Eskom Regulatory Clearing Account (RCA) - FY 2019 NERSA Public Hearings Date:10 February 2020 Klerksdorp, North West
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Eskom Regulatory Clearing Account (RCA) FY 2019 NERSA Public Hearings Date:10 February 2020 Klerksdorp, North West
Eskom’s RCA application in accordance with the
Electricity Regulation Act
Legal Basis of the MYPD methodology
The legal basis for the MYPD Methodology is provided in the Electricity Regulation Act (ERA), 2006 (Act
No. 4 of 2006). The Methodology is subordinate to the requirements of ERA and the Electricity Pricing
Policy. The requirements from these two documents will at all times supersede those of the Methodology.
Section 4(a)(ii) of the Act states that ‘the Regulator must regulate prices and tariffs’. Further, section 15(1)
and (2) of the Act prescribes the following tariff principles:
(1) A license condition determined under section 14 relating to setting or approval of prices, charges and
tariffs and the regulation of revenues –
a) Must enable an efficient licensee to recover the full cost of its licensed activities, including a
reasonable margin or return;
b) Must provide for or prescribe incentives for the continued improvement of the technical and
economic efficiency with which the services are to be provided;
c) Must give end users proper information regarding the costs that their consumption imposes on the
licensee’s business;
d) Must avoid undue discrimination between customer categories; and may permit the cross subsidy
of tariffs to certain classes of customers.
(2) A licensee may not charge a customer any other tariff and make use of provisions in agreements other
than that determined or approved by the Regulator as part of its licensing conditions.
Eskom has made this Regulatory Clearing Account (RCA) application to recover
efficient costs in accordance with the ERA and MYPD Methodology
2
NERSA’s prudency guidelines is the basis of
Eskom’s RCA application
(section 3.5 of the RCA application)
Extracts from NERSA’s Prudency Guideline
Page 5
Page 5
Page 8
3NERSA’s prudency guidelines is the basis of
Eskom’s RCA application
(section 3.5 of the RCA application)
Extracts from NERSA’s Prudency Guideline
Page 12 & 13
Page 17
4NERSA’s prudency guidelines is the basis of
Eskom’s RCA application
(section 3.5 of the RCA application)
Extracts from NERSA’s Prudency Guideline
Page 18
Eskom has applied the principles of NERSA’s prudency guideline in this RCA
application
5Eskom fully supports NERSA decision with
addressing matters related to governance failures
• On 7 March 2019, the NERSA Media statement as confirmed by the NERSA Chairman
at the media briefing was as follows with reference to previous revenue decisions:
“The Energy Regulator also considered that Eskom conceded that certain
governance failures occurred in Eskom, however, at the time of the above decisions
and although some of the adjustments were effected, the extent of the governance
failures or amounts associated therewith had not been fully quantified. The Energy
Regulator may initiate its own investigation into the governance failures in Eskom
and may effect adjustments to Eskom’s revenue based on the relevant outcome of
its investigation and/or those undertaken by bodies or entities, including, but not
limited to, Eskom, National Treasury, the Special Investigating Unit, the South
African Directorate for Priority Crime Investigation (Hawks), the Parliament of the
Republic of South Africa or any Commission of Enquiry as and when they are
concluded or a conclusive outcome is reached and the costs associated therewith
have been quantified.”
• Eskom is on record in support of this approach as clarified during previous submissions
• As an example, the recovery from Mc Kinsey has already been included in the RCA
balance determination related to the FY 2018
Eskom is committed to complying with the approach decided by NERSA
with regards to amounts associated with governance failures
6The Regulatory Clearing Account (RCA) is the
regulatory mechanism for risk management
RCA is a risk management mechanism to deal with variances between what was determined by
NERSA for purposes of its revenue determination, and what actually materialised (per Eskom’s
audited financial statements) - a backward looking reconciliation
Landscape for RCA application:
Focus of this consultation is FY 2019 RCA application. Various forward looking clarifications on Eskom’s
operations are of interest. However, ample other opportunities are available for addressing these
1. The submission is based on the MYPD Methodology, published by NERSA during October 2016
2. It is further influenced by the decision and reasons for decision for MYPD 3 RCA for FY 2014
published in March 2016
3. The reasons for decision for MYPD 3 RCA FY 2015, 2016 and 2017 are being reviewed by the
Eskom Board in a High Court application
4. Due to uncertainty in the environment at that time, NERSA approved a single year application for
2018/19
5. The Energy Regulator decision for FY 2019 was an average nominal increase of 5.23%
6. The Eskom Board initiated a process of reviewing the NERSA decision for 2019 through an
application lodged at the High Court. The matter has been heard and a judgement is reserved.
7. Once this RCA balance for FY 2019 determination has been made by NERSA, by 24 March 2020 in
terms of the requirements of the ERA, a subsequent liquidation decision will be made
8. The liquidation decision will inform on the extent and timing of the price adjustment
7Key RCA related Changes in MYPD methodology
The methodology as released in October 2016 now allows operating costs to be re-
measurable and the calculation for RAB and return has changed
MYPD 3 MYPD 4
methodology methodology
Revenue due to sales
volume changes
Primary energy costs
Regulated Asset Base and Previously
Return was CECA
Operating costs
8RCA application FY 2019
(Section 2.2 of RCA application)
Decision Actuals RCA RCA
RCA for FY 2019 Variance
FY 2019 FY 2019 adjustments FY 2019
Total Revenue Rm 190 348 179 892 10 456 (5 006) 5 450
Primary Energy , Rm 86 094 99 489 13 395 3 392 16 786
Coal 39 177 49 903 10 726 1 689 12 416
Open Cycle Gas Turbines (OCGTs) 345 3 768 3 423 - 3 423
Other 782 - (782) - (782)
Other primary energy 7 595 9 320 1 725 - 1 725
Independent Power Producers 26 596 24 952 (1 644) 1 369 (275)
International Purchases 3 216 3 740 524 - 524
Environmental levy 8 093 7 805 (288) - (288)
Demand Response – Instantaneous 110 - (110) 110 -
Demand Response – Supplementary 162 - (162) 162 -
Demand Response – Programme administration 18 - (18) 62 44
Other costs 104 254 106 871 2 617 2 221 4 838
Depreciation 24 903 26 427 1 524 - 1 524
Return on Assets (ROA) 28 117 28 107 (10) - (10)
Research & Development (R&D) 112 90 (22) (22)
Demand Side Management (EEEDSM) - 29 29 (2) 27
Operating costs 51 122 52 218 1 096 2 223 3 319
Service Quality Incentives (SQI) - 166 166 - 166
FY 2019 RCA Balance Application 27 240
Nuclear decommissioning from RCA FY
83
2013/14 decision phased in over 10 years
Total RCA balance 27 323
9Clarification of RCA adjustments
1 Revenue - (R5 006m) 5 IPPs – R1 369m
Adjustments made to the revenue reflected in the Adjustment related to recognition of capacity
AFS relate to ensuring that all billed revenue is payments for the Department of Energy IPP Open
included by adjusting for non-electricity revenue, Cycle Gas Turbine (OCGT) plants as well as
demand response revenue as well as excluding reversal of provisions
any load shedding volume in the variances
2 Coal – R1 689m 6 Operation costs – R2 223m
Adjustments are mainly as a result of other
Adjustments from AFS related to application of
income (adjustment related to McKinsey refund
NERSA’s MYPD methodology
already included in a previous RCA balance
decision) and arrear debt (adjustment related to a
3 Other – R782m cap on arrear debt in the revenue decision)
“Other” in the primary energy section illustrates a
mismatch between the NERSA revenue decision 7 EEDSM – (R2m)
and the primary energy decision
Adjustment related to the application of NERSA’s
MYPD methodology – i.e. the variance for
4 Demand response – R334m
programme costs is not a pass-through since
Adjustment related to the application of NERSA’s Eskom achieved more MW compared to the
MYPD methodology – i.e. the variances for decision
instantaneous and supplementary is not a pass-
through since Eskom achieved more MW and
GWh compared to the decision
10Eskom’s FY 2019 RCA submission is driven
substantially in specific areas – Revenue
Variance
The MYPD Methodology refers to the variance between the total actual and
Legislation total decision as below:
• 17.1.1.5 Adjusting for other costs (7) and revenue variances where the
variance of total actual revenue differs from the total allowed revenue
• It would be incorrect to further divide the total actual revenue variance
Approach into fixed and variable elements – since the variable elements are already
addressed through the volume related aspects of the PE, etc costs. If this
is done – results in double counting to the detriment of the consumer
(when actual volumes are higher) or the detriment of Eskom (when actual
volumes are lower)
• The total approach is in line with the MYPD methodology
• The correction of such initial over-estimation/under-estimation of sales -
does not increase/decrease the overall cost to the consumers, but merely
represents deferred / advance recovery of the fixed cost as per NERSA
revenue decision
Variance • NERSA determined a higher sales volume compared to what actually
materailised. Sales volume variances are due to lower international sales
explanation
as well as poor economic conditions for local sales
• Sales is ~3 922 GWh lower than the determination
• Revenue from sales is R10 billion lower than the determination . After
various adjustments, revenue variance in RCA calculation is R5 450m
11Eskom’s FY2019 RCA submission is driven
substantially in specific areas – Operating
Expenditure
• The new methodology allows for operational expenditure to be re-
Legislation measurable for RCA balance applications.
• It requires the most recent prudently and efficiently incurred actual costs
when making a decision and adjusting for prudently incurred over or under-
expenditure on operating costs as may be determined by the Energy
Regulator
• Many remnants of what seems to be a previous decision were abandoned
Approach in the final decision.
• In addition, the decision is not made where the licensees and corporate
applications are considered. It was determined that the number of
employees would be aligned to the sales volume in 2008.
• Recognition of other developments in the industry did not seem to have
been considered.
Variance • The FY 2019 determination left Eskom with a funding shortfall. This
shortfall needed management intervention and a re-prioritisation of cost
explanation
between the different licensees and cost categories
• Key variances were experienced in employee benefit costs for the benefit
of Eskom. Eskom implemented extreme measures, such as an embargo
on external appointments to work within the financial constraints. Eskom
has assumed in its application that the efficient number of employees
would have reached 39 186 for FY 2019 but the actual number was 38 292
• Variances for maintenance costs were in favour of the consumer. Due to
the financial constraints, Eskom was required to reprioritise, defer and
revise its approach to maintenance
12Eskom’s FY2019 RCA submission is driven
substantially in specific areas – OCGT
revenue
• In accordance with the MYPD Methodology, the gas turbine usage should
Legislation be allowed as it was incurred to ensure security or supply and was utilized
as a last resort before the implementation of load shedding.
Variance • The system operator was required to dispatch more OCGTs (both
Eskom’s and IPPs) than in the NERSA determination or assumed in
explanation
Eskom’s application
• The dispatch was undertaken in accordance with NERSA’s scheduling
and dispatch rules
• The utilisation of OCGTs contributed towards minimising load shedding. In
accordance with the MYPD Methodology, the gas turbine usage should be
allowed as it was incurred to ensure security of supply and was done so
as a last resort before implementing load shedding
• OCGTs were used during peak and emergency periods throughout the
year. OCGT and IPP usage reduced load shedding by providing additional
capacity. The use of OCGTs must be considered in combination with all
other available options to manage the power system
• Reduced usage of the OCGTs would increase the incidents, duration and
severity of load shedding. The knock on effect of this would be worsening
plant performance and longer time periods to return to operation
• Variance between determination and actuals for FY 2019 illustrate the
need to use OCGTs to minimise impact of load shedding on SA economy
• The variance between NERSA’s decision and actuals for Eskom’s OCGTs
was ~R3.4 billion
13Eskom Regulatory Clearing Account (RCA) FY 2019 Coal Cost variances
Coal accounts for 74% of the Primary Energy
variance
• The Primary energy variance accounts for
Coal cost 12, 416 ~61% of the RCA balance. Of this coal
accounts for 74% of primary energy
OCGT 3,423 • A large portion of the variance is due to the
R11 billion lower decision from NERSA of
Other PE 1, 725 which coal was the most impacted.
• The significant use of OCGTs was used to
IPPs (275) alleviate a constrained system and avoid
load shedding.
International
Purchases
524 • OCGT IPPs where offset by the
Renewable IPPs.
Levy (288)
• Variance in other PE is mainly due to start
up fuel and oil due to additional start-ups
DMP 44 that occurred
• The other reflected here is due to a
Other (782)
mismatch between the NERSA revenue
decision table and the primary energy
Total 16,787 decision table in the reasons for decision
(R782 m)
15Eskom has applied the legislative framework
in arriving at the Coal cost variance
• The Energy Regulator will approve the coal benchmark price (i.e. average
R/ton) per contract type (Cost Plus, Fixed Price, Medium-Term and Short-
Term) and Alpha for each contract type in the final MYPD decision (MYPD
Methodology par 12.2.1).
• The R/ton coal price and R/ton/km transport cost (rail and road) shall be
escalated using the formula in the contracts. (MYPD Methodology 12.2.2)
• The coal benchmark price is determined by the Energy Regulator in order to
be used in comparison with the actual coal cost for the purpose of determining
pass-through costs.
• The coal benchmark price will be compared to Eskom’s actual cost of coal
burn (R/ton) using a Performance Based Regulation (PBR) formula. The PBR
formula is the maximum amount to be allowed for pass-through, calculated by
applying the following formula per contract type:
• PBR cost (Rand) = (Alpha x Actual Unit Cost of Coal Burn + (1 – Alpha) x
Coal burn Benchmark price) X Actual Coal Burn Volume.
16Due consideration needs to be given to the
Prudency criteria
(section 3.5 of RCA application)
Apart from the MYPD Methodology, when assessing coal costs the Guidelines for
Prudency Assessment are key in terms of the extract below:
Extracts from the Guidelines for Prudency Assessment:
8.3 In assessing prudency, it is also necessary to make a distinction between
forecast and committed costs, as explained below:
a) Forecast costs are costs that the utility has not yet paid, and which it still retains its
discretion as to whether the disbursement thereof will be made
b) Committed costs are costs that the utility has already spent or has entered into a
binding commitment to pay or is subject to other legal obligations that leave it with
no discretion as to whether to make the payment in the future. The disallowance
of committed costs is particularly problematic for a regulated utility because
the utility and its shareholders will have no choice but to bear the burden of
those costs themselves which in Eskom’s case shifts to the tax payer.
Page 17
17Lower base cost of coal in determination and impact of
mining PPI index resulted in major RCA variance
In Eskom’s view, NERSA did not consider principles in MYPD methodology and guideline for
Prudency assessment in relation to committed costs, committed contracts and escalation of coal
costs of committed contracts
NERSA’s assumptions in revenue decision Why a different approach should have been
adopted by NERSA
NERSA validated its approach of using a simple A theoretically calculated composite index applied
indexing of FY 2014 RCA R/t. The FY2014 R/t was from 2014 may not have been applicable
escalated using a mining index and coal transport
costs were escalated using CPI. Coal costs and escalations are determined by the
underlying cost drivers of the colliery and through
negotiated outcomes. Thus, the escalation
mechanisms of the various contracts require rigorous
analysis
Expectation of coal to increase/decrease by mining
PPI and transport of coal to move by CPI without
considering underlying cost drivers which are
generally stipulated within contracts (as required by
the methodology) could result in major variances.
Expectation for coal price to decrease in 2015 year. Eskom’s cost from underlying contracts did not
decrease mainly because of the already committed
contracts.
18Characteristics and basis of Mining PPI Index
reflects a selling price output rather than a cost
index - Coal and gas only weigh 25% of index
• The PPI is based on the mine gate price, i.e. first selling price from the mine.
• The mining PPI, as published by Stats SA, is a consolidated index, which is not representative of
Eskom’s coal costs and therefore cannot be directly used to evaluate the escalation.
• Other components of index, e.g. gold & PGM, are influenced by basket of cost drivers that is different
from that of coal.
• The index fluctuates based on the selling price of the commodity rather than the input or production
price of that specific commodity.
Stats SA PPI for Mining:
19NERSA’s decision for coal costs for FY 2019 period was
lower than its own decision and actual for FY 2018
R/t
650
600 • Revenue allowed for coal cost for
550 FY 2019 decreased sharply from
FY 2018 to FY 2019.
500
450 • On the coal side, this resulted in
400 the benchmark R/t for FY 2019
being almost on par with FY 2017
350 and falling below the benchmark
300 R/t for FY 2018.
250
• NERSA has not clarified why it
200 was considered reasonable that
150 the R/t cost for FY 2019 would
decrease compared to the
100 previous year, apart from stating
50 that a composite index was
applied to the FY 2014 RCA R/t.
0
FY2017 FY2018 FY2019 FY2020 FY2021 FY2022
20Decision to close Arnot Power Station also impacted
RCA variance
NERSA’s assumptions in revenue decision Why a different approach should have been
adopted by NERSA
All electricity generation related to Arnot Power Arnot replacement power would have been
Station was removed by NERSA from the production generated by a marginal cost power station with a
plan. coal cost probably higher than the weight average
cost determined by NERSA, as the production plan
Reduction in production at Arnot Power Station will is derived on a least cost basis.
be transferred to other cheaper coal fired stations
where coal procured at a lower average R/t (36% The practicality of change in generation mix and
lower than Eskom’s application); improvement of EAF must also be considered (as
per paragraph 12.1 of the methodology)
With regards to coal burn costs, NERSA disregarded However, the existing coal contracts were
the MYPD methodology requirement to consider considered in arriving at the revenue decision for FY
existing coal contracts when making the FY 2019 2020 in MYPD4- where the exact R/ton was
revenue decision. determined to be prudent
The fuel procurement costs were considered as The fuel procurement costs were not duplicated in
duplicated and therefore disallowed. the FY 2019 revenue decision and thus should not
have been disallowed
Eskom had provided all the information related to coal contracts to NERSA.
21Nersa disallowed 20% of Eskom’s costs while Eskom’s
actual costs were 8% higher than that applied for
+7.82% • NERSA disallowed almost 20% of the coal
burn cost for which Eskom applied.
• NERSA’s allowed coal cost (R/t) for FY19
-19.34% +33.67%
was lower than the FY18 projected R/t at
the time of application.
• Most of the coal in the application was
already contracted for.
• Even if Eskom removed all uncontracted
52 coal from its application, Eskom would
R bn 49
not have met the allowed cost.
39
• Assumptions in the application regarding
coal production and removal of burn from
Arnot Power Station did not materialise.
• Additional ST/MT coal was purchased to
bring stock days to acceptable levels
which was the main reason for the actual
Application Decision Actual costs being 8% higher than the
application.
22Eskom follows a defined contracting process for
coal as per Eskom’s procurement procedure
1 2 3 4 5 6
A need / Develop Competitive
Evaluation of
Enquiry Contract
requirement Commercial Tenders issued (RFP) Negotiations
tenders Award
is identified Strategy to the market
• The starting point for procurement is when a need for coal is identified, usually from the electricity
production plan.
• A mandate is obtained from the appropriate governance committees to issue either an RFI or an RFP to
the open market, giving respondents a duration within which to respond.
• Thereafter, responses are evaluated by the relevant teams and a shortlist compiled of potential suppliers
with whom negotiations will be held.
• Depending on the mandate, negotiations may be concluded and contracts signed.
• Closed enquiries to be issued to the market in cases of urgent or emergency enquiries.
Conditional upon National Treasury prior approval and is ratified by Eskom’s governance
committees including board.
The process is governed by Eskom’s procurement procedure 32-1034 which
incorporates but not limited to the principles of the PFMA, PPFA, National Treasury
Procurement Instructions, RSA Constitution, B-BBEE Act amongst others
23As part of an ongoing improvement process,
Eskom has identified levers to improve
efficiencies in the business
• Optimisation of coal stockholding to release working capital.
• Reducing the coal road haulage rate on the new transportation contracts
• Optimisation of coal prices in line with Long Term strategy
• Reinvestment of capital in Cost Plus mines
• Extension of currently favourable coal contracts where possible.
• TFR to provide own, build & operate rail solutions, so Eskom can focus on
core business
• Re-negotiation of Majuba rail transportation rates with Transnet Freight Rail
• Renegotiation of some of the coal contracts on the higher end of the price
spectrum.
24Conclusion
Conclusion on Eskom FY 2019 RCA application
• Eskom’s RCA application is based on MYPD Methodology and NERSA RCA FY 2014 reasons
for decision
• Eskom’s revenue is determined by NERSA through a revenue application process and then the
RCA process which this submission addresses. The RCA is meant to ensure that Eskom can
recover its full efficient costs as the actual realities have occurred differently than assumed
during the revenue decision
• Eskom’s RCA application is for R27 240m
• None of the financial ratios and free cash flow outcomes determined by NERSA has
materialised
• Eskom has not yet recovered revenues, determined by NERSA to be efficient and prudent,
incurred as far back as FY 2015, by FY 2020
• In addition, NERSA has decided that this trend would continue for revenues previously
determined to be efficient and prudently incurred during the FY 2017 to only be recovered in the
FY 2023. The methodology does not allow for the time value of money to be included
• In light of NERSA’s mandate to balance the impact on sustainability of Eskom with the impact of
consumers, Eskom proposes that this RCA balance for FY 2019 be recovered as soon as
possible
2627
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