1. INTRODUCTION 2. APPLICABLE LAW

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1 Consultation document regarding the Republic of Mozambique Pipeline Investments Company (ROMPCO) pipeline s preliminary gas transmission tariff determination for 2011/ INTRODUCTION 1.1 The Energy Regulator is mandated in terms of the National Energy Regulator Act, 2004 (Act No. 40 of 2004) (herein under referred as the NERSA Act ) to regulate the electricity, piped-gas and petroleum pipeline industries in terms of the Electricity Regulation Act, 2006, the Gas Act, 2001 and the Petroleum Pipelines Act, Section 4(h) of the Gas Act, 2001 (No. 48 of 2001) (herein-under referred as the Gas Act ) provides that the Energy Regulator must monitor and approve and, if necessary, regulate transmission and storage tariffs. 1.3 In line with this requirement, the National Energy Regulator of South Africa (NERSA or Energy Regulator) has published a notice for the public to comment on its preliminary determination of the gas transmission tariff for the ROMPCO s pipeline. This preliminary determination is done as per the Guidelines for Monitoring and Approving Piped-Gas Transmission and Storage Tariffs in South Africa (herein under referred as the Tariff Guidelines ). 1.4 This consultation document provides background information and the basis of the preliminary determination calculation for the gas transmission tariff for ROMPCO s pipeline. Interested parties are invited to submit written comments to the Energy Regulator on or before 05 March APPLICABLE LAW 2.1 The Energy Regulator is required to monitor and approve, and if necessary, regulate piped-gas transmission and piped-gas storage tariffs in terms of section 4(h) of the Gas Act of 2001 (Act No. 48 of 2001) ( the Gas Act ). In practice, this requirement is interpreted as follows: In monitoring and approval, NERSA does not set tariffs but will review tariffs prepared by licensees or applicants for transmission and storage facilities; ROMPCO Draft Tariff Determination for 2011/12 Page 1 of 7

2 NERSA can request licensees or applicants to amend the levels of tariffs or tariff structure or both; and NERSA can approve or decide not to approve a tariff. 2.2 If NERSA decides not to approve the proposed tariff, then section 4(h) of the Gas Act requires the NERSA to regulate the tariff. The process to be followed in regulating the tariff is outlined in the Tariff Guideline. In regulating, NERSA will regulate by determining the tariffs, if necessary, to ensure that NERSA is fulfilling its regulatory duties, inter alia by ensuring tariffs are cost reflective and applied in a non-discriminatory manner. 2.3 For monitoring purposes, the application for a tariff must be provided on an annual basis, although applicants are allowed to apply for approval of multi-year tariffs. 2.4 The approved tariff becomes the applicable tariff and discounts are permissible. It must be noted that the discounts should be consistent with the objectives of the Gas Act as well as section 22 of the Gas Act. 2.5 The approved tariff will by virtue of section 22 of the Act also apply to third parties. 3. TESTING OF PROPOSAL 3.1 According to the Tariff Guidelines, applicants are required to submit a tariff application based on their respective preferred methodology that may be chosen from the approved menu of tariff methodologies. 3.2 Each tariff application is reviewed using the same methodology chosen and used by the applicant and any other appropriate information or method for assessing the reasonableness of each application by the Energy Regulator. 3.3 Alternative tariff methodologies or variations on the methods listed on the menu may be used by the applicant, provided that such method is proven, tested and verifiable. 3.4 Therefore, to review ROMPCO s application for reasonableness, the Energy Regulator used the Rate of Return ( RoR ) methodology. 4. ROMPCO TARIFF APPLICATION 4.1 The Energy Regulator issued a licence to ROMPCO on 21 February 2007 to operate a gas transmission facility. ROMPCO operates an 867 km natural gas transmission pipeline from the Temane gas fields in Mozambique to Secunda in South Africa. ROMPCO Draft Tariff Determination for 2011/12 Page 2 of 7

3 4.2 On 27 December 2002, during the construction of the pipeline, ROMPCO entered into a Gas Transportation Agreement (GTA) with Sasol Gas, to transport 120 million gigajoules of gas per annum to South Africa. The GTA sets the tariff at R4,64/GJ as at January 2000, adjusted quarterly using the South African Producer Price Index (PPI), excluding any expansion related charges, based on a ship or pay for 80% of the 120 million Gigajoules per annum. This tariff formula was incorporated into the Schedule One to the Agreement referred to in section 36 of the Gas Act. 4.3 Therefore, the tariff for volumes up to 120 million gigajoules per annum is determined using the above formula whilst the tariff for any additional volumes due to expansion investment is determined using the Tariff Guidelines. 4.4 To comply with the Tariff Guidelines, ROMPCO has submitted a transmission tariff application for the additional 27 million gigajoules not covered by the formula in the Agreement. A copy of the tariff application is available on the NERSA website. 4.5 ROMPCO is applying for a tariff of R11.39/GJ based on the formula in the Heads of Agreement (HOA) between itself and Sasol Gas. The HOA dated 28 September 2007 provide the following provisions: i. the transmission of an additional volume of gas of 27 MGJ/a with a 7 year ramp-up period; ii. a transmission tariff of R8.50/GJ as at 30 September 2007, adjusted quarterly with the South African PPI; and iii. a minimum annual shipment volume (or ship-or-pay) of 92% of the contracted annual shipment volumes. 5. ELEMENTS OF ALLOWABLE REVENUE 5.1 As mentioned above, the Energy Regulator used the Rate of Return ( RoR ) methodology to in the determination of ROMPCO s gas transmission tariff, in line with the Tariff Guidelines. The formula of RoR used is as follows: AR = (RAB x WACC) + E + T + D ± C Where: AR - Allowable Revenue RAB - Regulatory Asset Base WACC - Weighted Average Cost of Capital E- Expenses T - Taxes D - Depreciation C Clawback ROMPCO Draft Tariff Determination for 2011/12 Page 3 of 7

4 2011 TARIFF AR CALCULATION NERSA (Rm) (AR = (RAB*WACC) + E +D +T±C) WACC 5.75% Return on assets Operating Costs Depreciation and Amortization Allowable Revenue before tax Tax Clawback 0.00 Total AR Volume (MGJ/a) 147 R/GJ The paragraphs below provide an analysis of each component of the allowable revenue formula. Starting Regulatory Asset Base (SRAB) 5.3 In terms of section of the Tariff Guidelines, the value of the RAB is the inflation-adjusted historical cost or trended original cost ( TOC ) of plant, property and equipment less the accumulated depreciation for the period under consideration plus net working capital. The formula for this is as follows: Regulatory Asset Base = Trended Original Cost of Property, Plant & Equipment (v) - Accumulated Depreciation (d) + Net Working Capital (w) 5.4 Using the above formula, the resultant SRAB for ROMPCO is as follows: 2011 TARIFF - SRAB CALCULATION SUMMARY (RAB = v-d +net working capital) NERSA (Rm) Trended Original Cost (TOC) Net Working Capital Total RAB The Energy Regulator took into account the entire pipeline assets, including the Compressor Station in the determination of the regulatory asset base of R m. Depreciation (d) and Amortization 5.6 Section of the Tariff Guidelines provides that accumulated depreciation (d) is the cumulative depreciation against plant property, vehicles and equipment in service should be calculated on a straight line basis over the economic life of the asset. 5.7 This yielded a depreciation expense of R417.92m. The inflation write up from the trending of the asset value which was amortized over the estimated remaining economic useful life of these assets was R121.77m. ROMPCO Draft Tariff Determination for 2011/12 Page 4 of 7

5 Net working Capital (w) 5.8 According to the Tariff Guidelines, net working capital refers to the various regulatory asset-base funding requirements other than utility plant in service. This is determined using the following formula: Net working capital = inventory + receivables + operating cash + minimum cash balance trade payables. 5.9 The Energy Regulator used the working capital expenditure of the entire pipeline and the Compressor Station as provided by the applicant. Tax (T) 5.10 Section 4.4 of the Tariff Guidelines provides that the flow-through tax approach is the Energy Regulator s preferred tax methodology. Under this approach, only the current taxes payable are factored into the allowable revenue and recovered during the tariff period under review The Energy Regulator used the flow-through tax approach to determine the amount of tax payable in the allowable revenue. Deferred tax was not taken into consideration since the flow-through tax method does not provide for future income taxes payable outside the tariff period. Expenses (E) 5.12 The Energy Regulator is required by section 4.3 of the Tariff Guidelines to assess the operating and maintenance expenses using principles such as whether the expenses were prudently incurred, its controllability and efficiency The Energy Regulator adopted the operating and maintenance expenses figure of the entire pipeline and the Compressor Station as provided by the applicant. Weighted Average Cost of Capital (WACC) 5.14 In its application, ROMPCO did not provide the building blocks for the WACC calculation since it submitted the nominal WACC set by Sasol Limited of 15.76%. 6.1 The Energy Regulator used the following formula in its determination of ROMPCO s WACC: WACC Where: E = equity Dt = debt E Dt E Dt Dt E ( real) * Ke( real) * Kd ( real) Ke (real) = real cost of equity derived from the Capital Asset Pricing Model (CAPM) Kd (real) = the post tax real cost of debt ROMPCO Draft Tariff Determination for 2011/12 Page 5 of 7

6 5.15 A minimum debt structure of 30% was used in the calculation of WACC, as prescribed by the Tariff Guidelines The mark-to-market risk free rate of a selected 5 to 10 year government of South Africa bonds were used for the expected risk free return (Rf) in the estimation of cost of equity. This yielded a real risk free rate of 3.68% The market return (Rm) was calculated using the JSE ALL Share Index, converted from a nominal to real value for the previous 25 years (March 1985 to March 2010). The average month-to-month CPI over the same period (March 1985 to March 2010) was used. This yielded a real market risk premium (MRP) of 5.80% The beta (β) was determined by proxy. As a proxy, the average of six gas pipeline companies chosen by the Energy Regulator and listed on stock exchanges must be used as per the Tariff Guidelines. The following US companies were used by NERSA as proxies: AGL Resources Inc. UGI Corporation South Jersey Industries WGL Holdings Inc. The Laclede Group Piedmont Natural Gas Company Inc This methodology resulted in a leveraged beta of 0.78 for ROMPCO s gas pipeline business and a real cost of equity (Ke) of 8.20% The Energy Regulator used a weighted cost of debt (Kd) derived from ROMPCO s weighted borrowing rate The CPI used in calculating the real cost of debt is a forecasted CPI for the next 12 months (5.8%). The CPI information was sourced from the Bureau of Economic Research (BER) It must be noted that the sources of information prescribed by NERSA were used as data sources for calculating the WACC. Clawback 5.23 Since this is ROMPCO s first tariff application, there was no claw back calculated. 6. ANALYSIS OF PROPOSED TARIFF 6.1 ROMPCO is requesting a tariff of R11.39/GJ based on the HOA agreement with Sasol Limited. This tariff was set based on the formula used to determine the tariff for the initial volume capacity of 120mGJ/a covered by Schedule One to the Agreement. ROMPCO Draft Tariff Determination for 2011/12 Page 6 of 7

7 6.2 However, all volumes above the 120mGJ/a should be determined using the Tariff Guidelines for the approved tariff to comply with the objects of the Gas Act. 6.3 As a result, although the tariff determined using the rate of return methodology of R7.20/GJ is 37% lower than the R11.39/GJ ROMPCO is applying for, it allows for full cost recovery and earns a return commensurate with risk as required by the Gas Act. 6.4 It is the view of the Energy Regulator that the tariff should be determined using the RoR methodology so as to set a base which is cost reflective, allows for full cost recovery and earns a return commensurate with risk. 7. IMPLEMENTATION 7.1 The approved tariff for the first quarter of 2012 for the initial volume capacity of 120mGJ/a covered by the Agreement is R10.33/GJ. This is 30% higher than the R7.20/GJ proposed for the additional 27mGJ/a. 7.2 Given that there will be two different tariffs for the gas transmitted through the same pipeline, there might be a need for a blended or averaged tariff so as to reduce the risk of unfair discrimination among customers using the same pipeline. 7.3 If the tariffs are blended, the resultant weighted tariff would be R9.59/GJ for a total throughput of 147 million gigajoules. This is 7% lower than the current tariff of R10.33/GJ determined using the formula prescribed in the Agreement. However, the allowable revenue derived from the blended tariff of R1410m is the same as the allowable revenue derived from charging two different tariffs for different volumes. 7.4 If however the letter of the Agreement is followed, two tariffs should be charged, namely R10.33/GJ for 120 million gigajoules and R7.20/GJ for 27 million gigajoules. 7.5 The table below summarises the above scenarios. Tariff Structure Allowable Revenue Rm Unblended tariff (27mGJ/a@ R7.20/GJ) and (120mGJ/a@R10.13/GJ) 1410 Blended tariff (147mGJ/a@R9.59/GJ) There are advantages and disadvantages to blending the tariffs and in light of this, comments are also being solicited from stakeholders on the implementation of the tariffs. ROMPCO Draft Tariff Determination for 2011/12 Page 7 of 7