COST-OF-SERVICE REGULATION

Introduction

Cost-of-service regulation is a traditional form of economic regulation under which an electricity utility is permitted to recover the efficient and prudently incurred costs of providing electricity, together with a reasonable return on capital. Its purpose is to protect consumers from excessive monopoly pricing while ensuring that regulated utilities remain financially capable of maintaining networks, investing in infrastructure and providing reliable electricity services. In South Africa, this approach is reflected in the Electricity Regulation Act 4 of 2006, NERSA tariff methodologies, the Electricity Pricing Policy and Eskom’s Multi-Year Price Determination framework.

Statutory Basis

Section 15(1) of the Electricity Regulation Act requires tariff methodologies to enable an efficient licensee to recover the full cost of its licensed activities, including a reasonable margin or return. Tariffs must also encourage technical and economic efficiency, provide consumers with appropriate information about the costs created by their consumption, avoid undue discrimination and may permit cross-subsidisation between customer groups.

NERSA therefore regulates electricity prices rather than allowing monopoly utilities unrestricted freedom to determine them.

Calculation of the Revenue Requirement

Under cost-of-service regulation, the regulator first determines the utility's allowable revenue. Eskom's Multi-Year Price Determination methodology is expressly based on a cost-of-service and rate-of-return approach.

Allowable revenue generally incorporates operating and maintenance expenditure, primary-energy costs, depreciation, transmission or network expenses and a return calculated on the Regulatory Asset Base. Historically, the MYPD formula has included the Regulatory Asset Base multiplied by an approved return, together with efficiently incurred operating and energy expenses and various regulatory adjustments.

For the current MYPD6 period, NERSA continues to assess Eskom's revenue requirements for generation, transmission and distribution separately. NERSA's January 2025 determination covered the 2025/26, 2026/27 and 2027/28 financial years and applied efficiency adjustments to Eskom's claimed costs.

Prudence and Efficiency Review

Cost recovery is not automatic. NERSA may disallow expenditure that is unnecessary, inefficient, excessive or imprudently incurred. The methodology therefore attempts to prevent regulated utilities from simply transferring every operational cost to consumers.

The principle creates an important balance: legitimate costs necessary for reliable electricity supply should be recoverable, but consumers should not be required to finance avoidable inefficiency. The MYPD methodology expressly requires operating expenditure to be efficiently and prudently incurred.

Regulatory Asset Base and Return

Capital-intensive utilities require substantial investment in generation, transmission and distribution infrastructure. Cost-of-service regulation therefore permits an appropriate return on the Regulatory Asset Base (RAB).

NERSA must nevertheless balance investor sustainability with affordability. In its MYPD6 distribution decision, NERSA phased Eskom's return to support gradual movement toward cost-reflective tariffs and to reduce sudden tariff shocks for consumers.

Municipal Cost-of-Supply Regulation

Municipal electricity distributors are also subject to NERSA tariff oversight. Cost-of-supply studies identify the expenses attributable to different customer categories and assist in producing cost-reflective tariff structures. NERSA publishes a specific Cost of Supply Framework and Methodology for electricity distributors.

CASE LAW

National Energy Regulator of South Africa v Borbet SA (Pty) Ltd [2017] ZASCA 87

Facts: Eskom sought an additional tariff adjustment through the Regulatory Clearing Account mechanism. NERSA approved the adjustment, which was challenged by industrial electricity consumers.

Legal Issue: Whether NERSA had rationally and lawfully applied its tariff methodology.

Judgment: The Supreme Court of Appeal confirmed that NERSA's tariff determination constitutes administrative action and is subject to judicial review under PAJA.

Legal Principle/Ratio: A specialised regulator possesses regulatory discretion, but it must apply the governing methodology rationally, fairly and consistently.

Significance: The case confirms that cost-of-service calculations and revenue adjustments cannot be arbitrary merely because they involve complex regulatory expertise.

United Democratic Movement v Eskom Holdings SOC Ltd [2023] ZAGPPHC 1949

Facts: Litigation concerning electricity supply and load shedding required the court to examine aspects of Eskom's regulatory and pricing framework.

Legal Issue: How statutory tariff principles and Eskom's cost-recovery methodology operate within electricity regulation.

Judgment: The High Court recognised that the MYPD is a cost-of-service methodology designed to permit recovery of allowable revenue while promoting prudent and efficient operations.

Legal Principle/Ratio: Full-cost recovery applies to an efficient licensee, not to every expenditure claimed by the regulated utility.

Significance: The decision illustrates the central balance between utility sustainability, efficiency and consumer protection.

Conclusion

Cost-of-service regulation remains a central foundation of South African electricity pricing. It allows utilities to recover efficient operating and capital costs while subjecting those costs to NERSA scrutiny. The model therefore seeks to combine financial sustainability, investment incentives, affordability, transparency and protection against monopoly overcharging.