Eskom has entered into a number of agreements to supply
electricity to electricityintensive businesses where the revenue
from these contracts is linked to commodity prices and foreign
currency rates or foreign production price indices that give rise
to embedded derivatives.
The embedded derivatives have been divided into three
categories:
• 
commodity and/or foreign currency derivatives 
• 
foreign currency or interest rate derivatives 
• 
United States production price and foreign currency derivatives 
Valuation
The fair value of embedded derivatives is determined by using a
forward electricity price curve to value the host contract and the
derivative contract is valued by using market forecasts of future
commodity prices, foreign currencies rand exchange rate,
interest rate differential, future sales volumes, production price
and liquidity, model risk and other economic factors.
The forecast cash flow is determined and then discounted at the
relevant interest rate curve. The net present value of the cash
flows is then converted at the rand/foreign currency spot rate to
the reporting currency. The fair value of the embedded derivative
is adjusted, where applicable, to take into account the inherent
uncertainty relating to the future cash flows of embedded
derivatives such as liquidity, model risk and other economic
factors. The important assumptions are obtained either with
reference to the contractual provisions of the relevant contracts
or from independent market sources where appropriate. These
assumptions are:
• 
spot and forward commodity prices 
• 
spot and forward foreign currency exchange rates 
• 
spot and forward interest rates 
• 
forecasted sales volumes 
• 
spot and foreign production price indices 
• 
liquidity, model risk and other economic factors 
Embedded derivatives that are not separated are effectively
accounted for as part of the hybrid instrument. Nonoption based
derivatives are separated on terms that result in a fair value at
the date of inception of zero. Optionbased derivatives are
separated on the terms stated in the contracts and will not
necessarily have a fair value equal to zero at the initial recognition
of the embedded derivative resulting in dayone gains or losses.
These dayone gains or losses are recognised over the period
of the agreement. The fair value will depend on the strike price
at inception.
The only significant unobservable input is the United States
producer price index (PPI).
Valuation assumptions
The forward electricity curve used to value the embedded
derivatives at 31 March 2014 is based on the current MYPD 3
approved tariff increase of 8% for 2014/15 to 2017/18, whereafter
a forecasted return on the regulatory asset base is used until
maturity.
The contracted electricity price used to value embedded
derivatives is based on a combination of the factors in the table
below over the contracted period.
Forecast sales volumes are based on the most likely future sales
volumes based on past trends and taking into account future
production plans in consultation with industry specific experts
and key customer executives.
The fair value of embedded derivatives takes into account the
inherent uncertainty relating to the future cash flows of embedded
derivatives, such as liquidity, model risk and other economic
factors.
The following valuation assumptions for the future electricity price curve discussed above for the valuation of embedded
derivatives were used and are regarded as the best estimates by the board:


Year ended 31 March 

Input 
Unit 
2014^{1} 
2015^{1} 
2016^{1} 
2017^{1} 
2018^{1} 
2019^{1} 

Aluminium 
USD per ton 
1 716 
1 865 
1 939 
2 005 
2 068 
2 127 

Volatility 
Yearonyear (ratio) 
0.22 
0.22 
0.22 
0.22 
0.22 
0.22 

Rand interest rates 
Continuous actual/365 days (%) 
5.57 
6.74 
6.84 
7.28 
7.55 
7.79 

Dollar interest rates 
Annual actual/365 days (%) 
0.09 
0.52 
0.57 
1.03 
1.48 
1.87 

United States PPI 
Yearonyear (%) 
3.27 
2.20 
2.33 
2.20 
2.41 
2.32 

Rand/ USD 
USD per rand 
0.09 
0.09 
0.08 
0.08 
0.07 
0.07 

2013 

Year ended 31 March 

Input 
Unit 
2013^{1} 
2014^{1} 
2015^{1} 
2016^{1} 
2017^{1} 
2018^{1} 

Aluminium 
USD per ton 
1 886 
1 962 
2 045 
2 128 
2 213 
2 288 

Volatility 
Yearonyear (ratio) 
0.25 
0.25 
0.25 
0.25 
0.25 
0.25 

Rand interest rates 
Continuous actual/365 days (%) 
5.10 
5.66 
5.42 
5.71 
6.00 
6.32 

Dollar interest rates 
Annual actual/365 days (%) 
0.24 
0.93 
0.41 
0.53 
0.71 
0.96 

United States PPI 
Yearonyear (%) 
1.14 
1.49 
2.21 
2.47 
2.42 
2.38 

Rand/USD 
USD per rand 
0.11 
0.10 
0.10 
0.09 
0.09 
0.08 

1. 
Forward curve based on financial years. 
Sensitivity analysis
The approximate change in the value of embedded derivatives if one of the inputs is changed is disclosed in note 4.2 Financial risk
management – market risk under currency risk (note 4.2.1), commodity risk (note 4.2.2), interest rate risk (note 4.2.3) and other price risk
(note 4.2.5).
The carrying amount of the embedded derivative liabilities for the group is R9 332 million (2013: R11 481 million) and R9 331 million (2013:
R11 480 million) for the company. Refer to . 