National Energy Regulator of South Africa and Another v PG Group (Pty) Ltd and Others

• Jurisdiction: South Africa
• Judge: Cameron J, Froneman J, Jafta J, Khampepe J, Ledwaba AJ, Madlanga J, Mhlantla J, Nicholls AJ and Theron J
• Judgment Date: 15 July 2019
• Docket Number: CCT 131/18 [2019] ZACC 28
• Hearing Date: 15 July 2019
• Counsel: IV Maleka SC (with H Mutenga and N Kekana) for the first applicant. A Cockrell SC (with M Stubbs) for the second applicant. W Trengove SC (with JJ Meiring) for the respondents.
• Court: Constitutional Court

Khampepe J (Cameron J, Froneman J, Jafta J, Ledwaba AJ, Madlanga J, Mhlantla J, Nicholls AJ and Theron J concurring):

Introduction

[1] In terms of the Gas Act, [1] the statutory functions of the first applicant, the National Energy Regulator of South Africa (Nersa), include regulating gas prices in the prescribed manner; monitoring and approving, and if necessary regulating tariffs for the transmission of gas; and promoting competition in the gas industry. [2] Where Nersa has determined that there is inadequate competition in the gas market, it is mandated by the Gas Act to approve maximum gas prices that a regulated entity may charge through the imposition of a condition in the licence of that entity. [3]

[2] The first and second applicants, Nersa and Sasol Gas (Pty) Ltd (Sasol), seek leave to appeal against a judgment of the Supreme Court of Appeal [4] reversing a decision of the High Court of South Africa, Gauteng Division, Pretoria [5] (High Court), and reviewing and setting aside the decisions of Nersa to approve Sasol's maximum gas price and transmission tariff applications on the dual bases of irrationality and unreasonableness.

[3] The respondents are all large-scale consumers of piped gas who were aggrieved by Nersa's decision to approve Sasol's applications as the approval resulted in a substantial increase in the prices they had been paying.

Legislative and factual background

[4] In the late 1990s and early 2000s Sasol and a Mozambican partner developed natural gas fields in Mozambique and built a pipeline to pump gas to South Africa. In consideration for this investment, the South African Government and Sasol concluded the 'Mozambican Gas Pipeline Agreement' (Pipeline Agreement) on 26 September 2001. The Pipeline Agreement incorporated a 'Regulation Agreement' that allowed Sasol to determine its gas prices with reference to 'market value pricing'. Under market-value pricing, the price for each customer is generally set just below their individual and particular cost of switching

Khampepe J (Cameron J, Froneman J, Jafta J, Ledwaba AJ, Madlanga J, Mhlantla J, Nicholls AJ and Theron J concurring)

to an alternative fuel. This was done in order to compensate Sasol for its investment in the Mozambican gas field development.

[5] The Pipeline Agreement was conditional upon the inclusion of a provision in the Gas Act (which at the relevant time was in the process of being drafted) that made the agreement binding on Nersa for 10 years. The market-value pricing regime came to an end on 25 March 2014, following which Sasol's gas prices were subject to regulation by Nersa.

[6] The Gas Act came into force on 1 November 2005 and Nersa is the gas regulator referred to in the Gas Act. [6] In terms of s 4(g) of the Gas Act, Nersa is required to regulate maximum prices, in terms of s 21(1)(p), in 'the prescribed manner'. Section 21 sets out the framework and requirements that Nersa must consider when imposing licence conditions on a regulated entity. More specifically, where Nersa has determined that there is inadequate competition in the gas market, s 21(1)(p) requires Nersa to determine, as a condition of a licence for a regulated entity (in this case, Sasol), 'maximum prices' which it must approve.

[7] The prescribed manner referenced in s 4(g) of the Gas Act is described in reg 4(3) – (4) of the Regulations. [7] Regulation 4(3) provides that:

'[Nersa] must, when approving the maximum prices in accordance with section 21(1) (p) of the Act —

(a)

be objective ie based on a systematic methodology applicable on a consistent and comparable basis;

(b)

be fair;

(c)

be non-discriminatory;

(d)

be transparent;

(e)

be predictable; and

(f)

include efficiency incentives.'

[8] Regulation 4(4) provides:

'Maximum prices referred to in subregulation (3) must enable the licensee to —

•

recover all efficient and prudently incurred investment and operation costs; and

•

make a profit commensurate with its risk.'

[9] Section 4(h) of the Gas Act also provides that Nersa's function is to 'monitor and approve, and if necessary regulate, transmission and storage tariffs and take appropriate action when necessary to ensure that they are applied in a non-discriminatory manner as contemplated in section 22'. Section 22 goes on to elaborate on the requirement of non-discrimination.

[10] During the course of carrying out its statutory functions, Nersa determined that there was inadequate competition in the piped-gas

Khampepe J (Cameron J, Froneman J, Jafta J, Ledwaba AJ, Madlanga J, Mhlantla J, Nicholls AJ and Theron J concurring)

market. Prompted by Nersa's determination, on 24 December 2012, Sasol made two applications, the one for determination of its maximum gas prices (Maximum Price Application) and the other for the determination of its transmission tariffs (Tariff Application).

[11] Applications for approval of transmission tariffs are determined in accordance with Nersa's Guidelines for Monitoring and Approving Piped-Gas Transmission and Storage Tariffs in South Africa of 1 May 2009 (Tariff Guidelines). The Tariff Guidelines provide for the use of various methodologies by an applicant for tariff calculation. In its Tariff Application, Sasol opted for the 'Rate of Return' methodology. It adjusts the overall tariff level according to a company's efficient level of accounting costs and costs of capital. It is based on the calculation of revenue a company will be allowed to earn to cover its efficient operational expenses and to provide a return on its efficient level of investment in capital and assets.

[12] After public hearings and further submissions, Nersa approved Sasol's Tariff Application on 26 March 2013. Nersa published reasons for its decision on 24 April 2013 (Tariff Decision).

[13] Nersa's decision with regard to the Maximum Price Application was based on three interrelated steps, some of which pre-dated Sasol's application.

[14] The first step was to determine the methodology by which the maximum prices would be set under s 21(1)(p) of the Gas Act (Maximum Pricing Methodology). This process involved Nersa publishing a first and second draft methodology for public comment and, finally, publishing the approved methodology on 28 October 2011. Nersa published its reasons for adopting the methodology on 24 November 2011.

[15] The Maximum Pricing Methodology stated that the maximum prices proposed by an applicant or licensee were to be reviewed on the basis of a formula using indicator prices in a basket of coal, diesel, electricity, heavy fuel oil (HFO) and liquefied petroleum gas (LPG), with their respective weightings being apportioned at 37% for coal, 24% for diesel, 37% for electricity and 1% for both HFO and LPG. Allowance was also made for discounts in respect of different categories of customers. After stating that it recognised the basket-of-alternatives method to be 'appropriate under the prevailing circumstances', the Maximum Pricing Methodology states:

'However, where the licensee deems the price determined by this methodology to be materially lower or higher than its preferred and appropriate gas price in that it impacts on the ability to compete and/or recover efficiently and prudently incurred costs and make a profit commensurate with risk, then the Energy Regulator will allow such licensee to opt for the use of the "pass-through" approach to ensure that the licensee fully recovers all its efficiently and prudently incurred costs and makes a profit commensurate with its risk as provided for in the legislation. This will of course apply to instances when the preferred

Khampepe J (Cameron J, Froneman J, Jafta J, Ledwaba AJ, Madlanga J, Mhlantla J, Nicholls AJ and Theron J concurring)

and appropriate price is either higher or lower, than the one determined by using the approach explained in sections 3.1 to 3.4. The approach will then become the systematic methodology to be consistently applied throughout the licence period for such a licensee electing to use this ''pass-through'' approach.'

[16] The pass-through approach requires an applicant to justify their proposed price for gas on the basis of a cost-based price build-up, including at least the cost of procured or produced gas, and any transportation or regasification costs. The transmission and distribution tariffs and the trading margin, determined under this methodology, would be added to the maximum energy price. The pass-through approach is a simple 'cost plus percentage' method of determining a price. Its use is commensurate with reg 4(4), which provides that maximum prices must enable the licensee to recover all efficient and prudently incurred investment and operational costs; and make a profit commensurate with its risk.

[17] Nersa's second step was to determine whether there was inadequate competition in the gas market within the meaning of s 21(1)(p). Nersa first published a draft inadequate-competition determination in September 2011, followed by a final inadequate competition determination on 29 February 2012. [8]

[18] The third step was to determine Sasol's Maximum Price Application. In the application, Sasol elected to use the basket-of-alternatives method and not the pass-through approach for the determination of its application. After initial public comments, Nersa published a draft of its determination of Sasol's application on 11 February 2013. After further

Khampepe J (Cameron J, Froneman J, Jafta J, Ledwaba AJ, Madlanga J, Mhlantla J, Nicholls AJ and Theron J concurring)

public hearings and submissions, Nersa approved the Maximum Price Application on 26 March 2013. On 24 April 2013 Nersa published reasons for its approval of the Maximum Price Application (Maximum Price Decision). Nersa's approval was on the following bases:

(i)

The maximum gas price is R117,69. This price is subjected to six...