Electricity pricing debunked

The amount paid by households for electricity in relation to what industry pays appears to spark as much debate as Eskom’s overall price application. Virtually every sphere of business and society made its voice heard through written and oral submissions during the National Energy Regulator of South Africa’s (Nersa’s) public participation process to evaluate Eskom’s price increases.


At the public hearings, held in all nine provinces, debate centred on not only the price increase applied for, but also the need for an appropriate tariff structure. Questions are asked about how Eskom decides how much it should charge its customers, and whether there is justification for differentiation. There is, indeed, justification for differentiation, considering the country’s electricity pricing policy, to which Eskom adheres.


Electricity tariffs are bundles of para- meters which Eskom applies to recover measured costs (such as energy consumed) and unmeasured costs (such as service costs). There are many ways to set elec- tricity prices. In Eskom’s case, tariff design is guided by three aims.


Firstly, tariffs must contain cost-reflec- tive signals that promote economic efficiency and sustainability.

Secondly, tariff structures must not expose Eskom to unacceptable revenue risk and must provide the means for adequate revenue recovery to ensure reliability of supply. Thirdly, tariffs should be designed to be as nondiscriminatory as possible by taking into account the needs of all customers on a fair and equitable basis. These aims are in conflict at times, and tariff design needs to be skilfully under- taken to find an appropriate balance between the tariffs.


Once a tariff is designed, approval is sought from Nersa for its promulgation. This is a lengthy process, during which intensive stress testing is undertaken by Nersa to verify that good tariff design principles have been applied and to identify any unforeseen consequences of the change to the tariff menu sought by Eskom.


Eskom currently offers 24 tariffs to its customers: nine are for business and industry, seven for residential customers and eight for rural customers. The tariff that is best suited to a customer will depend on factors such as customer size, con- sumption pattern and location.


A manufacturer with the ability to shift the time of electricity consumption to Eskom’s off-peak periods (after 20:00) will normally opt for a tariff with a time-of-use component to take advantage of the lower off-peak rate. The differential is considerable. During winter, a busi- ness on a time-of-use tariff buys electricity for a small fraction of the peak-period cost. The reason is cost reflectivity. During times of high demand, peaking power stations – those specifically built to run for short periods – are deployed to keep the lights burning. Diesel peaking power stations are relatively inexpensive to construct but very expensive to operate. Time-of-use tariffs reflect this higher cost.


Plans are well advanced to extend the time-of-use tariff feature to household tariffs. The first 10 000 homes supplied by Eskom to opt for a time-of-use tariff will be converted this year. The tariff, known as Homeflex, has a peak and off-peak rate. Technology supplied by Eskom will enable homeowners to save through the tariff by automatically scheduling geysers, pool pumps, washing machines and tumble dryers to operate, where possible, during off-peak times without any inconvenience to the homeowner. Sensible lifestyle changes, such as switching off lights in rooms which are not occupied during peak times, will save even more electricity.


Certain customer classes receive subsidies, that is, they pay less for electricity than the cost of supplying the electricity to them. There is a common misconcep- tion that residential customers subsidise industrial customers. This is understandable when prices are compared in isolation – 29c/kWh, on average, for industry and 64c/ kWh for suburban households. However, direct comparison in this manner is incorrect as the cost of supply must be taken into account. It costs substantially less, for each kilowatt hour, to supply a large industrial customer than a house- hold, the former costing an average of 27c/kWh and the latter 68c/kWh.


Power generation costs are not the only consideration when determining costs of supply – electricity generated at power stations is transported to the different load centres in the country across transmission lines and delivered to large substations, from where power is fed through distribution networks to customers. Many more electrical networks have to be built, main- tained and operated to supply smaller customers than those required for larger customers on higher-voltage networks.


Residential tariffs, therefore, have a much greater percentage of network costs than bigger customers. In addition, greater amounts of electricity are lost in the form of heat on longer electricity lines, which further increases costs. As a ratio of overall consumption, smaller customers tend to use much more elec- tricity in the more expensive peak periods and tend to use electricity sporadically throughout the day.


The implication is that, while a large investment in electrical infrastructure needs to be made to supply households, this infrastructure is underused for most of the day. In contrast, businesses tend to use electricity more consistently, exhibiting a relatively flat consumption profile over a day. The network component of costs, as a percentage of a small customer’s bill, is, therefore, much higher for households. It follows that a household’s average cost of electricity for each kilowatt hour, including network costs, is higher than that of a larger customer.


The discrepancy between costs and prices for rural customers is even more pronounced. On average, rural customers (predominantly farmers) pay 74c/kWh, compared with an average of 96c/kWh to supply them.


Thus, industrial customers subsidise households and farmers, and pay an elec- trification levy to boot. The extent of the cross subsidy is currently R4-billion a year. This amount will rise as Nersa’s tariff decision comes into effect.

Finally, an environmental levy is pay- able by electricity consumers in South Africa. Government introduced an environmental levy of 2c/kWh on electricity produced using nonrenewable fuels, including coal, nuclear and petroleum. To recover the cost paid by Eskom to the South African Revenue Service, Eskom is obliged to include an additional 1,97c/kWh in its tariffs. The charge is reflected as a separate item on Eskom’s electricity accounts.

The monthly electricity bill is, therefore, an account of the costs which Eskom has incurred to supply its customer. These bills are as cost reflective as far as prac- tically possible, with in-built subsidies to households and rural customers.


Electricity tariffs are ever changing. So-called ‘inclining block rate’ tariffs will be introduced during the course of the year by Eskom and municipalities in accordance with the requirements of Nersa. Successively higher unit costs will be charged for increasing electricity consumption in four ‘blocks’. Block 1, for consumption up to 50 kWh a month, will cost 54,7c/kWh, and Block 4, for consumption above 600 kWh a month, will be charged at 83,74c/kWh. It pays to be as efficient as possible to avoid Block 4.


Electricity tariff design is about judgment and compromise as much as it is about engineering and statistics. Eskom’s complex approach has stood up to regular inter- national scrutiny and serves South Africa well. Adding one’s voice to the debate on electricity tariffs, prices and subsidies in South Africa is worthwhile. Nersa listens, and we all learn.


Article by Erica Johnston, Chief Officer : Networks and Customer Service, Eskom.  Courtesy of Engineering News website.


Friday, July 2nd, 2010 - News

 
   
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