DATE: 21 August 2012 Determining the Regulatory Asset Base Anthony Felet – Regulatory Finance Specialist 1

Agenda 1.Understanding the RAB 2.Asset Valuation – different approaches 3.Practical challenges with MEA/DORC 4.Suggested approach for MYPD 3  Starting value  Rolled forward mechanism  Works in progress 2

Understanding the RAB The Regulatory Asset Base (RAB) comprises of the value of the property, plant and equipment used to provide the regulated services Typically regulators apply the following principles for RAB:  Includes only assets necessary to provide regulated services  Based on the residual (depreciated) value of fixed assets  May include allowance for net working capital  Any capital contributions (external funding, subsidies) from customers or government/government agencies are excluded For capital intensive regulated entities, the RAB multiplied by the cost of capital will comprise a significant portion of the revenue allowance  Accordingly, a high level of scrutiny of its value is required at each MYPD 3

The RAB in tariff determination 4 Opex Capital costs Revenue Requirement Regulatory Asset Base (RAB) Rate of Return (WACC) Revenue Requirements = Opex + Depreciation + Rate of Return) Operation and Maintenance Manpower Primary energy Return on Assets Depreciation

Components of the RAB Regulatory Asset Base Existing Assets New Investments RAB roll forward / revenue re-setting Depreciation Capital Contribution Working Capital Construction Works in Progress RAB Closing Value = RAB Opening Value + Investments – Depreciation – Asset Disposal +/- Change of Working Capital +/-Change of Capital Contribution 5

Asset valuation approaches  Cost based approaches are appropriate for regulatory tariff purposes, however, the lower bound should reflect deprival value  Wide range of valuations are possible! Asset Valuation Methods Cost based Value based IHC DRC HC DORC/MEA DCF value Deprival value Market value 6

Practical challenges with RC/DORC/MEA Requires a degree of subjective judgement:  The appropriate level of capacity  The technology to be assumed for replacement  Criteria to be used to optimise the assets  The extent to which the assets are aggregated Requires considerable input in terms of manpower and financial costs - require expert advice e.g. from engineers and valuation experts Given the above:  High likelihood that MEA/DORC values will vary significantly from one valuation firm to the next, one control period to the next  Difficult in assessing whether redundant assets have been excluded from the RAB  Information asymmetry that regulators normally operate under makes regular and robust MEA valuation unviable and unrealistic 7

Suggested approach for MYPD 3 What is the appropriate starting point for MYPD 3?  Recorded values in asset register uplifted to movements to inflation  An independent DORC valuation, excluding redundant assets  Present market valuation RAB should be rolled forward from one MYPD period to the next according to:  Actual capex and depreciation  Movements in the US electricity capital cost index (adjusted for $US/ZAR exchange rate movements)  Working capital movements  Works in progress excluding capitalised interest 8