1. MYPD3 RCA Comment

Eskom submitted its Regulatory Clearing Account (RCA) application to NERSA in November 2015 for the first year of the third multi-year price determination (MYPD3), 2013-14. The EIUG submitted comments on this application in December 2015.

On 1 March 2016, NERSA approved a 9.4% electricity tariff increase for 2016-17, effective 1 April 2016 for Eskom customers, and 1 July 2016 for Municipal customers. In late April 2016, the EIUG received an unsolicited letter from the HEUG and their attorneys seeking support for their case. The EIUG Council discussed their request and decided that (1) it should continue to hold a watching brief over the legal dispute, and (2) it should make the letter available to all members’ companies for information/action as each member sees fit.

Accordingly, all members were sent the above-mentioned letter and requested to communicate directly with the HEUG should they wish to support them in any way. In summary, the letter stated that:

On 22 March 2016, the High-Energy Users Group (HEUG) of Nelson Mandela Bay Municipality (NMBM), which includes Borbet, Sovereign Food, Agri Steels, Autocast and Shatterprufe in its membership, issued papers seeking an interdict to prevent the approved increase from coming into effect.

Their argument was that:

“Eskom did not follow the RCA methodology prescribed by NERSA for applications of such a nature, accordingly, the application is un-procedural, was some 24 months late and for that reason is unlawful. The significance of this delay is that both NERSA and the public were prevented from making interventions that the intended early warning system laying at the root of the methodology was undermined, and both NERSA and the public were being presented with a fait accompli.”

In the face of the Interdict and prior to the hearing in the Pretoria High Court, it was proposed by Eskom and NERSA, and ultimately agreed between the legal teams, that the RCA decision would be reviewed by the High Court on an urgent basis. In addition, in papers filed at Court, Eskom conceded that if the RCA decision by NERSA is proven on review to have been incorrect, Eskom will refund all amounts that may have been overpaid from 1 April 2016.

On 16 August 2016, the North Gauteng High Court set aside the 9.4% tariff increase decision that was made by NERSA, in response to Eskom’s RCA application.

On 25 August 2016, NERSA announced that it would appeal the judgement made by the court.
In its media statement NERSA held that:

NERSA is of the view that the judgement is flawed. It has also created a hierarchy of issues in the application of the MYPD methodology without considering the objective of the methodology and how the RCA is decided.

Therefore, NERSA will be appealing the judgement on the grounds of it being premised on erroneous information, a non-implementable position, as well as its substitution of NERSA’s decision of 2014.

It is believed that the appeal will create certainty with regard to the regulatory framework as there will be an approved tariff in place during the appeal process. It will also allow an opportunity to clarify issues raised in the judgement.

The option to appeal is considered to be the most effective manner to remedy the situation created by the judgement while ensuring that regulatory certainty is sustained through the most available legal means without violating the contents of law and judgement.

The increase will stay in effect pending the outcome of the appeal by NERSA.

2. Eskom’s Critical Peak Day (CPD) Tariff application

At the Industry Energy and Tariff Working Group meeting on 26 January 2016, Eskom presented their submission to NERSA of the CPD tariff application. The tariff is applicable for voluntary implementation by Eskom’s qualifying large customers. Eskom’s application states that this tariff option has been internationally proved to reduce load on specific days when load reduction is required. This would be achieved by increasing the electricity price on these “system-constrained” days (critical peak days), and lowering prices on the non-constrained days. Eskom would give customers notification of which are critical peak days; these would be determined by the System Operator.

This option would be one of the demand response options used by Eskom to balance supply and demand. Eskom representatives have presented this option to key customers, engaged with them and considered comments throughout the year. However, due to the focus on the MYPD Methodology and the RCA court case, NERSA was only able to publish Eskom’s application on 19 October 2016.

As this is a voluntary tariff option, the EIUG did not submit comments to NERSA or Eskom from the group. It is aware that some individual member organisations engaged with Eskom and submitted written comments to NERSA. The Regulator’s decision is expected in January 2017.

3. MYPD Methodology

NERSA published the MYPD Methodology Revision Consultation Paper on 15 April 2016 for public comments. Through the lessons learnt in the MYPD3 process and its subsequent RCA applications, several shortcomings in the methodology were identified, particularly around the use of Open-Cycle Gas Turbines (OCGTs), coal procurement, sales volume projections and plant availability / maintenance issues.

The EIUG was granted an extension to 15 June 2016 to submit written comments. EIUG member comments were consolidated and sent for expert review, before the comment paper was finalised and submitted to NERSA. The full comment paper is available on the web portal.

Some specific comments raised in the EIUG comment paper include:

• The methodology to determine the WACC has the EIUG’s general support with the reservation that determining the “ß”, which is a measure of Eskom’s “market risk” compared to the overall market risk premium of the JSE, needs to take into account that Eskom’s systemic risk is considerably reduced by the “RCA” claw back mechanism.

• The calculation methodology of the Regulatory Asset Base (RAB) uses the replacement cost for calculation of the depreciation cost and the return on assets (ROA).  However, the “real” WACC is used when determining the Rand value for the ROA as opposed to the nominal WACC, if historical costs were used.

• Calculating the depreciated replacement cost (DRC) is complex and the EIUG’s comment was that clear rules for its determination are necessary and must be included as an Appendix in the published “Multi-Year Price Determination (MYPD) Methodology.”

• The EIUG’s view on sales to neighbouring countries is that these should be at a standard tariff (M’flex) as applicable at the point of delivery, and this revenue included in the regulated revenue calculation.  Any short-term sales to neighbouring countries must be above the variable cost, are non-firm and must utilise existing infrastructure.

• On the question of “Should the Energy Regulator approve revision of existing coal contracts and new coal contracts with a view to ensure cost effective coal procurement, thus eventually minimising increases in coal costs?” Its opinion was –  The regulator should rather ensure that Eskom’s procurement of coal take place on an open and competitive basis as required by the Constitution and the PFMA.

Conclusion

• In general, the greater the value of pass-through costs agreed to, the less risk Eskom carries. There should be a commensurate reduction in the WACC, as this risk is passed through to the customer (specifically the Beta used in the calculation of the cost of equity).

• If costs are to be passed through, transparency regarding the details of costs should be clear.

Following extensive consultation, including the publication of the revised MYPD Draft Methodology for stakeholder comments on 8 September 2016, NERSA published the final MYPD4 Methodology on 28 October 2016. On review of the Methodology, the EIUG was satisfied that NERSA had considered and included its key concerns in the final version.

The Executive Summary of the final methodology states:

1.1 To enhance regulation, certain sections of the Methodology have been revised to align objectives and increase transparency while minimising regulatory risks.

1.2 Lessons learnt from the previous Regulatory Clearing Account (RCA), as well as the stakeholder comments during the methodology consultation process, highlighted that certain sections of the Methodology did not adequately address some of the intended objectives, particularly with reference to Open Cycle Gas Turbines (OCGTs), sales volumes and coal procurement.

1.3 A major risk factor highlighted was the inaccuracies in sales volumes projections, as well as plant availability projections. Sales volume variations have been one of the largest components of Revenue Variance in the previous RCA and the rules have been revised to deal with this problem. Furthermore, a new section, namely ‘Production Plan’, has been introduced for alignment and to improve transparency.

1.4 During the RCA evaluation process, it was found that Eskom had been implementing maintenance activities without an improvement in the availability levels. In assessing the use of OCGTs, the Energy Regulator found that the OCGT rules had to be amended to take into account the collective impact of the entire fleet performance on OCGT utilisation. The OCGT rules have been further amended to be aligned with underlying principles defined in terms of least cost dispatch and referencing Scheduling and Dispatch Rules, as recommended during the consultation process.

1.5 Another key risk area was coal procurement. Coal costs have been increasing rapidly and it was not clear where the cost increases were coming from. To enhance transparency the Energy Regulator has amended the rules such that the single cost centre is disaggregated into various contract types because of the different risks per contract type.

1.6 New sections, such as ‘Ring-fencing of costs’, have also been included to minimise the risk of misallocation of funds.

1.7 The Energy Regulator envisages that implementing these amendments will improve efficiencies and minimise regulatory risk

The full methodology is available on the web portal.

4. Eskom’s MYPD4 Application

On 7 July 2016, NERSA issued the following Media Statement:

The National Energy Regulator (NERSA) announced today that it has approved Eskom’s application for an extension to submit the new Multi-Year Price Determination (MYPD) application until 1 April 2017.

On 1 March 2016, the Energy Regulator approved Eskom’s MYPD3 Regulatory Clearing Account (RCA) application for the financial year 2013/14. As part of its decision, the Energy Regulator requested Eskom to submit a new MYPD application within three months, based on the revised assumptions and forecasts that reflect recent circumstances.  On 12 May 2016, Eskom submitted an application requesting an extension to submit the new application on 1 April 2017. Eskom cited statutory consultation requirements and the revision of the MYPD Methodology as reasons for the request.  The Energy Regulator also decided that Eskom’s RCA applications for the second and third years of the MYPD3 (2014/15 and 2015/16) should be submitted together. The two RCA applications will be processed simultaneously once they have been received.

The EIUG is in the process of commissioning studies to update the price path, as well as some modelling of the changes between the original MYPD3 application and the current status quo. These pieces of work will build the fact-base on which it engages with stakeholders on the MYPD4 application.

1. Draft Carbon Tax Bill

National Treasury put a Draft Carbon Tax Bill out for public comment late last year; this draft proposed an implementation date of 1 January 2017. This draft has several flaws and the ITTCC, Chamber of Mines (CoM) and Business Unity South Africa (BUSA) have been actively engaging National Treasury on these issues.

Two workshops to discuss the methodologies proposed in the draft were held in April this year; National Treasury held one workshop with each affected sector, as well as a bilateral meeting with BUSA. At these meetings, National Treasury confirmed that the carbon tax would be revenue neutral on the price of electricity for the first phase, thus limiting the exposure on scope 2 emissions. Treasury stated they would achieve this by adjusting the Electricity (Environmental) levy and determining the premium price of carbon that is implicit in the renewables purchase through the Renewable Energy Independent Power Purchase Programme (REIPPP).

BUSA, with input from the ITTCC, commissioned Genesis Analytics to assist in the development of a submission to Treasury that covers two aspects in terms of the carbon tax to be paid by electricity generators:

1. Firstly, while the Bill provides for an offset of the carbon tax amount against the additional (implicit) cost of renewable energy that Eskom is forced to include in its generation mix, it is not clear how this will be done practically beyond the broad-brush strokes of the Bill and/or supporting documents.

2. Secondly, the media statement accompanying the Bill also commits the carbon tax to be electricity price neutral. The media statement and explanatory memorandum suggest it would achieve this through a complementary reduction in the environmental levy , but it does not clarify precisely how this will be done.

The final report has been submitted to National Treasury, who have confirmed receipt and are considering the contents as part of their work on this. Treasury has also requested inputs from Eskom and the Independent Power Producer (IPP) Office. Once these three stakeholders have completed their work on the data and methodology, they will engage with NERSA.

Another area of concern raised by Business and Industry in response to the draft bill is the trade exposure of some sectors. BUSA, Business Leadership South Africa (BLSA) and other business associations including the EIUG, commissioned DNA Economics to undertake an evaluation of the effectiveness and practicality of National Treasury’s proposed calculation of the Trade Exposure Allowance. The allowance is to be implemented to reduce the impact of the tax on sectors that face significant competition from international firms (in local and overseas markets) to protect their competitiveness.

On 29 September 2016, Business met with National Treasury to discuss the DNA report and the BUSA recommendations submitted for consideration based on the report. Brent Cloete from DNA Economics attended the meeting to present the DNA report, and answer some of the technical comments/questions raised by NT on the DNA report (he was not speaking on behalf of BUSA/BLSA).

Concerns were raised from both sides regarding the mapping and data used in each approach. Further work needs to be done to understand the mapping in greater detail to prove replicability and transparency of each method and to show the availability of the data.

In addition to the above-mentioned areas, more work is being done by National Treasury and business regarding the income tax deductibility of the carbon tax and the Z-factor (this is sector and in some cases company specific work).

2. Carbon Offsets

Complementary to the carbon tax, the Draft Regulations: Carbon Offsets were published by National Treasury for public comment on 20 June 2016 in terms of clause 20(b) of the Draft Carbon Tax Bill, 2015. The ITTCC submitted comments on 29 July 2016; the comments were broadly in support of BUSA’s more detailed comments; both documents have been shared with ITTCC members.

The National Treasury hosted a workshop on 25 November 2016 to discuss the Carbon Offset Regulations and the Carbon Offset Administration System. An overview of the regulations and their relation to the Carbon Tax was presented by Treasury. The Department of Energy presented the current Administration System (more on this in the next section). Stakeholders were also invited to give presentations, these included presentations from BUSA, EcoMetrix, KPMG and WWF.

While largely in support of a carbon offset scheme, most of the speakers raised the same concerns and challenges with the current regulations that have been raised in the written comments. Some of these key issues include:

• Carbon offsets are a key component of a holistic mitigation system that enables the transition to a lower-carbon economy. It is therefore critical that the carbon offsets are aligned with other mitigation policy instruments, like the proposed carbon tax, the carbon budgets and DEROs. It must also be borne in mind that mitigation instruments should promote behaviour change and not be punitive. Accordingly, there should be no limit to the tax-free allowance for the offsets as this imposition contradicts the overarching principle of reliance on least cost mitigation measures.

• The draft regulations and explanatory memorandum reflect significant differences in approach. There must be clarity in the regulations and explanatory memorandum and the terminology used by both Treasury and DoE.

• The current standards supported by the regulations and the current eligibility criteria pose significant limitations and challenges to implement or include other projects under the scheme. Other standards operating in South Africa should not be excluded. The current scheme is generally biased towards large projects which are more able to afford high transaction costs. In addition, the explanatory memorandum contemplates additional criteria which also appear to have been incorporated into the operating system.

• Some specific concerns regarding the eligibility criteria raised include the need to discuss the allowance of non-REIPP projects and the allowance of cogeneration.

• The geographic location limitation needs to be discussed.

• Offset projects that have been submitted to a qualifying standard, like CDM, but for whatever reason have not been registered or issued with credits within 12 months prior to the implementation of the carbon tax should be eligible.

• Because of the limitations in the current design, demand will exceed supply right from the outset.

National Treasury has provided feedback on some of these concerns and will share these slides with stakeholders. Furthermore, Treasury has committed to a bilateral meeting with BUSA early in 2017 where these will be explored further.

Carbon Offset Administration System

The Department of Energy (DoE) issued an invitation to participate in the stakeholder consultation workshop on the development of the Carbon Offset Administration System (COAS) for 12 October 2016.

The feedback below is courtesy of Mike Nash – PAMSA (edited by J. Morris)

The main purpose of the workshop was to explain the development of a system to administer the carbon offset process with regards to the carbon tax.

Some of the key take-aways from the presentation include:

• The carbon offset programme starts with the listing of carbon credits, that were earned through CDM, VCS or GS international standards, and transferred to the SA registry.

• Only credits that are transferred out of the “international” system and transferred to the South Africa registry can be used.

• Only credits earned through projects run in South Africa can be used.

• The usual CDM regulations apply as to what project can be used to generate credits, for example, additionally et al.

• The maximum allowable credit off-set is restricted to the tax regulations of 5-10%.

• Credits can be bought, sold, kept, retired or used as a tax offset.

• Carbon Tax Offsets require permission to be obtained in the form of an extended letter of approval from the DNA, and if successful transferred to them (?) and retired from your register.

• Credits cannot move from the South African registry to the international market registry.

There was very little mention of the work and costs involved in developing, registering, auditing and maintaining the requirements of the various standards, (CDM, VCS or Gold), not to mention the time and costs that these operations consume.

Several challenges with the presentation were picked up by business representatives at this workshop. Consequently, BUSA held a bilateral meeting with DoE and NT to discuss the proposed system on 22 November 2016. Comments will be submitted to Treasury and further engagement will be arranged in 2017.

3. Alignment between the Carbon Tax and the Carbon Budgets

There is still no certainty regarding the design of the tax and its alignment to other mitigation instruments, like the carbon budgets post-2020. The Department of Environmental Affairs (DEA) and National Treasury have jointly commissioned DNA Economics and Vivid Economics to undertake a study on the integration of the carbon tax and carbon budgets in South Africa for Phase 2 (post-2020). This is part of a larger body of work that the DEA has commissioned, looking at the Phase 2 Climate Change Mitigation Methodology.

The objective of this assignment is to review the principles used in approaching greenhouse gas emission reduction in South Africa and of combining the carbon budget and carbon tax; and assess the appropriateness and effectiveness of combining the carbon budget with the carbon tax in achieving South Africa’s emission reduction goal beyond 2020. While both instruments have merits, economic theory would suggest that there could be risks associated with applying both instruments to the same emissions at the same time. There is a desire to understand how they may be aligned to ensure that South Africa’s mitigation policy is placed on a coherent footing on the longer term, so that it can help deliver the emission reductions to which the country has committed. The South African mitigation system is reiterative work which will be refined over time. This analysis will be considered as an input to inform the second phase of the mitigation system.

BUSA hosted a meeting between the DEA, the consultants and Business to discuss their draft report, which was circulated on 15 July 2016. Several comments and questions were raised, especially around the assumptions used in the report. There were one-on-one engagements arranged with individual companies, civil society and academics to review the document. The final report will be sent to government to help inform the decision regarding what the Climate Change policy should look like post-2020. The ITTCC has submitted comments and requested to see the final DEA accepted report to review, before it is submitted to government.

4. Carbon Tax Economic Impact Report

Finally, National Treasury hosted a workshop to present their report entitled: “Modelling the Impact on South Africa’s Economy of Introducing a Carbon Tax”. This report concludes that:

The simulations suggest that the introduction of carbon tax would lead to estimated decrease in emissions in South Africa of 13% TO 14.5% BY 2025 & 26% TO 33% BY 2035. And that the tax will lead to a reduction in local air pollution and restructuring of the SA economy to being less emissions intensive.

The modelling results estimate that a carbon tax will reduce the economy’s average annual growth rate by only 0.15 percentage points.

Although National Treasury has indicated that this report is for information only and there will be no adjustments made, they are willing to receive comment.  National Treasury are planning to present this to the Parliamentary Portfolio Committee in conjunction with the updated Bill.  It is therefore imperative that Business states its concerns with some of the assumptions used in the modelling of the scenarios.

National Treasury is in the process of developing the updated Draft Carbon Tax Bill for publication. In parallel processes, they are working with the necessary stakeholders to develop the Carbon Offsets Regulations; Notices regarding the Trade Exposure Allowance; and the Implicit Price of Carbon. In a meeting with Business representatives on 29 September 2016, Treasury officials stated that it was unlikely they would complete their work in time for the necessary processes to give effect to the Bill from 1 January 2017. It is more likely that the new targeted implementation date will be 1 January 2018.

1. Security of Supply

The EIUG believes that security of supply will be stable for the short-to-medium term. At the time of writing, Eskom’s Energy Availability Factor (EAF) improved to around 78%. The Tetris outage management plan has allowed Eskom to plan and perform better maintenance. New capacity from Eskom’s Build Programme, DoE OCGT peaking plants and the Independent Power Producer Programme (IPP’s) have come online. Year to date, demand is 1.09% lower than the same period in 2015. Eskom has also reported a decline in sales volumes as follows: rail (7.9%), industrial (6.2%), mining (0.3%), and agriculture (0.7%). The System Operator is focusing on optimising the generation dispatch of the fleet to optimise the cost of generation.

Production in most of the energy intensive sectors is still below 2008 levels, with some operations having shut down entirely.

2. National Energy Efficiency Strategy (NEES)

An updated draft of the post-2015 National Energy Efficiency Strategy (NEES) was commissioned by the Department of Energy early this year. In February and March 2016, the EIUG engaged with the consultants in sector workshops as well as a bilateral meeting at BUSA. The intention stated by the consultants and the DoE at the time was for the final draft to be issued for public consultation throughout July and August 2016. However, since these early engagements, there has been no circulation of an updated document nor further stakeholder workshops on this.

The EIUG is also keeping a watch for the Mandatory Report of Energy Data regulations which are long awaited.

1. Consultation Paper on the Review of the Distribution Licensing Process

NERSA published the consultation paper on the review of the Distribution Licensing Process for public comment. The EIUG was granted an extension to submit written comments until 22 August 2016. Key concerns raised by the EIUG in its submission include:

We are extremely concerned that NERSA has chosen to review the current licensing arrangements for the electricity distribution sector. This introduces a significant new risk to our members’ businesses due to the potential change to a long established and stable licensing regime. Most of our members receive their electricity from Eskom. We consider Eskom to be a competent and reliable electricity supplier, and capable of meeting the supply and safety requirements of large electricity intensive customers.

We have canvassed the opinion of our members who are currently municipal customers. Most of our members, if given the choice, would want to switch to Eskom

as their supplier. Most municipalities do not have financial, technical, operational or logistical capabilities or competencies to meet the quality and reliability of supply, and safety requirements, of large electricity intensive customers.

Forcing large industrial customers to procure their electricity supplies from municipalities will increase both the cost of doing business and the supply risk, with devastating consequences for the sustainability of our members’ businesses. Similarly, allowing municipalities to levy a surcharge (i.e. a tax) on electricity supplied by Eskom in their areas, will increase the cost of doing business, and reduce the competitiveness of our members’ businesses with damaging implications.

Any attempt to change the existing supply arrangements to large industrial customers, threatens the economic well-being of South Africa and the future socio-economic prospects of its people.

The detailed comment paper is available on the web portal. EIUG comments were submitted to NERSA on 19 August 2016.

2. Third-Party Rules for Network Charges

NERSA sent out a communication to various industry players, including the EIUG, calling for comments on the document “Third-Party Rules for Network Charges” in September 2016. On review of the document, it was found that it did not have any material changes from the document circulated in early 2015 for review. However, to ensure completeness, we renewed the EIUG comment submitted in 2015 and submitted this to NERSA for consideration.

The EIUG believes that this is an important framework, given the substantial changes in the electricity supply industry, and the group will therefore continue to engage closely with NERSA in its development.

1. IRP Update

On 2 November 2016 Cabinet approved the publication of the Integrated Energy Plan (IEP) and the Integrated Resource Plan (IRP) for public comment. On 22 November 2016, DoE gave presentations to the media on both plans; these presentations were published, along with a briefing note on the DoE’s website.

The IRP presentation laid out the IRP2015 Base Case Scenario, a couple of sample scenarios and a list of potential future scenarios. The department invites the public to:

• Make input regarding the assumptions used;

• Comment on the Base Case scenario;

• Comment on any additional scenarios that should be considered; and

• Make any other input relevant to the process of developing the IRP and IEP

The IEP and IRP Assumptions and Base Case Reports were published in the Government Gazette on 25 November 2016.

The department committed to roadshows in Johannesburg, Cape Town and Port Elizabeth

between 7 and 15 December 2016.

The EIUG’s preliminary position on the IRP, without having analysed the detailed assumptions, is in line with the key messages in the Stakeholder Engagement pack:

The EIUG welcomes the publication of the IRP; the update has been long awaited. The country needs a cost/risk optimised plan for the determination of the future energy supply industry.

The EIUG needs to understand and interrogate the assumptions used against the current reality and future requirements to ensure the sustainability of our economy.

The EIUG will participate fully in the public consultation process, including the submission or written comments. The EIUG has requested an extension for the submission of comment to 31 March 2017 as the current period does not allow sufficient time for robust consideration.