1

South Africa: Electricity Pricing Considerations

Presentation at the National Electricity Summit

16 May 2008

2

Eskom Application for a Review of the 2008/9 Price

Increase in Context

3

As a result Eskom’s Average Selling Price has been declining

Eskom's average selling price deflated by CPI

0

5

10

15

20

25

30

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

ZA c

ents

/kW

h (2

005

CPI

pric

es)

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50

US

(200

5) c

ents

/kW

h

Average selling price

selling price in US (2005) cents RHS

4

If prices kept up with inflation alone since 1990, this would translate to a tariff level close to what is

achieved with a 60% increase in 2008/09Eskom's average selling price deflated by CPI

0

5

10

15

20

25

30

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

ZA c

ents

/kW

h (2

005

CPI

pric

es)

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50

US

(200

5) c

ents

/kW

h

Average selling price

selling price in US (2005) cents RHS

2005(Nominal

equivalent)

24c/kWh

2006(Nominal)

25c/kWh

2007(Nominal)

27c/kWh

2008(Nominal)

29c/kWh

5%

7%

9%

The resultant tariff is within 7% of what is

currently requested by Eskom

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• Coal and Diesel form a large part of Eskom’s input costs

• Prices of these two Primary Energy sources have been rising at a rate much higher than inflation whilst Eskom’s prices have been declining in real terms

• Input Costs have been rising at a rate higher than inflation vs. Eskom’s price which has been declining in real terms

Input Costs

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Producer Price Inflation – Coal(rising faster than CPIX or PPI)

100

120

140

160

180

200

220

240

260

Jan-

04

Mar

-04

May

-04

Jul-0

4

Sep-

04

Nov

-04

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep-

05

Nov

-05

Jan-

06

Mar

-06

May

-06

Jul-0

6

Sep-

06

Nov

-06

Jan-

07

Mar

-07

May

-07

Jul-0

7

Sep-

07

Nov

-07

Jan-

08

Coal - PPI CPIX PPI

`

Source: StatsSA P0142.1 PPI Report Table 14, Mining and Quarrying - Coal

Inde

x

Since January 2004, Coal index has increased by 93%compared to PPI of 29%

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Producer Price Inflation – Diesel(rising faster than CPIX or PPI)

100

150

200

250

300

350

Jan-

04

Mar

-04

May

-04

Jul-0

4

Sep-

04

Nov

-04

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep-

05

Nov

-05

Jan-

06

Mar

-06

May

-06

Jul-0

6

Sep-

06

Nov

-06

Jan-

07

Mar

-07

May

-07

Jul-0

7

Sep-

07

Nov

-07

Jan-

08

Diesel Oil CPIX PPI

`

Source: StatsSA P0142.1 PPI Report Table 16, Diesel Oil- Coast and Witwatersrand

Inde

x

Since January 2004, Diesel index has increased by 190%compared to PPI of 29%

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What has Eskom Applied for?

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• Primary Energy Expenditure > MYPD Allowance of R 12.921bn over the current 3 year period:– 2006/7 (Actual) = R 2.041bn– 2007/8 (Projected) = R 5.489bn– 2008/9 (Forecast) = R 5.391bn

• Accelerated Demand Side Management Expenditure > MYPD Allowance of R2.518bn over the current 3 year period (Target increased from 459MW to 1414MW):– 2006/7 (Actual) = R 226m– 2007/8 (Projected) = R 279m– 2008/9 (Forecast) = R 2.013bn

Application for Review of 2008/9 Price Increase based on:

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Proposed Price Increase (53% Real/60 Nominal)Additional Cost Recovery of R21.037bn for the MYPD (2006/7-2008/9)

13.53%

13.77%

5.12%

6.32%

14.05%

52.79%

0%

10%

20%

30%

40%

50%

60%

70%

Budget 2008/9 PE 2008/9 PE 2007/8 PE 2006/7 DSM 2008/9 Total

Pric

e %

(R 5 391m)

(R 5 489m)

(R 2 041m)

(R 2 518m)

(R 5 598m)

Awarded 20 December 2008 = R 5 598bnAdditional Applied for = R 15.439bn

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0

5

10

15

20

25

30

35

40

45

'2007/8 '2008/9 '2009/10 '2010/11 '2011/12 '2012/13

c/kW

h

Manpow er General Primary energy Depreciation Return

Cents per kWh (Constant Rands) – 53% (real)

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Annual Price Increases Going Forward(based on 53% increase in 2008/9)

Actual (1%)

Real Price Increases (above CPIX)

-20%

-10%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

'2007/8 '2008/9 '2009/10 '2010/11 '2011/12 '2012/13

PE Full MYPD + DSM Full (53%)

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Proposed Tariff Smoothing• To limit the negative effects of a sharp

increase of tariffs on the economy and poor households

• Proposals have been developed to smooth the tariff over the next 5 years

• However it is critical that the wholesale tariff reach 46c/kwh by 2011/12, which would be Eskom’s levelised costs

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Proposed Smoothing Options Real Price Increases

0%

5%

10%

15%

20%

25%

30%

35%

40%

'2007/8 '2008/9 '2009/10 '2010/11 '2011/12 '2012/13

Trajectory 2 Trajectory 5

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Implications of the smoothing• Smoothing effectively means that in year 1,

there is an under recovery of revenue which must be funded by an equity injection into Eskom;

• Tariff increases remain high for a longer period to allow the recovery of all allowable revenues;

• Partly as result of the smoothing of the revenue required and the current sub-prime crisis, there is significant risk of a funding shortfall for Eskom’s investment programme.

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0

5

10

15

20

25

30

35

40

45

50

'2007/8 '2008/9 '2009/10 '2010/11 '2011/12 '2012/13

c/kW

h

Manpow er General Primary energy Depreciation Return

Cents per kWh in Constant Rands Trajectory 2 (33% Real in 2008/9)

In 2007/08 and 2008/09 almost zero returns due to rules of existing MYPD seen in projections for 2007/08. From

2009/10 returns escalate BUT assumes smoothed price increases

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Protecting the Poor• Implementation of Differential Tariff Increases

to protect the Poor.

• Homelight is the tariff Eskom offers for the low income sector. The similar tariff type for SMME is Businessrate4.

• Note that most municipalities offer the same type of tariff for the poor (so-called “lifeline”tariffs), but it will be incumbent on Nersa to ensure Munics adopt a similar approach and implement differential tariff increases.

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Differential Increases applied (Eskom Tariffs) to achieve 33% (real) revenue increase for 2008/9

• The price increase is assumed over the full Eskom financial yearand is expressed as a nominal value (includes inflation).

• CPI-X of 7% assumed• Municipalities will experience a 53.5% increase in bulk tariff due

to a 9 month recovery period in compliance with the MFMA

Increase (2008/9) Increase (2008/9)

(%) 2007/8 2008/9 (Rands)

Homelight 20A 15.0% 45.27R 52.06R 6.79

Homepower 41.9% 367.63R 521.66R 154.03

Businessrate1 41.9% 465.11R 659.99R 194.88

Businessrate4 15.0% 305.58R 351.42R 45.84

Average Monthly BillEskom Tariff

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Conclusion

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• Eskom has already spent more on primary energy and demand side management than was budgeted for in the MYPD and will need to accelerate its spend further.

• The Eskom build programme is crucial in the light of the growing electricity demand. A sustainable balance sheet is critical as the bulk of Eskom funding is sourced from the capital markets.

• By 2012 the actual marginal costs of producing electricity will increase to about 46cents/kwh. Therefore tariffs have to approach this level over time.

• In this context smoothing is proposed given the fact that the 46 cents has to be achieved in 4 years time, therefore the tariff decreases substantially in Year 1 but remains at a relatively high level for the next 3 years before it approaches CPIX

Why an immediate Tariff Increase?

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Initiatives to control Eskom’s cost drivers• DSM – crucial in ensuring efficient energy

utilisation in general– Reduced demand means reduced primary energy

demand • Coal strategy – working with DME to increase

the amount of coal sourced from cost plus mines• Operational efficiency and maintenance practice

improvements by Eskom– Comprehensive benchmarking of Eskom operations– Modernisation of maintenance practices

• Capital inputs for the build programme – Local source strategy along with local manufacturing

capability development

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• Electricity tariffs must reflect the economic costs of production.

• A smoothing of the tariff is proposed over the next 5 years

• A pro-poor tariff structure is proposed for distribution customers within Eskom and Municipal supply areas.

Conclusion

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Thank you