Submission to NERSA: Eskoms application for

a selective reopener of MYPD 3

by Chris Yelland CEng, investigative editor, EE Publishers
This submission is in response to Eskom's application on 30 April 2015 to NERSA for
a selective reopener of NERSAs third multi-year price determination (MYPD 3), for
the period 1 April 2015 to 30 March 2018.
NERSAs task as Regulator is to ensure the financial sustainability of Eskom by allowing the
utility to recover, through electricity tariffs, all its efficiently and prudently incurred operating
costs, plus a fair return on assets employed.
Eskoms application seeks to pass through to customers of electricity via its tariffs in the three
year period from 1 April 2015 to 30 June 2018:
1. A 2c/kWh increase (from 3,5c/kWh to 5,5c/kWh) in the environmental levy on electricity
generated from carbon fuels.
2. Additional estimated diesel costs amounting to R32,9bn (i.e. an average of about R11bn per
year for three years) for its open cycle gas turbines (OCGTs).
3. The full estimated cost of power purchased from independent power producers (IPPs) via
Eskoms short-term power purchase programme (STPPP) amounting to R17,5bn (i.e. an
average of R5,8bn per year for three years).
Eskom calculates that for its 2015/16 financial year (from 1 April 2015 to 30 March 2016), if
such additional costs are recovered evenly over the full twelve months, this would result in an
additional price increase of 12,61% over and above the 12,69% increase already approved by
NERSA that came into effect on 1 April 2015. This would make a total Eskom price increase for
the 2015/16 financial year of 12,69% + 12,61% = 25,3%.
The additional 12,61% price increase applied for by Eskom for 2015/16 is made up of:
2,51% (environmental levy) + 6,77% (diesel) + 3,33% (STPPP) = 12,61%
Cost impact is worse than it seems
However, the reality is that if NERSA were to grant the additional 12,61% price increase by the
planned date of 30 June 2015, an Eskom price increase would only take effect from 1 August
2015 at the earliest, and the costs would have to be recovered over the remaining eight
months of the Eskoms 2015/16 financial year.
This would make the additional price increase for the remaining eight months of the 2015/16
financial year significantly higher, namely 12,61% x 12 / 8 = 18,92%.
This would also make the total price increase for the remaining eight months of the 2015/16
financial year higher still, namely 12,69% + 18,92% = 31,61%.
Affordability
While Eskom may claim to find it difficult to afford and absorb these (heavily overstated) costs
of R11bn + R5,8bn = R16,8bn per year for three years, the acting Eskom CEO paints a different
picture, and the reality is that the true unbudgeted extra cost that will be incurred by Eskom is
in fact a only a small fraction of R16,8bn, as will be shown later in this submission.
Yet Eskom is attempting to pass these full heavily overstated costs of R16,8bn per year through
to its customers, who have certainly not budgeted for any such costs increases, while the
question of affordability to the customer, be it to ordinary citizens or to the productive
economy, is completely ignored by Eskom in its application.

The question of affordability of Eskoms proposed increase to domestic, commercial,

agricultural, industrial, traction and mining customers will no doubt be more that adequately
covered by other submissions, and will therefore not be dealt with in any detail here.
Financial impact
However, as just one example of the dire consequences of Eskoms application for an additional
12,61% price increase for 2015/16, over and above the 12,69% already granted from 1 April
2015, consider the impact on municipal finances, as follows:
Municipalities have formal, consultative, budgeting processes governed by the Municipal
Finance Management Act. In light of the well-known statutory timelines for such processes, the
additional price increase that may be determined by NERSA (which is still unknown at this
stage) has obviously not been included in their budgets and tariffs for their financial year
commencing 1 July 2015.
Indeed, a directive from the National Treasury to municipalities (Annexure D of the Municipal
Finance Management Act Circular No. 75, dated 25 May 2015) states that: Any decision that
NERSA makes after 15 May 2015 will need to be deferred to the 2016/17 municipal financial
year.
It is clear that the Minister of Finance has the authority to extend the deadline date beyond 15
May 2015, but the fact is that: the Minister has already exercised his authority to extend the
deadline date from 15 March to 15 May 2015; the minister has not extended this further; and
the National Treasury has instead issued the above directive on 25 May 2015.
This means that any further price increase determined by NERSA for Eskom for 2015/16 cannot
be passed by through by municipalities to their own electricity customers. This will have
serious financial impacts for municipalities, many of whom are not in a good financial position
already.
Nor will municipalities be able to pay Eskom for any price increases after 15 May 2015 for the
2015/16 financial year, as such expenditure would be clearly unbudgeted and unauthorised by
the National Treasury.
What makes such application for a selective reopener by Eskom at this late stage of the
budgeting process particularly vexing to municipalities is that Eskom has known for at least the
prior nine months of the need to raise the matter of excessive diesel usage and STPPP costs
from 1 April 2015, as well as the municipal budgeting timelines involved, yet through its own
deficiencies has only issued its application at this late date, making effective consultation and
due process by NERSA, and budgeting and planning by municipalities and other electricity
customers, all but impossible.
Environmental levy not applicable
Some 2,51% of the 12,61% price increase applied for by Eskom would be to recover a 2c/kWh
increase from 3,5c/kWh to 5,5c/kWh in the environmental levy on electricity generated from
carbon fuels, which was announced by the Minister of Finance in his budget speech on 25
February 2015.
However, while this increase has not been published in the Government Gazette, and is
therefore not yet in effect, Eskoms application has assumed that the environmental levy will
take effect on 1 July 2015.
Furthermore, there is still some doubt as to whether the environmental levy will even be
implemented or not, and an implementation date of 1 July 2015 cannot be taken as a given at
this stage.
Therefore it is suggested that NERSA should reject Eskoms application for a price increase to
recover any increase in the environmental levy until such time as the effective date of the levy
increase is formally announced.

Diesel and STPPP costs claimed by Eskom result from its own failings
On page 5 of Eskoms application to NERSA for a selective reopener of MYPD 3, the utility
acknowledges that: In the original MYPD 3 submission, assumptions were made around the
commissioning dates of Medupi, Kusile and Ingula, and the expected performance of the
current generation plant, which have since changed. As a result, no provision was made for the
extensive running of OCGTs and the continuation of the STPPP agreements.
Eskom goes on further to state on page 6 of its application for a selective reopener that:
Since the MYPD 3 application, various factors including the further deterioration of generation
plant performance; unexpected significant events such as the boiler explosion at one of the
Duvha units; and the collapse on the Majuba power station silo have necessitated the use of
more expensive supply options like the use of the OCGTs and looking for more short-term
supply options to close the demand gap.
The question therefore arises as to why Eskom is applying to pass any additional (unbudgeted)
costs of diesel and STPPP energy costs through to the customer in the tariff at all, when, by the
utilitys admission, such costs result directly from its own failings (i.e. the late completion of
Medupi, Kusile and Ingula; the boiler rupture at Duvha; and the silo collapse at Majuba); and
can therefore, by no stretch of the imagination, be considered as prudently and efficiently
incurred.
Eskoms extra costs are overstated, and ignore all cost reductions that benefit the
customer
It is quite clear from the extracts of Eskoms application quoted above that the utility intended
to produce electricity from Medupi, Kusile and Ingula in the MYPD 3 period from 1 April 2015 to
30 March 2018, and that such costs have been budgeted and included in MYPD 3. Had it not
been for the utilitys own failings, the need for extensive use of the OCGTs and STPPP energy
purchases would have been avoided.
However, in the event that NERSA may even entertain passing through to customers via Eskom
tariffs any additional diesel and STPPP costs at all, it is noted that Eskoms claims for additional
costs of R11bn for diesel and R5,5bn for STPPP energy for its 2015/16 financial year are clearly
significantly overstated, and should be offset by an amount corresponding to the cost of
electricity already budgeted and included in MYPD 3, and which was to have been supplied by
Medupi, Kusile and Ingula.
However, to Eskoms discredit, it has not even mentioned any such offsets in its application to
NERSA for a selective reopener, let alone provided any disclosure of the costs of electricity
from Medupi, Kusile and Ingula that have already been budgeted and included for in MYPD 3.
Inadequate disclosure
As such, Eskoms application to NERSA for a selective reopener of MYPD 3 can be seen not
only to be deficient, but also dishonest in terms of ignoring any applicable cost offsets.
The disclosure of information in Eskoms application is also completely inadequate for analysts,
electricity customers and the general public to make any serious quantitative response, and as
such it is believed that the application should be rejected by NERSA and sent back to Eskom for
rework.
Simplified recalculation taking into account cost offsets
In the absence of disclosure by Eskom of any offset costs, a simplified example below, using
some conservative assumptions, calculates a revised electricity price increase, taking into
account such offsets. It is noted that NERSA and Eskom will no doubt have at their disposal
suitable resources and data to perform this recalculation very accurately.
In 2012, NERSA calculated and stated publicly that the levelised cost of electricity (LCOE) from
Medupi was likely to be about R0,97 per kWh, and on this basis, a conservative assumption for

LCOE from Medupi, Kusile and Ingula is taken, for the purposes of this example only, as R1,00
per kWh.
For Eskoms extra R11bn diesel claim for 2015/16, the price application states that this
corresponds to generation of 450 GWh a month from Eskoms OCGTs. This would then result in
an offset amount of 450 GWh x 12 months @ R1,00 per kWh = R5,4bn, and Eskoms claim
should therefore be reduced from R11bn to R5,6bn (i.e. R11bn R5,4bn) for the 2015/16
financial year.
For Eskoms R5,4bn claim for STPPP energy purchases in 2015/16, the price application states
that: in 2013/14 Eskom spent R815m procuring 931 GWh (i.e. R0,88 per kWh) on the STPPP ; in
2014/15 it projected to spent R1,561bn procuring 1651 GWh (i.e. R0,95 per kWh); and in
2015/16 it projects to spend R5,4bn. Assuming a price of about R1,05 per kWh for 2015/16, this
translates into STPPP energy to be procured in 2015/16 of R5,4bn / R1,05 per kWh = 5143
GWh.
With a levelised cost of electricity from Medupi, Kusile and Ingula of R1,00 per kWh as above,
this would result in an offset amount of 5143 GWh @ R1,00 per kWh = R5,1-billion, and
Eskoms STPPP claim should therefore be reduced from R5,4bn to R0,3bn (i.e. R5,4bn R5,1bn)
for the 2015/16 financial year.
The impact of excluding an increase in the environmental levy (for the time being), and
including the above offsets, would be a reduction in Eskoms claim for an extra price increase
for its 2015/16 financial year, from the 12,61% claimed to 3,63%.
It should be noted that every effort for the past twelve months by this author to establish from
Eskom the updated estimated cost-to-completion (CTC) and levelised cost of electricity (LCOE)
from Eskom for Medupi and Kusile has failed, and Eskom simply refuses to disclose this
information.
Cost increases for 2016/17 and 2017/18
While it is probably correct that additional diesel and STPPP costs are inevitable for 2015/16, it
is certainly not correct that the associated offsets to these costs in 2015/16 are simply ignored,
as Eskom has done.
However the assumption by Eskom that additional diesel costs of R11bn per year to operate
OCGTs as mid-merit generation plant for the 2016/17 and 2017/18 financial years are the most
cost effective solution to meeting generation capacity shortfalls, is also almost certainly not
correct.
Yet no alternative mitigation techniques and associated costs (such as integrated demand side
management, demand market participation, power buy-backs, increased renewable energy
procurements, power ships, conversion of OCGT diesel fuel to imported liquefied natural gas,
increased industrial cogeneration, etc.) are presented or considered in Eskoms application for
a selective reopener to MYPD 3.
It would appear that Eskom has simply chosen, in its own interests, to maximise its price
increase and to include the most expensive option of all for the next three years, even though
it is likely that cheaper options will almost certainly be used in 2016/17 and 2017/18.
Alternatives to a price increase
It is sometimes claimed by Eskom (and others) that NERSAs failure to grant Eskom the price
increases it wants places the entire financial sustainability of Eskom, and therefore the
economy of South Africa, at risk. It is further claimed that there are no alternatives for Eskom
other than to increase tariffs to ensure the financial sustainability of Eskom.
However, in a recent presentation to financial journalists, a cash flow forecast was presented by
acting Eskom CEO Brian Molefe, which was premised on no 12,61% additional price increase by
NERSA at all for 2015/16. A similar presentation was made by Mr. Molefe to Parliament on 12
June 2015.

In his presentation, Mr. Molefe stated that that even without the additional 12,61% price
increase for 2015/16 there would be no problem in rolling over R10bn of debt that becomes
due for repayment in 2015, and raising additional gross funding of R66bn by the end of 2015
(comprising R55bn debt + R10bn private placing + R1bn other funding).
This submission to NERSA makes it clear that Eskoms application for an additional price
increase of 12,61% is grossly overstated and should be no more than an additional 3,63%, if at
all. Furthermore, Mr. Molefes presentation to journalists and Parliament shows that Eskom is
ready and able to cope financially without undue hardship without any additional price increase
at all for 2015/16. It is also clear that the damage to the economy and municipal finances, and
the hardship faced by the general public, would be very significant, and far outweighs the
relatively low additional costs to Eskom, which are entirely of its own making and a result of its
own failings.
There are also significant other funding options available to Eskom and its shareholder such as:
sale of non-core assets by the shareholder to provide additional equity; sale of specific noncore assets by Eskom to raise capital; sale of specific generation assets by Eskom to raise
capital; unbundling and restructuring of Eskom generation in line with the 1998 government
white paper on energy policy; taking on of strategic equity partners to raise capital and gain
new management skills, know-how, resources, technology and vision; increased public
participation in Eskom through an initial public offering on the JSE and other bourses; and/or
combinations of the above.

Conclusion and recommendations

In light of the above submission, the meaning of the term selective reopener in Eskoms mind
becomes clear, namely: Eskom gets to select the highest possible costs that should be passed
through to the customer for the next three years; and Eskom also elects to ignore any cost
offsets that may benefit the customer.
In conclusion to this submission, it is therefore recommended that:
1. NERSA should reject Eskoms application for a price increase to recover any increase in the
environmental levy until such time as the effective date of the levy increase is formally
announced.
2. Due to the inadequate disclosure of information to enable a rational consideration of
additional costs, offsets and technology options to meet the generation capacity shortfalls
2016/17 and 2017/18, NERSA should reject Eskoms application for a selective reopener
for the last two years of MYPD 3, and NERSA should only consider the selective reopener of
MYPD 3 for the 2015/16 year. Eskom should therefore be instructed to rework and resubmit
any application for a reopener for the last two years of MYPD 3 if it feels this to be
necessary.
3. Due to:
-

the significantly overstated additional costs claimed by Eskom for 2015/16 without
any disclosure of offsetting cost reductions in this period;
acknowledgement by Eskom that the additional diesel and STPPP costs incurred are
a result of its own failings;
acknowledgement by the acting Eskom CEO that Eskom can proceed without any
additional price increase for 2015/16 without any difficulty;
the significant damage to the economy and hardship to domestic customers that
would result from any additional price increase over and above the 12,69% increase
approved from 1 April 2015; and

the ruling by the National Treasury that any decision that NERSA makes for an
additional price increase after 15 May 2015 will need to be deferred to the 2016/17
municipal financial year;

NERSA should therefore reject Eskoms application for any additional price for 2015/16.
4. In the event that NERSA may entertain the possibility of any additional price increase for
2015/16 at all after taking the above into account, this should be limited to 3,63%, or as
otherwise determined by NERSA after a thorough investigation and recalculation of the net
diesel and STPPP cost increases, taking into account the applicable offsetting cost
reductions in this year.

5. NERSA should advise Eskom and its shareholder to seriously consider funding options to
recapitalise Eskom and ensure its financial sustainability other than simply applying for
massive tariff increases year after year.