Power price hikes return to bite Eskom

The Chamber of Mines says Eskom should consider cutting its operating costs to balance its books. (Delwyn Verasamy, M&G)

The Chamber of Mines says Eskom should consider cutting its operating costs to balance its books. (Delwyn Verasamy, M&G)

Eskom is facing a pricing reckoning – something experts and economists have been warning of for as long as the power utility has aggressively been hiking electricity prices.

The parastatal is grappling with consumers’ sensitivity to price increases, which was highlighted in Eskom’s latest attempt to raise additional revenue by applying to the National Energy Regulator of South Africa (Nersa) in terms of the regulatory clearing account.

This is a mechanism that allows for the under-recovery or over-recovery of revenue during the time when a tariff determination is applicable. In this case, Eskom applied for what it deemed was an under-recovery of revenue for the first year (2013-2014) of the third multiyear price determination (MYPD3) five-year period.

The problem of price sensitivity, or in economic terms the price elasticity of demand, was clearly illustrated by the application. As Eskom raises the price of electricity, its customers use less power or find alternative sources.
This has hurt Eskom’s sales volumes and so its revenue has declined. To combat this, Eskom asked Nersa to make up the lost revenue through tariff increases.

A decision from Nersa was expected this week, but on Wednesday Nersa announced it was postponed because of “further verification that needs to be conducted on certain information”.

The delay came on the same day the 2016 budget was announced. In it Finance Minister Pravin Gordhan warned against sharp power price increases. “Further efficiency improvements are necessary at Eskom to ensure moderation in future tariff increases,” it said in the Budget Review.

Chris Yelland, an electricity expert and the managing director of EE Publishers, pointed out the problem of price elasticity when Eskom first made its regulatory clearing account application for the MYPD3 in November last year.

Almost half of the total R22.8‑billion extra revenue that Eskom is applying for – slightly less than R11.7-billion – is because of the difference between the utility’s revenue forecasts it made at the time of the MYPD3 tariff application and the amount it has received.

Of the R11.7‑billion, about R7.3‑billion is attributed to reduced sales to customers paying the standard tariff. The rest is attributed to the under-recovery of revenue from negotiated pricing agreements, such as that with the BHP Billiton’s large aluminium smelter, Hillside, in Richards Bay.

Eskom said the regulator, in its decision on the MYPD3 rate, assumed more revenue would be received from these agreements, resulting in the under-recovery from these customers.

The issue has been exacerbated by the lengthy delays in Eskom bringing new generating capacity on stream, as well as increasingly competitive forms of alternative and private power generation, including industrial cogeneration and a general slowdown in economic growth, say critics.

In public comments on the application, they argued that Eskom’s request amounts to “charging customers for saving electricity” and contributes to a “vicious circle” of rising tariffs and continuing reduction in electricity consumption. In public hearings around the country, municipalities, mining companies and organised agriculture were among those who criticised this aspect of Eskom’s application.

The application illustrated how sensitive Eskom’s consumers, and particularly its large industrial customers, are to price increases. Eskom, according to its application, forecast sales growth of 2.3% for 2013-2014, amounting to 227 776 gigawatt hours (GWh) of electricity. In reality, its sales growth was a mere 0.6%.

Large municipalities and the industrial and mining sectors were responsible for the biggest hits to its sales.

Slowdown in growth
This has been exacerbated by the slowdown in economic growth. Eskom forecast a growth rate of 4% for both 2013 and 2014 when it made its MYPD3 submission. But growth for 2014 was only 1.9%, according to its regulatory clearing account application.

For the large municipalities, the difference between what Eskom forecast and actual sales was 680GWh. Industrial sales fell short by 5 156GWh, and in the mining sector the shortfall was 3 555GWh.

Eskom said in its application that the drop in gross domestic product growth had affected particularly the large metropoles, such as the City of Johannesburg (and its electricity distribution arm, City Power) and the Ekurhuleni metro.

Eskom said price sensitivity and demand-side management measures – efforts by the utility to reduce demand – will “lower the [sales] growth, especially in the earlier years”.

The industrial sector, particularly the ferro and steel smelting sectors, which together saw a 4 283GWh drop in consumption, was affected by the higher prices levied during the winter. Eskom, according to its application, underestimated the extent to which the higher winter tariffs would reduce the use of furnaces by these sectors. It also overestimated the extent to which these industries would increase their electricity consumption once summer returned.

“Much more furnace load was taken out to do maintenance during the very high winter prices than anticipated,” it said. “Also, the high summer utilisation did not fully materialise due to lower orders received by the smelters as a result of low demand for their product.”

The emergence of cogeneration was another large factor in the reduced sales to industrial customers, according to Eskom. It listed the start of a “very successful” gas cogeneration plant by Sasol’s Infrachem division, which “displaced” 466GWh it had not included in its forecasts.

Sales to the mining sector were also hit hard because of plummeting commodity prices and other key factors. In the case of platinum, shaft closures, and project cancellations and delays because of labour unrest, saw the sector reduce consumption by 2 159GWh. The gold sector also came under pressure because of labour unrest and high salary increases, resulting in “downscaling and shaft closures”.

In public submissions to Nersa, many organisations had little sympathy for the Eskom argument that it needs to recover these sales losses.

The Chamber of Mines said the decreased sales had resulted from “Eskom’s inability to supply sufficient electricity” and from the global decrease in the demand for commodities.

“Customers who have lost revenue are now required to compensate Eskom in addition to their own losses,” the chamber said in its presentation.

It recommended that Eskom, instead of relying on the regulatory clearing account to ensure its revenue flow, should consider reducing its operating costs.

Lost revenue
The City of Cape Town said in its presentation that recovering this lost revenue from customers was “essentially charging customers for saving electricity”.

Instead, this money should be offset by the R7.1-billion profit that Eskom made during the 2013-2014 financial year, it recommended.

Farming body AgriSA said tariff hikes would simply lead to a “vicious circle”. “Further price increases will almost certainly lead to reduced electricity consumption, continuing an unsustainable cycle of under-recovery and unfavourable revenue variances,” it told Nersa.

“We urge Nersa to give greater consideration to the ability of customers to absorb cost increases and to the likely impact that further tariff increases will have on future demand and further revenue variances, which will give rise to further hefty [regulatory clearing account] applications.”

In 2010 economists warned that Eskom had not adequately accounted for the impact of price increases on consumer demand in its forecasts.

In the South African Journal of Science, academics Roula Inglesi-Lotz and Anastassios Pouris, of the University of Pretoria’s economics department, warned that in a previous MYPD application, Eskom had not “sufficiently taken into account the impact of the electricity prices in their electricity demand forecast”.

But Eskom’s spokesperson, Khulu Phasiwe, said it had incurred costs in “undertaking our mandate of supplying electricity, and these are legitimately claimable and in compliance with the Nersa MYPD methodology”.

Economic events caused “variability in projections and forecasts, which is what the South African economy experienced since the MYPD3”, he said, pointing out that GDP growth forecasts in 2011, when the submission was made, were reduced from 4% to the 1.9% that materialised.

“This, and other factors such as strikes and unfavourable commodity prices, led to a drop in consumption by our customers, thus causing a variance in our sales forecast,” he said.

The “volume variance” in sales related to Eskom’s regulatory clearing account claim was actually R7.3‑billion, attributed to standard tariff customers, and not the full R11.7‑billion, he said.

Internally, Eskom had optimised its capital and instituted a cost-saving programme that would yield R60‑billion in the full five years of the MYPD3 to ensure it remained efficient in its operations, Phasiwe said.

It would also continue to embrace independent power producers as a part of South Africa’s capacity plan and the use of “alternative sources as part of our energy mix into the future”, he said.

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