ESKOM RESEARCH REPORT

Transcription

1 ESKOM RESEARCH REPORT INTERNATIONAL BENCHMARKING OF ELECTRICITY TARIFFS AUTHOR(S) : LTE Energy in association with EA Energy Analysis, Denmark ORGANISATION : LTE COPYRIGHT ESKOM HOLDINGS LIMITED NO PUBLICATION OR DISSEMINATION OF ITS CONTENTS IS ALLOWED WITHOUT WRITTEN PERMISSION

2 RESEARCH REPORT INTERNATIONAL BENCHMARKING OF ELECTRICITY TARIFFS REPORT Confidential Page No:1

3 EXECUTIVE SUMMARY INTERNATIONAL BENCHMARKING OF ELECTRICITY TARIFFS OVERVIEW In the recent past Eskom has implemented a framework of pricing and tariff methodologies guided by the Strategic Pricing Direction for Tariffs documents whose objective in a broad sense is to promote economic efficiency and sustainability, ensure revenue recovery and promote fairness and equity. The current Eskom Tariff Methodology seeks to allocate the costs of its different divisions in a cost reflective manner as well as in conjunction with other parameters essential to each division so as to arrive at a tariff per customer category and account for subsidies in a way such that each cost per division and its tariff component does not affect revenue neutrality. It is with this background, the need arise for an international tariff benchmarking review. With the international benchmarking tariff study, Eskom wishes to contribute to the continued development and refinement of the tariff levels and structures in South Africa. BACKGROUND In the recent past Eskom has implemented a framework of pricing and tariff methodologies guided by the Strategic Pricing Direction for Tariffs documents whose objective in a broad sense is to promote economic efficiency and sustainability, ensure revenue recovery and promote fairness and equity. The utility s divisions have been unbundled, financially ring-fenced and regulated separately. This allows for the real costs per division to be known and adequately accounted for, and that the tariffs for each division can reflect cost levels and ensure revenue neutrality. This means that the sum of all tariff components is not more than the NERSA approved revenue requirement. The current Eskom Tariff Methodology seeks to allocate the costs of its different divisions in a cost reflective manner as well as in conjunction with other parameters essential to each division so as to arrive at a tariff per customer category and account for subsidies in a way such that each cost per division and its tariff component does not affect revenue neutrality. OBJECTIVES It is with this background, the need arise for an international tariff benchmarking review, which comes at a time of sustained volatility in a number of cost drivers for energy utilities. Increasingly, tariff structures seek to provide an incentive for reducing peak demand, reward customers for lowering their energy us and reduce the need for capacity expansion. To achieve these ends, utilities are increasingly considering alternative tariff structures, which include but are not limited to inclining block tariffs, time-of-use tariffs and controlled load tariffs. With the international benchmarking tariff study, Eskom wishes to contribute to the continued development and refinement of the tariff levels and structures in South Africa. One important aspect is continued comparisons and lessons learned from other countries around the world. It shall be noted that the report primarily provides a 2010 snapshot comparison. APPROACH REPORT Confidential Page No:2

4 The study covers the following three areas: Comparison of average tariff levels, comparison of tariff structure for selected customer groups, and comparison of tariff setting methodologies. The study compares tariffs in South Africa with a selected group of countries. The study is divided in three parts with the following issues to be included. Part A: Benchmarking of Eskom total average price against a selected group of countries with focus on an apples-versus-apples comparison of Eskom total average tariff (total regulated revenue divided by total sales volume) with that of other similar utilities in selected countries. The overall tariff comparison is provided in chapter 2.1. The following systemic sense-making factors qualify the comparative understanding of the total average tariff levels and have been provided for in chapter 2.2: (i) The trend of the total average tariff, (ii) the contribution of the average tariff to creating sustainable utilities, and (iii) the historical developments in exchange rates. Part B: Benchmarking of Eskom customer tariff categories against regional, developed and developing countries with focus on a comparison of customer categories tariff levels on average: municipality, large and medium industrial, residential, domestic etc. Each charge component comparisons include the consumers total average electricity unit cost by assuming typical customer profiles and assumptions. In order to compare price differences for different consumption volumes, typical standard consumers are defined for households and large and small industrial consumers. This is provided for in Chapter 3. Part C: Detailed comparison and discussion of tariff methodologies with a particular focus on a comparison and discussion of different tariff methodologies for a number of selected countries and utilities, see Chapter 4. This part carries out an analysis of selected countries in order to compare the tariff methodologies employed in these countries, the overriding factors in determining tariffs and how the choice of tariff methodology influences consumption for different consumer groups. RESULTS The Eskom tariff benchmarking study has provided a number of interesting findings and results. Of key results, discussions, cautions and lessons learned can the following be highlighted. For Part A the following general results can be noted: The benchmarking study of average tariffs is based on comparison of key national energy utilities total revenue and sales (Gwh). The ranking in column three is based on a simple exchange rate conversion of the resulting tariff per kwh in each utility. The benchmarking shows that South Africa (Eskom) is ranked fourth cheapest average tariff of the 15 countries utilities included in the survey. The last four countries (South Africa, India, Australia and China), however, only have marginally different average tariffs (+/- 2 SA cent). Then there is SA-cent up to the next group of countries (Argentina, Canada, US, Denmark, South Korea, Thailand, Kenya). The highest average tariffs can be found in Malaysia, Spain and UK South Africa (Eskom) is the third largest utility included in the benchmarking based on sales only smaller than the German and South REPORT Confidential Page No:3

5 Korean utilities. The smallest utilities included are the utilities from Kenya Argentina and Australia. The ranking show poor relation between sales and revenue South Africa (Eskom) is ranked as having the second largest inflation corrected tariff increase of the benchmarked countries during the last 8 years. UK had the biggest average tariff increase, while South Korea, Denmark and Canada had the lowest average increase. None of the countries included had a negative tariff to inflation increase rate over the last 8 years South Africa (Eskom) is has the third lowest RoA of the utilities included in the benchmarking. Denmark s DONG has by far the highest RoA, followed by utilities in India, Spain, Thailand, Germany, UK and Kenya. Only the Chinese and Argentina utilities have lower RoA than Eskom. No correlation between RoA and credit ratings can be seen The PPP results show that there is no correlation of the total average tariffs (based on exchange rate calculations) to the corresponding international PPP benchmarking of the national utilities including in the study. The PPP results also show markedly large changes in rankings for some countries, e.g. South Africa. Based on these findings it is found that the interpretation of the PPP results has to be undertaken with care, and it is suggested that further investigations into the use and practicability of the PPP comparison technique for power utilities. For Part B the following general results can be noted: Eskom s tariffs generally compare favourably with many other countries when considered as a price only comparison. The tariffs were not compared on an affordability basis. Eskom has the third lowest tariff for consumers using 200 kwh/month. Malaysia has the lowest tariff at this level. Tariffs in Vancouver are also lower than in South Africa. Still, the study showed that reducing the amount of kwh in the lowest tariff block or only providing the lowest tariff to households with single phase connections or prepaid meters etc. could be considered for improved financial feasibility and better international market match The marginal cost of electricity for South African consumers in the highest tariff block is on a par with tariffs in Australia and the lower European tariffs. The European tariffs generally include high energy taxes The average cost per unit for consumption of 1000 kwh/month under the Eskom block tariff is generally higher than tariffs in North America, but lower than in Europe, Australia, Malaysia and Brazil. Most countries have a flat rate tariff for consumers at this level so they do not benefit from the low-income block tariff as consumers do in South Africa Malaysia and Brazil have block tariffs that are aimed at assisting lowincome households. In Malaysia this is done with a number of small REPORT Confidential Page No:4

6 blocks, whilst in Brazil qualification for lifeline tariffs is based on the size of the connection Industrial tariffs in South Africa are generally more expensive than tariffs in North America. The South African tariffs are, however, listed prices. Very large industrial consumers in South Africa may well have negotiated their own contracts at a lower rate than those listed Cross subsidisation of rural consumers through industrial tariffs should be defined as a levy on transmission in order that wheeling agreements or the introduction of other pricing mechanisms do not circumvent or undermine the rural electrification programme. For Part C the following general results can be noted: There is low transparency in the tariff breakdown for residential consumers in South Africa Tariff methodologies are generally most transparent in countries with market systems and regulated monopolies in the transmission and distribution sectors. Generation is not regulated and determined by market economics whilst transmission and distribution is regulated using revenues caps or cost plus methodologies. In parts of the US and some Canadian provinces generation is also regulated through cost plus methodologies Important parts of the electricity system have been liberalized in many countries and competition has been introduced. To create the framework for the competitive part of the sector more rules and laws are needed for monopolies. A substantial part of the electricity sector in most countries is still regulated as monopolies. The regulation of monopolies is therefore still very important, also after the introduction of competition. This is so, not only because of the part of the consumer s prices that are payment to the monopolies, but also because the linkages between the competitive sector and the monopolies are very strong. CONCLUSIONS As almost always with international benchmarking studies, they raise more questions than they answer (which normally is good, as international benchmarking stimulate innovations, questions business as usual, contribute to competition and improvements). Some of the interesting hypothesis and trends that is raised by the general results for Part A, include amongst others: It seems like South Africa has a low average tariff (simple exchange rate) compared to other countries, while the opposite is the case for the PPP comparison. The consequences and implications of this for e.g. tariff setting need to be better understood REPORT Confidential Page No:5

7 It seems like South Africa in relation to PPP ranking is in a middle situation with a number of lower GDP income countries above, and higher GDP income countries below. The implications of this grouping also needs to be better understood It seems like there is an uncorrelated relation with utilities key parameters (e.g. sales, revenue, etc) and RoA (Return on Assests). Likewise it seems like there is no correlation between RoA and credit ratings. What are the underlying reasons for these non-correlations? For Part B the following general conclusions can be made: The affordability of electricity in South Africa is a key issue due to the prevalence of energy poverty in many households. A better understanding of the affordability of electricity will provide useful information in designing a lifeline tariff that is directed towards the target group rather than benefitting all consumers. This could lower the cost of supply for the utility and provide greater incentive for energy efficiency in households that can afford these measures The lowest block of 200 kwh per month is a high level of consumption. If the intention is to target low-income households then Eskom should consider re-evaluating the size of the first tariff block or attaching a requirement along the line of the size of connection. This would reduce cross subsidisation to those that do not require assistance and bring residential tariffs closer to reflecting the true cost of supply for those that can afford it. It may also allow for the lifeline tariff to be reduced if the affordability of electricity for low-income households is low The pricing of industrial tariffs could be based more closely on marginal pricing in order to send the correct price signals to large consumers and provide greater incentives for them to plan consumption according to the cost of supply at the time of consumption. This would provide a more nuanced pricing mechanism and allow for unforeseen system events to influence the electricity price for short periods as required. This could be done in association with offering fixed prices at a premium rather than at a discount as is the tradition in South Africa. Fixed prices should be seen as an insurance against high prices rather than an assurance of low prices. Fixed price contracts place the pricing risk on the utility and the utility should therefore be compensated for this. Variable price contracts place the price risk on the consumer and they are rewarded through low prices in off peak periods. This could be considered for consumers where time interval metering is possible and with a sufficient level of consumption. For Part C the following general conclusions can be made: Rules and regulations for transmission system, access to transmission system, wheeling and system operation should be assessed to find simple yet robust model for transmission pricing and wheeling rules REPORT Confidential Page No:6

8 Greater transparency in the breakdown of costs could be considered for consumers. This will also provide the opportunity for benchmarking distribution companies in South Africa with each other and internationally and should provide incentives to increase efficiency through regulation Differentiating between generation, transmission and distribution costs is an important part of unbundling utilities. Eskom is currently in the process of ring fencing generation, transmission and distribution. As in some other countries, this could be reflected in the tariff breakdown Transmission and distribution tariffs should represent grid investments that help reduce the overall cost of supply for the end user. The way investments are included in tariffs should be assessed and justified using the principle of least-cost-supply rather than least-cost-investment on a project-by-project basis. RECOMMENDATIONS Results, hypothesis and cautions leads to a number of key lessons learned and recommendations for the present international benchmarking study, including: The market share of the utilities included for each country should be increased to at least 50-60% of the national energy market to improve reliability in comparisons The utilities either need to be unbundled in Generation, Transmission, Distribution and Retail or other methodologies needs to be developed to further improve the apple-to-apple comparison. This also include a greater focus on generation technologies for comparisons Data collection should be complemented by direct data collection from included utilities. E.g. was China not included in the study due to lack of Annual Report data. China should (of many reasons) be included in the next study and other avenues of getting data from Chinese utilities should be used Detailed studies of the hypothesis of the study e.g. the use of PPP or the differences between different customer group tariffs, should be initiated to gain further lessons of the international benchmarking study A study should be made into the effect of reducing the number of kwh in the lowest tariff block and how this would affect the tariff in other blocks. This is in reality an alternative to large tariff increases. 200 kwh can be considered to be a high level of consumption for a low income household. There are most likely a number of free riders in this programme. A study could be carried out to assess this issue A study should be carried out to determine the marginal price of electricity in South Africa hour for hour for the last couple of years and scenarios for future years. This would provide the basis for determining a more nuanced pricing structure for large industrial consumers REPORT Confidential Page No:7

9 Development of a methodology for determining the value of investments for transmission and distribution and how these investments will influence the overall cost of electricity for the end user. This could also be applied for generation, but is best suited for grid companies Assess the needs of the market and determine how wheeling should be handled and develop market rules for use of transmission system. The above would constitute key component in a Terms of Reference for a possible new and expanded international tariff benchmarking study. INDUSTRY PERSPECTIVE As always with international benchmarking studies, numerous cautions and clarifications is needed in order not to make over-interpretations of the results. In this benchmarking studies attention should be made towards: The use of selected national power utilities as base for the international benchmarking. This has provided new results, but also showed the difficulties and need for further detailing of such studies: The different structuring of Annual Reports, the difficulties in separating Generation, Transmission, Distribution and Retail in the figures provided in the Annual Reports, lack of clarity in most Annual Report on what revenue contains, e.g. exploration, market sales, transmission sales delinked from own generation, etc (the lack of correlation between sales and revenues in table 2.3 is an indicator hereof) The use of simple exchange and PPP rates contributes to increased nuances in interpretations, but also decreased clarity The study attempted to unbundle the utilities in Generation, Transmission, Distribution and Retail costs. This proved to be an almost impossible task based on the information available for the desk study, which was based on Annual Report This contributes in some instances to difficulties in interpretation of the benchmarking results, e.g. the companies from Australia and Canada are pure generation companies, others are full GTDR companies, others again is even much more than that, e.g. oil exploration etc. as in the case of Germany and Denmark Data availability and specificity therefore has to noted as a serious limiting factor in providing bullet-proof apple-versus- apple comparisons. One reason for this can be related to the ownership structure of the utilities. There is no doubt that the government-owned companies, like e.g. South Africa, Malaysia and Thailand, provide clearer and more transparent data than private-owned companies that compete on a competitive energy market, e.g. UK, Germany and Spain South Africa and Eskom, of the countries and utilities included in the study, provide, with Denmark s DONG, the most transparent and easy data to analyze. This conclusion is based on the detailed analysis of Annual Reports 2010 published by the Utilities. REPORT Confidential Page No:8

10 KEYWORDS Average tariffs Benchmarking Consumer tariffs Data comparisons Exchange rates Industrial tariffs International Power Purchase Parity Power Utilities Tariffs Tariff methodologies Trends FUTURE REVIEW It is recommended that the present study is further detailed and extended whereby Eskom can contribute constructively to the trend and increased effort of international benchmarking of tariffs between power utilities. REPORT Confidential Page No:9

11 1 INTRODUCTION In the recent past Eskom has implemented a framework of pricing and tariff methodologies guided by the Strategic Pricing Direction for Tariffs documents whose objective in a broad sense is to promote economic efficiency and sustainability, ensure revenue recovery and promote fairness and equity. The utility s divisions have been unbundled, financially ring-fenced and regulated separately. This allows for the real costs per division to be known and adequately accounted for, and that the tariffs for each division can reflect cost levels and ensure revenue neutrality. This means that the sum of all tariff components is not more than the NERSA approved revenue requirement. The current Eskom Tariff Methodology seeks to allocate the costs of its different divisions in a cost reflective manner as well as in conjunction with other parameters essential to each division so as to arrive at a tariff per customer category and account for subsidies in a way such that each cost per division and its tariff component does not affect revenue neutrality. It is with this background, the need arise for an international tariff benchmarking review, which comes at a time of sustained volatility in a number of cost drivers for energy utilities. Increasingly, tariff structures seek to provide an incentive for reducing peak demand, reward customers for lowering their energy us and reduce the need for capacity expansion. To achieve these ends, utilities are increasingly considering alternative tariff structures, which include but are not limited to inclining block tariffs, time-of-use tariffs and controlled load tariffs. With the international benchmarking tariff study, Eskom wishes to contribute to the continued development and refinement of the tariff levels and structures in South Africa. One important aspect is continued comparisons and lessons learned from other countries around the world. 1.1 KEY ISSUES ADDRESSED AND METHODOLOGY UTILISED The study covers the following three areas: Comparison of average tariff levels, comparison of tariff structure for selected customer groups, and comparison of tariff setting methodologies. The study compares tariffs in South Africa with a selected group of countries. The study is divided in three parts with the following issues to be included. Part A Benchmarking of Eskom total average price against a selected group of countries with focus on an apples-versus-apples comparison of Eskom total average tariff (total regulated revenue divided by total sales volume) with that of other similar utilities in selected countries. The key overall results of the international benchmarking of average tariffs is presented followed by an outline of trends and hypothesis that can be drawn for these results, cautions and REPORT Confidential Page No:10

12 clarifications, and finally, by lessons learned and recommendations for the international average benchmarking study. The overall tariff comparison is provided in chapter 2.1. The following systemic sense-making factors qualify the comparative understanding of the total average tariff levels and have been provided for in country-to-country comparisons in chapter 2.2: (i) The trend of the total average tariff. Has the tariff increased or decreased relatively to inflation during the last decade? What is the expected trend for the tariff the next 3 years? (ii) the contribution of the average tariff to creating sustainable utilities, (iii) the historical developments in exchange rates, and (iv) the historical development of the power purchase parity (PPP). These four contextual sense-making background factors provide a systemic approach to understanding the average total tariff levels and making relevant comparisons between the selected countries and utilities. Part A of the study has been carried out as a desk top study using statistical data available from mainly the selected utilities annual reports (chapter 2.1), International Energy Agency, United Nations, European Union and other relevant national and international authorities (chapter 322). These data make it possible to compare total average utility tariffs in South Africa with utilities in selected countries. The study, besides a number of more well-known comparisons parameters, utilises Power Purchase Parity and Credit Ratings for comparisons purposes. Part B Benchmarking of Eskom customer tariff categories against regional, developed and developing countries with focus on a comparison of customer categories tariff levels on average: municipality, large and medium industrial, residential, domestic etc. Each charge component comparisons include the consumers total average electricity unit cost by assuming typical customer profiles and assumptions. In order to compare price differences for different consumption volumes, typical standard consumers are defined for households and large and small industrial consumers. The standard consumers used are based on the standard consumers used by EU Statistics for comparing tariffs between member countries. This is provided for in Chapter 3. Part C Detailed comparison and discussion of tariff methodologies with a particular focus on a comparison and discussion of different tariff methodologies for a number of selected countries and utilities, see Chapter 4. This part carries out an analysis of selected countries in order to compare the tariff methodologies employed in these countries, the overriding factors in determining tariffs and how the choice of tariff methodology influences consumption for different consumer groups. Correct pricing is essential in the electricity sector in order to ensure an efficient allocation of new capacity and reduced demand. Tariffs should send the correct price signals to consumers, but remain practical for utilities and consumers. An appropriate or effective electricity tariff is not in itself capable of stimulating investment in the electricity sector, however, a poorly conceived pricing structure is often sufficient to depress investments. There are four criteria that should be met to achieve an effective tariff: Marginal costs are reflected in the tariff; Recovery of total costs; Ease of computation and transparency; and Fairness. Chapter 5 includes conclusion and a discussion of the findings, while chapter 6 include references. REPORT Confidential Page No:11

13 1.2 COUNTRY SELECTION The study will focus on countries with similar market structures to South Africa and similar profiles for fuels consumed for generation, yet with variations in electricity tariffs when compared to South Africa. The countries included in the study part A for comparison of average pricing are the following countries: Country & Utility South Africa Argentina Pampa Energia Australia Macquarie Generation Canada Ontario Power Generation China China Resource Power Holding Denmark DONG India National Transmission Power Comp Germany EON Kenya Malaysia South Korea Profile and reason for selection Baseline country: GTDR, fuel based on coal, state-owned Third largest electricity market in Latin America with 95% electrification rates, thermal and large hydro generation dominant, rising electricity demand and declining reserve margins are giving rise to the need for investment in new generation capacity, electricity sector was unbundled in the early 1990s, 75% of generation capacity owned by private companies with transmission and distribution sectors highly regulated Large coal fired generation, significant renewable energy penetration with mix of merchant (IPP) and state owned generation companies Historically thermal and hydro with nuclear generation assets, state owned and merchant power companies, cross border electricity sales Second largest electricity consumer globally, world s third largest coal reserves and large hydropower potential, high annual growth in electricity demand and supply due to industrialization and urbanization, state power companies dominate generation and electricity supply assets with reforms separating power generation and electricity supply companies GTDR, previous mainly coal-powered and state-owned, now privatized with a high degree of market regulation, high governmental levies and taxes portion of the tariff breakdown, a high penetration of renewables maybe having the same GTDR and cost/tariff profile as Eskom in the near future World s 5 th largest installed capacity where thermal and hydropower holding the majority share, lack of access to electricity in rural areas, traditional fuels still used for cooking and heating needs Historically vertically integrated electricity utilities generation, wholesale trading and retail business with increasingly high proportion of renewable energy independent power producers due to EEG law (renewable energy feed in tariff law), large utilities have interests in gas and oil exploration Kenya Power & Lightning is the national generation, transmission, distribution and retail power company based on diversified fuel power input (gas, diesel, coal, hydro and IPPs) Gas and oil dominated generation base with coal and hydro capacity to a lesser degree, interconnections with Thailand and Singapore, state owned company the major player regulated by Department of Electricity and Gas Supply Nuclear power makes up a third of installed capacity and REPORT Confidential Page No:12

14 Korea Electric Power Company Spain Endesa Thailand EGAT UK Scottish & Southern USA AEP 45% of electricity supply due to high capacity factors, increased investment in renewable energy to reduce reliance on oil imports Growing renewable energy installed base spurred on by feed in tariff law, declining share of nuclear power, electricity consumption per person lower than EU 15 average Industry liberalisation underway to allow for IPPs to sell power to national utility, Liberalised electricity market, fossil fuelled generation still prevalent with renewable energy utilities growing market share due to renewable energy purchase obligation Over 3000 electricity utilities, made up of publicly owned, rural cooperatives and investor owned, electricity transmission networks owned by Independent System Operators (ISO) or Regional Transmission Organisations which operate on a not for profit basis and are obligated to provide grid access to numerous suppliers in order to promote competition Table 1.1 Reasons for country selection for Part A The countries to be included in Part B of study for comparison of average customer group pricing include the following countries: Country Reason for inclusion South Africa Baseline country Australia Coal based generation, block tariffs, good data available Brazil Low income block tariff, BRICS country Canada Low tariffs, good data availability Denmark Mixture of coal, gas and renewables with hydro and nuclear imports, high taxes, good data available Malaysia Block tariff with universal low income block, middle income country, large penetration of IPPs in generation sector USA Coal based generation, good data available Table 1.2 Reasons for country selection for Part B The countries to be included in Part C of study for comparison of pricing methodology include the following countries: Country Reason for inclusion South Africa Baseline country Australia Reliable information available, large Tx and Dx networks Canada Reliable information available Denmark Reliable information available, many small, locally owned distribution companies USA Reliable information available, ISO structure Table 1.3 Reasons for country selection for Part C REPORT Confidential Page No:13

15 2 PART A: BENCHMARKING OF ESKOM TOTAL AVERAGE TARIFF The objective in this chapter is to benchmark Eskom total average tariff against regional, developed and developing countries with focus on an apples-versusapples comparison of Eskom total average tariff (total regulated revenue divided by total sales volume) with that of other similar utilities in selected countries. Data from Annual Reports 2010 has been utilized 1. This overall tariff comparison is provided in chapter 2.1. Four systemic sense-making factors qualify the comparative understanding of the total and GTDR average tariff levels and have been provided for in chapter 2.2. These contextual sense-making background factors provide a systemic approach to understanding the average total tariff levels and making relevant comparisons between the selected countries and utilities. 2.1 INTERNATIONAL AVERAGE TARIFF BENCHMARKING Below is first provided the key overall results of the international benchmarking of average tariffs. This is followed by an outline of trends and hypothesis that can be drawn for these results, cautions and clarifications, and finally, by lessons learned and recommendations for the international average benchmarking study. Overall results. Table 2.1 below shows the overall result of the international benchmarking of the average electricity 2010 tariffs between key utilities in selected countries. Country Utility Av tariff ZAR Rank Malaysia TNB Spain Endesa United Kingdom S&S Germany EON Kenya KPL Thailand EGAT South Korea KEPCO Denmark DONG USA AEP Canada OPG Argentina Pampa It shall be noted that the Annual Reports 2010 used covers different periods, e.g. May 2009-April 2010, Jan 2010-Dec 2010, March 2010-Feb It has not been possible to standardize the period REPORT Confidential Page No:14

16 South Africa ESKOM India NTPC AUS MG China CRPH Table 2.1 Comparison of average total tariffs for selected national utilities based on annual reports 2010 The benchmarking study of average tariffs is based on key national comparison of energy utilities total revenue and sales (Gwh). The ranking in column three is based on a simple exchange rate conversion of the resulting tariff per kwh in each utility. The benchmarking shows that: South Africa (Eskom) is ranked fourth cheapest average tariff of the 15 countries utilities included in the survey. The last four countries (South Africa, India, Australia and China), however, only have marginally different average tariffs (+/- 2 SA cent). Then there is SA-cent up to the next group of countries (Argentina, Canada, US, Denmark, South Korea, Thailand, Kenya). The highest average tariffs can be found in Malaysia, Spain and UK. As mentioned is the overall benchmarking results based on comparisons of national key utilities revenues and sales in the year Below is provided a summary of the key figures used for the analysis. A simple exchange conversion to ZAR has been undertaken for comparison. Country Utility Sales GWh Revenue ZAR Germany EON 1,030, ,194 South Korea KEPCO 434, ,333 South Africa Eskom 218,591 69,942 USA AEP 205,869 91,020 UK S&S 205, ,380 India NTPC 205,091 64,636 Spain Endesa 175, ,357 Thailand EGAT 156, ,470 Canada OPG 88,600 35,475 China CRPH 70,223 20,950 Denmark DONG 47,000 21,741 Malaysia TNG 41,146 80,924 Australia Macquarie 21,424 6,720 Argentina Pampa 19,292 7,785 Kenya KPL 5,318 3,558 Table 2.2 Comparison of included power utilities sales and revenues 2010 based on annual reports 2010 Table 2.2 shows the ranking for sales and revenue of the selected national utilities. The ranking shows that: South Africa (Eskom) is the third largest utility included in the benchmarking based on sales only smaller than the German and South Korean utilities. The smallest utilities included are the utilities from Kenya REPORT Confidential Page No:15

17 Argentina and Australia. The ranking show poor relation between sales and revenue South Africa s sales / revenue factor is around 3, while most of the remaining have a factor 2 or even (much) lower. In the study was included a number of background analysis of the main benchmarking results. One background analysis dealt with the development of the tariff increase over the last 8 years compared to average national inflation rates. Table 2.3 ranks the countries according to highest tariff increases adjusted for inflation (only countries with comparable dataset is included). Country Real tariff increase Rank UK South Africa USA Germany AUS Spain Canada Denmark South Korea Table 2.3 Comparison of average tariff increase for countries based on www data from national power regulators] The average tariff increase (inflation corrected) shows that: South Africa (Eskom) is ranked as having the second largest inflation corrected tariff increase of the benchmarked countries during the last 8 years. UK had the biggest average tariff increase, while South Korea, Denmark and Canada had the lowest average increase. None of the countries included had a negative tariff to inflation increase rate over the last 8 years. In the study was finally included a background analysis of the credit ratings and RoA (Return on Assets) in the financial year Table 2.4 ranks the countries according to RoA 2. This ranking is correlated to the credit rankings. 2 What do the credit ratings mean? The used credit rating in this survey is based on Standard ; Poor credit ratings, which used the following terminology: AAA Extremely strong capacity to meet financial commitments. AA Very strong capacity to meet financial commitments.a Strong capacity to meet financial commitments, but somewhat susceptible to adverse economic conditions and changes in circumstances.bbb Adequate capacity to meet financial commitments, but more subject to adverse economic conditions.bbb is the lowest investment grade by market participants.bb+ Highest speculative grade by market participants.bb- Less vulnerable in the near-term but faces major ongoing uncertainties to adverse business, financial and economic conditions. B More vulnerable to adverse business, financial and economic conditions but currently has the capacity to meet financial commitments. CCC Currently vulnerable and dependent on favorable business, financial and economic conditions to meet financial commitments.cc Currently highly REPORT Confidential Page No:16

18 Country Utility ROA % Rank Rating Denmark DONG 50 1 A- India NTPC 31 2 BBB Spain Endesa 20 3 A- Thailand EGAT 19 4 Germany Eon 18 5 A UK S&S 15 6 A Kenya KPL 10 7 AUS MG 8 8 AAA USA AEP 7 9 BBB+ Malaysia TNB 7 9 BBB+ Canada OPG 6 11 A- South Korea KEPCO 6 11 A South Africa Eskom 5 13 BBB+ China CRPH 4 14 BBB Argentina Pampa 4 14 Table 2.4 Comparison of RoA and credit ratings based on annual reports 2010 The international benchmarking of the RoA and credit rating for year 2010 shows that: South Africa (Eskom) is has the third lowest RoA of the utilities included in the benchmarking. Denmark s DONG has by far the highest RoA, followed by utilities in India, Spain, Thailand, Germany, UK and Kenya. Only the Chinese and Argentina utilities have lower RoA than Eskom. No correlation between RoA and credit ratings can be seen. So much for the general results of the benchmarking study Part A. As almost always with international benchmarking studies, they raise more questions than they answer (which normally is good, as international benchmarking stimulate innovations, questions business as usual, contribute to competition and improvements). Some of the interesting hypothesis and trends that is raised by the general results, include amongst others: It seems like South Africa has a low average tariff (simple exchange rate) compared to other countries, while the opposite is the case for the PPP comparison. The consequences and implications of this for e.g. tariff setting need to be better understood It seems like South Africa in relation to PPP ranking is in a middle situation with a number of lower GDP income countries above, and most higher GDP income countries below. The implications of this grouping also needs to be better understood vulnerable.c Currently highly vulnerable obligations and other defined circumstances.d Payment default on financial commitments. Ratings from AA to CCC may be modified by the addition of a plus (+) or minus (-) sign to show relative standing within the major rating categories REPORT Confidential Page No:17

19 It seems like there is an uncorrelated relation with utilities key parameters (e.g. sales, revenue, etc) and RoA. Likewise it seems like there is no correlation between RoA and credit ratings. What are the underlying reasons for these non-correlations? Purchasing Power Parity as a comparison technique? The study undertook a separate study to compare the average total tariffs utilizing the Purchasing Power Parity comparison technique as developed by e.g. the World Bank, and in a simplified version by The Economist in its McDonald index. What is Purchasing Power Parity and how is it calculated? The simplest way to calculate purchasing power parity between two countries is to compare the price of a "standard" good that is in fact identical across countries. Every year The Economist magazine publishes a light-hearted version of PPP: the "Hamburger Index" that compares the price of a McDonald's hamburger around the world. More sophisticated versions of PPP look at a large number of goods and services. The World Bank PPP table was used in this study. Purchasing power parity (PPP) is a theory, which states that exchange rates between currencies are in equilibrium when their purchasing power is the same in each of the two countries. This means that the exchange rate between two countries should equal the ratio of the two countries' price level of a fixed basket of goods and services. When a country's domestic price level is increasing (i.e., a country experiences inflation), that country's exchange rate must depreciate in order to return to PPP. The basis for PPP is the "law of one price". Exchange rate movements in the short term are news-driven. Announcements about interest rate changes, changes in perception of the growth path of economies and the like are all factors that drive exchange rates in the short run. PPP, by comparison, describes the long run behavior of exchange rates. The economic forces behind PPP will eventually equalize the purchasing power of currencies. This can take many years, however. A time horizon of 4-10 years would be typical. The study converted the average tariffs to PPP values, see table 2.5, and investigated the development of the PPP rates over the last decade, see table 2.6. Table 2.5 and 2.6 shows the result of the PPP benchmark ranking of the selected national utilities. The PPP indicates the real tariff adjusted for short-term exchange rate differences. The PPP benchmarking shows that: South Africa (Eskom) is ranked as having the six most expensive PPP tariff of the 15 countries utilities included in the survey being in a middle group of counties having a PPP tariff between USD/kWh. Kenya, Thailand India and Malaysia has very high PPP tariffs, while in the bottom of the table are countries of South Korea, USA, Canada and Australia South Africa (Eskom) is ranked as having the third, largest increase in PPP with a PPP increase of 55% tariff increase only surpassed by India and Malaysia. South Africa thereby lost 55% in power purchase parity compared to the baseline (USA) during the last 10 years. At the other end of the table did the countries Germany, Denmark and Spain gain PPP against the baseline. REPORT Confidential Page No:18

20 The PPP results show that there is no correlation of the total average tariffs (based on exchange rate calculations) to the corresponding international PPP benchmarking of the national utilities including in the study. The PPP results also show markedly large changes in rankings for some countries, e.g. South Africa. Based on these findings it is found that the interpretation of the PPP results has to be undertaken with care, and it is suggested that further investigations into the use and practicability of the PPP comparison technique for power utilities. Table 2.5 Comparison of average PPP tariffs for selected national utilities based on annual reports 2010 PPP tariff in Country Utility USD Rank Kenya KPL Thailand EGAT India NTPC Malaysia TNB Denmark DONG South Africa ESKOM China CRPH Spain ENDESA Argentina Pampa UK S&S Germany EON AUS MG Canada OPG USA AEP South Korea KEPCO Table 2.6 Comparison of PPP increase over the last 10 years based on www data from national power regulators converted to PPP values (only countries with comparable dataset is included) PPP increase Country rank % increase Malaysia 1 85 India 1 85 South Africa 3 52 Thailand 4 42 China 5 20 AUS 6 14 South Korea 7 9 UK 8 3 Canada 9 0 Spain 10-3 Denmark 11-6 Germany Cautions and clarifications. But as always with international benchmarking studies, numerous cautions and clarifications is needed in order not the make REPORT Confidential Page No:19

21 miss-interpretations of the results. In this benchmarking studies attention should be guided towards: The (new/innovative) use of selected national power utilities as base for the international benchmarking. This has provided new results, but also showed the difficulties and need for further detailing of such studies: The different structuring of Annual Reports, the difficulties in separating Generation, Transmission, Distribution and Retail in the figures provided in the Annual Reports, lack of clarity in most Annual Report on what revenue contains, e.g. exploration, market sales, transmission sales delinked from own generation, etc (the lack of correlation between sales and revenues in table 2.3 is an indicator hereof) The use of simple exchange rate and PPP rates in the benchmarking contributes to increased nuances in interpretations, but also decreased clarity The study attempted to de-bungle the utilities in Generation, Transmission, Distribution and Retail (see table 2.7). This proved to be an almost impossible task based on the information available for the desk study. This contributes in some instances to difficulties in interpretation of the benchmarking results, e.g. the companies from Australia and Canada is pure generation companies, others are full GTDR companies, others again is even much more than that, e.g. oil exploration etc. as in the case of Germany and Denmark Data availability and specificity therefore has to noted as a serious limitating factor in providing bullet-proof comparisons. One reason for this can be related to the ownership structure of the utilities. There is no doubt that the government-owned companies, like e.g. South Africa, Malaysia and Thailand, provide clearer and more transparent data than privateowned companies that compete on a competitive energy market, e.g. UK, Germany and Spain. It is found that South Africa and Eskom, of all countries and utilities including in the study, provide the most transparent and easy to analyse data for public scrutiny. Reven ue mill Sales GWh Country Utility G T DR Total G T DR Total S Africa Eskom 49,732 29,492 43,577 69, ,591 ARG Pampa 4,866 19,292 AUS Macqu 1,003 21,424 Canada OPG 5,375 88,600 China CRPH 21,162 70,223 DK Dong 14,981 3,444 18,425 19,300 10,400 17,300 47,000 German EON 92,863 1,030,400 INDIA NTPC 461, ,09 KEN KPL 39,107 5,318 MAL TNG 30, , ,146 REPORT Confidential Page No:20

22 S Korea KEPCO 38, ,160 Spain Endesa 31, , , , Thai EGAT UK S&S 20, ,100 USA AEP 13, ,869 Table 2.7 Indicative table for comparison of GTDR between utilities Lessons learned and recommendations. Results, hypothesis and cautions, as outlined above, leads to a number of key lessons learned and recommendations for the present international benchmarking study of average tariffs. These include: The market share of the utilities included for each country should be increased to at least 50-60% of the national energy market to improve reliability in comparisons The utilities either needs to be de-bungled in Generation, Transmission, Distribution and Retail or other methodologies needs to be developed to further improve the apple-to-apple comparison. Greater focus also has to be placed on the different generation technologies and fuel sources Detailed studies of the hypotheses outlined above, e.g. should be initiated to gain further lessons of the international benchmarking study. Below is provided background data for each country and utility included in the international benchmarking study. The background data for each country and utility is compared to South Africa and Eskom. 2.2 BACKGROUND DATA Below is provided background data for the findings presented in chapter 3.1. Background data include brief data and descriptions of the included utilities, followed by data on the four sense-making factors included in the study Utility data Below is provided brief background data on all selected utilities included in the benchmarking study based on annual reports from Eskom, South Africa, in brief (Annual Report 2010) Countries of operation: South Africa, SADC countries Areas of operation (bn ZAR) Generation 49,7; Transmission 29,4; Distribution 43,5 Total revenue (bn ZAR) 69,942 Generation capacity (Mw) 41,194 Yearly production (Gwh) Fuel type generation Coal (99%), Hydro, Gas, Nuclear, Wind Staff 41,778 Market share (generation) 99 Ownership Government of Republic of South Africa Table 2.8 Eskom in brief REPORT Confidential Page No:21