May 2013

1. Portfolio Committee on EnergySecuring financial sustainability(in response to lower tariff decision) May 2013

2. Nersa Decision, Rationale and Implications Content 1 2 Eskom Response

3. Summary • NERSA granted Eskom 8% X 5, equating to revenue of R862bn which results in a shortfall of R225bn • Without appropriate intervention the NERSA decision will impact Eskom • The shortfall cannot be made up with efficiencies alone • Eskom’s response is being finalised through an integrated delivery programme which will: • continue to implement the committed savings of R30 bn and find further efficiencies • Consider how the business can be reshaped • Identify additional support that may be required • Look to the regulatory framework and rules to assist in addressing the challenge • Certain policy implications will have to be addressed with Eskom’s shareholder

4. Eskom’s MYPD3 application has a well defined point of reference • Application was based on the regulatory formula allows for the recovery of prudent costs (primary energy and operating ) depreciation and a return on assets which encompassed the following key principles: • Eskom’s aim shift its performance across all metrics in line with world class utilities • Costs kept at single digit increases • Primary energy increases of 8,6% (including coal at 10%), operating costs increases of 8% (maintenance key driver) • Electricity Pricing Policy (DoE - December 2008) – recovery of costs and earning return on assets at replacement value • NERSA previously allowed targeted return of 8.16% • Application reached 7,8% by 2017/18, averaged 4% over MYPD period • Debt guarantees – government support of R350bn • R60 billion subordinated loan fully drawn • Debt levels maintained within R350 billion guarantee ceiling – approximately 80% of funding secured Aim to achieve cost reflectivity improved Eskom’s financial profile and complimented its ability to fund itself with lower risk and government support

5. NERSA’s disallowances result in a R225 billion cash flow gap over the 5 year period Revenue reconciliation to application Commentary • Total disallowed revenue equates to R225 Billion • Key reductions in Primary Energy, Depreciation, Opex and returns • The implications have been weighted towards the end of the 5 year period Capex Phasing of disallowances 10bn 24bn 41bn 62bn 88bn

6. Key items which were disallowed by NERSA

7. Eskom View • Different assumptions : • What was efficient costs • Execution capability • Steps necessary to ensure security of supply • Inflationary increases in areas not subject to inflationary increases (insurance) • Different cost benchmarks assumed • View of starting point of cost base – forecast MYPD 2 decision v actual results

8. Strategic Implications • No explicit limitation of Eskom’s mandate • The following policy issues need to be addressed with the Shareholder to ensure alignment: • Eskom’s role in build beyond Kusile • Future role in IDM • Further Government support • The regulation of coal prices in SA and declaring coal a strategic resource

9. 2 Eskom Response

10. New considerations, developments and strategic levers are available since MYPD3 submission • Despite operational challenges, Eskom closed in a stronger financial position for FY13 than anticipated at time of submission • We have approved a business optimisation and efficiency programme (R30bncost reduction included in MYPD3 submission has been identified) • IPP determination was reduced due to rephasing per DOE allowances and thus reducing costs • An update of IRP2010 is under development to adjust for changes in assumptions • To date no build beyond Kusileis allocated to Eskom • Discussion on a country pact for coal prices has commenced • A joint Shareholder – Inter-government workgroup has been established to consider medium term constraints • We are engaging with NERSA on their MYPD3 determination, relating to the reasons for decision and assumptions made Mandate Financial Board approved a Business Productivity Program • In line with prudent operator principle, Board approved a technical operating standard of 80 (EAF) – 10 (PCLF) – 10 (UCLF) • We have secured demand market participationprograms • Board decision to reprioritise and redeploy manpower to support operational and strategic imperatives Stakeholder Operational

11. Eskom has developed a holistic plan to address the challenges posed by the determination… … which also gives consideration to the new levers available • Eskom has 2 year period in which to implement substantial changes to mitigate the shortfall • We have initiated an integrated delivery program to engage stakeholders and ensure financial sustainability • The integrated delivery program has been approved by our board and supported by our shareholder • Business Productivity program delivers 4 key objectives within Eskom’s Integrated Delivery Program NERSA response Efficiency and reshaping drive Strategic response for long term sustainability

12. This plan encompasses a systematic, rational approach to ensure that we are sustainable 1 2 8 3 Efficiency Regulatory Clearing Account 4 Business Productivity Program 5 Mandate GAP 6 Re =shape 7 Funding Options Capex Shareholder R225bn Gap Gap closed NERSA response Major efficiency and sustainability drive Strategic response to ensure long-term sustainability Use the Regulatory Clearing Account as a mechanism to claw back against the NERSA determination Immediate reprioritisation and efficiency drive to identify cash reduction opportunities (over 5 years but with a specific focus on years 1 and 2) 1 2 Address the Eskom mandate with key stakeholders, to reduce mandatory spend 3 Shape the business to realise long term efficiency gains 4 Explore funding alternatives 5 Align capex programme in line with available funding options 6 Additional shareholder support 7 Roll out of Business Productivity Program (BPP) 8

13. Key Issues to clarify with Nersa • Nersa will be approached to ensure clarity on the application of the regulatory rules and framework to inform decisions that need to be made towards achieving financial sustainability. • The application of the Regulatory Clearing account (RCA) • Commitment in writing on specific treatment of cost variances • Reviewing the benchmark for coal costs and putting in place the sharing mechanism for variances in advance each year • Allowing for shifting of capital expenditure within allowed amount • Allowing for additional benchmarks to be obtained and this be considered in prudency reviews • Committing to an annual valuation of the regulatory asset base • Agreeing on appropriate timing of efficiency improvements, eg, UCLF

14. Next steps • Stabilize the business for the next 2 years and roll out of business productivity and re-shaping programme to identify and extract operating and capital efficiencies • Achieve a country pact on coal prices • Deliver on our capacity expansion program • Determine the maximum amount that can be recovered by applying the RCA methodology • Agree RCA principles and implementation process with NERSA • Confirm Eskom’s role beyond Kusile • Explore shareholder support. • Confirm list of projects for next 5 years which is aligned to the capital expenditure

15. Thank you