Submission to NERSA: Eskom’s application for a “selective reopener” of MYPD 3

June 22nd, 2015, Published in Articles: EE Publishers, Articles: Energize

 

This submission is in response to Eskom’s application on 30 April 2015 to NERSA for a “selective reopener” of NERSA’s third multi-year price determination (MYPD 3), for the period 1 April 2015 to 30 March 2018.

Click here for the slides presented at the NERSA public hearings on 23 June 2015

Chris Yelland, EE Publishers

NERSA’s task as Regulator is to ensure the financial sustainability of Eskom by allowing the utility to recover, through electricity tariffs, all its efficiently and prudently incurred operating costs, plus a fair return on assets employed.

Eskom’s application seeks to pass through to customers of electricity via its tariffs in the three year period from 1 April 2015 to 30 June 2018:

  • A 2c/kWh increase (from 3,5c/kWh to 5,5c/kWh) in the “environmental levy” on electricity generated from carbon fuels.
  • Additional estimated diesel costs amounting to R32,9bn (i.e. an average of about R11bn per year for three years) for its open cycle gas turbines (OCGTs).
  • The full estimated cost of power purchased from independent power producers (IPPs) via Eskom’s short-term power purchase programme (STPPP) amounting to R17,5bn (i.e. an average of R5,8bn per year for three years).

Eskom calculates that for its 2015/16 financial year (from 1 April 2015 to 30 March 2016), if such additional costs are recovered evenly over the full twelve months, this would result in an additional price increase of 12,61% over and above the 12,69% increase already approved by NERSA that came into effect on 1 April 2015. This would make a total Eskom price increase for the 2015/16 financial year of 12,69% + 12,61%  = 25,3%.

The additional 12,61% price increase applied for by Eskom for 2015/16 is made up of:
2,51% (environmental levy) + 6,77% (diesel) + 3,33% (STPPP) = 12,61%

Cost impact is worse than it seems

However, the reality is that if NERSA were to grant the additional 12,61% price increase by the planned date of 30 June 2015, an Eskom price increase would only take effect from 1 August 2015 at the earliest, and the costs would have to be recovered over the remaining eight months of the Eskom’s 2015/16 financial year.

This would make the additional price increase for the remaining eight months of the 2015/16 financial year significantly higher, namely 12,61% x 12 / 8 = 18,92%.

This would also make the total price increase for the remaining eight months of the 2015/16 financial year higher still, namely 12,69% + 18,92% = 31,61%.

Affordability

While Eskom may claim to find it difficult to afford and absorb these (heavily overstated) costs of R11bn + R5,8bn = R16,8bn per year for three years, the acting Eskom CEO paints a different picture, and the reality is that the true unbudgeted extra cost that will be incurred by Eskom is in fact a only a small fraction of R16,8bn, as will be shown later in this submission.

Yet Eskom is attempting to pass these full heavily overstated costs of R16,8bn per year through to its customers, who have certainly not budgeted for any such costs increases, while the question of affordability to the customer, be it to ordinary citizens or to the productive economy, is completely ignored by Eskom in its application.

The question of affordability of Eskom’s proposed increase to domestic, commercial, agricultural, industrial, traction and mining customers will no doubt be more that adequately covered by other submissions, and will therefore not be dealt with in any detail here.

Financial impact

However, as just one example of the dire consequences of Eskom’s application for an additional 12,61% price increase for 2015/16, over and above the 12,69% already granted from 1 April 2015, consider the impact on municipal finances, as follows:

Municipalities have formal, consultative, budgeting processes governed by the Municipal Finance Management Act. In light of the well-known statutory timelines for such processes, the additional price increase that may be determined by NERSA (which is still unknown at this stage) has obviously not been included in their budgets and tariffs for their financial year commencing 1 July 2015.

Indeed, a directive from the National Treasury to municipalities (Annexure D of the Municipal Finance Management Act Circular No. 75, dated 25 May 2015) states that: “Any decision that NERSA makes after 15 May 2015 will need to be deferred to the 2016/17 municipal financial year.”

It is clear that the Minister of Finance has the authority to extend the deadline date beyond 15 May 2015, but the fact is that: the Minister has already exercised his authority to extend the deadline date from 15 March to 15 May 2015; the minister has not extended this further; and the National Treasury has instead issued the above directive on 25 May 2015.

This means that any further price increase determined by NERSA for Eskom for 2015/16 cannot be passed by through by municipalities to their own electricity customers. This will have serious financial impacts for municipalities, many of whom are not in a good financial position already.

Nor will municipalities be able to pay Eskom for any price increases after 15 May 2015 for the 2015/16 financial year, as such expenditure would be clearly unbudgeted and unauthorised by the National Treasury.

What makes such application for a “selective reopener” by Eskom at this late stage of the budgeting process particularly vexing to municipalities is that Eskom has known for at least the prior nine months of the need to raise the matter of excessive diesel usage and STPPP costs from 1 April 2015, as well as the municipal budgeting timelines involved, yet through its own deficiencies has only issued its application at this late date, making effective consultation and due process by NERSA, and budgeting and planning by municipalities and other electricity customers, all but impossible.

Environmental levy not applicable

Some 2,51% of the 12,61% price increase applied for by Eskom would be to recover a 2c/kWh increase from 3,5c/kWh to 5,5c/kWh in the “environmental levy” on electricity generated from carbon fuels, which was announced by the Minister of Finance in his budget speech on 25 February 2015.

However, while this increase has not been published in the Government Gazette, and is therefore not yet in effect, Eskom’s application has assumed that the environmental levy will take effect on 1 July 2015.

Furthermore, there is still some doubt as to whether the environmental levy will even be implemented or not, and an implementation date of 1 July 2015 cannot be taken as a given at this stage.

Therefore it is suggested that NERSA should reject Eskom’s application for a price increase to recover any increase in the environmental levy until such time as the effective date of the levy increase is formally announced.

 Diesel and STPPP costs claimed by Eskom result from its own failings

On page 5 of Eskom’s application to NERSA for a “selective reopener” of MYPD 3, the utility acknowledges that: “In the original MYPD 3 submission, assumptions were made around the commissioning dates of Medupi, Kusile and Ingula, and the expected performance of the current generation plant, which have since changed. As a result, no provision was made for the extensive running of OCGTs and the continuation of the STPPP agreements”.

Eskom goes on further to state on page 6 of its application for a “selective reopener” that: “Since the MYPD 3 application, various factors including the further deterioration of generation plant performance; unexpected significant events such as the boiler explosion at one of the Duvha units; and the collapse on the Majuba power station silo” have necessitated the use of “more expensive supply options like the use of the OCGTs and looking for more short-term supply options to close the demand gap”.

The question therefore arises as to why Eskom is applying to pass any additional (unbudgeted) costs of diesel and STPPP energy costs through to the customer in the tariff at all, when, by the utility’s admission, such costs result directly from its own failings (i.e. the late completion of Medupi, Kusile and Ingula; the boiler rupture at Duvha; and the silo collapse at Majuba); and can therefore, by no stretch of the imagination, be considered as prudently and efficiently incurred.

Eskom’s extra costs are overstated, and ignore all cost reductions that benefit the customer

It is quite clear from the extracts of Eskom’s application quoted above that the utility intended to produce electricity from Medupi, Kusile and Ingula in the MYPD 3 period from 1 April 2015 to 30 March 2018, and that such costs have been budgeted and included in MYPD 3. Had it not been for the utility’s own failings, the need for extensive use of the OCGTs and STPPP energy purchases would have been avoided.

However, in the event that NERSA may even entertain passing through to customers via Eskom tariffs any additional diesel and STPPP costs at all, it is noted that Eskom’s claims for additional costs of R11bn for diesel and R5,5bn for STPPP energy for its 2015/16 financial year are clearly significantly overstated, and should be offset by an amount corresponding to the cost of electricity already budgeted and included in MYPD 3, and which was to have been supplied by Medupi, Kusile and Ingula.

However, to Eskom’s discredit, it has not even mentioned any such offsets in its application to NERSA for a “selective reopener”, let alone provided any disclosure of the costs of electricity from Medupi, Kusile and Ingula that have already been budgeted and included for in MYPD 3.

Inadequate disclosure

As such, Eskom’s application to NERSA for a “selective reopener” of MYPD 3 can be seen not only to be deficient, but also dishonest in terms of ignoring any applicable cost offsets.

The disclosure of information in Eskom’s application is also completely inadequate for analysts, electricity customers and the general public to make any serious quantitative response, and as such it is believed that the application should be rejected by NERSA and sent back to Eskom for rework.

Simplified recalculation taking into account cost offsets

In the absence of disclosure by Eskom of any offset costs, a simplified example below, using some conservative assumptions, calculates a revised electricity price increase, taking into account such offsets. It is noted that NERSA and Eskom will no doubt have at their disposal suitable resources and data to perform this recalculation very accurately.

In 2012, NERSA calculated and stated publicly that the levelised cost of electricity (LCOE) from Medupi was likely to be about R0,97 per kWh, and on this basis, a conservative assumption for LCOE from Medupi, Kusile and Ingula is taken, for the purposes of this example only, as R1,00 per kWh.

For Eskom’s extra R11bn diesel claim for 2015/16, the price application states that this corresponds to generation of 450 GWh a month from Eskom’s OCGTs. This would then result in an offset amount of 450 GWh x 12 months @ R1,00 per kWh = R5,4bn, and Eskom’s claim should therefore be reduced from R11bn to R5,6bn (i.e. R11bn – R5,4bn) for the 2015/16 financial year.

For Eskom’s R5,4bn claim for STPPP energy purchases in 2015/16, the price application states that: in 2013/14 Eskom spent R815m procuring 931 GWh (i.e. R0,88 per kWh) on the STPPP ; in 2014/15 it projected to spent R1,561bn procuring 1651 GWh (i.e. R0,95 per kWh); and in 2015/16 it projects to spend R5,4bn. Assuming a price of about R1,05 per kWh for 2015/16, this translates into STPPP energy to be procured in 2015/16 of R5,4bn / R1,05 per kWh =  5143 GWh.

With a levelised cost of electricity from Medupi, Kusile and Ingula of R1,00 per kWh as above, this would result in an offset amount of 5143 GWh @ R1,00 per kWh = R5,1-billion, and Eskom’s STPPP claim should therefore be reduced from R5,4bn to R0,3bn (i.e. R5,4bn – R5,1bn) for the 2015/16 financial year.

The impact of excluding an increase in the environmental levy (for the time being), and including the above offsets, would be a reduction in Eskom’s claim for an extra price increase for its 2015/16 financial year, from the 12,61% claimed to 3,63%.

It should be noted that every effort for the past twelve months by this author to establish from Eskom the updated estimated cost-to-completion (CTC) and levelised cost of electricity (LCOE) from Eskom for Medupi and Kusile has failed, and Eskom simply refuses to disclose this information.

Cost increases for 2016/17 and 2017/18

While it is probably correct that additional diesel and STPPP costs are inevitable for 2015/16, it is certainly not correct that the associated offsets to these costs in 2015/16 are simply ignored, as Eskom has done.

However the assumption by Eskom that additional diesel costs of R11bn per year to operate OCGTs as mid-merit generation plant for the 2016/17 and 2017/18 financial years are the most cost effective solution to meeting generation capacity shortfalls, is also almost certainly not correct.

Yet no alternative mitigation techniques and associated costs (such as integrated demand side management, demand market participation, power buy-backs, increased renewable energy procurements, power ships, conversion of OCGT diesel fuel to imported liquefied natural gas, increased industrial cogeneration, etc.) are presented or considered in Eskom’s application for a “selective reopener” to MYPD 3.

It would appear that Eskom has simply chosen, in its own interests, to maximise its price increase and to include the most expensive option of all for the next three years, even though it is likely that cheaper options will almost certainly be used in 2016/17 and 2017/18.

Alternatives to a price increase

It is sometimes claimed by Eskom (and others) that NERSA’s failure to grant Eskom the price increases it wants places the entire financial sustainability of Eskom, and therefore the economy of South Africa, at risk. It is further claimed that there are no alternatives for Eskom other than to increase tariffs to ensure the financial sustainability of Eskom.

However, in a recent presentation to financial journalists, a cash flow forecast was presented by acting Eskom CEO Brian Molefe, which was premised on no 12,61% additional price increase by NERSA at all for 2015/16. A similar presentation was made by Mr. Molefe to Parliament on 12 June 2015.

In his presentation, Mr. Molefe stated that that even without the additional 12,61% price increase for 2015/16 there would be no problem in rolling over R10bn of debt that becomes due for repayment in 2015, and raising additional gross funding of R66bn by the end of 2015 (comprising R55bn debt + R10bn private placing + R1bn other funding).

This submission to NERSA makes it clear that Eskom’s application for an additional price increase of 12,61% is grossly overstated and should be no more than an additional 3,63%, if at all. Furthermore, Mr. Molefe’s presentation to journalists and Parliament shows that Eskom is ready and able to cope financially without undue hardship without any additional price increase at all for 2015/16. It is also clear that the damage to the economy and municipal finances, and the hardship faced by the general public, would be very significant, and far outweighs the relatively low additional costs to Eskom, which are entirely of its own making and a result of its own failings.

There are also significant other funding options available to Eskom and its shareholder such as: sale of non-core assets by the shareholder to provide additional equity; sale of specific non-core assets by Eskom to raise capital; sale of specific generation assets by Eskom to raise capital; unbundling and restructuring of Eskom generation in line with the 1998 government white paper on energy policy; taking on of strategic equity partners to raise capital and gain new management skills, know-how, resources, technology and vision; increased public participation in Eskom through an initial public offering on the JSE and other bourses; and/or combinations of the above.

Conclusion and recommendations

In light of the above submission, the meaning of the term “selective reopener” in Eskom’s mind becomes clear, namely: Eskom gets to select the highest possible costs that should be passed through to the customer for the next three years; and Eskom also elects to ignore any cost offsets that may benefit the customer.

In conclusion to this submission, it is therefore recommended that:

  • NERSA should reject Eskom’s application for a price increase to recover any increase in the environmental levy until such time as the effective date of the levy increase is formally announced.
  • Due to the inadequate disclosure of information to enable a rational consideration of additional costs, offsets and technology options to meet the generation capacity shortfalls 2016/17 and 2017/18, NERSA should reject Eskom’s application for a “selective reopener” for the last two years of MYPD 3, and NERSA should only consider the selective reopener of MYPD 3 for the 2015/16 year. Eskom should therefore be instructed to rework and resubmit any application for a reopener for the last two years of MYPD 3 if it feels this to be necessary.
  • Due to:

– the significantly overstated additional costs claimed by Eskom for 2015/16 without any disclosure of offsetting cost reductions in this period;
– acknowledgement by Eskom that the additional diesel and STPPP costs incurred are a result of its own failings;
– acknowledgement by the acting Eskom CEO that Eskom can proceed without any additional price increase for 2015/16 without any difficulty;
– the significant damage to the economy and hardship to domestic customers that would result from any additional price increase over and above the 12,69% increase approved from 1 April 2015; and
– the ruling by the National Treasury that any decision that NERSA makes for an additional price increase after 15 May 2015 will need to be deferred to the 2016/17 municipal financial year;

NERSA should therefore reject Eskom’s application for any additional price for 2015/16.

  • In the event that NERSA may entertain the possibility of any additional price increase for 2015/16 at all after taking the above into account, this should be limited to 3,63%, or as otherwise determined by NERSA after a thorough investigation and recalculation of the net diesel and STPPP cost increases, taking into account the applicable offsetting cost reductions in this year.
  • NERSA should advise Eskom and its shareholder to seriously consider funding options to recapitalise Eskom and ensure its financial sustainability other than simply applying for massive tariff increases year after year.

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