Part 1 Revenue Application: Multi-Year Price Determination ... - Eskom

Overview of Multi-Year Price Determination
2013/14–2017/18 (MYPD 3)
Determining a “fair” return on assets
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In assessing its revenue requirement, Eskom is allowed to factor in a fair return on assets
used to generate, transmit and distribute electricity, including assets under construction. The
return is earned on the assets operated by Eskom and should represent the total cost of
funding the business (both equity and debt) based on the weighted average cost of capital
(WACC), as determined by Nersa. This return is applied to the depreciated replacement
value of the assets (including assets under construction). The return is a key determinant of
Eskom‟s financial sustainability: it provides the revenue to meet debt interest payments and
build a base of retained earnings – essentially equity returns – that can anchor the balance
sheet. This will enable future borrowing and expansion of the asset base and ensure that
current debt can be repaid while providing Eskom with ability to achieve cheapest financing
option supported by standalone credit rating.
The revised funding plan for MYPD 3 will see Eskom reach a total debt of over R333 billion
on domestic and international capital markets at the end of the MYPD 3 period (peaking at
over R 360 billion in 2016/17). The net finance costs (cash component) will total R115 billion
over the same period. Total interest over the period is R140 billion including accruals.
Eskom‟s ability to service this debt – and build a base of retained earnings to secure future
borrowing – depends on its returns, which will swing from negative to positive after 2014/15,
resulting in a total return of R186 billion for the period. This leaves a cumulative return of
R46 billion to the shareholder at the end of MYPD 3. Eskom will sacrifice R209 billion by
earning less than the 8.31% return on assets. The R46 billion will not be paid as a dividend
but will be reinvested in the business, strengthening Eskom‟s balance sheet and contributing
towards a standalone credit rating.
By 2017/18, Eskom‟s real returns will have reached 7.8% before tax, which is lower than
Nersa‟s WACC of 8.16% (as determined for MYPD 2) and Eskom‟s currently calculated
WACC of 8.31% before tax. Eskom‟s real returns are also well below the returns any private-
sector investor would require. However, as a state-owned company with the benefit of
government guarantees, Eskom can tolerate a lower rate of return and still source funding
for its capacity expansion drive. The government of South Africa – Eskom‟s sole