Presentation to Select Committee on Economic Development NERSA CEO: Smunda Mokoena 24 August 2010

AGENDA Mandate of the Energy Regulator Current structure of the ESI Objects of the Electricity Regulation Act Extract from the RE white paper of 2003 REFITs I and II Facilitators Conclusion

MANDATE NERSA was established in terms of the National Energy Regulator Act, 2004 (Act No. 40 of 2004) Mandated by the Electricity Regulation Act, 2006(Act No. 4 of 2006) (“the Act”) to regulate the Electricity Supply industry in South Africa. s4 (a) (iv) of the Act states “The Regulator must issue rules designed to implement the national government’s electricity policy framework, the integrated resource plan and this Act.” NERSA was established in 2005 and is a successor of the National Electricity Regulator that regulated only the electricity supply industry. The Act extended NERSA’s regulatory mandate to Piped Gas and Petroleum Pipelines. However, today’s topic is limited to the electricity supply industry. NERSA is empowered by the ERA to make rules and thus REFITs were formulated under this mandate.

Current structure of the ESI Eskom Transmission Eskom Distribution Customers b Customers a Customers n Eskom Generation Large Power Users D1 D3 D2 Dn Imports / Exports IPPs Municipal Generators Local Authority Distributors The ESI is dominated by the vertically integrated utility – Eskom. They are licensed to generate, transmit, distribute, import and export electricity. Eskom supplies power to local authority distributors, large power users, industrial, agricultural and domestic customers. They are the only ones who hold a transmission licence in SA. They generate at least 90% of electricity in SA. Some municipalities have generation licences eg., Tshwane, Cape Town and Johannesburg. There are a few IPPs who supply power to Eskom, munics, and large power users eg. Kelvin for City Power, Sappi for Eskom.

Objects of the Act These are listed in s2 of the Act and the relevant ones for this presentation are to: (c) facilitate investment in the Electricity Supply Industry (e) promote the use of diverse energy sources and energy efficiency These two objects are relevant because the introduction of REFITs with premium in prices encourages investors to develop REFIT projects. REFITs also encourage the introduction of different technologies in the generation mix eg. Wind and solar over and above the conventional coal-based thermal generation.

Renewable Energy Policy The RENEWABLE ENERGY WHITE PAPER of 2003 states: In order to meet the long-term goal of a sustainable renewable energy industry, Government has set the following 10-year target for renewable energy:   10 000 GWh (0.8 Mtoe) renewable energy contribution to final energy consumption by 2013, to be produced mainly from biomass, wind, solar and small-scale hydro. The renewable energy is to be utilised for power generation and non-electric technologies such as solar water heating and bio-fuels. This is approximately 4% (1667 MW) of the estimated electricity demand (41539 MW) by 2013. The RE white paper of 2003 set a target of 10 000 GWh of energy to be derived from renewable energies by 2013. This would represent about 4% of an estimated 41539 MW of electricity demand by 2013. 6

Renewable Feed-In Tariffs (REFITs) Based on the above requirements NERSA introduced a REFIT framework in two phases. A REFIT is a pre-approved tariff for a specific Renewable Energy generation technology eg., wind By nature REFITs include a premium above tariffs for conventional generation mainly to attract investors and developers Requirements are objects of the Act and the RE white paper target

REFIT FINANCIAL ASSUMPTIONS Financial parameter Unit IPP REFIT Debt % 70 Equity 30 Nominal cost of debt 14.9 Inflation 8 Real cost of debt after tax 6.39 Tax rate 29 Real return on Equity ROE after tax 17 Weighted Average Cost of Capital (WACC) 12 These assumptions formed the basis for the determination of REFITs. 8

REFIT PHASE I Renewable Energy Feed – in Tariffs approved March 2009 In March 2009 NERSA published phase 1 of the REFITs with 4 qualifying RE technologies. The technologies are largely aligned with those listed in the RE white paper of 2003. They were the Concentrated Solar Power Trough with 6 hr storage at R2.10/unit; Wind at R1.25/unit; Small hydro (less or equal to 10MW) at 94c/unit and Landfill gas at 90c/unit. Eskom’s average price is currently 41c/unit – which is less that 50% of the lowest REFIT, this is the indication of the extent of the premium at which REFITs will be introduced. The premium is aimed at attracting private investors and developers into the power generation sector. This is largely aligned with the technologies mentioned in the REWP of 2003. 9

REFIT PHASE II Renewable Energy Feed – in Tariffs approved October 2009 Phase II introduced 5 more RE technologies namely Concentrated Solar Power w/o storage at R3.14/unit; Large scale grid connected Photo Voltaics at R3.94/unit; Biomass solid at R1.18/unit; Biogas at 96c/unit and Concentrated solar Power Tower with a 6hr storage at R2.31/unit. 10

Important features of the REFIT The REFITs will be escalated by CPI annually. A full tariff review will take place every year for the first five year period of implementation and every three years thereafter. The term of the Power Purchase Agreement (PPA) is twenty (20) years. The carbon revenue from the Clean Development Mechanism (CDM) was not included in the REFIT. Independent Power Producers (IPPs) may apply for CDM revenues separately. CDM revenues were not included because of their fluctuating nature. 11

Way Forward The NewGen regulations of 5 August 2009 require that NERSA issues rules on selection criteria for the REFIT programme. NERSA is currently finalising the rules and the standard REFIT PPA after a lengthy public consultation process Once the rules are finalised they will be forwarded to the System Operator or the Buyer. The Buyer will then kick start the process by issuing a Request for Qualification (RfQ) and a Request for Proposals (RfP). However, the National Treasury and the DoE have indicated that there are developments on the policy front that may require changes to the criteria that NERSA is finalising.

FACILITATORS These are initiatives that have been introduced by the DoE and NERSA to ensure that IPPs and RE IPPs in particular are assured that they may enter the power generation market and be assured of reasonable returns on their investments.

Rules for Power Purchase Cost Recovery Regulation 10 of the NewGen regulations requires that NERSA passes rules for the purpose of cost recovery by the system operator and the buyer. In response to this NERSA gazetted rules on Power Purchase Cost Recovery (CRM) after a public consultation process. The CRM basically addresses: Check of whether the proposed IPP will be affordable The allocation of risk between the buyer and the IPP Process to be followed by the buyer in seeking approval of pass through costs A list of recoverable/pass through costs The absence of a cost recovery mechanism was mentioned as one of the regulatory risks by investors. In response to this concern NERSA formulated the CRM rules and gazetted them in November 2009. The investors are most interested in the last item ie. Which costs would they be allowed to pass through to Eskom and thus the customers.

Integrated Resource Plan 1 (IRP 1) gazetted on 29 January 2010 On 29 January 2010 the DoE gazetted the Integrated Resource Plan 1 (IRP1) From the plan – under the ‘REFIT Wind’ and ‘REFIT other’ columns at least 200 MW of wind have been allowed and 625 MW of other RE technologies. Sere (100 MW) is the wind farm that was supposed to be built by Eskom.

Multi-Year Price Determination 2 (MYPD 2) SUMMARY OF ALLOWED REVENUE 2010/11 2011/12 2012/13  R’m R’m  Eskom’s own primary energy cost 36 464 40 486 45 351 IPP and Co-generation 2 304 4 299 5 819 Operating Expenditure 32 611 34 727 36 847 Depreciation 9 356 12 812 17 880 Return on assets 3 039 15 936 33 163 Demand Side Management 1 406 1 688 2 351   85 180 109 948 141 411 On 24 February 2010 the ER announced its decision on Eskom’s allowed revenues for 2010-2013 – MYPD2. The 2nd line shows what was allowed for purchases from IPPs namely R2,3bn in the 1st year, R4.2bn n the 2nd year and R5.8bn in the 3rd year – a total of R12.4bn in all. This should allay any concerns from prospective investors and developers that Eskom may not be in a position to pay for the energy purchases.

In Conclusion The Energy Regulator believes that: all perceived regulatory risks have been mitigated. once the rules on selection criteria for the REFIT Programme have been finalised the Buyer will be in a position to invite interested parties to bid before the end of 2010.

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