Electricity Pricing: Input by Eskom and National Energy Regulator

MINERALS AND ENERGY PORTFOLIO COMMITTEE
23 May 2007
ELECTRICITY PRICING: INPUT BY ESKOM AND NATIONAL ENERGY REGULATOR

Chairperson: Mr E Mthethwa (ANC)

Documents handed out:
Eskom presentation on Critical Electricity Pricing issues
National Energy Regulator of SA (NERSA) briefing on Electricity Pricing

SUMMARY
Eskom explained what informed its proposed price increase of 18% and identified the fundamental drivers it considered to be present in the industry today, as well as its capital expansion plans. It also gave its view on the pricing methodology developed by NERSA. NERSA presented on the policies and drivers that guided its activities. It also provided an overview of its regulatory activities over Eskom. Members remained concerned about the shortage of electricity capacity and were not convinced that electricity in South Africa was as cheap as what Eskom averred.

MINUTES
Eskom briefing
The Eskom delegation comprised of Mr Jacob Moroga: Chief Executive, Mr Fani Zulu Executive Manager: Office of the Chief Executive, Ms Pravashini Govinder: Regulatory Manager and Mr Reagan Moodley: Senior Advisor: Financial Planning.

Mr Moroga undertook the briefing which identified the fundamental drivers that were present in the industry and explained Eskom’s 18% price increase as well as giving Eskom’s view on the pricing methodology developed by NERSA.

Mr Moroga said that from the mid 1970s through the 1980s there had been a massive buildup of 30 000 megawatts (MW) of electricity supply. However times had changed and there was no longer excess of supply as demand had drastically increased. The growth of the economy was a contributory factor to the increase in demand. On 22 May 2007 a record setting 36 000 MW had been consumed. Eskom’s reserve margin had steadily been decreasing from 25% in 2001 to between 8 and 10% in 2007. It aspired to have a reserve margin of 15%, which was considered the global benchmark. Eskom was working on a line of demand for the next 25 years. It anticipated a 2.3% electricity growth rate in relation to a 4% economic growth rate.

Eskom needed to boost electricity supply with an additional 25 000 MW to what it had originally thought to be adequate. Mr Moroga pointed out that in 2006 electricity growth had anticipated to be 2.4% whereas in reality it had been 4.9%. Eskom’s capital expenditure over a five-year period from 2007/8 – 2011/12 was expected to be R150 billion.

The Committee was given a breakdown of the percentage allocations to be made to electricity generation, transmission and distribution. The bulk of the expenditure was earmarked for electricity generation due to the reintroduction of mothballed stations and the introduction of new power stations. Specifics were provided on major generation and transmission projects.

Mr Moroga explained that Eskom’s funding strategy had two sources. Fifty percent of its funding came from retained earnings and fifty percent from debt originating from both domestic and foreign markets.

He emphasised that Demand Side Management (DSM) was critical in mitigating the tight reserve margin in the next few years. Eskom aimed to have a DSM target of 500 MW of savings of electricity per year over the next six years.

Mr Moroga stated that SA had the lowest prices for electricity in the world. Australia was the next cheapest. At present the price of electricity in real cents per KW per hour of usage (c/KW/h) was 18 cents. Eskom had a low cost base and the price should idealistically be 25 c/KW/h. He noted that gaps existed and that the price would be 35 c/KW/h if Eskom were to use market prices. Real price increases were not uncommon internationally. Brazil, Chile Ireland and Austria were some of the countries referred to. The aim was for Eskom to achieve a balance between affordability, industrial viability and internationally competitive prices. Mr Moroga concluded that the achievement of capacity expansion objectives was non-negotiable. He added that Eskom always had a long-term view of the industry and catered for economic growth increases. It however wished to maintain its position as the world’s lowest electricity cost producer.

National Energy Regulator of SA (NERSA) briefing
The NERSA delegation consisted of Mr Mmbulaheni Mashanyu: CEO, Mr Thembani Bukula: Regulator Member: Electricity, Mr Mbulelo Ncetezo: Executive Manager: Electricity Regulation, Mr Brian Sechotlho: Head of Department: Electricity Pricing and Tariffs, Ms Masesi Koto: Legal Advisory Services and Mr Nhlanhla Cebekhulu: Communication and Stakeholder Management.

Mr Bukula presented the Committee with a background on the policies and drivers that guided NERSA’s activities. He also introduced members to the Price Regulation Method by way of a formula. Eskom was allowed a rate of return of 11.76% and its efficiency gains had to at least be 2%. The Committee was given a breakdown of Eskom’s allowed revenues for 2006/7, 2007/8 and 2008/9 together with its percentage price increases. Mr Bukula graphically illustrated the historic and long-term price path for electricity per c/KW/h. The comparison ranged from 1950 up until 2055. The average price for the entire period was 23.2 c/KW/h. The Committee was also given a graphical representation of price curves under four scenarios and thereafter under two.

Mr Bukula noted that Eskom had lodged an application on the 30 April 2007 for an increase in primary energy costs, the acceleration of the capital expansion program, an increase in operating expenditure, the fast-tracking of the DSM program, changes to the Multi-Year Price Determination (MYPD) rules and that the effective date of the changes be 1 April 2008.

Mr Bukula explained that the project plan considering the application by Eskom had four stages. The first stage would be an analysis and evaluation of the application, the second would entail price modeling and recommendations, the third stage dealt with stakeholder consultation and the final stage would be the approval process by NERSA.

Discussion
Mr J Combrinck (ANC) commented that it seemed that NERSA regulated only Eskom. He added that many years back the price of electricity had been more than 20c/KW/h. He asked why the rich paid less for electricity than the poor. Mr Combrinck felt that the Regional Electricity Distributors (REDs) should be put into operation as soon as possible, saying that municipalities would continue to be profitable even with the REDs coming online.

Mr Bukula (NERSA) explained that there were different pricing structures for municipalities. NERSA supported the REDs. Work on the legislation and framework for REDs was being completed.

Mr W Spies (FFP) referred to the fact that two years from now Eskom’s new operations would come into effect at a higher cost to the public. Prices would therefore increase and so would the profit margin of Eskom. Given the fact that profits would increase how would this be translated into performance bonuses for the top management of Eskom. Would such bonuses be paid out given Eskom’s current performance?

Mr Moroga (Eskom) said that on the issue of executive remuneration and bonuses, there were requirements for transparency. International benchmarking took place on both, that is, remuneration and bonuses were compared with those on offer internationally. There were many considerations in determining whether bonuses would be paid. Technical performance, outages, skills, financial, safety and the environment issues were taken into consideration.

Ms N Mathibela (ANC) asked Eskom if another power station would be built in the Western Cape to add to the power supplied by Koeberg. Was it true that households were using more electricity than industry? She referred to the price comparison with Australia and asked if one could make such a comparison given that conditions differed so much from those of Australia.

Mr Moroga replied that in the early mornings and evenings, residential consumers featured more than their industry counterparts. However in terms of usage, industries did use more electricity than residences.

Mr E Lukas (IFP) noted the fact that in the past SA had had an excess of electricity capacity whereas now capacity was lacking. He asked what importance the dividend rate held. SA’s electricity price might be cheaper than that of Australia but the reality was that electricity was still too expensive in rural areas as unemployment was rife.

Mr Moroga replied that the dividend rate was an important aspect to consider in determining prices as well as for a company to remain creditworthy. Eskom was however exempted from paying dividends to government. Eskom could borrow money at lower rates if its credit rating was good. He agreed with Mr Bukula on the issue of the REDs and on the importance of a dividend rate. National Treasury did expect dividends to be paid but in light of Eskom’s huge capital expansion plan, Eskom felt it necessary to retain such dividends. Eskom was aware of the vulnerability of rural communities and this was taken into consideration.

Mr C Kekana (ANC) said that the Committee attempted to tie issues raised in meetings with broader issues that emerge from say for example the President’s State of the Nation Address. He referred to the shortage of electricity capacity and asked how long it would take to complete the two new power stations. What was being done about beneficiation in the industry? He asked if research had been done on what electricity consumption was overseas. He referred to the fact that SA earned carbon credits for controlling carbon emissions and asked whether heavy power stations were using better technologies to limit pollution.

Mr Moroga answered that the lead-time to build a power station was 7-10 years. He commented that carbon emissions were a worldwide issue of great importance. In Europe there was a cost attached to emissions. The more emissions you produce, the more you pay. More advanced equipment was being used in order to reduce emissions. Eskom was moving towards the use of non-emitting technologies. Nuclear and hydropower were the options available. Over the next 20 years, Eskom intended to generate 20 MW of nuclear power. Discussions with Southern African Development Community (SADC) countries were taking place to foster co-operation in the supply of power. SA had an abundance of coal but the need existed for other viable sources of energy as well.

The Chair pointed out that the issue raised was not about the diversification of the energy mix but rather about the emissions from coal.

Mr Moroga conceded that Eskom’s attempts on coal emissions were limited but it nevertheless did what it could. Eskom was trying to improve efficiency of power stations. Few options were however available.

Mr Spies reiterated concerns about the possible increase in profits of Eskom due to price increases, being used as an indicator to grant performance bonuses to executives. He asked for timeframes on nuclear power and hydropower projects. To what extent had the hydro projects and Koeberg 2 been quantified?

Mr Moroga reiterated that processes were in place to keep check on the allocation of bonuses.

Ms Mathibela said that not much had been said about basic charges. She asked why no comparison had been made with Australia on price increases.

Mr Moroga reacted that basic charges for non-prepaid users was a factor. Charges for residential and industrial were also issues to be looked at. However Eskom did charge industries for the access to available increased capacity even though it was not currently being used. Some of the basic admin charges related to service charges in relation to the reading of meters etc.

Mr M Matlala (ANC) asked whether Eskom had programs in place to avoid outages in preparation for the 2010 World Cup and beyond.

Mr Moroga said that the 2010 World Cup was a six-week event and that from a public relations point of view, Eskom had to cater for 45 million people over the next five years.
He noted that FIFA and Germany had been consulted on the issue. The requirement was that each stadium needed to be self-sufficient in terms of its power generation. It could not use the grid as its primary source of power. The grid was only to be used as a backup.

Mr Combrinck asked NERSA what was being done at present about municipalities charging 3-4 times more for electricity than Eskom. Noting that in the Northern Cape six new mines were being built, he asked if more electricity would be supplied to them. Mr Combrinck commented that not much had been said about the solar energy project in the Northern Cape.

Mr Moroga replied that it might not be apparent but work was being done in the Northern Cape. There were two programs on solar heating in place and a pilot project had been started on a solar power station capable of generating 100 MW of power.

Mr Lukas asked if SA had enough electricity to supply neighboring states.

Mr Moroga responded that dedicated contracts were in place with neighboring states. A Southern African Power pool was in place. Every four years SADC countries met in order to discuss changing power demands and how to assist each other in the sale of power.

Mr Louw asked how NERSA regulated municipalities at present. He also asked whether price increases were being monitored.

Mr Bukula responded that municipalities had executive authority over electricity regulation. NERSA presently had no legal grounds on which to regulate municipalities. Legislation had not empowered NERSA to regulate municipalities. He however stressed the point that NERSA did set guidelines for municipal tariff increases. In certain instances NERSA had allowed tariff increases, in others it had rejected proposed tariff increases. Ninety per cent of the municipalities that applied, did conform.

The Chair noted that it was evident from the briefing that challenges did exist. He pointed out that in certain instances Eskom’s planning had not been spot on. For example in 2006 Eskom had anticipated growth in electricity to be 2.4% when reality it had been 4.9%. The Chair disputed the claim about the cheapness of electricity in SA. Eskom had a fragmentation of tariffs between 19 and 71 cents. The fragmentation of tariffs was a sore point and greater transparency was needed. It was unrealistic to compare SA to Australia as the dynamics of the countries differed greatly. SA was sitting with massive unemployment and electricity was by no means cheap. The excess electricity of the 1980s was at a time when the majority of the previously disadvantaged had no access. When democracy arrived there was an urgency on the part of the new government to create access to electricity. The Chair concluded that there were fundamental issues that needed to be flagged.

Mr Moroga said that the concerns of the Committee were noted and that Eskom would avail itself to address these concerns.

Mr Bukula also noted the Committee’s concerns and added that information especially on the fragmentation of tariffs would be made available.

The meeting was adjourned.