Politics that plunged Kenya Power into financial mess

A few months to last year’s general election, a lean team that determines power tariffs assembled in the Energy Ministry’s boardroom on the 22nd floor, Nyayo House in Nairobi.

In attendance were representatives from key parastatals in the sector. Also at the table were officials from the sector watchdog, the Energy Regulatory Authority (ERC). There was also a representative from the private sector.

The agenda of the day was how to keep costs of power low despite the happenings at home and abroad.

Before this meeting, the pressure was already mounting on the ERC to raise the Fuel Energy Cost (FEC) that had remained at Sh2.35 per kilowatt-hour for far too long.

There was also a major sector review of the new energy tariff that was hanging on the shoulders of the sector regulator. The tariff proposal submitted by Kenya Power would have seen the cost of electricity shoot up in an election year.

Political decision

This was a path no one wanted to take at the time. The Jubilee government, which was seeking reelection, had listed among its deliverables the connection of millions of people to the national grid.

The messaging was that the Government had brought down the cost of energy and wanted that to remain so.

Deputy President William Ruto never missed an opportunity to passionately point out how much work the Government had done in making electricity affordable.

Any upward review would jeopardise this position. At the time, all indicators were clear that Kenya Power had to do something about its pricing to reflect the reality on the ground.

But Energy Ministry officials would not entertain any change in tariffs. It was not going to happen. Kenya Power left with nothing. Politics had its way and the meeting ended having denied Kenya Power its chance to factor in the prevailing costs in its bills.

The decision to suspend passing on fuel costs to consumers would several months later come to hurt the firm.

But this was not the first time the listed power distributor was making a political decision. The manner in which the Sh18.5 billion Last Mile project was rolled out has been critisised for failing to consider economics.

“While connecting people to electricity is a good thing, the economic status of most of the people getting this power shows they need more basic things like food, clothing and shelter. It is obvious they are not going to have the ability to pay,” explained Dr Samuel Nyandemo of the University of Nairobi School of Economics.

Consequently, by the company’s own admission, more than half of its customers spend below Sh305 on electricity per month or Sh10 per day.

This bottom-end segment accounts for 55 per cent of Kenya Power’s total customer base of more than 6.5 million.

On the flip-side, transmission and distribution costs have in the last three years jumped from Sh21.7 billion to Sh33.4 billion.

And so when Kenya Power last week announced a profit warning, it was a matter of the chickens coming home to roost. Predictably, the company blamed last year’s long electioneering period.

“Revenue growth in the year was constrained by the depressed economic environment, poor hydrological conditions in 2017 and the protracted electioneering period,” said acting manager Jared Othieno in a statement last week.

“This slow business environment led to a significant decline in the company’s financial performance,” he said.

But why would a company, which is the only player in a market where it can determine prices as it likes, lose money the way Kenya Power has done?

Few companies in Kenya enjoy the privileges that the power utility firm has.

Besides its business being shielded from the market turbulence that rocks other firms in an open and competitive market, the electricity distributor has the blank cheque to pass on most of its costs to consumers.

In the monthly bill, Kenya Power passes most of the other costs not associated with its business to its consumers - among them the fuel and energy cost, forex adjustments, and inflation. This arrangement leaves it with virtually no exposure to outside risks.

It also collects at least six other levies shouldered by the power consumer on behalf of various agencies and power suppliers.

Currently, Kenya power surcharges three cents per kilowatt-hour consumed as ERC levy. The Rural Electrification Programme (REP) levy accounts for five per cent on the cost of units of power consumed. It is for the implementation of rural electrification projects. The final beneficiary is the Rural Electrification Authority (REA).

The Fuel Energy Cost is a variable rate per kWh, published monthly in the Kenya Gazette. It is reflective of the cost of generating electricity from thermal sources during the previous month.

Kenya Power collects this money from consumers and it is supposed to pass the whole of it directly to electricity generating companies, who in turn pay fuel suppliers.

This is the cost that the committee decided to keep steady, and ended up a huge miscalculation to Kenya Power finances. Kenya Power also collects five cents per kWh as the Water Resources Management Levy (Warma), which is charged on the cost of all units generated from hydropower plants above one megawatt.

Inflation adjustment is also a variable, depending on the consumer price index underlying factor.

The forex charge is related to the fluctuation of hard currencies against the Kenya shilling for expenditure related to power purchasing between Kenya Power and the power producers.

This shields the firm from booking any losses in this regard, which other players in the corporate sector such as Kenya Airways would have absorbed. On top of this, the firm will also pass on the Value Added Tax to the end user, nearly doubling the final bill. Another cushion for the firm came in the form of the fixed charge.

Until three months ago, the firm had been taking Sh150 monthly from its 6.6 million customers as a fixed charge. Whether one consumes any unit or not, they must pay this fixed charge which is supposed to help it maintain the transmission lines.

Fixed charge

This translates to Sh990 million every month or Sh11.8 billion annually. Assuming only 70 per cent of its customers are active throughout the year, the firm is still assured of Sh8.3 billion income for just having a connection.

Though this was taken away from the new tariff, it has been factored in the new billing structure announced in July. This means that it still gets its fixed costs at the end of the day.

However, in the past three years, the firm has been all over the country, connecting new people to the grid. It shrugs off criticism of moving too fast to connect power to as many people as possible to get the numbers, without considering the paying ability of the consumers.

The firm also moved with speed and jumped on the Jubilee governments election promises craze, to connect as many people to the grid at a faster pace than the growth of supply.

This, in turn, has given a lifeline to expensive diesel generators who thrive in times of shortages. By April this year, its customer base stood at 6.66 million customers, up from about 4.8 million it had at the end of the 2016 financial year.

This translates to about 900,000 new customers every year.

The biggest puzzle is why would a company, whose operations are closely shielded, and have recruited millions of new customers to have challenges in translating them into better earnings?

The economic advisors at the Energy Ministry had a plan. In theory, it was to work just fine.

Instead of having to change the fuel cost every time, they came up with a proposal of maintaining the charge at a fixed point, and recoup the losses when the tide is in their favour. While at it, support the Government’s plan of delivering stable and predictable power?

In the circumstances that the actual computed Fuel Cost Charge (FCC) is above that set cost, the charge to customers is maintained at the set cost and any amount not recovered by Kenya Power was to be recovered in subsequent months when the FCC falls lower than the set cost.

But as they would discover, this was a gamble that failed flat and left Kenya Power with a Sh10 billion hole to fill. There was a drought that ensured that diesel generators remained switched on.

The international oil prices also complicated the situation further after they made an about-turn and started spiralling upwards. After the election, the middle could not hold anymore and the ERC allowed Kenya Power to have its way.

It immediately adjusted the FCC to 4.35 per Kwh, a 36-month high. But this was a little too late. The firm had been caught in the middle of a political gamble and the fundamentals of the market. Kenya Power was also having problems of its own.

On top of piling debts and rise in costs of maintenance, it had challenges in accounting for all the glossy picture it had painted of having hundreds of thousands of new connections that apparently did not translate into actual revenue.

A comparison of the last three financial years paints a company that is spending faster than it is generating.

The firm had also burnt through its reserves during the connection frenzy. In 2015, the firm closed the year with bank balances of Sh23 billion.

In 2017, at the same time, the bank had only Sh2.9 billion its bank accounts, reflecting the level of activity at the firm.

Liquidity crunch

On top of this, it had an overdraft of Sh4.6 billion, a stark contrast from its previous three years where it needed no overdraft. Its borrowings rose to Sh111 billion, increasing its debt position by Sh6 billion.

It had also recalled its short-term deposits from its lenders and closed last year with Sh596 million, down from Sh4.2 billion it had in June 2015.

These are signs of a company that is in dire need of cash. To make matters worse, its tenders had attracted the attention of detectives who were snooping around for any impropriety.

Almost its entire top management, including its chief executive officer, would later be arrested and dragged to court to face various charges. ERC was also not helping, issuing erroneous forex charges.

The market had started noticing all these signs of trouble and these negatives seeped into the Nairobi Securities Exchange, which answered with fall in its share price, making it one of the poorest counters.

Last week, it made a profit warning, confirming that its financial health was going to take a beating from both its mistakes and the market conditions.

The firm which reported Sh7.27 billion in profits last year told its investors to expect that its earnings will be at least less by a quarter this year.

The company has indicated that it will give a more detailed explanation of its financial health during its next investor briefing.