Reasons for decision on Eskom’s Revenue Application: NERSA briefing, with Deputy Minister

Reasons for decision on Eskom’s Revenue Application: NERSA briefing, with Deputy Minister

13 March 2018

Chairperson: Mr F Majola (ANC)

Audio:

Meeting Summary

The National energy Regulator of South Africa briefed the Committee on the reasons for its decisions in relation to Eskom’s Revenue Application for 2018/19. The meeting was attended by the Deputy Minister of Energy.

The Regulator reported that it normally approved prices for a 5 year period and as the current period had expired, a new 5 year term was now due. Eskom had however approached Nersa to advise that it would only apply for one year period - 2018/19, citing uncertainty about government policy on the IRP and the IEPand other issues like the introduction of new IPP ’s. Until these were finalised Eskom could not model the impact on its financial requirements.

Eskom’s application to Nersa was for a 19.9% increase in its revenue. Nersa’s decision was to award Eskom an increase of 5.23%. The lower return was mainly due to a R29.1bn reduction in allowable costs and a lower than expected sales revenue forecast. The new total price now allowed by Nersa amounted to 93.79 cents per kilo watt hour (c/kWh). A key factor of the new environment within which Eskom operated was that of reduced demand (i.e. lower sales volumes) which higher tariffs would exacerbate.

Nersa was of the opinion that Eskom needed to control its costs better. Over the past four years (2013/14 to 2016/17) Eskom had been unable to recover the revenue allowed by Nersa approvals - on average there was a 10% under recovery per annum. One of the biggest concerns identified by Nersa was Eskom’s cost overruns on capital expenditure despite reduced income from sales revenues.

In order for Eskom to address the concerns regarding its revenue requirements, Nersa proposed some important challenges Eskom had to address urgently to bring things on even keel - namely:

That it had perpetually failed to collect its allowed revenues, whilst at the same time it had exceeded the expenses allowed by the regulator
Increased tariffs had resulted in decreased consumption of electricity. This could be attributed (amongst others) to customers reaching affordability levels in the current depressed and stagnant economy
In order for Eskom to break this vicious cycle (as outlined above), Eskom needed to reduce its costs (including its fixed cost base). This would reduce the revenue required to run its operations. At the same time it had to grow its sales volumes. The overall outcome of this meant that it would require smaller tariff increases going forward that should result in it attracting additional sales volumes. This incremental sales volumes would then require smaller tariff increases in the future as well.

Important discussion points raised by Members were related to concerns on what the lower than tariff increase would have on Eskom operations, the lack of proper costs controls at Eskom and the associated mismanagement and corruption and how Nersa approved tariffs would address these. Other concerns raised were on the Public Participation Process (PPP) Nersa conducted to engage stakeholders, when the IRP would be finalised as it was holding up tariff proceedings. The other aspect raised was in which government department Eskom should reside - Department of Energy (DOE) or Department of public Enterprise (DPE).

Meeting report

Opening Remarks
The Chairperson welcomed all to the meeting especially the Deputy Minister of Energy. He asked Committee members to stick to the agenda and not to stray to other issues (pertaining to Eskom). The Committee planned to invite Eskom to address them in due course, where other matter could be raised with them. He asked if the Deputy Minister had any opening comments to make.

Ms Thembisile Majola, Deputy Minister of Energy, apologised for not attending the previous Committee meeting. She explained that the reason that this presentation was not shared with the Committee earlier was due to the delay in processing and finalising Eskom’s revenue application that was received late by Nersa.

Mr M Matlala (ANC) asked if he could brief the Committee on a serious matter. He said it was not on the agenda but he felt the issue had to be raised, given the seriousness of the issue.

He said he was “attacked” by Eskom’s Parliamentary Liaison Officer after the previous week’s committee meeting. He was verbally abused by the individual. He was not sure about the identity of the person. The “assault” on him was unfair as he was only doing his work as a parliamentarian. According to him, this individual had also insulted other parliamentarians before, and he felt that it was about time that some action be taken against him. He felt the individual had to be banned from Parliament and that the Speaker had to be informed about the incident.

The Chairperson asked for comments from other members on the issue.

Ms Z Faku (ANC) proposed that Mr Matlala formally write to the Chairperson about his complaint and that the Chairperson could then take the appropriate action to address the issue.

Mr R Mavunda (ANC) supported the approach as outlined by Ms Faku.

The Chairperson said the matter would be attended to urgently as speaking to Members of Parliament in such a manner as outlined by Mr Matlala, was unparliamentary.

Briefing by National Energy Regulator of South Africa (Nersa)
Mr Muzi Mkhize, Petroleum Pipelines Regulator, Nersa, briefed the Committee on the Eskom Revenue Application. He introduced the rest of the Nersa team that would be supporting him - the CEO, Mr Chris Forlee and the HoD of Electricity Pricing and Tariffs, Mr Brian Sechotlho.

He said the enabling legislation used by Nersa to evaluate the application was the National Energy Regulator Act of 2004 (NERA), the Electricity Regulation Act of 2006 (ERA), Government’s policy on Electricity Pricing of 2008 (EPP) and the Integrated Resource Plan of 2011 (IRP). Another key legislative tool was the Electricity Regulations on New Generation Capacity as at May 2011.

He highlighted some of the key aspects of the ERA - namely the setting of tariffs and price structures that were efficient, sustainable and facilitated investment in the sector and provided universal electricity access. An important issue was that cross-subsidisation of tariffs were allowed between certain classes of customers (e.g. subsidies for the poor).

He said that Nersa normally approved prices for a 5 year period and as the current period had expired a new 5 year term was now due. Eskom had however approached Nersa and advised that it would only apply for a one year period - 2018/19, citing uncertainty regarding government policy on the IRP and the IEP (Integrated Energy Plan). Both these were in the process of being updated and would obviously affect Eskom’s operations. Other new developments like the imminent introduction IPP’s also had to be factored in.

The basic formula used to determine Eskom’s allowed revenue for an adequate return on its asset base was:

AR = E + (V-d+w)r + RCA.

AR = allowed revenue
E = expenses
V = value of qualifying property, plant and equipment (its regulatory asset base)
d = accumulated depreciation on qualifying property, plant and equipment
w = allowance for working capital
r = rate of return allowed using WACC (weighted average cost of capital)
RCA = regulatory clearing account.

RCA was an important mechanism that allowed a claw back mechanism (if the allowable revenue was inadequate due to changes in the environment on which the return was based). Alternatively, there could also be a situation where too much revenue was recouped and then the return had to be adjusted for that (i.e reduced). The RCA had indicated a claw back of around R66bn required by Eskom that will have to be considered in due course (finalisation targeted for June to August 2018).

Eskom’s application to Nersa was for a 19.9% increase in its revenue. Nersa’s decision was to award Eskom an increase of 5.23%. The lower return was due to a R29.1bn reduction in allowable costs and a lower than expected sales revenue forecast. An important issue was that increased prices resulted in reduced demand that impacted negatively on sales revenues. This reduced electricity sales volumes attributable to increased prices had been widening since steadily since the 2012/13 period and is currently at its widest.

The new total price allowed by Nersa amounted to 93.79 cents per kilo watt hour (c/kWh).

Mr Mkhize highlighted some of the other key issues in respect of Eskom’s application as dealt with by Nersa, i.e:
-OCGT (open cycle gas turbines) were removed from cost base as it was not operational currently
-IPP (Independent Power Producers) removed from cost base as it was not operational as yet.
-Primary energy costs from two coal fired power stations (Arnot and Hendrina) were removed as these were not operational due to refurbishments and/or mothballed due to surplus capacity.
-Some take or pay coal contracts were excluded as these decreased operational efficiency and were only enacted when and if required.
-A major downward adjustment of about R11bn was made on Eskom’s employee costs as Nersa was of the opinion that Eskom needed to control its costs better.
-Over the past four years (2013/14 to 2016/17) Eskom had been unable to recover the revenue allowed by Nersa approvals (on average there was a 10% under recovery per annum).
-One of the biggest concerns identified by Nersa was Eskom’s cost overruns on capital expenditure, despite reduced income from sales revenues. In the 2014/15 period the cost overrun was 21%, in the 2015/16 period it was 35% and in 2016/17 the cost overrun was 26% against approved values.

Nersa highlighted five issues to address Eskom’s current woes in terms of its revenue requirements.

-That the valuation of RCA’s had to be processed speedily.
-That the efficient and effective regulation of the electrify power generation industry did not just affect Eskom, but also others like the new IPP’s.
-Eskom had perpetually failed to collect the allowed revenues, whilst at the same time it had exceeded the expenses allowed by the regulator.
-Increased tariffs had resulted in decreased consumption of electricity. This could be attributed (amongst others) to customers reaching affordability levels in the current depressed and stagnant economic environment.
-In order for Eskom to break this vicious cycle (as outlined in bullet point 4 above), it needed to reduce its costs (including its fixed cost base). This would reduce the revenue required to run its operations. At the same time it had to grow its sales volumes. The overall outcome of this would mean smaller tariff increases going forward that should result in it attracting additional sales volumes. This incremental sales volumes would then require smaller tariff increases in the future as well.

Discussion
The Chairperson commented that the initial introduction of the Nersa delegation was not very clear and he asked Mr Mkhize to re-introduce attendees. He also asked that rather than having only males presenting the Nersa briefing if some of the females present could also participate.

He was concerned about how the very difficult message to break the vicious cycle as identified (higher tariffs that lead to reduced demand and hence pressure on revenues) from the Regulator to Eskom would be implemented - who would be responsible for its implementation.

Ms Faku asked how the decision by the Regulator to grant Eskom a lower than requested tariff increase would impact Eskom. She understood the reason etc. but was concerned on how it would affect Eskom.

Mr J Esterhuizen (IFP) made numerous comments about his concerns regarding Eskom and the role played by Nersa and other state agencies in its operations. He queried Nersa’s role and why it was actually here (at the Committee). He said Nersa had to ensure that monopolies were effectively regulated for the public good. Some of the things going on at Eskom was not good - he cited a report that Eskom was grossly overstaffed, it had 41 800 workers while only about 14 200 was actually needed. He wanted to know how Eskom’s staffing levels compared to other similar organisations. He said Eskom’s management had done irreparable damage to the country and wanted to know on what basis Nersa had calculated Eskom’s price requirements within the current environment of corruption and mismanagement.

He said Eskom had to find new ways to fund its costs. Eskom had even borrowed from the state pension fund and this has had a negative impact on the value and returns of the fund. He further wanted to know why Nersa did not provide better protection for Eskom which now owes government around R460bn. This was very scary and he wanted how this was allowed to happen. He wanted to know what Nersa’s view was on IPP’s, specifically the feed-in tariffs. He said the IPP programme was a good example of good governance implemented by government but that it was now being held hostage by trade unions.

He said the government bail outs to Eskom was no longer affordable - it was the biggest spender of government money AND the biggest waster of “our” money! He said the IFP could not accept this and would not support any increases to Eskom.

Mr G Davis (DA) commended Nersa for its strong stance against Eskom and the award of the lower increase vs. the much higher request. He wanted to know what the latest situation was regarding Eskom’s possible challenge to Nersa’s lower increase decision. He supported the notion that Eskom had to reduce its costs but wanted to know what Nersa’s recommendations were on what Eskom should and could do to reduce its cost base. He further wanted to know if Nersa knew the reason why Eskom’s view on electricity prices were that it was inelastic as opposed to Nersa’s view that it was elastic (although not part of this briefing by Nersa, it was contained in a separate report to the Committee). He wanted to know if Nersa had any view on when the updated IRP would be available. He said the IRP was holding up the 5 year price determination mechanism for Eskom.

Mr Davis asked if Nersa had calculated the cost of corruption at Eskom and what savings were possible going forward if this were taken into account. In addition, he wanted to know why some of the slides were removed from the slide pack presented to the Committee today vs. the slide pack mailed to the Committee earlier. What the reason(s) for this removal and who authorised it?

Ms T Gqada (DA) wanted more information the RCA and the amount if R66bn Eskom wanted to claim. She wanted to know why nothing was done on it for the last three years and why the issue was only raised by Eskom at this stage. She also wanted to know what the impact was for Eskom in respect of the lower tariff increase approved by Nersa.

Ms Gqada said the presentation depicting the price elements and percentages separately was confusing and that it would be better to show it one slide. Other concerns she had were as follows - what measures were in place at Eskom to conserve water, what were the suggestions from Nersa to Eskom to improve its cost controls and lastly what were the solutions advanced by Nersa that would enable Eskom to address the broad range of problems as identified?

Mr R Mavunda (ANC) wanted clarity from Nersa that the public participation process (PPP) on the Eskom Tariffs were adequate. He wanted to know if this only involved businesses and organisations or also individuals. He was especially concerned that some people in rural areas did not have access to these forums. He wanted to know if the time allocated to the PPP was sufficient. He asked if the public consultation period between 30 October to 20 November was enough and if the period leading up to 15 December for Nersa to arrive at its decision was adequate in terms of reaching a fair conclusion on the Eskom application and the input from the public.

He was also concerned that Eskom indicated it was still studying the decision by the regulator. He wanted to know if Nersa was not perhaps too hasty in its release of its decision given that Eskom may want to appeal it.

Mr Matlala thanked the Deputy Minister for being present. He wanted to know if tariffs had increased already. Communities were up in arms because of high electricity prices. At stake was the relationship between Nersa and Eskom. The latter was blaming Nersa for its woes. He reminded Nersa that some of the questions being asked today were not new and had been posed at them in the past.

Mr Matlala commented that the current presentation was very technical and not easy to follow. He said a key problem was the nature of the relationship between Nersa (in DOE stable) and Eskom (in DPE - Department of Public Enterprise). If these entities were in the same Department it would result in much better control and management of the issues at hand. This was a political issue that had to be resolved. He said there was a lack of service delivery by Eskom in rural areas (like the constituency he represents) and to him it seemed as if urban areas like Sandton appeared to getter to a better level of service.

The Chairperson said he understood the issue raised by Mr Matlala on Eskom and where it should reside - however the President had indicated that a review of SOE’s (State Owned Entities) would be done so a solution to the Eskom problem was on the cards. He agreed that there was a structural problem within government that hampered the effective solution of problems. Reorganisation of the state was needed to address the problem.

He said he understood that issues like the IRP, renewables projects in the pipeline, RCA’s and others were at play, but wanted Nersa to explain the logic on why a tariff increase for only one year as opposed to the 5 year plan was requested by Eskom.

The Chairperson said he was concerned that a lasting solution had to be found for Eskom going forward and that the problems and issues identified by Nersa would be addressed. He said some of the issues and queries raised regarding Eskom was best answered in another forum when the latter was present.

Mr Mkhize said he would address some of the queries and his colleagues would respond on others.

He replied that Nersa regulated entities in terms of what is prescribed by the Executive , i.e. legislation and policies that governed its operations as well as government frameworks (Nersa, DOE, Department of Public Enterprises, Eskom and National Treasury etc.). The tariffs charged by Eskom affected everyone and flowed through the whole economy.

Nersa received 23 000 public submissions on the tariff application. Each of its public engagement sessions were open to everyone so that a broad spectrum of stakeholders could raise their views on the matter. All nine provinces were visited as part of the PPP. However there was always room for improvement

Mr Mkhize said amongst the reasons Eskom advanced for only applying for a tariff increase for one year (2018/19) was because of some uncertainties in government policy that would impact its operations - some of these were - finalising the new IRP, new IPP’s coming on stream and the nuclear build programme.

Regarding lack of service in rural areas he said the issue was not as clear as just blaming Eskom - Eskom sold electricity to municipalities who on-sold power to its own customers. Municipalities maintained their own infrastructure.

He said the issue of having enough/not enough time to conclude the tariff application review and associated processes was not always easy to manage but he felt that the time allowed was adequate to enable Nersa to reach a credible decision. Being given more time may not mean a better result or the improvements in the result may not be significant enough, to justify the additional time.

According to Mr Mkhize, Nersa did not have any concrete responses or information that Eskom may want to challenge its findings. All views thus far were based on hearsay.

He admitted that the presentation was a bit technical. The reason why some slides were excluded from the current presentation (vs. what was emailed to members earlier) was because Nersa felt these did not add any value to the decision on the new tariff decision for Eskom, and was merely included (initially) to give some perspective of costs with/without renewables. He agreed that as South Africa was a “water poor” country, water usage was critical. Steam generation required water and Nersa ensured that water usage for power generation was within industry norms.

Mr Mkhize said that Nersa had engaged other departments - DPE and NT and DOE - on the efficiency of Eskom. Nersa was not pointing fingers, but merely indicating that cost overruns and other business efficiencies needed to be improved at Eskom. Nersa regulated for a balanced approach, fair returns in the interest of both the general public and for Eskom’s viability, not for its demise. He said a more comprehensive report on the Nersa decisions regarding the Eskom tariff application was available in the Reasons for Decisions (RFD) in Nersa's official report on the application.

In response to the query raised by Mr Esterhuizen on staffng, he advised that Nersa’s approach was a balanced one - staff numbers could not be changed overnight, those tend to occur gradually until the balance was right.

Mr Mkhize said people had a right to challenge (tariff) decisions made by Nersa.

Mr Chris Forlee, CEO, Nersa, said the Nersa RFD document contained all the necessary detail on the reasons and rationale behind Nersa’s decision to only approve the 5.23% vs. the 19.9% requested by Eskom. This level of detail (regarding a decision by Nersa on tariff applications) was unprecedented given the current status at Eskom. He said Nersa had provided a road map to Eskom that would address the current challenges. Some of these recommendations were:

cost reduction measures
improved asset efficiency (e.g. remove Hendrina and Arnot from asset base)
to maximise the use of power stations with lower running costs
use of cheaper coal (vs. more expensive coal)
creation of a Regulatory Efficiency Benchmark (to counter corruption and mismanagement) to aid tariff setting.
According to a World bank study, Eskom had three times more staff than was required. There was therefore a need to increase efficiencies and reduce costs.
A suggestion that an additional R72bn required to fund operations would not be recouped from customers but from other means - e.g. from shareholders or loans.

Mr Forlee said he removed the additional slides from the current slide pack as it added no value to the tariff application debate. Nersa had taken cognisance of the comments on the PPP and would have to take these on board and plan for a more inclusive approach on PPP’s in the future.

Regarding the impact on Eskom of the lower tariff decision, he said that Eskom had to re-look at its cost base and operational activities and improve these. A key aspect was to increase its efficiencies at all levels. Sales volumes were down, so its capital expenditure programme had to be adjusted in line with that.

Mr Brian Sechotlho, HoD: Electricity Pricing and Tariffs, Nersa, said Nersa’s rationale for electricity price elasticity was based on the current market environment where customers had options to use IPP’s, large solar power installations and others like roof top solar. Eskom’s argument that electricity pricing was inelastic was based on outdated information of four years ago, when these were not that prevalent.

On the implications for Eskom regarding the lower tariff increase, he made the following comments, in respect of some of the assessment ratios used by ratings agencies - namely:
Free Cash Flow - if Eskom implemented the efficiencies and necessary changes as suggested, it would have a free cash flow of about R32bn. This was very healthy.
Debt Service - this would improve to above 1.05, which meant that Eskom wold be able to service all its debt and loans
Interest Cover - this would improve to 1.37 and effect would be the same as for debt cover.

So the overall result was a much healthier financial situation at Eskom.

Mr Forlee said that Nersa had only approved the tariff increase for one year until 2019. From 2020 onwards Nersa would revert back to the 5 year tariff approval period and this had been communicated to Eskom.

The Chairperson said the issue surrounding Eskom and this tariff application had to be seen in the larger context. This could be seen in the unprecedented decision taken by Nersa to provide such detailed explanations in its RFD. He said the Eskom issue had to be dealt with in its totality and not just in isolation e.g. approving of tariffs.

Mr Esterhuizen was still concerned about Eskom’s high cost base - he said the Eskom Chairperson had a different view to that of Nersa. He wanted to know how customers such as BHP Billiton and Saldanha could negotiate such favourable tariffs as opposed to Eskom’s municipal customers whose price was much higher. He said the information on the slides that were removed from the presentation pack was not correct and he would have challenged it.

The Deputy Minister said “her understanding” of the favourable tariffs for BHP Billiton, was the result of an old contract that was negotiated during the late 1980’s when Eskom had substantial excess capacity and during a period of sustained low demand, hence the very favourable rate. These contracts were signed by the previous government of the day at that time. The new ANC led government had honoured those agreements even though it played no part in the previous pre-1994 government structures. Some of these contracts had expired but some still remained in place.

Regarding the issue of where Eskom should reside - in DOE or DPE - she said that this was a political question and that it would be addressed in due course. She did mention that taking on Eskom’s debt of around R300bn was not a prospect everyone looked forward to.

Mr Davis responded that Eskom’s view on electricity price inelasticity was very arrogant to think it could just pass on its increases to consumers. He wanted to know if Nersa knew why Eskom would use outdated 4 year old information for its price inelasticity argument - was it incompetence or a lack of information? He was not convinced that the information Nersa used on the slides omitted from the presentation was incorrect, specifically for old and new coal power generation. He wanted to know how nuclear energy would affect these costs.

Mr Davis further asked about the Road Map Nersa provided Eskom to bring its business back on even keel - he wanted to know what options were available to Nersa if Eskom did not adhere to the Road Map, would there be another bail out for this inefficient state utility?

He also asked if competition in the power sector would drive down costs and improve efficiency - perhaps it was time, he said, to open up the sector to other IPP’s.

Mr Davis asked the Deputy Minister if she was concerned about Eskom’s debt spiral and what the plans were to reduce the debt.

Mr Mavunda said he was not satisfied with Nersa response on PPP. He wanted more information on the methodology to ensure all views were heard. Which municipalities and regions were visited and if there were any consultations with deep rural constituencies.

The Chairperson commented that Nersa had already responded to the issue raised by Mr Mavunda and is aware of the concerns raised.

Mr Mkhize said that price elasticity was not available to all - only those who could afford other options could use alternatives whilst the poorer communities had very little room to manoeuvre and could not switch easily. He said Nersa had taken note of the concerns raised by Mr Mavunda and that those views would be taken on board. Eskom had a Board that was duty bound to ensure good governance. The Road Map for Eskom had been given to the Board who would have to ensure it was implemented to ensure operational activities were aligned to achieve proposed outcomes.

Mr Sechotlho said in his view, Eskom did not update its records on the changing power generation environment that now reflected a greater level of competition that favoured price elasticity more than in the past. He indicated that he was of the view that private sector involvement in the power generation sector would lead to efficiencies, particularly private-public partnerships.

Mr Forlee said that nuclear was factored into current tariffs, e.g. some costs at Koeberg nuclear plant were disallowed. These were related to storage costs.

The Deputy Minister said that monopolies existed inside and outside of governments and that it required different approaches to deal with it. The issue around the Eskom monopoly on electricity supply for SA had to be dealt differently as it supplied all the country’s electricity needs. Actions to redress operational problems at Eskom would have a major effect on the country as a whole.

She said Eskom could be called to the Committee to give account, as well as further engagements with DOE and DPE - but in essence the buck stopped with the shareholder, i.e. government.

She said price elasticity depended on options available to all, not just those who could afford it.

Regarding improving Nersa’s PPP in regions, she said that perhaps it was time to think of regional representations for Nersa in the provinces. She said that the oversight on power generation activities should not just confined to Eskom but had to include IPP’s so that a complete overview of the industry was in place.

She admitted that DOE was constrained regarding actions it could take to address concerns it had about Eskom as the latter reported into DPE.

The Chairperson asked the Deputy Minister to respond on the status of the IRP.

The Deputy Minister advised that the new Minister of Energy, Mr Jeff Radebe had asked the Department to reprocess the IRP to address the concerns raised by Cabinet.

The Chairperson said that a different way had to be found to conduct effective oversight and to ensure that important issues such as the issues raised by the Committee that emanated from agenda items on Eskom’s revenue requirements were addressed and resolved effectively and efficiently instead of the current impasse.

The meeting was adjourned.