Eskom's Strategic Response to NERSA's Tariff Decision and Financial Sustainability Initiatives

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