Submission to NERSA on Revised Submission to NERSA on Revised Eskom MYPD2Eskom MYPD2

Chemical and Allied Industries Chemical and Allied Industries AssociationAssociation

January 2010January 2010

Key issuesKey issues• Revised applicationRevised application• Focus on issues within NERSA mandateFocus on issues within NERSA mandate• Approach to energy consumption by chemical Approach to energy consumption by chemical

industryindustry• Impact of proposed increase on sectorImpact of proposed increase on sector• Impact of proposed increase on householdsImpact of proposed increase on households• Collaboration with EskomCollaboration with Eskom

Case studiesCase studies• Chlorine production:Chlorine production:

– Electricity raw material: 30% of input costsElectricity raw material: 30% of input costs– No possibility to cut the input without loss of productionNo possibility to cut the input without loss of production– Full cost recovery from customers will result in an increase in Full cost recovery from customers will result in an increase in

domestic water supply of 15%domestic water supply of 15%• Fertilizer productionFertilizer production

– 10% increase in fixed costs10% increase in fixed costs– Competition with imports constrains potential to pass on Competition with imports constrains potential to pass on

increaseincrease– Overall cost cutting to offset increase likely to result in job Overall cost cutting to offset increase likely to result in job

losseslosses– 15-20% reduction in operating profit which in turn will lead to 15-20% reduction in operating profit which in turn will lead to

review of investment decisionsreview of investment decisions

HouseholdsHouseholds• Strength of consumer demand direct impact Strength of consumer demand direct impact

on industryon industry• Disproportionate impact on householdsDisproportionate impact on households• More people under the poverty and ultra More people under the poverty and ultra

poverty linepoverty line• Undermines policy to extend electricity accessUndermines policy to extend electricity access• Eskom analysis in line with findingsEskom analysis in line with findings

Genesis FindingsGenesis Findings

Big PictureBig Picture• Eskom approach to the MYPD2Eskom approach to the MYPD2

– Determine funding (cash flow) requirements for operations and new capacity Determine funding (cash flow) requirements for operations and new capacity build and then justify tariff escalation to meet these build and then justify tariff escalation to meet these

• More appropriate approachMore appropriate approach– Determine true cost of supplying electricity from Eskom models through robust Determine true cost of supplying electricity from Eskom models through robust

analysis and then isolate the funding gapanalysis and then isolate the funding gap

– Determine if some of the immediate funding gap can be addressed through Determine if some of the immediate funding gap can be addressed through long-term project delays (given demand slump) and/or non-Eskom supply long-term project delays (given demand slump) and/or non-Eskom supply

– Determine the extent to which alternative funding mechanisms are feasible Determine the extent to which alternative funding mechanisms are feasible and what portion of the funding gap they can addressand what portion of the funding gap they can address

• ConclusionConclusion– Funding gap can be met through means other than loading tariffsFunding gap can be met through means other than loading tariffs

– Lower sustainable tariffs remain possible without introducing further supply Lower sustainable tariffs remain possible without introducing further supply risksrisks

Tariff proposalsTariff proposals

• Revised tariffs represent high-end estimates given information asymmetry and scope for further efficiency savingsRevised tariffs represent high-end estimates given information asymmetry and scope for further efficiency savings

• IHC provides a more objective and verifiable proxy for replacement cost than MEAIHC provides a more objective and verifiable proxy for replacement cost than MEA

• Eskom’s WACC estimate is too generous - our review suggests Eskom’s real pre-tax WACC is closer to 8.0%. Eskom’s WACC estimate is too generous - our review suggests Eskom’s real pre-tax WACC is closer to 8.0%.

• Operating costs increases for existing businesses should be at least limited to inflation, maybe betterOperating costs increases for existing businesses should be at least limited to inflation, maybe better

• DSM costs and shadow road tolls should not automatically be included in tariffsDSM costs and shadow road tolls should not automatically be included in tariffs

• Smoothing option equates to a Smoothing option equates to a 25%25% p.a. increase for MYPD 2 period p.a. increase for MYPD 2 period

C/kWh FY 2009/10 FY 2010/11 FY 2011/12 FY 2012/13 FY 2013/14 FY 2014/15

Eskom's proposed tariffs 33 45 60 81 91 103

Valuation of RAB from MEA to IHC

Reduction in depn charges (to IHC)

Reduction in WACC estimate (from 10.3% to 8%) - -3 -4 -5 -5 -6

Limit opex increases to PPI - -2 -3 -3 -4 -5

Removal of DSM and road maint. - -1 -1 -2 -2 -3

Rounding - 1 1 1 1

Revised tariffs (un-smoothed) 33 48 55 62 70 78

Revised tariffs (smoothed) 33 42 52 66 74 82

-11 -12 - 9 2 -10

Capacity and CapexCapacity and Capex requirements requirements

• Funding gap emerges from ambitious capex Funding gap emerges from ambitious capex programme programme

• We agree with Eskom’s revised application We agree with Eskom’s revised application that capex on Coal 3 and nuclear are not that capex on Coal 3 and nuclear are not required in this MYPD periodrequired in this MYPD period

– Crunch in next two years after which new Crunch in next two years after which new capacity will result in excess availability of capacity will result in excess availability of supplysupply

– Incorporating DSM/Price effect into demand Incorporating DSM/Price effect into demand estimates reveals more excess supplyestimates reveals more excess supply

• Delaying this capex to the next period does Delaying this capex to the next period does not introduce serious supply shortfall risks not introduce serious supply shortfall risks

• Delaying the capex does provide scope to Delaying the capex does provide scope to find alternative funding for these large find alternative funding for these large projects other than increases in tariffsprojects other than increases in tariffs

Addressing theAddressing the funding gap funding gap

• Funding gap much smaller and only emerges in FY 2011/12 Funding gap much smaller and only emerges in FY 2011/12

• More scope for new loans and significant amounts already raised since More scope for new loans and significant amounts already raised since November (e.g. Export Credit Agency, African Development Bank, World November (e.g. Export Credit Agency, African Development Bank, World Bank and French Banks)Bank and French Banks)

• Time available permits raising funding through the sale of power stations to Time available permits raising funding through the sale of power stations to private sectorprivate sector– Full sale of existing or new generation is in line with government policy on IPPsFull sale of existing or new generation is in line with government policy on IPPs

• We are confident the funding gap can be addressed through available We are confident the funding gap can be addressed through available funding mechanisms and not through higher tariffsfunding mechanisms and not through higher tariffs

R'm FY 2009/10 FY 2010/11 FY 2011/12 FY 2012/13 FY 2013/14 FY 2014/15

Cumulative cash surplus/(deficit) 20 455 8 018 -9 854 -28 776 -30 604 -40 362

Request to NERSARequest to NERSA

• Application of regulatory accounting principles in Application of regulatory accounting principles in a rigorous fashion a rigorous fashion

• Decisions should impose onus on Eskom to Decisions should impose onus on Eskom to improve efficiency of generation; address improve efficiency of generation; address challenges of bad debt and theftchallenges of bad debt and theft

• Guidance to municipalities on consequential Guidance to municipalities on consequential increases and cushioning the poorincreases and cushioning the poor

• Critical policy areas where Nersa is involved need Critical policy areas where Nersa is involved need to be actioned urgentlyto be actioned urgently

ConclusionsConclusions

• CAIA is committed to:CAIA is committed to:– aggressively encouraging a range of DSM aggressively encouraging a range of DSM

initiatives amongst its members initiatives amongst its members – working with Eskom and other stakeholders to working with Eskom and other stakeholders to

mitigate risks associated with a lower increasemitigate risks associated with a lower increase

• Ultimately: decision is how to balance the risk Ultimately: decision is how to balance the risk of poor security of supply against the risk of of poor security of supply against the risk of significant negative socio economic impact.significant negative socio economic impact.