South Africa: NERSA Makes Unaffordable Tariff Charges More Palatable

Last Updated: 12 March 2013
Article by Happy Masondo

On 28 February 2013 the National Energy Regulator of South Africa (NERSA) approved an 8% average increase per annum for the period from 1 April 2013 to 1 April 2014. During the period from 15 to 31 January 2013 NERSA convened public hearings as part of its procedural steps towards processing the Multi-Year Price Determination (MYPD3) application submitted by Eskom. In convening and presiding over these public hearings NERSA executes its duties under section 4 of the Electricity Regulation Act 4 of 2006 (Electricity Act). Section 4(a) (ii) of the Electricity Act enjoins NERSA to regulate prices and tariffs amongst other powers and duties of the NERSA.

In its oral presentation at one of the public hearings session Eskom reaffirmed "that it had received no indication in ongoing consultations with government of its willingness to inject further equity into the business, or extend further guarantees to assist Eskom in funding its large-scale capital expenditure."1

Following the approval of 8% by NERSA, Eskom has asserted that it will be difficult and challenging for Eskom to deliver on its mandate of keeping the lights on given determination by NERSA.

The NERSA public hearings were characterized by any and all persons, representatives of institutions, organized labour and all other interested parties were invited to make oral representations to NERSA on the MYPD3. In response to the submissions by Eskom, "many participants in the hearing argued that further government support was required, as the current emphasis on price increases could lead to business closures, job losses and social unrest."2 The Chamber of Mines (CoM), amongst others, in making its submissions "slammed state owned Eskom's proposed electricity price increase, saying it could result in further restructuring within South Africa's platinum and gold sectors."3 Experience has shown that "restructuring" is a euphemism for retrenchment and job losses.

Eskom is now caught between the proverbial rock and a hard place. In its application to the NERSA, Eskom in essence called for a paradigm shift with respect to the cost of energy and the appropriate recovery of such costs. Fundamental to the call for a complete change in how South Africans view the functions of the public utility, was that Eskom is a business with a profit motive and should therefore be in a position to run the operations and activities of Eskom like any other conventional business. It was, therefore, Eskom's contention that the historical manner in which Eskom has run its business of charging its tariffs below the cost it incurs in generation, transmission and distribution of electricity and the approach of business as usual is both unsustainable and untenable for Eskom.

On the other hand, consumers of electricity argued that the price hike of 16% would be unaffordable. It has to be accepted that it would be irrational and reckless for any South African to condone Eskom to continue to run an unsustainable business operation. However, the end users and consumers of the electricity generated, transmitted and distributed by Eskom must have a clear understanding of the principles used in setting the tariffs charged by Eskom. Through the MYPD3 application submitted to NERSA, Eskom explained the need for the total average electricity price increase of 16% per annum over a five (5) year period and motivated for the approval of the submitted application by NERSA.

In opposition to the proposed price increases most stakeholders contended that the approval of the price increase by NERSA would only spell disaster for most industries and business in general. According to the Managing Director of AEG Power Solutions, Trevor de Vries, "these additional increases would be the tipping point that will cause many local businesses to go under. Such sky high prices will most certainly also be a deterring factor that will prevent international companies from investing in South Africa."4

Nersa and the MYPD3

NERSA has made it clear that in reaching its decision to only approve an 8% price increase as opposed to the 16% applied for by Eskom. NERSA ensured that South Africans have full access to the NERSA processed. In addition, NERSA assured the South African public that through this process it promoted transparency and provided a full view into the process of tariff increases for electricity in South Africa. NERSA consistently encouraged all stakeholders and the members of the public in general to actively participate in the MYPD3 application process by submitting written comments, attendance at public hearings and making oral submissions at the public hearings.

Throughout the process of the public hearings the common and most repeated submission has been that the average increase of 16% per annum over a period of five (5) years is excessive and unaffordable. The profile of the public participants in the public hearings include amongst others an ordinary pensioner pleading for understanding and empathy that the 16% increase called for by Eskom far exceeds the affordability levels of her measly state pension of about R1050 per month. In a similar vein economists are arguing that Eskom's average electricity price increase application is excessive. NERSA obtained submissions and took all of them into account in determining whether the tariff hikes applied for by Eskom are justifiable and reasonable for approval.

Given the approval of 8% NERSA appears to have taken all submissions into account. According to Creamer "on just about every component of the revenue application, NERSA deviated from Eskom's requests-in some instances materially.5 NERSA indicated that it considered submissions ranging from Eskom's weighted average cost of capital, its regulatory asset base, primary energy costs, purchases from independent power producers, integrated demand management, economic, impacts, operating expenditure and tariff restructuring.

Eskom says increases are necessary

Eskom asserted that historically and currently electricity in South Africa has been and continues to be charged at below costreflective levels. Eskom stated such below cost reflective tariffs and charges were sustainable for the electricity industry, for the economy and for South Africans in general. Accordingly, Eskom applied for an average increase of 16% for each of the five (5) years of the MYPD36. In Part 1 of the MYPD3 (entitled Revenue Application), Eskom stated that the tariff increases spanning a period of five (5) years, applied for were necessary to achieve the following –

  • a gradual and predictable price path for households, businesses, investors and the country as a whole;
  • correction of the historical and current below cost-reflective levels which are not sustainable in the long run;
  • minimising economic distortions caused by the subsidisation of all consumers of electricity; and
  • transition to cost-reflective levels to support a sustainable electricity industry with sufficient resources to maintain operations, build new generating capacity and guarantee future security of supply.

Over and above the need to apply electricity prices or tariffs that are at cost-reflective levels, Eskom sought to be in a position to recover its costs and to make a reasonable return as contemplated in section 16(1) of the Electricity Act. Section 16 of the Electricity Act sets out the principles underlying the methodology in which a licensee such as Eskom is entitled to set tariffs to be approved by NERSA and to be charged to end users for the consumed electricity. Provided that Eskom carries out its licensed activities in an efficient manner, particularly in relation to the technical and economic delivery of services to end users of electricity, Eskom is entitled to reasonable and justifiable tariff increases.

Eskom has to demonstrate to NERSA that the MYPD3 application is justifiable and based on costs that are efficiently incurred.

The effect of the provisions of section 16(1) (a) of the Electricity Act is that, in setting its prices, charges, tariffs and the regulation of revenues, Eskom has to be enabled to recover its full cost of its activities, including a reasonable margin or return.7 On the face of it all that Eskom was asking NERSA to approve, was for Eskom to function and operate as any other conventional business enterprise with a profit motive. Eskom's argument was that "cost-reflective prices represent the true cost of generating, transmitting and distributing electricity".8 In essence the revenue request was said to consist of four (4) components –

  • primary energy costs;
  • operational costs;
  • depreciation; and
  • return on assets (both calculated using depreciated replacement value).

Following the approval of the 8% increase, NERSA maintains that it has based it determination on reason, facts and evidence and that the 8% tariff increase would not run Eskom into the ground. "Instead, it would ensure that the utility was efficient, effective and sustainable."9

Unjustifiably high increases

NERSA had its work cut out for it in reviewing all submissions made at the public hearings as well as the written submissions. In particular, NERSA was in fact required to take into account the repeated submissions made to the effect that Eskom's MYPD3 application was flawed in the calculation of the costs and the methodology adopted in reaching 16% as an appropriate average increase. According to some economists and industry experts "Eskom's price increase request of 16% per year for the next five (5) years was not justified...Eskom was demanding an exceptionally and unnecessarily high real return on the capital it had invested. By extension its pricing application was excessive."10

Contrary to the 16% average increase proposed by Eskom, industry experts such as the Energy Intensive User Group (EIUG) suggested that an 11% annual increase over the five (5) year period is sufficient to sustain Eskom and its operations. The EIUG NERSA approval means that the has done better than the 11% they has suggested. The general view amongst industry experts was that Eskom has applied for much higher returns on equity than any other utilities in the world. According to Donnelly: "Globally, utilities only derived returns on equity of 4% far below the 7.8% currently granted to Eskom."11 "In addition, other experts have questioned Eskom's calculations of the returns Eskom requires, the increases in the depreciation costs and the methodology used to determine such depreciation costs. Other commentators have stated that South African's electricity prices had rocketed by more than 17090 over the past five years, while administered electricity prices in other Brics (Brazil, Russia, India, China, South Africa) countries had decreased by more than 30% in the past decade. With the current 8% approved increase NERSA has ensured that "the lower than expected increase is good news for households and for the country's inflation outlook."12

It was be difficult for NERSA to approve the MYPD3 application while industry experts and economists alike were arguing that the methodology used by Eskom in reaching the proposed 16% increase was fundamentally flawed. It would appear that Eskom sought to have the double digit increases and "returns that would give it a standalone investmentgrade credit rating to allow it to secure enough funding to complete its second power station, Kusile and to ensure that it will be able to fund the building of new capacity after that..."13 The higher than inflation electricity price increase over a five (5) year period "could have made power in South Africa one of the most expensive in the world."14

Ironically, industry experts have pointed out that for a considerable period of time South Africa's electricity costs were always been the lowest in the world and in fact South Africa "was marketed as a good place to come to do business for investors because of its cheap electricity..."15 Most analysts and experts are now of the view that electricity has become an unaffordable source of energy and ArcellorMittal South Africa had already shut down its electric arc furnaces in Vanderbijlpark in 2012 because of rising electricity costs. A similar warning was issued by the Steel and Engineering Industries Federation of South Africa (SEIFSA) that "rising prices were placing sustainability pressures on metals and engineering firms, which were highly exposed to foreign competition.16 In its approval of the 8% increase NERSA pointed out that it had taken into account, amongst other factors, the fact that Eskom's request had come amid continuing global economic slowdown.

Conclusion

It would be a deviation from the tariff principles set out in the Electricity Act for NERSA to disregard submissions made to the effect that the methodology used by Eskom to calculate the return on investment was not only excessively high but it was in fact the highest the world over. In addition, the calculation of the depreciation had also inflated Eskom's expenses. The financial dire straits in which Eskom finds itself with its build programme and its need to obtain a standalone investment-grade credit rating should not be allowed to obfuscate the real cost-reflective charges.

The prevailing view amongst most stakeholders and industry experts who made their submissions to NERSA, was that a 16% tariff increase over a period of five (5) years was excessively high. Eskom had also submitted that it was well "aware that the price increases could negatively affect business but said its application sought to strike a balance between the needs of the economy and poor consumers and Eskom's sustainability requirements".17 With the fate of South Africans left in the hands of NERSA, the National Energy Regulator has allowed the principles of efficiency and sustainability to prevail, while taking into account the plight of civil society, business, labour unions, political parties and the general South African public.

Footnotes

1. Creamer T, "No more government support in the offing-Eskom" Creamer Media's Engineering News Online, 30 January 2013.

2. "Solar power solutions could lighten business burden in SA", www.esi-africa.com, 6 February 2013.

3. Odendaal N; "Proposed electricity price increase could result in more restructuring," Creamer Media's Weekly Online 31 January 2013.

4. See footnote 2 above.

5. C reamer Terence: "NERSA grants Eskom yearly increase of 8% between 2013 and 2018," Creamer Media's Mining Weekly Online, 28 February 2013.

6. Part 1 Revenue Application: Multi-Year Price Determination 2013/14 to 2017/18, MYPD3 17 October 2012, p5.

7 Supra, p6.

8. Supra, p49.

9. See footnote 5 above.

10. Antonio Ruffini, "Eskom MYPD3 16% price increase request not justified," www.esi-africa.com, 21 January 2013.

11. Lynley Donnelly; "Eskom's proposed tariff hikes face barrage of criticism", Mail & Guardian Business, January 18 to 24, 2013.

12. Allan Secombe; "NERSA grants 8% annual increases over the next five years,"www.bdlive.co.za, 28/02/2013

13. See footnote 11 above.

14. Ibid.

15. bid.

16. See footnote 1 above.

17. Ibid.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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