National Energy Regulator SA on Eskom prices, Transnet pipeline tariff, Sasol gas price, Independent System Market Operator Bill [B9-2012] adopted

Meeting report

Introduction by the Chairperson
The Chairperson welcomed Members of the Committee and the delegates from the National Energy Regulator of South Africa (NERSA). From 2012, NERSA, Eskom and other stakeholders had been engaged in the electricity price determination process, generally known as the Multi-Year Price Determination (MYPD), which in essence related to the regulation of electricity prices. The Committee was seized also with the process, and had to know what informed NERSA’s decision on the final determination, in view of the impact of energy and the whole process on human well-being. He described the process of price determination as “a journey”, as it was necessary to consider causes, the process and the impacts.

He noted that the Committee would today receive presentations from NERSA on the outcomes of Eskom’s Multi-Year Price Determination 3 (MYPD 3) application, the outcomes of the Transnet pipeline tariff and the SASOL gas application for maximum prices.

NERSA briefing: Eskom MYPD 3
Mr Thembani Bukula, Full-Time Member: Electricity, NERSA, tendered apologies for the Chairperson of NERSA who was only able to join the meeting at a later stage, and for the Chief Executive Officer of NERSA.

Mr Bukula presented a summary of what Eskom applied for in terms of the MYPD3. The MYPD3 period would run from 2012/13 to 2017/18. The total amount for which Eskom had applied was approximately R1.08 trillion. These costs covered returns, primary energy costs, costs for independent power producers (IPPs),  depreciation, integrated demand management, and operating costs. NERSA, after consideration, allowed Eskom a total revenue of approximately R906 billion. This meant that the revenue application was reduced by just over R1 billion.

The approved regulatory asset base was: R789 billion for 2012/13; R699 billion for 2013/14; R706 billion for 2014/15; R709 billion for 2015/16; R712 billion for 2016/17; and R717 billion for 2017/18.

Mr Bukula told the Committee that NERSA also adjusted Eskom’s returns. The allowed returns were calculated to allow Eskom to meet its debt obligation and also to allow for affordable and gradually increasing pricings, but to avoid price spikes.

The Committee was told that in regard to primary energy, Eskom applied for R418 billion, and NERSA allowed a total of R358 billion. Coal prices had escalated at 10% over the MYPD3 period and the base price for 2013/14 was adjusted to reflect actual history. For depreciation, NERSA allowed Eskom an amount of R139 billion out of the R189 billion which was applied for. For Integrated Demand Management (IDM), the operational Demand Market Participation (DMP) was maintained, the supplemental was limited to 800MW and the Power Buy Back allocation was not approved.

Mr Bukula outlined Eskom’s financial sustainability goals and the earnings before income tax, depreciation and amortisation (EBITDA). The EBITDA-to-interest cover ratio was given for the period from 2014 to 2018. For the five years from 2014 to 2018, the percentage price increase per year was 8.0%. Full details to support these figures can be seen in the attached presentation.

Discussion
The Chairperson welcomed the Chairperson of NERSA, Ms Cecilia Khuzwayo, who had now managed to attend.

The Chairperson thanked Mr Bukula for a brief yet very informative presentation. It was a crucial topic for both the social and economic life of the nation.

Mr K Moloto (ANC) asked how NERSA treated the works under construction from Eskom. Eskom could well have specified certain targets for work under construction when it applied for the tariff. On the IPP, NERSA had indicated that there was a shift that had to be effected, because some of the projects were not going to come on stream within the MYPD3 period. He therefore asked where Eskom had got its IPP figures from. In respect of coal costs, he asked what percentage of coal cost increases was indicated by miners during the public hearings. Finally, he asked if NERSA got any indication from the Department of Water Affairs on its tariff increases.

Mr Bukula replied that the work-under-construction rules were included in the calculation of the approved asset base. The cost items for the various years were shifted to the periods when they were going to be concluded. What was not included, however, was the calculation of the interest during construction. In regard to the IPP dates, he noted that Eskom was given dates by the Department of Energy. However, due to financial flow shifts and changes, NERSA had taken these new dates as the dates to be used in the MYPD. There had been interactions with the Chamber of Mines and a number of other coal stakeholders on coal prices, and the increases projected would be over 16% or 17%. Eskom was intending to enter into a pact with the mines to keep the increases at 10%. NERSA was satisfied that the coal costs were being contained, and were not going to escalate any further. Finally, he noted that NERSA had consulted with the Department of Water Affairs and the costs allowed were calculated taking into consideration the water tariffs in the new dams and infrastructure.

Mr L Greyling (ID) said that the presentation by NERSA showed that the opinions brought forth during the public hearings had been considered carefully. He said that it seemed as though Eskom wanted to use its return on equity as the driver for its calculations, although most utilities tended to use the weighted cost of capital. In future, he wondered therefore if NERSA would be asking Eskom to use weighted cost of capital. He was of the opinion that the return on equity, which Eskom was asking for, was way too much and it was a good thing that NERSA reduced it. He also believed that NERSA was correct in not approving the power buy-back, as it was absurd that companies had to be paid to not produce. He wondered if NERSA had examined the actual coal procurement regime at Eskom, and whether it had looked into the contracts entered into by Eskom; he had asked the question because, from what he was hearing, there was a lot of concern that Eskom seemed to be moving from long-term contracts to short-term contracts, and buying from smaller producers.

Mr Bukula replied that Eskom was in fact signing long-term contracts, not short-term contracts. The coal market had its own dynamics, yet NERSA believed that that the targets which Eskom had set for itself were safe enough. NERSA wanted Eskom to move away from the return on equity calculations in the future, but the electricity pricing policy also imposed certain ways in which calculations were to be done and revised. 

Mr J Selau (ANC) asked if NERSA had considered the policies and plans that government as a whole had for the nation and society. He wondered if it was contradictory that government was approving of solar water heaters, while NERSA was rejecting them.

Mr Bukula replied that the issue of solar water heaters was not a contradiction as it had already been included in national policy.

Mr Selau also wanted to know what NERSA meant by “excessive contingency fees”.

Mr Bukula noted that the contingency fees in a project should be around 10%. In some years, these fees were going up to about 30%, and that was what NERSA wanted to reduce. The intention was to keep the fees at about 10%. 

Mr J Smalle (DA) wondered why there was no mention of the fluctuation of diesel prices, given the said primary energy resources and the pattern of how coal and some petroleum products prices had fluctuated over the past years. He asked if there was any compensation given to the fluctuation of inflation in this regard. He also asked if there had been any talks with business regarding the power buy-backs’ effects on their businesses.

Mr Bukula replied that the indices that had been used to escalate the prices and costs for coal were the appropriate ones, and not the CPI ones. This also applied for nuclear and petroleum products. The applicable indices had been used for the various elements. On the issue of power buy-back, there was a need for a dialogue between all the stake holders because if there was a shortage of power at any point, even the energy-intensive users were going to lose out. 

Mr Moloto asked what constituted the other costs, which were limited to inflation-linked increases. He also wanted to know what were the double counted items that were removed.

Mr Bukula replied that the other costs included communications, IT and purchase of new systems. The double counting was experienced in some of the operational costs, and these details could be provided to the Committee. 

Ms N Mathibela (ANC) thanked NERSA for listening to the consumers and approaching Eskom on the issue of high prices. She asked if NERSA was also regulating the municipalities.

Mr Bukula replied that NERSA regulated municipalities and the recommendation to NERSA, which was possibly going to be approved, was that the average increase for municipalities would be 7%.

The Chairperson said that he wanted an elaboration on the whole process. Applications were made by Eskom and approvals were done by NERSA after public consultations. He wanted NERSA, however, to share with the Committee some of the other operational issues, as that was when issues of municipalities and sectoral tariffs came into play.

Mr Bukula described the process followed. NERSA started with determining the average increase and then giving that to Eskom, which then calculated what its increases in the different customer categories would be. After this calculation, the increase to local authorities was 7%, whilst the increase to Energy Intensive Users was 8.4%. Eskom then submitted an application for the different tariff structures, which would then be approved by NERSA. The next step was that NERSA would then give a guideline to the municipalities.

Mr Selau asked if the approvals in the MYPD3 were not going to have an impact on the opening of the Kusile and Medupi power stations. He thought 25 years was not a very long time for NERSA to seek to predict where the country would be.

Mr Bukula replied that the changes of over 25 years were simply speculations, but what was of more importance were the changes which were going to occur over the next two to three years.

The Chairperson said that the briefing was just the beginning of a very long and interesting process and the Committee was still going to have many more interactions with NERSA on the MYPD process. 

NERSA briefing on the Transnet Pipelines 2013/14 Tariff Decision
Dr Rod Crompton, Regulator Member: Petroleum, NERSA, gave the presentation on the Transnet Pipelines 2013/14 tariff decision.

Dr Crompton told the Committee that Transnet had a network of 32 pipelines which consisted of approximately 3 800 km of pipelines. Transnet was also in the process of implementing the New Multi-Product Pipeline (NMPP), which was a 24-inch pipeline from Durban to Gauteng, and some other inland pipes. He told the Committee that the process was running late by about three years. The Minister of Public Enterprises had published a statement on the investigations into the project.

There had been public consultations on the pipelines tariff since September 2012, including five events.

Dr Crompton said that Transnet had applied for allowable revenue of 22.6%, but NERSA had only approved 8.5%. Some notable issues in the application were that it was a single year tariff application instead of a multi-year; there was a large claw-back; and there was a decline in the total network volumes.

The Committee was presented with graphs that indicated the Transnet Allowable Revenue percentage increases, and the actual amounts relating to the applications versus the decisions or approvals (see attached presentation). The factors considered in the decision and approval included the regulatory asset base, the weighted average cost of capital, weighted average cost of capital return, operational expenses, depreciation, F-factor, claw-back, claw-back deferment, tax allowance, allowable revenue, percentage increase in allowable revenue, debt ratio and interest cover. Graphs were also presented to the Committee on the impact of the NMPP on the regulatory asset base and the petrol price structure.

With regards to pipeline volumes, Dr Crompton told the Committee that lower volumes meant higher tariffs and higher inland fuel prices. The possible reasons for the decline in volumes included price regulation; oil companies changing procurement and marketing strategies; increased demand for niche products not transported in pipelines; and lower growth in fuel demand.

NERSA was collaborating with the Department of Energy (DOE) to see what could be done. Transnet’s forecast increase in volumes for 2013/14 was 4.6%.

Discussion
Mr Smalle asked for clarification on the issue of quadrupling the asset base of Transnet. He asked if the initial investment made by government, prior to the building of the new pipeline, not part of the process of quadrupling the asset base of Transnet. He asked, in view of the niche products which were being brought inland, whether any provision was being made for these products to be transported in the pipeline, and whether indeed they could be carried in the pipeline. He wanted details of the storing capacity in the inland areas, and what the arrangements were to deal with these issues.

Dr Crompton answered the question on quadrupling of Transnet’s asset base by explaining that the project was being financed as a “pay-as-you-go” kind of project, so revenue from tariffs was being used to pay for the project. This meant that Transnet was borrowing money on the longer term basis, but the interest on the loans had to be recovered from the tariffs paid by the users of the pipeline. The incremental inland cost recovery levy was administered by the Minister of Energy and public comment had been requested with the intention of repealing the Gazette. The comments were going to inform the decision on whether there was enough capacity. Transnet’s intention was that it should be able to transport all products, including the niche ones, but the reason this was not currently being done was linked to the storage capacity. It was true that storage capacity was a challenge. Transnet was in the process of upgrading its capacity and, once that was done, it would be able to transport all products. There was, however, a large variety of allowed products, with six grades of petrol, two grades of diesel and biofuels. This made pipeline logistics more difficult. In the industry as a whole, there had not been much construction until 2006, when NERSA came into being. There was currently a construction boom within the industry and the capacity was going to be upgraded. Some of the construction was taking place inland and some on the coast.

Mr Smalle asked who was accountable for the three-year delay on the NMPP project, and how the project was regulated.

Dr Crompton explained that the NERSA Act noted that NERSA had the responsibility to establish whether costs were prudently incurred. NERSA’s investigations into the project had started but the project was not yet completed, and the final costs had not yet been established. NERSA was gearing itself to do the final examinations. It did not want to jump to  any conclusions as to whether costs were prudently incurred.

Mr Moloto said that in view of the escalations in the pipeline costs and the explanations given, he was of the opinion that the costs were not incurred prudently. He wondered how NERSA was going to deal with the costs, and whether they would be included in the tariff determination.

Dr Crompton replied that the costing that had been done by Transnet was for the whole project and not for specific modules. This made it difficult for the costs to be examined in a piecemeal fashion. The terms of reference that the Minister of Public Enterprises had differed from those used by NERSA as a regulator. There was, however, some debate as to what was meant by the term “prudent”. One example was the aspect of choosing one quote from amongst three. The choice of one could still be considered as prudent, even if all the three quotes were twice as much as they should normally have been.

The Chairperson said that NERSA had told the Committee that Transnet did a single year tariff application instead of a multi-year approach, and asked if there was any possibility of compelling a change to a more desirable and conventional trend. He asked, with regard to the petrol price structure, what the implications were of regulating only one product.

Dr Crompton replied that the way the Act was construed was that NERSA had to make a decision when it received an application. This meant that if no application was made, NERSA could just not decide, on its own, to impose a multi-year approach on Transnet. However, NERSA had expressed the view that it would prefer a multi-year determination as this gave more certainty to investors, stakeholders and other financiers.

In regard to the petrol price structure and the implications, he said that because there were two regulators regulating the petrol price structure - the Minister of Energy and NERSA - different kinds of decisions were going to be taken when different methodology was used. NERSA was engaging with the Department of Energy to try to get consistency on methodology and research. On a common sense level, it could be argued that it made more sense to have only one regulator, but this was a matter for government to determine.

The Chairperson said that the last point was critical, as the energy sector seemed to be one of the victims of the complication of multi regulation, and the Committee must be mindful of this challenge. He said that he had noticed that regulation in the energy sector was fundamental as it brought peace of mind to all the stakeholders, most importantly the public. He also said that it was important for NERSA to continue to update the Committee on the prudence review process, and said that the Committee wanted to have an open-door policy for presentations from NERSA at any time.  The lessons learnt from NERSA could be used not only in the electricity and petroleum sectors, but in other sectors and industries also.

NERSA briefing on the SASOL Gas Transmission Tariff Application & Maximum Prices Application for Piped Gas
The Chairperson said that the gas sector was a very crucial and he was hoping that in the near future, the Department of Energy would brief the Committee on its operations. In the meantime, NERSA had been asked to brief the Committee on its level of readiness to facilitate the operations, and the progress from 5% to 20% penetration. 

Ms Ethèl Teljeur, Full-Time Member: Piped Gas, NERSA, said that she would outline the role that NERSA played and could play in improving the gas market. NERSA regulated the piped gas industry, and a special regulatory agreement was entered into between the government and Sasol Limited, in September 2001, which focused on rights and obligations and allowed for a special regulatory dispensation period up to ten years.

Ms Teljeur said that the Gas Act and the Regulations required a fundamental price restructuring and that this would require amendments to the pricing provisions. The Gas Act required non-discrimination in terms of prices, tariffs and other conditions. The Act mandated NERSA to approve maximum prices for distributors, reticulators and all classes of customers, and to regulate where there was inadequate competition. The removal of price discrimination meant that prices for some customers were to go down or remain the same, and other prices would rise. In particular, the smaller customers whose prices were based on LPG would get price reductions, whereas some large customers whose prices were related to coal would face price increases.

Sasol Gas Ltd had applied to NERSA for approval of maximum gas prices, for the prescribed customer categories, for a multi-year period from 26 March 2014 to 30 June 2017. It had also applied for transmission tariffs for 26 March 2014 to 30 June 2015. The legal basis for the application was that NERSA regulated the Piped-Gas industry in terms of the Gas Act, 2001 (Act No. 48 of 2001). Regulations were issued by the Minister of Energy in terms of the Gas Act. The Gas Act and the Regulations contain more “light handed regulation”, which was fundamentally different from electricity regulation.

Ms Teljeur told the Committee that price restructuring meant that prices could go up or down. However, the current application was for maximum prices, as distinct from actual set prices. The application by Sasol complied with the appropriate methodology, as NERSA had urged Sasol to apply early to assist industry. Sasol made its application on 23 December 2012. The Gas Act required immediate compliance. There was a 12 month implementation period to provide certainty and allow customers to negotiate, assess implications, and complain to NERSA when the actual price that they would be charged was clear.

The elements considered in the application included: methodology chosen; pricing period; NERSA calculation of maximum prices; NERSA forecast of maximum price; and Sasol gas application maximum price. In respect of the discounts by customer classes, NERSA accepted the discounts as provided by Sasol. Sasol discounts per customer class were based on its international study of comparable customer classes.

Ms Teljeur presented graphs to the Committee that outlined what Sasol had applied for and what was approved by NERSA. The graphs also indicated the impact on small customers (see attached presentation).

Discussion
Mr Smalle said that he had looked at the methodology of the pricing, but he was trying to understand the basis of where gas started, before it got to 128 kilojoules. He noted that Sasol was paying for a kilojoule, and he presumed that was what NERSA was referring to as the “actual cost”. If so, then he wondered if it was reasonable for Sasol to have a cost recovery and a margin of profit. He asked how NERSA reached the 128 kilojoule figure, whether this was given by Sasol, or was calculated by NERSA itself. In addition, he noted that NERSA had said that it wanted fair competition within the prices, but had also spoken of reductions and voluntary discounts, and he wondered what role NERSA played in managing the voluntary discounts, and what tool it employed to ensure that there were no discrepancies in the discounts.

Ms Teljeur replied that it was not usual for oil and gas prices to be determined on a cost price basis. For oil, there was a world oil price, but increases in the prices did not necessarily mean that the cost of extracting oil had increased, as the prices were mostly based upon demand and supply. The other concern was that, in the regulation of a value chain, the products were not free, so the cost of extraction could not be the sole determining factor. This was why NERSA did not take the cost route. Had it done so, it would not have enhanced, but actually have hindered incentives and entry into the sector. The question whether Sasol had not recovered the majority of the cost referred mostly to the transmission tariff, rather than the price of gas.

She added that in respect of transmission pipelines, South Africa needed huge infrastructure development if it really wanted to grow the gas market. The way in which NERSA regulated transmission tariffs was different to other industries, although there were certain similarities, because for gas there was a need to be more flexible.

She explained that in calculating the 128 kilojoules, NERSA developed a methodology which was simple, predictable and transparent. The formula allowed NERSA to arrive at the same outcome for the maximum gas energy price as at 26 March 2013. However, Sasol used an estimate for 2014 and that was what NERSA did not do. In relation to the fair competition aspect, she noted that the regulations stipulated that maximum prices had to be approved per class, and they also prescribed what the classes were. These classes were based on volumes and were approved by the Minister. The categories ranged from 4 000 to 40 000 gigajoules and then from 40 000 to 400 000 gigajoules.

Mr Greyling said that he was going to speak only on a few generalities, as it was quite a complicated affair where only some aspects of the gas price were regulated. On one hand there was a free market and on the other hand, there was a regulated market. What had been evidenced in most of the media reports was that most of the industrial customers feared that this would lead to massive price increases, would affect profitability, and could also lead to job losses. He asked for an indication of NERSA’s reading of the situation, and how it could be contained. He said that what he would like to see in the sector was that there was an affordable price, and allowance for a competitive industry, and that the price would encourage people to switch from electricity to gas. He asked if the current pricing regime was doing that, and, if it was, how it was doing this. It was also important to get prices that would encourage investors to get into the sector and improve infrastructure, and again he asked if the current pricing was inviting enough for investors.

Ms Teljeur said that although the media had taken up the issues, the NERSA processes had given customers a lot of opportunities for engagement. The biggest difficulty was that, in terms of the Gas Act, NERSA could approve maximum prices only. This meant that the customers could face difficulties in doing accurate forecasting, and this was the basis for the media statements. The “feared” price increase was not factual at the current stage. On the issue of balancing the affordability, she made the point that although switching to gas was not the only alternative, one of the key objectives of the Gas Act was that NERSA should promote the gas industry and competitive markets. NERSA was doing this by providing a stable regulatory framework that signaled to investors that there were potential profits and good returns to be made.  

Ms Mathibela pointed out that Sasol was the only player on the Mozambique gas pipe, and asked if this meant that no other player could get on board.

Ms Teljeur replied that the agreement allowed for third party access, if a newcomer were to be able to ship specific volumes of gas. At the end of the special dispensation, the normal provisions of the Act would come into play, and these stated that third party access must be provided where there was uncommitted capacity. The problem with that particular pipeline was that it was already nearing its maximum capacity. 

The Chairperson said that the Committee was running out of time, but he had a few questions to ask. He wondered if the maximum price was the only remedy available to NERSA to enhance competition in the gas sector. In future, he thought that the issue of setting up prices versus approval had to be considered, as this had an impact on incentives and investments. It was important for NERSA also, at a later stage, to explain why, in certain instances, it “approved” the tariffs whilst in other instances it “determined” the tariffs. It would be interesting for the Committee to know the impact of the different approaches.

The Chairperson apologised for the lack of time.

Adoption of Independent System Market Operator Bill
The Committee proceeded to the adoption of the Independent System Market Operator (ISMO) Bill.

The meeting was adjourned.