SEIFSA’s submission to NERSA

Eskom’s third MYPD3 RCA for Year 2 (2014/15), Year 3 (2015/16)

and Year 4 (2016/17)

May 2018

PRESENTED BY:Marique Kruger & Dr. Michael Ade

EC DIVISION - SEIFSA

marique@seifsa.co.za

THE STEEL AND ENGINEERING INDUSTRIES

FEDERATION OF SOUTHERN AFRICA

SEIFSA is a Regional Federation representing 23 independent

employer Associations in the metal and engineering industries, with a

combined membership of roughly 1 300 companies employing about

200 000 employees. The Federation was formed in 1943 and companies

in Associations federated to it range from giant steel-making

corporations to micro-enterprises employing fewer than 50 people.

DISCLAIMER

The views expressed in this presentation do not necessarily

represent those of SEIFSA Associations and/or their member-

companies

ELECTRICITY COST

IS A SIGNIFICANT CONTRIBUTORY FACTOR TO THE TOTAL INPUT

COSTS BASKET OF THE M&E CLUSTER

A CONTINUOUS INCREASE IN ELECTRICITY TARIFFS IS NOT

SUSTAINABLE FOR BUSINESSES

MAIN MESSAGE

M&E CLUSTER SHARE IN MANUFACTURING Manufacturing division and major group

Metals and Engineering Sub-Components

Manufacturing Weights

M&E Weights*

1 2 3 4

M&E sector 9 of 20 Manufacturing

Comprises 45% of Manufacturing

% %

Petroleum, chemical products, rubber and plastic products

Rubber products 1.34 4.62

Plastic products 2.86 9.86

Basic iron and steel, non-ferrous metal products, metal products and machinery

Basic iron and steel products 3.44 11.86

Basic Non-ferrous metal products 2.73 9.41

Structural metal products 1.86 6.41

Other fabricated metal products 3.86 13.31

General purpose machinery 2.51 8.66

Special purpose machinery 3.51 12.10

Household Appliances (Radio, TV and Comm.

apparatus) 0.81 2.79

Electrical Machinery Electrical machinery and apparatus 1.65 5.69

Motor vehicles, parts and accessories and other transport equipment

Bodies for motor vehicles, trailers and

semi-trailers 0.46 1.59

Parts and accessories (Motor Vehicle) 2.76 9.52

Other transport equipment 1.21 4.17

Total 29.00 100.00

OVERVIEW OF THE M&E CLUSTER

• The cluster’s share in manufacturing output is nearly 30 percent and it

contributes about 3.6 percent of GDP to the South African economy. In

2017, it generally provided employment to roughly 450 000 people

directly (540 000 including informal), including approximately 250 000

workers in its energy-intensive sub-components.

• In the same period, the cluster also significantly contributed to

employment in other industrial sectors with forward and backward

linkages such as the agriculture, mining and quarrying, the petroleum

and chemicals, the automotive, the transport and the construction and

building sectors.

• Challenges experienced by the cluster in recent years are still prevalent

and the prolonged structural change (instead of a cyclical decline) has

made it very difficult for companies to benefit from a slight up-tick in

production.

PRODUCTION STILL TO RETURN TO

STATUS QUO ANTE 2007/08

• Although the sector has managed to claw back some output in 2017 since the

disastrous production during the global financial and economic crises which

peaked in 2009, it is still to attain the record high pre-crisis production levels.

• Frequent electricity price increases, coupled with other constraints – including

productivity – are detrimental to the continuous growth of the cluster.

GENERALLY POOR PRODUCTIVITY

• A high electricity price increase, which has the propensity to increase the basket of input

costs, will not help in remedying the situation.

INCREASING COSTS OF EMPLOYMENT

M&E CLUSTER REMUNERATION/VA vs NET MARK-UP

vs INVESTMENT

ELECTRICITY COST

IS A SIGNIFICANT CONTRIBUTORY FACTOR TO THE TOTAL INPUT

COSTS BASKET OF THE M&E CLUSTER

A CONTINUOUS INCREASE IN ELECTRICITY TARIFFS IS NOT

SUSTAINABLE FOR BUSINESSES

MAIN MESSAGE

THE ENERGY-INTENSIVE SECTORS IN THE ECONOMY AND THEIR INTERDEPENDENCIES

Most available on electricity share of input costs in economic sectors (2016)

Selected economic sectors

Electricity share of input costs

(R Million: constant 2010 prices) Employment (formal)* 2016

Gross value added

(R Million: constant 2010 prices)

Agriculture, forestry and fishing 1,308 873,880 65,843

Mining and quarrying 6,845 457,291 225,300

Food, beverages and tobacco 2,075 244,366 83,633

Textiles, clothing and leather 618 91,896 10,995

Wood and wood products 308 44,171 10,501

Paper and paper products 742 37,274 11,615

Coke and refined petroleum products 167 22,630 34,630

Basic chemicals 505 21,155 14,460

Non-metallic minerals 142 48,043 15,045

Basic iron and steel 1,527 35,322 24,730

Basic non-ferrous metals 1,563 18,363 12,370

Machinery and equipment 439 109,293 22,349

Transport equipment 743 110,851 26,505

Construction (contractors) 486 607,998 109,132

Transport and storage 3,746 368,190 190,944

21,212 3,090,722 858,053

*Based on Quarterly Employment Statis tics except for agricul ture, where figures are based on Quarterly Labour Force Statis tics

INTER-DEPENDENCE BETWEEN M&E CLUSTER AND OTHER SECTORS

ELECTRICITY SHARE AS PERCENTAGE OF

INTERMEDIARY INPUT COSTS FOR THE M&E CLUSTER (2016 data)

Inputs

Sub Sectors

Metals and

Engineerin

g Total

%

R Million

(Current Prices) % R Million

1 2 3 4

Rubber products 4.6 647 4.15 15,601

Plastic products 10.1 291 1.34 21,678

Basic iron and steel products 11.2 6292 4.10 153,311

Basic non-ferrous metals products 10.7 5800 13.64 42,511

Metal products excluding machinery 19.8 1433 1.95 73,464

Machinery and equipment 20.0 841 1.25 67,083

Electrical machinery and apparatus 5.7 504 1.22 41,368

Television, radio and communication equipment 2.9 79 0.78 10,102

Motor vehicles, parts and accessories 11.1 1034 0.60 172,490

Other transport equipment 4.0 180 1.46 12,318

Total 100 17,101 2.80 609,926

Electricity

THE ENERGY-INTENSIVE SECTORS IN THE ECONOMY AND THEIR INTERDEPENDENCIES

• Electricity costs represent on average three percent of intermediary inputs for the M&E sector and

varying percentages of turnover recorded in the basic iron and steel products (8 percent), the basic

non-ferrous metals (6 percent) and other transport equipment (14 percent).

• For some basic metals companies (smelters, foundries), this can be a significant portion of their

input costs, thereby restricting future production capacity.

• This shows how serious an impediment electricity costs can be.

• Apart from transport costs (which are also often exacerbated by energy costs), coal and energy

costs represent up to 42 percent of the production costs of some large companies in the steel

industry.

• Therefore, it is very important that electricity price increases are contained in order to reduce overall

production costs, which may ultimately lead to more job losses and the closure of strategic

industries (like the steel industry).

ELECTRICITY COSTS RELATIVE TO TURNOVER (M&E)

Table 5: Electricity costs relative to turnover

Sub Sectors Metals and Engineering

% R Million % R Million %

1 2 3 4 5

Rubber products 4.6 647 4.15 19,462 3.32

Plastic products 10.1 291 1.34 52,784 0.55

Basic iron and steel products 11.2 6292 4.10 79,265 7.94

Basic non-ferrous metals products 10.7 5800 13.64 98,277 5.90

Metal products excluding machinery 19.8 1433 1.95 117,744 1.22

Machinery and equipment 20.0 841 1.25 113,991 0.74

Electrical machinery and apparatus 5.7 504 1.22 110,641 0.46

Television, radio and communication equipment 2.9 79 0.78 13,130 0.60

Motor vehicles, parts and accessories 11.1 1034 0.60 382,715 0.27

Other transport equipment 4.0 180 1.46 1,320 13.61

Total 100 17,101 2.80 989,329 1.73

Electricity Turnover rate

Despite electricity costs not being such a large portion of input costs, they

represent a significant portion of the turnover of the electricity-intensive

sub-components of the M&E sector.

PRODUCTION COSTS BASKET

Cost inflation per item (over 12

months) Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 Dec-17

Total cost inflation

(12 months average)

%

M&E Cluster Composite Input Costs -5.1 -4.7 -4.8 -1.4 -4 -4.1 -1 1.7 0.9 3.4 5.2 3.4 -1

PPI (Final Manufactured Goods) 5.9 5.6 5.2 4.6 4.8 4 3.6 4.2 5.2 5 5.1 5.2 5

PPI (Intermediate Manufactured Goods) 6.7 7 6.8 5 3.1 2.1 1.5 2 2.1 4.1 4.2 3.2 4

Electricity and Water 10 9.3 10.8 5.9 6.4 6.2 3.5 2.6 6 3.6 4 3.3 6

Source: Statistics SA; SEIFSA

M&E Cluster Composite Input Cost Index VS PPI Vs Electricity inflation (12 months average)

PRODUCTION COSTS INFLATION

• From the table above, electricity price inflation has come down substantially,

with NERSA granting Eskom a lesser increase for the 12 months starting July

2017

• However, the current twelve-months average electricity inflation is still higher

than that of the selling price inflation (both PPI final and PPI intermediate).

Although electricity constitutes the smallest weighting in the M&E composite

input cost index (15%), it has significantly contributed to reduced margins,

given its direct influence on the long-run production pattern of the sector.

• It is generally difficult to start a new business in the M&E sector, due to the

start-up costs involved and electricity cost is a significant factor.

• Entrepreneurs find it difficult to enter the sector due to the higher cost base,

while intrapreneurs find it challenging to operate and be innovative under

increasing costs and diminishing returns.

PRODUCTION COSTS BASKET Cont.

• Also, the twelve-months average PPI for intermediate

manufactured goods (factory gate prices), which is more relevant

to the M&E sector, is higher than the composite input cost index.

An additional electricity price increase will add to production costs

and further reduce margins.

• Profit levels are low, there is general difficulty in doing business

compounded by stagnant innovation and investment levels. A tariff

increase will exacerbate the situation.

PRODUCTION COSTS BASKET Cont.

• A simulation of the effects of an additional estimated 35% electricity tariff increase

on the current status quo and on the total input costs basket provided insight to

the impact a change in electricity prices has on overall inflation.

• An estimated 35% increase in electricity tariff will result in an additional R6 billion

increase in electricity costs in the M&E sector, resulting in an additional R213

billion increase in intermediary input costs for the cluster.

• The higher proportional increase in input costs leads to a corresponding decline in

electricity share (2.79%), highlighting the sensitivity of the M&E sector to electricity

price increases as intensive users seek alternative means of power.

• Evidently, the M&E sector cannot sustain a huge increase in electricity prices.

• A large increase is not sustainable and will lead to huge job losses in the sector.

PRODUCTION COSTS BASKET Cont.

TRADE-OFF BETWEEN ELECTRICITY SHARE OF INPUT COSTS AND PRODUCTION

85

90

95

100

105

110

115

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Prod

ucti

on I

ndex

(20

15=1

00)

M&

E el

ectr

icit

y sh

are

of in

put

cost

s (%

)

Electricity share of input cost vs M&E Production

Electricity share of input costs (LHS) M&E Production (RHS)

CAPACITY UTILISATION AND INVENTORIES IN THE SECTOR

• Capacity utilisation (the ratio of actual output to the maximum potential output) is

an important measure in the sector.

• Under-utilisation of capacity increases unit costs of production due to idle

capacity, wears and tears of equipment and low levels of investment, renderingthe management of inventories at optimum levels almost impossible.

M&E CLUSTER GROSS DOMESTIC FIXED INVESTMENT AND FIXED CAPITAL STOCK, % OF OUTPUT

• When the fixed capital stock is compared to the net operating surplus (as a

proxy for profit margins) trend over time, the challenges of the sector become

more vivid.

NET OPERATING SURPLUS vs FIXED CAPITAL STOCK IN THE M&E CLUSTER

ELECTRICITY COST

IS A SIGNIFICANT CONTRIBUTORY FACTOR TO THE TOTAL INPUT

COSTS BASKET OF THE M&E CLUSTER

A CONTINUOUS INCREASE IN ELECTRICITY TARIFFS IS NOT

SUSTAINABLE FOR BUSINESSES

MAIN MESSAGE

M&E CLUSTER TOTAL EXPORTS, IMPORTS AND TRADE BALANCE (2017)

• The electricity-intensive sub-industries in the M&E sector are also the most robust

exporters and earners of foreign exchange.

THE M&E CLUSTER TRADE POSITION

SHARE OF INTERMEDIARY INPUTS IMPORTED BY THE SECTOR

• The uncertainty and sometimes repetitive costs incurred in manufacturing these intermediary

inputs have led to difficulties in planning, further accelerating the closure of domestic

production facilities, leading to net importation of these products. This largely explains why the

value for intermediate imports has consistently increased since 2009.

90.0

110.0

130.0

150.0

170.0

190.0

210.0

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

R B

illio

n

Intermediary inputs imported

WORLD STEEL PRODUCTION vs SA STEEL PRODUCTION

WORLD APPARENT STEEL USE vs SOUTH AFRICA APPAENT STEEL USE

ELECTRICITY COST

IS A SIGNIFICANT CONTRIBUTORY FACTOR TO THE TOTAL INPUT

COSTS BASKET OF THE M&E CLUSTER

A CONTINUOUS INCREASE IN ELECTRICITY TARIFFS IS NOT

SUSTAINABLE FOR BUSINESSES

MAIN MESSAGE

EXPECTED BUSINESS ACTIVITY AND EMPLOYMENT

• Even though business confidence has slightly picked up against the backdrop of

recent domestic political shifts, the fear is that increasing electricity costs may

add to the input costs component and eventually reduce production. This mayalso reverse the gains made in clawing back employment in the sector.

DECOMPOSING SEIFSA’S CORE MEMBERSHIP INTO EMPLOYMENT

(877 SMMEs and about 28,000 jobs at risk, including from some medium to large companies)

0-1013%

11-2420%

25-4921%

50-9918%

100-24917%

250-4997%

500-9992%

1000->2%

Classification (range): 0-49 employees (small and micro companies); 50 or more employees (medium to

large companies). Classification adapted from TIPS (Trade and Industrial Policy Strategies) (2017).

The Real Economy Bulletin. TIPS Publishing.

CONCLUSIONS

• SEIFSA is opposed to any increase at all to the current electricity price.

However, if such an increase should be found to be completely necessary, then

SEIFSA believes that a much lower percentage increase than requested should

be considered.

• SEIFSA understands the current challenging situation faced by Eskom,

particularly the need to ensure the utility’s financial sustainability.

• However, Eskom’s financial sustainability is inextricably linked to the financial

sustainability of its customers, which need an affordable tariff to maintain

sustainability and, thus, remain Eskom’s customers.

• High electricity price increases will definitely have a crippling effect on the M&E

sector, which is struggling to adjust to structural changes and revert to the pre-

crises production levels.

• The M&E sector, together with the mining and quarrying, construction and

automotive sectors, contributed nearly 24 percent of the country’s GDP in 2017.

The multiplier effect is potentially double this amount (including job prospects),

given the huge existing potential in both forward and backward linkages.

Therefore, sustaining these sectors is crucial for the economy.

CONCLUSIONS Cont’d

• As systematically highlighted, electricity is an absolutely essential input for the

M&E cluster.

• Excessive electricity tariff increases will eventually stifle ESKOM’s supply in the

long term as large energy-intensive sectors progressively cut down on demand

and install their own powerful diesel generators to mitigate costs.

A further consequence will be the erosion of Eskom’s customer base as more

users switch to the expanding pool of independent power producers.

Therefore, it is essential that any tariff increase should be based on

reasonableness, with directives for Eskom to improve on efficiencies, as a further

inevitable consequence will be more loss of jobs in the M&E cluster.

If the tariff applications go through, it will be a critical setback for the M&E cluster’s

efficiency and competitiveness and act as a constraint to the possibility of the

sector maximising its long-run production function.

The proposed increase in tariff will also have a negative impact on both the

individual companies in the M&E cluster and the economy in general.

PRESENTED BY:

Marique Kruger and Dr. Michael Ade

ECONOMIST

marique@seifsa.co.za

Web: www.seifsa.co.za

Tel: 0861 SEIFSA

THANK YOU

Marique Kruger