Agenda

1. National Electricity RegulatorTariff Approval Process Presentation to:Parliamentary Portfolio Committee on Minerals and EnergyProf Anthon Eberhard – Board MemberDr Wolsey Barnard – EM: RegulationMr Brain Sechotlho – HoD: Tariffs and Pricing9 April 2003

2. Agenda • South Africa’s electricity industry • National Electricity Regulator (NER) • Tariff regulatory methodology • Tariffs structures and customer categories • Eskom price increase process • Municipal price increase process • Future tariff regulation • Future electricity prices

3. South Africa’s Electricity Industry

4. The Supply Chain PRIMARY ENERGY SUPPLY SUPPLY SIDE GENERATION TRANSMISSION & DISTRIBUTION MARKETING, SALES, & CUSTOMER SERVICE DEMAND SIDE RESIDENTIAL AGRICULTURAL INDUSTRIAL KEY CUSTOMERS COMMERCIAL

5. SA Electricity Industry • Generation Eskom 4 Mun/Private • (41 800 MW) 96% 4% • Max demand • 31 800 MW) • Transmission Eskom - 100% • Distribution Eskom 177 Munic’s • Sales 55% 45% • Customers 40% 60%

6. Gross Generation 198 TWh Private 3.1% Munic. 1.3% Eskom 95.7% Energy Flow between the role players in the Electricity Industry in South Africa Distribution Purchases for End Use 194 TWh End Use 191 TWh Domestic 19.4% Municipal and Other Distributors 45% Agriculture 2.3% 44.9% Mining 17.4% Eskom T r a n s m i s s i o n Industry Manufac. 42.4% Eskom Distributors 55% 55.1% Comm. 10.3% 0.1% Transport 3.1% SAPP Imports SAPP - Exports from South Africa General 5%

7. Distribution of electricity • Eskom is a national distributor – Eskom customers in WC and Limpopo province have the same tariffs • Municipalities distribute only to customers within their demarcated boundaries – local distributor • Eskom distribute to its customers within municipal boundaries • Differences between Eskom and Municipal tariffs • Different customer mix • Different consumption patterns • Dependent on surpluses made by munic’s

8. National Electricity Regulator (NER)

9. Power and Functions of NER • Powers/ functions/ mandate of NER are to be found in the Electricity Act, Government Policies and Mandate from Minister of Minerals and Energy • Objects: “Exercise control over the electricity supply industry so as to ensure order in the generation and efficient supply of electricity” • Functions: • Issue licences; generation above 5 GWh annually • Determine prices/conditions for electricity supply • Settle disputes • Collect information • Perform inspections of equipment • Advise Minister on any matter relating to the ESI

10. Role of NER • Protect interests of electricity customers • Ensure efficient electricity supply industry • Ensure lowest cost electricty prices • Ensure acceptable quality of service and supply • Ensure long term provision and development of electricity services • Ensure fair play amongst suppliers – level playing field

11. Tariff Regulation Methodologies

12. Economic Regulatory Methodologies • Different regulation methodologies used worldwide by regulators: • Benchmarking • Rate of Return Regulation (RoR) • Incentive Based Regulation (IBR) • Methodology will be dependent on the state of development of the electricity industry • Apply different methodologies for Eskom and Municipalities – Eskom national utility that generate, transmit and distribute; Municipalities only • distribute electricity

13. Rate of Return (RoR) • Cost plus methodology of evaluating tariff increases • Definition: The revenue required by an entity is equal to the cost to supply plus a fair rate of return on the rate base • Methodology was published on the NER website for comments – Comments received and methodology is being refined

14. RoR formula • ROR is calculated as a Weighted Average Cost of Capital • Where the cost of debt is given by the Government bond R153 • The cost of equity is calculated using the Capital Asset Pricing Model • Assets are allowed only when productive • Expenses are allowed using the prudency judgement

15. Incentive Based Regulation • To follow RoR • Gives incentives for the improvement in productivity • Given by this formula • P(new) = P(old) [1+CPI –X + Z] • Difficult to calculate X • Applied with some successes in Britain, Norway, Australia, New Zealand etc • Favoured in many countries because it closely mirrors competition

16. Tariffs structures and customers categories

17. Tariffs structures and customer categories • Domestic low tariff • Applicable for residential low usage customers (Average usage equal to 100 kWh/month) • Domestic high tariff • Applicable for residential high usage customers (Average usage equal to 800 kWh/month) • Ruraltariffs • Applicable for customers in rural areas (Rages form very low to very high seasonal consumption) • Commercial tariff • Applicable to small businesses with an average usage of 2000 kWh/month

18. Tariffs structures and customer categories cont. • Large/industrial tariff • Applicable for large customer who are on a Maximum Demand (MD) meters – NER uses a MD of 200 and a load factor of 30 % as a benchmark • Special pricing agreements • Large customers that have short to medium term contracts linked to generation availability and/or commodity prices

19. Eskom price increase process

20. Eskom price increase process1996 - 2000 • The revenue requirement methodology was applied • Determine the revenue that Eskom requires to run its operation in the following year; compare it to the previous year’s revenue and approve the percentage if reasonable – cost based methodology • Govt compact (1994 & 1996) – Eskom to decrease their prices in real terms by 20 % by 2000 • Compact achieved

21. Eskom price increase process2001 • Corportarisation of Eskom – become tax paying entity • Shareholder compact between government and Eskom • Eskom applied for an increase equal to CPI • CPI estimated at 6.2 % • NER decided to use the CPI – X + Z formula: • X was to be an efficiency factor and Z was an allowance for uncontrollable costs and other risks faced by Eskom (last year of electrification funding) • X = 2 and Z = 1 • Price increase = 5.2 %

22. Eskom price increase process2002 - 3 • 2002 to current • Development of RoR methodology • RoR applied for the Eskom price increase • Price increase history

23. Eskom price increase process • Bi-weekly meetings with Eskom as early as January • Discussions are around the methodology to be applied and the format of the application and not about the number/percentage increase to be approved • Eskom submits application at end July for only one increase per annum in January the following year • NER staff evaluates application from July to mid-October • Towards end of October NER’s Tariffs and Pricing committee considers staff recommendations and makes further recommendations to NER board • NER board considers recommendations and makes final approval where satisfied • NER informs Eskom of its decision • Eskom informs customers

24. Municipal price increase process

25. Municipal Tariffs • Munics buy from Eskom and then sell to end-use customers • Munics then puts a mark-up on Eskom’s price • Eskom price normally lower than municipal price • In 1995 the NER developed the a documents called “Interim National Distribution Tariff System (INDTS)” to guide munics in moving towards similar tariffs – At least in terms of structures • The process has been reasonably successful • Rationalised municipal tariff structures fromabout 2000 to 1100

26. Brief summary of the INDTS • Pricing philosophy • Cost behaviour and cost definitions • Recommended tariff structures • Allocations of cost in structures • Benchmarking of electricity prices • Cross subsidies • Taxation of electricity • Document is on NER website www.ner.org.za

27. Future tariff regulation

28. Future plans for tariffs • Tariff structure rationalisation • Demarcation • In preparation for REDs • Evaluating current munic applications according to RED area • Further benchmarking is necessary • Development of methodology of regulating the retail part of the business • Different from rest of electricity sector - low asset base • Transparency and cross-subsidies • Within customer tariff structures • Between tariff structures

29. Cross-subsidisation c/kWh Revenue Cost - Agricultural Bulk Commercial Domestic Electrification Industrial Traction

30. Future Tariff structures • Will apply Rate of Return methodology for Eskom until divided into separate entities • Incentive Based Regulatory Methodology (IBR) will be introduced when ESI and EDI restructuring is completed - Transmission • Framework for managing municipal tariffs in process of refinement in preparation of REDs • Introduction of Wholesale Electricity Pricing System (WEPS) for large customers

31. WEPS • Developed in order to level the playing field between large municipalities/Eskom distribution/large customers • Unbundling of the tariffs into energy, wires and customer service components • Allows for more transparency and cost reflectivity • Currently in the process to introduced for a selected group of customers where unbundling is possible

32. Future electricity prices

33. Demand Forecast Southern Africa

34. Future prices • SA was in fortunate position of generation over capacity for last 20 years • SA will have to invest in new peaking generation capacity within the next 4 to 8 years • These investments needs 3-5 years lead times, depending on the technology that will be used • Replacement costs of base load power station about R35 billion • Will also need to invest in Demand Side Management processes – can extend the building of the next power station for up to 5 years • Government announced that private sector will be given opportunity to invest in next generation capacity • Will invest if returns are market related and linked to risks • Eskom as a corporate entity operates in the same environment • Electricity prices will increase to allow for these future investments

35. Conclusion • NER used internationally accepted regulatory methodologies • RoR methodology has been applied for Eskom price increase – done on an annual basis • Last 7 years price increases were below CPI • National distributor • Municipal tariffs evaluated according to INDTS • Tariffs have been rationalised • Need refinement in preparation for REDs • Future tariff regulation will be influenced by ESI and EDI restructuring processes • Future electricity prices will increase due to future capacity requirements