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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.

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1.4 The above definition of MVP opens the door to customer complaints

regarding:

(a) whether MVP is a maximum price per customer;

(b) which alternate fuel to use for the MVP calculation and how to establish

the alternate fuel;

(c) when and how must Sasol Gas provide MVP information to customers;

and

(d) 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 NERSA1 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).

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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 Customers2); 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 Regulations3 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 2004. 3As promulgated by the Minister of Minerals and Energy on 20 April 2007.

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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 non-

compliance with clause 1.16 of Schedule One to the Agreement.

2.8 As stated above, the Energy Regulator is empowered to regulate the piped-

gas 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.

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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 Customers4); 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 2004.

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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.

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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

0 – 5 000 GJ/a 12% discount on the relevant customer’s then prevailing market value price

5 000 – 15 000 GJ/a 6% discount on relevant customer’s then prevailing market value price

15 000 – 40 000 GJ/a 4,5% discount on relevant customer’s then prevailing market value price

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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.

3.10 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).

3.11 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.

3.12 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).

3.13 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.

3.14 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.

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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.

3.16 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 Customers5); 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.

3.18 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 2004.

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customer or anticipated place of use (in the case of Greenfields Customers)

at the time of converting to natural gas.

3.19 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).

3.20 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.

3.21 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.

3.22 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.

3.23 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.

3.24 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

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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.

3.25 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.

3.26 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’.

3.27 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.

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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.

3.30 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.

3.31 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.

3.32 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.

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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.

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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 Customers6 and Greenfields Customers7.

5.3 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

Site8.

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.

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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.

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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 2014. 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 non-

discrimination.

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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 m3 of natural gas.

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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 2004.

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.

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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 40 000 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.

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ANNEXURE A

Market Value Pricing (MVP) Calculation Model

STEP Model Notes

1 Volume - Volume of alternative fuel per annum delivered to the customer's premises or 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 usage8 Actual Alternative Fuel Cost (R/GJ) - the product of Steps (4;5;6;7)

Operating Exepenses Difference ( e.g Electricity Vs Gas)

9 Operating Costs differential (R) - the operating costs of the customer's use of the alternative fuel minus all the 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) - 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

12 NPV of Capital Costs Differential (R/GJ) - the Net Present Value (NPV) of the capital costs differential in step (11) divided by volume in step (3)

13 MVP Calculatation before discounts (R/GJ) - sum of Steps (8;9;10)