The Economic Impact of Electricity Price Increases on ... - Eskom

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<strong>The</strong> sharp increases in electricity tariffs since 2008 have been met with significant public resistance. Some critics contend that “consumers have borne the brunt <strong>of</strong> a series <strong>of</strong> unjustifiable electricity price increases” Key Points • An association representing large industrial electricity consumers, the Energy Intensive Users Group (EIUG) have argued that rising electricity prices pose a serious threat to growth and that many industries are at “the tipping point” (EIUG, 2011). • In a 2011 report, the Energy Intensive Users Group maintain “ that South Africa must have a transparent affordable [electricity] price” and argue that the affordable price path is one that balances viability, economic growth, global competitiveness and social development (where viability is defined as a price path that reflects a fair and efficient cost <strong>of</strong> supply) (EIUG, 2011). • While the EIUG appear to support the notion that the electricity prices need to rise to a ‘cost-reflective’ level in principle, they argue that lower and more ‘affordable tariffs’ can be achieved by manipulating five aspects <strong>of</strong> the Eskom’s ‘allowed revenue’ formula– namely the rate <strong>of</strong> depreciation, the rate <strong>of</strong> return on assets (WACC), the cost <strong>of</strong> new capacity, assumptions regarding independent power producers and taxes and levies. • Following a similar line <strong>of</strong> argument, Xstrata Alloys (January 2011) and Frost and Sullivan (2011) call for a ‘justifiable’ electricity price path for South Africa which <strong>of</strong>fers viable and affordable tariffs and that balances and supports future supply requirements with developmental objectives. <strong>The</strong>y argue that four options to mitigate high electricity prices should be considered (see below) 36 Industry Options to Mitigate High <strong>Price</strong>s Lower Eskom’s allowed return on assets Don’t revalue the asset base (retain historic cost accounting) Exploring the policy options available Lower the target for renewable energy generation capacity in the current integrated resource plan Allow independent power producers (IPPs) to sell to a system operator and to trade bilaterally ©2012 Deloitte Touche Tohmatsu Limited. All rights reserved. 4
However each <strong>of</strong> the options presented by industry representatives suffer from considerable drawbacks. <strong>The</strong> first option, lowering Eskom’s ROA is not consistent with the fundamental principles <strong>of</strong> an effective pricing regime – tariffs that are ‘cost-reflective’ tariffs and promote a financially sustainable electricity supply industry. Option Argument Criticisms and Implications Lower Eskom’s return on assets (ROA) 37 Deloitte • A return on assets sensitivity analysis indicates that this is one variable which can be easily adjusted to change the trajectory <strong>of</strong> the electricity price path. • Dropping the allowed ROA from 8% to 6% drops the electricity price by 10c/kWh while still allowing Eskom to effectively manage its balance sheet. Exploring the policy options available • <strong>The</strong> ROA component should be designed to ensure the sustainability <strong>of</strong> Eskom by providing for sufficient revenue to maintain and upgrade existing infrastructure and investment in new capacity when required (Danilyuk, 2009). • <strong>The</strong> allowed return on assets is not determined arbitrarily but must be referenced to the utility’s actual risk-adjusted weighted average cost <strong>of</strong> capital (WACC). • If the ROA is set below the true risk-adjusted cost <strong>of</strong> capital, the resulting tariff is not cost-reflective, will not allow Eskom to recover the full cost <strong>of</strong> its assets or provide incentive to invest further. IPPs facing a higher cost <strong>of</strong> capital also have little incentive to invest. • Tariffs that do not reflect the true cost <strong>of</strong> electricity supply lead to a misallocation <strong>of</strong> national resources and to mismatches between electricity supply and demand (Vedavalli, 1989). • To assume that equity costs less than it actually costs implies that the shareholders (the state and taxpayers) would be subsidising electricity prices. (Joubert, October 2011). • In addition as noted in section 2.6.1.2 for the current MYPD2 period NERSA did not in fact calculate Eskom’s allowable revenue on the basis <strong>of</strong> its published methodology. NERSA determined the “reasonable margin or return” on assets to 8.16%, but instead awarded Eskom a real (pre-tax) Weighted Average Cost <strong>of</strong> Capital (WACC) <strong>of</strong> 0.08%, 2.8% and 4.2% for the three respective financial years. This is because Eskom is currently still transitioning to more cost-reflective tariffs and a massive one-<strong>of</strong>f price adjustment would be politically unviable. ©2012 Deloitte Touche Tohmatsu Limited. All rights reserved. 4
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The Economic Impact of Electricity Price Increases on ... - Eskom

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