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SALGA comments on ESKOM MYPD2 Application 20091222 - SALGA Letterhead

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SALGA comments on ESKOM MYPD2 Application 20091222 - SALGA Letterhead Powered By Docstoc
					      Submission to NERSA
Regarding Eskom’s Application for a
  Multi-Year Price Determination
    2010/11 to 2012/13 (MYPD2)


              Final Version



            21 December, 2009
Table of Contents


1      Introduction ....................................................................................................... 1 
     1.1         Background and status of submission                                                                       1 
     1.2         Basis of local government’s interest                                                                      1 
2      Assessment of Eskom’s Application .............................................................. 2 
     2.1         A welcome paradigm shift                                                                                  2 
     2.2         Government’s critical role as policy maker                                                                3 
     2.3         Compliance with existing policy frameworks                                                                6 
     2.4         The revised demand forecast and security of supply                                                        6 
     2.5         How realistic is the funding strategy?                                                                    7 
     2.6         How efficient is Eskom?                                                                                 11 
     2.7         How much risk is too much?                                                                              11 
3      Consideration of Alternatives ........................................................................ 12 
     3.1         Access to information                                                                                   12 
     3.2         Has Eskom bitten off more than it can chew?                                                             12 
     3.3         SALGA’s proposed alternative                                                                            12 
4      Conclusion ....................................................................................................... 13 
                       SALGA Submission to NERSA Regarding
         Eskom’s Proposed Multi-Year Price Determination for 2010/11 to 2012/13



1 Introduction
1.1   Background and status of submission

Call for stakeholder comments
NERSA has requested stakeholder comments on Eskom’s application for a review of
the utility’s electricity tariffs for the period from 1 April 2010 to 30 March 2013
(MYPD2).
SALGA has previously commented on Eskom’s Proposal of 30 September (The
“Proposal”) in terms of the process required by the Municipal Financial Management
Act (MFMA). A copy of SALGA’s earlier comment is attached for reference and
should be read in conjunction with this document.
This document presents SALGA’s comments on Eskom’s 30 November application
(the “Application”).

Public hearings
SALGA understands that NERSA will hold public hearings on the matter during
January 2010 and hereby wishes to express its interest in making a presentation,
preferably at the Gauteng venue.

1.2   Basis of local government’s interest
Local government is a major stakeholder in Eskom with the following bases of
interest:

Legal basis of interest
The constitution grants municipalities legislative and executive authority over
electricity reticulation. This authority is recognized in the Electricity Regulation Act,
the Municipal Financial Management Act, the Municipal Structures Act and the
Municipal Services Act, amongst other statutes.
The legislative framework entrusts municipalities with an important regulatory role
over the last leg of the electricity supply chain. This function requires municipalities to
protect the interests of the consumer and to achieve a balance between various
objectives.
Eskom’s performance as an up-stream supplier and also as a distributor within
municipal areas of jurisdiction is therefore of direct interest to municipalities.

Developmental basis of interest
The constitution and various local government statutes require municipalities to act in
the interests of their constituencies, to promote local development and to ensure that
basic services, including electricity services, are provided to all and are as affordable
as possible.
Eskom is proposing an average increase above present-day tariffs of 120% over
three years and 181% over five years. In real terms this will lead to a 188% increase
over three years and 214% over five years.


                                            1
                       SALGA Submission to NERSA Regarding
         Eskom’s Proposed Multi-Year Price Determination for 2010/11 to 2012/13

These massive increases will have a generally inflationary impact and will lead to
serious hardship for private and public consumers of electricity. Poor households will
be particularly hard hit.

Commercial and financial basis of interest
The distribution of electricity is a major business activity for municipalities which
helps to generate much needed revenues for other municipal services. Tariff
increases on the scale proposed by Eskom will be a shock to the system, with
unpredictable results. In all likelihood the incidence of bad debt and electricity theft
will rise, which will place further strain on municipal finances.

Own consumption basis of interest
Municipalities consume a substantial amount of electricity in the course of delivering
municipal services. For instance, the pumping and treatment of potable water
supplies and waste water, provision of street lighting and the operation of civic
amenities all depend on electrical energy. The increased cost of electricity will put
pressure on municipal budgets which will, in turn, lead to increased rates and taxes
and further hardship for households and businesses.

Summary
Municipalities purchase and distribute approximately 40% of Eskom’s output. They
are therefore directly affected by Eskom’s proposed tariff increase.
Besides the immediate financial concerns, local government is legally obliged to
motivate for the lowest possible tariff increase, and to consider any alternative which
might assist with this objective.
These mandates and interests therefore form the basis of SALGA’s response to
Eskom’s Application.

2 Assessment of Eskom’s Application
2.1   A welcome paradigm shift
In comments on previous Eskom tariff applications SALGA has been very critical of
the lack of transparency in Eskom’s applications and the alarmingly weak state of the
energy policy framework within which these decisions must be taken.
SALGA is therefore very encouraged by Eskom’s statement that, during the process
of consulting with National Treasury, SALGA and other stakeholders,
      “it became clear that a significant paradigm shift is required to achieve a
      successful outcome for Eskom and South Africa. Stakeholders required a more
      inclusive approach to addressing the country’s challenges”. 1

It appears to SALGA that Eskom is beginning to realize that it cannot and should not
shoulder responsibility for the country’s power sector entirely on its own. Eskom’s
statement that it “should place its confidence in the ability of other stakeholders to



1
       Eskom MYPD2 Application, 30 November, 2009. p14.


                                           2
                       SALGA Submission to NERSA Regarding
         Eskom’s Proposed Multi-Year Price Determination for 2010/11 to 2012/13

contribute to a solution” 2 is therefore an important shift in sentiment which is to be
commended.
However, as Eskom correctly notes in section 4 of its Application, this paradigm shift
can only succeed if other stakeholders play their part.
      “A concerted effort would be required to ensure that these risks are effectively
      managed. However, the management of all of the resultant risks are not within
      the control of Eskom and the participation of all stakeholders is necessary to
      manage these risks to ensure a suitable outcome and the achievement of our
      long-term goals as a country. Success depends on a collaborative effort by
      Eskom, Government, customers, business, communities and other stakeholders.
      An effective partnership is therefore necessary to achieve success.” 3

In section 6.4 of its Application Eskom spells out the tasks which, in its view, each of
these stakeholders need to complete during the next three years in order to achieve
security of supply. SALGA strongly agrees with Eskom in this regard and commits to
playing its part in achieving a successful country outcome.

2.2   Government’s critical role as policy maker

The need for a national capacity plan
SALGA has previously pointed out that the challenge of funding new generation
investments has been recognised for many years and that it is therefore inexplicable
that Government and Eskom have taken so long to finalise a pricing and funding plan
for the utility and the sector. Eskom raises the same concern on page 15 of its
application when it states that,
      “The funding model for Eskom, and by implication, Eskom’s price increase
      application should therefore be made in the context of and taking into account a
      country debate and country choices regarding our energy future and should
      address, amongst others, the following questions:

          •   How much electricity generation capacity is required to enable economic
              growth and social development?

          •   What is the best mix of primary energy sources (i.e. coal, nuclear, solar,
              wind, etc) for such capacity?

          •   Who should build this capacity?

          •   How much will it cost?

          •   How should it be funded?

          •   What is the role of a competitive energy supply environment in the South
              African economy?” 4

It is alarming to SALGA that Eskom is in the dark about these issues, and that
NERSA is expected take a decision on a three year tariff determination in the
absence of clear national policies.

2
       Eskom MYPD2 Application, 30 November, 2009. p17.
3
       Eskom MYPD2 Application, 30 November, 2009. p21.
4
       Eskom MYPD2 Application, 30 November, 2009. p15.


                                                3
                       SALGA Submission to NERSA Regarding
         Eskom’s Proposed Multi-Year Price Determination for 2010/11 to 2012/13

The lack of an agreed country capacity plan is just once example of the chaotic and
incoherent approach to policy making for the electricity sector. The need for such a
plan was recognised in the Energy White Paper of 1998 which stated that
     The Department of Minerals and Energy will ensure that an integrated resource
     planning approach is adopted for large investment decisions by energy suppliers
     and service providers, in terms of which comprehensive evaluations of the
     economic, social and environmental implications of all feasible supply and
     demand side investments will have to be undertaken. In the electricity sector’s
     case, the National Electricity Regulator will only license new facilities upon the
     satisfactory completion of an integrated resource plan. 5

In January and February this year the Minister issued two notices of her intent to
pass regulations in terms of the Electricity Regulation Act which were intended to
regulate, amongst other matters, electricity supply planning and the procurement of
new generation capacity. 6
These draft regulations were subsequently combined into a single regulation which
was gazetted on 5 August 2009. 7 This regulation provides for the development of an
integrated resource plan (IRP) to regulate the licensing of new generation capacity
and the recovery of costs arising from independent power producers.
As this regulation is now in force Eskom is bound to comply with it and NERSA must
take it into account when evaluating Eskom’s MYPD2 Application.
SALGA is aware from a recent Department of Energy (DOE) press conference that
the department has prepared a draft IRP, but only intends to begin public
consultation on the matter during 2010.
Since the IRP must form the basis of Eskom’s capital programme, which is the main
driver behind the high tariff increases, it is a critically important framework for
NERSA’s review of the Eskom Application, and should therefore be available to all
stakeholders to inform their assessments and comments. SALGA has requested
DOE to share the draft IRP on at least two occasions, but no response has been
forthcoming.
SALGA has several concerns with this process. Firstly, it is regrettable that DOE has
taken so long to get regulations into place to govern the important process of
resource planning – despite having committed more than ten years ago to establish
such a framework.
Secondly, it is deeply concerning that the draft IRP has not be made available to
stakeholders, despite government having known for almost a year that this document
needed to be finalised by this stage.



5
       Department of Minerals and Energy. White Paper on the Energy Policy of the
       Republic of South Africa. December 1998. Section 8.1.1.
6
       Government Gazette No. 31849 of 30 January, 2009 and Government Gazette No.
       31891 of 13 February, 2009.
7
       Government Gazette No. 32378 of 5 August, 2009. Regulation 721. Electricity
       regulations on new generation capacity.


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                          SALGA Submission to NERSA Regarding
            Eskom’s Proposed Multi-Year Price Determination for 2010/11 to 2012/13

And lastly, it is alarming that DOE appears to believe that the draft and secret IRP
document is nonetheless a legitimate basis for NERSA to evaluate Eskom’s
Application.
         “Acting DDG Ompie Aphane, who has overseen the drafting of the IRP, indicated
         that the National Energy Regulator of South Africa (Nersa), which will pronounce
         on Eskom's three-year tariff path on February 24, would use the IRP, rather than
         Eskom's proposals, to make its determination on the capital-project aspect of
         Eskom's application.” 8

On the contrary, SALGA suspects that the absence of a legitimate IRP may
constitute a fatal flaw, leaving the process open to potential legal challenge and
certainly diminishing its credibility in the eyes of stakeholders.

Impact of policy failure on service delivery
Government’s failure to resolve this critical policy framework in good time has had a
direct impact on the cost of service provision. As Eskom notes in its application
         “…Eskom is also facing significant financial challenges to meet its operational
         costs. This is due partly to the increased costs that have resulted because of a
         low reserve margin.
                                                                                     9
         … and higher operating costs due to the higher plant utilisation levels.”

In other words, government’s failure to take decisions on new generation capacity in
good time has led to low reserve margins, which has led to higher primary energy
costs than should have been the case and sub-optimal use of existing plant due to
compressed maintenance cycles. These two factors are inflating operating costs
which has caused Eskom to apply for higher tariff increases than would otherwise
have been the case. Municipalities, businesses and households are therefore directly
bearing the consequence of government policy failure.

Time for a review of the electricity pricing policy?
SALGA earlier response to the Eskom Proposal (see attached) noted the need for
pricing policies which keep electricity affordable for poor households.
Although government’s electricity pricing policy was adopted fairly recently 10 the step
change in electricity prices may constitute grounds for a review of this policy. Any
review should consider at least the following:
     •    The level, funding and efficacy of targeting of free basic electricity services;
          and
     •    The extent to which the principle of cost-reflective tariffs is appropriate given
          the very high level of income inequality in South African society.




8
          No Kusile delay in SA's Cabinet-endorsed electricity road map. 4 December
          2009.           http://www.polity.org.za/article/no-kusile-delay-in-sas-cabinet-endorsed-
          electricity-road-map-2009-12-04
9
          Eskom MYPD2 Application, 30 November, 2009. p8.
10
          Electricity Pricing Policy. December, 2008.


                                                  5
                          SALGA Submission to NERSA Regarding
            Eskom’s Proposed Multi-Year Price Determination for 2010/11 to 2012/13

SALGA requests Eskom and the relevant national government departments to
establish a suitable process to agree on the optimal approach to protecting the poor
from the forthcoming price increases.

2.3       Compliance with existing policy frameworks
Government has already announced certain policy positions and statements of intent
which should inform the country capacity plan. In particular

      •    The decision that 30% of new generation capacity should be built by IPPs;
      •    Targets on renewable energy production targets published in the Renewable
           Energy White Paper; and
      •    The carbon constraints stemming from the long term mitigation scenarios.


In its comment on the 30 September Proposal SALGA requested Eskom to provide a
clear indication of the extent to which its capacity plan was complying with these
policy positions during the MYPD2 period and beyond.
SALGA notes with regret that Eskom’s Application has failed to provide any further
information in this regard.

2.4       The revised demand forecast and security of supply
As Eskom notes, the sales forecast is “the first and crucial building block of Eskom’s
price increase application”. 11
SALGA had a number of concerns with the demand forecast contained in the
30 September Proposal, and requested Eskom to clarify its assumptions on demand
and the impact of the various demand management programmes under
consideration.
In its 30 November Application Eskom provides a revised demand forecast, a more
detailed explanation of the factors taken into consideration, and a review of the risk
factors – of which there are many.
SALGA is concerned that Eskom’s Application fails to consider the implications if
actual demand is materially different to Eskom’s forecast during the MYPD2 period.
For instance, if demand price elasticity plays a more significant role than Eskom has
allowed – and in fact Eskom appears to have completely discounted the causal link
between price and demand – then it is possible that demand may be materially lower
than Eskom’s forecast. In which case revenues will be materially lower too. Whilst
lower revenues will to some extent be offset by lower primary energy costs, a
reduction in revenue could jeopardise Eskom’s ability to fund its capital programme –
which will create a security of supply risk.
On the other hand, if demand turns out to be materially higher than Eskom’s forecast
then the country may also face a security of supply problem since the reserve margin
is, in Eskom’s own words, “finely balanced”. 12

11
           Eskom MYPD2 Application, 30 November, 2009. p46.
12
           Eskom MYPD2 Application, 30 November, 2009. p20.


                                              6
                             SALGA Submission to NERSA Regarding
               Eskom’s Proposed Multi-Year Price Determination for 2010/11 to 2012/13

   SALGA therefore requests NERSA to closely examine Eskom’s demand forecasting
   assumptions, and to test the consequences of higher or lower actual demand for
   Eskom’s finances and for the country’s security of supply. If the risk in this “finely
   balanced” system is unacceptably high then the public should be informed and
   alternative approaches should be considered before a final decision is made on the
   tariff increase.

   2.5    How realistic is the funding strategy?
   SALGA original response to Eskom’s 30 September MYPD2 Proposal raised a
   concern that the Proposal did not contain a clear funding plan for the period and
   requested that Eskom address this issue more fully in its final submission to NERSA.
   Whilst Eskom’s 30 November Application contains substantially more information on
   the funding strategy it has also given rise to a whole new set of concerns.

   Is the funding strategy efficient?
   The following table highlights some figures from Eskom’s projected income statement
   and cashflow, together with a brief analysis. 13
(R millions)                                    FY10/11    FY11/12   FY12/13   FY13/14    FY14/15
Revenue                                          98,355    132,579   180,107   206,757    236,550

Capex (inc IDC)                                  96,303    108,320   103,991     86,310   106,683
Capex                                            87,646     94,417    86,239     68,783    88,905
IDC                                               8,657     13,903    17,752     17,527    17,778

Funding                                          60,000     56,000    50,000     35,000    35,000
Shareholder loan & equity                        20,000     10,000    10,000
Clean technology fund                                        3,000
Borrowings                                       40,000     43,000    40,000     35,000    35,000

Capex funded from sources other than long-       36,303     52,320    53,991     51,310    71,683
term funding
Portion of capex funded from sources other           38%      48%        52%       59%       67%
than long-term funding


   The table contrasts Eskom’s planned capital expenditure programme with its funding
   strategy. The difference between the two must be funded from other sources, such
   as short-term borrowings or annual earnings.
   The proportion of capital expenditure which is not funded by long-term borrowings is
   surprisingly high, at an average of 47% over the MYPD2 period, and projected to rise
   to over 60% in the following years.
   The heavy reliance on annual cash-flows is very unusual for a utility, since the bulk of
   this expenditure will go on assets with a 50 year design life. Normally speaking a



   13
           Eskom MYPD2 Application, 30 November, 2009. p83.


                                                 7
                          SALGA Submission to NERSA Regarding
            Eskom’s Proposed Multi-Year Price Determination for 2010/11 to 2012/13

utility should seek to fund capital expenditure with an appropriate mixture of equity
and debt with a long-term tenor.
Eskom’s funding strategy appears to have been shaped by the following constraints:
     •    The projected cost of the capital programme;
     •    The R40 million cap on annual borrows; and
     •    The limited options for equity raising.


Since the second and third factors appear to be hard constraints Eskom is only really
able to control the scale of the capital programme.
SALGA has previously recommended that Eskom consider the option of deferring
Kusile for three years and filling the resulting capacity gap with a combination of
DSM, REFIT and IPP programmes. It is not clear from Eskom’s response in the
Application whether or not this option was considered and, if so, why the option of
deferring Kusile was rejected?
One consequence of Eskom’s heavy reliance on annual cash flows to fund its capital
expenditure is that profits will balloon in future years. 14
(R Millions)                     FY09/10    FY10/11     FY11/12    FY12/13    FY13/14    FY14/15
EBIT                                  710    12,893      36,085     71,239     82,130     95,089
Profit before tax                  -3,478     7,867      29,305     62,811     72,793     85,337
Tax (current and deferred)           -970     2,217       8,231     17,627     20,442     23,973
Net income/-loss                   -2,508     5,650      21,074     45,184     52,351     61,364


Profits after tax are projected to rise to R45 billion by the end of the MYPD2 period,
and on up to R62 billion two years later.
Since Eskom is a company, the rise in annual profits will inevitably lead to a massive
expense on company tax. By year three the tax bill will rise to R17.6 billion and by
year five to R24 billion. This ‘leakage’ from the electricity industry is a direct result of
Eskom’s strategy of funding capital asset creation from annual surpluses – rather
than from long term debt. On the face of it then, there appear to be real grounds to
question whether Eskom’s funding strategy is efficient? Or perhaps more
fundamentally, whether Eskom is trying to do too much with the limited means
available to it?

Is the funding strategy realistic?
Besides efficiency concerns, SALGA also wishes to query whether the funding
strategy is realistic? For instance, on page 20 of its Application Eskom states that,
         “In the absence of a collaborative approach with Government and other
         stakeholders, this approach will increase South Africa’s exposure to risks related
         to security of supply. It will also increase the risk profile of Eskom’s operations




14
          Eskom MYPD2 Application, 30 November, 2009. p83.


                                                 8
                       SALGA Submission to NERSA Regarding
         Eskom’s Proposed Multi-Year Price Determination for 2010/11 to 2012/13

      and financial sustainability. In particular, the assumed levels of borrowings and
      equity are optimistic and may not materialise.” 15

The availability of borrowings and equity will play a crucial role in determining
whether Eskom is able to complete its planned build programme. SALGA is
concerned that any shortfalls in this regard may expose the country to undue risk if
Eskom’s new-build projects cannot be funded, and hence cannot be completed on
time.
Alternatively, Eskom may have to return to NERSA and, once again, request an
interim tariff increase over and above the MYPD2 determination.

Availability of debt
Eskom states that
      “Although it is likely that Eskom will be able to source in excess of R40bn in
      FY09/10, funding in excess of R40bn in FY10/11 and FY11/12 may not be
      feasible and will need to be raised from unconventional sources, which may be
      more expensive than projected.” 16

SALGA requests NERSA to interrogate Eskom’s assumptions regarding its debt-
raising capacity and the nature of the ‘unconventional sources’ referred to above – in
order to evaluate the probability and consequences of any shortfalls in debt funding.

Availability of equity
Besides government’s existing quasi-equity commitments over the MYPD2 period,
Eskom is proposing to raise at least R20 billion in private equity in two equal tranches
in the first and second years of the period. This private equity is proposed to arise
from the sale of a partial stake in the incomplete Kusile power station.
Since the option of private equity was not mentioned in the original Proposal, SALGA
presumes that the idea has only arisen during the 30 days between the submission
of the Proposal and the final Application. SALGA is therefore concerned that Eskom
may not have adequately considered this option or tested its feasibility.
As Eskom notes in its Application
      “To the extent that Eskom can raise sufficient equity funding, it will be in a
      position to moderate tariff increases in the short term. However, equity is the
      most expensive form of funding, which will have an adverse impact on tariffs in
      the long run. As equity participation is traditionally a long-term relationship,
      Eskom must ensure that it brings broader benefits than purely a cash injection.” 17

It is difficult to see how a private investor could bring ‘broader benefits’ to the Kusile
project? Private participation would normally be expected to bring efficiencies in the
areas of design, engineering and procurement. But all these aspects are already
complete or largely complete. Since Eskom clearly intends to remain responsible for
operating the plant there is also no scope for a private investor to influence operating


15
       Eskom MYPD2 Application, 30 November, 2009. p20. Own emphasis.
16
       Eskom MYPD2 Application, 30 November, 2009. p21. Own emphasis.
17
       Eskom MYPD2 Application, 30 November, 2009. p24. Own emphasis.


                                              9
                       SALGA Submission to NERSA Regarding
         Eskom’s Proposed Multi-Year Price Determination for 2010/11 to 2012/13

costs and efficiency outcomes. In fact all the private investor can really do is provide
capital – which as Eskom correctly notes is not without its problems,
      “Equity funding by the private sector will require, inter alia, a long term power
      purchase agreement (PPA) and is likely to be more expensive than Eskom’s
      required returns, putting further upward pressure on tariffs.” 18

Experience to date with Eskom’s procurement programmes for Independent Power
Producers (IPPs) has not been promising. These programmes have all stalled,
mainly because of the lack of certainty as to Eskom’s price path and government’s
funding strategy for the utility – neither of which are under Eskom’s control. As
Eskom notes in its Application,
      “To attract equity finance, the equity financier will require an appropriate return
      on its investment, which is a function of, inter alia, the regulated tariff and the
      cost of debt funding. Equity investors will require a clear insight into the Eskom
      business plan, and will need to gain confidence in the governance structures and
      the ability of management to implement the business plan” 19

Given the level of uncertainty around the Eskom business plan there must be a
significant risk that such a procurement (or sale) will not be finalised within the target
time frame? In which case NERSA should take care to examine the implications of
lower levels of equity for Eskom’s borrowing programme and any other
consequences which may arise.

An alternative approach to raising equity?
In SALGA’s comment on Eskom’s original Proposal it was suggested that Eskom
should consider alternative funding models – including the possibility of selling off
some or all of its existing power stations in order to raise funds for the new
construction programme.
This option may have several advantages over the Kusile sale option. Firstly, the
existing stations have a performance history which investors can evaluate, as
compared to Kusile which has yet to run.
Secondly, existing power stations have no completion risk and no risk of construction
cost over-runs.
And lastly, the outright sale of one or more existing power stations would achieve a
real transfer of risk to a private operator, and therefore the prospect of efficiency
gains, whereas the sale of a minority stake in Kusile brings no prospect of efficiency
gains since Eskom will still be the operator.
Although it is not the place of NERSA or a revenue determination process to dictate
how Eskom should raise equity, it is at least incumbent on NERSA to evaluate
whether Eskom’s proposed funding programme is practical or not.




18
       Eskom MYPD2 Application, 30 November, 2009. p21.
19
       Eskom MYPD2 Application, 30 November, 2009. p27. Own emphasis.


                                              10
                       SALGA Submission to NERSA Regarding
         Eskom’s Proposed Multi-Year Price Determination for 2010/11 to 2012/13

2.6   How efficient is Eskom?
Eskom’s Proposal of 30 September suggested significant cost increases in all areas
of the business. Following stakeholder feedback Eskom has clarified some cost
drivers and committed to cost reductions in some areas. Nonetheless, SALGA is
concerned about the rate of cost inflation projected by Eskom and requests NERSA
to undertake a detailed due diligence of the costing budget. In particular, SALGA
requests NERSA to review the procurement processes which have resulted in what
appears to be an abnormally high capital cost per kilowatt of installed capacity for
Eskom’s two new coal power stations.
SALGA also wishes to query the projected cost of liquid fuel contained in Table 5 of
the Proposal and Application. Based on a standard heat rate for Eskom’s gas
turbines the fuel price per litre appears to be around 1.8x that suggested in Annexure
A: Table of Assumptions. Alternatively the forecast dispatch level may be higher than
the energy sent out shown in Table 5?

2.7   How much risk is too much?
Whereas the Proposal of 30 September mentions the word ‘risk’ on 34 occasions, the
final Application of 30 November has added a further 48 instances.
Eskom is clearly “concerned about the increased risk profile” and goes to great
lengths in its Application to identify and tabulate the various risks that it, and by
extension the country, will face. The utility concedes that
      “…even with a 45% price increase Eskom had significant cash shortfalls and was
      exposed to certain risks. The current approach has increased that risk
      profile. We have made aggressive assumptions, thus increasing the margin for
      error. Any one change could therefore have a significant knock on effect.” 20

Even if Eskom achieves all its internal targets, it still acknowledges that
      “…the treatment of all of the resultant risks are not within the control of Eskom
      and the participation of all stakeholders is necessary to manage these risks to
      ensure a suitable outcome and the achievement of our long-term goals as a
      country. Success depends on a collaborative effort by Eskom, Government,
      customers, business, communities and other stakeholders. An effective
      partnership is therefore necessary to achieve success.” 21

These statements are deeply alarming to SALGA. If the level of risk is as high as
Eskom suggests then surely the country’s decision makers must question whether it
is wise to proceed with the strategy that Eskom proposes?
SALGA is not convinced that Eskom has adequately explored or divulged the
implications for security of supply should one or more of these risks factors come to
pass. The original Proposal and the final Application are largely concerned with
motivating for Eskom’s preferred view of the future – and give little attention to
alternative outcomes other than to identify risk factors and allocate responsibility for
controlling these factors. This is not a robust approach to planning. The country’s


20
       Eskom MYPD2 Application, 30 November, 2009. p20.
21
       Eskom MYPD2 Application, 30 November, 2009. p5. Own emphasis.


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                          SALGA Submission to NERSA Regarding
            Eskom’s Proposed Multi-Year Price Determination for 2010/11 to 2012/13

power strategy should recognize that there is a high level of uncertainty, and have
contingency plans in place to deal with a wider range of circumstances than just the
‘preferred’ scenario. Sensitivity analysis would be an important step towards better
planning. SALGA trusts that the additional confidential information which Eskom has
provided to NERSA includes analysis of this nature?

3 Consideration of Alternatives
3.1       Access to information
Without access to the IRP model and Eskom’s detailed budget and financing
assumptions it is very difficult for SALGA, or any other stakeholder, to accurately
assess the level of risk embedded in Eskom’s Application, and whether it is
appropriate or tolerable for the country.
SALGA trusts that NERSA has been afforded greater access to this kind of
information and that NERSA will question Eskom’s assumptions and undertake the
necessary sensitivity studies before reaching its decision.

3.2       Has Eskom bitten off more than it can chew?
Based on SALGA’s review of Eskom’s Proposal and its final Application, it is difficult
to avoid the conclusion that the utility has bitten off more than it can chew. The
combination of:

      •
      Extended delays by government on new capacity decisions;
      •
      A massive new-build programme which has ballooned in cost;
      •
      Inadequate planning by Eskom and government as to how the new-build
       programme would be funded;
   • Public finance constraints on the amount of equity that can be injected into
       the utility;
   • Lender constraints on the amount that can be lent to Eskom; and
   • Political, social and economic constraints on the rate at which average tariffs
       may be increased
… have all conspired to create intolerable pressure and, it would appear,
unacceptable levels of risk.

3.3       SALGA’s proposed alternative
SALGA and other stakeholders have previously suggested that Eskom, and
government as its shareholder, should consider alternative approaches in order to
reduce risk and lessen the scale of the tariff increase. SALGA’s proposed alternative
consists of three main components:
1. Raise equity through sale of existing assets: If Eskom and government are willing
       to sell a portion of Kusile, then why not consider the sale of one or more of
       Eskom’s existing power stations? On the face of it there are strong reasons
       why this would be a better alternative than the sale of a minority stake in a
       partially built power station;




                                             12
                       SALGA Submission to NERSA Regarding
         Eskom’s Proposed Multi-Year Price Determination for 2010/11 to 2012/13

2. Reduce revenue requirements by deferring capital expenditure: Tariff increases
      could be significantly reduced if at least a portion of the capital programme
      was pushed out into the next MYPD period. There is a high risk that this will
      happen anyway if Eskom’s equity and borrowing projections turn out to have
      been over-optimistic; and lastly
3. Accelerate IPP programmes: It is surprising to SALGA that so little emphasis is
       placed on conventional and renewable IPPs during the MYPD2 period. It is
       unclear whether this is a product of government’s secret IRP, or Eskom’s own
       planning. Since both Eskom and government regard the entry of IPPs as an
       inevitable step there should be no objection to the acceleration of IPP
       projects. These projects will relieve pressure on Eskom’s balance sheet and
       introduce diversity into the generation industry. Because IPP projects are
       generally smaller than Eskom’s projects they are quicker to construct and
       much more flexible. These are valuable attributes in a time of uncertain
       demand and low reserve margins.
Informed commentators have suggested that the application of these three options
could contain MYPD2 tariff increases to below 30% per year. In SALGA’s view this
would be a substantially better outcome than the current Application.

4 Conclusion
SALGA appreciates Eskom’s efforts to increase transparency and move towards a
partnership paradigm. It is a pity that the Department of Energy has failed to follow
the same philosophy with its Integrated Energy Planning process.
SALGA is very concerned about the level of risk to which Eskom is now exposed.
The increased risk arises from the decision to lower the tariff increase from 45% to
35% without making a concomitant reduction in the scale of the capital programme.
SALGA has therefore proposed that Eskom and government consider an alternative
approach based on three main components:
       1. Raising equity through the sale of existing assets;
       2. Reducing revenue requirements by deferring capital expenditure; and
       3. Accelerating IPP programmes.
SALGA believes that these are reasonable and implementable options which should
bring greater flexibility, improved tolerance to uncertainties and a lower level of risk.
SALGA notes that the Eskom Application is primarily concerned with the revenue
which the utility will be allowed to earn for the MYPD2 period – as distinct from the
pricing policy which will allocate this revenue burden across various consumer
categories. SALGA is deeply concerned about the impact of the envisaged price
increases on low income households and requests government, NERSA and the
electricity industry to undertake a review of the Electricity Pricing Policy to see what
could be done to address this concern.
SALGA trusts that these comments will assist NERSA in its difficult task of evaluating
Eskom’s Application.


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