South Africa's Electricity Prices At the Tipping Point We cannot afford to get it wrong! Presenting to the DTI PPC 2 November 2012

AGENDA Primary Sector leads Job & Economic Growth MYPD3 Prices will Slash Growth and Jobs Industrial, Commercial and Domestic Sectors Impacted The Solution Conclusion

The delicate balance in transformation! Job retention/creation in primary, secondary and tertiary sectors ExplorationMiningConcentrating Smelting/ Extraction Metal Refining Producing Products for Manufacturing Value Chain Producing Products for Retail Marketing & Sales China, India, Russia etc are progressively taking jobs from South Africa by importing South African ore in raw form and investing in these higher value adding steps! South Africa then has to import the value add good from China. South Africa is selling its birthrights! New Job Creation SA cannot leapfrog the value nodes without a surplus of skilled labour! Plus Tertiary Value Chain Jobs Primary Value Chain Jobs Plus Secondary Value Chain Jobs

Interrupted! South Africa’s Economic Transformation Source: GAPMINDER

Growth driven by credit fuelled Non-tradable Sectors Tradable export sectors have languished….. Tradable sectors Non-tradable sectors Low Job Creating High Job Creating

Non-tradable sector – Sucking-in imports and creating external imbalances, such as running large current account deficits…..

South Africa’s Challenge is Formidable The worst of two worlds Source: EIA Magnitude of Economy Transformation Scale of Energy Transformation

AGENDA We are at a Tipping Point Primary Sector to lead Job & Economic Growth MYPD3 Prices will Slash Growth and Jobs Industrial, Commercial and Domestic Sectors Impacted The Solution Conclusion

Losing the Balance Must be Tough on Costs, Subsidies & Sales… Soft on Prices Price Sales Costs & Subsidies Costs & Subsidies Too Low! Rising Too Fast & High! = Unaffordable Too High! Dictating Industrial Policy?

Electricity Prices are Making South Africa Non Competitive MYPD3 IRP 2010 Future Economy? Sources: IRP2010, Eskom, Frost & Sullivan, EIUG Eskom's MYPD3 Application EIUG Modelling Best Case Efficiency Price Path Worst Case Efficiency Price Path 130 Rc/kWh (by 2022) Eskom's MYPD3 Application (Scenario 1)

The Tipping Point for RSA Source: Eskom and The U.S. Energy Information Administration (EIA) Mining & Industrial Residential Industrial Commercial Residential Commercial

Threat to the Future of Silicon Smelting in South Africa

Threat to the Future of Steel Production in South Africa Source: EIUG Steel Industry Data 2022 South Africa MYPD3 Scenario 1

Threat to the Future of FeCr Smelting in South Africa MYPD 3 US mills per kWh Source: CRU for comparison up to 2011, SA escalations going forward shown in real 2011 terms with CPI of 5% assumed

Commodity World Rank in reserves RSA % share of known total global reserves PGM's188% Manganese180% Chromium172% Gold114% World Chrome Ore resources by region Breakdown of market share for FeCr production SA Ferrochrome market share is being displaced to China Flight of South African Industry!

Open Closed Semi- closed Notwithstanding that South Africa is the World leader in ferrochrome manufacturing technology—almost 100% locally-sourced China India Kazakhstan South Africa Furnace type (Open vs Closed) Furnace type (Open vs Closed) China India Kazakhstan South Africa Furnace size (MVA) Furnace size (MVA) China 4.08 India Kazakhstan South Africa Power consumption (MWh/t) Power consumption (MWh/t)

SA Mining and Industry being Priced out of Jobs Cost of doing business in SA has grown at an alarming rate SA FeCr industry cost growth Source: CRU, Xstrata Analysis, Company annual reports CAGR 11.1% CAGR 8.4%

Serious Impact from Electricity Price increases Sample of 13 Large South African Industrial Companies Source: Genesis Analytics

Mining Alone – An Essential Core Of SA Economy Creates 1.3 million jobs ( direct & indirect). Accounts for about 19% of GDP (9% direct, 10% indirect & induced). Critical earner of foreign exchange >50%. Accounts for 20% of investment (12% direct). Attracts significant foreign savings (R1.4 trillion/ 29% of value of JSE). 17.7% of corporate tax receipts, 2011 R26bn & R5.5 billion in royalties. R437 billion in expenditures, +/- R389 billion spent locally. R89 billion spent in wages and salaries 50% of volume of Transnet’s rail and ports 94% of electricity generation via coal power plants 15% of electricity demand About 37% of country’s of liquid fuels via coal R4 billion spent on skills development R1.4 billion spent on community investment

AGENDA We are at a Tipping Point Primary Sector to lead Job & Economic Growth MYPD3 Prices will Slash Growth and Jobs Commercial and Domestic Sectors also Impacted Recommendations Conclusion

Household electricity prices on PPP basis using the Big Mac Index – 2009 to RSA 2012 RSA 2009

AGENDA We are at a Tipping Point Primary Sector to lead Job & Economic Growth MYPD3 Prices will Slash Growth and Jobs Industrial, Commercial and Domestic Sectors Impacted The Solution Conclusion

Recommendations A. Cut Inefficient Costs A. Improve ESKOM Operating Efficiencies B. Improve ESKOM Capital Cost Efficiencies C. Accelerate IPP’s D. Remove Non-Electrical Subsidies E. Improve Consumption Efficiencies B. Increase Electricity Sales C. Reduce Excessive Safety Margins if Funding Allowances

Eskom’s Operating Efficiencies Low! A Universal Fact: Unplanned Work is > 50% more expensive than planned work A Universal Fact: Unplanned Work is > 50% more expensive than planned work MetricEskom's StandardActual Today Availability Factor >90%<84% Unplanned Work <3%>14% IPP’s and Competition will Ensure Efficiencies Return

Eskom’s Building Efficiencies Low IPP’s < 75 c/kWh Eskom 95 c/kWh Source: Black & Veatch

Inefficiency in Current Domestic Demand Reducing Increasing

Eskom Revenue is Guaranteed Prices Soar if Energy Sales are Low or Fall = Revenue Requirement Cost of Sales O&M Overhead Costs Asset Depreciation + ++ Prudent expenditure x Other Return & Depreciation Return & Depreciation ++ % Return on Assets (ROA) Asset Base Levies Taxes Claw-back Primary Energy Imports IPP Purchases Staff Maintenance Revalued Assets WUC Forecast Energy Sales Forecast Energy Sales = RevenuePrice Reduce Prices by Increasing Sales Reduce Prices by Increasing Sales

Reduce Excessive Safety Margins in Funding Source: Frost & Sullivan ParameterCurrentJustifiable Return on Assets Real 8,16%4 to 6% Asset ValuationHistoric to ReplacementSlower transition FinancingTariffTariff and Project Financing Eskom Debt Equity0.2 to to 0.8 Price (10% ROA) Price (4% ROA) d:e (4% ROA) d:e (10% ROA) Justifiable d:e Justifiable Price

Subsidies are Killing Jobs By 2017/18 >24% of the Industrial Tariff is Subsidy Contribution By 2017/18 It could be >30% Excluding Municipal Subsidies Added

On Top of this Municipalities are Loading the variable (energy) charges The true reflection of what is actually being charged is however often understated due to non-standard charges. NERSA regulates categories consisting of an energy charge, a demand charge and a fixed charge. Surcharges and levies fall outside the mandate of NERSA and Nersa is thus not in a position to regulate additional levies or surcharges that municipalities impose. Municipalities appear to be able to apply such non-standard charges at their discretion with little or no regulation. Sources: BDO, select municipalities

And on Top of this Municipalities are also Loading the fixed (Demand) charges A recent BDO analysis of the purchase costs from both Eskom and the municipalities making up the study found that there is a heavy bias in the costs for the demand charge component of electricity. The tariffs bear the imprint of historical investment decisions at the point of their inception. The question must be asked why such inflated charges are still being charged against equipment that should be fully depreciated. Sources: BDO, select municipalities

AGENDA We are at a Tipping Point Primary Sector to lead Job & Economic Growth MYPD3 Prices will Slash Growth and Jobs Industrial, Commercial and Domestic Sectors Impacted The Solution Conclusion

Conclusion Tough on Costs, Subsidies & Sales Soft on Prices A.Cut Inefficient Costs – Do Not Simply Increase Prices B.Refine funding Model – Regulatory Methodology needs to be reassessed C.Remove Excessive Funding Safety Margins D.Increase Sales – This reduces Prices E.We do not need Subsidies – Just Remove the non Cost Reflective charges

QUESTIONS 34