Colloquium on impact of administered prices on the manufacturing sector 6 March 2013 Portfolio Committee on Trade and Industry

NERSA announcement Eskom requested a revenue increase of 13% a year plus 3% for Independent Power Producers (mainly in the DoE’s renewable energy procurement programme) giving a total of 16% a year for the next 5 years. NERSA’s determination allows for an average price increase of 8% a year for the next five years, including costs for IPPs. NERSA has not yet published its full Reasons for Decision. Eskom will have to study the consequences of NERSA’s decision and assess its impact for Eskom. Eskom is busy developing the detailed rates for the various tariffs in line with NERSA’s determination. Eskom will be in a position to provide more detail on tariffs and other initiatives once the decision has been unpacked and analysed. This presentation will focus on broad principles. 2

Economic impact of electricity tariffs Many studies (Pan African Consulting, University of Pretoria, Economic Modelling Solutions and Deloitte) were conducted to determine the economic impact on the various industries. Various scenarios were modelled but not as low as 8%. The results of empirical studies suggest that the mining and manufacturing sectors are likely to suffer the largest declines in output if electricity prices rise but there is considerable variation within these sectors. The construction and finance and business services sectors emerge as the industries that are the least affected by electricity price increases. Macroeconomic modelling of the impact of price increases reveals that because of second-round impacts the services sectors are more exposed to electricity prices than basic vulnerability assessment would suggest. Manufacturing on aggregate appears to be fairly resilient to price increases, but there is considerable variation in the vulnerability of different sub-industries and firms within this very diverse sector. A simple profit vulnerability analysis suggests that the paper and chemical manufacturing industries are vulnerable to price increases despite their relatively low reliance on electricity as an input as their already slim profits would be quickly eroded by electricity price increases. For some industries the quality of supply is more important than the price of electricity, as their processes is dependable on a continuous and steady supply of electricity. 3

4 44 Share of electricity in total costs - selected mining companies Manufacturing sector is too diverse to make generalisations about the vulnerability of sector to rising electricity prices Basic metals are one of the most heavily reliant on electricity, both in terms of the share of electricity in direct costs and measures of electricity intensity. Cement production is also quite heavily reliant on electricity, however the ability of cement producers to pass on increased costs is relatively strong. Paper and pulp-manufacturing is also a relatively energy intensive activity, but the share of electricity in total costs seems to vary considerably from one plant to the next. Sappi report that electricity costs ranged from 5% to 9% of total costs for three of its plants. Manufacturing Some of the studies are out-dated

5 Comparison of electricity intensity of SA industries to counterparts in the OECD suggests that there is significant scope for energy efficiency gains 5 This is particularly true in the non- metallic miners, mining and quarrying, agriculture, paper and basic metals sectors. If South Africa is to remain competitive relative to its OECD counterparts under more stringent trade regimes, including carbon and climate change considerations, improvements in efficiencies will be necessary. Electricity efficient technologies can be costly and can take a long time to implement, especially within capital intensive sectors like mining. A study by HSRC (2008) found that only short term energy saving options available to the mining sector, which did not involve reducing output, were in hostels or administrative offices. Source: (Inglesi-Lotz & Blignaut, 2011) Scope for efficiency gains Sectors Electricity intensity GWh/$million Difference between OECD & SA South Africa OECDDifference Weighted relative to output difference Agriculture and forestry %1242.4% Basic metals %644.2% Chemical and petrochemical %462.9% Construction %-155.9% Food and tobacco %-7.8% Machinery %-416.9% Mining and quarrying %482.1% Non-metallic minerals %3169.7% Paper, pulp and printing %1758.6% Textile and leather %398.3% Transport equipment %-21.7% Transport sector %505.7% Wood and wood products %162.5% Once-off incentives should be provided to industry to replace inefficient plant, BUT not through subsidised electricity tariffs.

Eskom and municipalities (including Metros) Municipalities make up 45% of Eskom sales. Eskom tariffs are based on its unique customer base and the cost-to-serve these customers. Customers pay for electricity up to the point they take electricity. Not possible for all distributors (Eskom and municipalities) to have the same tariffs - due to different circumstances, type of customers and cost bases. Similar electricity users (Size and voltage level), within and beyond Eskom’s borders, pays different prices due to the different cost structures between Eskom and municipalities. The regulatory process for municipalities is less stringent than that for Eskom.

WHAT IMPACTS THE COST OF ELECTRICITY TO CUSTOMERS? 1.The voltage of the supply The lower the voltage the greater the cost More assets have to be built and maintained Greater technical losses (energy has to travel further) 2.The location of the supply Rural networks are more expensive than urban networks as there are less customers per transformers and greater distances between customers. Eskom has the majority of the rural customers in SA The distance from the power stations also impacts costs i.e. it costs more to supply the Cape than Joburg as electricity has to travel greater distances. 3.How and when energy is used The more energy used in peak periods, the more expensive is the generation cost as more expensive generators and fuel has to be used 4.The size of the supply Larger supplies get more individualised service and therefore have a higher retail cost

Eskom’s tariffs – cost reflectivity Eskom designs its tariffs based on the principle of cost reflectivity. Tariffs are also to send out a signal to use electricity efficiently and to promote usage in different time periods. Support the intent of IBT to provide relief to the poor against increasing electricity tariffs. Not designed around economic customer classes, but around tariffs that are based on the cost to supply electricity to the point where the electricity is used. Eskom does not deviate from the NERSA approved standard tariffs except for one customer with a Negotiated Pricing Agreement. Any tariff that is not cost reflective must be recovered from another tariff – cross-subsidisation. Types of cross-subsidies: Inter-tariff subsidies; Rural networks, Electrification (historical & operational), Geographical Intra-tariff subsidies; Geographical, Voltage, Load factor External Subsidies; Energy Taxes, Free Basic Electricity (FBE) 8

Eskom supports industry by ensuring localisation where possible. Localisation includes local to site for some services like catering. Through Eskom’s preferential procurement process local suppliers were developed, including those suppliers assisting the IDM process. Eskom has regular discussions with industry leaders, like the Manufacturing Circle, to see how Eskom can support industries. Regular meetings are held with suppliers, like coal suppliers, to see how suppliers can assist Eskom in containing the cost. Eskom supports suppliers not only within its own borders but also beyond its borders. Eskom supports municipalities by assisting with tariff structuring and other initiatives. Industries with flexibility in manufacturing plant assist Eskom with demand response for a financial benefit. Eskom’s support to its customers 2015/11/259

Eskom support (continue) Eskom cannot support industry through subsidised tariffs but can assist with other initiatives like IDM. Subsidisation of one industry will be at the expense of other industries. Therefore, a National cross-subsidy framework is required in line with Government’s economic policy. The policy must include the funding of subsidies and criteria for subsidisation. Eskom propose to participate with industry and government to: Agree on measures to protect specific sectors of the economy and specific sectors of society informed by economic analyses and part of the government's industrial policy; The focus needs to be on sectors of the economy where South Africa has a strategic advantage and market power; Development of a National cross-subsidy framework. 10

Conclusion Research showed all countries have a goal to move towards cost-reflective tariffs. Most countries are replacing aging infrastructure and/or adding new infrastructure to cope with growing demand and a shift in the energy mix. Nearly all countries have policies to protect some sector of society; The common thread in all of this is that the State is significantly involved in determining the sectors and type of support that is needed. In the successful cases, it is also involved in co-ordinating the support and ensuring there is fiscal support. Due to the various spheres of Government involved in electricity pricing, it is critical that National Government plays a significant role in determining which sectors of society and the economy require support, ensuring there is a level playing field between customers of Eskom and municipalities and ensuring there is fiscal support either to the suppliers of electricity and/or the consumers of electricity. 11

Recommendations The following key recommendations are made: An inter-governmental task team needs to set up to agree on measures to protect specific sectors of the economy and specific sectors of society. The extent of the support should be informed by the various economic analyses that has been done and inline with the NDP industrial policy. The focus needs to be on sectors of the economy where South Africa has a strategic advantage and market power. For example in the platinum, ferrochrome and ferromanganese sectors. This is to ensure that there is coherence between support for the ferroalloys sector and pricing in the platinum by-products sector. An inter-governmental task team needs to agree on measures to align municipal tariffs and Eskom tariffs to level the playing field in the manufacturing sector and ensure that there is sufficient fiscal support for the municipalities to maintain infrastructure and support social services. An inter-governmental task team must assist with the development of a National cross-subsidy framework. 12

Thank you 13