Eskom 2018/19 Revenue Application
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1 Eskom 2018/19 Revenue Application Nersa Public Hearings Bloemfontein 15 November 2017
2 Where we are coming from This revenue application is being made for the year 2018/19, after the Energy Regulator maintained its revenue decision made in 2013 for the 2017/18 year, where it approved total allowable revenue of R205 billion. The allowed revenue resulted in an average increase of 2.2% due to base adjustments made in preceding years following approved RCA balances for Eskom (12.69% for 2015/16 for MYPD2 and 9.4% for 2016/17 for first year of MYPD3). The 2.2% average increase resulted in consumers receiving an effective decrease in electricity prices in real terms, in a situation where costs to produce electricity are increasing. Eskom, in this revenue application for the 2018/19 year has applied the NERSA MYPD methodology of 2016, with a phasing-in of return on assets being applied Allowed revenue and price adjustments decisions will be applicable from 1 April 2018 This revenue application does not include any RCA applications for the MYPD 3 period. Eskom understands that NERSA will process RCAs for years 2, 3 and 4 of the MYPD 3 period at a later stage. The adjustments will be applicable from 1 April 2019 onwards in a phased manner 1
3 Eskom s revenue application is completed within the legislative and NERSA s regulatory framework Framework Electricity Pricing Policy (EPP) Electricity Regulation Act (ERA) Municipal Finance Management Act (MFMA) Multi-Year Price Determination (MYPD) Methodology Eskom Retail Tariff & Structural Adjustment (ERTSA) Methodology Requirements Provides guidelines to NERSA in approving prices and tariffs for the electricity supply industry Enable an efficient licensee to recover full cost of its licensed activities, including a reasonable margin Avoid undue discrimination between customer categories May permit cross subsidy of tariffs Only implement tariffs determined by NERSA Eskom consults with SALGA & National Treasury prior to submission to NERSA Municipal tariffs tabled in Parliament by 15 Mar for 1 July implementation Determines allowable revenue (AR) for efficient costs and fair return where AR = (RAB WACC)+E+PE+D+R&D+IDM±SQI+L&T±RCA RCA not included in this revenue application Allows for NERSA determined allowed revenue to be recovered by the assumed volume of sales for each year of the revenue period. Determines rate adjustments to tariffs applicable to customer groups and schedule of standard prices applicable to different Eskom tariffs Notes: Regulatory asset base (RAB); Primary energy (PE); Service Quality incentives (SQI); Expenditure (E); Levies & Taxes (L&T); Research & Development (R&D); Weighted Average Cost of Capital (WACC); Integrated Demand Management (IDM); Regulatory Clearing Account (RCA) 2
4 The MYPD methodology through the allowable revenue formula was applied AR= (RAB WACC)+E+PE+D+R&D+IDM±SQI+L&T±RCA Primary Energy (incl imports and DMP) IPPs Operating expenditure (incl R &D) Integrated Demand Management Depreciation Return on Assets Tax & Levies Revenue = Return on assets = % cost of capital allowed X depreciated replacement asset value 3
5 Based on the MYPD Methodology the total allowable revenue is R219.5 billion for FY2018/19 Allowable Revenue (AR) Fx Application FY2018/19 (R m) Regulated Asset Base WACC (%) Returns RAB ROA % Absolute Revenue increase of R14.3 bn (7%) from previous Nersa decision Expenditure Primary energy IPPs (local) E PE PE Standard tariff customers contribute to 3.6% increase in allowed revenue International purchases Depreciation IDM Research & development Levies and taxes RCA PE D I R&D L&T RCA Export and NPA revenues account for 3.4% increase in allowed revenue About 15% of allowed revenue related to IPP costs Total Allowable Revenue
6 Rand billions Application of the NERSA Allowable Revenue formula indicates a revenue growth of R14.3 billion R13.2b R1.0b R2.8b R0b R11.2b -R12b -R1.8b R219.5 R205.2b Revenue requirement grows by R14.3 bn MYPD3 Revenue 2017/18 IPPs Operating Cost Primary Energy International Purchases Depreciation Returns Evironmental levy Total Allowable Revenue 2018/19 Increases in allowed revenue when compared to MYPD 3 (2017/18) decision mainly due to: Increases in IPP costs due to additional IPP programmes; marginal increase in other PE costs Increases in operating costs (compared to previous MYPD decision close to inflation increases for actuals Change in MYPD methodology in treatment of cost of imports (with concomitant increase in import revenue) Decrease in allowed revenue when compared to MYPD 3(2017/18) decision mainly due to : Further sacrifice in return on assets Decrease in environmental levy due to lower energy sent out 5
7 Electricity price impact in 2018/19 Standard tariff revenue has increased by R7 251 million which equates to revenue increase of 3.6% from NERSA s decision for the 2017/18 year. As the revenue is recouped from a lower sales volume, the overall price increase required is 19.9% for 2018/19. The 19.9% average increase translates to a 1 July 2018 local-authority tariff increase of 27.5% to municipalities. Municipalities continue to pay at the 2017/18 rates for the period 1 April 2018 to 30 June This is due to the Municipal Finance Management Act (MFMA) requiring Municipal tariff changes to be made only from 1 July each year. Standard tariff Unit 2017/ /19 Standard tariff revenue R m Standard tariff sales volumes Standard tariff price GWh c/kwh Standard tariff price adjustment % 2.2% % 6
8 Price Impact % Factors influencing the overall price increase 7.0% 0.5% 23.8% -6.0% 5.5% 1.4% 16.3% 2.1% 19.9% 9.4% Adjustments Operating costs Depr, Returns, SPAs & Exports Sales volumes rebasing IPPs International Purchases Price before operating costs changes Opex Generation own PE costs Price after operating costs Depr & Returns SPAs & Exports Overall Price Increase With average 2.2% increase in 2017/18 and 19.9% proposed average increase in 2018/19 Average for two years is 11% 7
9 Conservative assumption have been used for RAB, migration of ROA towards WACC, and depreciation AR= (RAB WACC)+E+PE+D+R&D+IDM±SQI+L&T±RCA Regulatory Asset Base (R m) Return on Assets (R m) Depreciation (R m) Assets Ave RAB Generation Working capital & WUC Return on Assets (ROA) 8.4% Transmission Eskom RAB Returns Distribution Generation Phased in ROA 2.97% Total Depreciation Transmission Phased in Returns Distribution Returns sacrificed Opening RAB balance for FY2019 is based on the MYPD 3 decision which is then adjusted for the latest capital expenditure forecasts for the period FY2014 to FY2018. Eskom will revalue the RAB for subsequent revenue application in accordance with Nersa condonation decision MYPD methodology allows for ROA as proxy for interest costs, tax and equity return to the shareholder In accordance with Nersa decision migration of ROA towards full WACC is phased over a longer period. NERSA MYPD 3 decision of 4,7% for FY2017/18 is reduced to 2.97% for FY2018/19 revenue application. In accordance with the MYPD methodology, depreciation is computed by dividing RAB over remaining life of respective assets. Therefore depreciation amounts have remained relatively similar to 2017/18 as a similar RAB value is used for the FY2018/19 revenue application 8
10 Rand millions Primary Energy costs assumptions AR= (RAB WACC)+E+PE+D+R&D+IDM±SQI+L&T±RCA Environmental Levy International Purchases / / /19 IPPs Other Eskom PE OCGT Fuel Cost Coal 9
11 R m Operating Costs increase by average of 7.3% over the period AR= (RAB WACC)+E+PE+D+R&D+IDM±SQI+L&T±RCA Employee benefits- CAGR of 4.9% p.a. from 2013/14 to 2018/19 on back of a declining staff complement O&M costs escalate by CAGR of 7.3% after normalising for once off transactions 2019 Opex Employee benefit of R28.3bn (46%); Maintenance of R17.7bn (29%); Other opex of R15.8bn (25%) Operations & Maintenance Employee benefits 7.3% 4.9% 2012/ / / / / / /19 10
12 Further in- depth details to be shared at this public hearing Determination of Tariffs in Accordance with NERSA s ERTSA Debt owed to Eskom Price Elasticity of Demand 11
13 Annual tariff increase context The annual tariff adjustment occurs each year after the MYPD decision Purpose is to recover incremental allowed MYPD decision Compliance to the Electricity Regulation Act (ERA) Adjust the previous year s approved tariffs
14 Municipal Finance Management Act (MFMA) MFMA guides the annual Eskom tariff adjustments and NERSA timelines Creates two set of tariff rates for Eskom i.e. Eskom directly supplied and municipal tariff rates Non-municipal Higher tariffs over 12 months 1 April non-municipal increase 1 July municipal increase Municipal Higher tariffs over 9 months Until 30 June Period available to recover the MYPD allowed annual revenues
15 Calculation of ERTSA Schematic * Annual = 1 April to 31 March 1 MYPD decision Yr n annual Standard tariffs a) Forecasted Sales volumes b) Revenues (cost + returns) International Local NPA 2 Standard tariffs (annual) a) Forecasted Sales volumes b) Revenues (cost + returns) 3 Municipal tariffs (annual) 3 Non-municipal tariffs (annual) a) Forecasted Sales volumes b) Revenues a) Forecasted Sales volumes b) Revenues 4 Municipal tariffs: 1 July increase a) April to June at previous year tariffs 5 1 April increase = ERTSA a) i.e. Lower increase to Homelight 20A b) July to March at a higher than ERTSA% - adjusted ERTSA% b) Difference recovered in the affordability subsidy 14
16 The ERTSA Municipal and non-municipal tariff increases The Municipal and Non-municipal tariff increases are calculated as per the NERSA tariff increase calculation methodology (named ERTSA). Over 12-months of the Eskom financial year, the municipal and non-municipal tariff increases are the same. 15
17 2018/19 Average Standard Tariff Increase Annual Average Price increase Applying ERTSA Illustrative Standard Tariff Category Increases 16
18 2018/19 Homelight 20A impacts (Low-usage residential) For 350kWh monthly electricity consumption, on the Homelight 20A tariff, customers would pay an additional R57 per month 17
19 Debt Overview as at End September 2017 Total debt September % 31.0% 15% 7% 51.0% 59% Overdue debt September 2017 Overdue debt > 30 days reflected only 50.0% 29% 1% 5% 46.0% 66% Municipal (bulk only) Soweto (Excl Int) Large Power Users Residential (other) Debt group Total debt Change Mar-17 Grand total R39bn R8bn R31bn Debt group Total debt (Rm) Change Mar-17 Grand total R19bn R4bn R14bn LPU Large Power users Commercial and Industrial Customers, supply size >100KVA SPU Small power users Residential, Agricultural and small Commercial supplies, supply size < 100KVA Municipal overdue debt increased by R3 billion (interest charges less significant when compared to debt) Soweto SPU > 30 days overdue debt excl. interest increased by R0.2 billion Other debt > 30 days decreased by close to R0.5 billion Total & Overdue debt excludes international customers (SAE) 18
20 Debt Composition by Customer Group Sep_2017 Customer Group Total Debt Current Debt Overdue Debt SPU Customers Soweto SPU Customers LPU Customers Municipal Customers Top customers only (use more than 100Gwh per year) Total % of Total Debtors are in Soweto, Municipalities and Top customers 90% of Current Debt is in the Large Power User sectors 94% of Overdue Debt is in Soweto and Municipalities Customer Group Total Debt % Current Debt % Overdue Debt % SPU Customers 7% 8% 5% Soweto SPU Customers 15% 1% 29% LPU Customers 7% 12% 1% Municipal Customers 59% 54% 66% Top customers only (use more than 100Gwh per year) 13% 25% 0.01% Total 100% 100% 100% 19
21 Municipal Overdue Debt remains a Key Challenge Municipal debt increased in 2017 by R3bn Rbn Eastern Cape 0.37 Free State Gauteng 0.86 Kwazulu Natal 0.20 Limpopo 0.55 Mpumalanga 3.0 North West 1.01 Northern Cape 0.73 Western Cape 0,08 Mar 17 Sep 17 20
22 Payment Level Performance Overview March 2017 YTD Customer Payment Level (bills vs payments) Total billed customers 6 March 2017 YTD Payment Level 100% 99.9% 99% 96% 97% 181 5% Payments R bn Non-payment R bn Other LPU Top Customers SPU Munics Soweto Total incl. Customers interest Total Customer Service payment level for March 2017 YTD is 97%. The March 2017 ytd payment level for Soweto excluding interest is 16%. Municipality overdue debt deteriorated since March 2017 and this has an impact on the overall payment level for this financial year. Eskom s revenue application maintains Nersa s decision of including 0.5% of allowed revenue as an impairment cost 21
23 Debt Recovery Mechanisms Soweto Rollout of prepaid and Split metering Municipalities Stakeholder engagement at all levels PAJA process and active monitoring of payment arrangements Supply interruptions Other Customers Credit and collection practises including disconnections Payment arrangements and settlement agreements Debt collection agencies Review of policies in place Top customers Business rescue customers were written off while winding down of settlements are in progress (minimal recoveries) Minimal overdue debt in this sector currently 22
24 Illustration of Price Elasticity Various studies of price elasticity of demand for electricity have estimated electricity demand as relative inelastic e.g. textiles and clothing -0.23, manufacturing -0.3, metals -0.31, ferro-alloys commodities Thus, at -0.3 a real increase in price of 10% would cause a volume reduction of 3% This dynamic would however mostly be observed once electricity prices reach a level that is close to the cost of viable alternatives A simple calculation shows however that a 10% general price reduction would require a 16.9% volume increase merely to break-even financially (and assuming that primary energy increases at the average cost of Primary Energy per kwh) 23
25 In a study we look at elasticity as a tool for measuring the responsiveness of electricity demand to changes in price and income Overview of the Concept of Elasticity Elasticity is the ratio of the percentage change in one variable (price/income) relative to the percentage change in another variable (demand for electricity). A good is said to be price elastic if its elasticity is greater than 1 meaning that a 1% increase in price would reduce the quantity demanded by more than a 1% (Example 1). Similarly a good is price inelastic if elasticity is less than 1, meaning that a 1% increase in price would reduce the quantity demand by less than 1% (Example 2). The elasticity therefore, is simply the slope of the product demand curve, because of the negative relationship between price and quantity demanded, price elasticities are usually negative while income elasticities are typically positive. A number of factors determine the elasticity: Substitutes: The more substitutes, the higher the elasticity as people can easily switch from one good to another as price changes Percentage of income: The higher the percentage that the product s price is of the consumers income, the higher the elasticity Necessity: The more necessary a good is, the more inelastic Duration: The longer the price change holds, the higher the elasticity as more and more people will stop demanding the goods Price Price Example 1: Demand curve of a price elastic good Price elastic Elasticity = slope, e.g. -1.4% Quantity Example 2: Demand curve of price inelastic good Price inelastic Elasticity = slope, e.g. -0.6% Quantity menu
26 Price but price elasticity must be considered in the context of income elasticity and also over time (as it is a dynamic variable) Price elasticity of electricity Because electricity is considered to be a necessity rather than luxury good, demand for electricity across countries is generally found to be inelastic or insensitive to price changes. While the typical theoretical demand curve has constant slope (straight line, such as those on previous slide), the demand curve for electricity in South Africa however, is likely to look more like the figure on the right. With prices having been kept unsustainably low for some time, we can expect prices to rise and as they do electricity costs will begin to have a noticeable impact on company /household income, so the curve becomes more elastic. Hypothetical demand curve for electricity in SA inelastic again menu Price elastic zone inelastic zone Quantity
27 Autonomous consumption Electricity consumption Price But price elasticity must be considered in the context of income elasticity and also over time (as it is a dynamic variable) Price elasticity of electricity Because electricity is considered to be a necessity rather than luxury good, demand for electricity across countries is generally found to be inelastic or insensitive to price changes. While the typical theoretical demand curve has constant slope (straight line, such as those on previous slide), the demand curve for electricity in South Africa however, is likely to look more like the figure on the right. With prices having been kept unsustainably low for some time, we can expect prices to rise and as they do electricity costs will begin to have a noticeable impact on company /household income, so the curve becomes more elastic. Hypothetical demand curve for electricity in SA inelastic again Price elastic zone inelastic zone Income elasticity of electricity Relationship between income and electricity consumption Quantity The income elasticity of electricity demand measures the sensitivity of consumption to changes in income. Because electricity is considered to be a necessity an economy will consume some power even if income is zero - a country will borrow money to consume power to cover their basic needs. If income growth is driven by electricity-intensive economic activity (industrialisation), the income elasticity of electricity will be quite elastic. As an economy becomes more developed it typically becomes more service oriented and employs more efficient technologies, so the elasticity of income will start to fall and could eventually become quite inelastic (figure on right) menu Real income Inelastic zone Income elastic zone
28 In conclusion, Eskom will supply electricity which comes at a cost that needs be recovered Eskom has delivered R47billion of savings over the first 4 years of MYPD3 We have continuously been striving to improve operations, commission new capacity as soon as possible and aim to extract cost efficiencies over the period Our business contains a substantial element of fixed costs that are not easily reduced in the short term. This will require consideration and balancing of socio economic factors which must be considered before making a final decision Eskom s debt commitments have increased significantly over the last few years with a major portion that has been guaranteed by Government. Our debt maturities reflect a step change in the near term that requires a strong balance sheet to cover these commitments Eskom, believes that this revenue application has taken these factors into account in aiming to keep cost escalations close to inflation and phasing in of returns to mitigate impact on the customer 27
29 Thank you
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