Eskom price calculation is misfiring
Electricity price increases in SA have been significantly above inflation for the past decade. For the middle class this is a nuisance, but for low-income households and energyintensive industries, it is a much more serious problem.
The first hearing for Eskom’s revenue application for 2018-19 was held in Cape Town on October 30 with the National Energy Regulator of SA (Nersa). It dealt with the thorny issue of its request for a 19.9% standard tariff increase. Since this is just the average increase, it will translate to about 27.5% for municipalities.
Civil society, community members, local government and analysts provided comment for consideration. The Eskom document under discussion is 163 pages long, with some fairly technical components and complex mathematical formulas.
But this process is missing the point of what urgently needs to be done.
Nersa provides a multiyear price determination (MYPD) methodology, and the latest version is from October 2016. This methodology is the template for how Eskom goes about applying for tariff hikes and much of the content is its justification for numbers it has plugged into the formulas.
While part of the methodology deals with “reasonable costs” that are incurred in producing electricity, there is a section of adjustments before any of Eskom’s costs are even considered. It is in this section of the application that some critical issues arise.
For example, 9.4% of the hike is based on what is called “sales-volume rebasing”.
In 2013, an assumption was made regarding how much electricity Eskom would sell from 2013-17. This was part of the third version of the MYPD, or MYPD3.
As it turned out, Eskom had much lower sales volumes than expected over the MYPD3 period, but the methodology allows it to factor this shortfall into future electricity tariffs.
So the methodology allows for the future price of electricity to be increased because of an inaccurate sales prediction made five years ago.
When businesses fail to meet sales targets, the strategy should be to sell more units. How will increasing the price help, if there was evidently less than expected demand at the lower unit price?
However, the methodology allows for perverse logic to prevail. Electricity is a basic service, so it cannot just be examined through a business lens — and increasing a basic service cost at more than three times the rate of inflation, during tough times is clearly not in the national interest.
Linked to the sales volume is the broader “allowed revenue” component. This is essentially an income allowance granted to Eskom based on several factors including operations, maintenance, research, depreciation, taxes and primary energy costs.
Rather than functioning as a cap on the profit Eskom can make, it effectively allows the utility to adjust prices to achieve these income targets. It is also an incentive to inflate electricity demand projections as this will increase the allowed revenue.
This is a difficult situation for Eskom, as selling more power is tricky in a period of decreasing demand. While Eskom still provides the majority of electricity, there are now other options, and these alternatives are becoming more and more attractive as Eskom price hikes balloon.
Eskom once provided some of the cheapest electricity in the world and there was hardly an option (or need) to buy electricity elsewhere. Climate change was a fringe issue, centralised power generation was the norm, coal was king and Eskom was not on the verge of financial collapse.
It was also a smaller grid system with a lower national rate of electrification.
In 2017, the circumstances are very different, but Eskom is in many ways continuing as if it is operating in circumstances that prevailed two decades ago.
There is a global trend towards decentralised generators of electricity and reduced reliance on power provided by utilities. Around the world, renewable energy is taking off at an unprecedented rate, providing cleaner and cheaper electricity at small and large scale.
So the more the utility puts up prices, the stronger the push for people and businesses to adopt alternatives, leaving the utility with even lower revenue.
If this is combined with the widely quoted opinion that Eskom is “too big to fail”, SA is in a bit of a pickle.
The MYPD pricing methodology is not working. Each year Eskom comes knocking because it is looking to recover their “allowed revenue”.
There is a strong argument to change the methodology and develop a more suitable tariff system that does not encourage the overestimation of electricity demand while clawing back the difference later.
But this does not solve the fundamental issue that the Nersa hearings on the Eskom revenue application have once again highlighted: Eskom needs to change. A vertically integrated monopoly based on burning coal to produce power is no longer sustainable.
A good starting point would be for dedicated and focused state-supported resources to grapple with this challenge. It will not be easy because of the vested interests of the few, but these are outweighed by the needs of the many.
SA must urgently develop a plan for how to fairly transition to an equitable, low-carbon energy sector, and what role a reshaped Eskom can play. This is where Nersa, an independent regulator, can recognise that underlying the revenue application is a much bigger issue than the price hikes.