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					                            POSITION PAPER

                         2007 ENERGY SUMMIT


Theme: “Energy Security for Sustainable and Shared Economic Growth for All”

                        25th - 27th September 2007


       Cost Reflective Tariff in the Electricity Sector

    Sector and Sub-Sector: Energy Sector (Electricity)

          Electricity Policy Analysis and Regulation Directorate
                            Matthews Bantsijang
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                                Definitions and Abbreviations

  EDI: Electricity Distribution Industry

  ESI: Electricity Supply Industry

  EWP: White Paper on Energy Policy

  IPP: Independent Power Producer.

  NERSA: National Energy Regulator of South Africa.

  RED: Regional Electricity Distributor.

  TOU: Time of use

  WEPS: Wholesale Electricity Pricing System.

Levy:       The over-recovery of revenue, in excess of the cost of supply, in order to generate funds
            to be applied to other customers and services. Levies can be transparent and quantified,
            or hidden and embedded within tariff rates. (NERSA definition: Is the positive
            difference between the real cost of supply and the actual price paid excluding any

Subsidy: The application of funds generated from levies, to ensure that other customers and
            services can be charged below cost. (NERSA definition: Is the negative difference
            between the real cost of supply and the actual price paid excluding any tax).

Cross-subsidisation: refers to the over-recovery of revenue from some customers, relative to cost of
            supply and the simultaneous under-recovery of revenue from other customers, relative to

            Cross-subsidisation tariff balancing process where the actual cost of electricity supply
            to one class of consumers is subsidised by another class of consumers of the same
            commodity. It can also occur across commodities.

Retail Electricity Pricing (REP): is the transfer price at which distributors, bulk purchasers and
            redistributes can sell electricity to end consumers.

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 Transparency: mean an explicit reflection of all cost that build up a tariff for example levies,
            cross subsidizes, etc.

 Cost-reflectivity: means the pricing method aimed at the full recovery economic cost of supplying
             electricity to a customer.

 Base-load demand: is the regular, consistent electrical demand required at any time of the day/
             night. The lowest point on the load demand curve.” Base load demand”: refers to a
             relatively continuous level of electricity demand.

                   Base-load unit refers to a power generator that is committed to meeting this
                    continuous level of demand.

                   Working in conjunction with base load units are intermediate units, which are
                    flexible enough to follow seasonal and daily changes in demand, and

                    Peaking units, are units employed to meet spikes in demand, such as when
                    everyone turns on their air conditioners on hot summer afternoons. Utility
                    companies employ generators as base load, intermediate, or peaking depending
                    upon their costs, with the least expensive units running first to cover base load
                    demand and the most expensive running last to cover peaking demand.

                   This ranking of generating units by cost is called the dispatch order and is the
                    central concept behind the economics of electricity supply.)

Peak demand/ lopping: This is the process where generation is required for short periods of time to
             meet the demands of the peaks in load.
Mid merit demand”: This is the cut off point of generation that separate base load demand and peak
Surcharge or revenue neutral levy: refers to charges imposed to compensate a supplier for a short-
             term loss of revenue due to changes in tariff structure.

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              Cost Reflective Tariff in the Electricity Sector

   Policy Statement

This proposed policy framework recognizes the characteristics of electricity generation, viz.
base load, mid merit and peak demand and the implication for consumer classes to be
charged cost reflective tariffs based on time-of-use principle. At the same time, the White
Paper on Energy Policy (EWP) recognizes the social responsibility of different spheres of
government to assist the domestic sector and therefore allows the NERSA to regulate
domestic electricity tariffs through a suite of supply options combined with capacity
differentiated tariffs and connection fees for various consumer classes.

In line with the EWP to address these challenges, electricity pricing policy, to be implemented
by the Regulator, will be informed by the following approach.

              Price signals should result in economically optimal investments in electricity
               infrastructure and consumption of electrical energy. Government is of the view
               that this will generally be achieved through the use of cost-based electricity tariffs
               which include capital replacement costs (long-run marginal costs).
              The level of electricity prices should essentially be determined by the utility’s
               revenue requirements, while the tariff structure should be determined by the
               structure of costs.
              Recognising that many households are presently unable to afford cost based
               tariffs; government acknowledges that moderately subsidised tariffs for poor
               domestic consumers are necessary for equity reasons.
              To limit possible negative impacts and ensure effective political accountability
               subsidies should, as far as possible, be transparent to the public.
              Cross-subsidies should have a minimal impact on the price of electricity to
               consumers in the productive sector of the economy.

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          a.   Various cross subsidies in the Electricity Industry

It is well known that retail tariffs (those of Eskom and municipalities) are not cost-reflective.
The types of levies to be raised (and the level thereof) are fully dependent on
Government policy in this regard. As a starting point, levies need to be raised to ensure
revenue neutrality for the distributors. Levies can only be phased out if mechanisms are
approved by the NERSA to re-balance the retail tariffs of the distributors, to ensure
continued profitability. The levies currently identified (and which should as far as
possible be made transparent) are:

              Inter-tariff cross-subsidisation: This is the subsidisation of one tariff class by
               another. The most well known form of this subsidy is the subsidisation of rural,
               electrification and domestic customers, mainly by large industrial customers.

              Intra-tariff cross-subsidisation: This type of cross-subsidy happens if some
               customers within a customer class subsidise others in the same class. This type
               of subsidy can usually be attributed to pricing structures that do not reflect the
               underlying cost structures.

              Voltage level subsidies are the result of incorrectly allocating the supply costs
               to customers connected at different supply voltages. This typically results in low
               voltage customers being the recipients of subsidies.

              Geographic cross-subsidies result from incorrectly allocating the supply costs
               to customers in different geographical locations in South Africa. Cross-
               subsidisation takes place from low cost areas (i.e. those close to generation
               resources) to high cost areas, typically the coastal areas, far Northern Cape and
               Northern Province (Limpopo).

              Other levies and taxes, such as applying profits from electricity sales to
               municipal rate funds.

          b.   Exclusion of levies and taxes

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Invisible levies have in the past been imposed on purchases of electricity by industrial and
traction customers in order to cross-subsidise domestic and commercial end-user customers
for whom electricity may otherwise be unaffordable.

Levies have also in the past been imposed in order to subsidise the electrification programmes
in South Africa. Municipalities can impose levies on electricity consumers supplied by them
under the provisions of the Constitution, for the purpose of cross-subsidising other services.
The Department of Minerals and Energy has no jurisdiction on taxes and levies, as these are
the National Treasury and municipal functions respectively.

          c.   Renewable electricity pricing

Renewable energy is mainly on the piloting stage in the South African electricity industry and
therefore does not constitute a large section of the electricity industry. It was initially introduced
mainly in rural areas, in the form of SHS (solar home system) as part of Government‟s
initiatives to facilitate the universal access to electricity. However, it is recognised that it can
systematically complement grid-based connections especially to meet peak demand. Similarly,
it can introduce competition or compete with other methods of generating electricity by allowing
the easy participation of Independent Power Producers (IPPs) mostly at generation level.

Another dimension of renewable energy is their contribution towards environmental friendly
forms of energy. A strong inhibiting factor in renewable energy pricing is the availability and
accessibility of this technology. Currently, it is subsidized, as part of the Government‟s
electrification programme and therefore, a pricing policy position or an amendment to this
policy will be formulated once this sector increases significantly. Their licensing of operation
will still be subject to verification by the NERSA.

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   Electricity Price

         a. Cost reflectivity

The Energy White Paper specifies that the electricity industry should move towards cost-
reflectivity in the medium to long-term.     This means electricity tariffs charged should be
equivalent to the real cost of rendering electricity services excluding subsidies. The policy
position of the Government is that in the Wholesale Electricity Pricing System (WEPS), there
should be no cross-subsidies applied at the generation level, to allow generators a fair
competitive environment and an opportunity for generators to compete with other generators
outside the country. The WEPS should also be cost-reflective. Cost reflectivity will further be
discussed in the retail section below.

         b. Transport/ Wheeling Charges

Transmission and distribution network owners may not refuse to allow other parties to wheel
electricity through their networks. However, they are entitled to be paid a fair amount for the
use of their networks. As part of the transmission grid code network owners will not be allowed
in any way to discriminate against other parties who wish to be connected to their networks,
provided only that such parties are willing and able to pay for such connections. The tariffs for
connection and wheeling, as well as any applications to change the structure and levels of
such tariffs, shall be approved by the NERSA.

It may be necessary, to take a due consideration of technical such as the reserve margin
requirements, interconnections and capacity constraints of the transmission networks
such as voltage level, peak-demand to avoid undue influence of the systems reliability.

      “There shall be mandatory third party access to un-committed capacity in the
       transmission line.”

        c.    Geographical differentiation

Transmission and distribution networks have both a spatial and a temporal dimension.
Electricity generators and loads connected to these networks are generally not located in the

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same places. It is therefore recognised that the cost of electricity will vary from place to place
on every network and also from time to time.

In line with the principle of cost reflectivity, there need to be geographic differentiation of
electricity tariffs from place to place along the transmission and distribution networks.

      “In the WEPS, it is proposed to divide the country into eight transmission network price
       zones, as defined by the National Energy Regulator.”

             d. Energy

       i.)          Energy Transportation

Electricity is usually transported at a high voltage levels to avoid the increase of network
losses. This is done to reduce the network cost especially if the two end-points are distant. For
business purposes, it is commercially more viable to purchase or transport large volume
electricity per fixed connection and transmission charge. The tariff for transporting each unit of
electrical energy in the transmission grid, including the connection charges will be approved as
part of license conditions. In certain areas, these may take into account the nodal zone, peak
demands, wheeling, system reliability, limitation of transferable power and congestion

             ii.)     Existing WEPS consumers

Most of the customers that fall in the WEPS (wholesale electricity pricing system) category are
large electricity consuming industries and municipalities. The municipalities undergo an annual
tariff review process determined by the NERSA. Most of these large industries have signed
long-term agreement approved and reviewed by the NERSA periodically with Eskom for a
long-term supply of electricity that may vary from more than a year up to a period of more than
ten years (10).

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While it is commercial sound to enter into agreement as they reduce the risk of price spikes
and allow for long term investment planning, it is worth noting that they are not cost-reflective
in the medium to long-term. It is the government intention that these contracts will be re-
absorbed into the WEPS or else be renegotiated through the tariff approval process in order to
accommodate the transitional aspects.

           iii.)      New entrants

The introduction of the WEPS is likely to cause differences of opinions and disparities to
municipalities and their respective customer bases. As the WEPS, this are large customers
connected to the municipal distribution system who will want to join the WEPS. Secondly it is
the unequal treatment of new WEPS customers who are likely to be exempted from a wide
range of tariffs charged by municipalities on their customers. If no arrangements are made,
municipalities are likely to lose their customer basis for revenue. In the similar manner, these
large industrial customers are likely to be exempted to avoid externality cost that may be
imposed by their respective municipalities.

        iv.)          Commodity Based Consumer

Some industries trading in commodities on international markets have signed supply
agreements (LTPPA – long term power purchasing agreements) based on special commodity-
linked electricity tariffs. These tariffs vary with the commodity prices in the international
commodity markets. These industries may cross-subsidise or may be cross-subsidised by the
rest of the ESI depending on the performance of commodity prices in these markets. While
recognizing the sanctity of these agreements, it is not expected that the rest of the EDI should
subsidize these industries when commodity prices are unfavourable.

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        v.)          „Contestable’ customers

The understanding of the industry in terms of the definition of the contestable customers which
is not legislated are customers which consumer more than 100GWh per annum in the
contagious site. Also recognising that the Electricity Regulation Amendment Bill, which is still
to be enacted, propose that all customers supplied at distribution level will be equivalent to
reticulations customers. Taking a lead from this Bill, all distribution customers will be
reticulation customers including those who consumer more than in 100GWh per annum
supplied at 132 kV or lower voltage. Transmission customer that are consuming more than
100GWh per annum (very limited number), will still be captive customers supplied by Eskom
as the single transmission company in South Africa even for the future.

Captive customers supplied as reticulation customers, on the other hand, cannot carry such
risk and the REDs in whose area they are domiciled will have the obligation to supply them.

      “Customer choice of supplier will be extended to other consumers when applicable in
       the medium to long term as well, but these consumers will not necessarily qualify for the

        vii.)        Who qualifies to buy at WEPS

To a large extent, all domestic, small commercial and industrial consumers and not for profit
institutions will be captive customers to the distributors. These are the commercial and
business entities whose electricity consumption exceeds 100GWh of electricity consumption
per annum and supplied at 132 kV or lower voltage, including municipal entities. These
customers will always buy electricity from the licensed distributors servicing the area.
      “Captive customers cannot carry the risk of power failure and the RED domiciled has
       the obligation to supply them.”

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         viii.)   Externality costs

An externality can be defined as inter-dependence between different economic participants
outside the price mechanism. Externality is said to exist when the utility of an individual
depends not only on the good consumed by the individual but also on the activity of other
individuals. A distinguishing feature is interdependence between individual outside the price
mechanism. For the electricity industry, externality costs may relate to the pollution of
environment in the form of gases produced, pollution of rivers, uneconomic usage of the

The industry participants are encouraged to use environmental friendly modes of generating
and supplying electricity. This comes as part of the license and tariff approval conditions. The
Department has taken initiative through some of its programmes to encourage the use of
renewable energies, and where necessary even in generation. With the increasing awareness
of the effects of pollution such as global warming, it becomes necessary for investors to
consider externalities as an input in their production costs. This can be done through the
purchase of environmental friendly technologies in generation such as CCGT or engaging in
pollution elimination research at their own costs.

Penalties and compensation of individuals affected by electricity-related activities is addressed
through provisions in the Electricity Regulation Act (Act No 4 of 2006), the Occupational Health
and Safety Act (OHSA), the Expropriation Act of 1973 and the Water Act (Act No 36 of 1998).

       ix.)       Obligations to supply

The obligation to supply is related to customer choice:

        Where a customer is captive to a particular supplier, that supplier must have an
         obligation to supply that customer. Where a customer has a choice of supplier, a
         particular supplier cannot be obliged to supply that customer.

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        Eskom has been regarded as the supplier of last resort as the decision taken by the
         Cabinet, and hence that its de facto to the obligation to supply. The Electricity
         Regulation Act empowers the Minister of Minerals and Energy to take a decision in
         terms of who has the obligation to supply. With the formation of the REDs and the
         possible entry of private investors in the electricity supply business and other players
         (traders, retailers, financial brokers, etc.) into the electricity supply industry (ESI) in
         future, the obligation to supply becomes important.

        With regard to captive end-user customers, the REDs shall have an obligation to supply.
         No end-user customer who can demonstrate that (s)he            can pay for the services
         rendered, may be refused access to any REDs network.

Also, in this regard, the obligation to supply is related to a customer choice:
        “Where a customer is captive to a particular supplier (Transmission or reticulation), that
         supplier must have an obligation to supply that customer. All customers shall have
         obligation to pay for the electricity services provided.”

        “Where a customer has a choice of supplier in the future, a particular supplier cannot be
         obliged to supply that customer.”


     a. Cost reflectivity and Transparency

According to the White Paper on Energy Policy for South Africa, “Cost-reflective tariffs will be
applied at electricity distributor supply points in due course”. In this regards, all electricity
prices shall be differentiated into components for the electrical energy itself, the
transportation of the electrical energy along transmission and distribution wire
networks, and any services rendered to the purchaser (such as metering, billing, sales
and marketing, administration, etc.)

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As stated in the Energy Policy White Paper, electricity tariffs shall be cost reflective in the
medium to long term.          However, it is recognised that electricity must also be affordable
especially to indigent households. Cost reflective tariffs now may not be affordable for certain
categories of consumers in a short term. Therefore, as a trade-off between cost reflectivity and
affordability, the cost reflectivity of distribution tariffs will be phased in over a longer period from
the date of implementation of the Regional Electricity Distributors (REDs). In line with section
74 of the Municipal Systems Act of 2000, which gives municipalities the right to
subsidise poor households in their areas of jurisdiction, affordability mainly refers to the
affordability of the indigent people which then means that the period for phasing out the cross
subsidies in the electricity industry will be linked to the reduction of energy poverty.

According to the Energy White Paper, all tariffs, levies, taxes, subsidies and cross-subsidies
contained within electricity prices must be transparent and must be indicated on electricity bills
presented by suppliers, traders, retailers and distributors to their customers.

While recognizing the need for time of use (TOU) cost of supply variations, for affordability
reasons, the tariffs charged to electrification customers shall be capped within the concept of
cost-reflectivity.    The NERSA shall from time to time determine a reasonable tariff for
electrification customers and also provide details on the implementation of this policy in line
with the electricity industry legislations.

    b. Transport

In the near future energy charges shall be separated from the distribution charges.                   A
customer will be required to pay for both the energy and the distribution (transportation)
charges separately. This method will not be applied in South Africa if the distribution business
is not separated from the retailed business.

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  c. Retail/Support functions

      i.)       Cross subsidies in context

The retail or the distribution business of electricity has been the most subsidized unit of the
whole electricity industry. Low electricity consuming SMME‟s in municipal supply areas:
SMME‟s, especially small electricity consuming industries are supplied through annually
adjusted tariffs by distributors (Eskom or Municipalities). In most cases the municipal tariffs
are higher than those for similar sized industrial consumers (outside long-term supply contracts
for IEUI‟s) supplied by Eskom. The extent of cross-subsidisation of industrial consumers in
municipal as compared to those Eskom supplied areas is also not equitable, and needs to be
balanced if municipalities are to retain industrial customers in their licensed areas.

Different consumers are explained in detail below:

               Intensive Electricity Using Industries (IEUI’s): Industries and the commercial
                sector form the backbone of the South African economy. Therefore, there is a
                need for the provision of inexpensive electricity as part of the input costs in
                production. Most of the large electricity consuming industries have arranged long
                term supply agreements with Eskom generally on favourable terms to the
                industry.   Recognising the sanctity of these agreements and the NERSA will be
                required to devise an alignment procedure within the transitional phase.

               Commercial Consumers: These are mainly businesses in the Central Business
                Districts   and   other   office   buildings,   hospitals,   clinics   and   government
                departments.      Once again, electricity tariffs have a similar profile as the OEUI‟s
                for customers supplied by Eskom and municipalities.

               Agricultural Customers: The agricultural sector requires high electricity capital
                investment in infrastructure and has the lowest demand in relative terms. This
                sector is mainly supplied by Eskom and is extremely subsidised.               The tariffs

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                charged are generally insufficient to cover the capital, maintenance and
                operational cost associated with the infrastructure. This sector is therefore highly
                subsidised by other electricity consumers.

               Domestic Consumers: The domestic sector is mainly responsible for the peaky
                nature of the electricity demand curve. The peak demand is the most expensive
                of the three levels of demand. The domestic tariffs do not reflect this anomaly
                and are thus highly cross-subsidized by other sectors. The electrification
                customers connected through the National Electrification Programme are further
                cross-subsidised since such customers cannot afford to pay for both capital,
                operational and maintenance cost of the electricity infrastructure provided to
                them. Subsidy is mainly provided by the industrial sectors.

        ii.)     Refer to Municipal Systems Act (powers and functions of municipalities)

Section 74 of the Municipal Systems Act of 2000 gives municipalities the right to subsidise
poor households in their areas of jurisdiction.        The EWP in principle recognises this by
supporting the provision of energy to the poor at an affordable tariff. However, the principle of
transparency as outlined on the EWP is not in line with section 74(2)(i) of the Municipal
Systems Act which gives municipalities the right to disclose tariff adjustment for subsidising of
the poor. The provision of affordable tariffs to poor households should be inline with the
content of this policy.

        iii.)    Multi-Year Price Determination

The annual Eskom price adjustment is awarded by the NERSA within their multi-year price
(MYPD) determination process. The plan detailed in this paper does not address the
MYPD process, and only deals with structural changes to the tariffs, based on the NERSA
approved tariffs revenue requirement and volumes.

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      d. Support to other classes of consumers

        i.)   FBE in context

To be inline with principle of universal access to electricity as embodied in the EWP, a Free
Basic Electricity (FBE) electricity amount of up to 50kWh per month per qualifying grid-
connected household was introduced. This up to 50kWh amount of energy is funded through
the fiscus and any amount consumed beyond 50kWh will be purchased at the ruling municipal
or Eskom tariffs. This is done to avoid any further cross-subsidies in the electricity industry.
However, for practical reasons and uniformity of the process within different capacity municipal
entities, it is proposed there be a national FBE tariff policy that will be subjected to the NERSA
approval process.

The Department of Minerals and Energy will monitor the viability of FBE together with the
Department of Provincial and Local Government (dplg) and advice accordingly if a need arise
for tariff adjustment to accommodate FBE. It is the responsibility of NERSA to approve the
tariff adjustment recommended by DME in consultation with National Treasury and dplg.

       ii.)   Special Tariffs for Special Customers

This category of consumers pertains to special institutions of government like community
centres, government departments, schools (private and state aided) and clinics, non-
governmental organizations (NGOs) and Community-based Organisations (CBOs).                    The
electricity demand of these institutions varies and it is for this reason that distributors classify
them differently either as commercial or domestic consumers.

Many non-profit institutions approached the Department of Minerals and Energy to request
consideration for special tariffs. The restructuring of the EDI as proposed in the EWP,
necessitates the move away from subsidies in the EDI. Notwithstanding the above, cost-

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reflectivity approach reduces price distortions thereby preparing consumers for the introduction
of competition in the electricity sector.

In that regard, government institutions nationally, provincially and locally shall be required to
budget for the full cost of electricity services anticipated in the financial year in questions. Any
subsidies must be procured through the inter-governmental transfers.

In respect of other seasonal industries like the agricultural sector, the national and provincial
government departments shall be required to budget for the full cost of a basket of
commodities that need subsidisation.          This may include but not limited to infrastructure,
machinery, fuel, feed, seeds and electricity as anticipated in the financial year in question.

       Government Departments shall be responsible for providing a basket of subsidies to be
       made available to the target consumer classes in their areas of operation or mandate.
       These subsidies shall be provided as line items on the budgets of relevant departments
       for the institutions mentioned above.

       iii.)   Time Frame

The extent of cross-subsidisation in the industry (± R 2bn to Eskom‟s rural and electrification
customers and a further ± R 2,5bn to municipal rate funds) should leave no doubt that cross-
subsidisation is likely to remain for a very long time. The extent of price increases necessary to
remove cross-subsidisation is such that phasing subsidies out fully will be a process that will
take many years, if huge step changes and price-instability are to be avoided. Furthermore,
most municipalities do not have alternative rate funding mechanisms to replace the levies on

       The new pricing regime will have to be implemented simultaneously with the
       implementation of the REDs which will have the transition, medium and long term phase
       of implementation and the time frames will be determined and annually reviewed by the
       Minister of Minerals and Energy.

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       iv.)   Exclusion of levies and taxes

In spite of the EWP objective on the cost reflective pricing of electricity, it is likely that at least
some level of subsidisation of electrification and rural customers will have to remain, for
affordability considerations. Although it is generally preferred that social services should be
funded from the fiscus (as opposed to levying a tax on electricity input costs), this is unlikely to
happen in the near future. While Government is currently funding most of the capital
associated with electrification, but not the operating losses, no further funding from
Government is expected.

As indicated levies identified are currently applied at the level of consumption. Levies and
subsidies within normal retail tariffs are currently hidden. The introduction of WEPS will see the
introduction of transparent levies in that tariff. An issue that deserves serious attention with the
EDI / ESI restructuring, is the level (i.e. consumption or generation) at which levies should be
raised in future.

Levies are collected on a volumetric base i.e. the total volume of energy consumption is
applied to the appropriate rate in order to determine the Rand value of the levies. Although
other mechanisms would be possible (e.g. a levy on the network capacity used by the
customer, a fixed monthly charge, a levy based on the customers‟ production volumes etc.) the
WEPS Task Team concluded that a volumetric levy would be most appropriate.

      In terms of the principle of transparency, all subsidies and cross-subsidies shall be
       made transparent in future.       In line with the principle of cost -reflectivity, all cross-
       subsidies and levies shall be phased out over a period of up to ten years.
      However, in line with the principle of affordability, there will be a need to continue
       to implement some, subsidies and cross-subsidies in the foreseeable future to
       ensure universal access to electricity.

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As stated above, transfer pricing from Generation and Transmission to Distribution is cost-
reflective, within the assumed definition of cost reflectivity (this includes, e.g. minimal
geographic cost reflectivity at present).

      Invisible levies have in the past been imposed on purchases of electricity of large
       consumer categories in order to cross-subsidise other categories of end-user customers
       for whom electricity may otherwise be unaffordable. Levies have also in the past been
       imposed in order to subsidise the electrification programmes in South Africa.

      In terms of prevailing legislation, municipalities can impose taxes on electricity
       consumers supplied by them, for the purpose of cross-subsidising other services.

It will be the large customers and hence current contributors to levies that will gain access to
WEPS and the future competitive markets. This introduces the possibility of these customers
escaping their contribution to levies, unless mechanisms are introduced to prevent that.

      The NERSA shall design and implement mechanisms within the WEPS to ensure that
       WEPS customers continue to make a fair contribution to levies until a substitution
       funding mechanism has been implemented.

Quantifiable contributions to subsidies have been calculated and will be recovered from WEPS
as transparent levies. Non-quantifiable contributions to cross-subsidies are recovered by way
of a transparent WEPS surcharge, determined as the difference between revenue at the retail
and WEPS tariffs, using the historic load profile as reference.

Since a tariff change from a retail tariff to WEPS will not change the costs and hence revenue
requirement of distribution businesses to any significant degree, levies can only be reduced if
alternative central funding mechanisms have been determined.          Industry restructuring will
therefore not change the underlying costs or the need for cross-subsidisation. It is only
mechanisms to collect and disburse levies and subsidies that could be changed.

It is important to note that any levies to be imposed on qualifying WEPS customers (those
customers that will qualify to purchase energy in the Wholesale Market) are recovered at the

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level of end consumption. During the current form of the EDI, WEPS customers will be billed
by the distribution sector. The EDI will retain the revenue from the levies within the business
and apply it to subsidise other customers within its jurisdiction.

      In a case of intensive energy users on WEPS, not paying to a distributor, mechanisms
       must be set up to ensure the transfer of such levies to an appropriate distribution (and
       future REDs).

Eskom‟s WEPS Task Team recommended that levies should be calculated and raised at the
level of generation (as opposed to consumption). For a variety of reasons this recommendation
cannot be implemented initially. It further recommended the:

      “All levies, subsidies and cross-subsidies shall be made transparent in the future.”

      “Cross subsidies will be phased out over a period of ten years.”

      “The collection and distribution of funds for subsidies and cross-subsidies shall be
       regulated by the NERSA in collaboration with the DME and the National Treasury until
       these have been completely phased out. Regular reports shall be made to the National
       Treasury and Parliament.”

       v.)      Institutionnel Arrangements

The economic component framework of the Electricity Pricing Policy shall be implemented and
monitored by the NERSA and Municipalities in line with the prevailing electricity regulation
legislation. The line function government departments will administer the subsidies.


             a. Historical perspectives

The Electricity Distribution Industry (EDI) and the Electricity Supply Industry (ESI) are being re-
structured, in accordance with government‟s decisions. The EDI will be restructured into six
(6) independent Regional Electricity Distributors (REDs).

                                          10 November 2011
                 Energy Summit Paper 2007 – Department of Minerals and Energy                  21

Restructuring in the ESI will bring a number of issues to the fore, in particular, the issue of
electricity pricing and tariff composition. This paper addresses key issues of electricity pricing
in general and in particular, cross-subsidisation.

Cross-subsidisation has always been part of the electricity pricing landscape in the South
African Electricity Supply Industry. Some customer classes would find it difficult to afford
electricity at fully cost reflective prices. Cross-subsidisation of customers has been entrenched
in electricity pricing, without any explicit government policy that determined the “rules”.
Although the Energy White Paper holds that “Cost reflective tariffs will be applied at electricity
distributor supply points in due course”, as a key policy objective, it is also commonly
understood that the immediate removal of cross-subsidisation may have negative implications
to the continued affordability of electricity to many classes of consumers. The government
must provide policy guidance to the industry in respect of the implementation modalities of the
above policy statement.

The issue of cross-subsidisation is largely managed within the distribution businesses. With
the advent of financial ring-fencing of electricity businesses of municipalities from the
mainstream municipal functions, and the Eskom‟s Transmission and Generation groups, the
transfer pricing from these groups to the Distribution group will be cost reflective, within the
constraints of Eskom‟s total allowed revenue determined by the NERSA. It should be noted
that large municipalities taking supply at high voltage also contribute to the subsidisation of
Eskom‟s rural and electrification customers.

In addition, large customers of these municipalities also subsidise their own electrification and
domestic customers. This has been at the heart of the “unlevel playing field” issue between
Eskom Distribution and municipal distributors. This issue will automatically be addressed by
EDI restructuring and the establishment of REDs, and perhaps through the introduction of the
Wholesale Electricity Pricing System.

                                         10 November 2011
                 Energy Summit Paper 2007 – Department of Minerals and Energy                   22

The extent of existing cross-subsidisation is extremely difficult to quantify, since cost of supply
studies are generally not conducted with that objective in mind. Eskom‟s pricing plan,
published in 2001, quantified some inter-tariff cross subsidies. According to that study, the
price of electricity has to increase by approximately 90% and 50% for rural and urban
electrification customers, respectively. Such an increase would generate approximately R 2
000m additional revenue that could be used to reduce large customer tariffs by approximately
13%. Pricewaterhouse Coopers estimated the subsidisation of municipal rate funds at ± R 2
400m per annum.

   Policy Applicability

          a. Issues

                  i. Internal Environmental Factors

                         1. Policy Clashes

Since it is the local sphere of government that is tasked with discharging such a service, there
is a need to strike a balance between a number of factors including but not limited to tariff
setting and Municipal levies, etc. National government regulate basic electricity/energy through
national policy and it will be good for all the parties to understand the differences.

                 ii. Short and Medium Term Implications

The need for addressing the challenges relating to service authorities is very important and
within a medium term there is a need to address those challenges by other stakeholders
mainly national government and provincial government assisting service authorities.

                 iii. Long Term implications

                                         10 November 2011
                 Energy Summit Paper 2007 – Department of Minerals and Energy                   23

Implementation of National Pricing Policy Framework whereby NERSA regulate the tariffs and
municipalities responsible for setting their electricity levies in line with National Treasury
polices and regulations.


          a. Limiting factors

   Municipalities impose unregulated levies on electricity consumers supplied by them under
    the „provisions of the Constitution, for the purpose of cross-subsidising other services and

   Municipalities using electricity as the source of income fore - (thin spread of available
    technical, human and administrative capacity).

   Targeting - limited consumer data bases in small/poor/rural municipalities to facilitate
    provision, monitoring and evaluation of FBE. Timing of capital funding requirement i.r.o.
    IDP could be out of step with the FBE roll out requirements.

   Precision of methodology to phase-in and target “the poor”.

          b. Enablers

                     Beneficiaries of good Electricity Pricing Policy

The sole intention of Electricity Pricing Policy Framework is to assist in the provision of energy
to consumers at the cost reflective and transparent tariffs. Municipalities are well placed to take
a leading role in implementing the pricing policy when is done.

This intervention by government is therefore aimed at alleviating some of the difficulties
associated with electricity pricing and to promote access to energy in poor households.
Municipalities have a responsibility to master and implement electricity pricing inline with
National Government Policies within their jurisdiction.

                                        10 November 2011
                    Energy Summit Paper 2007 – Department of Minerals and Energy              24

    Other stakeholders Involved

The following institutions are main stakeholders involved/ affected by the pricing regime of
        Eskom;
        Department of Provincial and Local Government;
        National Electricity Regulator of South Africa (NERSA);
        National Treasury;
        Municipalities;
        South African Local Governments Association (SALGA); and
        Department of Public Enterprises.
        The list is not exhaustive.

    Resolution Options and Ease of Achievement

The Department of Minerals and Energy will have to fast track the completion of the new
Electricity Pricing Policy.

    Recommendations with implementation timelines

The envisaged time for the completion of the new Electricity Pricing Policy is early 2008 and
the implementation has to commence immediately.

    Proposed Implementation Plan of Actions

       There is an urgent need to have the new electricity pricing regime as Electricity Pricing
        Policy in place.

                                           10 November 2011
                Energy Summit Paper 2007 – Department of Minerals and Energy                  25

   NERSA and the Department of Minerals and Energy are doing studies on Electricity
    Pricing that will inform the development of Electricity Pricing Policy in South Africa with
    both studies envisaged to be completed by the end of this year.

   The Department of Minerals and Energy is developing new Electricity Pricing that and will
    be published for all stakeholders comments.

   Robust consultation is ongoing with stakeholders paving the way for the development of
    Electricity Pricing Policy.

   Once a the Electricity Pricing Policy in place, there will be a need for the facilitation for
    the implementation of that Policy, it is essential for the ESI to adequately manage the
    transitions without negatively affecting innovative cost and efficiency initiatives.


                                        10 November 2011

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