rendered to the communities concerned.

In response, Professor Eberhard expressed the hope that the proposed new REDs would address price inconsistencies and the tendency to use profit from the sale of electricity to subsidise other municipal service provision. He confirmed that the NER was preparing to assume responsibility for regulating the gas industry in keeping with new policy developments. He noted that the export of electricity to other SADC states currently constituted approximately two per cent of total sales, with imported electricity from Cahora Bassa meeting approximately two per cent of overall South African demand. Considerable benefits to consumers could emerge from integrating electricity generation across the region as well as across the different coal- and water-based technologies currently in use.

In this regard, Mr Ngcobo commented on the potential for harnessing new gas fields in the Democratic Republic of Congo (DRC) and Mozambique with a view to meeting South Africa's growing energy requirements.

Professor Eberhard advised Members that, in theory, consultancy fees for researching new generating technologies fell under Eskom Enterprises and should not, in fact, be passed onto consumers at all. A public education drive would need to precede the electricity price increases anticipated in making provision for improved generating capacity. The privatisation of energy generation could mitigate further price increases over time. The rationalisation of cross-subsidisation structures sought to arrive at more cost-reflective tariffs that more explicitly and transparently addressed consumer needs across the spectrum of customer categories. However, clear direction was needed from Government on the issue of poor households. He again appealed for detailed information on the poor quality of electricity supply to rural areas.

Dr Barnard reiterated earlier comments on the relatively high cost of distributing electricity to areas of low demand. He noted that distribution networks in these areas tended to be particularly vulnerable to supply interruptions. Mr Sechotla undertook to refer concerns expressed by Members on this and other supply-related issues to the NER's compliance and monitoring team. Mr Nash invited members of the team to East London with a view to addressing the numerous difficulties experienced by electricity consumers there. Mr Ncgobo suggested that this monitoring team could play a useful role in educating members of the public on the rationale underpinning some of the issues concerned.

In closing, Professor Eberhard assured Members of the NER's ongoing commitment to improved efficiency with a view to mitigating price increases, once again emphasising the need for clear policy guidelines in respect of addressing the needs of poor households.

The Chairman thanked members of the NER delegation for a comprehensive appraisal of the price setting process. He reiterated a request made at an earlier briefing by the NER that the Committee be kept informed of each step in processing Eskom's next application for an electricity price increase expected to be formally tabled in July. This would be one way of demonstrating Members' commitment to ensuring that all future prices could, in fact, be justified.

The meeting was adjourned.