The National Energy Regulator of South Africa (Nersa) has approved a nominal Eskom power tariff increase of 24,8% as from April 1, 2010, and subsequent increases of 25,8% and 25,9% for 2011/12 and 2012/13 respectively, chairperson Cecilia Khuzwayo announced on Wednesday.

In November last year, South Africa's State-owned power utility Eskom applied for increases of 35% a year over the three-year second Multi Year Price Determination (MYPD2) timeframe, having initially requested yearly increases of 45%, which it said were necessary to help it cover rising operational and capital costs.

Following an extensive process of consultation and deliberation, during which Nersa received 427 comments on the proposed tariff hikes and listened to 85 oral presentations across all nine provinces,

Khuzwayo reported that it would allow Eskom to recover revenue of R85-billion in 2010/11, R105-billion in 2011/12 and R141-billion in the final financial year of the control period.

The utility had requested revenues of R99-billion, R146-billion and R216-billion for the period. But the regulator had placed some severe constraints on Eskom's internal cost increases, particularly in the area of primary energy and human resources.

In fact, Nersa's full-time member responsible for electricity Thembani Bukula noted that it had refused to grant Eskom the cost increases it had been seeking. "For instance, on its human resources costs, Eskom was asking for about 8% and we have reduced those costs to about 5,6% over the three years," Bukula said, adding that its determination shaved about R7-billion off Eskom's applied-for cost increases in the first year alone.

Nevertheless, the average electricity price would rise from around 33c/kWh to 41,5c/kWh this year, and then to 52c/kWh in 2011/12 and to over 65c/kwh in 2012/13. This, however, was, in Eskom's view, below a cost-reflective level, which the utility reported to be northwards of 70c/kWh.

But the increase was already wildly unpopular and would definitely add to inflationary pressures and could also limit economic growth and job creation prospects. Nersa calculated the impact on inflation as being less than 1,5% a year over the three-year period, Bukula said.

MOSTLY NEGATIVE REACTION

But the South African Chamber of Commerce and Industry said that, while Nersa's decision brought certainty, it was still expecting that about 250 000 jobs would be lost as a consequence of the hikes, while the increases would be a factor in inflation remaining outside the target range of from 3% to 6%.

The Steel and Engineering Industry Federation of South Africa (Seifsa) expressed "frustration" at the hikes. "This setback for business and its employees comes a week after the positive budget and [Industrial Policy Action Plan 2] focused on creating an additional 500 000 jobs for new job entrants and create 2,5-million jobs over the next ten years respectively. The first will now be a lot harder to achieve and latter will have to start by mopping up the unemployment caused by this announcement," Seifsa said.

The country's largest labour federation Cosatu, meanwhile, hinted to strike action, noting that the increases are more than four times the current rate of inflation and "totally unacceptable".

One of its affiliates, the National Education Health and Allied Workers Union (Nehawu), describing the decision as "outrageous".

"This increase makes a mockery of the government's promise for the creation of decent work because it threatens the survival of small businesses whose collapse would exacerbate the loss of jobs," Nehawu said.

Another powerful affiliate, the National Union of Metalworkers of South Africa (Numsa) said that it "abhors" the decision.

"These increases will jeopardise the developmental agenda," Numsa said, while calling on call on the ANC and its partners to reject the approved tariffs.

"The failure by the collective to provide leadership on this matter will lead to popular mass retaliation on the streets by the working class and the poor," Numsa warned.

Similarly, the far smaller Solidarity union said that the announcement "was a severe blow for job creation and investment in South Africa".

Earthlife Africa, meanwhile, said that it was not surprises by the decision, which it criticised for further entrenching coal-powered stations. Further, by leaving the special purchase agreements that Eskom had with certain industries unchanged meant that citizens would continue paying more for electricity, while "these industries will be protected".

Energy Minister Dipuo Peters said that she respected the decision taken by the regulator. But she added that it had become necessary to conclude the "price path for the electricity industry in order to eliminate the uncertainty around the funding of the capital programme for the sector".

ESKOM, S&P'S AND MINING CHAMBER

Eskom's own on-the-record response was muted, with the utility saying only that it was currently studying the full details of the determination and acting chairperson Mpho Makwana indicating that it would only make further comment once it had determined the "specific implications".

However, some company official, speaking on condition of anonymity, expressed disappointment, particularly with the way Nersa had chosen to phase in the revaluation of assets, which resulted in far lower depreciation costs than would otherwise have been the case. The return approved would probably not even cover the interest costs associated with the debt-funded assets, nor would it cover interest during construction.

Ratings agency Standard & Poor's (S&P's) was more assertive in its critique, saying that, "government support for Eskom has become even more important for the company to maintain its credit standing".
"The announced tariff increase of about 26% is negative news in that it is significantly below the tariff assumed by Eskom in its last application," S&P's Konrad Reuss said.

"Our analysis already takes into account some uncertainty surrounding the actual tariff outcome.

Nevertheless it will be important to see what mitigating measures are being considered by Eskom to offset the lower-than-expected tariff increase. It will also be important to assess the effect of the tariff increase on the company's liquidity position," Reuss added, noting that Eskom's stand-alone credit profile would remain "very weak" in the short term, making continued government support critical from a ratings perspective.

S&P's affirmed Eskom's BBB+ long-term foreign currency rating in January 2010.

The only immediate positive reaction came from the Chamber of Mines of South Africa, which expressed its "appreciation" of the decision, particularly in light of the damage that would have been caused by the 35% increase a year proposed by Eskom.

The chamber had itself recommended a 25%-a-year increase over three years, noting that such an increase would also be congruent with multi-stakeholder consensus about the need for price smoothing.

But it added that the tariff increases would still affect employment, production and economic growth, as well as mining costs.

"Mines will still have to implement measures to deal with the impact of the increased costs," the chamber said.

Similarly, Frost & Sullivan energy programme manager Cornelis van der Waal argued that the hike was in line with expectations, albeit at the "bottom end of our predictions".

"We anticipated that 25% would be the very minimum for the increase," Van der Waal said, adding that the decision sent the message that, while electricity prices had to increase, Eskom could not increase tariffs at the rate it wanted.

DSM AND IPPS

The regulator shrugged off suggestions that it had made its decision under duress, stressing that it had followed "due process" and that the determination had been framed within its legally defined mandate - a mandate that drew on the National Energy Regulator Act and was also guided by the Integrated Resource Plan (IRP) and Electricity Pricing Policy (EPP).

CEO Smundo Mokoena stressed that these legislative and policy tools, while lacking in certain respects, had nevertheless been sufficient for a determination to be made.

The much-criticised IRP indicated that some 10 000 MW would have to be added to the power system by 2016, with the EPP calls for a migration to cost-reflective tariffs over a five-year period.

However, the determination did deviate from the IRP in respect of Kusile, given that there was a misalignment between its timing of the first unit being added in 2013 and Eskom's assertion that it would only be possible by 2014.

In the final analysis, the determination was based on a revenue requirement formula, against which Eskom is allowed to recover prudently incurred operational and capital costs, while making a "reasonable" rate of return.

Under the formula, Nersa allowed Eskom to recover its primary energy and operational costs; costs related to independent power producer (IPP) and cogeneration contracts; depreciation costs a return on assets and demand-side management (DSM).

Nersa allocated R5,4-billion for DSM over the three years, which should partly enable Eskom to roll out a number of its demand-dampening projects, such as solar water heaters.

Over the period, some R12,4-billion was also allocated to Eskom to cover contracts with IPPs and cogenerators.

The rate of return that should be allowed and the basis for its calculation emerged as a key theme during the recent public hearings into Eskom's application, which was unable to draw support from any sector of society, including the ruling ANC.

In its application, the utility has interpreted the stipulation (contained within the electricity pricing policy) for a revaluation of its assets to mean that it should use the modern equivalent asset (MEA) revaluation model. By contrast, many commentators argued that the "less subjective" index historic cost methodology would be the best regulatory practice.

The regulator decided to base the revaluation of assets using the MEA method, but phased in over five years, not three.

It also based its determination on a weighted average cost of capital, or WACC, of 8,16%.

But Bukula stressed that the MEA model would be reviewed within the MYPD2 period, while Eskom was unlikely to actually achieve a WACC of 8,16% during the period.