Eskom On The Verge of Debt Trap, CEO Warns

Eskom Revenue Application
Multi-Year Price Determination (MYPD 4)

FY2019/20 - 2021/22
September 2018
Content
│Eskom Revenue Application│
Content
Preface ....................................................................................................................................................... 7
Executive Summary ................................................................................................................................ 10
1.1 Key elements of allowed revenue for the 2019/20 - 2021/22 financial year ............................ 14
1.2 Recovery of efficient costs ......................................................................................................... 15
1.3 Earning a reasonable return on assets ...................................................................................... 18
1.4 Revenue recovery ........................................................................................................................ 18
1.5 Electricity price impact in 2019/20 - 2021/22 ............................................................................. 19
2 Basis of Application ..................................................................................................................... 20
2.1 Legislative and regulatory framework ....................................................................................... 20
2.1.1 Electricity Regulation Act (Act No. 4 of 2006) ...................................................................... 20
2.1.2 Electricity Pricing Policy ....................................................................................................... 20
2.1.3 Government Support Framework Agreement ...................................................................... 20
2.1.4 Municipal Finance Management Act (Act 56 OF 2003) ....................................................... 21
2.1.5 Multi-Year Price Determination (MYPD) Methodology ........................................................ 21
2.1.6 Focus is the revenue application for the 2019/20 - 2021/22 financial years ....................... 22
2.1.7 Guideline on Minimum Information Requirements for Tariff Applications (MIRTA) ............. 23
2.1.8 Eskom retail tariff and structural adjustment (ERTSA) methodology .................................. 23
3 Context of MYPD 4 Application .................................................................................................. 24
3.1 Key assumptions to address possible uncertainty during MYPD 4 period ........................... 24
3.2 Eskom Governance challenges being addressed .................................................................... 24
3.3 Eskom Business Model ............................................................................................................... 25
3.3.1 Eskom responses to business model challenges ................................................................ 26
4 Allowable Revenue....................................................................................................................... 28
4.1 Allowed Revenue formula ........................................................................................................... 28
4.2 Allowed revenue if MYPD Methodology is applied ................................................................... 28
4.3 Proposed MYPD 4 Allowed revenue application ...................................................................... 29
4.4 Revenue recovery ........................................................................................................................ 30
4.5 Electricity price impact during application period ................................................................... 30
4.6 Comparison to assumptions in draft IRP .................................................................................. 30
4.7 While tariff increases debt continues to increase .................................................................... 31
5 Indicative Standard Tariff Increase ............................................................................................ 33
5.1 Application of the ERTSA methodology .................................................................................... 33
5.2 Indicative increases by Standard tariff categories ................................................................... 34
5.2.1 1 July Municipal (Local authority) tariff increase .................................................................. 34
5.2.2 Eskom direct customers (Non-local authority tariff) increases ............................................ 34
5.2.3 Affordability subsidy charge increase .................................................................................. 34
5.3 Environmental levy recovery ...................................................................................................... 34
Eskom Holdings MYPD4 Revenue Application FY2019/20 - 2021/22│ Page 2 of 115

Content
5.4 Average tariff category increases .............................................................................................. 35

5.5 Protection of poor households ................................................................................................... 35
5.6 Tariff structural changes during the MYPD4 control period.................................................... 37
6 Sales Volumes .............................................................................................................................. 38
6.1 Introduction to Sales volumes .................................................................................................... 38
6.2 Robust process to project sales volumes ................................................................................. 38
6.3 Projected sales volume ............................................................................................................... 39
6.4 Review of projected sales volumes............................................................................................ 40
7 Energy Wheel ................................................................................................................................ 41
8 Production Plan ............................................................................................................................ 45
8.1 Background to the production plan ........................................................................................... 45
8.2 Production Planning Process ..................................................................................................... 45
8.3 Production Plan outcomes .......................................................................................................... 46
9 Energy Losses .............................................................................................................................. 47
10 Weighted Average Cost of Capital ............................................................................................. 48
11 Regulated Asset Base, Depreciation and ROA ......................................................................... 50
11.1 Assets (including WUC) comprise the following components: ........................................... 52
11.2 Assets as per the March 2016 asset valuation ...................................................................... 52
11.3 Work under construction (WUC) ............................................................................................. 54
11.4 Depreciation .............................................................................................................................. 55
11.5 Assets excluded from RAB ..................................................................................................... 56
11.6 Return on assets ....................................................................................................................... 56
12 Capital Expenditure...................................................................................................................... 59
13 Primary Energy ............................................................................................................................. 64
13.1 Overall summary of primary energy ....................................................................................... 64
13.2 Trends in primary energy costs .............................................................................................. 64
13.3 Revenue for coal costs ............................................................................................................ 65
13.3.1 Summary of coal burn costs for MYPD 4 period.................................................................. 68
13.4 Independent Power Producers (IPPs) .................................................................................... 68
13.5 Water costs ............................................................................................................................... 70
13.6 Open Cycle gas Turbine (OCGT) Fuel .................................................................................... 70
13.7 Demand Response ................................................................................................................... 70
13.8 Environmental levy ................................................................................................................... 71
13.8.1 Environmental levy payment ................................................................................................ 71
14 Operating Cost ............................................................................................................................. 72
14.1 Overall summary of operating costs ...................................................................................... 72
14.2 Employee Benefits.................................................................................................................... 73

Content
14.2.1 Staff complement ................................................................................................................. 73

14.2.2 Employee benefits increases ............................................................................................... 74
14.3 Operating and Maintenance costs .......................................................................................... 75
14.3.1 Generation maintenance...................................................................................................... 75
14.3.2 Transmission ........................................................................................................................ 76
14.3.3 Distribution ........................................................................................................................... 76
14.4 Other Operating Expenses ...................................................................................................... 77
14.5 Research, Testing and Demonstration ................................................................................... 78
15 Economic Landscape Changes .................................................................................................. 80
15.1 World Bank Report ................................................................................................................... 80
15.1.1 Breakdown of Hidden costs ................................................................................................. 83
15.1.2 Comparisons, benchmarking and efficiency of Operating and Maintenance cost............... 84
15.1.3 Transmission and Distribution: ............................................................................................ 84
15.1.4 Generation: .......................................................................................................................... 86
15.2 Economic Impact Study ........................................................................................................... 86
15.3 Economic Landscape Changes .............................................................................................. 86
15.3.1 Overview of historical trend in electricity consumption in South Africa ............................... 86
15.3.2 Trend in electricity prices ..................................................................................................... 88
15.3.3 Requirements of an efficient electricity pricing regime ........................................................ 88
15.4 Macroeconomic impacts of alternative scenarios ................................................................ 89
15.4.1 Aim of the study ................................................................................................................... 89
15.4.2 Key scenario assumptions, and scenarios modelled ........................................................... 89
15.4.3 Interpreting results of hypothetical scenarios – particularly post-downgrade ...................... 91
15.4.4 Approach .............................................................................................................................. 91
15.4.5 Key findings and results ....................................................................................................... 92
15.5 Concluding remarks on economic impacts ........................................................................... 96
16 National Treasury and SALGA responses ................................................................................. 99
16.1 Summary of key responses provided to comments by National Treasury ........................ 99
16.1.1 Period of the MYPD submission .......................................................................................... 99
16.1.2 Economy-wide impacts of the proposed tariff ...................................................................... 99
16.1.3 Sales volume assumptions ................................................................................................ 103
16.1.4 Municipal Debt ................................................................................................................... 105
16.1.5 Regulatory Clearing Account ............................................................................................. 105
16.1.6 Primary energy ................................................................................................................... 106
16.1.7 Operating expenditure ....................................................................................................... 107
16.1.8 Regulatory asset base and return on assets ..................................................................... 107
16.1.9 Proposed tariff increases ................................................................................................... 108
16.2 Summary of SALGA responses related to the MYPD 4 Revenue Application ................. 108
16.2.1 Impact on economy and affordability ................................................................................. 108
16.2.2 Customer –centricity by lower increases in tariffs ............................................................. 108
16.2.3 Further cost containment is required ................................................................................. 108
16.2.4 Depreciation and construction of assets ............................................................................ 109
16.2.5 Depletion of coal reserves ................................................................................................. 109
16.2.6 Changes to energy mix ...................................................................................................... 109
16.2.7 Fraud and corruption .......................................................................................................... 109
16.2.8 Rationalisation of Municipal Tariffs .................................................................................... 110

Content
17 Revenue requirements for licensees ....................................................................................... 111

17.1 Generation allowable revenue ............................................................................................... 111
17.2 Distribution allowable revenue ............................................................................................. 111
17.3 Transmission allowable revenue .......................................................................................... 112
18 Conclusion .................................................................................................................................. 113
List of Tables
Table 1: Total Allowable Revenue for the MYPD 4 Period ................................................................. 11
Table 2: Eskom Debt Commitments ................................................................................................... 12
Table 3: Revenue Recovery................................................................................................................ 19
Table 4: Standard tariff price increase ................................................................................................ 19
Table 5: Proposed Allowable Revenue Application ............................................................................ 29
Table 6: Recovery of Revenue ........................................................................................................... 30
Table 7: Standard tariff average price increase .................................................................................. 30
Table 8: Standard tariff increases ....................................................................................................... 35
Table 9: Projected sales forecast ........................................................................................................ 40
Table 10: Energy production per plant mix (GWh) ............................................................................. 46
Table 11 : Cost of Capital.................................................................................................................... 49
Table 12: Regulatory Asset Base (RAB) summary ............................................................................. 52
Table 13: Extract from Consultant 2016 Asset Valuation Report ....................................................... 53
Table 14: FY2016 RAB values as assumed for purposes of MYPD3 Revenue Decision .................. 54
Table 15: Depreciation ........................................................................................................................ 55
Table 16: Assets funded via upfront contributions and DOE .............................................................. 56
Table 17: Return on Assets................................................................................................................. 57
Table 18 : Capital Expenditure ............................................................................................................ 60
Table 19: Detailed Primary Energy cost ............................................................................................. 65
Table 20 : Detailed Operating costs .................................................................................................... 72
Table 21: Quasi-fiscal deficits of Utilities under current performance in country reference years ...... 83
Table 22: Power lines .......................................................................................................................... 85
Table 23 : Generation Allowable Revenue ....................................................................................... 111
Table 24 : Distribution Allowable Revenue ....................................................................................... 112
Table 25 : Transmission Allowable Revenue .................................................................................... 112

Content
List of Figures
Figure 1: Key contributors to increase in Allowed Revenue ............................................................... 13
Figure 2: Contributors to Revenue Requirement ................................................................................ 15
Figure 3: Break down of Primary Energy costs................................................................................... 16
Figure 4: Operating costs .................................................................................................................... 17
Figure 5: Extract from Integrated Resource Plan ............................................................................... 31
Figure 6: Price levels and increase in debt ......................................................................................... 32
Figure 7: Current cross-subsidies in Eskom tariffs 2017/18 ............................................................... 36
Figure 8: Sales Forecasting Process .................................................................................................. 39
Figure 9: The Energy Wheel for the Application year 2019/20 ........................................................... 42
Figure 10: The Energy Wheel for the Application 2020/21 ................................................................. 43
Figure 11: The Energy Wheel for the Application 2021/22 ................................................................. 44
Figure 12: Overall Production Planning process................................................................................. 46
Figure 13: Process for valuation of existing assets ............................................................................ 51
Figure 14: Coal procured categorised by contract type (%) ............................................................... 66
Figure 15: Annual coal expenditure per supply source ....................................................................... 66
Figure 16: Key cahllenges in Eskom’s coal procurement environment .............................................. 67
Figure 17: Coal price comparisons ..................................................................................................... 67
Figure 18: Summary of REIPP costs over life of contracts ................................................................. 69
Figure 19: Average energy price for REIPP contracts (2018 ZAR) over BId Windows ...................... 69
Figure 20: Operating costs .................................................................................................................. 73
Figure 21: Projected of number of employees over the MYPD 4 period ............................................ 74
Figure 22: Comparison of Electric Supply Costs with cash collection in 2014 ................................... 82
Figure 23: Breakdown of hidden cost ................................................................................................. 84
Figure 24: Summary of scenarios modelled ....................................................................................... 91
Figure 25: Impact on trend in real GDP and employment growth....................................................... 92
Figure 26: Impact on government Debt-to-GDP ratio ......................................................................... 93

Preface
Preface
This Multi-Year Price Determination (MYPD) 4 revenue application is for the period 2019/20
to 2021/22 financial years. This revenue application has been prepared in accordance with
the MYPD methodology as published by NERSA during October 2016. The NERSA
revenue and tariff decisions will be implemented from 1 April 2019 for non-municipal
customers and from 1 July 2019 for municipal customers. The previous revenue application
was for a single year revenue application and was implemented for the one year period
from 1 April 2018 to 31 March 2019 for non-municipal customers; and 1 July 2018 to 30
June 2019 for municipal customers.
The MYPD methodology addresses two broad aspects, namely, the MYPD allowed
revenue application and the adjustment of the allowed revenue through the regulatory
clearing account (RCA) process. The focus of this application is the MYPD revenue
application for the 2019/20 to 2021/22 financial years. Once NERSA has determined the
allowed revenue in terms of the MYPD methodology, the tariffs and price adjustments are
determined by NERSA on an annual basis for the three year period. These tariffs and price
adjustments are determined in terms of the Eskom retail tariff and structural adjustment
(ERTSA) methodology, as published by NERSA during March 2016.
This revenue application does not include any RCA applications. The RCA applications for
the 2014/15, 2015/16 and 2016/17 financial years (2nd, 3rd and 4th years of the MYPD 3
period) were submitted to NERSA during May 2016, July 2016 and July 2017 respectively.
NERSA has processed these three RCA applications. The public were afforded an
opportunity to provide written comments and NERSA has undertaken national public
hearings on the three RCA applications. The RCA balance decisions for the three years
were made on 14 June 2018.
A total RCA balance decision of R32.69 billion was made, as follows:

 RCA balance of R12.577 billion for the 2014/15 financial year;
 RCA balance of R12.058 billion for the 2015/16 financial year; and
 RCA balance of R8.055 billion for the 2016/17 financial year.
The RCA balance of R32.69 billion will be recoverable from the standard tariff customers,
local Special Pricing Agreements (SPAs) and international customers. The reasons for
decision for the RCA balance decisions are yet to be published at the time of this MYPD 4
submission.

Preface
NERSA has communicated that an implementation plan for the RCA balance of year 2
(2014/15), year 3 (2015/16) and year 4 (2016/17) of the MYPD3 will be developed for
approval by the Energy Regulator by 30 September 2018. Eskom understands the RCA
balances are likely to be implemented in a phased manner with effect from 1 April 2019.
The RCA decision to be made by NERSA by 30 September 2018 coincides with the
implementation of the MYPD 4 revenue decision. The RCA application for the 2017/18
financial year (5th year of the MYPD 3 period) will be submitted during September 2018.
This brings to an end the RCA applications for the MYPD 3 period. All the RCA applications
related to the MYPD 3 period were in accordance with the MYPD methodology published
by NERSA during December 2012. In addition, the RCA application for the 2018/19 year
will be made after the publishing of the annual financial results for the 2018/19 year
(submission estimated to be during August 2019) in accordance with the MYPD
methodology published during 2016. It is thus clarified that RCAs will continue to be applied
for on an annual basis, in accordance with the requirements of the MYPD methodology.
In the spirit of transparency, Eskom has included detailed submission documents to allow
for further robust debate and understanding. These submission documents include:
 Eskom Revenue Application, Multi-Year Price Determination (MYPD) 4, for 2019/20 to

2021/22 period
 Eskom Generation Licensee Revenue Application, MYPD 4 for 2019/20 to 2021/22
period
 Eskom Transmission Licensee Revenue Application, MYPD 4 for 2019/20 to 2021/22
period
 Eskom Distribution Licensee Revenue Application, MYPD 4 for 2019/20 to 2021/22
period
 Ancillary services – Technical Requirements
 Independent Economic Impact Studies
- An overview of electricity consumption and pricing in South Africa - An analysis of
the historical trends and policies, key issues and outlook in 2017
- The macroeconomic impacts of alternative scenarios to meet Eskom’s five-year
revenue requirement
 Abbreviations & Glossary

Preface
Note on Casting of Tables

Certain tables may appear not to cast. However, it needs to be noted that in most cases the
amounts reflected in the tables are rounded off to the nearest million rand. Thus the totals are a
true reflection of the underlying complete amounts.

Executive Summary
Executive Summary
This revenue application is being made for the 2019/20, 2020/21 and 2021/22 financial
years following the Energy Regulator decision for the 2018/19 financial year of an average
nominal increase of 5.23%. NERSA determined the total allowable revenue for the 2018/19
year of R190bn. This decision was made on the back of a 2.2% increase for the last year
(2017/18) of the MYPD 3 period where it approved the total allowable revenue of R205bn.
The allowed revenue resulted in an increase of 2.2% due to the base adjustments made in
the preceding years as a result of the approved Regulatory Clearing Account (RCA)
balances for Eskom (12.69% for 2015/16 and 9.4% for 2016/17). Both the 5.23% and 2.2%
average increases resulted in consumers receiving a below inflation average increase over
these two years. The Eskom Board has initiated the process of reviewing the NERSA
decision for the 2018/19 financial year through an application lodged in the North Gauteng
High Court. The notice was served on NERSA on 7 June 2018. NERSA has indicated that
it will respond to this application. The application made is for the Court to set aside this
administrative decision.
Eskom is making a revenue application of R219bn, R252bn and R291bn for the 2019/20,
2020/21 and 2021/22 years respectively. This is arrived at by the following considerations.
The implementation of the MYPD methodology will entail Eskom applying for cost reflective
revenue that covers efficient and prudent costs as well as a return on assets corresponding
to the weighted average cost of capital. A cost reflective tariff is one that allows Eskom to
recover its efficient and prudently incurred costs and earn a reasonable return. The
remainder of the building blocks in terms of the NERSA revenue formula, for this revenue
application are in accordance with the MYPD methodology. This would result in a price
increase of over 90% in the 2019/20 year. Due to the stage that the country is in with
regards to migration towards cost reflectivity, this is not an option that Eskom is
considering.
As a first step towards sustainability of Eskom, it would be preferable for Eskom to ensure
that the revenue caters for prudent and efficient costs as well as a reasonable return that
matches the debt service commitments (interest and debt repayments). Thus the revenue
related collectively to depreciation and return on assets must match the debt service
commitments entailing the debt repayments and interest payments. This would manifest in
a 29% increase in 2019/20, 13% in 2020/21 and 4% in 2021/22 financial years respectively.
However, in the interest of the potential impact on consumers, Eskom has agreed to make
a further sacrifice.

Executive Summary
Eskom, in this revenue application has applied the NERSA MYPD methodology, with a
smoothed price path over the MYPD 4 period by phasing-in of the return on assets. The
phased implementation was adopted ensure that by the 3rd year (2021/22) the revenue
allowed covers the full debt service commitments. This revenue requirement would
correspond to a phased 15% average price increase for each year of the MYPD 4 period.
However, the allowed revenue being applied for does not cover the entire debt commitment
costs, equating to a cash shortfall totalling approximately R50 billion for 2019/20 and
2020/21. This is a significant sacrifice being made by Eskom in the interest of allowing the
economy to adjust as the migration towards cost reflectivity.
Eskom will use the proceeds from the liquidation of the MYPD3 RCA decisions to
contribute to mitigating the debt service shortfalls.
The details are reflected in the summary table below.
TABLE 1: TOTAL ALLOWABLE REVENUE FOR THE MYPD 4 PERIOD

Application Application Application Forecast Forecast
Allowable Revenue (R'millions) AR Formula
2019/20 2020/21 2021/22 2022/23 2023/24
Regulated Asset Base (RAB) RAB 1 268 310 1 336 120 1 401 506 1 459 328 1 503 987
WACC % ROA X -1.32% -0.21% 1.45% 1.76% 2.46%
Returns -16687 -2765 20314 25722 37032
Expenditure E + 56 619 59 820 62 663 64 633 67 860

Primary energy PE + 73 386 75 876 79 561 87 983 96 393
IPPs (local) PE + 29 590 34 324 41 002 44 468 46 877
International purchases PE + 3 533 3 734 3 957 4 194 4 459
Depreciation D + 64 651 72 919 75 649 85 838 94 160
IDM I + 189 193 202 213 225
Research & Development R&D + 176 187 198 210 223
Levies & Taxes L&T + 8 272 8 198 8 147 8 108 8 180
RCA RCA +
Subtotal R'm 219 730 252 485 291 692 321 369 355 408
Not claimed in Application
Corporate Social Investment (CSI) - - 192 - 193 - 151 - 149 - 166
Total Allowable Revenue 219 537 252 292 291 542 321 221 355 242
Eskom’s reliance on debt has been increasing over the last few years. This is reflected in
the debt commitments for the MYPD 4 period and beyond. The table below shows the debt
commitments over the application period. In this MYPD 4 application, Eskom has sacrificed
the return on assets to only allow for a significant recovery of the debt commitments for the
period. Eskom’s total debt commitment is a sum of the debt to be repaid and the interest
payment. In the revenue application these payments are required to be accommodated by
the sum of the depreciation and return on assets. However, Eskom is applying for the
phased recovery that corresponds to a resultant average price increase of 15% for each of

Executive Summary
the three year period. Eskom experiences a shortfall of approximately R50bn over the
MYPD 4 period when compared to meeting debt commitments.
TABLE 2: ESKOM DEBT COMMITMENTS

Eskom Debt Commitments (R'm)
2019/20 2020/21 2021/22 2022/23 2023/24
Debt securities and borrowings repaid 34 115 49 951 49 431 56 085 92 952
Interest paid 39 058 45 115 46 041 49 384 48 607
Total Debt service 73 173 95 066 95 472 105 469 141 559
Return + Depreciation 47 964 70 154 95 963 111 560 131 192
Variance in debt service cover -25 209 -24 912 491 6 091 -10 367
As required by the MYPD Methodology, Eskom has requested an independent revaluation

of its regulatory asset base (RAB) to determine the depreciated replacement cost. This
value of the RAB will differ from the historic cost reflected in Eskom’s financial statements,
since it is a replacement cost that has been depreciated for the remaining life of the asset.
The changes in the key contributors to the increase in the electricity price over the three
year application period when compared to the NERSA revenue decision for the 2018/19
year are illustrated in the figure below. It needs to be noted that the two key areas that
NERSA made significant changes in its decision when compared to the actual costs and
projections provided. These areas included primary energy costs, specifically coal costs
and operating expenditure. In most instances, the decision required Eskom to immediately
reduce its cost base from 1 April 2018 to what NERSA had previously approved as efficient
and prudent revenue in its MYPD 3 decision. Thus it is offered, that the compound average
growth rate (CAGR), in the figure below, for primary energy costs and operational
expenditure would be significantly lower when compared to efficient and prudent
projections for the 2018/19 year.

Executive Summary
FIGURE 1: KEY CONTRIBUTORS TO INCREASE IN ALLOWED REVENUE
The key reasons for requesting a smoothed price increase of 15% per annum includes that
many elements that are outside of Eskom’s operational control that contribute to the
increase in revenue requirement over the three year period. The two key elements that
contribute to this are the increase in debt service costs and IPP costs as illustrated in the
figure above. Due to the significant variance between Eskom’s application and the NERSA
decision for key elements of primary energy, an initial increase is seen for the 2020 year.
The subsequent nominal primary energy increases are minimal. Eskom has made every
effort to control its operational costs resulting in muted nominal increases and even a
decrease in the latter years.
Eskom expects that the price impact to consumers for the 2020, 2021 and 2022 financial
years will comprise a combination of the MYPD 4 revenue requirement as well the phasing-
in of the RCAs for the 2015, 2016 and 2017 financial years. NERSA has undertaken to
make a decision with regards to the RCA phased implementation by end September 2018.
It is thus understood that the RCA adjustment decision will be made prior to the MYPD 4
revenue decision and related price adjustments.
Eskom is operating an ageing Generation fleet, notwithstanding the new power stations
under construction. More than half of the stations and more than half of the coal-fired
stations will be over 37 years old by the start of the MYPD4 period. Due to various

Executive Summary
constraints, most notably inadequate capacity and financial limitations, the mid-life
refurbishment and enhancement projects that are required to maintain and improve
technical performance as plants age, have generally not been implemented. Together with
high utilization that places higher than expected wear and tear on components and
systems, in particular since 2008, this has contributed to a steady decline in generating
plant availability over the past decade. Due to a combination of performance
improvements, additional capacity (both Eskom and IPPs), as well as stagnant demand,
the rapid decline in availability post 2010 has been arrested and availability has improved
to 78% in 2017/18 from a low point of 72%. The constraints, particularly financial, however,
remain and the reversing overall trend to maintain and improve current performance
continues to be a challenge.
1.1 Key elements of allowed revenue for the 2019/20 - 2021/22 financial year
Eskom’s allowed revenue requirement is based on the Electricity Regulation Act, 2006 (Act
No.4 of 2006), Section 15(1) requires tariff principles which:
• Must enable an efficient licensee to recover full cost of its licensed activities, including
a reasonable margin or return
This basis is reinforced in the Electricity Pricing Policy and the MYPD Methodology.
Eskom has applied this principle to the extent possible, where efficient and prudent costs
are motivated and included. As referred to previously, the return on assets (ROA) continue
to be phased-in over the MYPD 4 period.

Executive Summary
FIGURE 2: CONTRIBUTORS TO REVENUE REQUIREMENT
The figure above illustrates the key contributors to the allowed revenue for each of the
MYPD 4 application years. Key contributors are the debt service costs represented by
depreciation and returns. This is followed by primary energy costs and operating costs.
1.2 Recovery of efficient costs
a. Primary Energy costs:
Primary energy costs equate to the costing of the electricity supply required to meet
demand. The three sources of electricity supply are Eskom own generation, domestic
independent power producers (IPPs) and regional imports as is depicted in the figure
below.

Executive Summary
FIGURE 3: BREAK DOWN OF PRIMARY ENERGY COSTS
Due to the roll out of DOE renewable IPP programmes up to bid window 4.5, local IPPs
have grown over the last few years. Eskom’s own generation is used to meet the balance
of supply as renewables are non-dispatchable. The expected revenue requirement related
to the IPP programme is approximately R105bn for the 2019/20 to 2021/22 application
years.
Eskom’s strategy for the procurement of coal is based on a portfolio mix, with the majority
being sourced from long term contracts. However, it is not possible to contract for all of
Eskom’s coal requirements on long term contracts. It is prudent to have a portfolio of coal
supply agreements that allows flexibility to meet changing electricity demand patterns. The
largest component of the projected annual coal costs is the costs from existing and new
long term coal sources. This is in line with the first principle of the long term coal supply
strategy, namely, securing long term contracts with mines close to power stations. Revenue
related to coal costs is approximately R198bn for the three year application period.
Cross border purchases, substantially from Cahorra Bassa will cost approximately R11bn
for the three year period.
Approximately R 25bn is the allowed revenue related to environmental levy costs based on
a rate of 3.5c/kWh energy generated. It is assumed for the planning period that no further

Executive Summary
rate increases will occur. This environmental energy revenue is paid to the South African
Revenue Services (SARS).
b. Operating costs:
Operating expenses are expected to escalate on a year on year basis from 2019/20 on an
average, at less than inflation. Almost half of the operating cost is attributable to employee
benefits with the maintenance and other opex making up the remainder.
FIGURE 4: OPERATING COSTS
It is expected that employee costs will increase, on an average, by less than inflation over
the period. Significant efficiencies would be achieved over the period by reducing the
number of employees without compromising the required skills in appropriate areas. The
employee benefits comprises of direct remuneration (salary, pension, medical aid, bonus,
overtime) and indirect remuneration (training and development, temporary and contract
staff). Eskom’s total labour cost escalations over the last 5 years have tracked the market
escalations.
As the business strives to accelerate maintenance programmes, and given the ageing plant
it is expected that maintenance costs should increase. Eskom will ensure that maintenance
is carried out prudently and efficiently.
The growth in other operating costs is on average less than inflation for the period. Included
in this category are costs such as insurance, information technology, fleet costs, legal and
audit services, security, travel expenses, billing costs, connection/disconnection costs,
meter reading, vending commission costs and telecoms.

Executive Summary
1.3 Earning a reasonable return on assets
Return on assets is computed on a revalued regulatory asset base (RAB) with the intention
to cover interest costs and earn an equity return. The opening RAB balance for FY2019/20
is based on the valuation undertaken by independent external consultants, with a modern
equivalent asset value (MEAV), which is then adjusted for the latest capital expenditure
forecasts for the period FY2020 to FY2022. The average starting RAB value for FY2020 is
approximately R 1 268bn. Key reasons for the change in the RAB value is the change in
the overnight cost of generation which has increased between the previous 2010 valuation
(used for MYPD3 and the FY2019 revenue decision) and the 2016 valuation. The RAB was
valued as at 31 March 2016 for the purposes of this application. The previous RAB
valuation was undertaken during 2010.
To minimise the impact of price increases on the consumers the return on assets is
phased-in over a longer period than envisaged at the time of the MYPD 3 application. This
reflects the sacrifice that Eskom is proposing to allow for migration to cost reflectivity. Thus
the return on assets being applied for is R861m and the depreciation being applied for is R
213bn over the three year MYPD 4 period.
costs, equating to a cash shortfall totalling approximately R50billion for 2019/20 and
2020/21. This is a significant sacrifice being made by Eskom in the interest of allowing the
economy to adjust as the migration towards cost reflectivity.
1.4 Revenue recovery
Eskom’s Company revenue is recovered from negotiated pricing agreement (NPA)

customers, international customers and the balance from standard tariff customers.

Executive Summary
TABLE 3: REVENUE RECOVERY
MYPD3
Decision Application Application Application Forecast Forecast
Revenue recovery (R'millions) Decsion
2018/19 2019/20 2020/21 2021/22 2022/23 2023/24
2017/18
NPA and International Customers 6 259 13 938 15 045 16 340 18 084 18 583 19 858
Standard tariff Customers 198 954 176 410 204 492 235 952 273 458 302 638 335 385
Total Allowable Revenue 205 213 190 348 219 537 252 292 291 542 321 221 355 242
The recovery of the Negotiated Pricing Agreement (NPA) revenue is in accordance with the
contracts that have been concluded with the entities. The revenue recovered from
international customers would also be in accordance with the contracts with the
international customers and utilities.
1.5 Electricity price impact in 2019/20 - 2021/22
The impact on the standard tariff average price increase of the allowed revenue being
applied for is reflected in the table below. An assumption is made based on the latest
available standard tariff volumes as determined prior to this application being made. In
accordance with the NERSA MYPD methodology, a revision on the sales volume to reflect
the prevailing situation just prior to NERSA making its decision can be considered by
NERSA.
TABLE 4: STANDARD TARIFF PRICE INCREASE

MYPD3
Standard tariff price impact Unit Decision
2018/19 2019/20 2020/21 2021/22 2022/23 2023/24
2017/18
Standard tariff revenue A R'm 198 954 176 410 204 492 235 952 273 458 302 638 335 385
Standard tariff sales volumes GWh 223 217 188 082 189 584 190 218 191 699 192 866 194 304
Standard tariff price c/kWh 89.13 93.79 107.86 124.04 142.65 156.92 172.61
Standard tariff price adjustments % 2.2% 5.23% 15.0% 15.0% 15.0% 10.0% 10.0%
Every effort is being made to smooth the tariff increase over the MYPD 4 period. This
results in an average 15% increase over the three year period. As clarified previously, the
allowed revenue being applied for does not allow for the debt service commitments to be
recovered in each year. The equity return is not at all catered for. This is a sacrifice that
Eskom is proposing in the interest of NERSA being in a position to balance the
sustainability of Eskom with the impact on consumers.
Eskom understands that NERSA will make a decision on the phasing-in of the Regulatory
Clearing Account (RCA) applications for the 2014/15, 2015/16 and 2016/17 years. It is thus
likely that the average price increases experienced by consumers during the MYPD 4
period would need to take the RCA adjustments into consideration.

Basis of Application
2 Basis of Application
2.1 Legislative and regulatory framework
The adherence to the various related legislative, regulatory and licence

requirements form the basis of the MYPD application. A revision to allow for
the smoothing of the tariff increases as well a migration towards cost
reflectivity is accounted for. The following are applicable to the
determination of Eskom’s allowed revenue and resulting tariff adjustments.
2.1.1 Electricity Regulation Act (Act No. 4 of 2006)
Prescribes tariff principles including:
• Revenues enabling an efficient licensee to recover the full cost of its licensed activities,
including a reasonable margin or return;
• Avoidance of undue discrimination between customer categories;
• Permitting the cross subsidy of tariffs to certain classes of customers by the Energy
Regulator;
• Approval of tariffs by the Energy Regulator
2.1.2 Electricity Pricing Policy
EPP gives broad guidelines to the Energy Regulator in approving prices and tariffs for the
electricity supply industry.
2.1.3 Government Support Framework Agreement
The Government Support Framework Agreement (GSFA) with regards to the Department of
Energy procured Independent Power Producers, under section 34 of the Electricity
Regulation Act, was signed by Government (represented by the Ministers of Energy,
Finance and Public Enterprises) and Eskom in 2012. In accordance with section 3.1.4(e) of
the GSFA, Eskom is required to consult with and seeks approval from the Department of
Energy (DOE) together with the Department of Public Enterprises (DPE) and National
Treasury with regards to the proposed amounts for IPP purchase costs and payment
obligations to be included in any revenue application.

2.1.4 Municipal Finance Management Act (Act 56 OF 2003)
Eskom is required to take into account comments from the National Treasury and organised
local government on the draft revenue application. The revenue application should include a
motivation for adjustment of tariffs; consideration of impact on inflation targets and other
macroeconomic policy objectives; Eskom’s efficiency improvements and objectives. The
need to timeously table approved adjusted tariffs in Parliament for implementation for
Municipal customers. Eskom has solicited comments from National Treasury and SALGA.
Comments received have been considered in the finalisation of this submission to NERSA.
2.1.5 Multi-Year Price Determination (MYPD) Methodology
The revenue application is based on the requirements of the MYPD methodology as

published by NERSA during October 2016. The MYPD methodology addresses two broad
aspects, namely, the MYPD allowed revenue application and the adjustment of the allowed
revenue through the regulatory clearing account (RCA) process. The focus of this
application is the MYPD revenue application for the 2019/20 - 2021/22 financial years.
It is clarified that this revenue application does not include any RCA adjustments. NERSA
made decisions on the how the MYPD methodology requirements could be complied with in
its decision on Eskom’s application for condonation during the 2018/19 revenue application.
Eskom has made assumptions to meet the requirements of the MYPD methodology in this
MYPD 4 application in accordance with the above-mentioned NERSA decisions.
In developing the MYPD Methodology, the following objectives were adopted by NERSA:
 to ensure Eskom’s sustainability as a business and limit the risk of excess or

inadequate returns, while providing incentives for new investment;
 to ensure reasonable tariff stability and smoothed changes over time consistent with
socio-economic objectives of the Government;
 to appropriately allocate risk between Eskom and its customers;
 to provide efficiency incentives without leading to unintended consequences of regulation

on performance;
 to provide a systematic basis for revenue/tariff setting; and
 To ensure consistency between price control periods.

2.1.6 Focus is the revenue application for the 2019/20 - 2021/22 financial years
Eskom made a revenue application for the 2018/19 financial year during August 2017. The
final application was for total allowed revenue of approximately R213bn. This corresponded
to an absolute increase of 3.7% in allowed revenue when compared to the revised revenue
decision for the last year of the MYPD 3 period made by NERSA. However, the price impact
would have been higher due to the allowed revenue being recovered from a lower sales
volume. This is due mainly to the recovery of the allowed revenue through sales volumes
which have decreased by more than 13% when compared to the NERSA decision for sales
volumes in the last year of the MYPD 3 period.
On 15 December 2017, NERSA made a decision of a total allowable revenue of

approximately R190bn for the 2018/19 financial year, representing a 5.23% increase in
average selling price – albeit reducing allowed revenue by roughly R29bn as compared to
Eskom’s original application. This corresponds to approximately R22bn less than what
Eskom had requested in its revised application (due mainly to a lower assumption on local
IPP costs of R7bn). Nersa’s decision resulted in dropping the allowed revenue in absolute
terms by R15bn from R205bn (2017/18 year 5 of MYPD3) to R190bn (2018/19). On the
back of 2.2% increase for the 2017/18 year, this results in an average increase (nominal) of
approximately 3.75% over the two years. This is in the context of Eskom still migrating
towards being in a position to recover the cost of producing the electricity.
This MYPD 4 application revenue application for the period 2019/20 to 2021/22 financial
years is made on the back of these previous decisions.
2.1.6.1 Application does not include RCA adjustments
It is clarified that Eskom has not applied for any RCA adjustments in this revenue
application. The RCA process is backward looking and allows for adjustment of future tariffs
to address past variances (in accordance with the MYPD methodology) between the
revenue decision and the actuals that panned out. When a new MYPD revenue application
is made, it is forward looking and based on projected assumptions. There is a direct link
between MYPD decisions and RCA applications where risks are managed in RCA
applications. Thus if a significant risk is passed to Eskom at the stage of a revenue decision,
the impact would materialise in a RCA application. Thus the consumer is protected from the
risk at an initial stage during the revenue determination. Variances in RCA applications are
linked to two key sources:
• Variances in costs due to a changing environment and assumptions that materialize

after the MYPD decision;

• Assumptions made during the MYPD revenue decision which do not materialise.
2.1.7 Guideline on Minimum Information Requirements for Tariff Applications

(MIRTA)
Eskom accepts that MIRTA is not prescriptive. It is a guideline providing direction to the
licensee in compiling a revenue application. Eskom will endeavour to address the
requirements as far as possible.
2.1.8 Eskom retail tariff and structural adjustment (ERTSA) methodology
The 1 March 2016 ERTSA methodology is the NERSA regulation governing the tariff
increases to the Standard tariffs. The ERTSA is applicable to Eskom’s Standard tariffs for
local authorities (Municipal) and non-local authorities (non-municipal).
Once the NERSA has made a revenue determination for an Eskom MYPD application,
Eskom is required to submit an ERTSA application prior to the start of each year of approved
MYPD period. The ERTSA application consists of an application for the rate of adjustment to
Standard tariffs and the proposed Schedule of standard tariffs for each financial year.
An indication of this revenue application’s impact on Standard tariffs’ increases to the

different tariff groups is contained in Section on indicative increases to Standard Tariffs.
For the MYPD4 period, this revenue application does not deal with any potential Eskom tariff
changes. Going forward, within the next 3 years, Eskom wishes to provide for tariff
structures that meet the changing needs of customers and Eskom. Eskom will make
separate submissions to NERSA to propose and implement Standard tariff structures
changes during the control period.
Although there may be differentiated impact amongst customers, the basis is that the
allowed revenues and NERSA decision forecasted sales would be applied to ensure that
only the allowed Eskom revenue is recovered.

Context of MYPD 4 Application
3 Context of MYPD 4 Application

3.1 Key assumptions to address possible uncertainty during MYPD 4 period
The key reason for the NERSA approval of a single year revenue application by Eskom for
the 2018/19 year was the level of uncertainty in the planning horizon. Many of these
uncertainties still prevail during the 2018 calendar year when this MYPD 4 revenue
application is being prepared. However, the Eskom Board has decided to make certain key
assumptions with regards to the specific areas of uncertainty and submit a three year
application for the 2019/20 to 2021/22 financial years.
A draft updated Integrated Resource Plan (IRP) 2018 was published for public comments on
27 August 2018. The public was invited to make comments within 60 days. It is envisaged
that the IRP will then be finalised subsequent to this. For the purposes of this revenue
application, it is assumed that no further allocations for Eskom-build will be made for the
MYPD 4 revenue period in the Integrated Resource Plan, should it be finalised during the
MYPD 4 period. No further allocation of Independent Power Producer contracts will be
made, in addition to that which has been included in this application, as approved by the
relevant Government Departments in accordance with the GSFA.
As the Carbon Tax is still in a consultation process it is assumed not to have any material
impact on this MYPD 4 revenue application. In the event, that any material impact does
occur, relevant adjustments would need to be made. This could be implemented during the
ERTSA implementation or RCA adjustment process. It is assumed that legislative changes
that markedly affect the operations of Eskom’s business and license conditions will not occur
during the MYPD 4 period.
3.2 Eskom Governance challenges being addressed

The appointment of the new Eskom Board of Directors by government in January 2018 was
seen as a step in the right direction for Eskom’s operational and financial stability. As at
September 2018, the following interventions related to Eskom’s governance challenges have
been instituted.
 10 implicated senior executives exited. Finalisation of outstanding disciplinary hearings

relating to senior executives being accelerated.
 11 criminal cases opened, five of which involve nine senior executives.
 Total of 1 049 outstanding disciplinary cases since April 2018, of which 628 have been
finalised, resulting in 75 employee exits.

 239 whistle-blowing cases investigated, 122 of which have been concluded. Disciplinary
process is under way in respect of 67 confirmed cases.
 Remedial action has been taken against 25 staff doing business with Eskom; 7 exited.
 Lifestyle audits of senior management in progress. There is effective declaration of

interest.
 Investigated all irregular supplier contracts (five are no longer doing business with
Eskom). Recovered R902 million from McKinsey with an additional R99 million
recovered relating to interest.
Eskom is cooperating with eight regulatory bodies conducting major investigations. These
are National Treasury procurement investigations, Zondo Commission, Hawks, SIU,
Parliamentary Inquiry, National Director of Public Prosecutions, Standing Committee on
Public Accounts and SAPS.
It is clarified that this MYPD 4 application does not include any of the known cases of
corruption, fraud or irregular expenditure.
3.3 Eskom Business Model
The Business Model for any organisation refers to the way in which an organisation is
structured and financed to deliver specific goods and services to a preferred market in order
to fulfil its fundamental objective or purpose. How it does so successfully, speaks to the
unique ways in which the socio-economic context – together with specific rules of
engagement; competitor relations and stakeholder expectations – is addressed and
ultimately adds value to the customer.
Eskom is a State Owned Enterprise (SOE) whose key objective is to assist in lowering the
cost of doing business in South Africa; enabling economic growth; and providing stability of

electricity supply through providing electricity in an efficient and sustainable manner. Like
conventional agents of state, the purpose of the organisation is to realise the objectives of
Government, which are to eliminate poverty and reduce inequality through specific growth
priorities, detailed in the National Development Plan1.
Eskom’s objectives to support building a competitive and comparative advantage for South
Africa’s economy through growth and development, revolves around reliable electricity
delivery. This has been possible given an established vertically integrated structure of
owning and operating power stations; an integrated national transmission grid and
distribution networks, as well as a history of extending electricity access to all citizens served
by those networks.
Electricity delivery addresses the objective of poverty alleviation, not only through the
availability of electricity – which is fundamental for economic growth and social development
– but also because it attracts investment, which in turn drives job creation and increased
levels of employment. Another aspect addressed by electricity supply is the reduction of
inequality as driven by the transformation programme. This is a three pronged approach
that:
 ensures electrification to those not yet connected to the national grid so that access to
electricity for previously un-electrified communities can be rectified
 focuses on B-BBEEE procurement to support the empowerment of previously
disadvantaged sectors of the population and address the class based inequalities of the
past
 develops learners (through a skills and training pipeline aimed to place them effectively
in meaningful jobs both within the organisation and/or the industry) and communities
(through dedicated CSI efforts) as independent contributors to the wider socio-economic
landscape
3.3.1 Eskom responses to business model challenges

Eskom is currently responding to the threat of a “death spiral” in a number of ways to
transition the business and turn it towards growth. This transitional approach must be both
adaptive and resilient with regards to technology choice (current, emerging and future) and
how this technology can be applied to accommodate changing demand and supply needs,
as well as address competition from disruptive technologies. This means that Eskom has to
1 National Development Plan (https://nationalplanningcommission.wordpress.com/the-national-development-plan/)

consider new generation investments carefully: firstly with regards to the timing to avoid
stranded assets, secondly considering the investment risk and thus to explore smaller,
incremental responses. The following operating principles will determine the future shape of
operations:
 Ensure that Eskom plant remains consistently reliable and provide the required reserves
 Increased flexibility by lowering operating minimums
 New Plant must consider flexible options (OCGTs, CCGTs and Engines)
 Decrease demand during peak and increase demand during other hours to best utilise
the base load plant already on the system.
The transition takes into consideration the need for security of supply and the continued
viability of the grid, cost reduction to address the financial sustainability crisis and a focus on
revenue stability and recovery. Initiatives also include a review of the operating model and
consideration of the structure of the company, to ensure efficiency and effectiveness.
This is being achieved through the “Design to Cost” plans which focus on reducing costs, but
also diversifying into new products and markets to sell more of the existing and in the longer
term, new relevant products. These longer term options for new products and markets are
being considered through work on the Future Role of Eskom, such as directly developing
new generation in the region considering local and regional market dynamics as criteria.
Customer centricity is at the heart of the proposed transition. In particular, investment

decisions now need to be made with the changing market and customer in mind. New
revenue growth will prioritise those products that are currently disruptive, e.g. renewables
through rooftop PV, storage and smart technologies. This will allow Eskom to off-set lost
sales and continue to meet changing customer needs. In addition, Eskom will grow into new
areas which will boost current electricity sales through selling of excess capacity, working
with government to encourage new industrial investment and positioning itself for sales
positive technologies such as e-mobility.
Eskom will also diversify into markets where core competencies can be sold as a service, as
well as leverage the use of land and servitudes. To support this transition and avoid the
“death spiral”, operational improvement; strategic repositioning into new areas will all be
needed with the necessary trade-offs.

Allowable Revenue
4 Allowable Revenue
4.1 Allowed Revenue formula
Eskom’s revenue requirement application for MYPD 4 period 2019/20 – 2021/22 is based on
the allowed revenue formula as reflected in the MYPD methodology:
𝐴𝑅 = (𝑅𝐴𝐵×𝑊𝐴𝐶𝐶)+𝐸+𝑃𝐸+𝐷+𝑅&𝐷+𝐼𝐷𝑀±𝑆𝑄𝐼+𝐿&𝑇±𝑅𝐶𝐴
Where:
𝐴𝑅 = Allowable Revenue
𝑅𝐴𝐵 = Regulatory Asset Base
𝑊𝐴𝐶𝐶 = Weighted Average Cost of Capital
𝐸 = Expenses (operating and maintenance costs)
𝑃𝐸 = Primary Energy costs (inclusive of non-Eskom generation)
𝐷 = Depreciation
𝑅&𝐷 = Costs related to research and development

programmes/projects
𝐼𝐷𝑀 = Integrated Demand Management costs (EEDSM, PCP, DMP,

etc.)
𝑆𝑄𝐼 = Service Quality Incentives related costs
𝐿&𝑇 = Government imposed levies or taxes (not direct income taxes)
𝑅𝐶𝐴 = The balance in the Regulatory Clearing Account (risk

management devices of the MYPD)
4.2 Allowed revenue if MYPD Methodology is applied

Eskom is not considering the scenario where a full return on assets is being applied for. It is
felt that the resultant increases would be untenable for the consumer. The Eskom Board has
decided to only consider options that continue to phase-in of the return on assets.
Comparisons will be made to the debt commitments. This, in essence is a further extension
of the implementation of the Electricity Pricing Policy.

Allowable Revenue
4.3 Proposed MYPD 4 Allowed revenue application

This revenue application is being made for the 2019/20, 20120/21 and 20121/22 years
following the Energy Regulator decision for the 2018/19 year of an average nominal increase
of 5.23%.
Eskom is making a revenue application of R219bn, R252bn and R291bn for the 2019/20,
2020/21 and 2021/22 years respectively. Eskom, in this revenue application has applied the
NERSA MYPD methodology, with a smoothed phasing-in of the return on assets. The
phased implementation of the return on assets is to ensure that a significant portion of the
interest cost and repayment costs are covered over the three year period. However,
the allowed revenue being applied for does not cover the entire debt commitment costs.
Due to the smoothing of the price, Eskom does not recover sufficient revenue in the first two
years of the application period to enable the payment of the interest and debt commitments
in those years. It is only in the third year of the MYPD 4 that the debt commitments are
forecasted to be catered for in the revenue application. This is a significant sacrifice being
made by Eskom in the interest of allowing the economy to adjust as cost reflectivity is being
migrated towards. A cost reflective tariff is one that allows Eskom to recover its efficient and
prudently incurred costs and earn a reasonable return. The remainder of the building blocks
in terms of the NERSA revenue formula, for this revenue application are in accordance with
the MYPD methodology. The details are reflected in the summary table below.
TABLE 5: PROPOSED ALLOWABLE REVENUE APPLICATION

2019/20 2020/21 2021/22 2022/23 2023/24
WACC % ROA X -1.32% -0.21% 1.45% 1.76% 2.46%
Returns -16687 -2765 20314 25722 37032
Expenditure E + 56 619 59 820 62 663 64 633 67 860

IPPs (local) PE + 29 590 34 324 41 002 44 468 46 877
Depreciation D + 64 651 72 919 75 649 85 838 94 160
IDM I + 189 193 202 213 225
Research & Development R&D + 176 187 198 210 223
Levies & Taxes L&T + 8 272 8 198 8 147 8 108 8 180
RCA RCA +
Subtotal R'm 219 730 252 485 291 692 321 369 355 408
Corporate Social Investment (CSI) - - 192 - 193 - 151 - 149 - 166

Allowable Revenue
4.4 Revenue recovery

Eskom’s Company revenue is recovered from international customers, negotiated pricing
agreement (NPA) customers with the balance from standard tariff customers.
TABLE 6: RECOVERY OF REVENUE
MYPD3
Revenue recovery (R'millions) Decsion
2018/19 2019/20 2020/21 2021/22 2022/23 2023/24
2017/18
NPA and International Customers 6 259 13 938 15 045 16 340 18 084 18 583 19 858
Standard tariff Customers 198 954 176 410 204 492 235 952 273 458 302 638 335 385
Total Allowable Revenue 205 213 190 348 219 537 252 292 291 542 321 221 355 242
The recovery of the Negotiated Pricing Agreement (NPA) revenue is in accordance with the
contracts that have been concluded with the entities. The revenue recovered from
international customers would also be in accordance with international customers’ contracts
and utilities. It is clarified that NERSA will make a decision on the phasing of any RCA
adjustments related to RCA balance determination made by NERSA during June 2018. In
accordance with the NERSA communication, the phasing of the RCA implementation will be
approved by September 2018.
4.5 Electricity price impact during application period

The impact on the standard tariff price increase of the allowed revenue being applied for is
reflected in the table below. An assumption is made on the latest available standard tariff
volumes as determined prior to this application being made. In accordance with the NERSA
MYPD methodology, a revision on the sales volume to reflect the prevailing situation just
prior to NERSA making its decision can be considered by NERSA.
TABLE 7: STANDARD TARIFF AVERAGE PRICE INCREASE

MYPD3
Standard tariff price impact Unit Decision
2018/19 2019/20 2020/21 2021/22 2022/23 2023/24
2017/18
Standard tariff revenue A R'm 198 954 176 410 204 492 235 952 273 458 302 638 335 385
Standard tariff sales volumes GWh 223 217 188 082 189 584 190 218 191 699 192 866 194 304
Standard tariff price c/kWh 89.13 93.79 107.86 124.04 142.65 156.92 172.61
Standard tariff price adjustments % 2.2% 5.23% 15.0% 15.0% 15.0% 10.0% 10.0%
4.6 Comparison to assumptions in draft IRP

The following figure illustates the assumptions made in the draft IRP (2018) with regards to
the price curve for electricity. This would be used to make comparisons for determining
further investments in the electricity industry.

Allowable Revenue
FIGURE 5: EXTRACT FROM INTEGRATED RESOURCE PLAN
The IRP states that : “From financial year 2017/18, the tariffs will immediately move to ‘cost-
reflective’ levels as per the NERSA methodology”
The implication of the IRP tariff is
• By Jan 2019 – the cost reflective price would be 110c/kWh (2017)
− Corresponds to 124c/kWh (2019)
− Assume 30% increase from 94c/kWh in Jan 2019
• By Jan 2022 – the cost reflective price would be 115 c/kWh (2017)
− Corresponds to 154c/kWh (2022)
These assumption being made in the draft IRP indicate the significant migration required for
Eskom tariffs required to become cost reflective.
4.7 While tariff increases debt continues to increase

Since 2008/9 financial year, the average price of electricity has increased from
approximately 20c/kWhr to 94c/kWhr in the 2018/19 financial year. It is recognized that this
is approximately a five-fold increase. However, a more alarming trend has been an
approximate ten-fold increase in Eskom’s debt within the same period. It is recognised that
Eskom’s capital expansion programme has also occurred during the same period.
This illustrates the challenges being faced by Eskom as it migrates towards cost reflective
tariffs that allow for efficiently and prudently incurred costs with a reasonable return. To be
sustainable, there is a need to increase the cash from operations and minimise the amount
of debt being raised. Thus the migration towards cost reflective tariffs is central to the

Allowable Revenue
sustainability of a utility such as Eskom. Debt would continually need to be raised to be in a

position to fund the capital requirements to continue to operations of the business.
FIGURE 6: PRICE LEVELS AND INCREASE IN DEBT
Price levels and Debt increasing

500 000 100
400 000 80
Rand millions
Price c/kWh
300 000 60
200 000 40
100 000 20
0 0
2013/14
2007/08
2008/09
2009/10
2010/11
2011/12
2012/13
2014/15
2015/16
2016/17
2017/18
2018/19
Total debt (LHS) c/kWh (RHS)

Indicative Standard Tariff Increase
5 Indicative Standard Tariff Increase

5.1 Application of the ERTSA methodology
After the NERSA MYPD determination, the increased municipal and non-municipal Standard
tariffs are submitted to NERSA for approval; in compliance with the NERSA March 2016
Eskom Retail Tariff and Structural Adjustment (ERTSA) methodology. The provided
indicative increases to the Standard tariffs are determined as follows:
• The annual average increases to the municipal and non-municipal tariffs used to
determine the respective municipal and non-municipal annual revenues are the same as
per Rule 5 of the ERTSA methodology.
• The 1 July municipal (Local authority) tariff increase is calculated as per Rule 6 of the
ERTSA methodology. That is, for implementation at the beginning of the local authority
financial year (01 July) that is three months into the Eskom application year. The 1 July
municipal increase provides for the Eskom recovery of the municipal annual revenues
during the Eskom financial year.
• The non-municipal (Non-local authority) average increase is the annual average increase
as per the ERTSA methodology Rule 5.8.
• The Homelight 20A increase follows on Rule 7.1 and Rule 7.2 that provides for the
Energy Regulator as part of the MYPD to allow cross-subsidies and that these subsidies
can be implemented as a part of the annual average increase:
- For the provided indicative increases, as this is a new MYPD application, the non-
municipal average increase is applied; any lower tariff increases to the Homelight
20A tariff are for the NERSA determination.
- In this application, the increase to the Affordability subsidy charge that caters for the
recovery of lower increases to the Homelight 20A tariff reflects the recovery of the
cumulative lower increases to the Homelight 20A tariff since 2013/14. The
affordability subsidy charge increase therefore remains at around the same level as
the non-municipal average increase.
• The ERTSA Standard tariff increases do not result in structural changes and
implementation of new tariffs as per the ERTSA methodology rule 3.2. Eskom will make
applications for Structural changes after the revenue application that will include updating

the Standard tariffs with the latest cost of supply for tariffs; changes to TOU tariffs, etc. -
this is further discussed below.
• The indicative increases to the Standard tariffs only include the consideration of this
application’s applied for revenues and forecasted sales and therefore do not include any
consideration for purposes of implementing the RCA adjustments as per the Rules 5.1
and 5.2 of the ERTSA methodology.
5.2 Indicative increases by Standard tariff categories

After applying the ERTSA methodology to recover revenues through the Standard tariffs, the
2019/20, 2020/21 and 2021/22 indicative increases by Standard tariff categories are set out
in the table below.
5.2.1 1 July Municipal (Local authority) tariff increase

Using the ERTSA methodology; the 15% average increase translates to a 1 July 2019 local-
authority tariff increase of 17.60% to municipalities. Municipalities continue to pay at the
previous year’s rates for the period 1 April to 30 June as per the Municipal Finance
Management Act (MFMA). This equates to a price increase of 17.60% from 1 July 2019; a
price increase of 14.20% from 1 July 2020 and a price increase of 15.20% from 1 July 2021.
5.2.2 Eskom direct customers (Non-local authority tariff) increases

The 1 April 2019 non-municipal tariffs’ increase including the Homelight 20A tariff is the
ERTSA / annual average increase of 15% for 1 April 2019; a price increase of 15% from 1
April 2020 and a price increase of 15% from 1 April 2021.
5.2.3 Affordability subsidy charge increase

The 28 February 2013 MYPD3 decision `provides that the affordability subsidy charge is
recovered from key industrial and urban non-municipal customers. Consequently, the large
industrial and urban (non-municipal tariffs paying the affordability subsidy) will on average
experience an additional average 0.49c/kWh from 1 April 2019/20 that is an additional 0.48%
to the 1 April 2019 15% increase; an additional 0.9% from 1 April 2020/21 and an additional
1.29% from 1 April 2021/22. This amounts to an increase of 15.41% to the Affordability
Subsidy charge on 1 April 2019. From 1 April 2020 the affordability subsidy charge
increases by 15.71% and from 1 April 2021 this is a 15.84%.
5.3 Environmental levy recovery

As part of the ERTSA submission, an environmental levy charge rate(c/kWh) is used to
recover the costs of the environmental levy from all customers. For Standard tariffs, the

environmental levy recovery is embedded in the energy tariff charges. For local NPA and
export sales an explicit environmental levy charge is applicable.
5.4 Average tariff category increases

In summary; the 2019/20 to 2021/22 average tariff category increases is set out in the table
below:
TABLE 8: STANDARD TARIFF INCREASES

Standart Tariff Category Increases 2019/20 2020/21 2021/22
Total Standard tariff 15.00% 15.00% 15.00%
Municipalities:
Municipalities - effective 1 July 17.60% 14.20% 15.20%
Eskom Direct Customers (non-municipal tariffs):
Businessrate; Public Lighting; Homepower; Homelight
15.00% 15.00% 15.00%
60A; Landrate; Landlight
Megaflex; Miniflex; Nightsave Urban; WEPS; Megaflex
Gen
* Affordability subsidy charge (where applicable) 15.41% 15.71% 15.84%
* Other tariff charges 15.00% 15.00% 15.00%
Ruraflex; Nightsave Rural; Ruraflex Gen 15.00% 15.00% 15.00%

Homelight 20A
Block 1 (>0-350kWh) 15.00% 15.00% 15.00%
Block 2 (>350kWh) 15.00% 15.00% 15.00%
5.5 Protection of poor households

Poor households are particularly vulnerable to increases in electricity tariffs because they
have little ability to adapt. Eskom believes it is important to protect these poor households
from the full impact of the electricity price increase through targeted subsidies, with a
transparent cross-subsidy structure aligned with a national cross-subsidy framework to be
developed for the country.
To date, tariff subsidies have evolved in the absence of a subsidy framework and there has
been very little analysis of the long-term impact on consumers, whether subsidy contributors,
recipients, or even the economy as a whole.

Subsidies for poor households
The government, local authorities and Eskom have put in place a number of measures to
ensure that low-income households have access to affordable electricity. These include:
 The electrification programme, which subsidises the cost of connecting a house

to a 20A (low consumption) electricity supply. This complements an already
subsidised tariff.
 The free basic electricity programme, which provides 50kWh (more in some
local authorities) of free electricity per month to identified indigent customers.
 Free energy-efficient CFL bulbs and solar water-heater rebates, which are
available to all residential customers as part of Eskom’s demand management
programme.
The IBT, which, together with lower-than-average tariff increases, has resulted in
subsidies of up to 42% for all residential customers. These subsidies are currently
recovered primarily from Eskom’s direct large urban (municipal, industrial and commercial)
contribution to Eskom related subsidies because municipalities do not contribute towards
the IBT-related affordability subsidies (they also need to cater for their subsidies).
customers, with Eskom direct industrial and commercial customers making the largest
Figure 7: Current cross-subsidies in Eskom tariffs 2017/18
The Inclining Block Tariff (IBT) was implemented by NERSA to cushion low-income
households that use very little electricity. The tariff has been successful in lowering the cost
of electricity for the poor. However, Eskom believes that the IBT as it is currently structured
does not sufficiently target low-income households and places an unsustainable subsidy
responsibility on urban customers. It also encourages affluent customers to move off the grid
using PV solar.

Eskom recognises that even in the absence of a national subsidy framework the poor still
need to be protected against the impact of the price increases. NERSA may therefore allow
cross-subsidies between various customer groups to be implemented as part of the annual
average price to benefit affected groups.
If NERSA continues to protect the poor with lower tariff increases to the Homelight 20A tariff
similarly as it did for the 2018/19 decision, the applicable tariff category increases after
applying the ERTSA methodology would be 2.4% less than average for Block 1 (>0-
350kWh) and 0.4% less than average for Block 2 (>350kWh) for the Homelight 20A tariff.
This option provides protection for the poor, but increases the level of subsidies for the non-
local authority urban tariffs. This may result in changes to the non-municipal and/or
municipal increases.
5.6 Tariff structural changes during the MYPD4 control period

This revenue application does not deal with any potential Eskom tariff changes, including the
proposed rationalization of municipal tariff currently with NERSA for a decision. To provide
for tariffs that meet the needs of customers and Eskom, the strategic objectives are as
follows:
• Tariffs to be more cost-reflective in structure i.e. fixed versus variable charges and in
level
• Tariffs that share volume risk between customers and Eskom and allow Eskom and the
customer to partner for mutual benefit.
• Tariffs must ensure fair compensation for the use of the grid by generators and loads
• Tariffs that incentivize customers to stay connected to the grid.
• Tariffs that increase sales and ensure adequate recovery of costs
• Tariff that enable better management demand and supply.
In order to pursue these objectives for the benefit of Municipal tariffs, Eskom would submit
Tariff structural changes submissions after the MYPD4 decision during the control period;
and implement the NERSA decisions on already submitted tariff structural changes.
More details of the proposed tariff structural adjustments are provided in the Distribution
licensee submission document.

Sales Volumes
6 Sales Volumes
6.1 Introduction to Sales volumes
The sales volumes and sales forecasting is summarised here. Details are provided in the
Eskom Distribution Licensee submission that forms part of Eskom’s submission.
Every effort is made to determine the projected sales volumes for the MYPD 4 period to
reflect what is known at the time of the submission. As summarised below and clarified
further in the Distribution MYPD 4 submission a robust and thorough process is undertaken
to provide sales volume projections. The MYPD methodology requires Eskom to provide
reviewed sales volume projections subsequent to this submission and prior to the NERSA
decision being made. Eskom understands that NERSA will undertake its own analysis before
making a decision to determine the veracity of the projected sales volume for the three year
period.
The determination that NERSA makes on the sales volume projection allows Eskom to
recover the allowed revenue decision through the sales volume. The revenue to be
recovered is for the fixed and variable costs. If the sales volume do not materialise as in the
MYPD 4 decision – it implies that Eskom does not recover the fixed costs that it would have
if the reality had turned out as in the NERSA MYPD 4 decision. However these revenues are
only fully recovered if all the sales are achieved as assumed in the decision. Therefore, in
the event of lower sales materialising, it results in Eskom not recovering the allowed revenue
components as was assumed. In the event of higher sales materialising than the NERSA
determination, it would result in Eskom recovering more revenue than determined by
NERSA. Variances are addressed as part of the RCA process.
6.2 Robust process to project sales volumes
A five-step process, as depicted in the figure below, is followed to forecast Eskom electricity
sales. This process includes the compilation of a six-year monthly detailed forecast with the
last four years of the period at an annual level using trends per sector.
The process includes a bottom-up approach to compile regional forecasts for each of the 9
regional Operating Units’ forecasts and for the top industrial and mining customers’ forecast.
This is followed by “one-on-one” work sessions with the forecasters at each of the regional
Operating Units and for customers to verify and confirm the validity of the forecasts. Once
agreement and consensus is reached, the 9 Operating units’ forecasts and the top industrial
and mining forecasts are consolidated into an Eskom national forecast. An 80/20 principle is

Sales Volumes
used during the bottom-up approach, that is, customers contributing 80% of the sales per
category are forecasted on an individual basis. The individually forecasted customers are
predominantly in Top industrial and mining customers’ category whose annual consumption
is greater or equal to 100GWh. The individual customer forecasts apply detailed insights and
information on individual customers’ usage and long-term plans. Thus Eskom is dependent
on receiving coherent responses from these customers with regards to their energy
requirements. It is plausible that the plans made by these customers for the application
period could change. Long term economic forecast trends and commodity prices are also
considered. In the finalization of the forecasted sales volumes, all abnormalities and outliers
are removed from the historical data before statistical trend analysis and statistical forecasts
are applied.
FIGURE 8: SALES FORECASTING PROCESS
6.3 Projected sales volume
The projected sales volume for the MYPD 4 period, as developed by the robust process
described above resulted in the following sales projections. It needs to be kept in mind that
since the sales forecasting process is the initial process for the preparation of the MYPD 4
revenue application, it was undertaken at least 9 months before the submission.

Sales Volumes
TABLE 9: PROJECTED SALES FORECAST
Actuals Projection Application Application Application Forecast Forecast

Sales volumes (GWh)
2017/18 2018/19 2019/20 2020/21 2021/22 2022/23 2023/24
Standard tariff sales 187 310 187 544 189 036 189 670 191 150 192 314 193 750
Negotiated pricing agreement 9 707 9 750 9 777 9 750 9 750 9 750 9 777
Export sales 15 173 14 895 16 146 16 227 16 843 15 803 15 972
Total External Sales 212 189 212 189 214 959 215 648 217 743 217 868 219 499
Internal sales 451 538 548 548 549 551 554
Total Sales 212 640 212 727 215 507 216 196 218 292 218 419 220 054
Year-on-year growth (GWh) - 1 909 87 2 780 689 2 096 127 1 635
Year-on-year growth (%) -0.89% 0.04% 1.31% 0.32% 0.97% 0.06% 0.75%
6.4 Review of projected sales volumes
As required by the MYPD methodology, Eskom will review the projected sales volumes prior
to NERSA making the revenue decision. This will be part of the normal quarterly update that
Eskom undertakes. Eskom will then provide NERSA with updated sales volumes to enable
NERSA to decide on a viable volume in making its decision.

Energy Wheel
7 Energy Wheel
Once the sales volume projections have been developed, the Energy Wheel is developed.
The energy wheel is a summary of the balance between the Eskom demand and supply of
energy. The energy wheels for the three application years are provided in this submission.
The demand side of the Energy Wheel portrays the total projected Eskom sales which are
made up of Distribution national sales and Export sales, inclusive of the transmission and
distribution losses. This makes up the total amount of energy that needs to be produced to
supply customers’ needs and is the starting point of the production planning process. This
energy forecast has been discounted with the impact of demand side management options.
The supply side of the Energy Wheel shows the volume of electricity that is required from
local and international power stations as well as independent power producers (IPPs) to be
supplied to Eskom’s distribution and export points (including the losses) to meet the demand
of those customers.

Energy Wheel
FIGURE 9: THE ENERGY WHEEL FOR THE APPLICATION YEAR 2019/20
ESKOM HOLDINGS SOC LTD

ENERGY WHEEL
FY2020
ALL FIGURES IN GWh
Generation of
Available for
Electricity Application Application Total Imports Application
Distribution
Generation 224 765 Generation (incl IPPs) 237 075 International Purchases 7 604
OCGT 211 International 7 604 Wheeling 1 887
Pumping (6 838) Wheeling 1 887 Total 9 491
IPP 12 099 Sub Total 246 566
Total 230 237 Pumping (6 838)
Total 239 728
Total Exports Application
International Sales 16 146

Wheeling 1 887
South African Power Pool Total 18 033
Internal Use Application Demand Application External Sales Application
Generated ( 114) Sales 214 959 Local 198 813

Internal Use 548 Losses 22 448 International 16 146
Total 434 Internal 548 Total 214 959 1
Generated ( 114)
Wheeling 1 887
Technical & Other Losses Application
Total 239 728
Distribution 16 281
Transmission 6 167
Total 22 448
Technical & Other Losses - % Application
Distribution 7.55%
Notes Transmission 2.50%
Notes
1 Total External Dx sales excluding internal sales of 548GWh and including international sales of 16 146GWh

Energy Wheel
FIGURE 10: THE ENERGY WHEEL FOR THE APPLICATION 2020/21

ENERGY WHEEL
FY2021
ALL FIGURES IN GWh
Generation of
Electricity Application Available for Distribution Application Total Imports Application
IPP 15 035 Sub Total 247 449
Total 240 484

Wheeling 1 882

Generated ( 114)
Wheeling 1 882
Total 240 484
Distribution 16 331
Transmission 6 189
Total 22 520
Technical & Other Losses - % Application
Distribution 7.55%
Transmission 2.50%
Notes
1 Total External Dx sales excluding internal sales of 548GWh and including International sales of 16 227GWh

Energy Wheel
FIGURE 11: THE ENERGY WHEEL FOR THE APPLICATION 2021/22

ENERGY WHEEL
FY2022
ALL FIGURES IN GWh
Generation of
Electricity Application Available for Distribution Application Total Imports Application
IPP 18 665 Sub Total 249 627
Total 242 755
Wheeling 1 882

Generated ( 114)
Wheeling 1 882
Total 242 755
Distribution 16 452
Transmission 6 244
Total 22 695
Technical & Other Losses - %
Distribution 7.55%
Transmission 2.50%
Notes
1 Total External Dx sales excluding internal sales of 549GWh + International sales of 16 843GWh

Production Plan
8 Production Plan
8.1 Background to the production plan
The details of the production plan are included in the Eskom Generation revenue application
submission. Only a high level summary is reflected below. Once the sales forecast
projections and energy wheel have been completed, the production planning process is
undertaken.
The main objective of production planning is to ensure optimal output from available power
stations to reliably meet the system demand at least cost, while recognising Generation,
primary energy and any other technical constraints. The key principle for Production
Planning is for the merit order dispatch to be maintained within known constraints.
Constraints may include emissions, coal shortages/surplus, water shortages and any other
technical constraints.
Merit order dispatch is achieved by deriving the merit order from the primary energy costs as
well as power station burn rates resulting in an energy cost (R/MWh) ranking per station
from the cheapest to the most expensive. Coal and diesel costs are the major contributors to
the variable cost of electricity production, and on its own, results in an accurate relative merit
order and optimum dispatch.
The Production Plan outcome provides the expected production level at each station which
is the basis of the Primary Energy (i.e. Coal, Water, Sorbent Nuclear, OCGT, Start-up Fuel,
Water Treatment, Coal Handling and Environmental Levy) cost projections.
8.2 Production Planning Process

The following figure summarises the production planning process that is followed. The inputs
include hourly demand forecast, planned and unplanned maintenance, ramp rates, variable
cost, capacity, number of units per station, minimum generation, operating reserve
requirements, commercial operation dates for Eskom new build, Import capacity, IPPs and
all other parameters required for modelling the system. Generators are dispatched from the
lowest variable cost to the most expensive generator in the system. Consideration is given to
particular constraints and requirements.

Production Plan
FIGURE 12: OVERALL PRODUCTION PLANNING PROCESS
8.3 Production Plan outcomes

The study assumes no restrictions on the fuel availability to the base-load stations, therefore
they are only restricted in their output through their available capacity, utilization factors and
position in the merit order. A base-load station first in the merit order will generate at full
available output in all hours, whilst a base-load station lower down in the merit order will
follow the load pattern from hour-to-hour. The table below shows the energy production mix
per plant technology from 2019/20 to 2023/24.
TABLE 10: ENERGY PRODUCTION PER PLANT MIX (GWH)
Production Plan Actuals Projection Application Application Application Projections Projections

GWh 2017/18 2018/19 2019/20 2020/21 2021/22 2022/23 2023/24
Coal 202 106 200 971 203 757 202 387 201 508 199 354 202 215
Nuclear 14 193 12 381 14 902 14 155 13 655 14 790 13 736
OCGT 118 211 211 211 211 211 211
Hydro 709 695 693 689 690 690 690
Pumped storage 4 479 4 478 5 069 5 164 5 091 5 027 5 155
Sere 331 344 344 344 344 344 344
Total Eskom Production 221 936 219 081 224 977 222 951 221 500 220 416 222 351
IPPs 9 584 11 451 12 099 15 035 18 665 19 890 19 902
International trader 9 997 11 834 9 491 9 463 9 462 9 461 9 487
Gross Production 241 518 242 366 246 566 247 449 249 627 249 767 251 740
Less-pumping -6 031 -6 035 -6 838 -6 965 -6 872 -6 786 -6 950
Nett Production 235 487 236 330 239 728 240 484 242 755 242 981 244 789

Energy Losses
9 Energy Losses
The nature of transporting electricity from generator to the end-users involves losses in
energy volumes (electrical or technical losses) that reduce the amount of electricity volumes
available for sale to end-customers. In addition, other energy losses may occur due to non-
metered usage related to electricity theft (non-technical losses). The representation of the
measure for the levels of the combined total technical and non-technical losses is by way of
loss factors.
Energy loss is an inherent risk in the electricity business and utilities globally are addressing
this issue, which costs billions of rand annually with developing countries being the worst
affected. Energy losses are incurred when energy is transferred from the suppliers to the
loads through the network. This energy lost, is approximately equal to the difference
between the energy supplied and the energy consumed.
 Transmission losses are determined by the difference between energy injected onto the
transmission grid and energy off-take at main transmission substations (MTS) and
interconnection points. The transmission losses are projected to be an average of 2.50%
for the application period.
 Distribution losses are determined by the difference between energy purchased

(measured at main transmission substations) and energy sold to all Distribution
customers. The industry norm for a Distribution network energy loss factor is 10% and
the current Distribution energy losses are projected to remain below the loss factor of
10% in the MYPD4 control period.
Energy losses have a direct effect and increases generation requirements (both capacity
and energy volumes) and primary energy costs.
Efforts are put in place to address non-technical losses.

Weighted Average Cost of Capital
10 Weighted Average Cost of Capital

The weighted average cost of capital (WACC) component of the building blocks to the
allowable revenue formula:
𝐴𝑅=(𝑅𝐴𝐵×𝑊𝐴𝐶𝐶)+𝐸+𝑃𝐸+𝐷+𝑅&𝐷+𝐼𝐷𝑀±𝑆𝑄𝐼+𝐿&𝑇±𝑅𝐶𝐴
The WACC is determined in accordance with the requirements of the MYPD methodology. It
is clarified that even though the determination for the WACC is made, it is not implemented
to the full extent in this MYPD 4 revenue application.
Electricity production and distribution is a capital or asset intensive industry i.e. significant
up-front capital investment is required in order to acquire the assets which are needed to
produce, transmit and distribute the electricity. The capital invested to acquire an asset is
thereafter recovered over the full operational life of an asset. The cost of such capital is an
inherent cost of the production of electricity and must therefore be recovered through the
price of electricity in order for the industry be sustainable, which includes meeting its debt
obligations. The capital structure consists of a weighting of equity and debt with Eskom
targeting 70% for debt and 30% for equity. Both debt and equity comes at a cost and thus
the weighted cost of capital (WACC) is utilised to determine the funding costs for
organisations. The NERSA regulatory methodology requires the earning of returns on assets
(ROA). These are in lieu of interest costs, which are not separately recovered as a cost
component.
In the recent past there have been several developments that have transpired which
negatively affected Eskom’s cost of capital. Credit rating downgrades by Standard & Poor’s,
Moody’s and Fitch rating agencies coupled with sovereign downgrades has placed further
upward pressures on funding costs.

Weighted Average Cost of Capital
TABLE 11 : COST OF CAPITAL
Weighted Average Cost of Capital Debt Equity WACC

Costs - Nominal 11.6% 22.1%
Weight 70.0% 30.0%
WACC nominal pre-tax 8.1% 6.6% 14.8%
Costs - Real 6.1% 16.1%
Weight 70.0% 30.0%
Inflation 5.2%
WACC real pre-tax 4.3% 4.8% 9.1%
Eskom’s updated WACC real pre-tax is 9.1% which is higher than the single year tariff
decision by 70 basis points. During the revenue application only a portion of the WACC is
claimed against the regulated asset base (RAB).

Regulated Asset Base, Depreciation and ROA
11 Regulated Asset Base, Depreciation and ROA

The capital related aspects of the MYPD allowed revenue formula are considered here. Key
aspects that are considered are the determination of the regulatory asset base, depreciation
and return on assets. As clarified previously, Eskom is not requesting the return on assets as
required by the MYPD methodology. This is the key area where Eskom is making a sacrifice
in the interest of only migrating towards a cost reflective return on assets.
The relevant aspects of the allowed revenue, in terms of the MYPD methodology considered
here are highlighted:
The ERA and the Electricity Pricing Policy (EPP) require the recovery of efficient costs and
earning a fair return on capital. The EPP and the MYPD methodology require that assets
are valued at replacement value for setting of regulated revenue. In accordance with the
MYPD methodology, Eskom has undertaken a revaluation of all completed assets used in
the generation, transmission and distribution of energy as at 31 March 2016.
This was undertaken by an independent entity that has international experience in the realm
of asset valuation for large infrastructure companies. As required by the MYPD
methodology, the determination of the regulatory asset base value is based on the costs to
replace these assets (i.e. Modern Equivalent Assets Valuation) and adjusted for the
remaining life. This valuation has been undertaken in accordance with the guidelines and
requirements of the International Valuation Standards. The basis of the valuation was the
Eskom fixed asset registers and comparisons were made with market data for actual
construction cost of similar assets. This valuation exercise was a continuation of previous
asset valuation exercises, during which site visits to samples of the physical assets were
performed. The Depreciated Replacement Cost (DRC) was determined through the
application of the cost approach methodology, which is a recognised approach for the
valuation of specialist assets which are not regularly traded. The cost approach methodology
includes the identification of the estimated new replacement cost of assets, which is then
adjusted to reflect physical, functional and economic obsolescence.

FIGURE 13: PROCESS FOR VALUATION OF EXISTING ASSETS
The asset values in the Regulatory Asset Base are therefore not shown at the new
cost to replace them but at their depreciated replacement cost. For example, if it costs
R1bn to replace an asset at the end of March 2016 which has two years remaining life out of
a total useful life of 25 years, the depreciated replacement cost at the end of March 2016
would be R80 m (i.e R1bn x 2/25). This valuation forms the basis of the RAB application as
shown in the table below.

TABLE 12: REGULATORY ASSET BASE (RAB) SUMMARY
MYPD3
Regulatory asset base (R'millions) Decision
2017/18 2018/19 2019/20 2020/21 2021/22 2022/23 2023/24
Assets (Including WUC) 690 268 666 220 1 222 211 1 280 726 1 335 936 1 385 007 1 424 171
Working capital and Equipment and vehicles 27 245 36 709 46 100 55 394 65 570 74 321 79 816
Average Eskom RAB 717 513 702 929 1 268 310 1 336 120 1 401 506 1 459 328 1 503 987
11.1 Assets (including WUC) comprise the following components:
In accordance with the MYPD methodology, the regulatory asset base is comprised of the
following:
 Assets as per the March 2016 asset valuation- the valuation only includes assets
already in use in the generation, transmission and distribution of electricity as at 31
March 2016. Included in these assets is 1 unit of Medupi of 794MW valued at
Depreciated Replacement cost of R40bn. All other assets in construction are not
included in the valuation but rather in the WUC.
 Work under construction (WUC): In accordance with the MYPD methodology, for assets
that constitute ‘creation of additional capacity’, the capital project expenditures or WUC
values (excluding IDC) incurred prior to the assets being placed in Commercial
Operation (CO) are included in the RAB and earn a rate of return based on the real
WACC.
 New constructed assets: This refers to assets transferred into Commercial Operation
subsequent to the 2016 asset valuation. It includes power station units as well as
networks commissioned subsequent to the asset valuation. Once commissioned, these
assets are included in the RAB for purposes of earning a return as well as for the
depreciation allowance. The depreciation allowance is calculated by dividing the cost of
the asset over the number of years that the asset is to be used for i.e. the useful life of
the asset.
11.2 Assets as per the March 2016 asset valuation
The extract of the Depreciated Replacement Costs (DRC) from the valuation report is shown
in the Table below. The valuation report excludes interest during construction (IDC) due to
the WUC being included in the RAB for ‘return’ purposes. In addition, working capital, asset
purchases and Work under Construction were also excluded since these were not part of the

scope of the consultants’ valuation project but will be added to the report’s values, in
accordance with the MYPD methodology.
TABLE 13: EXTRACT FROM CONSULTANT 2016 ASSET VALUATION REPORT
The RAB summary Table above reflects a growth in the average Eskom RAB of R565 billion
between the RAB values as assumed for purposes of the FY2019 revenue decision, and
those for FY2020. The key reasons for the growth are as follows:
 The RAB value for purposes of the revenue determination for FY2018/19 was not based
on a valuation exercise, due to the requirement for such valuation only becoming known
when the revised MYPD Methodology was published at the end of October 2016, which
did not allow sufficient time for the external valuation project to be completed. Eskom
thus requested condonation from complying with that requirement and proposed the use
of the last public domain RAB values i.e. as for the fifth year of the MYPD3 cycle.
NERSA approved the request for condonation.
 In addition, relative to the RAB for FY2018/19, the RAB for FY2020 is adjusted with
subsequent actual and planned capital expenditure and the consumer price index (CPI)
adjustments of approximately R196bn between FY2016 and FY2020.
- The existing asset base as at 31 March 2016 has been revalued, amounting to R853
billion (as shown in Table above) compared to the NERSA determination of R603
billion for FY2016 for purposes of the MYPD 3 revenue decision as reflected in
Table below. A key reason for the increase is due to the change in the overnight
cost which has increased between the previous 2010 valuation (used for MYPD3
and the FY2019 revenue decision) and the 2016 valuation. The overnight cost for
this purpose is determined by the consultants based on global benchmark costs for
similar infrastructure projects in the electricity industry.

TABLE 14: FY2016 RAB VALUES AS ASSUMED FOR PURPOSES OF MYPD3 REVENUE
DECISION
FY2016 RAB- MYPD 3 Decision

Generation Transmission Distribution Total Eskom
(R'millions)
Property and Plant 410 280 104 522 88 151 602 953
Equipment & Vehicles 1 029 1 576 1 860 4 465
Total Work Under Construction 69 536 6 140 10 710 86 385
Total Working Capital 15 450 -442 1 138 16 147
Total average RAB 496 295 111 796 101 859 709 950
The breakdown reflected in the table above is as per the extract of the NERSA ‘Reasons for
Decision’ for the MYPD 3 revenue determination as shown below:
11.3 Work under construction (WUC)
In terms of the MYPD methodology the criteria for inclusion of WUC into the RAB is for those
assets that are for the creation of additional generation, transmission and distribution
capacity and are defined as follows:
- Expansion – this is capital expenditure to create additional capacity to meet the future
anticipated energy demand forecast.
- Upgrade – this is capital expenditure incurred to ensure that the current and future
energy demand forecast is met.
- Replacement – this is capital expenditure to replace assets that have reached the end
of their useful life in order to continue meeting the current demand.
- Environmental legislative requirements – this is capital expenditure incurred to

ensure that the licensing condition is maintained thereby continuing to meet the current
energy demand forecast.
A WUC in essence refers to the capital expenditure being undertaken and meets the criteria
referred to above for inclusion in the RAB. In terms of the MYPD methodology, the WUC
balance is required to earn a return on assets but is not depreciated until assets are

transferred to Commercial Operation (CO). Only upon commercial operation (CO) do these
assets incur depreciation costs.
The transfers to CO from WUC for Transmission and Distribution assets are grouped into the
categories of substations and lines. For Transmission, these new assets are depreciated on
a normal useful life of 30 years for substations and 40 years for lines. Distribution
substations are depreciated on a normal useful life of 30 years and lines on a life of 25
years. Transfers to commercial operation for generation assets are grouped per station and
the normal useful life for depreciation is limited to the remaining life of the respective power
station.
11.4 Depreciation
As is required by the MYPD methodology, the annual depreciation allowance is determined

by dividing the cost of the asset less the residual value by the estimated useful life of that
asset. Table below reflects the revenue related to depreciation for the MYPD 4 period.
TABLE 15: DEPRECIATION
MYPD3 MYPD 3
Depreciation (R'millions) Decision decision
2017/18 2018/19 2019/20 2020/21 2021/22 2022/23 2023/24
Generation 19 170 15 328 49 878 56 948 58 392 67 446 74 338
Transmission 4 103 3 639 6 837 7 459 8 051 8 541 9 093
Distribution 5 925 5 935 6 903 7 422 8 029 8 679 9 367
Corporate 769 1 724 1 034 1 091 1 177 1 172 1 362
Total Depreciation 29 967 26 625 64 651 72 919 75 649 85 838 94 160
Depreciation on assets as per the FY2016 valuation is computed by dividing the

depreciated value of the assets over the remaining life of the respective assets as reflected
at the end of March 2016. There is a steep change between FY2019 and FY2020, which is
due to the following:
 The current asset valuation is higher by about R250 billion in FY2016 compared to the
MYPD3 values for FY2016. The reason for this was clarified previously in this
submission.
 The average remaining useful life estimates for the Transmission licensee is shorter in
the 2016 valuation when compared to assumption in the MYPD 3 decision whilst the
depreciated replacement cost (DRC) values have remained relatively the same. This is
due to the comparison to other energy infrastructure valuations undertaken by the
consultants who undertook the independent study

For the Generation – Other category of assets, all subsequent transfers to commercial
operation are depreciated over the asset life but limited to the remaining life of the power
station.
In the case of Transmission and Distribution – Other category of assets, all subsequent
transfers to commercial operation are depreciated over the normal useful life.
11.5 Assets excluded from RAB
The DRC for Transmission and Distribution assets as shown in table above, include assets
that are funded via upfront contributions and Department of Energy (DoE). The DoE funds
the electrification assets. In terms of the MYPD methodology these assets do not earn a
return on assets and their depreciation is not included in the revenue requirement. The total
assets shown in Table 12 and the depreciation reflected in Table 15 have therefore been
reduced by the values as shown in Table 16 below to exclude such assets.
TABLE 16: ASSETS FUNDED VIA UPFRONT CONTRIBUTIONS AND DOE

Assets funded via upfront contributions and DoE
2019/20 2020/21 2021/22 2022/23 2023/24
Opening balance (44 223) (43 750) (43 071) (42 227) (41 098)
Inflation on opening balance (2 477) (2 537) (2 584) (2 534) (2 466)
Transfer to CO (662) (643) (704) (763) (826)
Depreciation 3 613 3 859 4 132 4 427 4 747
Closing asset values (43 750) (43 071) (42 227) (41 098) (39 643)
The transfer to commercial operation (CO) in Table 16 above includes the completed assets
which have been funded upfront by customers. These transfers to CO do not include assets
funded by DoE since the capital expenditure for these electrification projects have been
excluded from this application.
The objective of tracking these assets as a separate asset class (as shown in Table 16) is
to ensure transparency; therefore both the RAB and the depreciation are reduced
accordingly.
11.6 Return on assets

Eskom, in this revenue application has applied the NERSA MYPD methodology, combined
with a smoothed phasing-in of the return on assets. However, the return on assets at the end
of the three year period do not reach the weighted average cost of capital (WACC) as
determined in accordance with the MYPD methodology, nor the WACC as was determined
by NERSA for purposes of the 2018/19 revenue determination. This phasing in approach

was limited to the degree required so as to ensure that the depreciation and return on asset
covers a significant portion of the interest and repayment costs over the three year period
and fully covers annual debt service costs (interest and principal) for the 2021/22 financial
year.
TABLE 17: RETURN ON ASSETS
2017/18 2018/19 2019/20 2020/21 2021/22 2022/23 2023/24

Return on assets (R'millions)
Decision Decision Application Application Application Forecast Forecast
Average RAB (R'm) 715 147 702 929 1 268 310 1 336 120 1 401 506 1 459 328 1 503 987
Full Return on Assets (ROA) % 7.65% 6.9% 9.31% 9.34% 9.37% 9.39% 9.40%
Returns (R'm) 54 709 48 502 118 032 124 730 131 257 137 015 141 391
Phased in ROA % 4.7% 4.0% -1.32% -0.21% 1.45% 1.76% 2.46%
Phased in Returns (R'm) 33 667 28 117 -16 687 -2 765 20 314 25 722 37 032
Returns sacrificed (R'm) 21 042 20 385 134 719 127 495 110 943 111 294 104 359
The table above illustrates the full return on assets (ROA) at the weighted average cost of
capital (WACC). The WACC was determined in accordance with the MYPD methodology.
The determined WACC was higher than the single year tariff decision by 70 basis points.
The returns in the above table indicate the return (ROA) that is determined by the application
of the MYPD methodology. However, Eskom is not applying for the full return. The return is
phased in to only substantially recover the debt commitments. The percentages for the
phased-in return is -1.32%, -0.21% and 1.45% which corresponds to -R16 687m, -R2 765m
and R20 314m for the each of the MYPD 4 application years. The returns sacrifice in the
table above shows that the extent of the difference between the full application of the WACC
and what is actually being applied for. The total ROA should have been R374bn if WACC
was applied for. However, Eskom is only applying for a ROA of approximately R1bn over the
MYPD 4 period. This results in a total sacrifice in this instance amounts to R373bn.
Eskom is cognisant of the impact of implementing this full return and will thus not be making
a revenue application related to the full ROA. It is agreed that this is an untenable request
and will not be considered.
As a first step towards sustainability of Eskom, it would be preferable for Eskom to ensure
that the revenue caters for prudent and efficient costs as well as a reasonable return that
matches the debt service commitments (interest and debt repayments). Thus the revenue
related collectively to depreciation and return on assets must match the debt service
commitments entailing the debt repayments and interest payments. This would manifest in a
29% increase in 2019/20, 13% in 2020/21 and 4% in 2021/22 financial years respectively.

However, in the interest of the potential impact on consumers, Eskom has agreed to make a
further sacrifice.
costs, equating to a cash shortfall of totalling R50bn for 2019/20 and 2020/21. This is a
significant sacrifice being made by Eskom in the interest of allowing the economy to adjust
as the migration towards cost reflectivity.
It is clarified that in the migration towards cost reflectivity, Eskom has opted to only make
adjustments to the ROA being applied for. The depreciation is an outcome of a formula
based on the MYPD methodology. The determination of the depreciation is also dependent
on the RAB valuation. This has been determined by an independent consultant in
accordance with internationally accepted cost based method. The primary energy costs and
operational cost projections are based on the actuals experienced for the 2017/18 year.
Significant motivations for each of the primary energy and operating cost projections are
addressed in each of the Eskom licensee submissions. It is thus surmised that it is
reasonable to only use the return on assets for any phasing proposal to be made. This is
exactly what Eskom has done in this revenue application.

Capital Expenditure
12 Capital Expenditure
12.1 Background
A summary of the capital expenditure to be undertaken in the application period and beyond
is provided here. Further details on the capital expenditure projections of each of the
licensees is included in the Generation, Transmission and Distribution MYPD 4 revenue
submissions that forms part of the Eskom MYPD 4 revenue submission.
The MYPD methodology allows for the capital related costs to be recovered over the life of
the assets through return on assets and depreciation. Thus it is clarified that capital
expenditure is not included in the allowed revenue regulatory formula.
The long life capital nature of the electricity industry requires significant focus on build and
replacement of assets for the functioning and reliability of the industry to provide the service
of delivering electricity. In the application window, Eskom capital expenditure plans will focus
on delivering the following projects:
• Generation new build programme- commercial operation of further units of Medupi and
Kusile with some units on accelerated construction plans
• Replaced, expanded and strengthened transmission grid which gets Eskom closer to N-
1 compliance whilst executing the Power Delivery Plan
• Generation technical plan capital expenditure
• Eskom will invest in Cost-Plus mines which will provide Eskom with a more sustainable
source of coal. This is included as future fuel.
• Eskom will also invest in projects to reduce particulate emissions and water
consumption, on the journey towards environmental compliance.
• Investments will be made in the refurbishment and strengthening of existing networks, in
building new networks for customers and in connecting IPPs. Eskom does not include
DOE funded capex into the regulatory asset base.
12.2 Summary of capital expenditure costs

A summary of the capital expenditure requirement is summarised in the table below. It is
clarified that capital expenditure funded by other entities is not included. This refers mainly to
the funding of electrification by the Department of Energy.

Capital Expenditure
TABLE 18 : CAPITAL EXPENDITURE

Capital Expenditure (excluding IDC) Actuals Projections Application Application Application Forecast Forecast
(Rand millions) 2017/18 2018/19 2019/20 2020/21 2021/22 2022/23 2023/24
Generation 34 836 40 713 47 924 36 758 35 452 28 683 32 077
Transmission 4 602 5 081 7 098 10 808 11 458 9 930 6 899
Distribution excluding DOE funded capex 5 173 3 938 5 783 6 284 6 332 6 692 7 094
Total licensee capex excluding future fuel 44 611 49 733 60 805 53 849 53 242 45 306 46 069
Future fuel 1 225 1 638 1 597 3 301 3 175 4 370 2 905
Total licensee capex 45 836 51 371 62 402 57 150 56 417 49 675 48 975
Corporate capex 1 667 1 671 1 400 1 622 1 904 1 827 4 517
Other 0 75 926 687 1 310 4 226 2 204
Eskom Company Capex portfolio (excl IDC) 47 503 53 117 64 728 59 459 59 631 55 728 55 695
12.3 Generation Capital Expenditure
Eskom is executing the largest capital expansion programme in Africa and

executes projects that ensure environmental compliance, transmission
strengthening, customer connections and refurbishment of existing assets
in accordance with Eskom’s project life-cycle model (PLCM).
The two largest projects are the new builds at Medupi and Kusile. Medupi is 95% complete
(as at August 2018) with units 6, 5 and 4 already in commercial operation adding 2 157 MW
to the national grid. Kusile is 89% complete (as at August 2018) with unit 1 already in
commercial operation, adding 720MW to the national grid.
In addition, Eskom is in the process of constructing the following key generation projects:
 Upgrading other existing plants (Matla, Kriel and Duvha Power Stations).
 Executing other Generation coal projects, such as emission compliance projects and
fabric filter plant (FFP) retrofits.
 Constructing a 68 km railway between Majuba Power Station and the coal railway hub in
the town of Ermelo in Mpumalanga.
 Executing the Koeberg steam generator replacement project for units 1 and 2.
 Executing the Ankerlig Transmission Koeberg Second Supply (ATKSS) Project.
 Executing the distributed battery storage project, as an alternative to a 100 MW
Concentrated Solar Power (CSP) plant, at Eskom distribution constrained sites close to
renewable energy Independent Power Producer (IPP) plants and at Sere Wind Farm.
12.4 Transmission Capital Expenditure

Eskom’s transmission network needs to be strengthened and expanded to
connect new loads and generation to the network to enable country
growth. In addition, investments for asset replacement are required for
assets which have reached their end of life in order to sustain a reliable
supply of electricity.

Capital Expenditure
Strengthening and capacity expansion includes generation integration projects required to

ensure that the network is able to evacuate and dispatch power from the source to the load
centres. It also includes projects for planned new customer connections, strengthening the
transmission network to allow for future demand growth and reliability projects relating to
Grid Code compliance requirements.
Replacement investments are required when assets have reached their end of life and can
no longer be reliably operated. These investments are prioritized based on asset condition,
network criticality and risk criteria.
Independent Environmental Impact Assessments (EIAs) are conducted in accordance with

National Environmental Management Act (NEMA) requirements for expansion and asset
replacement projects. Land and servitudes are procured for substation and line construction
projects based on valuations from independent and registered land valuators.
NERSA has published rules in the Grid Code governing investment in the transmission
network. Transmission plans the network according to the Grid Code and subject to funding
and other resource constraints, builds the network according to the Transmission
Development Plan (TDP). Where insufficient funds are available to develop the network, a
consistent set of rules is applied to prioritise projects and allocate funding in such a way that
the maximum benefit is gained for customers.
12.5 Distribution Capital Expenditure

Distribution capital investments support the continued productive life of
assets and the technical conditions necessary to maintain continued
electricity supply to secure revenue streams and improve customer
experience.
The applied for capital expenditure is required to strengthen and refurbish the Distribution
network to meet future growth requirements, whilst allowing the network to maintain current
performance standards.
A key priority is to ensure a reliable and sustainable power supply; the Distribution Licensee
will balance the need for resolving constrained networks whilst providing the supporting
infrastructure for maintenance activities. Historically, the Distribution network performance
gains are reflective of the investment choices made in the capital projects.
The Distribution network capital expenditure is employed in activities that are based on
extensive planning that are implemented for the required network performance. A 10-year

Capital Expenditure
master plan informs the capital investment programme that supports the forecasted
economic growth nodes.
The capital investment programme supports the establishment of the required capacity to
meet the future electricity demand with network performance at an acceptable level of
reliability, maintainability and operability. The capital expenditure is also reflective of the
execution capability within the Licensee, which is based on its own historical performance.
In compliance to the Grid code, a network development plan is formulated informed by the
10-year master plan for the immediate 3-5 year period. Distribution networks investment
drivers
The following factors are the key drivers for the CAPEX expenditure:
 Enabling capacity as a precursor for growth in the economy and support to government
led initiatives up until 2022.
 Further progressing towards regulatory and statutory requirements as per NERSA
requirements which include NRS requirements.
 Ensuring commitment to a Distribution landscape that is focussed on universal access,
IPP Integration and technological advancements, whilst maintaining current performance.
 The historical build-up is extensive and although continued investment is provided in this
area, given the deterioration in the network’s aging profile and regression in the
performance of the aged distribution networks, the requested investment may not fully
suffice.
 Capital for strengthening and refurbishing existing Distribution networks and for new IPP
projects.
12.6 Environmental Requirements
The environmental clause in the Bill of Rights sets the context for environmental protection,
providing for an environment which is not harmful to health and well-being and for ecological
sustainable development. The National Environmental Act and several Strategic
Environmental Management Acts (SEMA’s) give effect to the environmental right in the
Constitution. The development of environmental legislation has resulted in new and more
stringent requirements which Eskom is obligated to respond to in order to continue operating
it power stations. Given the nature of Eskom’s activities these requirements are far
reaching, they affect all the licensees in some manner, including air quality, protection of the
natural environment and biodiversity, water use and the impact on water resources, general
and hazardous waste management, the utilisation of ash and licensing processes. These
legislative requirements lead to operational and capital expenses which must be allowed to

Capital Expenditure
enable Eskom to retain its license to operate. Further details are provided in the Generation
Licensee submission.
12.7 Capital expenditure cost elements
 Basic plant cost

Basic plant cost refers to the basic plant cost estimate at a certain base date. Basic plant
costs are further sub-divided into placed and unplaced packages, local and foreign
component as well as fixed and variable components. No escalation is included in basic
plant cost.
 Contract price adjustments (CPA)/ Escalations

Contract Price Adjustments/Escalations refer to the inflationary adjustments on the basic
plant cost and are applicable to the variable portion of a contract or cost estimate. Contract
Price Adjustments formulae and indices for placed packages are specified in the contract
document e.g. SEIFSA Labour index, and are used to calculate these adjustments.
 Owners development cost (ODC)
ODC refers to the internal Eskom resource costs that are allocated to the project i.e. Project
management, Engineering, Quality assurance etc. These costs are thus capitalised. It also
includes cost directly related to the commissioning of a production unit i.e. commissioning
staff, commissioning coal etc.
 Contingency provision
The contingency provision is a risk allowance for unknown future costs, the contingency is
assumed based on the perceived risk in the project.
 Interest during construction (IDC)

Interest during construction refers to allocation of interest / borrowing cost to a project during
the construction phase.

Primary Energy
13 Primary Energy
13.1 Overall summary of primary energy

A summary of the key elements of the primary energy revenue elements are addressed
here. Further details are included in the Generation Licensee MYPD 4 revenue submission.
This section will cover the primary energy (PE) and levies & taxes (L&T) components of the
building blocks to the allowable revenue formula:
Primary energy costs equates to the costing of the production plan (electricity supply
required to meet demand). There are three sources of electricity supply comprising Eskom
own generation (majority), domestic independent power producers (IPPs) and regional
import of supply (international supply).
Due to the roll out of renewable IPP domestic progammes driven by DOE, there has been a
growing trend in local IPPs over the last few years. International supply represents
substantially the supply from Cahora Bassa. Therefore, Eskom’s own generation is used to
meet the balance of supply as renewables are non-dispatchable.
13.2 Trends in primary energy costs

Eskom’s primary energy cost escalations are summarised as follows:
• Generation own primary energy costs have a compounded average growth rate (CAGR)
of 6.4% per annum from 2018/19 to 2021/22
• Non-Eskom primary energy costs reflect a CAGR of 14.8% per annum between 2018/19
to 2021/22. Of this, local IPPs have a CAGR of 15.6%.
• Total primary energy reflects a CAGR of 9.0% per annum between 2018/19 to 2021/22
• Coal burn costs reflect a CAGR over the period of 7.8% per annum
The table below summarises the primary energy related revenue being applied for in this
MYPD 4 revenue application.

Primary Energy
TABLE 19: DETAILED PRIMARY ENERGY COST
Primary energy costs Actuals Projection Application Application Application Forecast Forecast
(R'millions)
2017/18 2018/19 2019/20 2020/21 2021/22 2022/23 2023/24
Coal usage 46 992 55 087 63 670 65 884 68 956 75 630 83 021
Coal obligations provisions - - - - - -
Water usage 1 796 2 639 2 641 3 036 3 279 4 701 5 058
Fuel & Water procurement service 110 121 132 122 128 134 142
Water procurement service 27 34 24 24 26 27 28
Coal handling 2 223 2 200 2 181 2 067 2 130 2 161 2 265
Water treatment 437 538 507 513 544 576 611
Sorbent usage - 59 138 210 319 392 684
Gas and oil (coal fired start-up) 2 149 2 164 1 893 1 815 1 862 1 899 1 983
Total coal 53 734 62 842 71 186 73 671 77 243 85 521 93 791
Nuclear 820 810 972 887 908 953 987
Coal and gas (Gas-fired) 8 9 9 10 11 11 12
Road repairs - - - - - - -
OCGT fuel cost 320 816 880 948 1 019 1 095 1 175
Demand Market Participation 160 319 339 359 381 403 428
Total Eskom generation 55 044 64 797 73 386 75 876 79 561 87 983 96 393
Environmental levy 8 061 8 068 8 272 8 198 8 147 8 108 8 180
IPPs 21 300 26 549 29 590 34 324 41 002 44 468 46 877
International Purchases 2 768 3 127 3 533 3 734 3 957 4 194 4 459
Total primary energy 87 172 102 541 114 781 122 131 132 667 144 753 155 909
13.3 Revenue for coal costs

While Eskom is a regulated entity, the coal market is unregulated, so Eskom competes with
local and global buyers on price and supply. Although South Africa has abundant coal
resources, coal in close proximity to the power stations is in dwindling supply. Where coal is
procured from sources which do not have a conveyor to the power station stock yard, the
coal must be transported by road and/or rail, instead of being moved over short distances on
conveyor. This adds complexity to the value chain, as well as cost. Eskom purchases
between 113 and 130 Mt of coal per annum. Coal is procured on three types of contracts:
• Cost Plus
• Long Term Fixed Price
• Short/Medium Term

Primary Energy
FIGURE 14: COAL PROCURED CATEGORISED BY CONTRACT TYPE (%)
Annual delivered trend in coal costs for each contracting type during the MYPD 4 period is
reflected in the figure below.
FIGURE 15: ANNUAL COAL EXPENDITURE PER SUPPLY SOURCE
Eskom is facing significant challenges with regards to securing coal for the operation of its
coal fired power stations. These challenges for the short to medium term are reflected in the
figure below.

Primary Energy
FIGURE 16: KEY CAHLLENGES IN ESKOM’S COAL PROCUREMENT ENVIRONMENT
Eskom has historically secured coal at very reasonable prices as reflected in the comparison
made by the Chamber of Mines. The trend continues in accordance with projections made
by Eskom in this application when compared to the Richards Bay price. The Chamber of
Mines has also established for the period 2008 to 2014 (no update available since then) that
the most significant contributors to the cost of mining coal, increases above the producer
price index.
FIGURE 17: COAL PRICE COMPARISONS

Primary Energy
13.3.1 Summary of coal burn costs for MYPD 4 period

Coal burn costs reflect a compound annual growth rate (CAGR) over the period 2018/19 to
2021/22 of 8% per annum.
Coal burn R/MWh increases above inflation from 2017/18 to 2019/20 and then it stays flat
over the rest of the forecasting period.
The relatively large increases in the coal cost in 2018/19 and 2019/20 may be attributed to
the following:
 The increase in the volume of coal on short/medium term contracts.

 The inclusion of unknown coal from 2018/19.
 The exclusion of coal from Optimum mine (stopped coal supply during 2017/18) for
Hendrina Power Station.
 Increase in transport costs associated with short/medium term and unknown coal.
 Decrease in volumes from cost plus mines as the impact of delayed investment and
ageing of mines manifests.
 The inclusion of take or pay payments from 2018/19 for coal from Grootegeluk mine for
Matimba and Medupi Power Stations.
13.4 Independent Power Producers (IPPs)

In accordance with the sections 3.1.4(e) of the GSFA, Eskom is required to consult with and
seeks approval from the Department of Energy (DOE) together with the Department of
Public Enterprises (DPE) and National Treasury with regards to the proposed amounts for
IPP purchase costs and payment obligations to be included in the MYPD 4 application for
the period 2019/20 to 2021/22. In addition, as required by the NERSA MYPD methodology,
projections for the subsequent two years (2022/23 to 2023/24) are included.
Although efficiencies are being realised in various renewable technologies, the Eskom
revenue application related to IPP costs increases over the MYPD 4 period. This is due to
the additional IPP projects being added to the existing contracts and the escalation included
in many contracts that have been finalised.

Primary Energy
FIGURE 18: SUMMARY OF REIPP COSTS OVER LIFE OF CONTRACTS
Renewable IPP costs continue to increase over the MYPD 4 period due to contractual
escalations and increasing number of contracts over the period. This increase in required
revenue related to IPP costs takes into consideration the decreasing trend in energy costs of
the various technologies over the bid windows (BW) as depicted in the figure below. It is
clarified that the contractual commitments made for the earlier bid window, at a higher
average energy price, will continue to be met throughout the duration of the contract.
FIGURE 19: AVERAGE ENERGY PRICE FOR REIPP CONTRACTS (2018 ZAR) OVER BID
WINDOWS

Primary Energy
13.5 Water costs

Eskom receives raw water from the Department of Water and Sanitation (DWS) and Rand
Water. This water is then treated for its intended use for human consumption or for the plant.
The power stations cannot function without water for cooling the plant and producing steam
for the turbines.
The cost of water is impacted, not only by how much water is consumed, but to a larger
extent by tariffs. Over the 2019/20 – 2021/22 periods, the total volumes of water consumed
decreases, but the cost of water is expected to increase because of the increase in existing
tariffs and the introduction of additional tariffs. These tariffs are legislated, as are their
increases.
The cost of water also depends on the source (certain schemes are more expensive). New
infrastructure is likely to be more expensive, so the water from that source will have a higher
tariff. Some schemes have specific tariffs; e.g. water from the Vaal attracts the Vaal River
Tariff. The introduction of environmentally friendly measures, such as the Demand
Management Levy or the Waste Discharge Charge, adds to the cost of water. Eskom is a
strategic user of water, consuming approximately 2% of the total annual use of the country,
which is equivalent to the consumption of the City of Cape Town. As the demand for
electrification grows, there will be an increased demand for scarce water supplies.
13.6 Open Cycle gas Turbine (OCGT) Fuel

From a planning perspective, the OCGTs are considered together with the other available
supply and demand options as peaking stations for use during peak hours which provides
space for essential maintenance at base-load stations as well as for emergencies as a last
resort before load reductions during extreme events. The load factor for OCGTs during the
forecasting period was assumed to be 1%, which translates to 211 GWh per annum. The
fuel used is mainly diesel (Ankerlig and Gourikwa). The price of the diesel is subject to the
international USD price of Brent crude oil and the ZAR/USD exchange rate. The official
Eskom economic parameters for the forecasting period were used in the calculations of the
fuel costs. The diesel used by Eskom is subject to a wholesale discount and a fuel rebate as
determined by the Minister of Finance.
13.7 Demand Response

The Demand Response (DR) programme fulfils an important role towards power system
security (even during times of surplus capacity) by providing the System Operator (SO) with
much needed flexibility and reliability. The SO uses reserves to control the interconnected

Primary Energy
power system frequency. These reserves are procured from both generators and the
Demand Response (DR) programme through the ancillary services process as defined in the
Grid Code.
Factors that could affect the frequency stability of the electricity supply include:
• System constraints caused by severe weather and/or power line faults
• Generator malfunctions (unexpected trips – loss of multiple Generation units)
• Substantial load and renewables forecast errors due to unforeseen circumstances.

13.8 Environmental levy
The environmental levy on the generation of electricity from non-Renewable generators was
promulgated in July 2009. All Eskom generators, with the exclusion of Hydro and Pumped
Storage Power Stations, were registered and licenced as manufacturing warehouses as
required by the legislation.
13.8.1 Environmental levy payment

From 1 July 2012, the environmental rate is 3.5c/kWh. The actual payments to SARS are
determined by the true metered generated volumes. For this submission the Production Plan
which measures Energy Sent Out as measured after the high voltage transformer is used to
derive the assumed cost. To obtain the Generated volume an expected auxiliary
consumption, based on actual historical performance, which is unique to each Power Station
is added to the Energy Sent Out volume as published in the Production Plan. This derived
Generated volume is then charged at the applicable Environmental Levy rate for that period
to obtain the forecasted cost per Power Station. It is assumed for the planning period that no
further rate increases will occur.
The methodology, as approved by NERSA is based on the principle that the levy is raised at
electricity production and that the electricity sales volumes is lower than the production
volume. Thus the environmental levy cost is equivalent to the revenue related to the
environmental levy.

Operating Cost
14 Operating Cost
14.1 Overall summary of operating costs
The operating costs at Eskom level are summarised here. Further details on each of the
licensees’ operating costs are provided in the Generation, Transmission and Distribution
MYPD 4 Revenue submissions which form part of Eskom’s MYPD 4 revenue application.
Integrated Demand Management is addressed in the Distribution Licensee MYPD 4
submission.
This will cover the operating expenditure (E) element of the building blocks to the allowable
revenue formula.
TABLE 20 : DETAILED OPERATING COSTS
Actuals Projection Application Application Application Forecast Forecast

Operating costs (R'millions)
2017/18 2018/19 2019/20 2020/21 2021/22 2022/23 2023/24
Employee benefit costs 24 455 27 140 26 762 27 684 28 935 30 370 32 147
Operating & Maintenance 26 304 28 214 29 232 31 235 32 515 32 834 34 184
Maintenance 13 992 16 462 16 272 16 964 18 541 18 497 19 382
Opex 12 313 11 751 12 959 14 271 13 974 14 337 14 802
Operating costs before other income 50 759 55 354 55 994 58 919 61 449 63 204 66 331
Other income (1 786) (1 127) (1 206) (1 244) (1 301) (1 368) (1 424)
Operating costs before Arrear debts 48 973 54 228 54 788 57 675 60 148 61 836 64 907
Arrear debt Impairments 3 643 4 436 2 196.7 2 525.3 2 914.9 3 220.9 3 400.4
Operating costs with Arrear debts 52 616 58 664 56 984 60 200 63 063 65 057 68 308
Corporate social investment - not claimed in
application (289) (292) (192) (193) (151) (149) (166)
TOTAL OPERATING COSTS 52 327 58 371 56 792 60 007 62 912 64 908 68 142
IDM - disclosed separately (138) (186) (189) (193) (202) (213) (225)
Research & development - disclosed
separately (111) (167) (176) (187) (198) (210) (223)
OPERATING EXPENDITURE
52 078 58 018 56 427 59 627 62 512 64 485 67 694
EXCLUDING IDM AND R&D
Eskom’s operating costs, excluding impairments, over the period 2020 to 2022 (application
years) have grown at rates less than inflation. Analysis reflects that employee benefits have
an average increase of 2.2% (after capitalisation) in this horizon. Similarly, the operating and
maintenance costs have an average increase of 4.8% over the period.
Significant efficiencies would be achieved over the period by reducing the number of
employees and seeking other efficiencies within the workforce numbers without
compromising the required skills in appropriate areas will be possible. This will be done by
re-training, re-deployment and re-skilling of the work-force and natural attrition. The growth

Operating Cost
in maintenance costs escalates due mainly to the increased maintenance in the network
businesses.
FIGURE 20: OPERATING COSTS
14.2 Employee Benefits
Approximately 80% of Eskom’s staff complement belongs to the bargaining unit and 20% are
positioned at managerial level.
Employee benefits costs are influenced by three main factors:

• Staff complements
• Employee benefits increases
• Level of remuneration
14.2.1 Staff complement
The planned number of employees for Eskom regulated business is assumed to decrease
over the application period. This will occur through planned attrition or alternates that support
savings initiatives and efficiencies.

Operating Cost
14.2.2 Employee benefits increases
When comparisons are made to Eskom’s employee benefit escalations,

they are either to the overall generic labour market (Market move) or to
average settlements (for bargaining unit). The employee benefit costs
comprise of direct remuneration (salary, pension, medical aid, bonus,
overtime) and indirect remuneration (training and development, temporary and contract
staff).
Eskom has recently settled its wage negotiations with the employees in the bargaining unit.
These settlement increase percentages formed the basis of the revenue application that is
being made. The settlement in the bargaining unit, with regards to the wage increases for
the 2019/20 and 2020/21 years was 7%. The concomitant adjustments to other benefits, as
negotiated, would need to be considered. The salary adjustments for the bargaining unit
employees are above the inflation rate. Assumptions were made on the salary adjustments
for the managerial employees as well. The overall increase in employee benefit costs is
tempered to a certain extent by a decrease in the number of employees.
FIGURE 21: PROJECTED OF NUMBER OF EMPLOYEES OVER THE MYPD 4 PERIOD
i. In assessing Eskom’s market position the following is important:
ii. Eskom has consistently benchmarked the salaries and related benefits of all levels of
employees to ensure meaningful market alignment. For this purpose Eskom
participates in market surveys conducted by both the Deloitte Salary Survey and
the PE Corporate Services salary survey. The two surveys cover 850 South African
employers, and more than 1.5 million employees. This process allows for the

Operating Cost
meaningful comparison of Eskom remuneration levels within the broader labour

market.
iii. Eskom operates from more than 450 geographic worksites across the country placing
strain on the supply and retention of skills in general. The extent of and the duration of
technical training and safety authorisation of employees deployed on the Generation,
Transmission and Distribution side of the business, further requires that measures are
put into place to stabilise the work force and minimise turnover.
iv. As a responsible employer and with due regard to the social and economic challenges,
salaries at lower level of the business are positioned above the market median,
however managerial level remuneration are closely aligned with the market.
14.3 Operating and Maintenance costs
As the business strives to accelerate maintenance programmes, and with the

aging of plant it is expected that maintenance costs should increase.
14.3.1 Generation maintenance
The key drivers for generation maintenance costs included
• Capacity expansion
Eskom is in the process of commissioning two new coal power stations – Medupi and Kusile.
Once fully commissioned, these will increase the Eskom fleet generating capacity by
approximately 20%.
• Reserve storage stations
According to the Production Plan, at an overall assumed Eskom fleet EAF of 78%, four coal
stations can be placed into reserve storage, as they will not be needed to produce electricity
to meet the demand. The stations are Hendrina, Grootvlei, Komati and Camden. In addition,
a “stress test” scenario at an EAF of 75% showed, however, that all 4 stations would need to
run to meet the system demand throughout the MYPD4 period. Therefore, at this stage, it is
premature to decommission these 4 stations and a decommissioning decision has not yet
been made. Generation has, however, reduced the operating costs at these 4 stations over
the planning period to reflect a reduction in activities during a period of reserve storage.

Operating Cost
• Ageing fleet and high UCLF impact on maintenance costs
The existing operational fleet of power stations is now on average about 32 years old and
more than half of the coal-fired fleet will be older than 37 years by the start of the MYPD4
period. Thus, a real increase in maintenance costs on this ageing fleet over the next 10
years is expected due to additional maintenance activities and mid-life refurbishments on
older power plants.
14.3.2 Transmission
Transmission maintenance workload is driven by the size of the network and the age of
assets. The expansion of the transmission network will result in increased maintenance
workload going forward. Transmission’s maintenance strategy includes the compilation and
review of maintenance philosophies, standards and procedures.
The maintenance philosophy is mostly time-based, but also considers the following:
• Operational information (usage)
• On- and off-line condition monitoring
• Plant performance information
• Non-intrusive functional testing
• Statutory requirements
• Safety of assets and people
Maintenance is planned and executed in accordance with maintenance standards and

procedures. A maintenance management system is used for maintenance planning and
scheduling.
Live line maintenance is utilised to overcome planned outage constraints or during

emergencies. This requires specialised skills and equipment which has an impact on
maintenance costs.
14.3.3 Distribution
Distribution’s existing infrastructure has reached an advanced stage of its asset life; planned
electrification networks now means certain networks are at near the end of life. Future
connection and changes in the customer base requires a sustainable maintenance regime.

Operating Cost
The following factors are important maintenance expenditure considerations
• Aging Network: Refurbishment requirements have been identified to address the aging
network. Inadequate refurbishment will contribute to increased maintenance
requirements. The inability to address these maintenance requirements will lead to
further declines in performance.
• Access to Skills: Maintenance requirements are based on Distribution having
sufficiently skilled resources. Reduction in these will compromise preventative and
corrective maintenance requirements
• Universal Access: Acceleration of the Universal Access Programme will result in
corresponding growth in the asset base which impacts the maintenance regimen.
Distribution maintenance strategy includes both preventative (planned) and corrective

maintenance (faults/unplanned).
An increased focus is placed on planned maintenance in shifting performance and will be

achieved through a number of key actions:
• Increase the ratio and time spent on planned maintenance and corresponding reduction
in unplanned maintenance towards the end of the application period
• Focus on Low Voltage (LV) networks due to its close proximity to the customer base,
specifically in the electrification areas
• A new proactive vegetation management which supports and aids the reduction of
conductor faults and leads to improved performance in reliability and quality of supply.
Distribution continues to embrace efficiency measures through its condition based

maintenance programs in its maintenance standards and regimes. These regimes are
further reflected within the maintenance strategies
• Trend in maintenance costs
There is an overall increase in maintenance costs over the MYPD 4 application period. The
maintenance undertaken is based on activities that need to be undertaken in accordance
with the maintenance requirements, strategy and legislative requirements.
14.4 Other Operating Expenses
Other operating costs are forecasted to grow from R12 959 m in 2019/20 to R14 271
m in 2021/22. These costs then forecasted to drop to R13 974m in 2021/22. This
reflects certain significant changes that occur during this period.

Operating Cost
Included in this category are costs such as insurance, IT (information technology), fleet
costs, legal and audit services, security, travel expenses, billing costs,
connection/disconnection costs, meter reading, vending commission costs and telecoms.
• Insurance cost increases reflect the increase in the asset base as well as global
premium increases. Factors that influence cover and pricing include insurance claim
trends, loss ratio performance, value of insurance excess, new-build programme, re-
insurance costs, increases in insured asset values and risk management efforts.
• The increase in Security expenditure is due to increased initiatives by Eskom to

safeguard assets, combat theft incidents and mitigate the related risks.
• Telecommunication services is required for supervisory control and data acquisition

(SCADA) and enabling remote access to fault recording systems as well as control
centre communications.
• Meter reading - reading of Small Power Users (SPU) and Large Power User (LPU)
billed customer meters are done mostly on a quarterly basis.
• Disconnection and Reconnection costs - costs incurred to manage outstanding debt by

disconnecting non payers and reconnecting once the payment is made.
• Shared services costs for billing customers – management of inflow and revenue
management compliance
14.5 Research, Testing and Demonstration
The electricity industry is going through significant challenges driven by

technology disruptors as well as market, policy and industry drivers. The
power utility needs to respond to these challenges with the need for greater
flexibility, rapid technology advances across the entire value chain and
adapting to changing business models.
Balancing social, environmental and economic imperatives relies heavily on technology

development and breakthrough to provide a way forward when all other routes appear
blocked. Eskom Research, Testing and Development (RT&D) is therefore dedicated to
finding technology solutions that can be applied primarily within Eskom to ensure it fulfils its
mandate to South Africa. ‘We are predominantly a technology early follower’ - Except for a
few carefully chosen areas, Eskom does not wish to lead technology development. Rather it
will focus on technology identification, acceleration and application, not technology
development.

Operating Cost
Eskom is a needs driven organisation focussed on the systematic acquisition of knowledge

and the application, development, refinement or demonstration of new and innovative
technologies and solutions to satisfy Eskom’s operational and strategic requirements
through centres of expertise.

Economic Landscape Changes
15 Economic Landscape Changes

15.1 World Bank Report
Certain points from the World Bank Report, Making Power Affordable for Africa and Viable
for Its Utilities, Masami Kojima and Chris Trimble, 2016 have been highlighted below. This is
hoped to provide a balanced view of the report.
 The report suggests that Eskom is overstaffed. Eskom should be able to perform its
function with less than half its staff. An analysis of this has been undertaken and is
summarised at the end of the section on the World Bank report.
 Of the 39 countries studied, only the Seychelles and Uganda were fully recovering their
operational and capital costs. In only 19 countries did the cash collected by utilities cover
operational costs; just 4 of these countries were also covering half or more of capital
costs, based on new replacement values of current assets. Such large funding gaps
prevent power sectors from delivering reliable electricity to existing customers, let alone
expand supply to new consumers at an optimal pace.
 A utility that does not cover its costs will struggle to deliver reliable electricity in sufficient
quantity.
 Quasi-fiscal deficits—the difference between the net revenue of an efficient utility and the
net cash it collects—averaged 1.5 percent of gross domestic product (GDP). It was
feared that the substantial quasi‐fiscal activities observed in these countries could have
large macroeconomic effects as governments were forced to intervene to finance these
activities.
 Most countries may need to increase tariffs. In two-thirds of the countries studied, the
funding gap cannot be bridged simply by eliminating operational inefficiencies; tariffs will
have to be increased even after achieving benchmark operational efficiency.
 Small, frequent tariff increases may find wider acceptance than infrequent large
increases. To eliminate fuel subsidies, India and Thailand raised fuel prices by small
fixed amounts every month, announced in advance, until cost-recovery levels were
reached.
 Targeting tariff increases to customers who account for the bulk of consumption and can
afford to pay more would limit adverse effects on the poor. As with commercial losses, it
would make sense to focus tariff increases first on large- and medium-size customers,
for whom affordability is not as significant a challenge as for small-consumption
households. Although the political sensitivity of tariff increases to wealthier consumers

cannot be ignored, it should neither be overemphasized. In the face of large utility

deficits and low access rates, there is no compelling reason to subsidize those who can
afford higher tariffs. Indeed, they could be asked to cross-subsidize low-income
consumers more, as long as the latter’s total consumption is a small fraction of the total
electricity sold. Successful examples of power sector reforms in emerging countries in
other regions show that middle- and high-income consumers in all tariff categories
usually accept cost-reflective rates provided the quality of electricity services is good.
 Sharp drop in commodity prices has had significant repercussions for Africa. The prices
of commodities crucial to the earnings of many African economies rose between 2001
and 2008, but have fallen sharply since.
 Some African governments have attempted to expand access to electricity by
subsidizing its use, the cost of connection to grid electricity supply, or both. However, in
the face of a falling fiscal balance, there is little room for large-scale government support.
This restriction underscores the need to improve utility performance, adjust tariffs to
achieve cost recovery, and design subsidy support in a way that maximizes the benefits
to the neediest.
 The full cost recovery approach covers all cash needs as well as all capital costs—with
depreciation and the rate of return on invested capital forming the basis for calculating
capital costs—and decommissioning costs where applicable. If all costs are fully
recovered from payments by consumers, the utility is financially sustainable over the
long run.
 The electricity sector in Africa is far from mature. The medium- to long-term target is to
reach tariff levels that fully cover all reasonably and prudently incurred costs. If, revenues
fall far short, the first priority is to meet all cash obligations.

FIGURE 22: COMPARISON OF ELECTRIC SUPPLY COSTS WITH CASH COLLECTION IN 2014
(U.S DOLLARS PER KWH)
 The Figure above compares the cash collected from bills sent out with the total costs of
supply—broken down into operational and capital expenditures—per kilowatt hour (kWh)
billed. The findings show that only the Seychelles and Uganda fully covered both
operational and capital expenditures. Cash collected in 19 countries covered operational
expenditures, leaving 20 with insufficient cash to cover these.

TABLE 21: QUASI-FISCAL DEFICITS OF UTILITIES UNDER CURRENT PERFORMANCE IN

COUNTRY REFERENCE YEARS
Source: Trimble et.al 2016

Note: Quasi-fiscal deficits are in current U.S dollars in the reference year
 The quasi-fiscal deficit is the difference between the net revenue of an efficient electricity
sector covering operational and capital costs and the net cash collected by the utilities.
The results of this computation are shown in table above. South Africa had the largest
quasi-fiscal deficit in absolute terms, $11 billion.
15.1.1 Breakdown of Hidden costs

Efficient operation—also referred to as benchmark performance—is defined here as follows:
 Transmission and distribution losses (both technical and commercial) of 10 percent of
dispatched electricity or lower
 100 percent bill collection
 The same staffing level as in well-performing, comparable utilities in Latin America

FIGURE 23: BREAKDOWN OF HIDDEN COST
15.1.2 Comparisons, benchmarking and efficiency of Operating and Maintenance

cost
In summary, the World Bank’s report estimated that Eskom's Transmission and Distribution
(T&D) staff should optimally number around 9596 and Generation 4648, for a total of
142442. They describe their methodology as follows:” The benchmark number of employees
for T&D is set by km of T&D lines with voltage greater than 1 kV and the number of
customers. The total numbers of employees reported in the utilities’ annual reports are
compared with the staff complement in utilities in three clusters of power utilities in Latin
America with similar numbers of customers and km of T&D lines. Clusters were first
identified in SSA, and then reference values were identified using utilities in Latin America
with similar characteristics, as described below” 3. For Eskom T&D their estimate was
apparently based on a network size of 79811km4 and customer base of 54776025. For
Eskom Generation they used a total installed capacity of 44281MW 6.
15.1.3 Transmission and Distribution:

The World Bank report’s source for Eskom’s network size was Eskom's Integrated Report
(IR) 20157. However, as the table below illustrates, the World Bank’s report omitted to factor
in the network below 22kV – clearly nothing more than a human error that slipped through.
2 Source: World Bank Policy Research Working Paper 7788 : Financial Viability of Electricity Sectors in Sub- Saharan Africa:
Quasi-Fiscal Deficits and Hidden Costs - Technical Report - August 2016, Table 10 p.48, August 2016
3 Page 79, for Transmission and distribution
4 Table A4.2, p.89
5 Table 10, p.48
6 Tables A3.1, A3.2, A4.1, p.85 to 88
7 Source: Fact Sheets Statistical Table 3, 'Power lines and substations in service at 31 March 2015'

The network size for Eskom as per the World Bank report is thus 21.7% of the actual
network size as it was at 31 March 2015:
TABLE 22: POWER LINES
Using a reference group of fourteen Latin American electricity utilities, the World Bank’s
report then calculated values for ‘clusters’ consisting of customer base and network size. For
larger networks the ratio was from 33 to 54 customers per km of network. Having derived /
assumed ratios for ‘customers per km of network’ for each cluster in SSA, it thus allowed the
optimal employee numbers to be estimated by using either the network size or the customer
base. For example: if assuming 50 customers per km of network, it would be possible to
express the optimum staffing number metric as either ‘500 customers per employee’, or
‘10km of network per employee’.
However, had Eskom’s correct network size of 368 331km been used instead of 7 9811km, it
would have been apparent that Eskom’s network is much less ‘dense’ in terms of ‘customers
per km’ i.e. around 15 customers per km (due to many individual customers being municipal
customers thus not counted as individual Eskom customers). The World Bank report also
comments on this matter i.e. “The most significant example is South Africa, where Eskom
sells to dozens of municipalities, which in turn account for 40 percent of sales to end-users.
Therefore for Eskom it would be more appropriate to derive optimal staffing numbers from
the (correct) network size which is nearly five times larger, or to use a more moderate ratio
of ‘customers per employee’ given that many customers are located within municipalities and
not reflected in the Eskom customer numbers.
For example, when using 16km of network per employee (equal to the World Bank report’s
average for the four largest Latin American networks and higher than their overall Latin
American average of 12), it translates to 23 000 employees for Eskom T&D (similarly, when
using a ratio of 240 customers per employee).

15.1.4 Generation:
For Eskom Generation the World Bank’s report estimated the optimum staffing number at
4648 for the total installed capacity of 44281MW, which implies a ratio of 9.53MW of
generation plant capacity per employee. This is significantly higher than the World Bank
report’s implied average for Africa of 2.3MW per employee – and with 75% of electricity
generation in SSA (excluding South Africa) produced from hydro and natural gas plants it
could be argued that the ratio of MW per employee for SSA should be higher than for
Eskom, not lower as implied by these numbers. For coal plant specifically, the World Bank
report implies a ratio of 2.44MW per employee in the case of Botswana, whilst using a ratio
for Eskom of 9.53MW per employee which is also (mostly) coal plant.
Eskom’s own further research based on published US Government data indicated that the
ratio of generation plant capacity per employee for US coal power stations is around 3.7MW
per employee. It therefore appears that also on the optimum staffing numbers for Eskom’s
generation activities, a human error might have slipped in. Using a more moderate ratio of
3.2MW per employee (14% lower than the US data for coal plants, but 30% higher than the
World Bank report’s ratio for coal as per Botswana and 40% higher than their ratio for SSA
for mostly hydro and natural gas plants), it translates to 14000 employees for Eskom
Generation.
It is thus hoped that these clarifications could be made with regards to the World Bank
report.
15.2 Economic Impact Study
Eskom had commissioned two studies with regards to economic impact. The first is an
overview and analysis of economic trends in relation to electricity. Certain trends are
discussed here to illustrate the changes in the economic landscape in South Africa. The
second study aims to provide an understanding of the macroeconomic impacts of alternative
scenarios to meet Eskom’s five-year revenue requirement. Each study is summarised here.
15.3 Economic Landscape Changes
Deloitte Consulting has undertaken to provide an overview and analysis of economic trends
in relation to electricity in South Africa. Certain trends are discussed here to illustrate the
noticeable changes in the economic landscape in South Africa.
15.3.1 Overview of historical trend in electricity consumption in South Africa
The relatively energy-intensive mining and manufacturing industries remain the dominant
consumers of electricity in South Africa – they account for circa 60% of national electricity

consumption and about 22% of GDP. The results of several local and international studies
on the key determinants of electricity consumption suggest that income or GDP is the
dominant driver of demand. The sensitivity of consumers to changes in electricity prices
appears to vary significantly over time and depends on the direction and magnitude of price
increases and the prevailing price level.
There is evidence of strong positive correlation between GDP growth and growth in
electricity sales in the country - the correlation coefficient between Eskom’s local sales of
electricity and GDP over the 20 years between 1997 and 2016 is 0.93. A previous study
found that the income elasticity of demand over the period 1990 to 2005 was almost unit
elastic. This means that a 1% increase in GDP was associated with close to a 1% rise in
electricity demand (once the influence of other important determinants such as price and
supply constraints have been accounted for).
In recent years and particularly since FY2012, growth in Eskom’s local electricity sales has
been much lower than growth in GDP. While GDP expanded at an average rate of 1.9% y/y
between FY2012 and FY2016 Eskom’s local electricity sales were falling, averaging -0.9%
y/y. In FY2013 electricity sales fell by ~4.2% y/y as a sharp fall in the global demand for
commodities hit production in South Africa’s relatively electricity-intensive mining and
manufacturing industries.
Supply constraints also put a brake on demand as Eskom re-introduced rotational

loadshedding in early 2014, and there was regular loadshedding between November 2014
and September 2015.
Electricity sales fell at an average rate of -0.3% y/y over the first three years of the 5-year
MYPD3 period which runs for 2013/14 to 2017/18 - much lower than the annual growth in
electricity sales of 1.8% that it forecast for these years when submitted its MYPD3
application. Much of the sales forecast variance can be attributed to disappointing GDP
growth - Eskom assumed that real annual GDP growth would average 4.5% but GDP growth
averaged just 1.5% in the first three years of MYPD3. The slower-than-anticipated sales in
first three years of MYPD3 were however also a result of unforeseen falls in global demand
for commodities and the re-emergence of local supply constraints. With annual GDP growth
forecast to average 1.8% for the 5-year period to 2021 (IMF & EIU forecasts), growth in
electricity sales is unlikely to average more than 1% per annum particularly given evidence
of a persistent trend-decline in the electricity intensity of growth and assuming that real
electricity prices will continue to rise as Eskom transitions to a tariff that is more reflective of
its prudently and efficiently incurred costs.

15.3.2 Trend in electricity prices
For much of the four decades to 2008/9 real (inflation-adjusted) electricity prices in South
Africa were on the decline. By 2007 electricity tariffs in South Africa were among the lower in
the world, but the power supply crisis that had been threatening for several years had also
reached a critical point. Eskom introduced loadshedding and was given the green light to
embark on a massive build programme – the first major increase in power generation
capacity the utility had undertaken in almost 30 years.
Between 2008 and 2013 NERSA approved several sharp increases in annual tariffs
which, in line with the regulatory methodology, would enable Eskom to raise the
future revenue streams in needed to cover the new build - electricity prices more than
doubled in real terms (inflation-adjusted) rising by a cumulative 114%. The sharp
increases in real electricity prices over the 5-year period were met with increasing public
resistance. NERSA subsequently awarded Eskom increases of roughly CPI plus 2% for the
5-year MYPD3 period. The tariff increases awarded by NERSA over the MYPD3 period
(since 2013) have proved inadequate and Eskom’s revenue shortfall has begun to
mount. In November 2016, S&P Rating’s agency further deepened Eskom’s non-investment
grade status to reflect Eskom’s deteriorating financial position which continues to put South
Africa’s sovereign credit rating at risk.
15.3.3 Requirements of an efficient electricity pricing regime
Electricity pricing regimes often try to satisfy a range of social, economic and political
objectives, but we argue that the primary objective must be to ensure that resources are
allocated efficiently. In terms of economic theory, a ‘cost-reflective’ tariff is defined as a tariff
equal to the long-run marginal cost (LRMC) of supply. While theoretically robust, LRMC is
difficult to accurately estimate and operationalise. It is argued that the RoR methodology
usually gives rise to tariffs that are equivalent to LRMC. The extent to which tariffs under the
ROR methodology approximates LRMC appears to depend on the basis for asset valuation
and/or the rules for depreciating the asset base. While an efficient pricing regime is a
necessary requirement to ensure the efficient delivery of electricity services by the utility
(even if a monopoly) it is not sufficient – internationally accepted governance practices must
be adhered to, to ensure that sound and least-cost investment decisions are made. Eskom
estimates that an approved tariff of 67.7c/kWh in 2014/15 would need to have risen by
23% in order to reach the fully cost-reflective tariff of 83.9c/kWh. It is noted however
that the gap between actual and cost-reflective tariffs is not static, particularly during a period
of capacity expansion when new assets are being added to the regulatory asset base.

Specific strategies for the transition to cost-reflective electricity tariffs in South Africa include:
 Encourage open conversations on the implicit electricity price subsidies which are
heavily reliant on the limited fiscal resources. Support the conversation with a coherent
communication strategy that provides the public with information on the magnitude of the
subsidy and their shortcomings. The regulator must review its approach on the regulation
of municipal tariffs to address large discrepancies in tariffs levied by municipal
distributors as this is an obstacle to the transition to cost-reflective tariffs.
 Government should develop a clear plan for the transition to cost-reflective tariffs, with
appropriate phasing and provision of targeted subsidies and other mitigating measures
for vulnerable groups.
15.4 Macroeconomic impacts of alternative scenarios
15.4.1 Aim of the study
The aim of this study is to provide an understanding of the macroeconomic impacts of

alternative scenarios to meet Eskom’s five-year revenue requirement. While, like previous
studies, the study should show the impacts on GDP, employment, and inflation during the
five-year period, it should also demonstrate the impact on the fiscus (debt ratios and budget
balance). We have also attempted to demonstrate some of the broader or longer-term
economic consequences of government debt accumulation in scenarios where tariff
increases generate insufficient revenue to cover Eskom’s costs – this included a scenario
where government debt accumulation associated with low tariff increases, triggers a sub-
investment grade credit rating downgrade.
15.4.2 Key scenario assumptions, and scenarios modelled
For this modelling exercise, Eskom advised Deloitte to model the impacts associated with
three alternative tariff scenarios – average annual increases over a five-year period of 8%,
13% and 19% respectively. In November 2016, when this study commenced, Eskom had not
yet finalised its forthcoming tariff application nor had it decided whether it would submit a
tariff application for a single-year or for a multi-year period. As such official estimates of
Eskom’s required revenue and sales forecasts over the next five years were not available,
the scenarios are therefore hypothetical and we have made the following key assumptions:
 We assume that the upper-bound annual average increase of 19% is what Eskom
requires to reach and maintain a cost-reflective electricity tariff over the 5-year period
from 2017 to 2021.

 We assume that Eskom’s total revenue requirement is the same across all tariff
scenarios and that it is equivalent to the revenue that would be raised if tariffs increased
at an annual average rate of 19%. For example, under the 8% tariff scenarios, Eskom
experiences an annual revenue shortfall equivalent to the difference between the total
revenue raised under a compounded 19% tariff increase and the compounded 8%
increase. We then have further scenarios to model how the shortfall will ultimately be
recovered– e.g. by raising additional government debt (borrowing) or taxes.
Three main categories of policy simulations were modelled, each with a different set of
assumptions and for three tariff path options – 8%, 13% and 19% (where applicable) This
resulted in a total of five simulations all of which represent an alternative potential solution to
meet Eskom’s total revenue requirement over a five-year period. The scenarios modelled
included a ‘tariff-only’ option where electricity tariffs increase at an annual rate of 19% over
five years and a baseline scenario (BAU) where tariffs increase at an average rate of 8%
and the revenue shortfall is funded by raising additional government debt. Further scenarios
included a 13% annual tariff increases with a debt-funded shortfall, an 8% increase with tax-
hike funded shortfall and a downgrade scenario, explained further below. At the time the
modelling was undertaken (January 2017) we judged that there was also a significant risk
that steadily rising government debt levels associated with the baseline tariff scenario of 8%
would trigger a sub-investment grade (S-IG) credit rating downgrade.
To simulate the economic impacts of this downgrade risk materialising we ran an alternative
baseline simulation (BAU2) where a steadily rising debt-to-GDP ratio and deteriorating
budget balance that is associated with an 8% average tariff increase triggers a S-IG credit
rating downgrade. A visual summary of the five simulations modelled is provided in the figure
below.

FIGURE 24: SUMMARY OF SCENARIOS MODELLED
15.4.3 Interpreting results of hypothetical scenarios – particularly post-downgrade
As explained above, the tariff increases are hypothetical. In addition, the potential S-IG
downgrade we modelled under the ‘alternative baseline’ (BAU2:8%, debt) has, in effect,
already transpired. While the magnitude of the tariff increases chosen are hypothetical the
scenarios still usefully illustrate the relative macroeconomic impacts of the various options
available to meet Eskom’s revenue requirement which include 1) Increasing the tariff alone
2) a combination of low tariff increases and raising government debt and 3) a combination of
low tariff increases and tax hikes.
Furthermore, while the anticipated S-IG downgrade has already occurred, it does not mean
that credit-rating downgrade risk associated with debt accumulation under a ‘much lower-
than-required’ tariff increase is now irrelevant or even diminished. As RMB (2017) notes,
countries that are downgraded to sub-investment-grade typically experience a continual
negative feedback loop. Following a SI-G event, as sentiment sours and interest rates
increase, the fiscal position deteriorates. As the fiscal position deteriorates, interest rates
rise and economic growth slows, further credit rating downgrades within ‘junk’ territory are
triggered. As RMB (2017) notes, “countries take seven to nine years, on average, to recoup
their investment-grade rating, following a downgrade, to speculative grade”.
15.4.4 Approach
The model selected for the simulation of the alternative scenarios to meet Eskom’s revenue
requirement is the University of Pretoria General Equilibrium Model (UPGEM) described in
Bohlmann et al. (2015). UPGEM is a flexible Computable general equilibrium (CGE) model
that for purposes of this study is used in standard recursive-dynamic mode.

15.4.5 Key findings and results
The results show that an annual tariff increase of 19% is expected to have a slightly negative
impact on GDP and employment growth relative to the baseline scenario (where tariffs rise
by 8% a year and government borrows the shortfall). For example, under the 19% tariff
scenario (1B), GDP is forecast to expand at an average rate of 2.0% y/y, which is 0.3
percentage points lower than the 2.3% y/y growth forecast in the baseline (BAU1). Total
employment is expected to grow at an average rate of 0.9% y/y under a 19% tariff increase
compared to 1.2% y/y in BAU1. This implies that under a 19% tariff increase scenario,
137000 fewer jobs will be created and sustained annually over the period 2017 to 2021,
relative to BAU1. These results are consistent with those NERSA (2013) obtained when it
presented the economic impact of similar tariff scenarios in its reason for decision on
Eskom’s MYPD3 tariff application.
FIGURE 25: IMPACT ON TREND IN REAL GDP AND EMPLOYMENT GROWTH – 1A, 1B, 3A
RELATIVE TO BAU1 AND BAU2
4.0 Real GDP growth
3.0
2.0
y/y%
1A: 13%, debt 1B: 19%, tariff

1.0 BAU2: 8%, downgrade 3A: 8%, VAT
BAU1: 8%, debt
0.0
2…
2…
2…
2…
2…
2…
2…
2…
2…
2…
Employment growth
1.8%
Growth in total employment
1.6%
1.4%
1.2%
1.0%
(y/y%)
0.8%
0.6%
0.4%
0.2%
0.0%
2016
2018
2020
2022
2024
2026
2028
2030
Our results however suggest that the impact of higher tariff increases on CPI inflation over
the next five-year period would be more muted than what NERSA (2013) previously

indicated. The simulation results suggest that scenarios with higher annual electricity price
increases of 13% and 19% (1A and 1B respectively) have very little impact on CPI inflation -
inflation rises in both cases by less than 0.1 percentage point, averaging 5.8% y/y in the five-
year period from 2017 to 2021 and 5.5% y/y thereafter. While the low-CPI impact
associated with relatively high tariff increases may seem counterintuitive, it can be attributed
to the fact that higher tariff increases are expected to have a negative impact on GDP growth
and employment. Given that GDP growth was already expected to be relatively subdued
over this period (relatively to potential GDP growth of 3%), sluggish demand is likely to keep
inflation in check.
We noted previously that in the economic analysis that NERSA presented in 2013, the
regulator did not acknowledge the fiscal consequences of ‘lower-than-required’ tariff
increases. Our results show that under the 8% tariff baseline scenario (BAU1) there is a
steady and marked deterioration in government’s budget balance and that the government
debt-to-GDP ratio is expected to reach 75% by 2021 and 104% by 2030. By contrast under
the 19% tariff scenario, the debt-to-GDP ratio stabilises at ~66%. Given the sharp
accumulation of government debt under a ‘much-lower-than-required tariff increase’, we also
noted that it was likely that BAU1: 8%, debt would trigger a sub-investment grade credit
rating downgrade and as such that it would be more accurate to compare the economic
impacts of a 19% tariff scenario with a scenario where an 8% tariff increase triggers a SI-G
downgrade (BAU2:8%, downgrade).
FIGURE 26: IMPACT ON GOVERNMENT DEBT-TO-GDP RATIO - 1A, 1B, 3A RELATIVE TO

BAU1 AND BAU2
120%
104%
100% 100%
88%
80%
Government debt to GDP (%)
68%
60% 67%
55%
1A: 13%, debt
40% 1B: 19%, tariff
BAU2: 8%, downgrade
20% 3A: 8%, VAT
BAU1: 8%, debt
0%
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
2023
2024
2025
2026
2027
2028
2029
2030

As noted earlier, the risk of an S-IG downgrade that we modelled under the ‘alternative
baseline’ (BAU2:8%, debt) has in effect, already materialised. On the 4th of April 2017,
Standard & Poor’s announced the downgrade of South Africa's long-term foreign currency
sovereign credit rating to sub-investment grade.
The results of our downgrade scenario show that when the rise in government debt that is
associated with a ‘much-lower-than required’ tariff increase is sufficient (together with other
economic and political risk factors) to trigger a sovereign credit-rating downgrade (BAU2:
8%, debt), South African’s end up worse-off than under a 19% annual tariff increase and the
negative economic impacts are likely in aggregate to be more severe for the following
reasons:
Firstly, our results show that under the ‘BAU2: 8%, downgrade’ scenario, growth in GDP and
employment will slow by almost as much as they would under a 19% annual tariff increase.
Simulation results show that under both the downgrade scenario (BAU2: 8% downgrade)
and 19% tariff scenario (1B:19%, debt) annual GDP growth will be 0.3 percentage points
lower than in BAU1. Similarly, under BAU2 and total employment growth is expected to
average 1.0% y/y which is an average of 0.2 percentage points lower than in BAU1, while
under scenario 1B: 19%, tariff employment will increase at an average rate of 0.9% y/y or
0.3 percentage points lower than BAU1.
Secondly, while our results suggest that the negative impact on GDP and employment that
follow a downgrade due to debt accumulation under a ‘much-lower-than-required’ tariff is
almost equivalent to a 19% tariff increase, South Africans are likely to end up worse-off in
aggregate under the downgrade scenario because of a simultaneous rise in debt and
interest rates that doesn’t occur under the tariff only scenario. Borrowing costs (or the
required return on investment) will rise by 1 percentage point (100bps) under BAU2 relative
to the 19% tariff scenario (1B) and the government debt-to-GDP ratio will rise steadily
reaching ~75% by 2021 and 100% by 2030 under BAU2, while under the 19% tariff
scenario, the debt-to-GDP ratio stabilises at ~66%.
Finally, under any scenario (including BAU1, BAU2 and 1B) where the revenue collected via
the tariff is insufficient to cover Eskom’s prudently and efficiently incurred costs, the price of
electricity is being implicitly subsidised. As the World Bank (2010:22) notes:
“Subsidising energy use involves providing it at a price below opportunity cost. This includes
non‐collection or non‐payment, selling electricity at a cost that does not reflect the long‐run
marginal cost of supply including capital maintenance.”

The economic harm and distortions that are caused by energy subsidies, including artificially
low electricity prices, is well-documented in the international literature. Some of the potential
macroeconomic, environmental, and social consequences of energy subsidies, as
documented by the IMF (2013) were summarised in Deloitte (2017) as follows:
 Energy subsidies crowd-out growth-enhancing or pro-poor public spending.

Energy subsidies, while often intended to protect consumers crowd-out other priority
spending (such as on social welfare, health, and education) and place an unnecessary
burden on public finances. Energy subsidies (unless specifically targeted) are a poor
instrument for distributing wealth relative to other types of public spending.
 Energy subsidies discourage investment in the energy sector and can precipitate
supply-crises. Energy subsidies artificially depress the price of energy which results in
lower profits for producers or outright loses. This makes it difficult for state-owned
enterprises to sustainably expand production and removes the incentive for private
sector investment. The result is often an underinvestment in energy capacity by both the
public and private sector that results in an energy supply crisis which in turn hampers
economic growth. These effects have been felt in SA.
 Energy subsidies create harmful market distortions. By keeping the cost of energy
artificially low, they promote investment in capital-intensive and energy-intensive
industries at the expense of more labour-intensive and employment generating sectors.
 Energy subsidies stimulate demand, encourage the inefficient use of energy and
unnecessary pollution. Subsidies on the consumption of energy derived from fossil
fuels leads to the wasteful consumption of energy and generate unnecessary pollution.
Subsidies on fossil-fuel derived energy also reduce the incentive for firms and
households to invest in alternative more sustainable forms of energy.
 Energy subsidies have distributional impacts. Energy subsidies tend to

disproportionately benefit higher-income households who consume far more energy than
lower income groups. Energy subsidies directed at large industrial consumers of energy
benefit the shareholders of these firms at the expense of the average citizen.
Deloitte (2017) goes on to give specific examples of the economic harm and distortions that
can be attributed to the historic under-pricing or implicit subsidisation of electricity. In South
Africa these are argued include:
 Artificially low electricity tariffs discouraged investment in South Africa’s

electricity supply industry and helped to precipitate the 2008 power supply crisis.

The subsidised tariffs frustrated attempts by the government to attract private investment
in the early 2000s and helped to precipitate the supply crisis of 2008.
 Subsidised electricity prices promoted investment in capital intensive industries

in South Africa at the expense of more labour-absorbing sectors. Kohler (2014)
traced the 40-year change in electricity intensity across a number of countries and
country groups and found that South Africa has amongst the highest electricity intensity
globally.
 Subsidised electricity prices, encourage the inefficient use of energy and

contributed South Africa to becoming one of the single-largest contributors to
global GHG emissions. Subsidies on the consumption of electricity generated by
Eskom which was mostly coal-based have arguably contributed South Africa becoming
the 18th largest country-level contributor to global CO2 emissions8.
15.5 Concluding remarks on economic impacts
It may be tempting to conclude that by limiting electricity tariff increases to 8% per annum
and requiring that Eskom and/or government borrow the revenue shortfall (and effectively
implicitly subsidise the price), it is possible to minimise the negative impacts of rising
electricity prices on GDP and employment growth in the short-term.
However, the results of the economy-wide impact analysis show that the fiscal and economic
consequences of awarding Eskom a tariff that is much lower than what it requires (to recover
its prudently and efficiently incurred costs), do eventually (and arguably have now) become
evident. Our results show that when the gap between the required and actual tariff increases
is large (an 8% increase awarded over five years when we assumed 19% was required) and
the shortfall is covered by raising debt, there is a steady and marked deterioration in
government’s budget balance and debt-to-GDP ratio. For example, under the baseline 8%,
debt scenario government debt-to-GDP ratio is expected to reach 75% by 2021 and 104%
by 2030. By contrast under the 19% tariff scenario, where all the required revenue is raised
via the tariff, the results show the debt-to-GDP ratio stabilising at ~66%.
8 Based on data from the EDGAR – emissions databased for global atmospheric research. 2015. Available
online at: http://edgar.jrc.ec.europa.eu/overview.php?v=CO2ts1990-2015&sort=des9

Over the past 10-years there has been a marked deterioration in both the financial position
of Eskom and the fiscal health of the South African government and this is evident from the
change in debt and credit metrics that is summarised. Since 2008, South Africa’s long-term
foreign-currency rating has been downgrade by 3 notches from lower-medium grade to
speculative grade or ‘junk’ by two of the three major rating agencies. Eskom’s long-term
local-currency corporate bond rating has been downgraded by between 5 and 10 notches,
from upper-medium grade in 2008 is now rated ‘highly-speculative’ by Standard and Poor’s.
A summary of key debt metrics shows that since 2008 (when Eskom embarked on its
massive capital expansion programme) the South African government’s capacity to meet its
debt obligations (and to raise additional debt or issue guarantees on debt of state-owned
enterprises) has become far more constrained and as such vulnerability to eventual non-
payment has increased. In terms of the National Treasury broad risk management guidelines
(updated in 2008)9 – net loan debt, provisions and contingent liabilities should not exceed 50
per cent of GDP while the broader SADC macroeconomic convergence target was to limit
the metric to 60 per cent of GDP. While this metric stood comfortably within these prudential
limits at 34.4% GDP in 2008, in 2017 it stands at 67% of GDP – exceeding both the self-
imposed risk guideline and broader SADC convergence target. Net loan debt (excluding
provisions and contingent liabilities) is expected to reach 47% of GDP in 2017/18 (up from
22.6% in 2007/8). Government now spends 11.5% of its total revenue servicing the interest
on debt (up from 8.9% in 2007/8) illustrating how the fiscal space is becoming increasingly
constrained.
It is also clear that substantial support provided by government to Eskom over the past 10
years both in the form of equity and guarantees has impacted on the deterioration in
Government’s overall debt metrics. Eskom initially received support from government in the
form of a R60bn shareholder loan which was converted into equity in 2015 and in the form of
a further R23bn equity injection completed in March 201610. Government also approved
R350bn worth of guarantees on Eskom’s debt of which Eskom had drawn on R218bn worth
by 2017/18 (the agreement is to be extend to 31 March 2023). Government guarantees of
SOE debt rose from R65bn in 2008 to a total of R445bn in 2017 and 77% of this is for the
electricity sector which also covers Eskom’s power purchase agreements with IPPs.
9 National Treasury (2008) National Budget Review, February 2008.
10 Moody’s Investor Service (2017) Moody's places Eskom's Ba1/A2.za ratings on review for downgrade

Following the sub-investment grade downgrade of South Africa’s long-term foreign currency
in April 2017 and subsequent downgrade of Eskom’s corporate debt by S&P to ‘highly-
speculative grade’, neither Eskom nor the South African government will be in a position to
raise further debt to meet Eskom’s future revenue requirement without the risk of triggering
further sovereign credit rating downgrades.
In the present context, if Eskom is awarded much-lower-than-required tariff increases, it will

put South Africa at greater risk of remaining within the continual negative feedback loop that
countries typically experience following an SI-G event. Our analysis shows that under low
tariff scenarios, Eskom’s revenue shortfall grows, the fiscal position deteriorates, interest
rates rise, sentiment sours, economic growth slows, further credit rating downgrades within
‘junk’ territory are triggered and the toxic loop repeats. As RMB (2017) notes, “countries
take seven to nine years, on average, to recoup their investment-grade rating, following a
downgrade, to speculative grade”.
Our simulation results show that in terms of the overall economic impacts - even a sharp
19% annual tariff increase over five-years would be preferable to a scenario where rapid
debt accumulation associated with a much-lower-than-required ‘8% tariff increase triggers
further credit rating downgrades.
While our results suggest that the negative impact on GDP and employment that follows a
downgrade due to debt accumulation under a ‘much-lower-than-required’ tariff is almost
equivalent to a 19% tariff increase, South Africans are likely to end up worse-off in aggregate
under the ‘low-tariff downgrade scenario’ because of a simultaneous rise in debt and interest
rates triggered by a downgrade. In addition, in the low-tariff scenarios, the price of electricity
remains implicitly subsidised, and as outlined in detail in Deloitte (2017), energy price
subsidies are associated with a wide-range of market distortions and economic harm.
In conclusion, it would be ill-advised for NERSA to continue to limit Eskom’s tariff increases
below cost reflective levels. It would also be incorrect given the current context and results of
this analysis to assume that this will limit the negative impact on GDP and employment, even
in the short-term. Our recommendation is that tariff increases should at least be sufficient to
transition Eskom towards a more cost-reflective electricity tariff (prudently and efficiently
incurred) over the next 5 years. This will reduce of the risk of South Africa being trapped for
a prolonged period in the continual negative feedback loop that countries typically
experience following an SI-G rating downgrade.

National Treasury and SALGA responses
16 National Treasury and SALGA responses
16.1 Summary of key responses provided to comments by National Treasury as part

of consultation process for the MYPD revenue application
16.1.1 Period of the MYPD submission
National Treasury felt that a three year application was preferable to a one year application.
A three year application provides a medium term view. It is felt that a longer term application
will allow for further phasing-in of prices towards cost reflectivity and provide certainty to
customers. There is agreement that the Integrated Resource Plan (IRP) will only impact
Eskom once the Minister of Energy makes determinations.
Eskom has further extended the period towards cost reflectivity by requesting even lower
returns on assets than the MYPD 3 period. Thus the application period is not related to the
period to migrate towards cost reflectivity. Eskom is in agreement that the Minister of Energy
will need to make determinations that will potentially impact Eskom’s investment
commitments. This is unlikely to occur in the MYPD 4 period. NERSA is likely to provide a
price trajectory for the longer term as reflected in the Electricity Pricing Policy. This will
provide certainty to customers.
16.1.2 Economy-wide impacts of the proposed tariff
National Treasury’s own analysis of the first round effects on consumer inflation shows that a
multi-year increase in electricity prices of 15% between 2019 and 2021 from the current
trajectory would increase headline CPI by 0.27, 0.31 and 0.32 percentage points in 2019,
2020 and 2021 respectively. A similar multi-year increase of 17.6% increase (i.e. municipal
tariff increase), would increase CPI by 0.35, 0.42 and 0.45 percentage points in 2019, 2020
and 2021 respectively, from the current forecast trajectory. Furthermore, it is worth stressing
that this analysis does not account for the second round cost of production effects, which are
likely exacerbate the overall impact of these tariff increases.
National Treasury concurs that shortages of electricity have a more detrimental impact on
the economy than higher prices which are used to enable the financing of capacity
expansion. Various studies have shown that load shedding (especially unplanned load
shedding) has very large negative economic impacts, far more so than various other options
which may include running the gas fired power stations, buying back power from large

consumers, demand market participation and other alternatives. Higher prices tend to have
smaller economic impacts as they redistribute electricity and thus production from least
productive (less efficient) to be more productive (more efficient) firms. This results in more
optimally allocated resources. This is true to the extent that electricity prices converge to
cost reflective levels, which are not inflated by operational inefficiencies, poor management
and unjustified cost overruns.
In the long run, cost reflective tariffs, including the internalisation of the cost of negative
externalities associated with electricity supply, will ensure more efficient use of electricity and
efficient allocation of resources in the economy and will raise economic growth rates over
time. It will provide the right signals for investment in the electricity sector for both Eskom
and Independent Power Producers (IPPs) as well as in cogeneration opportunities. The
correct pricing of electricity will help to stimulate investment in more efficient and less
environmentally damaging production methods and incentivise residential consumers to
consume electricity more efficiently. In the short-run, electricity prices also have an important
role to play in managing the supply and demand balance. Nevertheless, it is critical to
smooth the transition to cost-reflectivity in order to allow consumers to adjust and avoid
unnecessary employment and output losses.
Moreover, the history of load-shedding, or rolling brown-outs, in which various geographic

areas were denied electricity supply in a staggered and planned fashion in order to maintain
stability of the grid when demand outstripped electricity supply, has brought several critical
concerns to the fore. South Africa may face repeated crises in the electricity sector as a
result of the lack of sustainability of Eskom, the sovereign credit rating downgrades and
policy and regulatory uncertainty. Rising electricity prices and periods of load shedding have
dampened demand for electricity and resulted in domestic and industrial customers
switching to alternative electricity supply sources. Therefore, resolving the poor performance
and sustainability of Eskom will be critical if South Africa is to achieve the economic growth
required to address poverty and progress towards achieving the Government's aim of
economic transformation.
Impact of electricity price increases
National Treasury also ran a shock in its Computable General Equilibrium (CGE) model
incorporating a higher price (a 15% increase per year, for three years) in electricity
generation and distribution. A 15% annual increase in the price of electricity reduces GDP
growth by an average of 0.1 percentage points each year, compared with baseline growth.
The macroeconomic effects are tabled below.
Table 1: Macroeconomic effects of an increase in the price of electricity

Deviation in average
growth from baseline
Percentage points
Absorption -0.1
Private consumption -0.3
Fixed investment -0.2
Change in inventories 0.0
Government consumption 0.4
Exports -0.3
Imports -0.3
Gross domestic product at market -0.1

prices
Source: National Treasury
On a sectoral basis, there are pronounced negative effects on the mining sectors, as these
are energy-intensive industries, as well as directly on the electricity industry. The electricity
industry is directly affected by weaker demand owing to the large increase in the price of
electricity. Weaker demand for electricity is seen across the household income groups, but is
relatively stronger for the higher income households who can switch to alternative forms of
energy.
Figure 1: Estimated impact on sectoral GVA growth
Source: National Treasury
Impacts of the proposed tariff on Eskom customers
The following comments are based on the research conducted by National Treasury into the
impact of electricity tariff increases on households and select listed companies. The findings
of the research indicated that the impact on households will be as follows:
a. Using household data from the Income and Expenditure Survey, even under a
relatively low projected electricity tariff path, electricity expenditure by households will
almost double by 2030. Lower income households, particularly deciles 1 to 5, will be
the most affected as electricity represents a larger proportion of their expenditure
basket.
b. However, low income groups (LSMs 1 to 4) will be able to adjust more easily as they
can use basic non-electricity based appliances to reduce their electricity consumption
(e.g. gas/ paraffin cookers) and thus electricity expenditure.
c. A sharp increase in electricity tariffs will make electricity-alternative household

appliances (e.g. gas stoves, heaters, rooftop PV’s) relatively cheaper. This means that
households in the higher income groups (LSMs 8, 9 and 10) will be able to mitigate the
impacts of the tariff increases on their overall household expenditure.
d. Although low and high income households will be able to mitigate the effects of
electricity price increases somewhat, National Treasury’s findings suggest that middle
income households (LSM 5 and LSM 6 in particular) will be the most vulnerable to
rising tariffs. This is due to their higher electricity consumption, yet lower average
income that limits their ability to invest in appliances that will reduce their electricity
consumption more significantly. Thus electricity prices increases will likely have a large
negative effect on these households.
On the other hand, the findings of the research indicated that the impact on firms will be as
follows:
e. By analysing the financials of 21 listed companies it was determined that under a high
tariff scenario, the net present values of the operating profits of firms could be reduced
by up to 17%, dependant on energy intensity.
f. Own-generation’s viability is growing and some firms have already reached the point
where it makes sense from a financial perspective, even in moderate tariff trajectory to
invest in own-generation.
g. If firms continue to undertake these investments or improve their energy efficiency they
will be able to mitigate the impact of the tariff increases somewhat.
Impacts of the proposed tariff on Eskom and municipalities
The mitigation strategies employed by households and firms described above will have an
adverse impact on electricity sales for Eskom and municipalities. Looking at households
specifically, under relatively conservative assumptions and a moderate tariff path (of a 10%
per annum increases over the next 5 years), about 26% of total residential electricity sales
could go off-grid by 2030.
From an analysis of 21 listed companies, our estimates show that the equivalent of up to
34% of mining, 8% of industrial and 1% of commercial electricity generation sales currently
supplied by Eskom have the potential to go off-grid by 2040.
Furthermore, such a steep increase in electricity tariffs will increase the prevalence of non-
technical load losses, as certain households can no longer afford the higher tariffs yet still
continue to use electricity.
Eskom notes the analysis by National Treasury. Eskom has also commissioned two
economic impact studies that have been summarised in this submission and have been
included in the submission made to NERSA for public consultation. In addition, a study
undertaken by the World Bank, also summarised in this submission, indicates that 81% of
the hidden costs (hidden from consumers by not being reflected in price) in Eskom’s price of
electricity is due to underpricing. Eskom supports Government continuing to developing
sector specific incentives and the protection of the poor. In the holistic economic impact
study commissioned by Eskom it is demonstrated that the impact on the fiscus would be
much more severe if prudent and efficient cost reflective prices of electricity are not applied.
16.1.3 Sales volume assumptions
The sales forecast is perhaps one of the most crucial assumptions as it ultimately
determines not only what the price will be but also what expenses need to be covered.
National Treasury suggests that further clarity be provided on how sales volumes were
assumed.
Eskom concurs with National Treasury with regards to the significance of the sensitivity of
the sales volume. Eskom makes every effort to ensure that consideration is taken of a
variety of factors when determining its proposed sales forecast. In addition, NERSA
undertakes its own analysis. NERSA then makes the final decision on the sales forecast to
form the basis of the MYPD 4 determination. The process that Eskom follows in arriving at a
sales volume assumption is a very rigorous one and a huge amount of effort is put into the
process to ensure the compilation of an accurate sales forecast over a period of 6 months. It
can be confirmed that Eskom definitely compares the bottom up with a top down approach to
make sure that the forecast makes sense from all angles and that the bottom up approach is
realistic. To test that the bottom up approach forecast is in line with historic trends the total
sales growth with many years of history is analysed and interrogated. A “linear and
exponential trend line” to the total sales trend is normally used to check the budget trend
line.
Eskom further look at a wide variety of relationships, especially the relationship of electricity
demand to other macro variables, e.g. GDP, commodity prices, exchange rates. An
important part of the forecast is to focus on these relationships specifically for the Key
Industrial Customers (KIC) and mines that are reliant on exchange rate and commodity
prices. The submission document also shows the major commodity tables and economic
parameters that is utilised.
In determining price elasticity proper analyses is done with available information and the
findings tested with KICs. It is important to note that when you consider income elasticity,
one should be careful not to double count the impact of price elasticity. In the price elasticity
impact determination there is already a component of the income elasticity, as price elasticity
inherently sends a message as to what level customers will be able to tolerate higher
electricity bills when competing for spending on other more/equal important expenditures,
such as food, water and other. In addition Eskom also had a look at inflation rates, mostly for
the residential type of customers, but price elasticity and the savings drives overshadowed
that impact.
In representative customer engagements, time was spent to discuss the proposed price path
and the implication on energy intensive users, but Eskom takes note of National Treasury’s
suggestion that the price elasticity impact of such a high increase could be more what was
anticipated in the submission. In line with the MYPD methodology, the mitigation of the sales
variance can be addressed through the consideration of a more recent sales forecast at the
time of the NERSA decision.
To avert the declining trend Eskom has put in place a growth initiative with stretch targets to
grow additional sales over and above what will transpire from the market. A sustainable
solution requires a coordinated national (SA Incorporated) effort and should consider all
options. Eskom is completely supportive of any policy interventions by the Government in
ensuring further economic growth that is likely to attract further industrial investment.
16.1.4 Municipal Debt
National Treasury is concerned that in many cases, Municipalities attempt to buffer the
impact of Eskom increases by not passing on the full impact of the bulk increase burden to
their customers and decreasing maintenance. National Treasury has linked percentage
collection of electricity revenue to the price of electricity. It is recognised that high level of
debt arrears imposes a burden on Eskom's funding and subsequently tariffs, as the
relationship between Eskom prices increases and outstanding debt is a vicious cycle.
Therefore, National Treasury recommends that Eskom considers different scenarios for the
likelihood of increases in non-payments and the resulting net impact on revenue as a result
of the proposed tariff increases. National Treasury recognises the impact that the increasing
debt owed by municipalities have on Eskom’s financial sustainability and is supportive of the
steps being taken by Eskom to exercise their contractual rights in relation to defaulting
municipalities as well as other steps, e.g. the installation of prepaid meters, which are aimed
at mitigating the outstanding amounts.
Eskom understands that the Municipal tariffs are regulated in accordance with a benchmark
increase as determined by NERSA. Eskom understands in certain cases, Municipalities
request NERSA to allow for electricity price increases to be above the benchmark
determined by NERSA. It is understood that NERSA, will address Municipalities not keeping
to their license conditions with regards to the requisite maintenance that needs to be
undertaken. Eskom notes the suggestions made by National Treasury and will ensure that
these activities are strengthened. Eskom appreciates National Treasury support in
addressing its recovery of debt.
16.1.5 Regulatory Clearing Account
National Treasury notes that the RCA has not been taken into account in preparing this
application and that this may result in amendments to the increases presented by Eskom in
the draft application.
National Treasury is correct. Eskom will not be including any RCA adjustments in the MYPD
4 revenue application.
16.1.6 Primary energy
National Treasury clarifies that Primary energy costs are likely to vary with levels of sales
volumes. Eskom indicated that overall primary energy costs are expected to increase by an
average rate of above 7% over the MYPD4 period with coal costs increasing at an annual
average of about 8%. Concern was raised about detailed information to be provided to
NERSA with regards to coal costs. Eskom is required to provide NERSA with estimated
costs over coal for a period of 10 years. National Treasury required clarity on the MYPD
methodology with regards to revenue related to coal costs. Clarity was required on the
MYPD methodology on actual and projected costs of coal. National Treasury cautioned on
prudently managing coal stockpiles to avoid high coal stockpiles. National Treasury wishes
Eskom and Government to engage with relevant stakeholders to develop a long-term
strategy on the procurement of coal.
In the application, Eskom states that currently there is no excess generation capacity and
their production plan shows that that there will be operational excess capacity as from
2020/21 financial year. However, this contradicts the entity’s Medium-Term System
Adequacy Outlook (MTSAO) published in October 2017.
National Treasury wishes to have a competent and independent economic regulator in the
water sector.
Eskom will provide all the detailed information required in terms of the MYPD methodology.
Eskom, in this application will implement the requirements of the MYPD methodology. The
actual information will be provided for the 2017/18 year. Projections will be provided for the
2018/19 year. The projections for the three application years and a further two years will be
provided in the submission to NERSA. NERSA requests this information to undertake its
prudency evaluations on all the cost elements of the regulatory formula. The MYPD
methodology recognises that recent actual and projected information is required to
determine the prudency of the application. The MYPD methodology recognises that the most
recently available information should form the basis of the NERSA determination.
Eskom, in this submission will provide further details on the process to be followed with
regards to generation units that are in reserve storage. It is clarified that there would be
differences between Eskom actuals and the MTSAO scenarios. Further analysis of primary
energy costs have been undertaken since the draft submission. Many of the areas
highlighted by National Treasury have been addressed. These will be provided to NERSA as
part of the final submission.
Eskom has adhered to the MYPD methodology, to the extent possible, when making this
revenue application. The MYPD methodology requires the licensee to apply for only efficient
and prudent costs. The Eskom Board has decided to review the NERSA 2018/19 revenue
decision.
Eskom understands that the viability of a water regulator could be explored.
16.1.7 Operating expenditure
National Treasury proposes that Eskom provides more details on the employee benefit
costs.
It is accepted that further details on the employee benefit costs are provided in this
submission.
16.1.8 Regulatory asset base and return on assets
National Treasury proposes that the valuation of the RAB and determination of depreciation
in terms of the MYPD methodology be clarified. It is clarified by National Treasury that asset
values for regulatory purposes differ from historical values.
National Treasury is concerned that Eskom is applying for a return on assets at a rate lower
that the WACC. This decision is important in ensuring that Eskom is able to recover
sufficient returns to be able to pay its obligations. The financial sustainability of Eskom would
be eroded which increases the risk of a call on the government guarantee or that
government may be required to support the utility financially. National Treasury believes that
it is critical to highlight that Eskom’s capacity to continue to operate on a tariff which is below
the cost reflective level is a consequence of the extensive support that government has
provided to Eskom. This support has enabled Eskom to raise the capital required to
undertake the build programme and, moreover, has reduced the cost of borrowing for the
entity. National Treasury recognises the need to phase in electricity price increases to
achieve a cost reflective level so as to allow the economy to adjust over time.
Eskom has requested an independent consultant to determine the RAB value of existing
assets. There is a significant increase in the depreciated replacement value of the RAB.
Further details are provided in this submission.
Eskom notes the motivation for Eskom to be in a position to be able to sustain itself. Credit
rating agencies have recognized that the migrating towards a price that reflects the efficient
and prudent cost of electricity is fundamental for this. It is argued that the only lever being
considered to allow for migration to cost reflectivity is the further phasing in of the ROA.
16.1.9 Proposed tariff increases
National Treasury is concerned about the level of cross subsidies that could impact the
competitiveness of certain industries. It is not only the average price that is of concern – but
more so the cross subsidies. A proposal is made to for a more comprehensive debate on the
cross subsidies.
Eskom supports such a debate.
16.2 Summary of SALGA responses related to the MYPD 4 Revenue Application
16.2.1 Impact on economy and affordability
SALGA has requested specific information related to various aspects of Eskom’s MYPD 4
revenue application. This includes sales forecasting, primary energy, imports, IPPs,
operations and maintenance and environmental levy
Eskom has endeavoured to update the revenue application submitted to NERSA by

addressing the information requested by SALGA. This is undertaken to the extent possible.
16.2.2 Customer –centricity by lower increases in tariffs
SALGA is concerned that the 15% increase for three years is not customer-centric. The
addition of the RCA adjustment imposes further burden. SALGA feels that customers will
opt to go off-grid or result in non-payment. Has impact on poorer communities who opt to
use more dangerous forms of electricity. It is felt that all sectors are being impacted.
Eskom is still in the process of migrating towards cost reflectivity. Thus Eskom is not yet
recovering its prudent and efficient costs and a reasonable return in this application. With
regards to distressed sectors, the Department of Energy is leading in the process to address
the requirements of various sectors with regards to their electricity needs.
16.2.3 Further cost containment is required
Eskom is urged to continue with finding further efficiencies. Only efficient costs should be
applied for. The comparison to inflation related increases are proposed. With regards to
employee benefit costs non-value adding benefits should not be included.
Eskom is committed to ensuring that it continually finds efficiencies. This is evident in the
lower than inflation increases in the operating expenditure.
16.2.4 Depreciation and construction of assets
SALGA requested that the MYPD methodology be changed to consider depreciation as

reflected in the AFS. A separate application should be made for construction of assets.
Eskom is required to comply with the MYPD methodology. Any changes in the MYPD
methodology are best addressed with NERSA.
16.2.5 Depletion of coal reserves
Eskom together with Department of Energy need to urgently invest in acquiring new coal
mines and supplies in South Africa if the long term sustainability of the coal fired generation
assets is to be maintained. Eskom then needs to be held accountable to strict payment
terms for the coal supplied. Further, government intervention should be sought to introduce
some taxation on the export of coal. At the moment coal mines are getting better prices on
the export market and so are sending their coal overseas.
These are policy decisions and will need to be addressed in the appropriate forum. Eskom is
willing to participate.
16.2.6 Changes to energy mix
SALGA makes various proposals for changes to the energy mix including renewable and
nuclear. Proposals are made for additional IPP contracts.
These are policy related proposals and best dealt with through the Department of Energy.
16.2.7 Fraud and corruption
SALGA is concerned about the levels of fraud and corruption in Eskom and proposes further
transparency.
Eskom has clarified in its submission that various measures are underway to address the
fraud, corruption and irregularities.
16.2.8 Rationalisation of Municipal Tariffs
Concerns have been raised on particular aspects of Municipal tariffs as is being considered
by NERSA.
NERSA is in the process of addressing the rationalisation of Municipal Tariffs.
Revenue requirements for licensees
17 Revenue requirements for licensees

Eskom’s allowable revenue requirement comprises that of Generation, Transmission and
Distribution businesses. Generation contributes about 75% of the allowable revenue with the
networks making up the balance.
17.1 Generation allowable revenue
Generation revenue requirement over the three year application period is

R632bn. Generation own primary energy is R229bn, IPPs adds R105bn
and international purchases of R11bn. The operating expenditure is R96bn.
Debt commitments are covered through depreciation and returns of R165
billion over the three year application period.
TABLE 23 : GENERATION ALLOWABLE REVENUE

2019/20 2020/21 2021/22 2022/23 2023/24
WACC % ROA X -1.32% -0.21% 1.45% 1.76% 2.46%
Returns -13520 -2237 16358 20611 29540
Expenditure E + 30 468 32 466 33 691 34 158 35 721

IPPs (local) PE + 29 590 34 324 41 002 44 468 46 877
Depreciation D + 49 878 56 948 58 392 67 446 74 338
IDM I +
Research & Development R&D +
Levies & Taxes L&T + 8 272 8 198 8 147 8 108 8 180
RCA RCA +
Total R'm 181 608 209 309 241 107 266 968 295 506
Corporate Social Investment (CSI) - 154 - 151 - 108 - 106 - 117
17.2 Distribution allowable revenue
Distribution revenue requirement is R98bn over the three year application

period. This covers expenditure of R75bn. Debt commitments are covered
through depreciation and returns of R23bn.
Revenue requirements for licensees
TABLE 24 : DISTRIBUTION ALLOWABLE REVENUE

2019/20 2020/21 2021/22 2022/23 2023/24
Regulated Asset Base (RAB) RAB 111 391 116 895 123 063 128 853 134 353
WACC % ROA X -1.32% -0.21% 1.45% 1.76% 2.46%
Returns -1466 -242 1784 2271 3308
Expenditure E + 23 584 24 787 26 342 27 741 29 383
Primary energy PE +
IPPs (local) PE +
International purchases PE +
Depreciation D + 6 903 7 422 8 029 8 679 9 367
IDM I + 189 193 202 213 225
Levies & Taxes L&T +
RCA RCA +
Total Allowable Revenue R'm 29 210 32 161 36 356 38 904 42 284
17.3 Transmission allowable revenue

Transmission external revenue requirement over the three year period is
R34bn covering expenditure of R12bn. Debt commitments are covered
through depreciation and returns of R23bn.
TABLE 25 : TRANSMISSION ALLOWABLE REVENUE

2019/20 2020/21 2021/22 2022/23 2023/24
Regulated Asset Base (RAB) RAB 129 366 138 442 149 898 161 100 169 952
WACC % ROA X -1.32% -0.21% 1.45% 1.76% 2.46%
Returns -1702 -287 2173 2839 4185
Expenditure E + 3 777 3 844 4 005 4 116 4 340
Primary energy PE +
IPPs (local) PE +
International purchases PE +
Depreciation D + 6 837 7 459 8 051 8 541 9 093
IDM I +
Levies & Taxes L&T +
RCA RCA +
Total Allowable Revenue R'm 8 912 11 016 14 229 15 497 17 618
Note that this represents external costs and excludes technical losses and ancillary costs.
Conclusion
18 Conclusion
Eskom has applied the MYPD methodology, the requirements of the Electricity Regulation
Act and other relevant legislative and regulatory requirements when the revenue application
was being determined for the 2019/20 to 2021/22 financial years. Eskom has been guided
specifically by the MYPD methodology in providing NERSA with efficient and prudent costs
that include the actuals for the 2017/18 financial year; projections for the 2018/19 financial
year; projections for application purposes for the 2019/20 to 2021/22 financial years and
projections for post-application purposes for the 2022/23 to 2023/24 years. In accordance
with the MYPD methodology, NERSA will undertake its detailed assessment and evaluations
to determine the efficiency and prudency of this information provided to guide its
determination.
The Eskom has been striving to keep cost escalations close to inflationary levels which have
been highlighted as follows:
The total primary energy increasing by CAGR of 8.9% per annum, including IPPs
costs.
– Eskom’s own primary energy costs excluding local IPPs growing at a CAGR of
6.5% per annum for the application period.
– Coal burn costs (Rbn) increase at a CAGR of 4.96% over the application period
and the CAGR is 7.41% for the 2018/19 to 2021/22 period
– Coal burn cost in R/ton increase at a CAGR of 8.37% over the application period
and the CAGR is 8.37% for the 2018/19 to 2021/22 period
– IPPs costs escalate at 15.6% per annum over the three year application period.
Operating and maintenance costs, which include employee benefit costs, are
escalating at 3.5% per annum over the application period which is below inflation.
– Employee benefits escalating by CAGR of 2.2% per annum and reduction of staff
complement.
– Maintenance is escalating by CAGR of 4% per annum.
– Other operating costs are escalating by CAGR of 6% per annum.
Conclusion
Eskom has made every effort, to implement measures that move towards more efficient
processes to manage operational costs.
Capital expenditure grows with focus on completing new build projects, maintaining existing
power stations, strengthening and expanding network businesses. It is clarified that none of
the generation units will be decommissioned in this period. The indications from stress tests
undertaken by Eskom is that certain units could serve as reserve storage units – but are
likely to be utilised if certain risk factors materialise.
As required by the MYPD methodology, the depreciated replacement value of the regulatory
asset base has been revalued by an independent process. There is a significant increase in
the RAB value when compared to previous valuations due mainly to the changes in the
overnight costs of generation plants.
In order to limit the revenue requirement and therefore the electricity price impact, Eskom
has further phased the migration towards cost reflectivity to allow only for the combination of
depreciation and return on assets related revenue to significantly address the debt service
commitment requirements. A cash shortfall of approximately R25 billion relating to debt
service commitments exists in each of the 2019/20 and 2020/21 financial years. In this
revenue application, Eskom will only be able to cover the debt service commitments in
2021/22 financial year. This is a significant sacrifice being made by Eskom in a bid to allow
for the economy and customers to benefit through this phased approach.
National Treasury has provided the following response with regards to the return on assets:
“National Treasury is concerned that Eskom is applying for a return on assets at a rate lower
that the WACC This decision is important in ensuring that Eskom is able to recover sufficient
returns to be able to pay its obligations. The financial sustainability of Eskom would be
eroded which increases the risk of a call on the government guarantee or that government
may be required to support the utility financially”.
In addition, the World Bank notes (as summarised in the economic impact studies in this
submission):
“Subsidising energy use involves providing it at a price below opportunity cost. This includes
non‐collection or non‐payment, selling electricity at a cost that does not reflect the long‐run
marginal cost of supply including capital maintenance.”
Eskom is cognisant of the potential impact of the increase in various sectors. It is imperative
for Government to urgently address implementing further sector specific incentives to ensure
Conclusion
that the impact on the economy is considered. Government and NERSA have mechanisms
to help protect residential customers and these may need to be strengthened.
Eskom has highlighted areas where it will make proposals for the structuring of tariffs that
respond to developments in the electricity industry. A framework for cross subsidies will
need to be considered.
It is hoped that NERSA will consider the impact on the consumers as well as and the
sustainability of Eskom in making its determination. This revenue application of over
R750bn requires a thorough analysis by the Energy Regulator and reasons for decision that
are well supported by facts and reasoning in terms of the MYPD methodology and other
guiding legislation and regulations.
Eskom has highlighted areas where it will make proposals for the structuring of tariffs that
respond to developments in the electricity industry. A framework for cross subsidies will
need to be considered.

Eskom On The Verge of Debt Trap, CEO Warns

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Eskom On The Verge of Debt Trap, CEO Warns

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Eskom Revenue Application

Multi-Year Price Determination (MYPD 4)

Eskom Holdings MYPD4 Revenue Application FY2019/20 - 2021/22│ Page 2 of 115

5.4 Average tariff category increases .............................................................................................. 35

Eskom Holdings MYPD4 Revenue Application FY2019/20 - 2021/22│ Page 3 of 115

14.2.1 Staff complement ................................................................................................................. 73

Eskom Holdings MYPD4 Revenue Application FY2019/20 - 2021/22│ Page 4 of 115

17 Revenue requirements for licensees ....................................................................................... 111

Eskom Holdings MYPD4 Revenue Application FY2019/20 - 2021/22│ Page 5 of 115

Eskom Holdings MYPD4 Revenue Application FY2019/20 - 2021/22│ Page 6 of 115

A total RCA balance decision of R32.69 billion was made, as follows:

Eskom Holdings MYPD4 Revenue Application FY2019/20 - 2021/22│ Page 7 of 115

 Eskom Revenue Application, Multi-Year Price Determination (MYPD) 4, for 2019/20 to

Eskom Holdings MYPD4 Revenue Application FY2019/20 - 2021/22│ Page 8 of 115

Note on Casting of Tables

Eskom Holdings MYPD4 Revenue Application FY2019/20 - 2021/22│ Page 9 of 115

Eskom Holdings MYPD4 Revenue Application FY2019/20 - 2021/22│ Page 10 of 115

The details are reflected in the summary table below.

TABLE 1: TOTAL ALLOWABLE REVENUE FOR THE MYPD 4 PERIOD

Returns -16687 -2765 20314 25722 37032

Expenditure E + 56 619 59 820 62 663 64 633 67 860

Corporate Social Investment (CSI) - - 192 - 193 - 151 - 149 - 166

Eskom Holdings MYPD4 Revenue Application FY2019/20 - 2021/22│ Page 11 of 115

TABLE 2: ESKOM DEBT COMMITMENTS

Application Application Application Forecast Forecast

As required by the MYPD Methodology, Eskom has requested an independent revaluation

Eskom Holdings MYPD4 Revenue Application FY2019/20 - 2021/22│ Page 12 of 115

FIGURE 1: KEY CONTRIBUTORS TO INCREASE IN ALLOWED REVENUE

Eskom Holdings MYPD4 Revenue Application FY2019/20 - 2021/22│ Page 13 of 115

Eskom Holdings MYPD4 Revenue Application FY2019/20 - 2021/22│ Page 14 of 115

FIGURE 2: CONTRIBUTORS TO REVENUE REQUIREMENT

1.2 Recovery of efficient costs

a. Primary Energy costs:

Eskom Holdings MYPD4 Revenue Application FY2019/20 - 2021/22│ Page 15 of 115

FIGURE 3: BREAK DOWN OF PRIMARY ENERGY COSTS

Eskom Holdings MYPD4 Revenue Application FY2019/20 - 2021/22│ Page 16 of 115

FIGURE 4: OPERATING COSTS

Eskom Holdings MYPD4 Revenue Application FY2019/20 - 2021/22│ Page 17 of 115

1.3 Earning a reasonable return on assets

1.4 Revenue recovery

Eskom’s Company revenue is recovered from negotiated pricing agreement (NPA)

Eskom Holdings MYPD4 Revenue Application FY2019/20 - 2021/22│ Page 18 of 115

TABLE 3: REVENUE RECOVERY

1.5 Electricity price impact in 2019/20 - 2021/22

TABLE 4: STANDARD TARIFF PRICE INCREASE

Eskom Holdings MYPD4 Revenue Application FY2019/20 - 2021/22│ Page 19 of 115

The adherence to the various related legislative, regulatory and licence

2.1.1 Electricity Regulation Act (Act No. 4 of 2006)

Prescribes tariff principles including:

2.1.2 Electricity Pricing Policy

2.1.3 Government Support Framework Agreement

Eskom Holdings MYPD4 Revenue Application FY2019/20 - 2021/22│ Page 20 of 115

2.1.4 Municipal Finance Management Act (Act 56 OF 2003)

2.1.5 Multi-Year Price Determination (MYPD) Methodology

The revenue application is based on the requirements of the MYPD methodology as

 to ensure Eskom’s sustainability as a business and limit the risk of excess or

 to appropriately allocate risk between Eskom and its customers;

 to provide efficiency incentives without leading to unintended consequences of regulation

 to provide a systematic basis for revenue/tariff setting; and

 To ensure consistency between price control periods.

Eskom Holdings MYPD4 Revenue Application FY2019/20 - 2021/22│ Page 21 of 115

On 15 December 2017, NERSA made a decision of a total allowable revenue of

2.1.6.1 Application does not include RCA adjustments