DETERMINATION OF LESOTHO ELECTRICITY COMPANY (Pty) Ltd s APPLICATION FOR A TARIFF INCREASE FOR 2012/13

Transcription

1 LESOTHO ELECTRICITY AUTHORITY In the matter regarding a DETERMINATION OF LESOTHO ELECTRICITY COMPANY (Pty) Ltd s APPLICATION FOR A TARIFF INCREASE FOR 2012/13 1. DECISION After duly considering the application, written and oral submissions from stakeholders, reasons, facts and evidence provided thereof, the Lesotho Electricity Authority (LEA) Board, at its meeting held on May 31, 2012, decided and resolved as follows: A tariff increase of 7.9% on the energy charges for all customers; A tariff increase of 9.7% on the maximum demand charges for industrial and commercial customers; and The energy and maximum demand tariffs for all customer categories be increased as shown in tables 1 and 2 below. Table 1: LEC for 2012/13 Customer Categories Old percentage change Adding Customer Adding Rural Electrification large customers for others Final including levies Old including levies Page 1 of 21 Final Tariffs Percentag e increase Industrial HV % % Industrial LV % % Commercial HV % % Commercial LV % % General Purpose % % Domestic % % Street Lighting % %

2 Table 2: LEC MD for 2012/13 Customer Old Maximum Demand Percentage Maximum Demand Categories (M/kVA) Change (M/kVA) Industrial. HV % Industrial. LV % Commercial. HV % Commercial. LV % The above figures exclude a 5% VAT. 2. THE APPLICANT LEC is a Government owned company registered in terms of the Companies Act of It was established in terms of the LEC (Pty) Ltd Establishing and Vesting Act 2006 wherein the assets, liabilities, rights and obligations of the former Lesotho Electricity Corporation were vested in the company. It was subsequently issued a Composite License in terms of Section 50 of the Lesotho Electricity Authority Act 2002 as amended (hereinafter referred to as `the LEA Act ) to transmit, distribute and supply electricity. 3. THE APPLICATION The Authority received a Tariff Review Application from LEC on 13 February, A modification letter by LEA was written on 1 March, 2012 requesting, amongst others, that the company should comply with Tariff Review and Filing Procedure, Economic and Financial Regulatory Models and provide additional information. LEC submitted a modified application on 27 April, 2012 but did not fully comply with the Procedure and provision of some additional information requested. The modified application (referred to as the application ) indicates that:- LEC is a state owned company registered in terms of the Company Act of 1967 and it was established in terms of the LEC (Pty) Ltd Establishing and Vesting Act 2006; Page 2 of 21

3 LEC is conducting its business in terms of a composite license issued by LEA to transmit, distribute and supply electricity in the country; and The Company has a defined service territory in which it has an obligation to supply customers with electricity, and the company is responsible for economic procurement of power. The application states that LEC has made the proposed tariff increases to strive for commercial sustainability of the company and ensure reliability of supply. Issues to be considered when designing tariffs are also stated. The application lists and explains business units established within the company and the basis for allocating costs to them. This includes how different cost items are allocated in each one of the company s business units. It further gives the objective and the justification for the tariff increases. The reasons for the tariff increases are stated as: Need to increase security in all electricity infrastructure by way of deploying security personnel; Increased costs of imported power due to increased demand and bulk supply purchase prices; Increased staff costs (inflation, compulsory medical aid, insurance premium, payment of provident fund and severance pay) aimed at retaining staff and the associated fringe benefits tax; and M88.6 million return on investment. The application provides information on how the depreciation expenses, capital and operational expenditures were worked out; including weighted average cost of capital (WACC). Summary costs allocated to four business units namely Page 3 of 21

4 generation, transmission, distribution, and procurement and supply (P&S) are provided and they form the basis for a revenue requirement of M603.9 million. This amount is explained as the basis for the proposed cost-reflective tariffs contained in the application. The said cost-reflective tariffs result in a tariff increase of 37%. LEC finally concludes that the required revenue for 2012/13 is reduced by about 10% to M550 1 million comprising cost of sales, operating expenses and a return on assets. This reduction results in what LEC states as a non cost-reflective scenario. The basis for introducing the scenario is stated as generous tariff increase awarded by the Authority in 2011/12, three (3%) percent salary increases for public servants which LEC perceives will downgrade their standard of living, and increases in oil prices that LEC also perceives may affect output of large industries. To get the required revenue, the LEC proposes tariff increases of 25% and 27% for energy and maximum demand, respectively. 4. APPLICABLE LAW The legal mandate of the Lesotho Electricity Authority to make a determination of tariff applications is derived from the LEA Act. In terms of this act, Section 22 (f) thereof, it is the function of LEA to regulate prices charged to electricity consumers. 5. PUBLICISING OF THE APPLICATION In terms of Section 24 (6) of the LEA Act, the Authority is required to publish a notice in newspapers and other local media to allow electricity consumers and other interested stakeholders to comment on the reasonableness of the tariffs applied for. Accordingly, a public notice was issued on 03 May, 2012 for stakeholders to make their comments. Stakeholders were given until 18 May, 1 The original revenue requirement by LEC was M and the requested tariff increases was 25% on energy and 27% on maximum demand charges. The reasons for the revised figure were given during stakeholders public hearing. Page 4 of 21

5 2012 to submit their comments. The notice further requested those stakeholders who had interest in making oral presentations before the Pricing and Tariffs Committee of the LEA Board to indicate accordingly so that appropriate arrangements could be made. At the close of that day, comments had been received from Consumer Protection Association (CPA), large industrial customers (Humin Jeanswear (Pty) Ltd, CGM Group), Forum of Electrical Practitioners Industry (FEPI), Queen Mamohato Memorial Hospital, Lesotho Textile Exporters Association (LTEA), Lesotho Industrial Employers Association (LIEA), Bakers Association of Lesotho (BAL) and domestic customers. 6. PUBLIC CONSULTATION SESSION A public hearing was held on 22 May, LEC and representatives from FORMOSA, FEPI, Lesotho Chamber of Commerce and Industry (LCCI) and CPA made representations before the Pricing and Tariffs Committee of the LEA Board. In its presentation, LEC described its business as, amongst others, regulated, capital intensive, having high fixed costs and using imported capital equipment. The company stated its objectives as guaranteeing security of supply, increasing connections and regulatory compliance. It went further to mention its challenges in meeting the objectives, of which the main ones were: the need to replace old equipment, inability to make profit, low returns in electrification and regional power shortage which requires LEC to import 40% capacity support from Eskom and EDM. In addition, LEC stated that its Long-Run Marginal Cost (LRMC) of electricity was based on imports from EDM and ESKOM. This implied that LEC costs were high as it imported from high cost suppliers. The `Muela effect of stabilizing prices had diminished as its limited supply did not meet demand. Page 5 of 21

6 LEC cited the following as factors driving the need for tariff adjustment:- Planned shutdown of `Muela in October and November 2012 for maintenance which would cost the utility M67 million of imported electricity compared to M12 million charged by ` Muela; Growing customer base resulting in increased operating expenditures; and Antiquated equipment that needs to be maintained frequently. The proposed tariffs by the Applicant were as shown in Table 3 below. Table 3: LEC proposed tariffs for 2012/13 Financial Year Presented during Public Consultation process Customer category Current energy ( M/KWh) Proposed energy charges (M/KWh) Increase in M/kWh Excluding Levies excluding levies Industrial HV Industrial LV Commercial HV Commercial LV General Purpose Domestic Street Lighting In conclusion, LEC stated that the proposed tariff increases in Table 3 translate into 25% increase on energy charges for all categories of customers. This is however, not consistent with information in the last column of the Table as the proposed increases translate into an increase in energy charges ranging from 25% to 56%. FEPI, in its presentation, mentioned that increasing electricity tariffs by 25% would result in households who were poor and living in rural areas reducing their Page 6 of 21

7 electricity consumption and resorting to other sources of fuel. It argued that the connection charges were already unaffordable and tariff increases would exacerbate the problem of poor access to electricity. It further stated that expensive electricity services could also result in electricity infrastructure not being fully utilized. FEPI appealed to LEC to market electricity services in new electrification areas so that electrification projects became sustainable. This could be done by scaling up customer education on electricity efficiency and cost effectiveness compared to other fuels, such as using electricity to boil water compared to using other fuels. FEPI mentioned that LEC could also market and promote use of electricity in the rural areas by providing electrical appliances. It urged LEC to cut expenditure on expensive cars, ensure adherence to electrification standards and ensure customers did not incur huge transport expenses to buy electricity by increasing the number of sales agents within the vicinity of their customers. FEPI concluded by recommending that the increase in tariffs should not exceed 8%. LCCI explained that the proposed increase would have negative effect on small and medium enterprises. As such businesses consuming electricity to the value of M per month would have to pay M additional due to the proposed increase. It urged LEC to charge those who consumed more less and vice versa. It advised the Company to engage in cost cutting measures such as energy efficiency and loss control measures. Finally, it urged the company to explore other means of financing its increasing costs other than through customers. FORMOSA representative explained that the increase in electricity tariffs would make the industry less competitive globally as their input costs would increase. The representative recommended that the increase should therefore not exceed inflation rate. Responding to the question on how LEC should recover the bulk supply costs, FORMOSA indicated that there was a need for LEC to be creative in ensuring that both the company and its customers, especially, large ones Page 7 of 21

8 would not be adversely affected. Operational efficiency was given as one possible means of cutting costs. The presentation by CPA highlighted that LEC disregarded the importance of information dissemination to the stakeholders and this referred to failure by the applicant to provide the 2010/11 audited financial statements. It further pointed out that LEC should run different scenarios to show the impact of dollar market impact instead of making decisions based only on speculation. It posited that the tariff adjustment would adversely impact on Basotho, consumers, textile industries and employees. For the consumers, the cost of living would increase and the textile industries would collapse leading to loss of jobs by many Basotho. It also mentioned that investors would desert Lesotho and this would result in LEC being competitive in the labour market while the country was not. It further cited that according to Pareto Optimality, consumers should not be worse-off in order to provide for additional consumers, and this appeared to be the case. Finally, CPA recommended that LEC should not be granted the proposed adjustment instead it listed recommendations to protect consumers, some of which are given below:- LEC should find alternative sources of financing a 10% salary increment; There was need for competition authority in order to deal with market failures; and LEC should provide sufficient information in order for the regulator to make an informed decision. Page 8 of 21

9 7. ANALYSIS 7.1 LEC s Costs and Required Revenues The LEC s revenue requirement was made up of the following major cost items: Bulk Supply Purchases; Operating Expenses; Labour Costs; Depreciation; and Return on Investment Bulk Supply Purchases In 2011/12 financial year, LEC was allowed M for bulk supply costs and the company had paid M as shown in table 4 below. Table 4: LEC's Actual bulk supply Costs for Intake point Bought in kwh Amount Paid in Maloti (M) Average Price in Maloti/kWh Maseru Bulk Supply Butha-Buthe- Clarens Qacha s Nek Muela EDM Total This meant LEC had over-recovered by M during the 2011/12 financial year. In line with the Pass-through Principle and its implementation Procedure approved by the Authority s Board in November 2011, the LEC s bulk supply costs for the financial year 2012/13 should take into account the overrecovery realised in the previous year. 2 LEA reconciled figures from invoices received show that the company has paid M indicating that the company paid less by M1 million. Page 9 of 21

10 The proposed LEC s bulk supply costs of M for the financial year 2012/13 appeared reasonable. The average price for bulk purchases in 2011/12 was 8.8% higher compared to the previous financial year s price. In order to cater for increase in demand of 3% 4, the LEC s bulk supply costs were also adjusted by 3% to M200 million, inclusive of technical losses. The adjusted amount, which is 13% increase from 2011/12 actual bulk supply costs, would be adequate to cater for increase in demand and bulk supply costs which include the shutdown of Muela in October and November Table 5 below does not support the reasons advanced by LEC that demand would be increasing in Butha-Buthe by 26% and Qacha s Nek by 31%, and the effect of the Muela Hydropower plant shutdown. In fact, energy imports in Maseru and Clarens intake points would decrease by 24% and 0.5%, respectively while imports from EDM would increase by 74%. Table 5: LEC's Forecast bulk supply Costs for Intake point to be Bought in KWh Amount to be Paid in Maloti (M) Average Price in Maloti/kWh Maseru Bulk Butha-Buthe Qacha s Nek Muela EDM Total Operating Expenses LEC s allowed operating expenses, excluding depreciation and labour costs, were M54.6 million in but LEC s actual operating expenses were M75.8 million, indicating 39% increase compared to the allowed costs by the Authority. 3 LEC application requests M221.7 million, inclusive of M26.6 million losses. 4 LEC s proposal stated that demand will increase by 10%. Page 10 of 21

11 For 2012/13, LEC proposed a budget of M million for operating expenses which was 57% higher compared to the 2011/12 allowed revenue. In the absence of supporting information from LEC, the basis on which LEA could assess the reasonableness of these costs was inflation, increase in sales and customer growth. Based on the data provided by LEC, connections would increase by 10% and sales by 3% as shown in table 6 below. Based on the inflation rate of 4.9%, half the predicted growth in sales and the increased customer connections 6, the operating expenses in LEC s allowed revenues would be M60.8 million, an increase of 11.4% instead of 57% as proposed by LEC. Table6 : sales (kwh), Connections and Revenue per kwh Increase in Item Actual in Projected in Percentage Sales (kwh) % Connections % Total Revenue % Revenue (M) Required per kwh % LEC s Labour Costs LEC s allowed labour costs for 2011/12 were M97.6 million but the actual costs were M101.3 million, indicating 4% higher than the allowed costs. For the financial year 2012/13, the company proposed M112.3 million for the labour costs, indicating 15% increase compared with the allowed labour costs in 2011/12 financial year. Whist the Company had provided the Authority with justification for the increased staff costs, mainly to cater for inflation, staff retention, increased staff fringe benefits and increased fringe benefits tax; LEC s 5 Operating expenses for the regulatory accounts is M99 million and 80% higher than the allowed revenue for Based on international best practices (incentive-based regulation), labour costs are allowed to increase in line with growth in business and in LEC this is shown by increase in connections and MWh sales. Page 11 of 21

12 justification was not in line with the conclusions of the benchmarking study conducted by the Authority in , which indicated that the company s actual staff compliment (excluding vacant positions) appeared excessive and staff numbers should not increase substantially as the number of connections continued to increase. The 15% increase in labour costs proposed by LEC was attributed to increases in salaries (at and above inflation rate) and staff numbers which were above the efficient levels recommended by the study. The company should consider provision of either gratuity or severance pay to its employees and not the current practice where both were provided. In order to maintain efficient level of staffing at LEC, the Authority considered increase in staff costs that was in line with inflation and customer numbers. This would mean labour costs were allowed to increase by half the increase in customer numbers plus the rate of inflation. On this basis, labour costs in LEC s allowed revenue would be M107.3 million instead of M112.3 million proposed by LEC. This would represent an increase of 9.9% compared to allowed labour costs in 2011/ Depreciation Charge LEC s depreciation charge for regulatory accounts should take into account assets financed through grants and by customers. The depreciation charge should be adjusted downwards by income from these two sources. Since there was no proper asset register to differentiate these assets, the depreciation charge as proposed by LEC should be recovered from the tariffs. The company would be carrying out a revaluation exercise during the 2012/13 financial year and the charges would be reviewed when the results of the revaluation were available. Once this exercise was complete, LEA would expect the findings to be communicated to it before submission of next financial year (2013/14) tariff 7 Economic, Regulatory and Financial Model Study undertaken by ECA Consultants on behalf of LEA Page 12 of 21

13 application. The Authority would only consider such an application after receiving the revaluation exercise report or findings LEC s Return on Investment Based on economic and regulatory financial models developed by the Authority, the company s return on its investment was reflected as M93.7 million. The downward review of the return to M7 million by LEC during the public hearing, could signal that the Government, as the sole shareholder of LEC, was not keen to claim dividends from the company. However, the Authority was of the view that the proposed return on investment by LEC needed to be maintained at last year s level of M13.9 million until such time that Government of Lesotho (GoL) policy directive was obtained. Again, lack of proper asset register at LEC prohibited separation of assets so that grants, donations and customer financed assets did not form part of the Regulatory Asset Base (RAB). During 2012/13, the Company should finalize and provide to the Authority the proper asset register detailing all the assets categories. Failure to provide a proper asset register to the Authority would render LEC s application for a tariff increase for 2013/14 incomplete. Page 13 of 21

14 7.2 LEC s Adjusted Revenue Requirement Adjustments made in 7.1 above lead to the revenue requirement shown in table 7 below. Table 7: LEC Revenue Requirement Cost Items in 2011/12 Actual in 2011/12 Variance between and Actual in 2011/12 Projected LEC Costs for Adjusted LEC Costs for 2012/13 based on the approved costs in 2011/12 Adjusted LEC Cost minus Projected for 2012/13 Cost of Sales Bulk Purchases Repairs and maintenance Diesel and oil Operating Expenditures Labour Depreciation Other expenses LEA License Sub-total (Cost of sales and operating expenditures) Return on Asset LEC's Total Required Revenue (excl. levies) Based on the figures in table 7 above, on average, tariffs would need to increase by 6.5% without levies and 6.4% inclusive of levies. The average increase was consistent with a 6.5% 9 increase in revenue required per kwh as shown in table 6 above. 8 The figure is slightly below last year LEC s allowed return on investment and would be reviewed with the outturns in 2012/13 when LEC applies for Tariff Review. 9 Average price increase is equal to expected total revenue divided by expected sales compared to previous year s average M/kWh. Page 14 of 21

15 7.2.1 Average Tariff increase In order to achieve the adjusted required revenue indicated in table 7 above, the average increase in tariffs would be 6.5% and the tariffs would be increased as indicated in tables 8 and 9 below. Table 8: LEC for 2012/13 Customer Categories Old percentage change Adding Customer Adding Rural Electrification large customers for others Final including levies Old including levies Final Tariff Percentage increase Industrial HV % % Industrial LV % % Commercial HV % % Commercial LV % % General Purpose % % Domestic % % Street Lighting % % Table 9: LEC MD for 2012/13 Customer Old Maximum Demand Percentage Maximum Demand Categories Charge (M/kVA) Change (M/kVA) Industrial. HV % Industrial. LV % Commercial. HV % Commercial. LV % The above figures exclude a 5% VAT. Page 15 of 21

16 The above tariffs would enable the utility to generate M473.7 million from its customers. This is shown in table 10 below. Table 10: LEC 2012/13 Revenue Based on the Tariffs Customer Categories Revenue Based on the Estimated Sales in 2011/12 Total Revenue in 2012/13 Industrial. LV Commercial. HV Commercial. LV General Purpose Domestic Street Lighting Total Revenue based on Revenue based on approved MD charges Customer categories MD (M/kVA) MD Forecast for Total Revenue from MD Charge Industrial. HV Industrial. LV Commercial. HV Commercial. LV LEC s Total Revenue based on MD LEC S Total Revenue Based on approved Tariffs Page 16 of 21

17 7.2.2 Regulatory Accounts LEC should submit Cost Allocation Manual to the Authority for approval and on the basis of the approved manual and allowed revenues prepare regulatory accounts for 2012/13. These accounts would be the basis for 2013/14 preparation and submission of regulatory information to the Authority. In the absence of an approved Cost Allocation Manual, LEC s future tariff applications would be compromised. To this end, LEC is obliged to submit the Manual for approval before the next application Compliance with Regulatory Decisions and Tariff Filing and Review Procedure Despite previous Regulatory Decisions on Tariff Determination and approved procedures for tariff filing and review, the LEC was not able to fully comply with those directives and approved procedures. This had led to the company providing the Authority with insufficient data which was not compliant with the procedure. Furthermore, there was little progress regarding issues that ought to have been addressed by the company which were emanating from the previous determinations. Tariff submissions to the Authority did not obtain the necessary approval from the LEC s Board. As such supporting information, such as the Budget, was not consistent with the tariff application. In future, LEC s tariff application should be consistent with their approved budget. Furthermore, LEC s application should be supported by proof that the same had been approved by its Board. Proof in this instance should be a Board Resolution confirming approval of the application. To this end, any application submitted without the Board s resolution would be considered incomplete. Page 17 of 21

18 7.2.4 Lack of Audited Financial Statements for 2010/11 The Authority had noted with serious concerns that the Company had no Audited Financial Statements for 2010/11. The Audited Financial Statements form part of the key information requirements in relation to the Company s performance and tariffs reviews. The situation was further exacerbated by the fact that the latest Audited Financial Statements of 2009/10 of the Company had been qualified, mainly on issues that affected tariffs such as assets of the company. To correct the above, LEC should ensure that prior to 2013/14 tariffs review, it had audited statements for both 2010/11 and 2011/12. Page 18 of 21

19 8. CONCLUSIONS From its analysis of LEC s Tariff Application, the written and oral submissions from stakeholders, reasons, facts and evidence provided thereof, and LEC s response to both LEA and public comments, LEA Board had found justification for a M550 million revenue requirement inadequate. LEA Board therefore concluded as follows: A. The requested 25% and 27% increase in energy and demand charge respectively, requested by LEC in order to meet its revenue requirement of M550 million did not have sufficient justification for the proposed costs for each of the proposed business units of the company. B. LEC revenue requirement, after making the adjustments, was M473.7 million and to achieve this adjusted required revenue, the average increase in tariffs would be 6.5%. C. The Company s return on assets was relatively low and needed further investigation and to be addressed in line with tariff restructuring exercise being undertaken by the Authority. D. The Company s operating expenses were proposed to increase by 57% and this was not related to inflation, increased sales and customer connections. E. LEC s staff costs increase of 15% was high and the increase was not consistent with the recommendations of the Benchmarking Study that was undertaken by the Authority. F. LEC s estimates of bulk supply costs were based on 25% tariff increase from Eskom and assume high losses of M26.6 million and had not taken into account over-recovery realized in 2011/12. Page 19 of 21

20 9. APPROVAL A. The Board therefore approved that the LEC tariffs should be increased as shown in tables 11 and 12 below. Table 11: LEC for 2012/13 Customer Categories Old Charge percentag e change Adding Customer Adding Rural Electrification large customers for others Final Charge including levies Old including levies Final Tariff Percentage increase Industrial HV % % Industrial LV % % Commercial HV % % Commercial LV % % General Purpose % % Domestic % % Street Lighting % % Table 12: LEC MD for 2012/13 Customer Old Maximum Demand Percentage Maximum Demand Categories Charge (M/kVA) Change (M/kVA) Industrial. HV % Industrial. LV % Commercial. HV % Commercial. LV % The above figures exclude a 5% VAT. 10. EFFECTIVE DATE The effective date of the new tariff structure shall be June 01, 2012 Page 20 of 21

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