AfricanAfrican UtilityUtility WeekWeek 20072007

EskomEskom ’’ss CogenerationCogeneration ProjectProject

Thursday 31 st May, 2007 Contents

• An industry perspective on cogeneration • Background – Eskom’s challenge • Strategic issues • The need for a “pilot project” • Objectives & Principles of a pilot project • Eskom’s “Pilot Project” • What is Eskom Offering • Attendant issues • Risk to Eskom Industry Perspective Power Generation in South Africa

• GDP growth of 6% per annum projects electricity growth of 4% per annum • Generation capacity will need to be expanded annually ~1200MW • Cost of new generation capacity high – a large percentage of the world is currently expanding its generation base; Sellers market • 2005 power generation by Eskom & Munics: 92% coal and 6% nuclear • Short term base load generation capacity expansion – Coal fired • Cogeneration in SA – approximately 3% • Waste gasses and waste heat potential in large industry is potentially 2.2% of national demand (could be achieved by 2010) increasing to 6% by 2016 / 2018 • No current national policy exists to introduce cogeneration into the South African energy / generation mix • Current decision making on cogeneration projects takes far too long, frustrating industry Industry Perspective Energy Management in South Africa

• Compared to Europe – relatively inefficient • Government policy frameworks include: – The energy efficiency policy of South Africa – The White Paper on Renewable Energy – The Energy Efficiency Accord (EEA) • Targets established for energy improvements include: – 15% improvement in energy efficiency by industry by 2015 – 10,000 GWh (4%) of projected demand to be from renewable energy sources – 2013 – Several EIUG members have endorsed the EEA in support of energy efficiency improvements • Efficiency improvements promote and ensure sustainable development • Department of Minerals and Energy (DME) have committed to supporting and providing incentives, enabling industry’s response to meeting established targets Industry Perspective Environmental benefits

• Cogeneration has in most cases, a direct and immediate beneficial impact on the environment at large

• South Africa is amongst the worlds highest per capita CO 2 emitters due to its large installed coal generation base • Development of CDM projects in South Africa have proven difficult to justify, primarily due to the relatively low avoided costs of electricity purchases • European Union (EU) targets established for emission reductions will in time, impact on the South African economy Industry Perspective Cogeneration can make a difference

• Energy to be used for cogeneration is already in the system; Overall emissions would therefore be reduced by harnessing this energy, as well as an improvement in energy efficiency • Cost of cogeneration (electricity) will be less than costs of alternative new base load power plants • Lead time for cogeneration plants estimated to be 24 to 30 months from order – substantially quicker than alternative base load power plants • Unit sizes significantly smaller than existing Eskom power plants, reducing risk associated with unplanned outages • Cogeneration units are directly linked to an industrial process, so in most cases, reduction in net electricity demand is associated with generator outages • Transmission system losses may be reduced due to distributed generation advantages, with associated capacity being freed up on the system • Cogeneration projects create employment opportunities Industry Perspective Large industry participation

• Power generation is not core business! • Large industry is required to produce acceptable investment returns for its shareholders; Cogeneration projects will therefore compete for Capital Expenditure • Large industry is however committed to energy efficiency projects in support of government and associated initiatives • Eskom’s current average cost of electricity generation does not make cogeneration projects financially viable; A mechanism will need to be introduced to close the gap between cogeneration and existing power generation in South Africa • Many EIUG industry players are able to convert waste energy into cogeneration (electricity) at a lower cost than new generation capacity in South Africa Industry Perspective Enabling drivers

• Fast and efficient implementation of the long term cogeneration framework developed by NERSA in conjunction with Fieldstone, Eskom and industry • An avoided cost model, based on the cost of new base load power plant should be adopted in determining the ceiling price of competitive cogeneration projects, as adjusted and determined by NERSA • Industry should be given an opportunity to bid for cogeneration against the avoided cost (as above), and where cheaper, be contracted to supply cogeneration (electricity) to the market • Promulgation and implementation of the NERSA guidelines allowing industry to develop, bid for, and develop cogeneration projects, to be contracted with Eskom • In many cases, industry have completed feasibility studies for cogeneration projects, and are ready to respond The Eskom challenge

• Eskom Exco during June 2006, challenged the organisation to develop new cogeneration opportunities in South Africa – A target of 900MW 1 was established, to be achieved within a 5 year window, ending March 2011

• Enterprises Division (Project Development) was requested to implement the challenge, and in so doing - – Support NERSA’s initiative to established a cogeneration framework (guidelines) that will promote new cogeneration – Pursue and actively procure cogeneration opportunities that make good business sense – An Eskom cogeneration workgroup was established internally to support the initiative – Eskom has worked jointly with the EIUG workgroup, NERSA and others in industry to meet its objectives Strategic Considerations

• Cogeneration has potential to deliver capacity “quickly” – Reduced lead times for additional capacity • Cogeneration may provide electricity at lower cost than conventional generation (not all Cogeneration is cheaper) • Cogeneration potentially reduces investment in networks and supports distributed generation – Transmission cost savings • Cogeneration may improve industrial efficiency and can be environmentally friendly e.g. Combined Heat and Power (CHP) – Deferred investment at (possible) lower cost – Overall efficiency gains • Environmental benefits • Improved reliability and quality of supply • Employment / BEE opportunities The need for an Eskom Interim or “pilot project”

• NERSA’s guidelines, regulations and implementation programme may take some time to conclude • Window of opportunity exists between now and approximately 2012 – Eskom’s first new base load power plants due to come on line during 2011 to 2012 • The initial “pilot” will allow both Eskom and NERSA an opportunity to gauge the cogeneration market in SA – Quantity and size of the market offering – Cogeneration mix, location, profile – Pricing of cogeneration options being proposed – Timing of potential cogeneration projects • Results from the “pilot” project will feed into the current NERSA guidelines and thinking • Lessons learned will be carried forward into the long term model for SA Objectives & Key principles of the Project

• Develop the necessary tender documentation to attract new cogeneration • Obtain NERSA support and approval for the process • Develop a standard contract for cogeneration developers which is bankable (PPA) • Have a transparent evaluation process to evaluate tender submissions • Implement the process in a timely fashion • Develop a ceiling price which will be approved by NERSA beyond which contracts will not be offered

• Transparency – Well defined and clearly understood process – Known implementation parameters – Equitable treatment across projects – Determination of qualifying projects

• Simplicity – Procedural simplicity for projects to achieve regulatory approval – Minimisation of transaction negotiations – Minimisation of transaction costs Eskom’s Pilot Project = Tender Process

The Pilot Project being considered for implementation by Eskom is essentially a tender process, designed to attract, and contract cogeneration opportunities within predetermined parameters.

• Stage 1 – Assess interest in Cogen – Expressions of Interest – Identify those qualifying as cogeneration • Stage 2 – Assess Developers Capability (may be simultaneous with stage 3) – Invitation to Tender – Developer Evaluation • Stage 3 – Bidding Process – Bidding Process – Bid Evaluation – Participant Notification and award of Contract • Stage 4 – Implementation & Delivery – Participant Monitoring of project implementation What is Eskom offering?

• An opportunity to attract and contract new cogeneration into the market • It must be cogeneration • The cogeneration must as far as possible, be new build – i.e new plant or re-commissioned plant = new capacity • Bid in prices will not consider renewables generation that potentially require renewable energy grants or an additional subsidies. (i.e. Must be cost effective as a stand alone cogenerator – renewable component must be included in the bidding price) • “Cheapest bids” from technically and commercially qualified bids win contract provided that they do not exceed the ceiling price set by Eskom’s avoided cost model – there will be modifiers for siteing and timing (first on line) advantages • Maximum 15 year contracts being envisaged • A standard contract (PPA) will be developed for the Cogeneration projects which is envisaged to include inter alia – Payment profiles aligned with energy needs • supporting TOU / peaking periods; Winter vs. Summer etc. • Two contract structures (PPA’s) – “Simple” PPA with reduced penalty and governing principles for small scale cogeneration projects estimated currently at <50MW 1 – Advanced PPA for cogeneration projects ≥50MW 1 • No negotiation is being designed into the PPA as a matter of simplifying and streamlining the process Attendant Issues

• Each developer must bid in a price and return a signed contract (PPA) • Bid Prices higher than Eskom Avoided Cost 1 will not be considered • Eskom “Cogeneration avoided cost” will be benchmarked against baseload coal taking into account other benefits/disadvantages of cogeneration – this is the current thinking • A performance bond must be submitted in favour of Eskom to encourage timely developments of cogenerators (>50MW projects) • Cogeneration developers will require 15 year contracts but may opt for shorter duration • Network Connections offered in timely manner • Structure of bid price – Indexation – CPI for part of price? – Energy tariff – Pass Through components ? – Profiling within year but not on multi year basis Risks & Mitigation

1. Cogeneration can not be dispatched like normal generators Risk - Cogeneration operates when Eskom least requires it Mitigation - Need to design contract with appropriate incentives to generate when Eskom needs energy - Structure payments to reflect time of use benefit to Eskom. i.e. pay more at peak times and very little at off-peak time 2. Prices for Cogeneration production – may vary widely Risk - Price erodes Eskom’s profits through NERSA pass-through of Cogen costs while maintaining retail prices as is - Contracts could be more expensive than Eskom’s marginal cost Mitigation - Cogeneration will not be contracted if it is more expensive than Eskom’s system avoided cost. NERSA pass through approval required 3. Cogeneration Developer’s commercial operation date may be several years away Risk - Cogeneration comes on line too late to address short term capacity deficit Mitigation - Build an incentive into tender process to bring Cogeneration on line as early as possible; offer contracts for commercial operation dates within the next four years and provide a price adder for early entry right up to present time to reflect the real value to Eskom 4. Tender process does not attract interest Risk - Eskom falls short of its target Mitigation - Publish the process widely including at NERSA’s Cogeneration workshop and through KSACS links with industry; Media coverage may be considered 5. Tender Process derives too much interest Risk - Eskom receives resultant contracts well in excess of its target Mitigation - Eskom may include a cap in the volume of capacity contracted if required ESKOMESKOM HoldingsHoldings LtdLtd

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