Discounts to some benefits all, says Eskom

National energy regulator Nersa on August 24 approved an application from Eskom to grant the distressed Silicon Smelters plants in Polokwane and eMalahleni discounted tariffs for a limited period of two years.

Last week it dealt with an application from the same Eskom to increase the average retail tariff by 20%, which Nersa is expected to publish for comment soon. Nersa is also expected to process two other shelved increase applications, after the earlier court ruling that set aside an order that they were submitted following a flawed process, was set-aside on appeal.

In an earlier version of this 20% application that Moneyweb has seen, Eskom argues that even if Nersa grants the full 20% increase, its tariffs would not yet be cost reflective.

Still, it argues in the Silicon Smelters matter that the envisaged special pricing agreement would not entail a discount below cost.

Moneyweb asked Eskom to reconcile these two positions.

Eskom corporate specialist Charles Mahony, told Moneyweb that the contention that average retail tariffs were not yet cost reflective, was based on section 15(1) of the Electricity Regulation Act (ERA) which provides that the revenue Nersa allows Eskom to recover through approved tariffs “must enable an efficient licensee to recover full cost of its licensed activities, including a reasonable margin or return”.

Eskom’s 20% tariff application is calculated on a return on its approved regulatory asset base of 2%, which is way below the cost of capital Nersa approved of 7.65%. Eskom states that its current cost of capital is in fact marginally higher than the 7.65%.

On a macro level Eskom therefore argues even if the tariff increase is granted in full, the increased tariffs would not yet be cost reflective.

Mahony says cost reflectivity at a tariff level is something else.

Each and every customer does not pay the tariff that reflects the cost of supplying him or her. If that were the case, small residential communities in rural areas far from power stations would never be able to afford electricity due to high transmission and distribution costs.

In fact, large users subsidise smaller users through three different levies charged on the so-called Megaflex tariffs:

• An electrification and rural subsidy for low-use rural customers paid by all large users and municipalities;
• Inclining Block Tariff affordability subsidy for the first block, which is residential customers using small amounts of electricity paid by large Eskom users only (not the municipalities);
• An urban low voltage subsidy paid by all high voltage large users and municipalities.

The first and second levy together amounts to a subsidy of about 10c/kWh paid by large users to the benefit of other Eskom customers, Mahony says.

Against this backdrop, Eskom approached the case of Silicon Smelters with the aim of assisting the distressed manufacturer while improving the utilisation of its own assets to the benefit of all customers, Mahony says.

The fact is that Eskom has a surplus of generation capacity. It also has to maintain its infrastructure, whether Silicon Smelters use electricity or not. If it could revive and maintain the demand from this client, it could at least partly cover fixed costs. Alternatively, the entire fixed cost previously covered by Silicon Smelters before closure would have to be recovered from other clients, Mahony says.

The profile of Silicon Smelters’ electricity use, which is constant day and night, further makes it a valuable client to Eskom as it buys electricity during the night when other customers are sleeping and Eskom’s surplus is even bigger than during the day.

Eskom has designed a tailor-made minimum price for each of the Silicon Smelters plants. The minimum price in each case is well in excess of what it refers to as the short-run marginal cost, which is based on the extra cost required to run four of Eskom’s most costly coal-fired power stations plus a safety margin.

In other words, both the generation capacity and the infrastructure needed to deliver the energy are there anyway. What more would it cost to supply Silicon Smelters? To be on the safe side, Eskom calculated what it would cost if it had to run the most costly power stations in its fleet for that purpose, added a safe margin and arrived at a tariff.

The tariff could fluctuate depending on several variables, the main ones being volume of electricity used and time of use. Eskom has built in interruptibility, which means that in a constraint situation Eskom is allowed to switch off or restrict the supply to Silicon Smelters to protect the electricity system or avoid interruptions to other clients.

That kind of flexibility can be very valuable to a system operator, as Eskom has seen when load shedding was a reality.

Notwithstanding these variables, Silicon Smelters would always pay at least the minimum price, recovering the short-run marginal cost plus a contribution to its fixed costs.

At the end of each month reconciliation is done and the company gets a rebate according to the special pricing arrangement.

Mahony says it is not sustainable for Eskom to grant tariffs on this basis in the long run, but for a short period it benefits all customers. Conditions might change at the end of the two-year period and the client could return to normal tariffs.

He says Eskom has about ten other applications from large users for tariff discounts. The utility has rejected a few and has approached others proactively.

Not all of these businesses are distressed and it is not a requirement to be, he says, provided that non-distressed users must have under-utilised equipment that could be utilised at the right price, to the eventual benefit of all consumers.

The general framework to deal with the applications is currently being finalised by the Department of Energy and National Treasury and should be available soon, he says.

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