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Author: Chris Yelland, EE Publishers|

24 March 2013 23:14

Analysis of Eskom's special electricity pricing deals with BHP

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Chris Yelland takes a detailed look at the structure and nature of the pricing arrangements.

Since the Supreme Court of Appeal judgement on 15 March 2013 ordering Eskom to disclose the formulae by which the price of electricity to BHP Billiton’s Hillside and Mozal aluminium smelters is calculated, much has been written in general terms about the effective price per kWh currently being paid by BHP Billiton. This article analyses the structure and nature of the pricing arrangements for Hillside Potlines 1 & 2, Hillside Potline 3 and Mozal Potlines 1 & 2 in more detail.

Hillside Potlines 1 & 2

The electricity supply contract for Hillside Potlines 1 & 2 was signed on 11 November 1992 by Allen Morgan, the executive director (sales and customer service) at Eskom at the time, and Robert Balfour, the managing director of Alusaf Ltd. The contract, with a duration of 25 years, commenced on 30 July 1995 and ends on 30 July 2020.

The structure of the electricity pricing arrangement is in the form of a two-part tariff, with a monthly energy component based on the kWh delivered, and a monthly demand component based on the maximum kVA demand metered during the billing month.

Both the energy and the demand rates are directly proportional to the current aluminium price measured in US $ per ton, and the Rand/US $ exchange rate. An increasing aluminium price increases the price of electricity, while a strengthening Rand decreases the price, as follows:

Energy rate [R per kWh] = 6,54 x AL x R/$ x 10-6
Demand rate [R per kVA] = 3237 x AL x R/$ x 10-6

where

AL   = the current 3-month LME sellers price for 99,7% high-grade aluminium ingot expressed in US dollars per ton
R/$ = the current Rand / US Dollar exchange rate

There is no escalation or linkage of the Hillside Potline 1 and 2 energy and demand rates to either the US Producer Price Index or the SA Producer Price Index, or to Eskom’s cost of generation or transmission. Nor are there any top or bottom limits to the energy or demand price. As such the electricity rates are not cost reflective in any sense.

Based on a load of 900 MW, a load factor of 0,98, a power factor of 0,99, the current aluminium price of $2054 per ton and a R/$ exchange rate 9,1, the current total price of electricity supplied to Hillside Potlines 1 & 2 is calculated as R0,2088 per kWh (see Appendix 1).

Hillside Potline 3

In 2001, BHP Billiton started planning a third aluminium potline at Hillside, and on 10 December 2001, a 24-year electricity supply contract was signed by Jacob Maroga, executive director (distribution) at Eskom at the time, and Mahomed Seedat, vice president and COO Southern Africa at Billiton Aluminium SA Ltd. Electricity supply was to commence no later than 30 June 2004 and the contract terminates on 30 June 2028.

The structure of the electricity pricing arrangement for Hillside Potline 3 is also in the form of a two-part tariff, with a monthly energy component and a monthly kVA demand component. There is also a monthly capital component that recovers the cost of transmission infrastructure incurred by Eskom in providing and increased supply for Potline 3.

However, unlike Hillside Potlines 1 & 2, in the case of Potline 3 there is no linkage of the energy and demand rates to the aluminium price in US $ per ton or to the R/$ exchange rate. Instead, the price is based on energy and demand rates of the 2001 Eskom Nitesave tariff, escalated at the beginning of each subsequent year after 2001 based on changes in the South African Producer Price Index for domestic output of South African industry groups, as follows:

Energy rate [R per kWh] = R0,0726 x SA PPIf / SA PPIi
Demand rate [R per kVA) = R40,23 x SA PPIf / SA PPIi

where

SA PPIi = the initial South African Producer Price Index for November of the year 2000
SA PPIf = the final South African Producer Price Index for November of the year prior to the current year

The total energy and demand price calculated using the above rates is then subject to a voltage discount of 7,13% and a transmission surcharge of 1%.

In addition, for Hillside Potline 3, upper and lower limits are provided for the total electricity rates per kWh (incorporating both the energy and demand components), as follows:

Lower limit [R per kWh] = $0,008 x R/$ x US PPIf / US PPIi
Upper limit [R per kWh] = $0,02 x R/$ x US PPIf / US PPIi

R/$       = the current Rand / US Dollar exchange rate
US PPIi = the initial US Producer Price Index for all commodities for November of the year 2000
US PPIf = the final US Producer Price Index for all commodities for November of the year prior to the current year

Based on a load of 450 MW, a load factor of 0,98, a power factor of 0,99, the relevant SA and US Producer Price Indices and  R/$ exchange rate of 9,1, the current total price of electricity supplied to Hillside Potline 3 is calculated to be R0,2643 per kWh (with the upper and lower limits of the total price calculated as R0,2721 per kWh and R0,1088 per kWh respectively), plus a capital charge of R0,0108 per kWh (see Appendix 1).

The effect of this pricing arrangement for Hillside Potline 3 is to lock the energy and demand prices, starting at the 2001 levels that are widely acknowledged to be significantly below Eskom’s average cost of supply, and thereafter to escalate the 2001 prices annually only by the SA Producer Price Index, while the balance of customers in South Africa suffer massive annual electricity price increases of many times the official inflation rate, as Eskom moves to cost reflective pricing. And just in case, a top limit on the electricity price that can be charged by Eskom is then also provided to further protect BHP Billiton.

Mozal Potlines 1 & 2

After successful negotiations by Eskom with BHP Billiton to remove any linkage of the electricity price for Mozal Potlines 1 & 2 in Mozambique to the aluminium price and Rand / US Dollar exchange rate, an amended agreement for the supply of electricity was signed by Eskom on 28 May 2010, with the revised pricing arrangement coming into effect from 31 March 2010 until expiry on 15 March 2026.

The structure of the electricity pricing arrangement for Mozal Potlines 1 & 2 is a single all-inclusive tariff, as opposed to separate energy and demand components for the Hillside contracts. There is also a monthly wheeling charge by Motraco, a joint venture transmission company of the regional utilities of Mozambique, South Africa and Swaziland, for wheeling of power from South Africa via Swaziland to Mozal in Mozambique.

The all-inclusive electricity tariff of initially R0,245 per kWh in 2010 is then escalated at the beginning of each subsequent year after 2010 based on changes in the SA Producer Price Index for domestic output of South African industry groups, plus 1% per annum, as follows:

All-inclusive electricity price [R per kWh] in year n +1 = R0,245 x (SA PPIn / SA PPIn-1 + 0,01)

where

SA PPIn   = the South African Producer Price Index for October of year n
SA PPIn-1 = the South African Producer Price Index for October of year n-1

The initial wheeling charge of US $1 284 370 per month in 2010 is converted to Rands monthly and escalated at the beginning of each subsequent year after 2010 based on changes in the US Producer Price Index for all commodities, as follows:

Wheeling charge [R per month] = $1 284 370 x R/$ x US PPIf / US PPIi

where

R/$       = the current Rand / US Dollar exchange rate
US PPIi = the initial US Producer Price Index for October 2009
US PPIf = the final US Producer Price Index for October of the year prior to the current year

Based on a load of 900 MW, load factor of 0,98, a power factor of 0,99, the relevant SA and US Producer Price Indices and R/$ exchange rate of 9,1, the current total price of electricity supplied to Mozal Potlines 1 & 2 is calculated to be R0,3119 per kWh, with the wheeling charge calculated as R0,0214 per kWh (see Appendix 1).

Again, the effect of this pricing arrangement for Mozal Potlines 1 & 2 is to lock the energy and demand prices, starting at the 2010 levels, which are below Eskom’s average cost of supply, and thereafter to escalate the 2010 prices annually only by the increase in the SA Producer Price Index plus 1%, while the balance of customers in South Africa suffer massive annual electricity price increases of many times the official inflation rate, as Eskom moves to cost reflective pricing.

The rationale for this is probably that Mozambique supplies some 1000 to 1500 MW of cheap hydro-electric power from Cahora Bassa, which is then wheeled through South Africa and Swaziland to Mozal in Mozambique.

Conclusion

Appendix 1 shows that the current total average rate for electricity supply (including all energy, demand, capital and wheeling costs) across BHP Billiton’s Hillside and Mozal aluminium smelters amounts to R0,2715 per kWh based on the information made available to the media by Eskom, and the assumptions and calculations detailed.

It is important to note that the Regulator is required to approve all special electricity pricing arrangements, and that this was in fact one of the suspensive clauses of (at least) the Hillside Potline 3 contract. In a letter to BHP Billiton on 5 February 2002, Eskom confirmed that the National Electricity Regulator (NER) had approved the special pricing arrangements. The CEO of the NER at the time was Dr. Xolani Mkwhanazi, who is currently the chairman of BHP Billiton South Africa, and is listed in Who’sWho Southern Africa as president and COO of Aluminium South Africa at BHP Billiton.

For the last few years, Eskom has been unsuccessful in efforts to renegotiate the unfavourable Hillside Potline 1, 2 & 3 contracts, where electricity is currently supplied significantly below Eskom’s average cost of supply. BHP Billiton has resisted any changes, and in 2012 the matter was then referred by Eskom to the National Energy Regulator of South Africa (NERSA) for review.

The Regulator will no doubt consider the legalities of the special pricing arrangements included in the contracts, whether they are fair, reasonable and in the national interest, or whether they are unreasonably discriminatory and prejudicial to other customers of electricity in South Africa.

Thembani Bukula, the NERSA regulator member responsible for electricity, has been quoted as saying that the review will be held in public in the next few months, and that one of the possible outcomes is the contracts may be declared invalid.

Topics: eskom, bhp billiton, electricity pricing deal, electricity supply contract



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