GUIDELINE DOCUMENT TO MUNICIPALITIES ON THE DESIGN OF A DOMESTIC INCLINING BLOCK RATE TARIFF

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1 GUIDELINE DOCUMENT TO MUNICIPALITIES ON THE DESIGN OF A DOMESTIC INCLINING BLOCK RATE TARIFF 1. BACKGROUND AND APPROACH 1.1. During the National Energy Regulator of South Africa (NERSA) stakeholder consultation on the Eskom interim price application (early 2009), many stakeholders called for the introduction of pro-poor tariffs On 25 June 2009, NERSA made a determination on the abovementioned application and granted Eskom a 31.3% price increase. NERSA further approved a differentiated (lower) price increase of 15% for the Eskom Homelight 1 & 2 customers with the rest of the customer base subsidizing the Homelight 1 and 2 customers. The decision was as follows: The approved price increase on the average standard tariffs includes a limited price increase of 15% to both Eskom and municipalities poor customers (i.e. Homelight 1 & 2 tariffs). It must be noted that this is an interim measure until the implementation of inclining block rate tariffs for protection of the poor. The full implementation will occur in the Multi-Year price Determination 2 (MYPD2) The abovementioned decision was supported by Section 22(2) of the Electricity Regulation Act, 2006 (Act No. 4 of 2006) which states that a licensee may not discriminate between customers or classes of customers regarding access, tariffs, prices and conditions of service, except for objectively identifiable differences approved by the Regulator Following the above mentioned decision, NERSA commenced with an international benchmark study on the design of an Inclining Block Tariff (IBT) for domestic/ residential customers. This study included utilities and regulators such as BC Hydro, Nova Scotia Power Incorporated, Royal Thai Government ( Thailand), Georgia Environmental Protection Division During the analysis of the MYPD 2 decision, NERSA subsequently also investigated various other options of providing protection to low-income tariff customers. The table below highlights these options: OPTIONS 1. Capping Increase to the poor: Differentiated Pricing 2. Increasing the Free Basic Electricity (FBE) Allocation from 50kWh to 70kWh or even 100 kwh REASONS FOR NON-SELECTION This option resulted in major revenue losses to municipalities, especially municipalities which have a predominantly residential customer base It also does not always target the people for whom it is intended The authority responsible for the FBE allocation levels is the DoE together with COGTA and the National Treasury. Page 1 of 9

2 NERSA therefore did not have the mandate and/or authority to enforce this option 3. Introduction of Real Time Pricing This would require major system changes with regards to metering with high costs and may even results in much higher prices for the poor Table 1: Options Considered for Low Income Customer Protection 1.6 During the study on the design and structure of the IBT it was found that an IBT rate structure would allow the achievement of : a) protecting low income tariff customers, and; b) promoting energy efficiency. For these reasons the IBT was selected as the most preferred and viable option. 1.7 Furthermore, the principle of an IBT was supported by the South African Electricity Supply Industry: Electricity Pricing Policy GN 1398 of 19 December 2008 (EPP) which states that: : Low income tariff customer subsidization: Charging an appropriate tariff structure that allows for maximum subsidization at low consumption levels with gradually reducing cross-subsidies as the consumption levels increase. 1.8 On 24 February 2010, the Energy Regulator approved the implementation of IBTs concurrently with the 2010/11 price increase, in order to provide for cross-subsidies for low income domestic customers, as required by the EPP. 2. INTRODUCTION OF IBTs 2.1 Definition and explanation of an IBT An Inclining Block Rate Tariff is a tariff structure where the customers consumption is divided into blocks. Each block has a price per unit of energy consumed in that block; which increases with each succeeding block i.e. it consists of different prices for different energy consumption levels. For example, in a total consumption of 100kwh per month, a low block rate for the first 50kWh of consumption and a higher block rate for the balance of consumption Illustrative Example: Page 2 of 9

3 Block 4 >600kWh 88.00c/kWh Block kWh 74.00c/kWh Block kWh 58.00c/kWh Block kWh 54.00c/kWh Thabo consumes 650kWh/month. In 2009/10 the municipality offers Thabo a single energy rate tariff at a tariff rate of 73.00c/kWh. Thabo s monthly bill would therefore have been R In 2010/11 the municipality introduces an IBT. Thabo s consumption level remains at 650kWh/ month. His bill based on an IBT structure will therefore be as follows: DETAILS BLOCK 1 BLOCK 2 BLOCK 3 BLOCK 4 TOTAL IBT BLOCKS >600 (kwh) CONSUMPTION (kwh) TARIFF RATE (c/kwh) CHARGE TO 50x x x x0.88 THE CUSTOMER TOTAL (R/Month) Table 2: Illustrative Example of an IBT This example also illustrates that the IBT is based on the principle of incremental pricing i.e. the user is charged incrementally higher on the block rates as consumption increases. This is similair to the progressive tax system. Therefore, if Thabo reduces his consumption by 50kWh per month, his bill will reduce to R Similiarly, If Ntombi consumes 1200kWh per month: - Her bill on the single energy rate of 73.00c/kWh will be R (average of 73.00c/kWh) - Her bill on the IBT structure will be R (average of 76.17c/kWh) Page 3 of 9

4 This illustrates that the higher bill would encourage Ntombi to consume less thus resulting in energy conservation. On the other hand the low level consumers falling in block 1 and block 2 will be protected from the higher tariffs as the IBT rates of 0.54/kwh and 0.58/kwh respectively are lower than the existing single energy rate of 73.00c/kWh 2.2 Design Principles of an IBT The following key design principles have been applied to develop the inclining block rate structure: the need to be easy and economical to administer/implement; the need to ensure stability, simplicity and understandability and transparency; the need to utilize appropriate metering and supply technology; the customers ability to pay; equity: preserving a degree of cross-subsidies to ensure support to low income customers; the requirement to shield the poor from the impact of unacceptably high price increases; the need to ensure revenue neutrality to the utility i.e. the utility should neither make a profit nor a loss in revenue because of changes in tariff structures In order to keep in line with the design principle that the tariff should be easy and economical to administer/implement it was decided to limit the IBT to a 4 block tariff structure. 2.3 Development of an IBT The table below summarizes the 4 Blocks, consumptions levels, the basis for the block range used in the development of the IBT during the MYPD2 period for both Eskom and municipalities: Blocks Consumption Levels Basis of Block Range Block KWh Equal to FBE KWh Cushion low income large families that may Block 2 spill over from Block kwh Presumed average household consumption Block 3 informed by National Treasury assumption Block 4 >600kWh Remainder Table 3: Block Design The next step was to set the residential/ domestic benchmarks based on the abovementioned IBT design. In order to determine the residential benchmarks, the baseline point had to be determined. The residential/domestic benchmarks were determined on the basis as summarized below: Page 4 of 9

5 Block Consumption Levels 2009/10 Baseline Benchmark per RED Rationale for the baseline point Block kwh Domestic To ensure that the increases in this Indigent benchmarks category remain within inflation level and provides protection to the low income customers. Block kwh Domestic Indigent Maintain the objective of low income customer tariff subsidization for those customers who spill over from first block by retaining same baseline for both block 1 and 2. Block kwh Domestic Low To ensure that the increases of average consumption households are limited to the average guideline increases Block 4 >600 kwh Domestic High Higher end of the residential benchmarks and representative of the marginal cost for additional supply Table 4: Baseline benchmarks Once the baseline point was determined the residential/domestic benchmarks were determined on the basis as summarized below: Block Basis of benchmark increase Block 1 Limited to CPI ( as allowed for Eskom) Block 2 CPI + % equal to or less than Eskom Real WACC% allowed Block 3 Average (fully distributed) cost Block 4 Domestic High benchmark plus guideline increase(long Run Marginal Cost + Residual Revenues) Table 5: Basis of benchmark increases 2010/11 Inputs (%) & & The following are the resultant 2010/11 benchmarks energy charges (i.e., excluding the fixed charges) when the abovementioned principles are applied: c/kwh Block 1 Block 2 Block 3 Block 4 RED RED Page 5 of 9

6 RED RED RED RED Table 6: Benchmarks- 2010/11 at % guideline increase c/kwh Block 1 Block 2 Block 3 Block 4 RED RED RED RED RED RED Table 7: Benchmarks- 2010/11 at % guideline increase As illustrated above, for 2010/11 there were two sets of benchmarks (19% and 22%) applicable to municipalities. The 19% guideline referred to those municipalities that implemented a 34% price increase in 2009/10 whilst the 22% guideline referred to those municipalities that implemented a 25% price increase in 2009/ Municipalities that implemented any other increase in 2009/10 were handled on a caseby case basis 2.4 Information Requirements In order to assess the IBT structure as proposed by the municipality the following data/ information is required from the municipalities: Proposed block energy rate tariffs for the 4 blocks in accordance with NERSA approved benchmarks Proposed Fixed Charge Customer numbers as per existing domestic tariff categories together with the related consumption Provide details regarding impact on revenues and calculations thereof. 2.5 Determination of IBTs For municipalities, the IBTs are assesses for the domestic high and domestic low tariff categories. The domestic low tariffs are based on an average consumption level of 400kWh and the domestic high is based on an average consumption level of 800kWh The IBTs are then determined as follows: Test 1 Compare energy rates to benchmarks: The NERSA approved benchmarks will be used to assess the proposed IBT energy rates of the various municipalities with final Page 6 of 9

7 recommendations being made by the analyst. The IBTs will be assessed for domestic low (400kWh) and domestic high (800kWh) tariff categories Test 2 Compare weighted average tariff to guideline increase (inclusive of fixed charge): The proposed fixed charges of the municipality will then be added to the average energy rate of the municipality. This will result in the average tariff rate after fixed charges (average tariff). (The fixed charge is considered separately to ensure that the increases fall within the guideline increase. The fixed charge has not been embedded into the tariff as the fixed charge for each municipality differs). Test 3 Ensure Revenue Neutrality: The final test is to ensure that the introduction of IBTs does not result in unintended windfall revenue gains or losses. The 2009/10 domestic/ residential revenues are compared to the revenues achieved with the IBTs to ensure revenue neutrality. Where the introduction of the IBT s results in a shortfall for the municipality, a revenue allowance protection is built in to ensure that the shortfall in revenues does not occur Example without Revenue Protection: This example is based on a domestic high tariff with average consumption of 800kWh and a customer base of 500. The total bill before the fixed charge is calculated using the inclining block energy rates as proposed by the municipality. The energy rates proposed must be comparable to the NERSA benchmark levels (if rates proposed by the municipality are above the benchmark levels sufficient motivation must be provided). In this example, the block rates used as follows: Blocks TOTAL Block Rates(c/kWh) Consumption (kwh) Monthly Bill (R/Block) Table 8: Calculation on monthly bill based on IBT rates The resultant average energy charge is c/kWh ( total bill divided (571) by 800kWh). Comparison of Average Tariff (inclusive of fixed charge) to guideline increase Total bill before fixed charge Average energy charge (c/kwh) Basic/Service Charge (R/month) Average tariff after fixed/basic charge /11 (c/kwh) Average 2009/10 Tariff (NERSA Approved) (c/kwh) Page 7 of 9

8 Percentage Increase/Decrease(-) -1.74% Guideline i.e. 19% or 22% 19.00% 2009/10 Total Revenues R /11 Total Revenues R Revenue Increase/(Shortfall) R Table 9: Calculation of tariffs excluding revenue protection fee The basic/service charge as proposed by the municipality is then added to the average energy charge resulting in an average tariff after the fixed charge of 77.69c/kWh. This average tariff of 77.69c/kWh yields revenues of R3 729mil and illustrates that with no revenue protection charge included the municipality will make a revenue shortfall of R on this tariff category Example with Revenue Protection REVENUE CALCULATION (500 customers) The same energy rates and fixed charge as per the example above is used. However, this time a revenue protection fee is built into the tariff. The revenue protection is calculated to ensure that the above shortfall is corrected. The maximum level of the revenue protection fee is set to ensure that the average increase on this tariff category is equivalent to the guideline increase. In the example below a revenue protection fee of R131.00/month( set at maximum level) is included bringing the average increase on the tariff category to 19.00%. This results in an average tariff of 94.01c/kWh and yields a revenue increase of R Comparison of Average Tariff (inclusive of fixed charge) to guideline increase Total before fixed charge Average energy charge (c/kwh) Service Charge Revenue Protection (R/month) Average tariff after fixed/basic charge /11 (c/kwh) Average 2009/10 Tariff (NERSA Approved) (c/kwh) Percentage Increase/Decrease(-) 19.00% Guideline i.e. 19% or 22% 19.00% REVENUE CALCULATION ( 500 customers) 2009/10 Total Revenues R /11 Total Revenues R Revenue Increase/(Shortfall) R Table 10: Calculation of tariffs inclusive of revenue protection fee Page 8 of 9

9 2.6 Challenges & Mitigation Strategies During consultation with various Municipalities and metering system vendors, various challenges were identified. These challenges together with mitigation strategies are highlighted below: CHALLENGES Prepaid Tariff Challenges: Some municipalities need to update vending software to enable implementation on prepaid customers Billing systems: The billing systems of municipalities are currently not compatible to cater for billing on the NERSA IBT structure Municipalities requiring an IBT structure different from that proposed by NERSA Table 11: Challenges and Mitigation Strategies 2.7 Advantages of IBTs MITIGATION STRATEGIES Municipalities must liaise with their metering vendors to ensure that systems are updated to allow for IBT implementation in 2011/12 NERSA will also assist municipalities by sharing information on how other municipalities have successfully implemented IBT on their systems Municipalities are advised to commence with updating of billing systems to ensure that IBTs can be fully implemented in 2011/12 (engagements with billing system companies should commence to analyse scope of work, costs etc) NERSA will consider different IBT structures as proposed by municipalities. However, the municipality must provide reasons and evidence and to why a different structure is required. Furthermore, the principle of providing low income tariff customer subsidization must be maintained In previous years, ( 2008/09 and 2009/10 in particular) NERSA approved differentiated price increases (lower increase) for the domestic low/indigent customers. This resulted in revenue losses for municipalities. Municipalities with a predominantly domestic customer base were most affected As demonstrated above, the introduction of the ensures the revenue protection of the municipality. The IBT is therefore considered the optimum method of achieving protection to low income tariff customers whilst also ensuring the sustainability of the municipality. End. Page 9 of 9