Information from Eskom

Eskom’s chief financial officer, Calib Cassim, has confirmed that Eskom has applied for an electricity price increase of 20,5% for Financial Year 2023, which commences on 01 April 2022.

The details of Eskom’s MYPD 5 application is available on Eskom’s website. A summary thereof is presented here.

The recent High Court judgement requires Nersa to process this MYPD 5 revenue application for the Financial Year 2023. The remaining two years’ application is still the subject of a court review application. This is referred to as the Part B of the review application.

Background

The MYPD 4 period comes to an end on 31 March 2022. In terms of the Electricity Regulation Act (ERA), Municipal Finance Management Act (MFMA) and the MYPD methodology, Eskom is required to make a revenue application to the regulator timeously to allow for the implementation from 1 April 2022, of a Nersa-approved price adjustment.

In accordance with the ERA, Eskom can only implement price adjustments which have been approved by the regulator. The approved revenue and tariff decisions will be implemented from 1 April 2022 for non-municipal customers, and from 1 July 2022 for municipal customers.  

Legislative and regulatory framework requirements

Key legislative and regulatory requirements which guide Eskom in making its applications include:

• Municipal Finance Management Act: This application has met the requirements of Section 42 of the MFMA, which stipulates that Eskom must consult with National Treasury and SALGA (South African Local Government Association) prior to making a revenue application to NERSA. In addition, Eskom’s application must be made timeously to allow the regulator to make revenue and tariff decisions to facilitate municipal budgeting processes. The optimal timing is the December prior to the municipal financial year, which is from 1 July to 30 June of the following year. This means that, for MYPD 5, Eskom understands that the regulator must decide by December 2021.
• Electricity Regulation Act (ERA): The key requirement for Eskom when it makes its application, and for NERSA when it makes its determination, is the ERA and MYPD methodology. Nersa requires Eskom to meet the requirements of the MYPD methodology, which is in essence is the translation of the requirements of the ERA, in this instance. This means that Nersa must enable an efficient licensee to recover the full cost of its licensed activities, including a reasonable margin or return.
• Government Support Framework Agreement (GSFA): In terms of the GSFA, Eskom is required to ensure that collective approval is received from the Department of Mineral Resources and Energy (DMRE), Department of Public Enterprises (DPE) and National Treasury for Section 34 (of the ERA) independent power purchases and associated costs.
• Other legislative and regulatory requirements and precedents: Various guidelines and rules including the Minimum Information for Tariff Applications, Prudency assessments, Grid codes and regulatory rules are considered by the regulator. The outcomes of court judgements and orders will need to be respected. The adherence to the other related legislative including environmental legislative requirements, regulatory and licence requirements form the basis of the MYPD application. Eskom has however allowed for the smoothing of the tariff increases as well as a migration towards cost reflectivity.

"Eskom is applying for prudent and efficient costs and a phased-in return Eskom applies for efficient and prudent costs based on projections for the MYPD 5 period."

These projections are based on motivations provided for each of the changes in the particular cost element of the regulatory formula. The details in the environment related to each particular efficient cost is also provided, to the extent possible. The MYPD methodology, with regards to the revenue application is based on a particular formula. The regulatory framework in which Eskom’s regulated revenue and tariffs are set provides that the licensee is to recover its prudent costs of service. This ‘cost of service’ approach is a common feature of regulatory pricing frameworks and is employed by NERSA in other sectors; by other economic regulators within South Africa; and by utility regulators globally.  

What revenues is Eskom applying for the MYPD 5 period?

Eskom is making a total revenue application of R279-billion, R335-billion and R365-billion for FY2023, FY2024 and FY2025 respectively. Nersa has already determined that in addition to the MYPD 5 revenue determination, previous RCA determinations of R14,4-billion will be recovered in FY2023.

How are potential inefficiency, corruption and fraud and related revenue addressed in the revenue application?

Eskom makes an application for revenue related to efficient costs. The details of each of these revenue items are motivated in this submission. Appropriate comparisons, trends and benchmarks are provided for the regulator’s consideration. In response, Nersa decides based on the requirements of its regulatory rules, guidelines on prudency assessment and its analysis. It is envisaged that NERSA also bases its decision on appropriate comparisons, trends and benchmarks.

This allows for a robust process where efficient costs are considered for this revenue decision. Any inefficiency is excluded from the revenue decision in this manner. As directed by NERSA, Eskom will address any recovery of funds related to any corrupt activity through a refund in the RCA applications. This ensures consumers pay only for the recovery of the efficient cost of electricity.

The revenue allows Eskom to continue to provide electricity

The Nersa-allowable revenue formula enables Eskom to recover the cost of:

• Primary energy: Includes key types of fuel to produce electricity  
  • Eskom related – coal, water, nuclear fuel, diesel for open cycle gas turbines, etc.
  • External – Independent power producers (IPPs), environmental levy and carbon tax.
• Operating costs: Includes various aspects of operating the electricity system and related services  
  • Employee benefits – staff related costs
  • Operating and maintenance – for operating the electricity system and for the upkeep of generators and networks by maintaining these assets.
  • Other operating cost – includes insurance, metering, information technology, fleet costs, legal and audit services, security, travel expenses, billing costs, etc.
• Asset related revenue is recovered over the life of the assets  
  • Depreciation – on commissioned assets is recovered through the tariff in accordance with a method determined by the regulator over the life of the asset.
  • Return on assets (ROA) – Eskom is still migrating towards a level that has been determined by Nersa previously. This full asset-related revenue is not being applied for.

Allowable revenue application for MYPD 5 period

The allowable revenue being applied for in this revenue application is summarised in Table 1 and Figure 1 below.

 

Recovery of efficient costs  

Primary energy costs: Primary energy costs equate to the costing of the electricity supply required to meet demand. The three sources of electricity supply are Eskom own generation, domestic independent power producers (IPPs) and regional imports. Eskom’s primary energy related revenue contributes 30%, 25% and 24% of the allowable revenue corresponding to R80-billion, R79-billion and R84-billion for the application years respectively.

Thus, a relatively static trend in the Eskom primary energy contribution to allowable revenue is occurring. This is mainly due to production volumes from Eskom decreasing with a moderate increase in the cost of most primary energy components under Eskom’s control.

IPPs experience an upward contribution trend towards allowable revenue over the three application years. The contributions to the total allowable revenue for each financial year increases from 25%, to 25,5% to 28% over the application period. These increases are due to a substantial increase in the volume of energy secured from mainly renewable energy from IPPs. The total energy secured from IPPs increases from a projection of 20 TWh in FY2022 to approximately 53 TWh by FY2025. Of this total, renewable energy accounts for an increase from approximately 18 TWh (projected for FY2022) to 41 TWh (application for FY2025).

The non-renewable sources of IPPs energy increases from a projection of 0,8 TWh in FY2022 to approximately 12 TWh by FY2025. This is mainly due to the risk mitigation programme. These correspond to a total cost R70 billion, R85-billion and R102-billion for the three years respectively. Thus, from the FY2024, the revenue related to IPPs will exceed that of Eskom’s primary energy.

Implication of environmental levy and carbon tax

The contribution of environmental levy and carbon tax combined, increases from 3% to 5% and drops to 4% in each year of the application respectively. This shows the impact of the introduction of carbon tax liability from January 2023. When the carbon tax liability is implemented, the contribution of environmental levy and carbon tax accounts for over 8,5c/kWh.

Collectively for IPPs, environmental levy and carbon tax, the contribution to allowable revenue increases from 28% to 30% to 32% over the application period. These are defined as items of the revenue that Eskom includes in the revenue application – but has no control over. They could be defined as externally influenced. The costs associated with most Eskom related primary energy elements have remained relatively static from the MYPD 4 period to the MYPD 5 period. The increase in the coal price rate (average R/ton) is less than 10%, when costs of logistics are included. Eskom’s strategy for the procurement of coal is based on a portfolio mix, with the majority being sourced from long term contracts.

However, it is not possible to contract for all of Eskom’s coal requirements on long term contracts. It is prudent to have a portfolio of coal supply agreements which allows flexibility to meet changing electricity demand patterns. The largest component of the projected annual coal costs is the costs from existing and new long term coal sources. This is in line with the first principle of the long-term coal supply strategy, namely, securing long term contracts with mines close to power stations.

Operating costs: Eskom’s overall operating costs, over the period FY2023 to FY2025 (application years) have grown at a CAGR of approximately 5%. Analysis reflects that employee benefits have an average CAGR increase of 2,32% (after capitalisation) in this horizon. Similarly, the operating and maintenance costs have an average increase in CAGR of 2,15% over the period. The other operating costs see a marked drop with a CAGR of negative 3,34% over the application period.

The workforce

Significant efficiencies would be achieved over the period by reducing the number of employees through natural attrition and voluntary separation packages. Containing the workforce numbers without compromising the required skills in appropriate areas will be possible. This will be done by re-training, re-deployment and re-skilling of the workforce and natural attrition. Voluntary separation packages were taken in the previous years.

Eskom has applied for a smoothed phasing-in of return on assets

As required by the MYPD methodology, Eskom has requested an independent revaluation of its regulatory asset base (RAB) to determine the depreciated replacement cost. The value of the RAB is determined as at 31 March 2020. The opening RAB balance for FY2023 is based on the valuation undertaken by independent external consultants, with a modern equivalent asset value (MEAV), which is then adjusted for the latest capital expenditure forecasts for the period FY2023 to FY2025. This RAB value will differ from the historic cost reflected in Eskom’s financial statements, since it is a replacement cost that has been depreciated for the remaining life of the asset.

Return on assets is computed on a revalued regulatory asset base (RAB) with the intention to cover interest costs and earn an equity return. The average starting RAB value for FY2023 is approximately R1263-billon. The phased implementation of the return on assets together with depreciation allows for a significant portion of the interest cost and debt repayment costs to be covered over the three-year period.

Debt commitment costs

The allowed revenue being applied for does not cover the full debt commitment costs. Rather, progress is being made towards covering these debt commitment costs. Due to this smoothing of the price, Eskom experiences a significant shortfall in the first year of the MYPD 5 period. A net shortfall of approximately R29-billion is experienced just to meet Eskom’s debt commitments. Eskom will not be in a position to provide for any return on equity for the entire application period. An EBITDA margin of approximately 35% would be considered reasonable for Eskom presently. However, this EBITDA margin is not reached.

Thus, the return on assets is being phased-in to allow for the smoothing of the tariff. This is the decision that Eskom is proposing to allow the average price of electricity to migrate towards cost reflective tariffs. In the absence of such a phasing, the price increase being requested will be much higher. Eskom is making this proposal, to allow for consumers to experience a smoother price increase. However, this proposal is accompanied by risks which need to be managed. It is unfortunate, that further burden is required to be applied on the fiscus. The efficient costs do not go away and need to be funded. In essence the subsidy provided to all consumers is continued to be provided for a longer period.

"The implementation of the MYPD methodology will entail Eskom applying for a cost-reflective revenue that covers efficient and prudent costs as well as a return on assets corresponding to the weighted average cost of capital. A cost-reflective tariff is one that allows Eskom to recover its efficient and prudently incurred costs and earn a reasonable return."

The remainder of the building blocks in terms of the NERSA revenue formula, for this revenue application are in accordance with the MYPD methodology. If Eskom applies its approved weighted average cost of capital of 11,5% (real, pre-tax), the average increase in the revenue will be approximately 95% (FY2023), 2% (FY2024) and 7% (FY2025). A return on assets of 7,1%, as determined by Nersa for the MYPD 4 period, would result in a price increase of approximately 71% in FY2023, 2% increase in FY2024 and 7% increase in FY2025.

If Eskom were to ensure that a minimal positive return on assets of 0,01% were to be applied for in the first year of the application period, it would result in a 32% increase for that year. Due to the stage that the country is in with regards to migration towards cost reflectivity, these are not options that Eskom is considering.

As a first step towards the sustainability of Eskom, it would be preferable for Eskom to ensure that the revenue caters for prudent and efficient costs as well as a reasonable return that matches the debt service commitments (interest and debt repayments). Thus the revenue related collectively to depreciation and return on assets must match the debt service commitments entailing the debt repayments and interest payments. This would manifest in an approximate increase of 34% in the FY2023, 4% in FY2024 and 13% in FY2025. However, in the interest of the potential impact on consumers, Eskom has proposed a longer phasing-in period.

This is considered to be having a significant impact on consumers and is therefore not being applied for. However, the allowed revenue being applied for does not cover the entire debt commitment costs, equating to a cash shortfall totalling approximately R29-billion for the MYPD 5 period. This is a significant further phasing being proposed by Eskom in the interest of allowing the economy to adjust as the migration towards cost reflectivity. Eskom will use the proceeds from the liquidation of the RCA decisions to contribute to mitigating the debt service shortfalls.

Recovery of Medupi, Kusile and Ingula (MKI) capital related costs  

The contribution of the capital related costs recovered from the consumer for Medupi, Kusile and Ingula power stations are demonstrated in the table below.

As clarified above, the capital related costs are recovered through depreciation and return on assets. For the application years, when Medupi, Kusile and Ingula power stations are collectively considered, then the amount related to these three new power stations is R4434-million, R14 521-million and R15 283-million for each of the application years respectively.

Thus the consumer’s contribution accounts for 1,5%, 4,3% and 4,2% of the total allowable revenue being applied for. This corresponds to a very small portion of the price of electricity.

Stability in Eskom own costs

The figure below illustrates the compounded annual growth rates in the various elements over the MYPD 5 revenue application period.

Eskom has achieved a status in the MYPD 5 application where it’s operating costs and its primary energy costs have stabilised to 5% CAGR for the three-year period. This indicates the level of control Eskom has instituted to reach such a status. Similar trends were observed for operating costs in the MYPD 4 period. Due to the return on assets being phased-in, the CAGR is negative.

Significant increases in the compounded annual growth rate (CAGR) for IPP costs of 46% (due mainly to increased volumes from mainly renewable energy) is seen over the three-year period. Similarly, increases in CAGR for carbon tax over the two-year period from FY2023 to FY2024 is 93%.

Year-on-year increases dominated by IPP increases  

The figure below indicates the key contributors to the increase in the price of electricity on a year-on-year basis.

The key contributors for the price increases over the MYPD 5 period have been identified. It appears that externally controlled elements of the allowable revenue will have the biggest impact on the price increase.  

• FY2023: Of the 20,5% increase IPPs account for 12,81% increase, carbon tax 1.09% increase, elements under Eskom direct control contribute approximately 7% of the increase.
• FY2024: Of the 15,07% increase, IPPs account for 5,36% increase and carbon tax 2,54% increase. More than half the increase is related to the external factors. Costs under Eskom control contribute approximately 7% of the increase.
• FY2025: Of the 10% increase, IPPs account for 5,11% increase. More than half the increase is related to external factors. Costs under Eskom control contribute less than 5% of the increase. The significant increase in IPPs is due to further increases in energy sourced from IPPs, the continual escalation on existing contracts and further technologies being introduced. The trend seen in the MYPD 5 period is likely to continue.

Tariff category increases to be experienced  

The resultant standard tariff increases that will result if NERSA approves the allowable revenue, as applied for, are shown in the table below.

Eskom requires reasonable tariff increases to address financial sustainability and liquidity challenges  

Liquidity and solvency risks pose an inordinate threat to Eskom’s ability to continue as a going concern. To improve liquidity, we have restricted organisational cash requirements through targeted savings. We had to rely on Government support to maintain a positive cash balance, with increases in equity. Due to high debt servicing obligations, maintaining the liquidity buffer at acceptable levels continues to be a challenge.

Although Government’s equity support assists with liquidity requirements, it does not adequately enhance Eskom’s long-term financial sustainability. The only way to achieve financial sustainability is to improve operating cash flows that results in positive free cash flows, with a strong focus on moving to a prudent, cost-reflective tariff. The power utility acknowledges the importance of cost savings to improve liquidity, with a focused cost curtailment programme over the next three years. Nonetheless, cost savings alone will not be sufficient to improve its financial health.

For Eskom and the electricity supply industry to continue to operate and maintain its assets in a reliable state, the price of electricity must migrate towards cost-reflectivity This will also ensure Eskom’s long-term financial sustainability. Without a cost-reflective tariff path, it will remain reliant on Government support, which implies that the taxpayer will continue to foot the bill for the revenue shortfall, which is contrary to the “user pays” principle.

Economic impact are best managed by continuing to migrate towards cost reflective prices of electricity

It may be tempting to conclude that by limiting electricity tariff increases and requiring that Eskom and/or Government borrow the revenue shortfall (and effectively implicitly subsidise the price of electricity), it is possible to minimise the negative impacts of rising electricity prices on GDP and employment growth in the short-term.

However, the results of an economy-wide impact analysis show that the fiscal and economic consequences of awarding Eskom a tariff which is much lower than what it requires (to recover its prudently and efficiently incurred costs), do eventually (and arguably have now) become evident.

The utility therefore recommends that tariff increases should at least be sufficient to transition Eskom towards a more cost-reflective electricity tariff (prudently and efficiently incurred) over the next few years. The protection of vulnerable sectors, including poor households and certain industrial sectors are being addressed by Government-led interventions. Eskom is dependent on Nersa making revenue and tariff decisions in accordance with its mandate, policy and relevant legislation.

Click here to download the full details of Eskom’s MYPD 5 application

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