Chamber of Mines Submission to NERSA on Eskom s MYPD3 Application

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1 Chamber of Mines Submission to NERSA on Eskom s MYPD3 Application Presentation by Roger Baxter Senior Executive, Strategy and Economics, and Mr Dick Kruger, Deputy Head, Techno-Economics Chamber of Mines of South Africa, 31 January 2013

2 PRESENTATION OUTLINE Introduction Economic Impact of Proposed Increases Dissecting the price increase proposal Coal related issues Chamber proposals Conclusion

3 Mining - The Flywheel of the RSA Economy Creates 1.3 million jobs ( direct & indirect). Accounts for about 19% of GDP (9% direct, 10% indirect & induced). Critical earner of foreign exchange >50%. Accounts for 20% of investment (12% direct). Attracts significant foreign savings (R1.4 trillion/ 29% of value of JSE). 17.7% of corporate tax receipts, 2011 R26bn & R5.5 billion in royalties. R437 billion in expenditures, +/- R389 billion spent locally. R89 billion spent in wages and salaries 50% of volume of Transnet s rail and ports 94% of electricity generation via coal power plants 15% of electricity demand About 37% of country s of liquid fuels via coal R4 billion spent on skills development R1.4 billion spent on community investment

4 South Africa s economic growth profile is imbalanced and constrained by the poor performance of the export sector RSA cannot solve its unemployment and poverty challenges on the basis of an advanced economy growth model (credit fueled, consumer driven, import intensive and imbalance creating growth in the non-tradable sectors). All parties recognise that higher levels of sustainable, balanced and labour absorbing economic growth is key to reducing unemployment (i.e. get tradable export sectors to boom). Government has developed the New Growth Path focusing on economic growth and employment creation.

5 Reliable & competitively priced electricity is vital to the country s growth, industrialisation, beneficiation and job creation ambitions Government policy recognises the need to facilitate growth in the country s tradable export sectors (mining & manufacturing). Having reliable and competitively priced electricity is a key for growth in these tradable export sectors, most of which are electricity intensive. It is the lack of electricity supply available for growth and rapidly escalating electricity costs that have contributed to the weak performance of the mining sector.

6 Does the Government Eskom Shareholder Compact focus on electricity price competitiveness? Key performance area Key performance indicator Keep the lights on Management of national supply/demand constraint DSM energy efficiency Internal energy efficiency Improve operations UCLF excluding emission control & s/t outages UCLF related to emission control & s/t outages Cumulative UCLF SAIDI System minutes<1 Deliver capital expansions Generation capacity installed & commissioned Transmission lines installed Transmission capacity installed & commissioned Reduce environmental footprint in existing fleet Relative particulate emissions Water usage per kwh sent out Maximise socio-economic contribution Local content in new build project Percentage of B-BBEE spend Implement coal haulage & road-to-rail migration plan Coal road-to-rail migration Pursuing private sector participation ISMO ring-fenced & set-up subsidiary Ensure financial stability Cost of electricity (target price) Interest cover Debt-to-equity ratio FFO as % of total debt Build strong skills Engineers Technicians Artisans Youth program

7 PRESENTATION OUTLINE Introduction Economic Impact of Proposed Increases Dissecting the price increase proposal Coal related issues Chamber proposals Conclusion

8 Eskom s proposed price increase in MYPD3 will result in a 587% increase in price in 11 years Eskom proposed trajectory Actual trajectory so far Up 238% in 5 years UP 587% in 11 years Source: NERSA/ESKOM

9 Eskom s proposed price increase will rapidly erode South Africa s electricity price competitiveness Source: NUS consulting , Chamber estimates

10 Metals and mining and quarrying are the most electricity intensive sectors in the economy and are the most exposed to higher electricity prices Source: Eskom

11 Electricity costs in platinum and gold mining have increased by 258% and 143% in past 5 years Source: Chamber of Mines

12 Electricity is fastest rising cost center in platinum and gold mining

13 Significant portions of PGM and gold sectors are marginal/loss-making at current prices after capex In PGMs >50% is marginal or lossmaking at a platinum price of R1600/oz (including cash costs and sustaining capex) In gold 37% is marginal or lossmaking (including cash costs, other costs and full capex) Source: Chamber of Mines/ JP Morgan /Cazenove

14 The electricity price is fast approaching a tipping point This tipping point is where electricity prices force companies to: Restructure (gold and coal) Defer/cancel new electricity intensive projects (negative for growth and job creation) This tipping point may result in a real decline in electricity demand as companies become unable to afford electricity.

15 PRESENTATION OUTLINE Introduction Economic Impact of Proposed Increases Dissecting the price increase proposal Coal related issues Chamber proposals Conclusion

16 NERSA Price determination mechanism for Eskom In terms of the Electricity Act of 1987, NERSA is required to look at prudently incurred costs and return on assets, which when added gives a revenue pool. This revenue pool divided by expected sales determines the average price. The two areas of greatest contention are in the areas of return on capital and depreciation expenses as the value attached to the weighted average cost of capital (WACC) and valuation of assets have significant implications for the prices of electricity paid by consumers. This is because both issues materially affect the return on capital and the return of capital (depreciation) and these areas alone constitute 65% of the average price increase proposed by Eskom for the period 2013/14 to 2017/18.

17 Key questions for the Chamber Is the regulated asset base a fair reflection of the value of Eskom s applicable assets? Is the 8% WACC calculation necessary for a 100% state owned entity which his a legislated market place, a sovereign balance sheet to support it and does not carry the same commercial risk as a stand alone private business? Does the pricing mechanism focus on extra incentives for cost competitiveness and efficiency?

18 The Regulated Asset Base is a key determinant of the price increase. Eskom has already received a huge revaluation windfall. Source: Eskom

19 Return on capital and depreciation charges are the fastest growing part of the MYPD3 (not primary energy) Source: Eskom

20 Return on capital and depreciation charges comprise 65% of the price rise Source: Eskom MYPD3 application, Chamber calculations

21 By 2017 Return on capital and depreciation account for 42.6% of total price vs 24.8% in 2013 Source: Eskom MYPD3 application, Chamber calculations

22 Coal costs fall from 27% of the price in 2013 to 21% of the price by 2017 Source: Eskom MYPD3 application, Chamber calculations

23 Concerns about the MYPD3 application Insufficient data was provided about Eskom s Regulated Asset Base. The largest component of the price increase is return on capital invested and depreciation charges. The pricing mechanism has insufficient incentives for encouraging cost competitiveness and efficiency.

24 Concerns about the MYPD3 application It is clear that Eskom s MYPD3 pricing application is predominantly focused on realising return on capital and return of capital metrics (depreciation and ROC) that would make the balance sheet exceptionally strong and achieve stand-alone investment grade status It is the Chamber s view that the return that Government gets from a 100% shareholding in Eskom is not only to have a financially sound electricity industry, but also to reap the dividends of competitively priced and reliable electricity supply that contributes to the economic growth, and industrialisation of the country. The Chamber believes that the MYPD3 application is too skewed in favour of Eskom s stand alone investment grade rating metrics than it is to the encouragement of growth.

25 PRESENTATION OUTLINE Introduction Economic Impact of Proposed Increases Dissecting the price increase proposal Coal related issues Chamber proposals Conclusion

26 STATUS QUO COAL BURNT DURING 2011/2012 : MT COAL PURCHASED DURING 2011/2012 : 127,18 MT AVERAGE COST OF COAL 2011/2012 : R209-04/T COAL COST WAS 57,4% OF TOTAL PRIMARY ENERGY COST & 29,19% OF TOTAL OPERATING COST

27 THE MYPD 3 SCENARIO: 2013/ /18 ASSUMES COST OF COAL INCREASES BY 10% / YEAR COAL BURN INCREASES FROM 128 MT/A TO 141 MT/A THE COST OF COAL AS A PERCENTAGE OF TOTAL COST DECREASES FROM 27.1% TO 21%

28 COAL AS A COST DRIVER COAL COST IS NOT THE MAJOR DRIVER IN THE INCREASED REVENUE REQUIREMENT

29 COAL QUALITY CALORIFIC VALUE REMAINED WITH ONE EXCEPTION BETWEEN 19 AND 20 MJ/KG FOR THE LAST DECADE. ASH CONTENT VARIED BETWEEN 28,6 % AND 29,7 % OVER THE SAME PERIOD COAL QUALITY IS DETERMINED BY CONTRACTUAL ARRANGEMENTS LINK PRICE TO QUALITY

30 COAL EXPORTS MYPD 3 ALLUDES TO A RECENT BOOM IN THE COAL-EXPORT MARKET COAL EXPORTS HAVE NOT INCREASED OVER THE LAST DECADE ESKOM NOT DEPRIVED OF COAL DUE TO EXPORTS

31 COAL EXPORTS

32 MINING CHALLENGES MPUMALANGA COAL FIELDS MATURE PRODUCTION UNLIKELY TO DECLINE DURING MYPD 3 PERIOD COAL FROM OPENCAST COLLIERIES INCREASING CURRENT CAPTIVE COLLIERIES ARE MATURE INCREASED MINING COST CAPITAL INVESTMENT REQUIRED AT CURRENT AND NEW COLLIERIES R650 MILLION PER MILION TON CAPACITY MINING INPUT COST WILL INCREASE, E.G WATER & ELECTRICITY

33 PRESENTATION OUTLINE Introduction Economic Impact of Proposed Increases Dissecting the price increase proposal Coal related issues Chamber proposals Conclusion

34 Chamber proposals to NERSA regarding MYPD3 The government needs to include price competitiveness and cost efficiency objectives in the shareholder compact with Eskom. The dividends from Eskom should include a price competitive and reliable electricity supply outcome that encourages growth and industrialisation. In this regard the government needs to seek an electricity pricing trajectory that keeps the electricity price within the first quartile of the international electricity price curve as published by NUS. NERSA should require from Eskom a more detailed statement of the valuation of Eskom assets. Eskom has already gained a huge revaluation windfall as a result of the shift to the depreciated replacement cost valuation methodology and it is critical that only the relevant assets are included in this calculation.

35 Chamber proposals to NERSA regarding MYPD3 cont. The government and NERSA need to consider lowering the cost of capital charge of 8% that Eskom is applying to its calculations. Eskom is a 100% owned company, is not exposed to significant competitive forces or risk, has a legislated guaranteed market place and has access to a strong sovereign balance sheet and therefore does not require an 8% cost of capital charge. The Government, with its strong balance sheet (debt-to-gdp ratio of about 40%) should consider providing further sovereign balance sheet support to Eskom to reduce the pressure on cost rises in the short and medium term.

36 The government has a strong balance sheet and can offer further debt guarantees to Eskom Source: IMF

37 Chamber proposals to NERSA regarding MYPD3 cont. The Government should consider exempting the tradable export sectors from the fossil fuel electricity levy. The R13 billion integrated demand management costs should be removed from the pricing application and this should be covered by the funds derived by the fossil fuel electricity levy. The actual need for the DoE open cycle gas turbine peaking plant should be investigated. Further private sector participation with access to the grid (ability to wheel) should be encouraged.

38 Chamber proposals to NERSA regarding MYPD3 cont. On the coal front Eskom believes that the country needs a stakeholder pact to curb electricity demand & limit increases in primary energy costs. The Chamber is of the view that, while SA is blessed with sufficient coal resources to meet not only local coal demand, but also demand for exports, substantial investment in infrastructure and new mines will be required to access these coal resources. The requisite expansion in mining can only be achieved if an appropriate and competitive return is offered to investors to induce the required investment. Such a competitive return can only be realised if a transparent market price exists for domestic supply of coal to Eskom. The Chamber is concerned that Eskom has not properly calculated the extra capital required to bring on stream new coal mines, and may have underprovided for primary energy in the MYPD3 application.

39 PRESENTATION OUTLINE Introduction Economic Impact of Proposed Increases Dissecting the price increase proposal Coal related issues Chamber proposals Conclusion

40 Conclusion The Eskom MYPD3 application is not affordable for the country and does not sufficiently capture the need to be congruent with the country s growth, industrialisation and job creation ambitions. Too much emphasis is being placed on the issue of a stand-alone investment grade rating. The Chamber is of the view that several measures can be employed that can reduce the price increase to a more acceptable level.

41 Conclusion South African Mining: Putting South Africa First

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