MARKET VALUE PRICING EXPLANATORY NOTES

Transcription

1 MARKET VALUE PRICING EXPLANATORY NOTES 1. INTRODUCTION 1.1 The Market Value Pricing (MVP) principle is prescribed in Schedule One to the Agreement Concerning the Mozambican Gas Pipeline between the Government of the Republic of South Africa and Sasol Limited ( Schedule One to the Agreement ). 1.2 Clause 8.3 of Schedule One to the Agreement provides that the basis for pricing within the constraints of the price cap will be MVP. 1.3 Market Value Pricing is defined in clause 1.16 of the Agreement as the determination of gas price by comparison with: (a) The cost of the alternative fuel delivered to the customer s premises or anticipated place of use (in the case of Greenfields Customers); plus (b) The difference between all the operating costs of the customer s use of the alternative fuel and all the operating costs of using natural gas; plus (c) The difference between the Nett Present Value (NPV) of the capital costs of the customer s continued use of the alternative fuel and the NPV of the capital costs involved in switching to natural gas, as would be reflected in the customer s accounts. Page 1 of 20

2 1.4 The above definition of MVP opens the door to customer complaints regarding: (a) (b) (c) (d) whether MVP is a maximum price per customer; which alternate fuel to use for the MVP calculation and how to establish the alternate fuel; when and how must Sasol Gas provide MVP information to customers; and how will the MVP be escalated (factors influencing the escalation of MVP). 1.5 More specifically, this document was prompted by the number of complaints received by the National Energy Regulator of South Africa (NERSA or the Energy Regulator ) regarding Sasol Gas compliance with MVP. 1.6 An analysis of the customer complaints and queries that NERSA received over the previous three years suggests that there are discrepancies between the definition of Market Value Pricing as per Schedule One to the Agreement and Sasol Gas implementation thereof. 1.7 The purpose of these Explanatory Notes is to answer each of the questions listed in paragraph 4.1 above and to clarify the application of MVP. 2. APPLICABLE LAW 2.1 NERSA 1 is a statutory body created in terms of the provisions of the National Energy Regulator Act, 2004 (Act No. 40 of 2004) ( the NERSA Act ). NERSA has, amongst others, a function to regulate prices. In regulating prices, it has to be guided by the provisions of the NERSA Act read together with the Gas Act, 2001 (Act No. 48 of 2001) ( the Act ). 1 Energy Regulator means the National Energy Regulator of South Africa established by section 2 of the National Energy Regulator Act, 2004 (Act No. 40 of 2004). Page 2 of 20

3 2.2 Furthermore, section 36 of the Act provides that the Energy Regulator is responsible for the administration of Schedule One to the Agreement. 2.3 Clause 8.3 of Schedule One to the Agreement provides that the basis of Sasol Limited s pricing within the constraints of the price cap will be Market Value Pricing. 2.4 According to clause 1.16 of Schedule One to the Agreement, MVP means determining the gas price by comparison with: (a) the cost of the alternative fuel delivered to the customer s premises or anticipated place of use (in the case of Greenfields Customers 2 ); plus (b) the difference between all the operating costs of the customer s use of the alternative fuel and all the operating costs of using (natural) gas; plus (c) the difference between the Nett Present Value (NPV) of the capital costs of the customer s continued use of the alternative fuel and the NPV of the capital costs involved in switching to (natural) gas, as would be reflected in the customer s accounts. 2.5 Regulation 4.2 of the Piped-Gas Regulations 3 provides that gas traders whose maximum gas prices are calculated by MVP in terms of Schedule One to the Agreement must inform their customers of the elements used to calculate their maximum gas price. Each of these elements is defined in paragraph 2.4 (a) to (c) above. 2 Greenfields Customer refers to an External Customer who, after 26 September 2001, constructs a facility on a new Site and whose facility receives piped-gas from Sasol for the first time at or after 26 March As promulgated by the Minister of Minerals and Energy on 20 April Page 3 of 20

4 2.6 Furthermore, regulation 4.6 of the Piped-Gas Regulations provides that when gas is sold, the accompanying sales invoice must itemise the constituent elements of the total price reflected on the invoice, including at least the cost of gas, any transport tariffs and any other charges. 2.7 It follows from the above that Sasol Gas Limited has to determine prices for its piped-gas customers in terms of MVP, except for customers who are resellers/traders of gas, as these customers get a special price stipulated in clause 9 and 10 of Schedule One to the Agreement. Failure to comply with the MVP constitutes a breach of certain conditions of licences granted by the Energy Regulator to Sasol Gas Limited (Sasol Gas) and constitutes noncompliance with clause 1.16 of Schedule One to the Agreement. 2.8 As stated above, the Energy Regulator is empowered to regulate the pipedgas industry in South Africa and to administer Schedule One to the Agreement. As a result, the Energy Regulator continuously monitors Sasol Gas Limited s compliance with the MVP. 3. ANALYSIS Rationale for MVP 3.1 The rationale for Schedule One to the Agreement and MVP was that Sasol Gas needed to make investment decisions, but there was no specific legislation for gas projects at the time, thus a regulatory regime had to be negotiated. As part of the regulatory regime, Sasol Gas was given a Special Regulatory Dispensation Period regarding exclusive rights to ROMPCO s infrastructure until 10 years after First Gas, and the right to negotiate the price of gas based on MVP on separate contracts with individual customers. Page 4 of 20

5 3.2 Furthermore, the MVP mechanism was meant to encourage and incentivise the customer to switch to natural gas. The MVP price has to be established for each customer in order that: the maximum price for each customer can be established; the discount for Small customers can be calculated; and each customer has the opportunity to contest the alternative fuel and the price of that fuel as assigned to the customer in terms of the provisions of Promotion of Administrative Justice Act, 2000 (Act No.2 of 2000) and the laws of natural justice. Elements of MVP 3.3 Schedule One to the Agreement defines MVP as determining the gas price by comparison with: the cost of the alternative fuel delivered to the customer s premises or anticipated place of use (in the case of Greenfields Customers 4 ); plus the difference between all the operating costs of the customer s use of the alternative fuel and all the operating costs of using (natural) gas; plus the difference between the Nett Present Value (NPV) of the capital costs of the customer s continued use of the alternative fuel and the NPV of the capital costs involved in switching to (natural) gas, as would be reflected in the customer s accounts. 3.4 The above definition implies that there are three elements of MVP which must be considered when determining the MVP for end user customers of Sasol Gas other than traders. The elements are: (a) Cost of alternative fuel delivered at the customer s premises or anticipated place of use Sasol Gas must base its price of gas on the market value price that applies to each individual. This market 4 Greenfields Customer refers to an External Customer who, after 26 September 2001, constructs a facility on a new Site and whose facility receives piped-gas from Sasol for the first time at or after 26 March Page 5 of 20

6 value price must be determined based on the costs of the alternative fuel used by the customer at the time of converting/switching to natural gas in the case of Brownfields customers. The alternative fuel may, for example, be coal, electricity, Heavy Fuel Oil, or LPG. If the customer s alternative fuel is, for example, coal, the price at which gas is sold to the customer would be significantly lower than the price would be if the alternative fuel was Heavy Fuel Oil. All the costs incurred by the customer by using coal will be compared with costs associated with use of natural gas. In the case of a Greenfields customer, the alternative fuel is identified based on the alternative fuel at the anticipated place of use. (b) Operating Cost The difference between operating cost of piped-gas and the alternative fuel is calculated based on the information reflected in the customer s accounts, not on the technical assumption regarding the operational costs elements associated with the assumed. example of cost information required includes operating cost of using coal and the operating costs of using (natural) gas. (c) NPV Calculation The difference between the NPV of the capital costs of the customer s continued use of the alternative fuel and the NPV of the capital costs involved in switching to natural gas. Annexure A (Annexure A calculation of MVP) provides a step-by-step approach on how MVP must be calculated, including the calculation of the NPV. Cost information required to calculate NPV includes capital cost of using alternative fuel and capital cost of switching to natural gas. The cost information to be used in the NPV calculation must be as reflected in the customer s accounts. MVP as a maximum price per customer 3.5 Clause 8.3 of Schedule One to the Agreement provides that the basis for pricing within the constraints of the price cap is MVP. Page 6 of 20

7 3.6 It follows from the above that clause 8.3 of Schedule One to the Agreement cannot be taken to mean that MVP is merely a guideline to setting prices. It means that the maximum gas price of each customer is set by MVP. 3.7 Therefore Sasol Gas cannot charge a customer a gas price which is above the maximum price determined by MVP, since MVP is equal to the approximate cost of alternative fuel and charging above it would not entice customers to switch. A price above the MVP will constitute non-compliance with clause 1.16 of Schedule One to the Agreement and a breach of Sasol Gas s licence conditions. 3.8 Not withholding the above, Sasol Gas is allowed to offer discounts on MVP in compliance with clause 12 which states the following: SASOL will negotiate the price of gas with Small Customers on an individual basis, but subject from First Gas to the discounts shown in the following table: ANNUAL QUANTITY PURCHASED DISCOUNT GJ/a 12% discount on the relevant customer s then prevailing market value price GJ/a 6% discount on relevant customer s then prevailing market value price GJ/a 4,5% discount on relevant customer s then prevailing market value price Page 7 of 20

8 3.9 In addition, Sasol Gas may offer discounts based on terms of its contract with individual customers, as long as the price is within the MVP level that is below MVP The argument regarding MVP as a maximum price can also be derived from the Piped-gas Regulations (published on 07 April 2001, under GNR.321 in Government Gazette 29792)(piped-gas regulations), piped-gas regulation 4(2) (c) Regulation 4(2)(c) states the following: Gas traders whose maximum gas prices are calculated by Market Value Pricing in terms of the agreement must inform their customers of the elements used to calculate their maximum gas price and of- (a) the alternative fuel available; (b) the operating costs for the alternative fuel and for gas; and (c) the Net Present Value for operating cost of the alternative fuel and the (d) operating cost of gas It should be noted that this regulation has a fundamental weakness in that it misquotes Schedule One to the Agreement where it refers to operating costs instead of capital cost (see the definition of MVP in 3.1 above) Furthermore, clause 16.1 provides that Sasol Gas is permitted to conclude all gas sales agreements with its customers on the basis of a separate, independent contract for each geographically separated Site A Site is described in Schedule One to the Agreement as a separate area of land with its buildings owned or rented by a gas consumer. Page 8 of 20

9 3.15 What is apparent from clause 16.1 of Schedule One to the Agreement is that there should be sales agreements concluded between Sasol Gas and its customers. These sales agreements should be concluded separately and independently for each geographical Site From this clause one can see that the words concluded separately and independently for each geographical site give a basis on which Sasol Gas should conclude sales agreements. Any basis other than the one provided will be contravening clause 16.1 of Schedule One to the Agreement. Alternative fuel at time of connecting to natural gas 3.17 According to clause 1.16 of Schedule One to the Agreement, MVP means determining the gas price by comparison with: the cost of the alternative fuel delivered to the customer s premises or anticipated place of use (in the case of Greenfields Customers 5 ); plus the difference between all the operating costs of the customer s use of the alternative fuel and all the operating costs of using (natural) gas; plus the difference between the Nett Present Value (NPV) of the capital costs of the customer s continued use of the alternative fuel and the NPV of the capital costs involved in switching to (natural) gas, as would be reflected in the customer s accounts From the above definition of MVP, Sasol Gas must base its price for gas on the market value price to each customer. This market value price must be determined according to the costs of the alternative fuel used by the 5 Greenfields Customer refers to an External Customer who, after 26 September 2001, constructs a facility on a new Site and whose facility receives piped-gas from Sasol for the first time at or after 26 March Page 9 of 20

10 customer or anticipated place of use (in the case of Greenfields Customers) at the time of converting to natural gas In other words, Sasol may charge different customer prices, depending on the alternative to gas that was available to the customer at the time of converting to natural gas or is available to the customer at the anticipated place of use (in the case of Greenfields Customers) These alternatives may, for example, be coal, electricity, or Heavy Fuel Oil. If the customer s alternative is, for example, coal, the price at which gas is sold to the customer would be significantly lower than the price would be if the alternative fuel was Heavy Fuel Oil The MVP approach ensures that all potential users of gas can switch to gas at a price which is lower than what they are currently paying for an energy source. It effectively legalises price discrimination Therefore, in order to implement clause 1.16 of Schedule One to the Agreement, it is important to establish which alternative fuel a customer converted from (at the time of the actual conversion to gas, not subsequent alternatives) in the case of a Brownfields customer Where a customer did not consume any energy prior to gas (as would be the case of a Greenfields customer), the alternative fuels considered at the anticipated place of use would be the alternative fuels Furthermore, when renegotiating a price, it is not required that a new MVP calculation is performed, as Schedule One to the Agreement only considers the price of the alternative fuel at the time of converting to gas. As a result, MVP of gas must not be based on any assumed or deemed logical alternative. Hence the emphasis of the difference between the Nett Present Page 10 of 20

11 Value (NPV) of the capital costs of the customer s continued use of the alternative fuel and the NPV of the capital costs involved in switching to (natural) gas, as would be reflected in the customer s accounts, in the definition of MVP The preamble of the Schedule One to the Agreement states that: And Whereas, in the absence of existing specific gas legislation, SASOL has requested a regulatory dispensation that will be binding on the future Gas Regulator; And Whereas such gas projects involve significant investment and risks and the RSA, GOM and SASOL will be required to provide guarantees and undertakings in order to enable The Project Furthermore, the preamble states that And Whereas the RSA is committed to promoting the introduction of natural gas in the South African economy at the lowest cost and as fast as possible From the above, it is evident that the rationale for Schedule One to the Agreement was that Sasol Gas needed to make investment decisions, but there was no specific legislation for gas projects at the time, so a regulatory regime had to be negotiated. As part of the regulatory regime, Sasol Gas was given a Special Regulatory Dispensation Period regarding exclusive rights to ROMPCO s infrastructure until 10 years after First Gas, and the right to negotiate the price of gas based on MVP on separate contracts with individual customers. Page 11 of 20

12 3.28 In light of the definition of MVP, the determination of the MVP should be based on the cost of alternative fuel used by the customer at the time of converting to natural gas. The rationale for this definition was to encourage and incentivise the customer to switch to natural gas. Informing customers about MVP 3.29 Gas traders whose maximum prices are calculated by MVP in terms of Schedule One to the Agreement must inform their customers of the constituent elements used to calculate their gas prices and of the MVP elements as provided for in regulation 4.2 of the Piped-Gas Regulations It is submitted that a customer must, before gas is sold to it, be informed of the elements used to calculate its gas price and that this should happen at the contracting stage and whenever the gas price is changed In addition, regulation 4(6) of the Piped-Gas Regulations indicates that when gas is sold, the accompanying sales invoice must itemise the constituent elements of the total price reflected on the invoice, including at least the cost of gas, any transport tariffs and any other charges The MVP price has to be established for each customer in order that: (a) a customer can use the MVP information to negotiate gas prices; (b) the maximum price for each customer is determined; (c) discounts to Small customers can be calculated; and (d) each customer has the opportunity to contest the alternative fuel ; and the price of that fuel as assigned to the customer by Sasol Gas. Page 12 of 20

13 3.33 In order for individual customers to assess their MVP (i.e. maximum) price, they must therefore know what alternative fuel is being used to determine the price and the differences in the operating expenditure and capital expenditure between the use of (natural) gas and the use of the alternative fuel. 4. ESCALATION OF THE MVP BASE PRICE 4.1 Clause 1.16 of Schedule One to the Agreement is silent on how the MVP may be escalated over time. It does not provide any guidance, same as the Gas Act and the Piped-Gas Regulations. 4.2 Despite lack of explicit guidance in clause 12 of Schedule One to the Agreement, NERSA s role and power in regulating or exercising control over indexation on MVP is inherent in its powers granted in terms of section 36 of the Gas Act, Piped-Gas Regulations 4.6 and clause 1.16 of Schedule One to the Agreement. 4.3 If the escalation mechanism is left without regulatory checks, it may have a significant negative impact on MVP level and result in prices being excessively higher than MVP levels. NERSA therefore has to provide guidance on how MVP indexation should be done in order to ensure compliance with clause 1.16 of Schedule One to the Agreement. Ideally, the escalation of MVP base price should be done in the same manner that is consistent with the alternative fuel applicable to the individual customer in order to avoid considerable divergence from the original MVP base price. 4.4 However escalation formula based on or referenced to inflation may still be relevant, as the impact on MVP can be minimal. This approach would be acceptable. Detailed options of the escalation mechanism will be presented in the template to be approved by NERSA at a later stage. Page 13 of 20

14 5. APPLICATION OF THE MVP PRINCIPLE 5.1 Clause 2 of Schedule One to the Agreement states that: the purpose of this Agreement is to set out the regulatory dispensation, binding the Gas Regulator, which will, to the extent detailed herein and for the period referred to in clause 3, be applicable to SASOL s current piped gas business, the proposed supply of natural gas from Mozambique and the sale of that gas into markets within South Africa. 5.2 The above implies that the price of gas for all Sasol Gas s customers, including customers that were signed before the First Gas (26 March 2004) has to comply with clause 1.16 of Schedule One to the Agreement. Therefore the MVP principle is applicable to all of Sasol Gas customers, i.e. so-called Brownfields Customers 6 and Greenfields Customers Furthermore, clause 16.1 of Schedule One to the Agreement provides that Sasol must conclude all gas sales agreements with its customers on the basis of a separate, independent contract for each geographically separated Site 8. 6 Brownfields Customer refers to an External Customer receiving piped-gas from Sasol Limited before 26 March 2004, including a customer which expands its facilities and thereby increases its gas consumption, but excluding those persons which convert their facilities after 26 March 2004 from other energy carriers to accept piped-gas. 7 See footnote 2 above. 8 Site means a separate area of land with its buildings owned or rented by a gas consumer. Page 14 of 20

15 5.4 Annexure A (Annexure A - Calculation of the MVP) of this document provides the different steps that must be followed in calculating the MVP of gas. Each of the steps provided in Annexure A is based on the provisions of Schedule One to the Agreement. 5.5 If the customer has more than one operation using two or more different alternative fuels, a weighted average of both alternative fuels can be considered. 6. SHORTCOMINGS OF MVP 6.1 MVP approach ensures that all potential users of gas can switch to gas at a price which is lower than what they are currently paying for an energy source. However, MVP approach has several shortcomings, some of which are the following: (a) There are new technological developments in the energy industry which bring opportunities for new alternative fuels. One of the shortcomings of MVP is that it does not take into consideration recent developments on alternative fuels. (b) MVP does not prescribe how prices must be escalated. As a result, some customers have prices which are escalated using a different alternative fuel than the one which was used to set a base price. For example, a customer with coal as an alternative fuel using LPG to escalate the MVP. (c) The price of gas which is determined by MVP is not competitive. It is difficult to compete with imports because of the price of gas which is very high. Page 15 of 20

16 6.2 NERSA is aware of the abovementioned shortcomings. Furthermore, it must be noted that the rationale for Schedule One to the Agreement was to provide guarantees and undertakings to Sasol Gas to enable the Mozambique to South Africa gas project, and to promote the introduction of natural gas in the South African economy. Government s intention was not to displace other fuels in the market, but to promote gas development on a commercial scale. 6.3 Furthermore, Sasol Gas s special regulatory dispensation is coming to an end on 25 March The provisions of MVP will also expire on this date. After this date, NERSA would be mandated by the Gas Act, 2001 to approve maximum prices for all classes of customers of piped-gas and enforce nondiscrimination. Page 16 of 20

17 GLOSSARY OF TERMS Act Means the Gas Act, 2001 (Act No. 48 of 2001). Brownfields Customer Means an External Customer receiving piped-gas from Sasol Limited before 26 March 2004, including a customer which expands its facilities and thereby increases its gas consumption, but excluding those persons which convert their facilities after 26 March 2004 from other energy carriers to accept piped-gas. Consumer Means a person who uses gas except for those persons who purchase gas from a reticulator. Gas Means all hydrocarbon gases transported by pipeline, including natural gas, artificial gas, hydrogen rich gas, methane rich gas, synthetic gas, coal bed methane gas, liquefied natural gas, compressed natural gas, re-gasified liquefied natural gas, liquefied petroleum gas or any combination thereof. Gas Regulator Means the Gas Regulator as contemplated in the Gas Act (Act No. 48 of 2004) and replaced by the Energy Regulator as contemplated in the National Energy Regulator Act (Act No. 48 of 2001). Gigajoules (GJ) A metric term used for measuring energy use. One (1) GJ is equivalent to the amount of energy available from 26.1 m 3 of natural gas. Page 17 of 20

18 Greenfields Customer Means an External Customer who, after 26 September 2001, constructs a facility on a new Site and which facility receives piped-gas from Sasol for the first time at or after 26 March Greenfields Reference price Means the reference price for Greenfields customers. Licensee Means any person holding a licence granted by the Energy Regulator in terms of the Act. Natural Gas Means a gaseous fossil fuel consisting primarily of methane, but including significant quantities of ethane, propane, butane, and pentane heavier hydrocarbons removed prior to use as a consumer fuel as well as carbon dioxide, nitrogen, helium and hydrogen sulphide. Price Means the charge for gas to a distributor, reticulator or final customer. Regulations Means the Piped-Gas Regulations made in terms of section 34 (1) of the Act. Residential Means household use of gas. Schedule One to the Agreement Means Schedule One to the Agreement Concerning the Mozambican Gas Pipeline between the Government of the Republic of South Africa and Sasol Limited, i.e. the Regulatory Agreement between the Minister of Minerals and Energy, the Minister of Trade and Industry and Sasol Limited. Page 18 of 20

19 Site Means a separate area of land with its buildings owned or rented by a gas consumer. Small Customer Means a customer consuming less than Gigajoules per annum of gas per Site. Year Means any sequential period of 12 months with the first year measured from the first day of the month in which First Gas occurred. Page 19 of 20

20 ANNEXURE A Market Value Pricing (MVP) Calculation Model STEP Model Notes Volume of alternative fuel per annum delivered to the customer's premises or 1 Volume - anticipated place of use (in case of Greenfields Customers) 2 Conversion Factor - Conversion factor used to convert alternative fuel energy measurement to gigajoules. E.g kwh to gigajoules 3 Volume (GJ) - product of Steps (1;2) Cost of Alternative (e.g Electricity) 4 Actual Alternative Fuel Cost (R) - Actual total invoice amount billed for alternative fuel consumed in step (1) 5 Actual Aternative Fuel Cost (R/unit) - divide step (4) by step (1) to get actual cost per unit of alternative fuel 6 Conversion (kwh to GJ) - conversion factor used to convert alterantive fuel cost per unit in step (5) above to rand per gigajoule. The same conversion factor applied in step (2) must be used. 7 Efficiency (e.g 80%) - efficiency of the alternative fuel usage 8 Actual Alternative Fuel Cost (R/GJ) - the product of Steps (4;5;6;7) Operating Exepenses Difference ( e.g Electricity Vs Gas) the operating costs of the customer's use of the alternative fuel minus all the 9 Operating Costs differential (R) - operating costs of using natural gas 10 Operating Costs Diferrential (R/GJ) - operating costs differential in step (9) divided by volume in step(3) NPV of Capital Costs differential (e.g Electricity Vs Gas) 11 NPV of Capital Costs Differential (R) - 12 NPV of Capital Costs Differential (R/GJ) - the Net Present Value (NPV) of the capital costs of the customer's continued use of the alternative fuel minus the capital costs involved in swithcing to natural the Net Present Value (NPV) of the capital costs differential in step (11) divided by volume in step (3) Page 20 of MVP Calculatation before discounts (R/GJ) - sum of Steps (8;9;10)