New Electricity Pricing Methodology: Stakeholders Highlight Risks

In trying to eliminate what it currently sees as problems with the way electricity tariffs are determined, energy regulator Nersa is determined to develop a new methodology, but this will also entail substantial risks, according to experts.

After consultation on the principles of the new methodology last year, Nersa published a consultation document on June 30 which details the new methodology.

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It has solicited stakeholder feedback by July 29 and expects to publish the final methodology by September 22.

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

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

This amount is then divided by the number of units the licensee expects to sell during the rate period to arrive at the unit price for the average standard customer.

In a subsequent process, the tariffs for the respective customer groups are calculated – all this must be approved by the regulator.

Risk mitigation

The methodology incorporates a risk mitigation mechanism that allows for retrospective adjustments in favor of the licensee or paying public if any of the assumptions underlying the rate determination deviate materially from what was intended. This is called the Regulatory Clearing Account (RCA).

If the required adjustment exceeds a predefined parameter, the rate determination must be reopened and recalculated from scratch.

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

Its treatment of municipalities, which consists of the annual publication of an indicative tariff increase and tariff benchmarks, has been widely criticized and challenged in court.

Eskom and Nersa have disagreed for several years on the application of the methodology. Eskom has challenged several tariff and RCA decisions in court and has always been successful.

Read: Nersa admits not having electricity tariff methodology in place

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

Expected 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 does not meet sales forecasts, he under-recovers revenue. This then leads to large adjustments in the ACR, which led to unexpected price shocks. As prices rise, sales fall even further, a vicious cycle known as the utility death spiral.
  • Cross-subsidies: Each consumer group has to pay them the true cost of supply.

Nersa proposes to unbundle the cost not only in terms of activity (production, transport and distribution) but also at the level of each plant.

He further wants to differentiate electricity users based on the type of load they use – base load, which is the stable and constant demand day and night required by customers such as mining and industry; semi-constant or average load that fluctuates during the day; short but intense load called peak load; and ad hoc emergency charging.

The idea is to then tie the charge to the cost of the factory that provides that charge.

In other words, customers who use peak load have to pay the cost of open cycle gas turbines that consume diesel, and customers who use base load have to pay the cost of coal and nuclear power plants, that operate at a much lower cost.

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

Read: CoJ plans to take over more power distribution from Eskom would hit businesses hard

Complexity will increase “significantly”

Ayal Rosenberg, managing director of metering specialist WeBill, warns that Nersa’s proposal will significantly increase tariff and metering complexity.

“Where you currently have four tariffs in the declining block tariff for residential customers, that [now] to be 16 years old,” he said.

Rosenberg says many of the meters currently in use across the country will not be able to measure what would be needed.

They will need to be replaced first, and it is unclear who will bear this cost.

He points out that the pricing 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 these institutions and the economy as a whole.

Deon Conradie, an independent consultant specializing in electricity pricing, agrees that meters – particularly in residential areas and large sections of the commercial sector – will need to be replaced to accommodate the proposed methodology.

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He says it is “too idealistic” given the current situation, such as the skills available in most local authorities, the availability of data, the “intense” need for information (as described by Nersa himself ) and the huge cost of setting up meters to accommodate all of this. .

“My biggest concern is that by introducing the proposed methodology when there is such an amount of offloading and uncertainty, it will create even greater financial risk for Eskom,” says Conradie.

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

He further questions the statement that the reopening of rate setting will be at the discretion of the regulator.

End cross-subsidies

Conradie further points out that Nersa proposes to remove cross-subsidies. Currently, industrial users subsidize households and Nersa proposes that these subsidies should in future be provided by the government.

“This is a matter of government policy, and even if it is the right principle, the money will now have to come out of the tax authorities and must be approved and budgeted by the government.

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

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

“This cannot happen overnight and will need to be implemented gradually. It will take the necessary skills and capabilities in many areas, additional funds to modify metering facilities and billing systems, the political will to make this happen so close to the next election, and in an economic environment extremely uncertain.

“I don’t think that’s realistic,” he said.

According to a recent court ruling, Eskom’s tariffs for 2023/24 will still be determined using the current methodology.

Those of the following year will however, according to the decree, be determined according to the methodology “which will exist at that time”.