Author & Presenter: S D Salvoldi, B Comm, Msc

Protection of the Poor through the implementation of the Social Electricity Tariffs: The South African Experience Author & Presenter: S D Salvoldi, B Comm, MSc, Corporate Specialist, Electricity Pricing Eskom

1. Introduction Protection of the poor in South Africa is part of a broader national strategy taking into account amongst others; existing government policy, implementation challenges and resources. National policy on protection of the poor needs to deal not only with electricity, but also the provision of other basic services and grants. With regard to providing relief to poor customers through electricity tariffs, a holistic solution is required through the involvement of various role players such as Eskom, municipal distributors, the National Energy Regulator of South Africa (NERSA), Government, local government and other stakeholders. This is not a decision that the electricity utility should be making as it involves all the people of South Africa independent of who provides the relief; and is therefore the accountability of Government to be managed in an integrated approach. However, in times of increasing electricity prices, there has to be a safety net for the poor. If not, the potential for increased non-payment and the usage of firewood and candles affecting the environment and quality of life of particularly children and women will significantly increase. South Africa has already made significant strides in addressing affordability through all of the above mechanisms:  The electrification programme, subsidising the cost of connection which provides free connections to 20A supplies in addition to a subsidised tariff.  The free basic electricity programme, which provides 50 kWh free per month to identified indigent customers.  Lower increases than the average price increase to the Eskom residential tariffs and a similar approach proposed for municipalities determined by NERSA. This has resulted in significant existing subsidies to the lower consumption residential tariffs.  Support for energy efficiency by providing CFL bulbs free of charge and providing rebates for solar water heaters. In light of the above, this paper shares South African Experience related to social electricity tariffs, the challenges with implementation and the suggested solutions.

2. The South African Experience

2.1. Government policy There is government policy that guides the setting of electricity prices and direction for socio-economic subsidies. This is the “Electricity Pricing Policy” 1of the Department of Energy. Notable policy positions regarding affordability are:  Cross subsidies must be approved and have a minimal impact on the economy (policy position 44)  Qualifying customers must be subsidised through the application of a life line tariff, which has a single energy rate limited to 20 Amps (policy position 48).  The level of the life line tariff should breakeven with cost at 350 kWh per month (Policy Position 49).  Domestic tariffs to become more cost-reflective, offering a suite of supply options with progressive capacity-differentiated tariffs at one end single energy rate and finally providing time of use tariffs for higher consumption supplies (policy position 36). Currently are a number of strategies used in South Africa to provide protection for the poor with regard to electricity tariffs, namely:  Free basic electricity (FBE)  Cross subsidies between tariffs  Tariff structures

2.2. Free basic electricity The provision of basic services for water, sanitation and energy is entrenched in the South African Constitution as an obligation of local government to improve the standard of living and to alleviate poverty in South Africa. In 2000, the South African Government announced a free basic service policy. This policy led to the Department of Energy (then Department of Minerals and Energy) developing an Electricity Basic Services Support Tariff (EBSST) Policy in 2003 which was implemented in the 2003/2004 financial year. This policy prescribed an allocation of 50 kWh per month to be provided to all poor households with an electricity connection The provision of FBE is funded through the local government equitable share (funding provided by national government to local government) to assist municipalities with the provision of free basic services, including free basic electricity, to poor households. . The obligation to identify the poor, in line with the South African Constitution lies with municipalities even where Eskom is the direct supplier of energy. Municipalities are required to identify the poor and are provided funding through the equitable share to provide FBE. Where Eskom is the supply authority, municipalities still need to identify who must receive FBE. To recompense Eskom for the provision

1Electricity Pricing Policy: http://www.energy.gov.za/files/policies/Electricity%20Pricing%20Policy %2019Dec2008.pdf of FBE a funding agreements is put in place between Eskom and the municipality to recover the cost of the free service. No funding is provided directly to Eskom from government as Eskom recovers this cost from municipalities in terms of the funding agreement. There are various approaches used to identify the recipients of FBE:  A targeted approach based on poverty/indigent registers of municipalities;  Universal approach (where all households receive FBE)  Tariffs are used as a targeting mechanism (e.g. for Eskom supplied customers the 20A tariff is used).  Individual municipalities do, however, use different approaches and different FBE kWh allocations to provide FBE to poor households between themselves and between their direct and Eskom supplied customers.

2.3. Cross subsidies in tariffs This paper will look at the Eskom tariffs and how they are used to address affordability. Eskom supplies 40% of the customers in South Africa to about 4.5 million customers, the majority of which are indigent. Eskom has a number of different tariffs catering for different category of customers. The majority of Eskom’s sales are to the Megaflex tariff. This tariff is applicable to large users of electricity supplying mainly municipalities and large industry, making up 78% of Eskom’s sales. Eskom’s sales to residential customers (on the inclining block rate tariff) makes up 4.5% of Eskom’s total sales, but it is within this category and the rural tariffs that the socio-economic subsidy reside. The following figure shows the Eskom sales per tariff: Miniflex Ruraflex Transflex 1 Transflex 2 TOU TOU TOU TOU Nightsave 1.4% 1.3% 1.2% 0.3% Off-peak rates 8.1% Nightsave Rural Off-peak rates 2% Businessrate Single energy rate 0.5%

Landrate Single energyrate Megaflex 2.3% TOU Publiclite 78% Single energy rate 0.1%

Inclining block tariffs Single energy rate 4.5%

Figure 1 – Eskom sales per tariff The Eskom tariffs are based on a cost of supply study, where costs are allocated to different cost drivers such as energy, networks and customer service for each customer category. Different customer categories will have different costs allocated to them depending on:  The voltage of the supply.  The density of the network to which customers are connected (rural/urban)  How the energy is used during the day and season  The capacity used by the customer. In recognition that many customers cannot afford to pay cost-reflective tariffs, Eskom’s retail tariffs also include cross- subsidies for specific tariff categories. Tariffs receiving subsidies pay less that the cost to serve and tariffs paying the subsidies pay more than the cost to serve. The tariff rates will be designed to achieve criteria other than just the cost to serve such as such as specifying a breakeven with costs of 350 kWh. Typically lower consumption customers like residential customers have much higher costs per kWh than larger users of electricity for the following reasons:  Typically a residential customer is supplied on the network at a low voltage whereas a large industrial customer would be supplied on the network at a high voltage. This means that many more electrical networks have to be built, maintained and operated to supply smaller customers than that which is required for larger customers on higher voltage networks. Residential tariffs overall costs therefore have a much bigger percentage of network costs than for larger customers.  More electrical losses occur at the lower voltages as the electricity has to travel further distances.  As a ratio of overall consumption, smaller customers also tend to use much more electricity in the more expensive peak periods.  Energy costs make up a much higher percentage of the overall cost to serve than network costs for industrial customers. The opposite is true for residential customers where network costs make up a much higher percentage of the cost to serve.

2.4. Using tariff structures - NERSA’s introduction of the inclining block rate tariff (IBT) In addition to all the above mentioned efforts to protect the poor in the past, NERSA made a decision to implement IBT in February 2010 after stating they would be investigating this tariff in a previous years’ revenue determination. This also included benchmark rates to be applied by municipal distributors. This is the first time in NERSA’s history that they developed a tariff and its rates on behalf of Licensees. The IBT is a tariff structure that provides increasing energy charges as consumption increases. An extract from the February 2010 NERSA decision is shown below: If an IBT tariff is used, it is to be noted that this is a tariff structure that is complex and that the tariffs rates must be set at least at the higher consumption levels to be cost-reflective. For the current Eskom tariffs the rates are set too low, which has resulted in increased subsidy levels to higher consumption customers that are not sustainable now and going forward.

3. Current level of subsidies in Eskom’s tariffs As a result of the implementation of the current strategies, it is important to note that existing electricity subsidies to protect poor households are significant. These are summarised in the table below. 2011/12 estimated subsidies in Eskom for residential customers R/bill Description Funding provided by government. Contributes towards the costs of Electrification R 1.70 connection Shortfall of cost versus tariff rates Tariff subsidies R 4.20 (impacts large power user’s tariffs by 5%) Funding by government, contributes to 50 FBE R 0.38 kWh free per month Total R 6.28 AS can be noted these are significant. If the level of subsidies are not managed through an integrated holistic approach, subsidies will have unintended consequences and the very people that should receive these subsidies will not be benefit. The provision of subsidies:  must be balanced against practical and financial realities,  should be targeted at the indigent (not create unintended consequences or allow the non-indigent to benefit),  not create imbalances and inequity between tariffs – risk of migration,  provide the correct economic signal and thereby ensure that there is no wastage of a scarce resource,  not be unsustainable and in turn make the subsidising tariffs unaffordable, and  must be equitably given to all the deserving customers

4. Implementation challenges with current policy There are number of challenges that have been identified with the current approach. These are:

4.1. FBE The following challenges have been identified:  The equitable share which is used to fund FBE is provided as an unconditional grant, which means that the local authority has the right to determine what this funding gets used for i.e. it does not have to be used to provide basic services.  There is inequity between FBE provided to Eskom customers and municipality customers. Only about a quarter of Eskom receive FBE, while it is estimated that Eskom supplies the majority of the poor in South Africa.  That funding is not provided directly to Eskom, but via the municipality.  Difficulty in identifying the poor, including the manpower resources required to identify the poor.  The cost to administer a targeted approach is high. 5. IBT challenges IBT does address affordability, but there are some unintended consequences in that it has removed the fixed charge based on the capacity signal for higher supply sizes, it does not cater for multiple homes on one meter/stand (typically backyard dwellings and housing developments), and the level of subsidies will increase unless the tariff is changed. Removing the previous tariff options and applying a one-size-fits-all approach to all residential customers has not worked. IBT for prepayment customers is also conceptually unfair, as the payment is based on the point of purchase and not on actual consumption, creating additional complexity and inequity towards prepayment supplies over conventional metered supplies. In addition, the implementation of IBT was not consistently applied between Eskom and other distributors. Eskom was required to implement IBT as designed by NERSA without any options to propose more practical or realistic approaches. Municipal distributors, in contrast were allowed to deviate from the structure and the level of rates, if motivated, and they were also allowed to retain alternative residential tariffs with fixed charges. This has resulted in non-consistent implementation throughout the Electricity Distribution Industry in South Africa (fixed charges for some tariffs, non-telescopic versus telescopic etc.) and confusion caused by the lack of clarity and rationale. This is a clear indication that the one-size-fits-all approach needs to be reviewed, including development of a guideline to direct the development of residential tariffs. Eskom’s stance is that, the poor need to be protected but that there needs to be adjustment to the current NERSA determined residential tariffs to be more cost- reflective and that residential customers are provided a suite of tariffs options, including a life line tariff, a single energy tariff to cater for multiple homes; and tariffs with fixed charges for the higher consumption customers.

6. A possible alternative approach If tariffs are used to address affordability, it is important that the cost to supply customers is well understood in order to quantify the amount of subsidies required. The first step in the tariff design process should be a cost of service study – to understand the costs associated with providing a supply to residential customers. The cost of service study should provide properly unbundled costs, which are segmented into appropriate categories. This is necessary to understand the subsidies that need to be provided, how to apply these subsidies to the targeted recipients, how to avoid leakage of the subsidies (to unintended beneficiaries) and the resultant impact on other customer. However, what needs to be raised and debated at a national level is whether subsidisation of the poor should be funded through cross-subsidies in electricity tariffs or through subsidies provided by the fiscus based on targeted recipients. Including cross-subsidies in electricity tariffs has created great inequity between the various distributors’ tariffs, as the outcome is based on their circumstances and whether they have the customer base to provide cross-subsidies or not. It also adds a significant burden on those paying the subsidies and in turn could cause the tariffs paying the subsidies to be unaffordable. It is Eskom’s view that consideration needs to be give whether electricity tariffs should be used to compensate for social requirements, and rather explicit subsidies are provided that are well understood and directly targeted through Government grants. Other options must be investigated such as:  Optimising the targeting and funding mechanisms  Lower tariffs (cross subsidies)  Tariff structures (inclining block tariffs or single energy rates)  Extending subsidy mechanisms such as grants by government for pensioners.

7. Conclusion Eskom acknowledges the difficulty and complexity facing government and NERSA regarding residential tariffs in light of increasing prices, the need to address affordability, and the diverse nature of all the parties in electricity industry in South Africa. FBE, while providing enough for basic needs must be better targeted and more equitably allocated between Eskom and municipal customers If it is agreed to use electricity tariffs to address affordability through cross-subsidies or and/or tariffs structures, this should be done within a national subsidy framework – including, among others, clarity on who should receive, definition of the poor, the role players, and impact on the economy, etc. An “ideal” tariff would need to balance many factors such as subsidies, energy efficiency, revenue impact, customer impact, fixed versus variable costs, and cost- reflectivity and be able balance these against one another. It is unlikely to achieve a fair balance of all issues and also to develop an ideal tariff for every distributor in South Africa, as each has a different customer base and circumstances, and to be able to also balance all factors optimally. An IBT structure is a very complicated tariff structure for customers to understand and for utilities to calculate the rates correctly. The more blocks there are, the more complicated it becomes and the more risk customers and utilities are exposed to. While it is accepted that IBT is often used to achieve energy efficiency and not always poverty relief – the appropriateness of such a tariff structure in the South African environment needs to be evaluated. Most utilities also offer residential customers other choices of tariffs. Energy efficiency, while a very important objective, will potentially have a devastating impact on distributors where tariffs do not have fixed charges to cover fixed costs – as experienced in Brazil. Without fixed charges, the utility carries all the risk associated with the reduction of sales, despite its unchanged fixed costs relating to the networks. If the tariff were meant to address poverty relief, this could have been easily achieved using a single energy rate tariff, based on a customer’s supply size.

The author would like to acknowledge Deon Conradie the Senior Manager Electricity Pricing, Eskom for his inputs to this paper