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1 Tariffs versus Return on Investment Title of presentation Cornelis van der Waal Industry Manager Africa Energy and Power Systems Power Indaba 2008, Cape Town, South Africa

2 TOC Current State of the Electricity Industry in Africa Different Role Players and their Objectives Utilities vs IPP s Calculation of a Fair Tariff Typical Payback Periods for Power Projects ROI Expectations vs. Type of Power Project The African Generation Industry Current Electricity Clients in SA The Reserve Margin in South Africa Traditional Price Increases in South Africa Some Examples

3 Current State of Electricity Industry in Africa Mostly one state dominated utility Limited new build programmes Insufficient reserve margin in most countries Poor medium term planning effectiveness Demand growth 50%+ increase from 1990 to present Feedstock supply insecurity Changing weather patterns (significant effect on hydro power plants) Increasing interest from Europe, the USA and - for various reasons - Asia to be involved as IPP s

4 Different Role Players = Different Aims and Objectives Government / Utility Lowest cost attracts investment in critical sectors such as mining and industrial development Lowest cost benefits the poor Stable and predictable price increases raise confidence and confirm good governance Stability in expansion makes budgeting easier IPP s Actions are profit driven Quality of service and reliability most important Tariff needs to be a fair reflection of generation costs and can lead to shock price increases In Africa there is a substantial political return premium expectation (sometimes in excess of 15%)

5 Utility versus IPP Utilities Primary Aim Generating, transmitting and distributing reliable electricity Primary Advantage Government funding and relationships Largest Restraint Funding and skills Rational for Existence To support government aims of development Profit IPP s Primary Aim Primary Advantage Access to funding, technology and skills Largest Restraint Lack of input into legislation and government contacts Rational for Existence Increased productivity, technical expertise and global experience

6 Calculation of a Fair Tariff Investment Cost + Operational Costs + Feedstock Costs + Profit + Costs of new equipment, construction, and the cost of debt Costs include salaries, maintenance and repair, overhead costs etc. Significant variations in in feedstock costs (hydro vs. diesel costs) Significant variations in expectations elements include payback period expectations, political risk and other risk premiums?? Hidden costs

7 Typical Payback Periods for Power Projects D e b t Project Expenses (Debt or Equity) Time Cash Flows Payback period depends on: debt to equity ratio cost of debt cost of operations maintenance and servicing expenditure tariff (cash flows) Typical payback period expectation between 10 and 20 years

8 ROI Expectations vs. Type of Power Project Long-term Base Load Type of technology: Coal, Gas, Hydro, Nuclear ROI Expectations: 5 to 15% Short term Base Load Type of technology: Diesel Generators, OCGT ROI Expectations: 10% to 30% Long-term Peak Load Type of technology: Pump Storage, Diesel Generators, OCGT ROI Expectations: 15% to 30% Short-term Peak Load Type of technology: Diesel Generators ROI Expectations: 25% to 35%

9 The African Generation Industry Generation Generation End User End User Generation Generation Utility Utility Transmission Transmission Distribution Distribution Municipality Distribution Distribution End User End User

10 Current Electricity Clients in SA Utility sells bulk electricity to two types of clients Industrial electricity users Price individually negotiated lots of government interference Price increases not always linked to normal price increases Municipal electricity users Municipalities purchase bulk power from the utility and sell it on to end-users Municipalities normally make profit on electricity sales to subsidise non-profitable operations such as refuse removal

11 The Reserve Margin in South Africa Reserve margin = 25% Reserve margin = 20% Reserve margin = 16% Reserve margin = 8-10% Reserve margin aspiration = 15% Peak Demand and Capacity (MW) Y e a r P e a k D e m a n d E x p e c te d P e a k D e m a n d In s ta lle d C a p a c i ty ( M W S e n t- o u t) O p e r a ti o n a l C a p a c i ty ( M W S e n t- o u t) MW Generation Supply and Electrcity Demand Year 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% Reserve Margin MW Position Moderate Long term forecasts - national + foreign MW 960MW MW 710MW Expected Demand Expected Capacity Reserve Margin

12 Traditional Price Increases in South Africa Price of Electricity to Industrial Customers (2007) Price Compared to South Africa 700% 600% 500% 400% 300% 200% 100% 0% South Africa Canada International Electricity Prices Sweden Finland Australia France USA Country Spain UK Price Increases in SA ( ) Cents per kwh Belgium Netherlands Germany Electricity Tariff in South Africa (2004 to 2008) New Year Italy Denmark 50.00% 45.00% 40.00% 35.00% 30.00% 25.00% 20.00% 15.00% 10.00% 5.00% 0.00% Percent Increase Gap increased to 74% from 30% in 2006 Capital commitments in excess of R340 billion Current pricing is half of the replacement value Cost of production is increasing IPP s will play an increasingly important role potentially generating 30% of SA s power needs Renewable projects currently getting a lot of attention