NERSA’s ‘reasonable judgment’ disciplined in latest Eskom court clash

South Africa’s resilience is being tested to breaking point under the combined weight of the Moody’s downgrade and the economic fallout of the Covid-19 crisis and lockdown. Businesses and domestic consumers hardly need more bad news in the form of significantly higher Eskom tariffs. Yet, following the High Court’s latest decision in the multipronged litigation battle Eskom is waging against the National Energy Regulator of South Africa (Nersa), this prospect looms large.

In a decision handed down on March 10, Judge Kollapen set aside Nersa’s single-year price determination for 2018/19 under the Multi-Year Price Determination Methodology (MYPDM) and granted Eskom leave to apply for a supplementary tariff determination after a final decision on its 2018/19 Regulatory Clearing Account (RCA) application.

But the judgment is less a major win in a power hike war, as it is judicial disciplining of Nersa’s discretion to apply ‘reasonable judgment’ in the best interest of the overall South African economy and the public. Nersa, like any other public institution, must act rationally, reasonably and in line with the dictates of procedural fairness when it determines tariffs.

Nersa regulates Eskom’s tariffs, but it does not have free rein. It is bound to follow the tariff principles set out in the Electricity Regulation Act, 2006, the Electricity Pricing Policy of 2008 and the MYPDM. These principles must allow an efficient licensee full cost-plus recovery, while also achieving reasonable tariff stability, smoothed changes over time and an appropriate allocation of commercial risk. In deciding Eskom’s price adjustment applications, Nersa must also apply the MYPDM, which details how the regulator should approach the various elements of allowable revenue, namely operational costs, primary energy costs and the regulatory asset base, besides others. Nersa is further bound by its founding mandate in the National Energy Regulator Act, 2004. Significantly, this Act requires that the regulator’s decisions be procedurally fair and clearly explained, in fact and law. Finally, Nersa’s decisions must comply with lawful administrative action, as set out in the Promotion of Administrative Justice Act, 2000.

Nevertheless, two features of the MYPMD afford Nersa some flexibility. The first is the RCA, a risk management device that provides for Eskom’s allowable revenue to be adjusted ex post facto on the basis of actual financial facts. The second flexibility mechanism allows Nersa to depart from the MYPMD and apply ‘reasonable judgment’ when determining Eskom’s allowable revenue “after due consideration of what may be in the best interest of the overall South African economy and the public”. The March decision deals squarely with how this reasonable judgment should be exercised.

This decision is the first of Eskom’s three court challenges against Nersa to be finalised. The utility is also seeking a full judicial review of Nersa’s RCA determination for the 2014/15 to 2016/17 financial years and a review of its fourth multiyear price determination, or MYPD4, which sets out tariff increases to the 2021/22 financial year. In February, Judge Kollapen dismissed Eskom’s urgent application for an order authorising a 16.6% and 16.7% tariff increase pending the review of the MYPD4, essentially on separation of powers concerns and deference to Nersa as a specialist body. The February decision, nevertheless, confirmed Nersa’s mandate to consider affordability and the impact of tariffs on consumers when it relies on the ‘reasonable judgment’ clause in the MYPDM, factors Eskom had argued were irrelevant.

In the March decision, Eskom attacked Nersa’s 2018/19 tariff determination on the basis that the tariff approved (5.23%, as against the requested 18.91%) continued a historical trend: tariffs set too low for Eskom to recover the full cost of its licensed activities plus a reasonable return. The utility also argued that Nersa had “reverse-engineered” its determination. Intent on keeping tariffs as low as possible, the regulator had misapplied and departed from the dictates of the MYPDM without giving Eskom the opportunity to make submissions on whether such departures were justified. This had affected how Nersa had dealt with coal prices, employee costs and the exclusion of the Hendrina and Arnot power stations from the regulatory asset base. For its part, Nersa argued that departures from the MYPDM were reasonable, particularly in a context where there had been serious breaches of good governance.

The court emphasised that the function of the ‘reasonable judgment’ clause in the MYPDM is to reconcile the competing interests of licensees and consumers. But if Nersa wanted to rely on this clause and depart from the MYPDM, it was obliged to take Eskom’s rights and interests into account, including the right to procedural fairness. Nersa needed to inform Eskom of any departure from the MYPDM and the alternative methodology it sought to apply, and allow the utility to make submissions. Failure to do so would undermine the rationality of its own decisions. Relying on procedural fairness, the court accordingly upheld nearly all of Eskom’s objections against Nersa’s 2018/19 tariff determination.

A significant hike in Eskom tariffs is therefore not inevitable and much will turn on how Nersa observes procedural fairness and is able to justify its exercise of reasonable judgment.