MARIA NKHONJERA<\/h3>

The Supreme Court of Appeal (SCA) in May 2018 made a decision to have the National Energy Regulator of South Africa\u2019s (NERSA) methodology for regulating piped-gas prices reviewed. The natural gas market has seen rapid expansion over recent years, growing as an alternative source of energy in South Africa and the southern African region. Gas is a key source of energy for both industrial and residential use. In the market for piped-gas, Sasol is the dominant supplier and importer of piped gas transmitted from Mozambique. In 2014, 347 manufacturing companies that used piped-gas, purchased it directly from Sasol, and for a number of production industries, gas is the single biggest input cost (about 20%). Any price increases would potentially undermine their competitiveness<\/a>. It turns out, Sasol has been charging prices that are 200-300% higher to large industrial customers, compared to prices that would have pertained in a competitive market.<\/p>

The concentrated nature of this market makes it more likely that anticompetitive behaviour can arise, including through monopolistic pricing. In this context, the gas sector is heavily regulated<\/a>, and developments in the regulation of the sector have important implications for market outcomes. In light of these developments and the importance of the piped-gas sector for industrial users, this article analyses the pricing methodology adopted by NERSA in regulating the piped-gas sector, and analyses the decision made by the SCA in this regard. \u00a0<\/p>

Piped-gas pricing regulation <\/em><\/p>

Between 2004 and 2014, Sasol Gas received Special Regulatory Dispensation to compensate for its early pipeline investments. This period referred to as Sasol\u2019s \u2018decade of grace,\u2019 afforded Sasol exclusive rights to the pipeline infrastructure<\/a>. During this period and in line with South Africa\u2019s Regulatory Agreement, NERSA monitored gas prices using a European Benchmark Price (EBP) that was used to cap Sasol\u2019s pricing<\/a>. The benchmarking approach, as envisaged in the Gas Act of 2001, was set to change following the ten year special dispensation.<\/p>

In the absence of sufficient competition, the Gas Act requires that NERSA develop a methodology to determine the maximum competitive price Sasol Gas is permitted to charge for piped-gas. In March 2014, NERSA reviewed the dispensation relating to gas in terms of the Gas Act, with reference to the prices and monitoring of the maximum price for piped-gas. NERSA\u2019s adopted methodology (Table 1) for setting the maximum price for piped-gas was benchmarked with reference to the comparative cost of a basket of alternative fuels, i.e. coal, diesel, electricity, heavy fuel oil and Liquefied Petroleum Gas (LPG). In the formula, coal, diesel and electricity are apportioned the bulk of the weight, making the prices of these variables critical to the final calculation.<\/p><\/div><\/div><\/div>

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The weights applied to the different energy indicators are based on the overall usage in the country and not on industry usage. The consideration of overall usage is problematic as more expensive fuels such as diesel are given greater weight. If the weights had been based on industry usage, the maximum price would be much lower given the heavier reliance on coal which is the cheapest of the alternative fuels<\/a>. \u00a0<\/p>

Although NERSA recognised that no single fuel is a perfect substitute for gas, the SCA found that it based the maximum price for gas on energy price indicators that were in fact more costly than natural gas. The chosen methodology was adopted by the Regulator in 2013, despite the concerns of large gas that the new methodology would result in prices higher than Sasol\u2019s average pricing at the time.<\/p>

NERSA also analysed gas prices in foreign markets (predominantly Europe) to further support and inform its methodology. The comparison to the European Union was meant to show that South African gas prices were not high, in relative terms.[2]<\/a> However, given different market conditions, European countries may not be appropriate comparators. South African gas consumers should be able to benefit from Sasol passing on a relatively low gas price (also given proximity to a large source of gas in Mozambique). The SCA took a view that pricing should rather be benchmarked against what a competitive gas price would be in the South African gas market.<\/p>

Essentially, what was meant to ensure that external customers (other than subsidiaries of Sasol) were subject to a price cap, as enacted through a regulatory framework, resulted in substantial increases in maximum gas prices for large scale consumers of piped gas, who by volume make up more than 50% of users<\/a>. In 2013, after NERSA approved Sasol\u2019s application for a maximum price of R117.69\/GJ for introduction in 2014, the Gas Users Group comprising glass, breweries, plastic, distribution and sugar manufacturers, filed an application to have NERSA\u2019s methodology reviewed.[3]<\/a> Although the case was initially dismissed by the High Court in 2016, the SCA recognised that the appeal should proceed, on reasonable grounds. The expectation was that 80% of Sasol Gas customers (largely small customers by number) would benefit from price reductions. With the given methodology, the expected decreases for different classes of users are presented in Table 2, where class 1-3 are small customers and class 4-6 represent large customers. \u00a0<\/p><\/div><\/div><\/div>

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However, when considered in terms of volumes purchased, 61% of customers would in fact experience an increase<\/a>. This increase would, for the most part, affect large customers<\/a>, given that small customers make up only 5% of Sasol customers (in terms of volumes purchased).<\/p>

\u00a0<\/em>The SCA then arrived at its ruling in May 2018 stating that:<\/p>

• the maximum gas prices determined by NERSA for the March 2014 to June 2015 period, be reviewed and set aside<\/p><\/li>

• any maximum prices approved by NERSA, for Sasol, shall apply retrospectively from March 2014 until the termination date of such approval and;<\/p><\/li>

• the costs of this application shall be paid by NERSA and Sasol jointly<\/p><\/li><\/ul>

  An extended decade of grace<\/em><\/p>

  Looking back at the 2004 to 2014period, piped-gas was priced according to the same principles used in NERSA\u2019s new methodology<\/a>. Sasol\u2019s pricing was determined with reference to the cost of alternative fuels for individual customers, which as mentioned do not reflect the true cost. This meant that if a customer was switching from electricity to gas, Sasol would charge the customer what they would have paid for electricity (less the switching cost). The price determined under this regulatory framework still entitled Sasol to charge a monopoly price, or higher prices to some of its consumers (Table 3).<\/p><\/div><\/div><\/div>

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  Sasol has stated that it believes that its pricing structure is appropriate for the sustainability of the gas industry, given its capital intensity and significant investments that have been made, and to incentivise further investments in the future.<\/p>

  Discussion<\/em><\/p>

  Although worth recognising that the new pricing methodology adopted by NERSA essentially allowed for increases in the price of piped-gas, as a monopolist, Sasol was effectively able to exercise and misuse its market power. This has had negative consequences on large users of piped-gas, in the form of higher prices, who are put at a competitive disadvantage.[1]<\/a> The ability for this to prevail is reflective of the highly concentrated nature of the industry and customers having no effective alternative suppliers. \u00a0<\/p>

  Although benchmarking may be a useful tool, the market for piped-gas is distinct from the basket of alternative energy sources used in calculating the piped-gas price<\/a>. The effectiveness of the methodology, and NERSA\u2019s function as regulator, therefore requires a clear understanding of what constitutes appropriate benchmarks, in order to guide the methodology. The benchmarks applied, together with the weighted combination of the various energy price indicators are crucial, and have not adequately constrained the pricing behaviour of Sasol in the piped-gas sector. The regulatory framework should also balance the interests of market participants, as it relates to essential exploration activities and investments into the sector. In the case of Sasol as a fuel producer in the inland region, the regulatory regime allowed for the exertion of market power, on grounds that this was necessary to support its investment activities<\/a>. From evaluating Sasol\u2019s inland fuel pricing, the importance of regulating prices together with creating separate incentives to encourage new investments is evident, including in terms of accounting for the likely impact on different categories of users.<\/p>

  [1]<\/a> Sasol Gas owns the distribution networks for piped-gas in South Africa and has exclusivity over distribution in specific areas in Gauteng, Mpumalanga, Free State and KwaZulu-Natal.<\/p>

  [2]<\/a> Industrial gas users had a preference for a cost-plus approach<\/a>.<\/p>

  [3]<\/a> During the special dispensation period, a comparison between South Africa\u2019s gas prices and 15 selected European countries (including those in the EBP) still found South Africa to have the second highest gas price out of those surveyed in 2012<\/a>.<\/p>

  [4]<\/a> Applicants included the PG Group, SA Breweries, Consol Glass, Nampak, Mondi, Distribution and Warehousing Network and Illovo Sugar.<\/p>

  [5]<\/a> Smaller customers on the other hand benefited from lower prices because they would have had more \u2018high cost fuel\u2019 alternatives.<\/p><\/div><\/div><\/div><\/div><\/div><\/div><\/div>\t\t\t\t\t\t<\/div>\n\t\t\t\t<\/div>\n\t\t\t\t\t<\/div>\n\t\t\t\t<\/div>\n\t\t\t\t<\/div>\n\t\t","protected":false},"excerpt":{"rendered":"

  \u00a0 MARIA NKHONJERA The Supreme Court of Appeal (SCA) in May 2018 made a decision to have the National Energy Regulator of South Africa\u2019s (NERSA) methodology for regulating piped-gas prices reviewed. The natural gas market has seen rapid expansion over recent years, growing as an alternative source of energy in South Africa and the southern […]<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"inline_featured_image":false,"footnotes":""},"categories":[21],"tags":[],"class_list":["post-3149","post","type-post","status-publish","format-standard","hentry","category-competition-review"],"acf":[],"yoast_head":"\n