May 2007FIELDSTONEAFRICA (PTY) LIMITED

Cogeneration Guidelines and

Framework for South Africa

Introduction to FieldstoneIntroduction to Fieldstone

CLIENTS

SERVICES INDUSTRY FOCUS

New York

London

Johannesburg

HyderabadM&APrivatisations

Capital raising Project finance

Debt restructuringStrategic financial advice

RenewablesInfrastructure Merchant plantUtility networksEmission creditsContracted plantEnergy retailing

DevelopersCorporates

GovernmentsFinancial investorsManagement teams

Independent directors/boards

Berlin

CLIENTS

SERVICES INDUSTRY FOCUS

New York

London

Johannesburg

HyderabadM&APrivatisations

Capital raising Project finance

Debt restructuringStrategic financial advice

RenewablesInfrastructure Merchant plantUtility networksEmission creditsContracted plantEnergy retailing

DevelopersCorporates

GovernmentsFinancial investorsManagement teams

Independent directors/boards

Berlin

IELDSTONE IS AN

INTERNATIONAL

INVESTMENT BANKING

FIRM

FOCUSED ON

ENERGY AND

INFRASTRUCTURE

Background Background to Cogeneration Framework and Guidelinesto Cogeneration Framework and Guidelines

Key driver:

need for energy savings

and new capacity

Key driver:

need for energy savings

and new capacity

Identified possible

contribution from

industrial electricity

consumers

Identified possible

contribution from

industrial electricity

consumers

LimitationsLimitations

Regulatory responseRegulatory response

• Looming capacity shortages - understood need from Nersa to

support measures which encourage energy saving or efficient

development of new capacity

• Looming capacity shortages - understood need from Nersa to

support measures which encourage energy saving or efficient

development of new capacity

• Unsolicited approaches from industry to Nersa and Eskom to

develop onsite, decentralized generation

• Unsolicited approaches from industry to Nersa and Eskom to

develop onsite, decentralized generation

• Need for clearly defined process to create enabling environment

– licensing and contracts

• Need for rational pricing of electrical output

• Need for clearly defined process to create enabling environment

– licensing and contracts

• Need for rational pricing of electrical output

• Nersa decision to develop guidelines and regulatory framework

to encourage development of the cogeneration sector

• Fieldstone engaged to assist in development of guidelines –

production of report following extensive consultation with

• Nersa decision to develop guidelines and regulatory framework

to encourage development of the cogeneration sector

• Fieldstone engaged to assist in development of guidelines –

production of report following extensive consultation with

industry, Nersa and Eskom

Cogeneration Guidelines Cogeneration Guidelines –– WhatWhat’’s Covered?s Covered?

Why cogeneration: benefits / need for support

What should be done to support Co-gen?

Long-term vs short-term objectives

Why Cogeneration Why Cogeneration –– DefinitionDefinition

What do we mean by cogeneration

Literature provide numerous sometimes contradictory definitions

Principle driven definition (rather than technology) chosen for Guidelines

Decentralized, non-

centrally dispatched

generation

2. and at least one of

Waste or certain

renewables based fuel

source for generation

Use of heat from

generation in industrial

process (CHP)

or

1. Primary definition

Why Cogeneration Why Cogeneration -- Principal ApplicationsPrincipal Applications

Industrial sites

District Heating/Cooling

Energy Efficient Building

Agri-industry

Why Cogeneration Why Cogeneration –– Possible BenefitsPossible Benefits

Use less fuel per unit of utilised energy product increased productivity

Decentralisation of energy production -Ease transmission grid congestionDefer transmission investment Avoid electrical lossesImproved reliability given location close to source of demand and ability to tailor output

Energy Efficiency

• Reduced Greenhouse gas emissions per unit of utilised energy product

• Potentially produce less environmentally damaging waste and effluent per unit of utilisedenergy product

• Reduction and mitigation of liabilities in carbon constrained future

• Ability to optimise EIA process

Environmental Benefits

Localised inside the fence generation –mitigating demand

Modular, small scale units – capacity added in step rather than in large “lumps”

Bring capacity online in reduced time frame versus large utility-scale power plants

Broaden scope of fuels used to produce electricity

Security of Supply

• Cogeneration project development as possible means of mitigating the countrywide development and engineering skills shortage

• Ideal BEE opportunity

• Ideal entry-point for the mobilization of private sector resources into the electricity sector

Social Benefits

Cogeneration

Why Cogeneration Why Cogeneration –– The Bigger PictureThe Bigger Picture

Central power station

Commercial

building

Local CHP plant

Storage

Storage

Power

quality

device

Flow

Control

Transmission Network

Distribution Network

Tomorrow: distributed/on- site generation with fully integrated

network management

Storage

Photovoltaics

power plant

Wind

power

plant House with domestic CHP

Power

quality

device

Storage

Commercial

building

Local CHP plant

Storage

Storage

Power

quality

device

Flow

Control

Yesterday

Why Cogeneration Why Cogeneration –– Need for Regulatory SupportNeed for Regulatory Support

Why given the above benefits hasn’t the sector seen significant investment as yet?

Reasons cited include:

� Market structure:� Single offtaker: no automatic route to market

� Lack of ability to wheel power

� Current pricing

� Pricing of backup power

� Lack of transparency – uncertainty over process to be followed

� Current process too bureaucratic

� Variations in cost of capital

� Payback horizon for industrial companies

� Development costs

Key barrier: current pricing of potential new capacity versus retail pricing against Eskom’s depreciated asset base � required essential feature of any support mechanism:

Pricing of output to be based on avoided cost of new generation rather than current wholesale power price

Why Cogeneration Why Cogeneration –– Need for Support Need for Support -- ExampleExample

Project funding

Economic benefit versus next best

Avoided cost of next best baseload plant – Line C

Cost of wholesale power – SA system – Line A

Cogeneration project avoided costs – Line B

Required Timescale for support

c/kWh

Time

Guidelines and Framework Guidelines and Framework –– ObjectivesObjectives

Given preceding points the guidelines and framework have two key objectives:

1. Define, and ideally simplify the process for developing, evaluating and implementing

cogen projects

2. Ensure rational pricing for qualifying cogeneration projects

Guidelines Guidelines –– Recommended Support Recommended Support -- OutlineOutline

Overarching Regulatory FrameworkOverarching Regulatory Framework

Determination of qualifying projectsDetermination of qualifying projects

Determination of rational priceDetermination of rational price

Suggested implementation mechanismSuggested implementation mechanism

Key Elements of Regulatory Support for Cogeneration

Provide overall sector

sustainability and bankability

Provide overall sector

sustainability and bankability

Provide specificityProvide specificity

Overcome current pricing

limitations

Overcome current pricing

limitations

Provide project bankabilityProvide project bankability

Guidelines Guidelines –– Overarching Regulatory FrameworkOverarching Regulatory Framework

Suggested long-term

approach

As part of Eskom’s licensing conditions oblige certain percentage of supply to come from cogenerated sources

Consistent with international regulatory best practice

Sector enabler: National Cogeneration

Standard

Nersa determined and approved avoided cost for price settingNersa approved long-term mechanism to allow and incentivise Eskom to recover cost of contracting with cogeneration plant

Project enabler: cost recovery mechanism for

Eskom

Long-term proposals are consistent with

international regulatory practice but are time

consuming and resource intensive

Need for an interim approach – Eskom

Pilot Programme

Guidelines Guidelines –– Determination of Qualifying ProjectsDetermination of Qualifying Projects

How to determine

which projects are

covered?

Expand on earlier definition:

3 Types of basic project covered by Framework

Projects utilizing process energy which would otherwise be underutilized or wasted

Examples:Waste Heat Recovery SystemsGeneration from waste gas Waste or discard solid fuel

Type I

• Primary fuel based generation projects which produce, as part of their core design, other usable energy in addition to electricity

• Examples:� Combined Heat and Power (“CHP”)

Type II

• Renewable fuel based projects, where the renewable fuel source is both a primary source of energy used for generation and a co-product of an industrial process

• Examples:� Sugar industry bagasse based generation

� Generation from forestry waste

�Wastewater based generation� Solid renewable waste

Type III

Guidelines Guidelines –– Determination of Rational PriceDetermination of Rational Price

Determining

“Rational” Price • Initially captures only those plant which are cost efficient versus alternative new capacity options

• As a result no effective subsidy provided to cogeneration plant

• This prioritizes low-cost capacity addition →may require additional incentives in future if

‘pure’ energy efficiency becomes a priority

Starting point – system avoided cost of new

generation as benchmark to be bettered

Capture maximum societal economic benefit (yellow square from earlier)

understood market mechanism

Requires capacity setting targets - difficult to specify amount and timing

Who runs and adjudicates auction?

Auction Capacity

Pros:• No limit on capacity• Reduce development risk - price a known factor

Cons

• How to determine “right” price• Risk of oversupply

• Some loss of societal benefit

Set price at percentage of avoided costs

First

Then either:

Current Preferred

Option is to use

auction to

determine prices –

Eskom Pilot

Programme as test

case

Or

Guidelines Guidelines –– ImplementationImplementation

Implementation

mechanism

Bankable, long-term PPA with Eskom encapsulating supported price

ESKOM ability to lock in long term power below its avoided costs

Eskom credit-passthrough – optimise cost of capital

Application of two-way metering for projects consuming power on-site i.e. paid for all power generated not only that dispatched onto the grid

Power Purchase Agreement with Eskom

Automatic project enabler

Draft PPA already in development for

Eskom Pilot Programme

Guidelines Guidelines –– LongLong--term Objectives term Objectives vsvs ShortShort--term Needsterm Needs

Trade off between long term objectives and short term constraints

Long term objective: ongoing supported program promoting cogeneration

development

� Fully developed and implemented regulatory framework: National Cogeneration

Standard

� Requires dedicated capacity & resource within NERSA: specific cogeneration function

Short term: urgent need to expedite development of new generation capacity.� Increased need to engage ESKOM

� Interim approach NERSA sanctioned tender for PPA’s with ESKOM

Eskom Pilot Programme

ENDEND