Workshop on Storage and Loading Methodology Version 3 10 May 2016 1
“Rules” of todays workshop • NERSA staff will explain the interpretation of the methodology and elements thereof. • NERSA staff will explain the practical implications of implementing the new methodology • Questions, clarification issues and guidance can be discussed and debated, but no specific decisions can be taken by the NERSA staff • Questions and debates will be allowed after each section [RAB, WACC, opex, clawback, tax, Tariff design] 2
What are we going to deal with today? • Changes in the new methodology • PPE • WACC-Debt ratio and Cost of Debt • Claw back • Tariff design • Standard options • Standard options are not different methodologies but merely standard values set by the Energy Regulator for certain elements in the formulas 3
The primary reasons for amending the methodology 1. Amendments to the Regulations; 2. Impractical outcomes of TOC (asset valuation, useful lives) 3. To place the valuation of different storage assets on a similar footing and thereby achieve similar tariffs (all other things being equal) thus improving the prospects of competition; 4. Harmonisation between Nersa’s tariff methodologies; 5. Moving closer to the DoE wholesale margin 6. To lower the regulatory burden on licensees; 7. Speedier processing 4
Why previous methodology [TOC] did not work 5
Why did TOC methodology not work? • Historical Records are either not available or are unreliable. • Useful life – ranges from 7 years to 80 years for same category of assets. This influenced TOC calculations. • BOOT type agreements created problems when actual useful life is applied. • Resulting tariffs were different for same service facilities. • Storage: Overlapping jurisdiction with DoE • DoE using different methodology (replacement cost no depreciation) • Concerns about accuracy of some storage tariffs • Difficult and cumbersome TOC calculations 6
New methodology 7
OPTIONS FOR APPLYING In the new methodology the licensee will have 3 options to follow when calculating Allowable Revenue and Tariffs: • Option 1: Comprehensive option (If actual investment costs are available IOC and if not available RV); • Option 2: Standard cost option 1 (Standard volumes, costing and tariffs); and • Option 3: Standard cost option 2 (own volumes and tariff design) 8
Is original Cost of Investment available? Yes No Use IOC -Indexed Use RV - Replacement original cost to Value calculate the PPE value Does the Applicant want to perform a comprehensive Replacement Value study? Yes No Perform a Use Standard option 1 comprehensive RV or 2 study as directed in Questions 3-4 in the 9 FAQ
REVISED ALLOWABLE REVENUE FORMULA Old Methodology Allowable Revenue Formula = (RAB [ PPE+w +/- def tax] x WACC)+E+D ± C +T New Methodology Allowable Revenue = (RAB [PPE+w] x WACC) + E + T 10
Element in Formula Old Methodology New Methodology Property Plant and Equipment [PPE] Trended Original Cost with depreciation Indexed Original Cost [IOC] or Replacement value [RV] without depreciation Working Capital Actual Working Capital Forecast with benchmarks from No change NERSA [Receivables 30 days etc] Deferred taxation Deduct Deferred taxation liability No deferred taxation effect taken into account in RAB calculation WACC – Cost of Equity [Ke] Risk Free [Rf] Average over 25 years Average over 30 years MRP Average over 25 years Average over 30 years Beta No change No change Risk Factors [LP,SSP and project risk] Allowed on detailed reasons Allowed on detailed reasons . In Standard options NERSA is going to be more lenient as Risk factors are not dealt with in the “cash flow” of financial models [Actual PPE and clawback ] Debt ratio Actual Debt Ratio with a minimum of 30% Target debt ratio of 35% Cost of Debt [Kd] Post tax Real- Actual with Tax shield in notional tax Post tax Real- Prime rate with Tax shield in notional tax calculation calculation Actual as approved by NERSA – Repairs and Maintenance 2% of Operational Expenditure Actual as approved by NERSA PPE Clawback Clawback on each element No Clawback on annual applications and Multiyear resetting Taxation Allowance Notional or flow trough taxation calculation Notional taxation calculation Tariff design Not prescriptive ,own design to suite business model Not prescriptive ,Own design to suite business model . Standard Option 1 – Standard volume 24 times capacity 11
RAB =PPE+w 12
Why did NERSA chose Indexed Original Cost or Replacement Value as a basis for determining PPE? Value of Property Plant & Equipment • Section 28(3)(a) - ‘recover the investment ’ • Regulations 4(2) (b) “recover capital investment and make profit thereon commensurate with the risk” and 4(7) (c) ”include only those assets that are prudently acquired.” • Public comment: Act prescribes “recover the investment ” not a proxy number • NERSA sought legal opinion • IOC: use actual cost ( “the investment”) and index with CPI, OR Replacement value [RV] when information on actual investment costs not available • If RV option is chosen the Standard options 1&2 are also available for 13 applicants
How will the Indexed Original Cost value of property, plant and equipment be determined? Comprehensive option: The IOC is determined by indexing the original prudently acquired cost [if available] of the asset in operation by inflation rate [CPI] using the following formula: • IOC FYn = IOC FYn-1 x KCPIn • Where: • FYn = Financial Year for which the tariff is being determined • FYn-1 = Financial Year prior to which the tariff is being determined • KCPIn = CPI Index value for twelve (12) months before the commencement of FYn divided by the CPI index twelve (12) months before the commencement of FYn-1. • Assets taken out of commission must the taken out of the regulatory asset base to be inflated 14
IOC Example IOC Example Formula FYn-1 1 April 2015 to 31 March 2016 Fyn 1 April 2016 to 31 March 2017 Headline CPI March 2014 a 102.5 index value Headline CPI March 2015 b 108.7 index value IOC value used in c 300 105 789 determination of FYn-1 KCPIn d=b/a 106.05 IOC value used in e=c*d 318 262 189 determination of FYn The calculation of IOC Asset values should preferably be performed by 15 using individual Asset items as per audited Asset Registers.
How must Replacement Value [RV] be determined? • If the original prudently acquired costs are not available, and the Regulator is in agreement with the non-availability, the replacement cost of operating assets [PPE] can be used and must be valued by the licensee and supported by a valuation performed by an appropriate independent professional firm on a Modern Equivalent Asset [MEA] basis. • This valuation is to be performed at least every five years and indexed at an appropriate inflation rate in the years between valuations. • If certain capital expenditure incurred by the licensee is not included in the definition of MEA such expenditure could be brought to the Regulator's attention with a request that it be considered for inclusion in the regulatory asset base or to be recovered as a part of the operational expenditure. This is subject to approval by the Regulator. 16
Template for Plant, Property and Equipment Cost element [R- million] Land General and civil works Building Works Road gantry Road receipt Rail gantry Tank farm Site product piping and equipment Fire protection facilities Electrical Infrastructure Security Systems Instrumentation and Control Other [supply detail] Engineering, Management and Construction Margin Total Cost Capacity[million litres] Replacement costs per Million litres 17
Will the Energy Regulator (ER) allow a transition period before assessing tariff applications on the IOC / RV basis? • Depending on the information submitted by licensees, the Energy Regulator will assess new tariff applications on either the Trended Original Cost (TOC) basis or on the IOC/RV basis for tariff periods ending December 2017. • Tariff applications for the period commencing on or after 01 January 2018 will only be evaluated on the IOC or RV basis. • Should a licensee not be in a position to implement the IOC or RV approach by 01 January 2018 , a motivation for extending this date is to be submitted to the Energy Regulator for consideration. 18
Will there be any clawback implications when tariff applications convert from TOC to the IOC or RV basis? – No clawbacks will be implemented . – The TOC basis for calculating the Allowable Revenue includes two elements relating to the Regulated Asset Base: (i) Return on RAB [WACC*RAB (a lower RAB value)] and (ii) depreciation over the useful life of the asset. – The IOC or RV basis of calculating the Allowable Revenue includes only one element relating to the Regulated Asset Base: Return on RAB [WACC*RAB (a higher RAB value)] with NO depreciation. Over time these elements should balance out. 19
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