Something must give, says Eskom on viability

BDLive | Apr 8, 2013 | Carol Paton

Experts differ after Nersa reveals reasons for 8% limit on tariff hike

ESKOM and independent analysts maintain that the utility cannot stay sustainable and cash-positive on the 8% tariff increase approved last week by the National Energy Regulator of South Africa (Nersa).

Eskom said on Sunday its reduced return on investment could affect its financial sustainability, and that it would now approach the government for a discussion on its mandate.

Nersa on Friday published its full reasons for the decision to grant Eskom an 8% tariff increase, slashing the utility’s return on investment, revising its depreciation allowance and cutting the fat out of its operating budget.

The result of the cuts is R100bn in savings over the five-year period covered by the application.

The reasoning assumes that although Eskom gets only half of the tariff increase it requested, it can remain financially viable and will not need to increase its borrowing, as the revenue shortfall is made up for by savings.

"The reduced revenue which Nersa has allowed is a huge challenge for Eskom. We will have to look at our operations for efficiencies, but efficiencies alone will not reduce costs to the level allowed for by Nersa. Something will have to give," said Eskom spokeswoman Hilary Joffe.

Independent analysts said although the revenue shortfall was compensated for on paper, this would not necessarily mean that Eskom would be cash-positive over the five-year period. The likelihood of Eskom needing further debt guarantees from the government remains high.

The Nersa member responsible for electricity, Thembani Bukula, said according to the regulator’s calculations, Eskom should be able to get by with an 8% tariff increase. "Eskom requested R1-trillion in revenues over the next five years in order to cover its operating and debt costs.

"We allowed for revenues of R906bn and found savings of R100 bn.… They should be able to do it with 8%."

Mr Bukula said the first chunk of savings was depreciation costs, which it cut from R189bn to R139bn. This was done by not allowing the addition of inflation to depreciation calculations, as assets were revalued every five years in any event. The second chunk was in slashing Eskom’s projected return on investment from variable levels from 1% rising to 8%, to 3%. Nersa believed this would be sufficient for Eskom to cover its financing costs.

However, this is controversial, as in previous price applications Nersa allowed a much higher return on investment. Mr Bukula said the return on investment allowed for this time was in line with international benchmarks for similar utilities.

Ms Joffe disagreed, as Eskom was "playing catch-up for years of earning returns well below international benchmarks".

Independent consultant David Holland, who with Investec investment strategist Brian Kantor made representations to Nersa on Eskom’s application, said he believed Nersa had made the right decision in cutting the real return on investment.

"In the previous price application, the regulator had allowed an 8% real return on investment, which is ridiculous. Regulated utilities worldwide get a 3%-4% real return on investment. Eskom pulled a fast one in the previous application and tried to make it stick in this one," he said.

The third area where Nersa cut costs was in stripping the fat out of a long list of line items in the operating budget, from primary energy costs for coal and nuclear fuel to corporate staffing costs. Increases were limited to inflation or forecast international prices, indicating that Nersa believed the operating budget had been padded out. Eskom disagreed, saying its application had built-in efficiencies. It questioned, in particular, its ability to control coal prices, which are unregulated.

Staff costs were limited to a 5.6% hike from the 8.6% Eskom requested.

Other areas where changes were imposed were a tighter capital budget without cutting projects, and limits put on the integrated demand programme, and a ban on paying for power buybacks through the tariff (which Eskom uses to control demand). Nersa disallowed the solar water geyser subsidies and subsidies to companies to become more efficient. Mr Bukula said the solar geyser project was already being funded by the Treasury and that companies should pay for their own energy-saving initiatives.

Nersa’s reasoning shows a regulator that is much more determined to regulate electricity prices than in the past and that has a greater determination to oversee Eskom.

But independent experts believe the assumption that Eskom will not need to increase its borrowing is not realistic.

Mr Holland said a large chunk of savings came from depreciation, a noncash expense with no bearing on cash flow. "As these are not cash savings, the borrowing requirement would still need to go up. I estimate it will increase to over R500bn, but this is nothing to be scared of. We need more power capacity for the country to grow and have many years to pay down the debt," he said.

Anton Eberhard, a member of the National Planning Commission and a professor at the University of Cape Town’s Graduate School of Business, said the rate of return regulatory methodology used by Nersa should be complemented with a thorough cash-flow analysis. "What Nersa is saying is, ‘Let’s smooth prices out’, which is right, because we need to be mindful of the impacts on the economy," Prof Eberhard said.

"But Nersa also needs to ensure the financial viability of Eskom. Eskom will be looking at the numbers and whether additional support is needed from its shareholder. I’m sure that conversation with Treasury will happen now."


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