New electricity tariff methodology: Stakeholders highlight the risks

Trying to eliminate what it currently sees as problems with the way electricity tariffs are determined, the National Energy Regulator of South Africa (Nersa) is determined to develop a new methodology, but that will also bring substantial risks, according to experts.

After consulting on the principles underpinning the new methodology last year, Nersa published a consultation document on 30 June, that details the new methodology.

It has invited comment from stakeholders by 29 July, and plans to publish the final methodology by 22 September.

The current multi-year tariff determination methodology is a two-step process in which the allowable annual revenue a licensee is entitled to is first determined for a period of three to five years.

This is based on the efficient cost of supply plus a reasonable margin.

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Thereafter, this amount is divided by the number of units the licensee forecasts it will sell in the tariff period to arrive at the unit price for the average standard customer.

In a further process the tariffs for respective customer groups are calculated – all of which the regulator must approve.

Risk mitigation

The methodology has a risk-mitigating mechanism that enables retrospective adjustments in favour of either the licensee or the paying public if any of the assumptions underlying the tariff determination deviate materially from what was anticipated. This is called the Regulatory Clearing Account (RCA).

If the required adjustment exceeds a pre-set parameter, the tariff determination must be reopened and recalculated from scratch.

This methodology is applicable to all licensees, although Nersa has applied it to Eskom only.

Its treatment of municipalities, which consists of the publication of a guideline tariff increase and tariff benchmarks annually, has been widely criticised and challenged in court.

Eskom and Nersa have been at odds with each other for several years about the application of the methodology. Eskom has challenged several tariff and RCA determinations in court, and has consistently been successful.

While Nersa seems to blame the methodology for some of the issues, sources within Eskom, close to the process, have argued that Nersa failed to implement the methodology correctly – and the courts have seemingly agreed.

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Hoped-for improvements

Some of the issues with the current methodology that Nersa hopes to address in the development of its new methodology are:

• Guaranteed revenue: If the licensee fails to achieve the sales forecast, it under-recovers revenue. This then leads to large adjustments in the RCA, which has resulted in unexpected price shocks. As prices rise, sales drop even further, a vicious circle known as the utility death spiral.
• Cross-subsididation: Each consumer group must pay the true cost of supply to them.

Nersa proposes unbundling the cost not only in terms of activity (generation, transmission and distribution), but also to the level of each power station.

It further wants to differentiate between electricity users according to the kind of load they use – base load, which is the stable, constant demand day and night required by customers like mines and industry; semi-constant or mid-merit load that fluctuates during the course of the day; short but intense load known as peak load; and ad hoc emergency load.

The idea is to then link the load to the cost of the plant that supplies that load.

In other words customers who utilise peak load must pay the cost of the diesel-gobbling open-cycle gas turbines, and customers who use base-load must pay the cost of coal and nuclear power stations, which operate at much lower cost.

Nersa also proposes that fluctuating costs that are beyond the control of the licensee, such as fuel costs, be adjusted monthly or quarterly.

Complexity will increase ‘dramatically’

Ayal Rosenberg, MD of metering specialist WeBill, warns that the Nersa proposal will increase complexity in tariffs and metering dramatically.

“Where you have four tariffs in the inclining block tariff for residential customers at the moment, it will [now] be 16,” he says.

Rosenberg says a large number of the meters currently in use countrywide will not be capable of the measuring that would be required.

They will first have to be replaced, and it is not clear who will carry that cost.

He points out that the tariff methodology goes to the heart of the finances of Eskom and all municipal distributors. In most cases these licensees are already financially vulnerable and if things go wrong it could have devastating effects on those institutions and the economy as a whole.

Deon Conradie, an independent consultant with specialist knowledge of electricity pricing, agrees that meters – especially in residential and large sections of the commercial sector – will have to be replaced to accommodate the proposed methodology.

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He says it is “too idealistic” given the current situation such as available skills at most local authorities, availability of data, the “intense” information requirement (as described by Nersa itself) and the huge cost to implement metering to cater for all this.

“My biggest concern is that by introducing the proposed methodology while there is such a huge amount of load shedding and uncertainty, it will create an even higher financial risk to Eskom,” Conradie says.

He points out that monthly or quarterly price adjustments may lead to increased price uncertainty and municipal laws only allow for tariff adjustments at the beginning of the financial year.

He further questions the statement that the reopening of the tariff determination will be at the discretion of the regulator.

Doing away with cross-subsidisation

Conradie further points out that Nersa proposes doing away with cross-subsidisation. Currently industrial users subsidise households and Nersa proposes that such subsidies should in future be provided by government.

“This is a government policy issue, and even though it is the correct principle, the money will now have to come out of the fiscus and needs to be approved and budgeted for by government.

“How real is that in the current economic situation that this will happen? Where will the money come from?”

Conradie says the real risk is the way the methodology will be implemented.

“It cannot happen overnight and will have to be phased in. It will need the necessary skills and capacity in many areas, additional funds for metering installations and billing systems to be changed, political will to make this happen so close to the upcoming elections, and in an extremely uncertain economic environment.

“I do not think it is realistic,” he says.

In terms of a recent court ruling Eskom’s tariffs for 2023/24 will still be determined according to the current methodology.

Those for the following year will however, according to the ruling, be determined in terms of the methodology “which will be in existence at the time”.

This article first appeared on Moneyweb and was republished with permission. Read the originals article here.