BRIEFING ON THE CURRENT ELECTRICITY CRISIS AND PRICING TO

1. 1 BRIEFING ON THE CURRENT ELECTRICITY CRISIS AND PRICINGTO The Portfolio Committee on Minerals and Energy 28th May 2008

2. Contents • The challenges at hand and measures adopted to meet them • Update on progress made • Key principles underlying our application • The regulatory rules and their impact on Eskom • Review of recent history • Need for a reserve margin • Evolution of the reserve margin • Generation fleet performance • Winter 2007 Review • Original Prognosis and Actual Performance • Coal Stockpile movement • Operating Challenges • Eskom’s Recovery Programme • Review of Load Shedding & Energy Savings to date • Winter 2008 Prognosis 2

3. 3 The Challenges at Hand….

4. Financial sustainability of Eskom • Eskom is facing significant financial challenges for 2008/9 and beyond. • Extraordinary increases in fuel costs are placing considerable strain on Eskom’s operating cash flow. • The capital expansion programme is placing real pressures on Eskom’s ability to finance needed additions to the county’s power supply. • Based on 14.2% price increase currently allowed, Eskom projects a loss for 2008/09 of R 7.9 billion. • The impact on Eskom’s financial sustainability is reinforced by credit rating agencies placing the utility on credit watch. 4

5. These are extraordinary times • Reserve margins are well below industry standards and leave no room for unplanned events. • Ageing plant is being run longer and harder than designed for. • The window of opportunity for doing maintenance is becoming tighter and tighter. • Operating costs are increasing at a more rapid pace. • The new build programme is greater than ever seen in South Africa. 5

6. Extraordinary measures are required • Eskom has applied for a significant increase in tariffs. • Massive capital investment is underway. • R343 billion over the next 5 years and is set to increase by more than R1.3 trillion in the long term. • Load shedding remains a possibility. • Increased use of load shedding since 2006 • National emergency declared on the 24th of January • A national energy savings drive is underway. • Significant support from the shareholder has been announced. • R60 billion in the budget 6

7. Where we are now To meet the short term needs of the industry we have.. • Completed significant planned maintenance programmes freeing up valuable generation capacity for the winter months. • Worked hard to limit further unplanned outages. • Continued to build up coal stocks and are securing new sources of long term coal supply. • Moreover, we are well into a significant capacity expansion programme that will see us through into the medium and long term. 7

8. Financial constraints A balance of solutions will be required to fund the capital expansion programme and maintain operations. • Shareholder support, prices and utility efficiencies all factor into Eskom’s planning. • Government support of R 60 billion over five years. • Ongoing efficiencies driven by Eskom in operations and procurement. • Most importantly, it is critical to maintain Eskom’s credit rating. Without this: • access to funds will be limited; and • the cost of those funds may be prohibitive. 8

9. 9 Progress update

10. Progress to date • Eskom has embarked on a capital expansion programme well beyond the scope seen in South Africa’s electricity supply industry. • 18 704 MW committed thus far • R254 billion of projects approved since 2004 • Major contracts placed since 2004 = R83 billion • Medupi = R42 billion • Bravo = R33 billion • Ingula = R1,8 billion • Ankerlig and Gourikwa = R5, 7billion • Capital expenditure since 2004 = R54,6 billion • 2005/6 R 11,3 billion (R8,8 million per working hour) • 2006/7: R17,8 billion (R8,8 million per working hour) • 2007/8 (Unaudited)t: R25,5 billion (R12,2 million per working hour) • 2008/9 (Forecast): R46 billion (R23 million per working hour) • 2 656 MW of power generation capacity brought on line since 2004. • 1,026 km of overhead line, • 4,740 MVA installed transformation • 6 new substations. • A DSM programme delivering 967 MW energy savings. 10

11. Key principles underlying our application • Prices need to reflect the efficient cost of electricity supply. • Tariff structures must recognise the importance of affordability to the poor. • Prices need to adjust to volatility in fuel and capital costs. • Government support will be needed for roll-out of the capital expansion programme. 11

12. Regulatory rules that adjust to changing industry drivers An important component of our proposal is that regulatory rules allow for adjustment to changing fuel and capital costs. • In previous Applications Eskom has proposed that prudent cost of supply be recovered as a pass through, and that annual adjustments are made for significant changes in costs. • Pass through is based on allowing for variations in fuel and capital costs which are unpredictable and uncontrollable to be included in price adjustments. • Eskom has proposed an even handed mechanism where customers would gain if these costs decrease. • Prudency reviews would overlay this ensuring that only efficient costs are recovered through prices. • Since the introduction of a Multi-Year Price Determination our applications for revenue allowances have consistently been based on the recovery of prudent costs of supply on the basis of the pass through principle 12

13. 13 Review of Recent History

14. Why should electrical systems be operated with a reserve margin and other buffers? 14 The Electrical Power System is considered the most complex system around. It is a mix of electrical, communication, mechanical, civil, information and management systems. A comprehensive list of things that could go wrong and the possible impact on other risks cannot be modelled. The ability to continuously visualise the current risk status is incredibly difficult and stressful. The impact of failures can be significant to catastrophic (i.e. blackout). There are various global examples of where this has occurred. Buffers in the system such as operating reserves, stockpile days, transmission and distribution network redundancy and resources allow the System Operator to deal with multiple events in real time while enabling sustainable medium to long term performance By continuously operating “on the edge”, you will not need many things to go wrong before you test your defence systems. You do not want to test your defence systems too often as the increased exposure will increase the likelihood of something going wrong and these barriers failing. South Africa’s ability to deal with a nationwide black out is untested and we cannnot rely on our neighbours to assist. 14

15. Operating Reserve Margin Generation Capacity Net Reserve Margin There are two key components to the reserve margin • Meet demand and supply side deviations instantaneously and then in the short to medium term replenish resources that have been utilised. • Deal with the loss of the single largest unit on the system or single point of import provision. • Deal with credible cascading events in the short term (<1 day). • Operating reserve margin plus the ability to cater for additional situations and circumstances including: • Deal with longer term loss of major units or significant disruptions in capacity provision (strike at a mine) • Ability to cater for short to medium term economic growth • Account for major seasonal variations 15 15

16. Re-establishing the Buffers – Eskom’s Recovery Programme 16 Supply Side Initiatives • Focus on key areas of plant performance and ensure resources and maintenance windows are provided to improve performance. To date 17 of the 23 identified units that required additional essential maintenance have been accommodated. As further assessments are done, more units will be identified. External benchmarking and reviews by other utilities has helped and will continue to be utilised (from the US, France and Germany). • Focus on managing the coal supply and handling. Currently the system stockpile days is at 17.4 days with 5 of the 12 power stations above 20 days, 3 between 15 and 20 days and 4 between 13 and 15 days. This has been on a steady upward trend. Challenge is delivery of the additional emergency coal purchases. Demand Side initiatives • Established separate task teams with key industrial customers and the top 11 municipalities to assess demand reductions and work on activities to accelerate energy savings. • Engagement with various government departments and other stakeholders on an energy conservation programme. Planning and Expansion • Integration of Transmission and Generation expansion planning and development of adequacy standards that will be entrenched in regulations. Plans review short, medium and long term in some detail. • Three programmes to attract non-Eskom generation; Pilot National Co-generation programme, Medium Term Power Purchase Programme programme and Base load IPP programme. Other programmes will be considered. • Focus on meeting current commitments on Return to Service programme, Gas1, Medupi, Ingula and Bravo projects. • Working with Government on streamlining decision making processes. 16

17. 17 Winter 2007 Review

18. Colour Coding • Green (sufficient operating reserves – 1800MW to 1900MW) • It is likely one may only have to use our scheduled generation resources and normal operating reserves. Green means we have the required level of operating reserves at our disposal. • Yellow (Between1800 and 800MW of operating reserves) • It is likely one will make extensive use of whatever DMP contracts we have and use EL1 extensively (i.e. generate above maximum capability rating at certain power stations). One may also make use of the interruptible load contracts over peak periods. • Orange (Up to 200MW short of meeting demand) • It is likely one will make extensive use of the interruptible load contracts and use the Open Cycle Gas Turbines in short bursts. • Red (between 1200MW and 200MW short of meeting demand) • It is likely one will resort to a high level of use of the Open Cycle Gas Turbines and Interruptible Loads and possibly have emergency load shedding in short bursts. • Brown (more than1200MW short of meeting demand) • It is likely one will have to resort to emergency load shedding. 18

19. Original Prognosis & Review Assumptions used for actual classification of a week • This is a comparison of version 5 of the 18 month winter plan • Prepared mid May 2007 • The actual load is that before any reduced load is added back • The contribution to variation from “planned color” is a combination of a number of factors • Although initial classification may be “brown”, where possible action are taken to reduce the risk of load shedding in real time • The reasons indicated here are merely indicative of likely key contributors for that specific week 19

20. Peak and energy comparisons 2006/2007 • A growth in the peak demand of 1706MW • During this peak contracted customers reduced demand by about 500MW • Load was shed at other times in winter 2007 for transmission constraints (late May 2008) in Mpumalanga and Gauteng • Potential Peak demand of just over 37 000MW 20

21. Operating Challenges – Meeting Demand in Winter • The peak demand indicated is the average for the hour. Within that hour there could be an instantaneous peak up to 1000MW higher than the average. Instantaneous demand in 2007 was about 38 000MW. • The demand increase rapidly between 5:30pm and 6:15pm as lighting, cooking and heating load throughout the country is switched on. Up to 3000MW of demand is introduced with an hour. This requires vigilance and rapid reaction capability at National Control. • The Transmission network requires extensive management to deal with this surge, with significant switching of reactive power devices to ensure that the network remains stable and an adequate quality of supply is provided. 21

22. Ability to meet the demand and energy required • The step change in demand of about 1700MW from 2006 was a significant operational challenge that the control centre had to adapt to. • Good generation performance improved the ability to meet the demand of winter 2007 • Strong reliance on customer contracts to reduce load almost daily • The performance of the OCGT’s was good and they were used extensively • The extensive pre-planning helps to actively contain a large supply/demand mismatch to manageable levels • The security of the primary energy levels after the winter was a major concern • The planning and procurement process to ensure sufficient liquid fuels worked well. • The energy usage was significant in winter 2007 with very high daily load factors 22

23. 23 Review of Load Shedding and Energy Saving

24. Why was planned or scheduled load shedding stopped? “ We are seeing evidence of increased energy savings from municipalities and Eskom is optimistic that further reductions to reach our 10% savings target are possible. A task team of senior Eskom executives and top officials of municipalities from around South Africa is to meet early next week to discuss the way forward in driving further energy savings. Recent savings, particularly from industry, have shown that it should be possible to achieve this objective sustainably through a concerted and committed effort by all of us. This is the spirit of Eskom’s engagement with municipalities and we would hope that it will not be necessary to reinstate scheduled load shedding. However, should the national grid come under unexpected pressure, there may be occasions where brief periods of load shedding could be required. Extract from Media Release – 30 April 2008 “ • We initially began load shedding because we were not seeing movement in the municipalities towards savings and there was a disproportionate burden on the direct Eskom switchable customers (specifically Key Industrial Customers). • After we introduced pre-emptive (scheduled) load shedding, we saw movement that resulted in initial savings by the municipalities and other customers. There were concerns about the consequences of load shedding from some stakeholders. • Although these do not yet amount to the required 10%, the direction of these savings indicated that with continued focus the required targets can be reached without further scheduled load shedding. • We acknowledge that coal stock piles and generation performance remains an operational risk and therefore a dedicated focus on achieving the 10% savings target is still required. • Mechanisms such as pricing and rationing will further support and drive the savings initiatives. 24 24

25. Evidence of Savings • Overall System Savings • March and April billing information is showing evidence of savings but not 10%. April data shows between 4 and 5% of energy savings against forecast. • April real time system information show a saving of between 4 and 5% on energy and 4 to 7% on maximum demand. • Top 12 Metros and Municipalities • Evidence of between 4 and 5% savings in energy demand in April based on billing data. This is against forecasted demand. • Key Industrial Customers • Evidence of up to 8% savings in energy demand in April based on billing data and this has been confirmed by metering data. This is against forecasted demand. 25

26. Engagement with Top 11 Metros and Municipalities • Issues with Municipal Load Shedding • Not all municipal customers were load shed (inequity) • Shedding outside of stipulated scheduled load shedding periods • Load shedding did not take place 6 days a week as requested • Load shedding durations did not average 6 hours per week • Some municipalities did not shed their allocated load • Some municipalities had stopped load shedding without formal agreement from Eskom that 10% savings had been achieved • Eskom/Municipal Task team (Top 11 Metros and Municipalities) • This team met on 06 May 2008. It was agreed that the following issues will receive priority attention • Measurement and baselines • Tariffs and incentives (specifically for the crisis) • Water heating management – priority technology • DSM funding process – Global application for funding for key issues • New Connections, dealing with this consistently • Communication – Consistent message, Customer education • Non – payment (Non-technical losses) • Technologies – smart metering, lighting etc. • Legal framework • A small Task Team has been established to look at the key high impact activities with a common approach and the funding requirements. A follow-up meeting has been convened for 23rd of May 2008. 26

27. Engagement with Key Industrial Customers and other Customers • Industry Task Team chaired by representative from Industry set up after the January load shedding incidents to advise Eskom’s Chief Executive. • Developed various work streams to provided forums for discussion and where necessary agreement on certain protocols. • Weekly meetings of some of the streams and the task team meets every 2 weeks. • Agreement reached on protocols to measure and verify savings against various baseline consumptions. • Information is shared on current power system status and prognosis. • Debate occurs on the various streams of Eskom’s recovery programme and input received on possible lines of action. 27

28. 28 Winter 2008 Prognosis

29. Assumptions for Planning Purposes • Load Forecast • Scenario A - Pessimistic • No more savings and cold winter starting in mid-May • Scenario B • Sustain savings at the current level (about 4 to 5% energy and up to 7% on peak demand) • Cold winter starting in mid May • Scenario C • Achieve required savings rapidly through conservation programme and engagement process. • Cold winter starting in mid May • Reality is probably somewhere around Scenario B • Others shown to indicate potential impact • Short term (May forecast) is slightly lower than Scenario B • Strong dependence on customer response • Supply Side • Generation maintenance plan as of 6th May 2008 • Allowance for 1850MW to 1900MW of operating reserves in real time • Sensitivities of 2000, 3000, 4000 MW unplanned outages and output reductions of Generation plant 29

30. Colour Coding • Green (sufficient operating reserves – 1800MW to 1900MW) • It is likely one may only have to use our scheduled generation resources and normal operating reserves. Green means we have the required level of operating reserves at our disposal. • Yellow (Between1800 and 800MW of operating reserves) • It is likely one will make extensive use of whatever DMP contracts we have and use EL1 extensively (i.e. generate above maximum capability rating at certain power stations). One may also make use of the interruptible load contracts over peak periods. • Orange (Up to 200MW short of meeting demand) • It is likely one will make extensive use of the interruptible load contracts and use the Open Cycle Gas Turbines in short bursts. • Red (between 1200MW and 200MW short of meeting demand) • It is likely one will resort to a high level of use of the Open Cycle Gas Turbines and Interruptible Loads and possibly have emergency load shedding in short bursts. • Brown (more than1200MW short of meeting demand) • It is likely one will have to resort to emergency load shedding. 30

31. Load shedding will be the last mechanism used to manage the system under any scenario 31 31

32. Coding for May – August 2008 • Continued and further Energy Savings is essential to ensure a stable system • Generation performance will still have a significant impact on the risk of manual load shedding • Planned maintenance will continue to optimised in the short term as far as possible depending on actual system status to minimise risks 32

33. Concluding statements (1/2) • Energy savings are required to manage the network constraints as well as maintain an adequate supply demand balance. • However it is still possible for single equipment failures in the transmission network to cause localised interruptions of supply which could persist for several days especially over peak periods. • The coal stockpile days improved in April, and are healthier with no stations under 13 days. • The supply demand balance is still very vulnerable and a continued focus is needed on maintaining the current level of savings and as quickly as possible achieving the targeted level of savings while focusing on generation and transmission plant performance. • Electricity prices need to reflect the efficient cost of services provided to customers including fuel and capital. • Tariff structures must recognise the importance of affordability to the poor. • Prices need to adjust to volatility in fuel and capital costs. • Government support will be needed for roll-out of the capital expansion programme. • Moreover, Eskom’s financial sustainability must be maintained to provide funds needed to carry out the expansion plan. 33

34. Concluding statements (2/2) An important component of our proposal is that regulatory rules allow for adjustment to changing fuel and capital costs. • The application of overly strong ‘incentive based’ cost caps within the MYPD is out of step with the needs of the industry. • Incentives should promote quality of service and needed capacity expansion. • The current MYPD rules based on fixed cost caps do not well address either of these matters, nor are such incentives appropriate for costs mostly driven by external factors. • In previous Applications Eskom has proposed that prudent cost of supply be recovered as a pass through, and that annual adjustments are made for significant changes in costs. • Pass through is based on allowing for variations in fuel and capital costs which are unpredictable and uncontrollable to be included in price adjustments. • Eskom has proposed an even handed mechanism where customers would gain if these costs decrease. • Prudency reviews would overlay this ensuring that only efficient costs are recovered through prices. • With more robust cost adjustment rules in place, there will not be the need for ongoing ad hoc applications for price increase. 34

35. 35 Thank you