South Africa's Electricity PricesAt the Tipping Point We cannot afford to get it wrong!

Presenting to the DTI PPC2 November 2012

AGENDA

• Primary Sector leads Job & Economic Growth

• MYPD3 Prices will Slash Growth and Jobs

• Industrial, Commercial and Domestic Sectors Impacted

• The Solution

• Conclusion

The delicate balance in transformation!Job retention/creation in primary, secondary and tertiary sectors

Exploration Mining ConcentratingSmelting/Extraction

MetalRefining

Producing Products for

ManufacturingValue Chain

Producing Products for

Retail

Marketing &Sales

China, India, Russia etc are progressively taking jobs from South Africa by importing South African ore in raw form

and investing in these higher value adding steps!South Africa then has to import the value add good from China.

South Africa is selling its birthrights!

New

Job C

reati

on

New

Job C

reati

on

SA cannot leapfrog the value nodes without a surplus of skilled labour!

Plus Tertiary Value Chain Jobs

Primary Value Chain Jobs

Plus Secondary Value Chain Jobs

Interrupted! South Africa’s

Economic Transformation

Source: GAPMINDER

Growth driven by credit fuelled Non-

tradable Sectors

Tradable export sectors have

languished…..

Tradable sectors

Non-tradable sectors

Low Job

Creating

High Job

Creating

Non-tradable sector – Sucking-in imports and creating external imbalances, such as running large current account deficits…..

AGENDAWe are at a Tipping Point

•Primary Sector to lead Job & Economic Growth

•MYPD3 Prices will Slash Growth and Jobs

•Industrial, Commercial and Domestic Sectors Impacted

•The Solution

•Conclusion

Losing the BalanceMust be Tough on Costs, Subsidies & Sales…

Soft on Prices

Price

Sales

Costs &Subsidies

Too Low!Too Low!

Rising TooRising TooFast &Fast &High!High!

= Unaffordable= Unaffordable

Too High!Too High!DictatingIndustrial

Policy?

Electricity Prices are Making South Africa Non Competitive

MYPD3 IRP 2010 Future Economy?

Sources: IRP2010, Eskom, Frost & Sullivan, EIUG

Eskom's MYPD3 Application

EIUG Modelling

Best CaseEfficiencyPrice Path

Worst CaseEfficiencyPrice Path

130 Rc/kWh (by 2022)

Eskom's MYPD3 Application (Scenario 1)

The Tipping Point for RSA

Source: Eskom and The U.S. Energy Information Administration (EIA)

Threat to the Future of Silicon Smelting in South Africa

Threat to the Future of Steel Production in South Africa

Source: EIUG Steel Industry Data

2022 South Africa MYPD3 Scenario 1

Threat to the Future of FeCr Smelting in South Africa

MYP

D 3

US

mill

s pe

r kW

h

Source: CRU for comparison up to 2011, SA escalations going forward shown in real 2011 terms with CPI of 5% assumed

Commodity World Rank in reserves

RSA % share of known total global reserves

PGM's 1 88%

Manganese 1 80%

Chromium 1 72%

Gold 1 14%

World Chrome Ore resources by region Breakdown of market share for FeCr production

SA Ferrochrome market share is being displaced to China

Flight of South African Industry!

Open

Closed

Semi-closed

8

13

18

23

28

33

38

43

Notwithstanding that South Africa is the World leader in ferrochrome manufacturing technology—almost 100% locally-sourced

China

India

Kazakhstan

South Africa

Furnace type(Open vs Closed)

China

India

Kazakhstan

South Africa

Furnace size (MVA)

China4.08

India

Kazakhstan

South Africa

Power consumption(MWh/t)

4.03

3.98

3.88

3.83

3.78

3.73

3.68

3.93

SA Mining and Industry being Priced out of Jobs Cost of doing business in SA has grown at an alarming rate

SA FeCr industry cost growth

Source: CRU, Xstrata Analysis, Company annual reports

CAGR 11.1%

CAGR 8.4%

Serious Impact from Electricity Price increases Sample of 13 Large South African Industrial

Companies

Source: Genesis Analytics

2012

2017

Mining Alone – An Essential Core Of SA Economy

• Creates 1.3 million jobs (500 000 direct & 800 000 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

AGENDAWe are at a Tipping Point

•Primary Sector to lead Job & Economic Growth

•MYPD3 Prices will Slash Growth and Jobs

•Commercial and Domestic Sectors also Impacted

•Recommendations

•Conclusion

Household electricity prices on PPP basis using the Big Mac Index –

2009 to 2012

www.Economists.co.za

RSA 2012

RSA 2009

AGENDAWe are at a Tipping Point

•Primary Sector to lead Job & Economic Growth

•MYPD3 Prices will Slash Growth and Jobs

•Industrial, Commercial and Domestic Sectors Impacted

•The Solution

•Conclusion

RecommendationsA. Cut Inefficient Costs

A. Improve ESKOM Operating Efficiencies

B. Improve ESKOM Capital Cost Efficiencies

C. Accelerate IPP’s

D. Remove Non-Electrical Subsidies

E. Improve Consumption Efficiencies

B. Increase Electricity Sales

C. Reduce Excessive Safety Margins if Funding Allowances

Eskom’s Operating Efficiencies Low!

A Universal Fact:Unplanned Work is > 50% more expensive than planned work

Metric Eskom's Standard Actual Today

Availability Factor >90% <84%

Unplanned Work <3% >14%

IPP’s and Competition will Ensure Efficiencies Return

Eskom’s Building Efficiencies Low

IPP’s< 75 c/kWh

Eskom 95 c/kWh

Source: Black & Veatch

Inefficiency in Current Domestic Demand

Reducing

Increasing

Eskom Revenue is GuaranteedPrices Soar if Energy Sales are Low or

Fall

=Revenue Requirem

ent

Cost of SalesCost of Sales

O&MO&M

Overhead CostsOverhead Costs Asset DepreciationAsset Depreciation

+

+ +

Prudent expenditure

Prudent expenditure

x

OtherOtherReturn &Depreciation

Return &Depreciation+ +

% Return on Assets (ROA)

% Return on Assets (ROA)

Asset BaseAsset Base

• Levies• Taxes• Claw-back

Primary EnergyImportsIPP Purchases

StaffMaintenance

Revalued AssetsWUC

ForecastEnergy Sales

ForecastEnergy Sales = Revenue Revenue

PricePrice

Reduce Prices byIncreasing Sales

0.30

0.35

0.40

0.45

0.50

0.55

0.60

0.65

0.70

0.75

0.80

0.85

0.90

0.95

1.00

1.05

1.10

1.15

1.20

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030

Debt

:Equ

ity R

atio

or P

rice

(R/k

Wh)

Price & Debt Equity Cones (Prices Real 2010)

Reduce Excessive Safety Margins in Funding

Source: Frost & Sullivan

Parameter Current Justifiable

Return on Assets Real 8,16% 4 to 6%

Asset Valuation Historic to Replacement Slower transition

Financing Tariff Tariff and Project Financing

Eskom Debt Equity 0.2 to 0.5 0.5 to 0.8

Price (10% ROA)

Price (4% ROA)

d:e(4% ROA)

d:e(10% ROA)

Justifiable d:e

Justifiable Price

Subsidies are Killing JobsBy 2017/18 >24% of the

Industrial Tariff is Subsidy

Contribution

By 2017/18 It could be >30%

Excluding Municipal

Subsidies Added

On Top of this Municipalities are Loading the variable (energy) charges

The true reflection of what is actually being charged is however often understated due to non-standard charges. NERSA regulates categories consisting of an energy charge, a demand charge and a fixed charge. Surcharges and levies fall outside the mandate of NERSA and Nersa is thus not in a position to regulate additional levies or surcharges that municipalities impose. Municipalities appear to be able to apply such non-standard charges at their discretion with little or no regulation.

Sources: BDO, select municipalities

And on Top of this Municipalities are also Loading the fixed (Demand)

charges

A recent BDO analysis of the purchase costs from both Eskom and the municipalities making up the study found that there is a heavy bias in the costs for the demand charge component of electricity. The tariffs bear the imprint of historical investment decisions at the point of their inception. The question must be asked why such inflated charges are still being charged against equipment that should be fully depreciated.

Sources: BDO, select municipalities

AGENDAWe are at a Tipping Point

•Primary Sector to lead Job & Economic Growth

•MYPD3 Prices will Slash Growth and Jobs

•Industrial, Commercial and Domestic Sectors Impacted

•The Solution

•Conclusion

ConclusionTough on Costs, Subsidies & Sales

Soft on Prices

A. Cut Inefficient Costs – Do Not Simply Increase Prices

B. Refine funding Model – Regulatory Methodology needs to be reassessed

C. Remove Excessive Funding Safety Margins

D. Increase Sales – This reduces Prices

E. We do not need Subsidies – Just Remove the non Cost Reflective charges

QUESTIONS

34