Eskom’s application to NERSA for review of the BHP Billiton electricity pricing agreements

April 7th, 2013, Published in Articles: Energize

by Chris Yelland, EE Publishers

Johannesburg, 7 April 2013

In order to understand the application by Eskom to the National Energy Regulator of South Africa (NERSA) for a review of the special electricity pricing agreements between Eskom and BHP Billiton for Hillside Potlines 1, 2 and 3, and the powers, authority and duties of the Regulator in such matters, it is necessary to look at the relevant South African legislation covering the regulation of electricity and its pricing.

The Electricity Act of 1987

The Electricity Act of 1987 and its various subsequent amendments have largely been repealed and replaced by the National Energy Regulation Act of 2004 and the Electricity Regulation Act of 2006. A 1994 amendment to the Electricity Act established the National Electricity Regulator (NER) as successor to the former Electricity Control Board. The Electricity Act required that, unless the Electricity Control Board (or the Regulator after 1994) determined otherwise, Eskom may not charge any customer tariffs other than those specified in the schedule of approved tariffs in its license, and that the Electricity Control Board (or Regulator) may, in specific circumstances, approve a deviation from a schedule of approved tariffs.

The National Energy Regulation Act of 2004

The National Energy Regulation Act of 2004 establishes and defines the powers, duties, composition and functioning of a single Energy Regulator (NERSA), as successor to the National Electricity Regulator (NER), to regulate the electricity, piped-gas and petroleum pipeline industries. NERSA is required to act in a transparent manner and in the public interest (as opposed to any individual or sectorial interest), independently of undue influence or instruction. Its decisions and rulings must be within its powers as defined in the Act, in the public interest, procedurally fair and consistent with the constitution and laws of South Africa. Decisions and rulings by NERSA must be in writing, based on evidence, facts and reasons that must be summarised, recorded and clearly explained as to their factual basis. NERSA decisions and reasoning must in general be made available to the public except for information protected in terms of the Promotion of Access to Information Act of 2000, and may be taken on judicial review and/or appeal in the courts.

The Electricity Regulation Act of 2006

The Electricity Regulation Act of 2006 establishes a national regulatory framework for the electricity supply industry, and makes NERSA the custodian and enforcer thereof. The objectives of the Act are to achieve efficient, effective, sustainable and orderly development and operation of electricity supply infrastructure in South Africa, ensure the interests and needs of present and future electricity customers and end-users are safeguarded and met, facilitate investment in the electricity supply industry, facilitate universal access to electricity, promote diversity of energy sources and energy efficiency, and facilitate a fair balance between the interests of licensees, electricity customers, end-users, investors and the public.

The powers of NERSA include the regulation and approval of electricity prices and tariffs, both standard and special, and to issue rules to implement the government policy framework, the Electricity Regulation Act itself, and the national integrated resource plan for electricity. In setting and approving tariffs, NERSA must ensure that a licensee does not charge a customer any other tariff or make use of provisions in agreements other than that determined or approved by the Regulator as part of its license conditions. NERSA must also prevent undue discrimination between customers or classes of customers in respect of access, tariffs, prices and conditions of service, except for objectively justifiable and identifiable differences approved by the Regulator.

Investigations and dispute resolution in terms of the Electricity Regulation Act of 2006

On receipt of a complaint or report of undue discrimination regarding tariffs where a licensee is involved, the Regulator must institute a formal investigation as prescribed in the Act. On completion of the investigation, a report must be submitted to the Regulator, who may then direct the licensee to rectify the matter within a reasonable time, failing which severe penalties may be applied. In relation to a dispute between a licensee and a customer or end-user of electricity arising out of this Act, the Regulator may undertake investigations and inquiries into the activities of the licensee, and must settle the dispute by such means and on such terms as the Regulator sees fit.

The Hillside Potline 1 and 2 negotiated pricing agreement

The contracts covering the special pricing arrangements between Eskom and Hillside Aluminium forPotlines 1 and 2 were signedon 11 November 1992 at a time whenDr. Ian McRae was the CEO of Eskom, and subsequentlycame into effect on 30 July 1995 at a time when Dr. McRae was the first chairman and CEO of the National Electricity Regulator. The negotiated pricing agreements deviate materially from any standard Eskom tariffs, and the energy and demand rates are directly proportional to the current aluminium price measured in US $ per ton, and the Rand/US $ exchange rate. There is no escalation or linkage to either the US Producer Price Index or the SA Producer Price Index, or to Eskom’s cost of generation or transmission. Nor are there any top or bottom limits to the energy or demand price. As such the electricity rates are not cost reflective in any sense. In recent times, the electricity price for Potline 1 and 2 has been less than half Eskom’s current average cost of supply, and less than Eskom’s current cost of primary energy.

Section 9 of the Electricity Act of 1987 requires that Eskom may not charge a customer tariffs other than those approved by the Electricity Control Board (or Regulator after 1994) and listed in the schedule of tariffs in Eskom’s license, and that the Electricity Control Board (or Regulator) may, in specific circumstances, approve deviations from the schedule of approved tariffs. However the specific circumstances in which the Regulator at that time could approve such deviations, and whether the Electricity Control Board or Regulator in fact approved the special pricing arrangements to Hillside Potlines 1 and 2 remain unclear. Neither NERSA nor Eskom appear to have any written or other record of decision in this regard.

Furthermore, Sections 14 and 21 of the Electricity Regulation Act of 2006 make it a condition of license that there should be no undue discrimination between customers or classes of customers in respect of tariffs and prices, except for objectively justifiable and identifiable differences approved by the Regulator. Although Dr. McRae’s wide experience in the electricity supply industry of South Africa and his key role in establishing the NER is widely acknowledged and praised, his term of office as chairman and CEO of the NER ended in 1997 amid some criticism of the conflicts of interest inherent in having an immediate past Eskom CEO serve as the Regulator of both Eskom and the municipal electricity distributors that procure power from Eskom.

The Hillside Potline 3 negotiated pricing agreement

The electricity supply contract containing the special pricing arrangements for Hillside Potline 3 was signed on 10 December 2001, and electricity supply was to commence no later than 30 June 2004. Unlike Hillside Potlines 1 and 2, the energy and demand rates for Potline 3 are not linked to the aluminium price in US $ per ton or to the Rand/US $ exchange rate. Instead, the initial energy and demand rates are those of the 2001 Eskom Nitesave tariff, escalated at the beginning of each subsequent year after 2001 based on changes in the South African Producer Price Index. The effect of the negotiated price agreement for Hillside Potline 3 is to lock the energy and demand prices, starting at the 2001 levels that are widely acknowledged to be significantly below Eskom’s average cost of supply, and thereafter to escalate the 2001 prices annually only by the SA Producer Price Index, while the balance of customers in South Africa suffer massive annual electricity price increases of many times the official inflation rate, as Eskom moves to cost reflective pricing.

One of the suspensive clauses of the Hillside Potline 3 contract was the Regulator’s approval of the special pricing arrangements by no later than 18 December 2001. In a letter to BHP Billiton on 5 February 2002, Eskom confirmed that the National Electricity Regulator (NER) had approved the special pricing arrangements, and that the suspensive conditions of the contract had been met. The CEO of the NER between 1999 and 2004 was Dr. Xolani Mkwhanazi, who is currently the chairman of BHP Billiton South Africa, and is listed in Who’sWho Southern Africa as president and COO of Aluminium South Africa at BHP Billiton.

Eskom’s application to NERSA for review of the negotiated pricing agreements

Electricity is a regulated commodity, Eskomis a regulated licensee of NERSA for the generation, transmission and distribution of electricity, and BHP Billiton is a customer and end-user of electricity under two different negotiated pricing agreements (Hillside Potline 1 and 2, and Hillside Potline 3) that deviate significantly from Eskom’s standard approved tariffs. The relevant and applicable South African legislation requiredapproval by the Electricity Control Board (before 1994) or the Regulator (after 1994) for all standard and negotiated tariffs and electricity price agreements between Eskom and its customers, and there are various procedures, conditions and requirements incumbent onthelicensee and the Regulator in respect of negotiated pricing agreements. For the last few years, Eskom has been trying to renegotiate the Hillside Potline 1, 2 and 3 contracts, while BHP Billiton has resisted any such renegotiation. The aluminium producer’s chairman in South Africa, Dr. Xolani Mkhwanazi, has stated publicly that it expects Eskom to honour the special pricing agreements, which extend until 2028.

In terms of the Electricity Regulation Act of 2006, a licensee or customer such as Eskom or BHP Billiton, or any other customer that feelsprejudiced orunduly discriminated against by the special pricing agreements, may refer the matter to the Regulator for investigation, and in terms of the Act the Regulator (or an independent mediator / arbitrator appointedby the Regulator) has powers of review and mayreach a decision and ruling, which ruling is regarded as the ruling of the Regulator. On 17 October 2012, Eskom submitted a formal application to NERSA for an investigation and review of the special pricing agreements in terms of Sections 15 and 32 of the Electricity Regulation Act in which it was argued that due to changed circumstances in South Africa the special pricing agreements are no longer in the public interest, prejudice the national security of supply and the economy, and unduly discriminate against and prejudice other customer classes and millions of customers paying Eskom’s standard tariffs. In its application, Eskom requests NERSA to address the validity of the public concerns and determine whether the special tariffs remain objectively justifiable in the current environment. As a result of the unresolved dispute between a licensed electricity supplier and an electricity customer and end-user consuming some 9% of Eskom’s electricity, in terms of its authority and powers under the Electricity Regulation Act of 2006, the Regulator is obliged to intervene and settle the dispute by such means and on such terms as it sees fit.

Conclusion

After being kept behind a veil of secrecy for decades by both Eskom and BHP Billiton, with claims that BHP Billiton would suffer untold competitive and otherdamages if details of the special pricing arrangements were made know,the courts ruled against BHP Billiton, and ordered details of the special pricing agreements to be made public. The judgement by the Supreme Court of Appeal on 15 March 2013 has thus paved the way for NERSA to proceed with the review requested by Eskom on 17 October 2012.

As Eskom is one of the parties to and a signatory of the contracts, with commercial vested interests therein, and accepted the special pricing agreements for many years when the prices were more favourable to the utility, perhaps its application for review by NERSA would be more credible and powerful coming from a customer, or members of a consumer body or industry association directly discriminated against and prejudiced by the special pricing arrangements. It may be that such customers or organisations may yet join the action with further requests for review.

In the light of the relevant legislation, background and circumstances detailed above, it would certainly appear that there is justification at this time in the public and national interest for an independent and open review of the special pricing agreements to resolve the ongoing dispute between the national electricity supply utility and the biggest customer of electricity in South Africa.While BHP Billiton SA’s chairman and former NER CEO,Dr. Xolani Mkhwanazi, is obviously vigorously defending the sanctity of the contracts that are so favourable to his company, as well as the NER’s owndecision approvingthe Hillside Potline 3 contract at the time, the current Regulator may well consider that the wider interests of the country, the public and the electricity supply industry should take precedence.

However, any NERSA decision may be taken on judicial review and/or appeal in the courts, where the law of contract may take higher priority through the eyes of a judge. And with so much at stake, whatever the Regulator rules, it seems almost inevitable that any decision by NERSA will be taken on review and appeal – perhaps all the way through to the Constitutional Court – in which case this matter will, in all likelihood, drag on for many years to come.

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