DRAFT TARIFF DETERMINATION for TRANSNET LIMITED PETROLEUM PIPELINES SYSTEM for 2012/13

DRAFT TARIFF DETERMINATION for TRANSNET LIMITED PETROLEUM PIPELINES SYSTEM for 2012/13 The Energy Regulator is publishing this document for public comment. This draft tariff determination uses numbers according to the analysis and in the discussion raises alternatives for public comment in regard to some elements. Members of the public wishing to submit comments should do so in writing. The deadline for comments is 20 January 2012. Written comments must be sent to Ms Erna Alberts at: Post: Petroleum Pipelines Tariffs Department The National Energy Regulator PO Box 40343 Arcadia Pretoria, 0007 Email: pipelines@nersa.org.za Fax: (012) 401-4700 In addition NERSA will conduct a public hearing on this application where oral representations may also be made. This public hearing is scheduled to be held at NERSA s offices at 526 Vermeulen Street, Arcadia, Pretoria, South Africa on 02 February 2012. NERSA 879-105 Page 1

TRANSNET LIMITED PETROLEUM PIPELINES SYSTEM 2012/13 TARIFF APPLICATION DRAFT TARIFF DETERMINATION 15 NOVEMBER 2011 NERSA 879-105 Page 2

Table of Contents Page Abbreviations and Acronyms... 6 Draft Decision... 8 Draft Reasons for Decision... 11 The application... 11 The applicant... 11 The decision-making process... 13 Stakeholder comments on the application... 13 Comments by Stakeholders... 14 Applicable law... 14 Outstanding matters as per previous tariff determination... 15 Assessment of the Application... 16 Calculation of Allowable Revenue (AR)... 16 Regulatory Asset Base (RAB)... 18 Regulatory Asset Base (SRAB)... 19 Value of non-current asset base (V-d)... 19 Allowance for Funds Used During Construction (AFUDC)... 22 Grant Funding and the AFUDC... 25 Net working capital (w)... 25 Deferred Taxation... 26 Transnet s Total Regulatory Asset Base (V d) + w ± dtax... 27 Weighted average cost of capital, post-tax, real (WACC post-tax, real )... 27 Gearing... 28 Cost of equity, post-tax, real (Ke post-tax,real )... 31 Risk free rate... 31 Market Return (MR)... 31 Market Risk Premium (MRP)... 31 Beta (β)... 31 Cost of debt real post-tax (Kd post-tax, real)... 33 Allocation of centrally raised and managed debt to Transnet Pipelines... 33 Impending corporatisation of Transnet Pipelines... 34 Return (RAB x WACC)... 35 Depreciation (D)... 36 NERSA 879-105 Page 3

Operational Expenses (E)... 37 Land rehabilitation costs (decommissioning provisions)... 39 Revenue addition to meet debt obligations (F-factor)... 42 Claw-back Adjustments... 46 Volume Adjustment (VA) and expenditure claw-back 2010/11 tariff year... 47 Expenses Adjustments (EA)... 48 Operating efficiency... 48 F-factor claw-back (FA)... 50 Debt cost adjustment... 50 Value of new operating property, plant, vehicles and equipment (new PPE) adjustment (Vd)A... 52 Time value of money... 54 Taxation (T)... 54 Tariffs... 55 Economic Impact... 57 Conclusion... 57 NERSA 879-105 Page 4

TABLES Page Table 1: Tariffs... 9 Table 2: Comparison of Allowable Revenue (Rands Millions and Percentages)... 17 Table 3: Allowable Revenue (Rands Millions and Percentages)... 18 Table 4: Comparison of Weighted Average CPI... 20 Table 5: NERSA verification of RAB (Rands Millions)... 21 Table 6: NERSA verification of Asset Additions and Useful lives in the RAB... 22 Table 7: Comparison of AFUDC (Rands Millions and Percent)... 24 Table 8: Net working capital... 26 Table 9: Comparison of RAB values (Rands Millions)... 27 Table 10: WACC calculation... 28 Table 11: Funding Gearing of the NMPP (New assets)... 29 Table 12: Debt Ratio... 30 Table 13: Calculation of Beta... 32 Table 14: NERSA s calculation of Transnet s Ke... 32 Table 15: Real post-tax cost of debt... 33 Table 16: Calculation of return on Assets... 36 Table 17: Depreciation... 36 Table 18: Operational Expenditure (Rands Millions and Percentages)... 38 Table 19: Operational Expenditure Basis of adjustments... 39 Table 20: NERSA s Calculation of Transnet s Land Rehabilitiation... 41 Table 21: Comparison Costs as per Transnet Application versus the Levy... 44 Table 22: F-Factor assessment based on Transnet s debt service obligations... 45 Table 23: Summary of claw-backs... 47 Table 24: Operating Efficiency... 49 Table 25: Cost of Debt Claw-back 2010/11... 52 Table 26: Regulatory Asset Base adjustment [(V-d)A]... 53 Table 27: Calculation of Normalised Tax allowance... 55 Page 5 of 57

Abbreviations and Acronyms AaOC AR CPI CPI f CWIP D d DSCR dtax Dt E EaOC Eq F GA IDC K d KdA K e MRP NRBTA OeA Opex OpexE RAB Rf Rf t SRAB Actual average operating cost Allowable revenue. Consumer price index Consumer price index forecast. Capital work in progress Depreciation and amortisation of inflation write-up Accumulated depreciation and accumulated amortisation of inflation write-up Debt service cover ratio Deferred tax Debt Expenses: maintenance and operating for the tariff period under review. Estimated average operating costs Equity Projected revenue addition to meet debt obligations for the tariff period under review General adjustment Interest during construction Cost of debt Cost of debt adjustment Cost of equity Market risk premium Net revenue before tax allowance Operating efficiency adjustment Operating and maintenance expense Operating efficiency Regulatory asset base Riskfree rate of interest The average monthly marked-to-market real risk-free rate of interest for the preceding period indicated Starting regulatory asset base Page 6 of 57

T t Tff(s) TOC V w WACC WA β Tax expense Prevailing corporate tax rate of the licensee Tariff(s) Trended original cost. Value of operating property, plant, vehicles and equipment. Net working capital Weighted average cost of capital Weighted average β of the proxy firms asset betas beta: The systematic risk parameter for regulated entities providing pipeline, storage and loading facility services Page 7 of 57

NATIONAL ENERGY REGULATOR OF SOUTH AFRICA (NERSA) In the matter regarding THE APPLICATION FOR THE AMENDMENT (TARIFF ADJUSTMENT) OF THE LICENCE TO OPERATE THE PETROLEUM PIPELINE SYSTEM By TRANSNET LIMITED (Licence number: PPL.pF3/20/1/2006) Draft Decision On XXXXX the National Energy Regulator of South Africa (NERSA or the Energy Regulator ) amended Transnet Limited s (Transnet) conditions of licence to operate its petroleum pipeline system as follows: 1. The tariffs listed in Table 1 are set from the first Wednesday of April 2012 (04 April 2012) to first Tuesday of April 2013 (02 April 2013). These tariffs will enable Transnet to realise an increase of 76.70% in allowable revenue compared to the 2011/12 tariff period (an increase from R1 957.72 million in 2011/12 to R3 459.23 million in 2012/13). 2. The tariffs set are maximum tariffs and are exclusive of VAT and apply with effect from 04 April 2012. Page 8 of 57

Table 1: Tariffs Destination Source 2011/12 Tariff. Cents per litre 2012/13 Tariff. Cents per litre % Change Alrode* Sasolburg 1.715 2.595 51.31% Klerksdorp* Sasolburg 3.761 6.425 70.81% Kroonstad Sasolburg 4.852 8.287 70.81% Langlaagte* Sasolburg 2.463 3.596 46.02% Pretoria West Sasolburg 4.307 7.356 70.81% Rustenburg* Sasolburg 5.439 7.465 37.24% Tarlton* Sasolburg 3.976 5.040 26.76% Waltloo* Sasolburg 4.232 7.079 67.28% Alrode Secunda 3.271 5.587 70.81% Coalbrook Secunda 6.105 10.428 70.81% Langlaagte Secunda 3.898 6.657 70.81% Pretoria West Secunda 5.642 9.637 70.81% Rustenburg Secunda 6.814 11.639 70.81% Tarlton Secunda 5.533 9.451 70.81% Waltloo Secunda 5.642 9.637 70.81% Witbank Secunda 2.617 4.469 70.81% Alrode* Durban 18.014 29.690 64.82% ORTIA(Airport) Durban 19.134 31.937 66.91% Klerksdorp* Durban 20.061 33.520 67.09% Langlaagte* Durban 18.762 30.692 63.58% Rustenburg* Durban 21.739 34.561 58.98% Tarlton* Durban 20.276 32.136 58.49% Waltloo* Durban 20.531 34.174 66.45% Bethlehem Durban 10.439 17.831 70.81% Kroonstad Durban 13.874 23.697 70.81% Ladysmith Durban 6.133 10.475 70.81% Natref Durban 16.299 27.095 66.24% ORTIA(Airport) Sasolburg 2.835 4.842 70.81% 3. The accounting treatment of the proceeds of the levy in terms of the Grant Funding Agreement between the Government of the Republic of South Africa and Transnet Limited, is that the proceeds must be recorded in a deferral account and used to offset the Allowance for Funds Used During Construction (AFUDC) related to the New Multi-Product Pipeline (NMPP) project costs and the F-factor adjustment has been made in accordance with projected debt funding requirements. 4. The allowance towards total provisions for land rehabilitation costs has been adjusted based on the new estimated land rehabilitation costs estimates Page 9 of 57

provided by Transnet and are to be recovered over the remaining economic useful lives of the respective assets. 5. Transnet must, in accordance with Regulation 9 (4) of the Regulations made in terms of the Petroleum Pipelines Act, 2003 (Act No. 60 of 2003) 1, provide NERSA with proof of financial security for purposes of rehabilitating land used in connection with a licensed activity. The financial security must be such that the funds will be available for rehabilitation, are protected against erosion by inflation, and are protected against Transnet creditors. 6. The 2011/12 and 2012/13 depreciation, corporate costs, operating and maintenance expenses will be subject to review and any differences will be clawed back in future tariff periods. 7. NERSA also decided that it will update the Guidelines on Minimum Information Requirements for Tariff Applications (MIRTA) documents to provide for additional details in identified areas to enable Transnet to submit its tariff applications in full compliance with MIRTA prescripts. 1 GNR 342 in Government Gazette No. 30905 of 4 April 2008 Page 10 of 57

Draft Reasons for Decision The application 8. On 29 July 2011, Transnet Limited submitted an application for the amendment of its licence to operate its petroleum pipeline system licensed under licence number PPL.p.F3/20/1/2006. The application was for a 83.3% increase in its allowable revenue (AR) for the period 1 April 2012 to 31 March 2013 (2012/13) and was made in terms of section 23 of the Petroleum Pipelines Act, 2003 (Act No. 60 of 2003), hereinafter referred to as the Act. 9. The Energy Regulator published this application on its website on 23 September 2011 for public comment. 10. On 27 June 2011 the Department of Energy (DoE) requested the Energy Regulator to set tariffs for Transnet Pipelines to be effective from the first Wednesday of April 2012, in order to be concurrent with the day when the retail price adjustments are made by the DoE. 11. On 14 September 2011, Transnet Limited informed NERSA that it would like to modify its application to accommodate the DOE s request. The applicant 12. Transnet Limited (hereinafter referred to as the applicant or Transnet), is a public company registered and incorporated as such in terms of the company laws of the Republic of South Africa pursuant to the Legal Succession to the South African Transport Services Act, 1989 (Act No. 13 of 1989). The applicant s company registration number is 1990/000900/06 and its registered head office is at 47 th Floor, Carlton Centre, 150 Commissioner Street, Johannesburg. Transnet operates the country s rail network (Transnet Freight), its ports (National Ports Authority), petroleum and gas pipelines (Transnet Pipelines) and other operations such as the South African Ports Operations and Page 11 of 57

Transwerk. Transnet Pipelines operates petroleum pipelines and a gas pipeline and is a division of Transnet Limited. 13. Transnet is a diversified transport and logistics group wholly owned by the South African Government. 14. Through its Transnet Pipelines division, Transnet operates approximately 3 000 kilometres of pipelines conveying refined petroleum products, crude oil and gas, as well as a storage facility for petroleum products at Tarlton near Krugersdorp. It is the dominant pipeline operator in South Africa and has a de facto monopoly of the pipeline conveyance of petroleum from Durban to inland destinations. 15. On 12 September 2007, Transnet was granted a construction licence (licence number PPL.p.F1/74-75/2007) to construct a 24-inch diameter petroleum products pipeline from Durban to Jameson Park and 16-inch diameter pipelines from Jameson Park to Alrode/Langlaagte and from Kendal to Waltloo, inclusive of accumulation facilities at Durban and Jameson Park. The applicant has named this project the New Multi-Product Pipeline (NMPP). 16. In its 2011/12 tariff application, Transnet stated that the planned date for phasing in the 16-inch pipelines was January 2011. In this current application, Transnet stated that the 16-inch pipelines were completed and brought into operation during April and May 2011 on the dates as follows: 16.1.1. A 16 inch pipeline from Jameson Park to Alrode (25 May 2011); 16.1.2. A 16 inch pipeline from Alrode to Langlaagte (25 May 2011); and 16.1.3. A 16 inch pipeline from Kendal to Waltloo (30 April 2011) 17. Transnet had also stated in its 2011/12 tariff application that the phasing in of the 24-inch pipeline will commence in January 2012. In this application Transnet reaffirmed that the 24 inch trunkline is still scheduled to come into operation on 1 January 2012 and will operate concurrently with the DJP during the 2012/13 year. The DJP will operate at a lower flow rate and the 24-inch trunkline will transport diesel only until the completion of the coastal and inland Page 12 of 57

terminals. Transnet indicates that, this will result in the optimal utilisation of the pipeline assets to ensure that the inland market s requirements are met. The decision-making process 18. NERSA published Transnet s original application on the NERSA website for public comment on 23 September 2011. Certain elements of the application were deemed by NERSA to be confidential and were excluded from the published application. 19. Notices of the application and an invitation for public comment were placed in the following newspapers on 23 October 2011: a) Business Day b) The Star c) The Mercury d) Cape Times e) The Pretoria News 20. The closing date for comments was 24 October 2011. Stakeholder comments on the application 21. NERSA received written comments from: a) Sasol Oil (Pty) Limited; b) Engen Petroleum Limited; c) Shell South Africa Marketing (Pty) Limited; d) Total South Africa (Pty) Limited. 22. The non confidential version of the comments were forwarded to Transnet for its response and were also posted on NERSA s website. Page 13 of 57

Comments by Stakeholders 23. In making its final decision, the Energy Regulator will consider all comments received from the stakeholders Applicable law 24. The legal basis for the Energy Regulator to set tariffs for petroleum pipelines is derived from the National Energy Regulator Act, 2004 (Act No. 40 of 2004) ( the NERSA Act ), read with the Act. 25. The Energy Regulator sets tariffs for petroleum pipelines in a manner prescribed by the Regulations made in terms of the Act 2 ( the Regulations ) and in accordance with section 28 of the Act. 26. In terms of section 28 of the Act, tariffs to be charged by licensees must be based on a systematic methodology applicable on a consistent and comparable basis 3. To this end, NERSA has published the Tariff Methodology for the Petroleum Pipelines Industry ( the Methodology ) that outlines the approach taken in this decision (5 th Edition of the Methodology, approved on 31 March 2011). This edition of the Methodology is available on NERSA s website at www.nersa.org.za. 27. Tariffs set by NERSA must also be fair, non-discriminatory, simple and transparent; predictable and stable; and such as to promote access to affordable petroleum products. 4 28. Furthermore, in terms of section 10(1)(b) of the NERSA Act, all NERSA decisions, including those relating to tariffs, must be in the public interest. 2 See note 1 above 3 Section 28(2)(a) of the Act 4 Section 28(2)(a)(ii)-(iv) Page 14 of 57

Outstanding matters as per previous tariff determination 29. In its Reasons for Decision (RfD) for Transnet s 2011/12 tariffs 5, NERSA decided that in the next tariff period it will: a) investigate the possibility of meaningful benchmarking of Transnet s petroleum pipelines; and b) review Transnet s 2010/11 and 2011/12 expenses and claw back the differences in the 2012/13 tariffs. 30. Pursuant to this decision, NERSA took the following actions: (a) Investigation into meaningful benchmarking (i) This investigation has commenced and is still in progress. It is anticipated a discussion document on benchmarking will be published for public comment shortly. (b) Transnet s expenses for the 2010/11and 2011/12 tariff periods (i) An analysis of Transnet s expenses was conducted as part of the audit of the Regulatory Financial Reports (RFR) prepared and submitted by Transnet in accordance with the Regulatory Reporting Manuals (RRM) prescript. The identified claw-back has been implemented in the tariff period under review. (ii) The 2011/12 expenses review will be concluded once audited financial statements of Transnet Petroleum Pipelines for the financial year ending 31 March 2012, are available. 5 Energy Regulator decision of 31 March 2011 on Transnet Limited 2011/12 tariff application Page 15 of 57

Assessment of the Application Calculation of Allowable Revenue (AR) 31. Data as supplied by Transnet, and that has been prepared in accordance with Minimum Information Required for Tariff Application (MIRTA), was used for most of the calculations performed in this determination. Where this was not the case, the reasons for not using the applicant s data are supplied. As a result of Transnet complying with MIRTA, the quality, clarity and completeness of the tariff application is much better in this tariff period under review. NERSA will update MIRTA documents to provide for additional identified details in specific areas to enable Transnet to further comply with MIRTA and enhance regulatory efficiencies. 32. As per the Methodology, the following formula was applied to determine Transnet s AR: Allowable Revenue = (RAB x WACC) + E + D + F ± C+ T Where: RAB = Regulatory Asset Base WACC = Weighted average cost of capital E = Expenses: maintenance and operating expenses for the tariff period under review D = Depreciation: the charge for the tariff period under review F = Approved revenue addition to meet debt obligations for the tariff period under review C = Clawback adjustment from a preceding tariff period in relation to the latest estimates for that tariff period T = Tax: estimated tax expense for the tariff period under review Page 16 of 57

33. In this tariff application, Transnet applied for a R1 630.7 million increase in its AR (83.3%) - an increase from R1 957.72 million in 2011/12 to R3 588.5 million in 2012/13 - see Table 2 below. 34. NERSA s calculation of the AR for Transnet in 2012/13 resulted in an increase of 76.70% - from R1 957.72 million for 2011/12 to R3 459.23 million for the 2012/13 tariff period. This is inclusive of the additional revenue allowed to Transnet in terms of the F-factor 6 to meet its debt obligations. These values are reflected in Table 2 below. Table 2: Comparison of Allowable Revenue (Rands Millions and Percentages) TPL 2012/13 Application NERSA 2012/13 Draft Determination Total Allowable Revenue this tariff period 3 588.50 3 459.23 Previous tariff period allowable revenues 1 957.72 1 957.72 year-on-year Rands increase 1 630.78 1 501.51 year-on-year % increase 83.30% 76.70% 35. The comparative values for the respective components in the formula for calculating the AR as determined by NERSA compared to the values as applied for by Transnet are presented in Table 3 below. 6 See paragraph 9 on page 23 of the Methodology for explanation Page 17 of 57

Table 3: Allowable Revenue (Rands Millions and Percentages) TPL 2012/13 Application NERSA 2012/13 Draft Determination Plant in service & General plant (PPE) 20 455.4 20 455.4 Borrowing costs 1 418.9 0.0 Levy -3 082.7 0.0 Deferred Tax -359.5-359.5 Less: F-Factor allowed in previous tariff(s) 0.0 0.0 Working capital 260.4 417.3 Total RAB for tariff period under review 18 692.5 20 095.9 Risk free rate 4.38% 4.38% Beta 0.810 1.034 Market risk premium 6.38% 6.38% Return on equity % (Ke, post tax real) 9.55% 10.98% Cost of debt % (Kd, post tax real) 1.62% 1.47% % Equity in capital structure 55.70% 38.57% % Debt in capital structure 44.30% 61.43% WACC % (post tax real) 6.03% 5.14% Equity return on assets, Rands 993.5 850.8 Debt return on assets, Rands 133.9 181.8 Total Return on Assets (WACC x RAB), Rands 1 127.4 1 032.6 Expenses 866.3 866.3 Decommissioning provision costs 20.7 3.1 Depreciation & amortization 398.8 398.8 Clawback -264.8-250.4 F-Factor 780.6 780.6 Revenue before taxes 2 929.0 2 831.0 Notional tax 659.5 628.2 Alllowable Revenue = RAB x WACC + D + E+ F + T +/- C 3 588.50 3 459.23 Previous tariff period allowable revenues 1 957.72 1 957.72 year-on-year Rands increase 1 630.78 1 501.51 year-on-year % increase 83.30% 76.70% Regulatory Asset Base (RAB) 36. The formula for determining the RAB is: RAB = (V d) + w ± dtax Where: V = Value of property, plant, vehicles and equipment Page 18 of 57

d = depreciation accumulated up to the commencement of the tariff period under review w = net working capital dtax = deferred tax Regulatory Asset Base (SRAB) 37. Regulation 5(2) of the Regulations deals with the determination of the RAB. 38. Paragraph 4.1.2 of the Methodology states that non-current assets are to be valued on the Trended Original Cost (TOC) basis or in accordance with Regulation 4(7)(b) of the Regulations which stipulates the following:...for assets in operation at the time of promulgation of these Regulations and for which historical cost records do not exist, an estimated value that the Authority accepts as most closely approximating their historical cost 39. The claw-backs are only calculated on audited financial statements. NERSA completed the determination of the Starting Regulatory Asset Base (SRAB) and the claw-backs for the years up to 2009/10 were implemented in the 2011/12 tariff period. The claw-backs for 2010/11 are applied in this tariff period under review (see section for claw-backs). 40. There are no claw-backs relating to the 2011/12 tariff period as these clawbacks will only be calculated on audited financial statements and will therefore be considered in Transnet s next tariff application. Value of non-current asset base (V-d) 41. The applicant submitted that the value of its operating non-current assets (V-d) is R20 455.4million. This value is based on NERSA approved SRAB plus additions of new NMPP assets brought into service. Page 19 of 57

42. The values are adjusted for inflation in accordance with the methodology. The methodology requires that the inflation adjustments must be based on the CPI and the same CPI data must be used to convert nominal return values to real return values in the WACC calculation. 43. In the calculation of WACC, the nominal cost of equity (Ke) is converted from nominal terms to real terms using actual historical CPI for the relevant period while the nominal cost of debt (Ke) is converted into real terms using forecast CPI obtained from the Bureau for Economic Research (BER). 44. To effectively apply the methodology, the asset values are trended by the weighted average (in proportion to the gearing applicable for the tariff period under review). The applicant has used a weighted average CPI of 7.3% while NERSA has used a weighted average CPI of 6.82% as shown in Table 4 below. Table 4: Comparison of Weighted Average CPI TPL 2012/13 Application NERSA 2012/13 Determination Capital Structure: Equity % 55.70% 38.87% Debt % 44.30% 61.13% Historical CPI 8.60% 8.27% CPI forecast 5.75% 5.90% Weighted Average CPI used for ToC 7.34% 6.82% 45. The use of the weighted average CPI to calculate the RAB trended original cost for the tariff period under review eliminates the need for cost of debt claw-backs that arises if the forecast CPI differs from the actual CPI in the tariff period under review, and reflects the proper application of the TOC approach. 46. In this application, Transnet has applied the above approach and determines the RAB to be R20 455.4 million. NERSA has checked the values provided by Transnet and found them to be acceptable. The slight difference shown in table below is due to the difference between the depreciation estimated by NERSA and the depreciation used by Transnet in the application (see section on depreciation). NERSA has therefore used the RAB value of R20 455.4 million Page 20 of 57

for the tariff period under review. NERSA calculation to check the RAB values is provided in Table 5 below: Table 5: NERSA verification of RAB (Rands Millions) Step1: Opening bal+additions-disposals 2011/12 2012/13 Asset Original Cost (BS1 opening balance) 2 362.38 7 316.43 Additions at cost (from BS2 - Asset Movements Reconciliation section) 4 954.05 10 517.08 Total Original Cost of assets 7 316.43 17 833.51 Write-up balance for existing assets b/f 3 039.44 3 566.89 Write-up of existing assets - current period 250.70 577.32 Write-up new assets additions-current period 383.95 717.28 Total indexation 3 674.09 4 861.49 Total trended original cost asset values 10 990.52 22 694.99 Asset disposals (from BS2 - Asset movements Recon section) Total asset (additions-disposal)- (BS1 closing balance) 10 990.52 22 694.99 Step2: Useful life Useful life (existing assets) 32.27 55.46 Useful life (additions assets) 73.14 71.17 Weighted average remaining useful life 56.46 64.03 Step3: Accumulated Depreciation (BS2) Accumulated Depreciation (BS2) 2 236.72 2 476.09 Accumulated Amortization of write-up (BS2) 288.97 373.78 Step4: NERSA estimate of RAB for Tariff period 8 910.67 20 544.15 TPL RAB for Tariff period 20 455.40 47. The RAB values exclude the capitalised borrowing costs and the off-setting levy as prescribed in the accounting for these amount (see section for AFUDC). 48. The RAB amounts include the pro-rata values of new assets brought into service during the tariff period under review. In accepting the pro-rata values provided by Transnet s application, NERSA analysed both their historical cost as well as their respective useful lives as shown in Table 6 below. Page 21 of 57

Table 6: NERSA verification of Asset Additions and Useful lives in the RAB Network Component Source New NMPP 16 inch New NMPP 24 inch Useful life (years) TPL Annexure C 2011/12 Additions ZAR (Millions) 2011/12 pro-rata additions ZAR (Millions) 2011/12 Weighted useful life of additions yrs 2012/13 Additions ZAR (Millions) 2012/13 pro-rata additions ZAR (Millions) 2012/13 Weighted useful life of additions 75.0 xxxxxx xxxxxx xxxxxx xxxxxx 75.0 xxxxxx xxxxxx xxxxxx xxxxxx Terminals 50.0 xxxxxx -- -- xxxxxx xxxxxx xxxxxx Other refined PPE Non-Pipelines Assets 44.3 xxxxxx xxxxxx xxxxxx xxxxxx xxxxxx xxxxxx 44.3 xxxxxx xxxxxx xxxxxx xxxxxx xxxxxx xxxxxx Total Additions 13 858.4 4 767.3 73.1 5 293.9 1 426.0 71.2 yrs Allowance for Funds Used During Construction (AFUDC) 49. The Allowance for funds/financing used during construction (AFUDC) is the sum of the net cost of borrowed funds (debt finance) used for construction purposes (interest during construction - IDC) and a reasonable rate of return on other funds/financing, like equity, when so used for construction. 50. The Regulatory Reporting Manual (RRM) issued by NERSA prescribes the manner in which the AFUDC is to be determined as follows:- Allowance for funds (financing) used during construction includes the net cost for the period of construction of borrowed funds (finance) used for construction purposes and a reasonable rate of return on other funds (financing) like equity, when so used, not to exceed, without prior approval of the Energy Regulator, allowances computed in accordance with the formula prescribed in paragraph (a) of this subparagraph. No allowance for funds (financing) used during construction charges shall be included in these accounts for expenditures arising from construction projects which have been abandoned. (a) The formula and elements for the computation of the allowance for funds (financing) used during construction shall be the approved weighted average cost of capital multiplied by the sum of:- (i) average balance in construction work in progress, (ii) plus average capital inventory balance, (iii) less construction accounts payable, Page 22 of 57

(iv) less asset retirement costs (if any are included in construction work in progress). (b) The weighted average cost of capital rate shall be determined in the manner indicated and approved by the Energy Regulator for the applicable year. 51. NERSA has not made any determination in the previous tariff decisions of the AFUDC for Transnet as prescribed in the RRM due to CWIP being left out of consideration of RAB in the previous tariff periods in accordance with the Regulations. 52. With a big proportion of the NMPP becoming used and therefore being included in the RAB in this tariff period under review, as well as the availability of the audited financial results of Transnet up to 2010/11 financial year, NERSA has requested Transnet to provide the detailed information prescribed as per RRM to determine the allowable AFUDC. 53. At this point NERSA has not finalised the approval of the AFUDC for Transnet because Transnet has not provided the required details in the schedule of debt financing used in the NMPP construction in order for NERSA to verify the capitalisation rate for AFUDC purposes. Once this detailed schedule of debt to be used in the AFUDC calculation is provided by Transnet and verified by NERSA, the same listed debt in the schedules becomes the debt to be rolled forward in Transnet Pipelines accounting records and used in future weighted average cost of capital calculations. 54. In the interim NERSA has provided the calculation of AFUDC for the period up to 2010/11. From the period 2007/08 to 2009/10 Transnet indicated that the NMPP was funded 100 per cent by debt. As a result, once the verification of debt is completed, the AFUDC to be approved may be equivalent to the audited capitalised interest during construction in that three year period. The 2010/11 AFUDC is also inconclusive due to the outstanding details from the debt schedule to be provided by Transnet. The 2011/12 and 2012/13 AFUDC calculations will be done by NERSA once the audited financial results of those respective years become available. Page 23 of 57

55. The NERSA analysis of the AFUDC for the period 2007/08 to 2010/11 is compared with the Transnet AFUDC application and is provided in Table 7 below. Table 7: Comparison of AFUDC (Rands Millions and Percent) AFUDC to be approved by NERSA 2007/08 2008/09 2009/10 2010/11 NMPP cumulative % funded by debt 100.0% 100.0% 100.0% 93.7% Cost of debt for NMPP (nominal) 6.97% 8.61% 10.00% 9.83% Cost of equity for Transnet Pipelines (nominal) - - - 19.0% WACC for AFUDC 6.97% 8.61% 10.00% 10.41% Versus TPL application as follows: NMPP % debt funding as per TPL clarification table 100.0% 100.0% 100.0% 81.6% Portion funded by equity 0.0% 0.0% 0.0% 18.4% Cost of debt for NMPP (nominal) N/P N/P N/P N/P Cost of equity for Transnet Pipelines (nominal) 30.6% Transnet 's WACC for AFUDC N/P N/P N/P N/P Note: N/P means "Not Provided" by Transnet Cost of Equity (Ke) used in AFUDC calculations as per RRM Volume 4, Page 15 #(b) Risk free rate 0.49% un-levered asset beta 0.364 Levered beta 1.163 MRP 7.30% Ke Real post tax 8.98% CPI historical 9.18% Ke nominal post tax for AFUDC calculation N/A N/A N/A 19.0% CWIP balances CWIP opening balance 0 805.8 3 071.8 5 975.9 CWIP closing balance as per TPL clarification 805.8 3 071.8 5 975.9 11 588.1 (i) CWIP average balance 402.9 1 938.8 4 523.9 8 782.0 (ii) plus average capital inventory balance - - - - (iii) less construction accounts payable - - - - (iv) less asset retirement costs - - - - Net CWIP for AFUDC calculation 402.9 1 938.8 4 523.9 8 782.0 AFUDC to be approved by NERSA 28.1 167.0 452.2 913.8 Transnet AFUDC calculations 28.1 167.0 452.2 1 448.9 Page 24 of 57

Grant Funding and the AFUDC 56. In his 2010 budget speech of 17 February 2010, the Minister of Finance announced a national fuel levy of 7.5 cents per litre to contribute to the funding of the NMPP pipeline between Durban and Gauteng. This was implemented by means of a Grant Funding Agreement between Transnet Limited and the Department of Energy, signed on 22 June 2010. 57. This grant funding (after VAT and income taxation) will be offset against the AFUDC of the NMPP project. The AFUDC and the grant funding monies received are therefore both recorded in a deferral account for the purposes of offsetting against each other. Any difference between the grant funding and the AFUDC approved by NERSA will be capitalised and added to the RAB when the assets come into operation. The depreciation of this balance added to the RAB will be calculated over the remaining useful life of the asset to which the balance is added. Net working capital (w) 58. Net working capital is calculated in accordance with the Methodology. 59. The applicant calculated its estimated working capital (w) during the tariff period under review to be R496.2 million, but only applied for R260.4 million. The R260.4 million was the amount for the 2011/12 tariff period and is therefore presumed to be an error. NERSA calculated the working capital for 2012/13 to be R417.3 million in line with the calculated Allowable Revenue. 60. Transnet states that inventory includes maintenance stock and petroleum stock owned by Transnet Pipelines. Transnet further states that the increase in inventory as a result of additional spares (non property, plant, equipment and standby parts for when the NMPP is put into operation) for the new 24 inch pipeline and Terminal 2 has contributed to the increase in working capital. Page 25 of 57

61. Transnet also indicates that the increase in working capital for the 2012/13 tariff period is primarily as a result of the increase in receivables due to the higher Allowable Revenue in the year. 62. The comparison between the working capital as calculated by Transnet and the value as determined by NERSA is presented in Table 8 below. Table 8: Net working capital TPL 2012/13 application NERSA 2012/13 Determination NERSA Allowable revenue 3 588.50 3 458.51 Less: F-Factor -780.6-780.6 NERSA Allowable revenue 2 807.90 2 677.91 Opex excluding decomm costs 866.3 866.3 Inventory as per TPL Balance sheet 197.2 197.2 Receivables 299.0 220.1 Operating cash 105.2 106.8 Minimum cash balance Trade payables (as TPL Balance sheet) -105.2-106.8 Net working capital 496.2 417.3 Number of days Receivables/AR 38.87 30.00 Number of days Cash / Opex 44.32 45.00 Number of days Payables 44.32 45.00 Deferred Taxation 63. The deferred taxation liability to be deducted from the RAB is that calculated to take into account timing differences relating only to the regulated property plant and equipment. Non-asset related balances are not taken into account in the calculation of the normalised tax and therefore the applicant is not expected to receive the cash flow benefit in the calculation of the AR. 64. In this application NERSA has used the deferred tax amount of R359.5 million as calculated by Transnet. Verification and any adjustments of the deferred tax amount as provided by Transnet will be done as part of the regulatory financial Page 26 of 57

reporting audit, by which time the phase-in of new assets that affect its calculations is expected to be known with certainty. Transnet s Total Regulatory Asset Base (V d) + w ± dtax 65. Transnet submits in it application that its qualifying RAB is R18 692.5 million for the tariff period under review. The RAB value as calculated by NERSA is compared to the RAB value as calculated by Transnet in Table 9 below. Table 9: Comparison of RAB values (Rands Millions) TPL 2012/13 Application NERSA 2012/13 Draft Determination Plant in service & General plant (PPE) 20 455.4 20 455.4 Borrowing costs 1 418.9 0.0 Levy -3 082.7 0.0 Deferred Tax -359.5-359.5 Less: F-Factor allowed in previous tariff(s) 0.0 0.0 Working capital 260.4 417.3 Total RAB for tariff period under review 18 692.5 20 095.9 66. NERSA has excluded the levy and capitalised borrowing costs/afudc in the determination of RAB as per the prescribed accounting for these monies. The prescribed accounting for the levies requires these levy amounts to be recorded in a deferral account and off-set against the allowance for funds used during construction (AFUDC) until the NMPP project is completed and the assets become used. At that point, any difference (net balance) in the deferral account will be transferred to be included in the RAB. Weighted average cost of capital, post-tax, real (WACC post-tax, real ) 67. Paragraph 5.1 of the Methodology prescribes the formula to determine the WACC. Page 27 of 57

68. Applying the methodology, NERSA calculations yielded a post-tax real WACC of 5.14% compared to Transnet calculation of 6.03% as presented in Table 10 below. Table 10: WACC calculation TPL 2012/13 Application NERSA 2012/13 Determination Risk free rate (Real) 4.38% 4.38% Beta 0.810 1.034 Market Risk Premium (Real) 6.38% 6.38% Cost of equity (Ke, post-tax real) 9.55% 10.98% Nominal cost of debt (as per TPL) 10.36% 10.36% CPI forecast 5.75% 5.90% Tax rate 28% 28% Nominal post-tax cost of debt 7.46% 7.46% Real cost of debt (Kd, post tax real) 1.62% 1.47% Capital Structure: Equity % 55.70% 38.57% Debt % 44.30% 61.43% WACC 6.03% 5.14% 69. The calculations of the individual elements of WACC above are explained in detail in the following paragraphs. Gearing 70. The debt ratio to calculate the WACC is a function of the RAB. Capital work in progress (CWIP) is specifically excluded from the RAB in accordance with the Regulations. 71. NERSA calculated the debt-to-asset ratio on a quarterly basis for the tariff period under review by taking into account Transnet s RAB qualifying time weighted debt, excluding CWIP. The new NMPP assets are included into the RAB based on the cumulative funding gearing ratio up to the year they are brought in use. Transnet provided the funding gearing ratio of the NMPP year to year from 2007/08 to date. NERSA analysed the Transnet Petroleum Pipelines Page 28 of 57

balance sheet structure (to include the retained earnings) in calculating the NMPP funding gearing ratio. The comparison between the NMPP funding gearing ratio provided by Transnet Pipelines and the results of NERSA s analysis of the balance sheet structure is presented in Table 11 below. Table 11: Funding Gearing of the NMPP (New assets) Balance Sheet Structure (Debt versus equity) 2009/10 2010/11 2011/12 2012/13 Change in debt Loan at R1.9bn 42 0 0 NMPP funding 4 088 2 817 2 491 1 263 Total 4 088 2 859 2 491 1 263 Cumulative total 4 088 6 946 9 437 10 700 Changes in equity Equity issued -469 2 774 0 Retained earnings 934 502 887 Reval. reserve-this should solely be from ToC & hence ignored 344 474 926 Total, excluding revaluation reserve 466 3 276 887 Total funding available 4 088 3 324 5 767 2 150 Cumulative total 4 088 7 412 13 179 15 329 % funded by debt annually - NERSA analysis 100.0% 86.0% 43.2% 58.7% Cumulative % funded by debt - NERSA analysis 100.0% 93.7% 71.6% 69.8% NMPP % debt funding as per TPL clarification table 100.0% 81.6% 66.0% 66.8% 72. NERSA has therefore used a gearing of 71.6% for assets brought into use in 2011/12 and 69.8% for assets to be brought into use in 2012/13 in the quarterly calculation of the gearing ratio. 73. NERSA also noted from the same balance sheet structure analysis that Transnet Petroleum Pipelines R2 774 million equity was issued in 2011/12. NERSA requested Transnet to provide relevant issuance documentation for the equity issued for the increase in equity from R1 356.3 million in 2010/11 to R4 129.8 million in 2011/12. Transnet responded that this is per Transnet policy to restructure the balance sheets of divisions as the raising and management of Page 29 of 57

funding is controlled centrally at Transnet. The gearing of the individual divisions was restructured to 45% (reflective of the March 2011 budget gearing). The restructuring is to bring the Transnet core divisions gearing in line with the planned average gearing of Transnet of 44.1% over the 5 year 2011/12 corporate plan period. 74. Transnet further indicates that the methodology (only sections applicable to TPL are quoted here) followed in the restructuring is as follows: where a division has a gearing of more than 45% at 31 March 2011, an interest free loan from Transnet Group Services which is deemed to be equity is injected to reduce the gearing to 45%;. and where a division has a gearing of more than 45%: First, the interest free loan is redeemed to the extent that the gearing is increased to 45%; Secondly, if after redemption, of the Group Services interest free loan the gearing is still below 45% or the entity does not have an interest free loan, a dividend is declared from the distributable results to bring the gearing up to 45%.... 75. Although the above changes arising from balance sheet restructuring have an impact on the gearing, this impact is somewhat limited by the manner in which NERSA calculates the gearing for the tariff period under review. The debt ratio to calculate the WACC is a function of the RAB, calculated as debt-to-asset ratio. The NERSA calculation of the time weighted gearing for the tariff period under review is provided in Table 12 below. Table 12: Debt Ratio % debt gearing calculation RfD 2010/11 RfD 2011/12 RfD 2012/13 RAB 2012/13 (Rands Mil) Debt-financed portion 2012/13 (Rands Mil) Q1 30.00% 30.00% 62.00% 18 939 11 741 Q2 30.00% 30.00% 62.00% 18 939 11 741 Q3 30.00% 30.00% 60.69% 19 158 11 628 Q4 30.00% 63.83% 61.03% 20 450 12 480 Average debt 30.00% 38.46% 61.43% 11 898 Eligible/interest bearing debt 4 153 11 898 Page 30 of 57

76. NERSA has therefore calculated a gearing of 61.43% compared to Transnet application gearing of 44.3%. Cost of equity, post-tax, real (Ke post-tax,real ) 77. The cost of equity is determined as per paragraph 5.6 of the Methodology. 78. All economic data relating to the cost of equity was used in accordance with the Methodology. Risk free rate 79. NERSA determined the applicable real risk-free rate to be 4.38% per cent. Market Return (MR) 80. The MR was calculated by NERSA using the Johannesburg Stock Exchange (JSE) All Share Index (ALSI) Total Return (TRI) data and converted from a nominal to a real value for the previous 300 months (April 1986 to March 2011). This yielded a result of 10.76%. Market Risk Premium (MRP) 81. Following the preceding discussion, NERSA calculated the MRP to be 6.38%. Beta (β) 82. NERSA used the procedure set out in Note 3 of the Methodology to calculate the beta. Page 31 of 57

83. The following companies were used as proxies: a) EQT Corporation b) Enbridge Inc. c) El Paso Corporation d) Magellan Midstream Partners, LP e) Plains all American Pipeline Limited Partnership f) Provident Energy Trust 84. NERSA does not calculate the beta for proxy companies, but uses publicly available data acquired from an independent source. The information on the raw beta for proxy companies is sourced from Bloomberg s calculations of beta using monthly data over a period of five years. 85. By applying the debt-to-asset ratio of 61.43% as previously determined, a relevered beta for Transnet s petroleum pipelines is calculated to be 1.034, as presented in Table 13 below. Table 13: Calculation of Beta No. Proxy Company NYSE Ticker Transnet Application NERSA 2012/13 Determination 1 EQT Corp EQT 0.078 0.078 2 Enbridge Inc ENB 0.156 0.079 3 El Paso Corp EP 0.107 0.144 4 Magellan Midst MMP 0.029 0.026 5 Plains All Am PAA 0.038 0.035 6 Provident Energy Ltd PVE 0.045 0.036 Unlevered asset beta for the tariff period 0.454 0.399 Transnet Final Beta for tariff period under review 0.816 1.034 NERSA Source of Raw Beta: Bloomberg, based on monthly 5 year data. NERSA un-levering and re-levering using Harris Pringle formula 86. The resultant post-tax real cost of equity for Transnet is calculated to be 10.98% as provided in Table 14 below. Table 14: NERSA s calculation of Transnet s Ke TPL 2012/13 Application NERSA 2012/13 Determination Risk free rate (Real) 4.38% 4.38% Beta 0.810 1.034 Market Risk Premium (Real) 6.38% 6.38% Cost of equity (Ke, post-tax real) 9.55% 10.98% Page 32 of 57

Cost of debt real post-tax (Kd post-tax, real) 87. Transnet provided its estimated weighted average cost of debt to be 10.36% for the tariff period under review and NERSA has used that figure. 88. NERSA applied an average Consumer Price Index (CPI) of 5.9% for the period under review. This forecast was obtained from the BER. 89. The real post-tax cost of debt as calculated by NERSA is 1.47% as presented in Table 15 below. Table 15: Real post-tax cost of debt NERSA TPL 2012/13 Application 2012/13 Determination Nominal cost of debt (as per TPL) 10.36% 10.36% CPI forecast 5.75% 5.90% Tax rate 28% 28% Nominal post-tax cost of debt 7.46% 7.46% Real cost of debt (Kd, post tax real) 1.62% 1.47% Allocation of centrally raised and managed debt to Transnet Pipelines 90. With respect to the cost of debt, the Methodology (Paragraph 5.7.4.1) states as follows:-...where the licensee has business activities that are not regulated by the Energy Regulator and the licensee raises corporate debt on behalf of the regulated activity/business the actual cost of debt charged to the regulated activities must fairly reflect causality with the regulated activity and the cost of debt associated with the assets in this risk class as well as the benefits received and is subject to approval by the Energy Regulator 91. As such, Transnet is required to allocate NMPP borrowing costs to the regulated petroleum pipelines activity to reflect causality. Page 33 of 57

92. The allocation process must, first; directly allocate to Transnet Petroleum Pipelines the debt and its actual cost that is borrowed specifically for the purposes of obtaining a Transnet Petroleum Pipelines licensed activity qualifying asset. This must then be followed by an allocation, (based on causality/benefits received) of general borrowings used to fund a Transnet Petroleum Pipelines licensed activity qualifying asset. The allocation must include details of each debt instrument in sufficient detail as to enable verification of the weighted average cost from the various debt instruments allocated in this manner 7. NERSA requested this type of allocation for the NMPP in the tariff period under review but Transnet response was not in this required manner. 93. The NERSA approach to general borrowings allocation is one that excludes legacy debt, and only includes the debt general borrowings during the period of obtaining the asset, including those borrowings made in advance in preparation (liquidity management) for obtaining the assets net of the interest earned from its short-term investment 8. Impending corporatisation of Transnet Pipelines 94. Transnet has agreed to the Government s request to corporatise Transnet Pipelines 9. 95. The corporatisation of Transnet Pipelines will, in-addition to removing the possibility of cross-subsidies between regulated and unregulated business as required by the PPA, contribute to creating tariff stability and predictability by shielding the pipelines from being affected by future events/decisions in the Transnet group that are not caused by the regulated petroleum pipelines activity. 7 This requirement is also aligned to Transnet s Accounting Policy for Finance Costs as disclosed in the published Transnet SOC Ltd Integrated Annual Report 8 Transnet SOC Ltd Integrated Annual Report 2011 9 Transnet SOC Ltd Integrated Annual Report 2011 Page 34 of 57

96. In view of this development, Transnet is required to carefully record the assets and liabilities that relate to the regulated pipelines activity that are transferred to the new corporate entity being created for the Transnet Petroleum Pipelines regulated activity. 97. In the context of the anticipated corporatisation of Transnet Pipelines and the significant (NMPP) debt carried by it, xxx xxxxxxxx xx xxxxxxx xxxxxxxxxx xx xxxxx xxxx xxxx xx xxxxxxxx xxxxxxx xxxx xx xxx xxx xxxx xx xxxxxx xxxxx xx xxx xxxxxxxx xxxxxxxxx xxxxxxxxx xxxxxxx xxxxxx xxx xx x xxxxx xxxxxxx. 98. xxx xxxxxxxx xx xxxxxxx xxxxxxxxxx xx xxxxx xxxx xxxx xx xxxxxxxx xxxxxxx xxxx xx xxx xxx xxxx xx xxxxxx xxxxx xx xxx xxxxxxxx xxxxxxxxx xxxxxxxxx xxxxxxx xxxxxx xxx xx x xxxxx xxxxxxxxxx xxxxx xxxx xxxx xxxx xxxx xxxx xxxxxxx xxxxxx xxxx xxx xxxxx xxxxx xxxxxxxxxxxxxxxxxxxxxxxxx xxxxx xxxxxxxxxxxxxxxxxxxxxxxxx xxxxx xxxxxxx. 99. The analysis shows that there is some degree of inter-relatedness between equity versus debt proportion in the capital structure and the F-Factor. When the equity proportion in the capital structure increases, the debt portion reduces which reduces interest payable and that in turn reduces the F-Factor. However, the cost of equity, (Ke) is higher than the cost of debt (Kd) which therefore leads to a higher WACC. The converse is also true. This assessment also points to the need to find an optimal balance/structure in the gearing and therefore the F-Factor required. Return (RAB x WACC) 100. Transnet s return is calculated to be R1 032.6 million by applying a RAB value of R20 095.9 million and a WACC of 5.14 per cent. The calculation of this value is provided in Table 16 below. Page 35 of 57

Table 16: Calculation of return on Assets TPL 2012/13 Application NERSA 2012/13 Draft Determination Total RAB for tariff period under review, Rands million 18 692.5 20 095.9 WACC % (post-tax, real) 6.03% 5.14% Total Return on Assets (RAB x WACC), Rands million 1 127.4 1 032.6 Depreciation (D) 101. The Methodology states that the allowable depreciation amount must be calculated on a straight line basis over the service life of each of the assets or classes of assets in the RAB for the tariff period under review. 102. Depreciation is to be calculated by using the method given in the example in Note 4 of the Methodology: Method to Determine Depreciation. 103. Transnet estimated its depreciation and amortisation expense to be R398.8 million a historic depreciation of R346.2 million and amortisation of write-up balances of R52.6 million. 104. NERSA has reviewed the calculations using the same estimation model as used in checking the RAB. NERSA has noted some differences between Transnet s depreciation calculations and the estimation model for both the 2011/12 and 2012/13. These differences will be verified and a claw-back applied. In the meantime, NERSA has used Transnet s depreciation and amortisation amounts of R398.8 million. The Transnet calculation as used by NERSA of the depreciation and amortisation is presented in Table 17. Table 17: Depreciation TPL 2012/13 application (Rands million) NERSA 2012/13 Determination (Rands million) Depreciation (historic) 346.20 346.20 Amortisation (write-up) 52.60 52.60 Total 398.80 398.80 Page 36 of 57