NERSA presentation at the PPC meeting held on 24 May 2006

Issues to be covered The Eskom price increase approach (2) Issues to be covered The Eskom price increase approach History The pricing compact The rate of return The multi-year price determination The Eskom structural adjustments Process The municipal tariff application process History and challenges The approval process New developments

(3) The pricing compact Eskom entered into a compact to decrease the real price of electricity by 20 % by 2000. Compact achieved in 1999. Need for new regulatory pricing regime.

New regulatory approach (4) New regulatory approach We approved a rate of return method for the regulation of Eskom in 2002 Definition: Cost to supply plus a fair rate of return on the asset base The main components of this approach are The appropriate rate of return as determined by the regulator (percentage) The costs/(expenses) that the regulator allows given Eskom’s business and its challenges/requirements The assets upon which the rate of return will be applied – this includes both existing assets and assets due to Eskom’s required investment programme for new capacity requirements This approach attempts to determine the revenues that are adequate to allow Eskom to continue supplying electricity to its end-use customers but also that electricity prices are not overly expensive to be unaffordable to such customers At the beginning the method applied to Eskom as a single entity without separation/(ring-fencing) Applied to ring-fenced businesses in 2004 The methodology was used for the price determination for 2003, 2004 and 2005

(5) The MYPD of Eskom In 2005 the NER Board (now NERSA) approved a move towards a multi-year price determination of Eskom arguing that this would give customers some certainty regarding electricity prices; A new mechanism was then developed to allow for the determination of prices over a longer period (3 years was then selected) The mechanism is broadly based on the rate of return method as discussed above but giving careful consideration on incentives for Eskom to improve on efficiencies The development of the mechanism involved a thorough stakeholder consultation process through a publication of various consultation papers and ultimately a public hearings held on 20 January 2006 The final determination of Eskom’s three year prices was made on 14 February 2006 This was communicated to Eskom on 15 February 2006 and to other stakeholders on 16 February 2006 The approved prices for the three years are 5.1 % increase for 2006/7; 5.9 % increase for 2007/8; and 6.2 % increase for 2008/9 Included in these prices is funds to be used for the restructuring of the distribution industry given to the EDI Holding (Pty) Ltd

Objectives within the mechanism (6) Objectives within the mechanism The mechanism should: Limit the risk of excess or inadequate returns; Give incentives for new investments especially in generation; Give reasonable tariff stability and smoothed changes over time; Be consistent with socio-economic policies; Give economic price signals especially at the margin; Give a good balance of commercial risk; Contain efficiency incentives; Be reasonably simple to understand and apply; Have no perverse incentives on performance; Have systematic basis for revenue/tariff setting – without replacing need for judgement; Ensure consistency between controls; and Ensure legal compliance.

Key issues within the determination (7) Key issues within the determination Appropriate asset valuation method for assets Real rate of return on indexed assets vs nominal rate on historic asset value; Determination re-opener: 3 % at regulator choice; 10 % mandatory; Ensure Eskom’s ability to borrow (domestic or international capital markets); Ensure no compromise quality and reliability of supply and that Eskom’s cash flow position does not warrant volatile price increases as with case in the 70’s and 80’s where increases were in the range of 33 % p.a.

Eskom’s retail tariff structural adjustments (8) Eskom’s retail tariff structural adjustments While the prices determination refers to the determination of revenues that Eskom will be allowed to earn in a given period, the retail structural adjustments are for ways in which these revenues will be collected from the different customer classes based on tariffs; Retail tariff structural adjustments should therefore, not earn any additional revenues for Eskom except that allowed through the price determination; The retail structural adjustment are based on The Energy white Paper; National policies; and Regulatory objectives and customer needs.

Eskom Retail Tariff Structural Adjustments (9) Eskom Retail Tariff Structural Adjustments Price Determination (MYPD) vs. Tariffs Eskom’s tariffs Tariff A Tariff B Tariff C Eskom’s revenue requirement Inflation Volume Eskom’s revenue requirement Sum of all tariffs components Tariff A Tariff B Tariff C Network R/kVA Energy c/kWh Admin R/cust Tariff components

Eskom retail structural adjustments (10) Eskom retail structural adjustments (process) Regulatory Process Stakeholder Interaction NERSA Eskom Customer Groups (e.g. EIUG, Agriculture) Other Stakeholders (e.g. SALGA; National Treasury, DPE) All Customers

Eskom retail tariff structural adjustments (11) Eskom retail tariff structural adjustments (Process) Regulatory Process (contd) Publication of proposals Workshops NERSA independent analysis (customer impact, economic impact, industry & govt. objectives) Revision of proposals if necessary NERSA public hearings Final approval Implementation (timing e.g. other customers 1 April; Municipalities 1 July i.t.o. MFMA

Eskom retail tariff structural adjustments (12) Eskom retail tariff structural adjustments (Process) Regulatory Process Annual process starts early in the year Time to assess impact of proposed changes, adequate stakeholder interaction Therefore limited change implemented 2007/8 (?) More far reaching changes 2008/9 (?) Ongoing process due to changing industry No major adjustments for 2006/7 and not much expected for 2007/8

Municipal tariff approval process (13) Municipal tariff approval process A guideline increase is developed based on the Eskom price increase – Guideline for 2006/7 is 5.9 % The guideline is then communicated to municipalities who then apply to the regulator The regulator compares the prices applied for the benchmarks and guideline increase and where these are compliant, they are approved Due to the MFMA municipalities are require to implement their approved increases on 1 July 2006 – no further increases will be allowed during the financial year

Municipal tariff approval process (14) Municipal tariff approval process In 1995 – Total number of munic approx. 400 Approx. 2000 tariffs in the industry Municipalities buy from Eskom and sell to end-use customers – discrimination between Eskom and munic customers The municipal tariff approvals are based on benchmarks developed in 1995 and adjusted 2003 and a guideline increase that is issued annually by the regulator In 1995 the regulator also approved an Interim National Distribution Tariff Guideline to assist municipalities in the development of tariff structures The document was then reviewed in 2003 and renamed National Retail Tariff Guideline

Thank you