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The case for and against Eskom’s R22.8bn clawback application

The case for and against Eskom’s R22.8bn clawback application

Photo by Duane Daws

29th January 2016

By: Terence Creamer

Creamer Media Editor

  

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It feels very much like a case of déjà vu as South Africa’s State-owned electricity utility seeks to claw back a whopping R22.8-billion for the first financial year, 2013/14, of the third multiyear price determination (MYPD3).

As has now become an entrenched pattern, Eskom has been facing a barrage of tough questions from the five National Energy Regulator of South Africa (Nersa) panellists presiding over Eskom’s Regulatory Clearing Account (RCA) application, amid intense criticism from stakeholders, who argue that Eskom rather than consumers should bear the brunt of revenue variances that had arisen owing to “management failings”.

Should the RCA application prevail, the implications for the electricity tariff, which has already almost quadrupled in less than ten years, would be significant. Indeed, if the full RCA amount sought were to be approved (which is unlikely), tariffs could rise by nearly 17% from April 1, instead of the 8% already sanctioned for the year and for each of the five years of the MYPD3, which runs from April 1, 2013, to March 31, 2018.

Nersa kicked off its hearings in Cape Town and will conclude the RCA consultation process in Midrand on February 5, with a determination to be made on February 26.

However, there has been one noticeable change in Eskom’s approach when compared with previous hearings, with CFO Anoj Singh and a number of Eskom specialists making the case rather than the far more combative CEO, Brian Molefe. The result has been a less acrimonious exchange with the Nersa panel, particularly when compared with the unsuccessful selective reopener, which was rejected by Nersa in 2014.

Nevertheless, Singh has faced robust questioning by Thembani Bukula, Jacob Modise, Nomfundo Maseti, Khomotso Mthimunye and Dr Rob Crompton regarding the prudence of Eskom’s application for additional primary- energy expenses, especially the R8-billion for extra diesel, and its calculation of a R11.7-billion “revenue variance”, arising as a result of lower electricity sales volumes during the period.

Eskom sold 194 778 GWh under its standard tariff, compared with the MYPD3 volume estimate of 208 442 GWh, resulting in lower revenue of R7.3-billion. In addition, the utility said it had received R3.8-billion less in revenue from its negotiated price agreements with the BHP Billiton aluminium smelters, which were spun off into South32, than had been allowed for in the determination.

Questions were raised as to what progress Eskom had made in dealing with the cheap smelter deals, which it had itself indicated were no longer sustainable in the current price environment. Questions were raised as to whether Eskom should be allowed to claw back revenue through the standard tariff for underrecovery on the special pricing deals with the smelters, as well as cross-border sales.

The application, Eskom insisted, was in line with the RCA methodology and had arisen as a result of a substantial difference between its audited costs and revenue for 2013/14, compared with that allowed for under the MYPD3 determination.

Singh also stressed that additional costs of R10-billion incurred during the year had been excluded from the application, including take- or-pay coal contracts for the much-delayed Medupi project, which was meant to begin operating during 2013, but only entered commercial operations in 2015. Also not included was R24-million, which Eskom said was its estimate of the loss of sales directly attributable to load-shedding.

Diesel Dust-Up
A key component of the RCA related to a more expensive primary-energy mix, compared with the MYPD3 assumptions, with a mammoth R8-billion more being spent on diesel used to operate the open-cycle gas turbines (OCGTs).

The prudence of Eskom’s diesel burn emerged as a key focus area for the panellists, with the R8-billion being sought close to the R10-billion approved by Nersa for the entire five-year determination period. In fact, Eskom spent R10.6-billion on diesel during the year, which was significantly higher than the approved level of R2.5-billion.

The extensive use the OCGT plants was justified by Eskom as being more prudent than the alternative of more frequent use of load- shedding, the economic cost of which was far higher than the cost of diesel.

The utility also argued that its use of the diesel- fuelled power plants, even during periods of low demand, had been technically prudent, as it had improved security of supply and sustained network integrity.

Nevertheless, Singh acknowledged that its attempt to clawback R8-billion for diesel use in 2013/14 was a “contentious” aspect of the application.

Besides diesel, Eskom was also seeking an additional R2-billion for extra net coal burn, R580-million more for additional spending with domestic independent power producers (IPPs) and R1.1-billion more with regional IPPs.

The coal burn variance, Eskom added, was the result of a combination of the positive volume variance of R1.4-billion and a negative coal price variance of R3.4-billion. The utility insisted that it had excluded the R1-billion coal costs relating to the Medupi take-or-pay agreement.

Eskom also included R2.5-billion for additional ‘other primary energy’, which it said was linked to costs for start-up gas and oil and nuclear fuel costs.

The extra nuclear fuel costs arose following a reassessment of the costs associated with the management of spent fuel, which came in R884-million higher than initially estimated.

Prudence Review
Nersa’s adjudication process would need to assess whether these costs were “prudently incurred” and/or would have been incurred by an efficient, prudently operated utility.

Eskom insisted that the application, the mathematics and compliance of which had been verified by Deloitte, was not based on forward-looking costs and budget estimates and did not offer an estimate of prudence, which was the “domain of Nersa”.

Nevertheless, the R22.8-billion was a substantial amount, representing nearly half of the utility’s 2015/16 funding requirement of about R47-billion. Should it be approved, it would improve Eskom’s ability to meet its financial commitments, its financial ratios and support its borrowing programme. It would not be sufficient, though, to return Eskom to an investment-grade credit rating.

In addition, given the unsuccessful selective reopener of 2015, the RCA application was being closely watched by investors, with Eskom acknowledging that the outcome might prove to be one of the most important factors in determining the price of its bonds and the cost of debt when it again attempted to access the local and global debt capital markets.

Singh stressed the legitimacy of the RCA application, arguing that the costs were incurred in the execution of its mandate to supply electricity.

He said the R8-billion extra spent on diesel had been incurred in the interests of avoiding the detrimental impact of load-shedding on the South African economy. “The negative economic impact was minimised during this period, with only three incidents of load curtailment and one incident of load-shedding for 13 hours.”

The utility also asserted that prudence was not a test of perfection, but rather a test of whether its actions were reasonable in the prevailing circumstances and without the benefit of hindsight.

Therefore, Singh called on Nersa to “consider the application in a balanced and constructive manner, taking into account all stakeholder needs”.

Strong Objections
However, all the other presenters at the hearing implored Nersa to prioritise South African consumers when making its determination, which was expected before the end of February.

Most also emphasised the weak economic climate and the deleterious effect that higher tariffs could have on the economy, as well as on investment and jobs.

The City of Cape Town’s Dr Leslie Rencontre said any additional increase in the tariff would have a further negative impact on Cape Town’s economy, revealing that the city had already sold 22% less electricity in 2014/15 than had been the case in 2006/7. He said electricity theft had also increased across socioeconomic groups as tariffs had risen over the past few years.

Rencontre urged Nersa to ensure that the 2016/17 tariffs were as close to the 8% determination as possible and also called for urgent reso- lution, noting that the city needed to make its budget and tariff proposals for 2016/17 available for public comment by the beginning of April 2016.

The South African Local Government Association’s Nhlanhla Ngidi added that, while the organisation supported Eskom’s financial sustainability, this should not come at the detriment of the public as a whole.

The National Association of Automotive Component and Allied Manufacturers’ Roger Pitot was more forthright in his condemnation of the RCA application, arguing that, if approved, it would undermine the competitiveness of an industry that had already shed 4% of its 50 000 jobs in the past two years.

Pitot said Eskom had proven itself to be an inefficient operator, with unplanned outages rising and the industry headcount dropping, while sales fell and projects were delayed.

“Eskom is clearly inefficient and is seeking to recover its inefficiencies through the RCA,” he said, while calling on Nersa to end the vicious cycle by insisting on a revised business plan detailing how the utility would migrate from its current position to become a globally competitive power producer.

Similar concerns were raised by Virgin Active’s Grant Scott, who warned that business was no longer able to absorb further tariff hikes, particularly given the impact on an already weak South African economy.

Project 90 by 2030’s Happy Khambule, meanwhile, urged Nersa to protect the public by advi- sing Eskom to pursue alternative funding options rather than applying for “massive tariff increases year after year”.

The Southern African Faith Communities’ Environment Institute’s Liz McDaid argued that Nersa should direct Eskom to its shareholder and the Department of Energy in order to revise the law to exclude profit making as part of Eskom’s mandate.

Agri Western Cape CEO Carl Opperman warned that farmers would be hard-pressed to absorb further increases.

“The effect of electricity costs will compound severely on the economic viability of wheat production,” Opperman warned, noting that drought conditions had already resulted in the Western Cape’s wheat production declining by 200 000 t last season, which represented a financial impact of R1-billion.

For the table grapes sector, where the current electricity cost per hectare was R14 000, or R255-million a year for the industry as a whole, any increase would result in electricity making up more than the current 6% of the total costs.

Meanwhile, Cape Chamber of Commerce and Industry executive director Sid Peimer argued that Eskom’s overestimation of demand during the period, as well as spending nearly 400% more than allocated on diesel to operate its open cycle gas turbines, raised serious questions about Eskom management and its ability to forecast.

“Our message is simple,” Peimer said. “First bring your costs under control before you ask business and the public for more money to pay for past mistakes.”

Peimer also described the reliance on tariff increases to keep Eskom afloat as “self-defeating”, as it would result in more and more consumers defecting from the grid. He also argued that it would send the wrong signal to penalise consumers for their more efficient use of electricity.

Edited by Martin Zhuwakinyu
Creamer Media Senior Deputy Editor

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