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CHAPTER ONE
1.1 Introduction And Background Of Study
South Africa is one of the most sophisticated and promising emerging markets, offering a unique
combination of highly-developed first world economic infrastructure, with a vibrant emerging
market economy. It is one of the highest ranking developing economies in Africa, leading the
continent by producing up to 40% of the continent’s industrial output. The country also
contributes 45% of Africa’s total mineral production. In addition South Africa’s state owned
power utility Eskom generates 40% of the electricity consumed by the entire continent. Social
and demographic changes since the abolishment of apartheid such as urbanisation, the
burgeoning middle class and an expanding workforce are also creating new growth momentum
in South Africa (KZN Department of Economic Development and Tourism, 2010).
Over the nineteen years of democratic freedom South Africa’s intrepid macroeconomic
developments have enhanced economic growth, job creation and have opened up South Africa to
world markets. South Africa’s success in restructuring its economic policies is undoubtedly
mirrored by its GDP figures, which reflected an unprecedented 62 quarters of uninterrupted
economic growth between 1993 and 2007, when GDP rose by 5.1% (SARB, 2012). However
due to South Africa’s increased integration into the global market, its GDP contracted to 3.1%
due to the 2008-09 global economic crisis. Nevertheless the economy continues to grow, driven
largely by domestic consumption even though growth is at a slower rate than previously forecast.
It is projected to grow at 2.7% in 2013, 3.5% in 2014 and 3.8% in 2015 (SARB, 2012).
Under its inflation-targeting policy implemented by the South African Reserve Bank (SARB),
prices have been fairly steady. In January 2013, the annual consumer inflation rate was 5.4%,
plummeting from December 2012’s 5.7% (SARB, 2012). Stable and low inflation protects living
standards, especially of working families and low-income households. However it is important to
note that developments in the energy sector pose a large constraint on the growth prospects of the
country. The dominant energy supplying company, Eskom, has drawn up a six-year capital
investment program to increase the energy capacity of the country. This has sparked a wave of
anxiety across the economy since Eskom is a vital facilitator of growth for virtually all sectors of
the economy (Seymour, Akanbi and Abedian, 2012).
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Over the period 1994 to 2010 the South African economy nourished itself with the existing
energy infrastructure built before 1994 without advancing in further capacity to meet the
growing demands of the economy. For the past three decades, electricity prices in South Africa
have been low and declining (Steyn, 2006). Conversely, in 2008 the trend in electricity prices
took a dramatic turn when, in response to serious power supply shortages, Eskom undertook a
large build program to increase its power generation capacity (Kohler, 2010).
The increment in aggregate demand for electricity rose as a result of higher economic growth
and the developmental needs of a modern economy. The failure to invest adequately has created
a real constraint on the growth prospects of the country as highly disruptive load-shedding
episodes were experienced in the country in 2008.From 2008 to 2011 real electricity prices rose
by 78%. It is argued that electricity prices will need to continue rising towards ‘cost-reflective’
levels so that a repeat of the costly over-investment in generation capacity in the late 1980s and
the current supply shortages can be avoided (Cameron and Rossouw, 2012).
Previously Eskom was able to charge low electricity prices because it did not bear the full
economic cost of the capital it employed. This cost was borne in part by the state\taxpayers.
Because of the lenient financial requirements Eskom historically enjoyed under full state
ownership it did not have to bear the full economic opportunity cost of the capital employed to
finance its investments (Steyn, 2006). While tariffs were sufficiently high to allow Eskom to
repay its debt they did not allow Eskom to recover full costs of its assets. As a result Eskom did
not accumulate reserves to replace its assets in future. Consequently, consumers enjoyed a 17
year decline in real electricity prices that resulted in some of the most inexpensive electricity in
the world. Although electricity prices rose by 78% in real terms between 2008 and 2011, they are
still considered low by international standards and are yet to reflect the full economic cost of
supplying power (Frost and Sullivan, 2011).
Electricity price adjustments in South Africa are currently determined by The National Energy
Regulator of South Africa (Nersa) through the Multi-Year Price Determination (MYPD)
methodology (2015). The MYPD is based on rate-of-return principles and was developed for the
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regulation of Eskom’s required revenues, which is the basis on which prices are effectively
adjusted. The basic properties of an ‘optimal’ electricity tariff which in addition to cost
reflectivity include satisfying objectives such as revenue adequacy have been accepted by both
Nersa and Government and are laid out in the Electricity Act of 1996 and Electricity Pricing
Policy of 1998. Conceptually, a ‘cost-reflective’ tariff can be defined as a tariff equal to the long
run marginal cost (LRMC) of supply, since this is consistent with the efficient allocation of
economic resources (Nersa,2012).
Following the establishment that power outages or ‘unsaved energy’ come at far greater cost to
the economy than rising electricity prices, a study by Deloitte (2012) found that load-shedding
had substantial economic impacts across most sectors of the economy and if continued at 10% of
total power capacity over a year could shave as much as 0.7 percentage points off GDP growth.
Thus the electricity supply crisis, finally prompted decision makers to respond to the capacity
shortage that had emerged. However, in the 20 years since Eskom had last invested in base load
capacity, electricity tariffs had declined to such an extent that it became apparent that Eskom
would not be in a position to finance the new build program on the basis of its existing low
tariffs and inadequate revenue stream (Deloitte, 2012).
It is asserting the inevitable that in order to provide a sustainable supply of energy more capital
investment is needed. Therefore, the state-owned utility requested an allowable revenue
allocation of nearly R1.1-trillion. This implied the request for permission from Nersa to increase
its average selling price from 61candkWh currently (2015) to a nominal 128candkWh by
2017and18, or a real price of 96candkWh. In March 2013, Nersa announced that Eskom would
be allowed to increase electricity tariffs at an average yearly rate of 8% between 2013 and
2018.This increase that was half the 16% initially required by the utility in its application for the
third multiyear price determination (MYPD3) period. The approved tariff increases, which were
premised on an allowable revenue of R906.6-billion, would result in the electricity price
increasing to 89.13candkWh by the end of the MYPD3 (Nersa, 2012, Creamer Media
Engineering News, 2013).
