In this opinion piece, the authors warn that the current approach to electricity tariff regulation is placing strain on the financial viability of municipalities

By Patrick Kelly and Patrick Naidoo

Annual increases in municipal charges take place in July each year and this week Stats SA’s Consumer Price Index reported that municipal electricity tariffs increased on average by 7.5%. This is slightly less than the 7.6% increase that the National Energy Regulator of South Africa (Nersa) set as a ceiling for municipal electricity increases. In turn, this maximum increase allowed is less than the 9.4% overall increase that Nersa permitted to Eskom following public hearings earlier in the year – although a recent court ruling, which is being appealed by the regulator, could affect this.

Meanwhile municipal debt owed to Eskom has been increasing, and last year the power generator threatened to cut off supply to 20 mainly rural municipalities. Eskom reports that the arrears debt is a serious threat to its financial liquidity. Total municipal debt to Eskom has doubled in each of the past three years to reach R5-billion at the close of Eskom’s 2016 financial year.

Given the historical uneven distribution of electricity in South Africa, municipalities are under a constitutional obligation to provide electricity in an equitable and sustainable manner. There is no doubting the massive improvement in equitable access to electricity. Stats SA’s 2016 Community Survey reported that over 90% of all households have an electricity connection compared with 77% in 1996. The nonfinancial census of municipalities, published by Stats SA, shows that the number of consumer units with a municipal electricity connection increased from 7.2-million in 2006 to 10.9-million in 2015. However, this expansion of electricity provision has challenged municipal financial sustainability.

There are two forms by which the poor are provided with electricity. Very poor families qualify for free basic electricity (FBE) – the cost of which is paid from national government transfers. Approximately 2.7-million households benefitted from FBE provided by local authorities in 2015. Households that use little electricity – but more than the free allocation – are cross-subsidised by higher-use customers through the inclining block tariff structure.

Government policy is that tariffs should be cost reflective, which should include cross-subsidisation, but not necessarily a surplus. From a financial perspective, surpluses from the trading services of municipalities (such as electricity and water) are used to offset losses incurred in the provision of general services (such as traffic control and fire protection). However, this is not always feasible, especially in smaller municipalities where the income base is inadequate. This means that the municipality has to rely on subsidies from the other levels of government, or provide fewer services, or run a deficit. As evident from the latest financial census of municipalities, deficits are commonplace in many municipalities, particularly the smaller ones.

Local government financial data published by Stats SA show that for the largest municipal electricity distributors, their surplus is equivalent to 11% of electricity revenue. This has shrunk over the past 10 years from an average of over 13%. The smaller municipalities which make up the bulk of Eskom’s debtors made a loss of 13% on their electricity operations in 2015, in contrast to a healthy surplus in 2006.

The reduction in net income is also a result of municipalities being forced to pay a greater proportion of their electricity revenue to purchase electricity from Eskom. According to Nersa’s costing structure as published in its annual consultation documents, in 2007 the purchasing of electricity comprised 67% of the retail price of electricity, this year it comprises 75%. The proportion allowed for ‘capital charges’ and ‘other costs’ which include indirect overheads and any surplus made from the electricity sales have systematically been reduced. The reduction of these proportions has long-term negative consequences for municipal finances.

One of the key features of electricity pricing over the past ten years has been the deliberate cross-subsidisation of tariffs to protect the poor from sharp electricity hikes. Cross-subsidisation is a common pro-poor strategy around the world. Business and high-use residential customers typically pay higher average rates than low-usage households because higher consumption attracts a higher marginal price. Nersa formalised the inclining block tariff in 2012, but it was preceded for a number of years by policy interventions aimed at ensuring low-cost electricity for the poor. Not only do the poor (or low-use customers) pay a lower tariff, but these tariffs have increased at a significantly slower rate than those applicable to high use households or businesses. From 2010, Nersa allowed a maximum increase to municipalities averaging 12% per year. Over the same period, tariffs for high-use domestic customers increased by an average of 17% whereas those for low-use customers increased by only 9% per year.

The overall impact of advancing equitable electricity provision through regulated tariff interventions has been to reduce net municipal income from electricity sales. The additional revenue gained from high-use customers has been insufficient to compensate the loss made on subsidising low-use households and the higher costs of purchasing from Eskom. The policy of cross-subsidisation by municipalities has put their financial viability under pressure, and it is uncertain how much longer it can continue. Eskom itself faces a number of challenges, and municipal debt is a R5-billion headache that it could well do without.

- Kelly and Naidoo are Chief Directors in Economic Statistics at Statistics South Africa