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We can’t blame others for high cost of electricity if we fail to plan properly

FINANCIAL STANDARD
By Hindpal S Jabbal | August 9th 2016

In an article published in this platform on July 19, I dealt with the scorecard on the ‘5,000+MW in 2016’ plan launched in September 2013.

Unlike the earlier prospectus of 2009 lauched by the Ministry of Energy, this one had no specific Least Cost Power Development Plan (LCPDP) to back it up.

In that article, I stated that over the past three years, Kenya’s gross domestic product (GDP) has grown by about 5.4 per cent, and demand for electricity by about 6 per cent. This is against highly exaggerated projections of 10 per cent and 15 per cent, respectively, which inform the 5,000+MW plan.

Further, in the period since the project was launched, almost 650 megawatts (MW) — 400MW of geothermal power and 250MW from three medium-speed diesel (MSD) thermal plants (one at Thika and two at Athi River) — have been added to the national grid. Yet, peak demand over this period has increased by only 232MW, despite Kenya Power connecting 2.6 million new customers to the grid.

Thus, the 250MW MSD plants installed by three different independent power producers (IPPs) have virtually become redundant, yet they attract close to $60 million (Sh6 billion) a year in idle capacity charges.

This has resulted in an electricity tariff increase of about Sh1/kWh, which was passed on to customers in 2014.

It is very likely that power costs could increase by another Sh3-Sh4/kWh if the 1,000MW Lamu Coal Plant project goes ahead as planned.

This plant, estimated to cost about $2 billion (Sh200 billion), will attract idle capacity charges of about $360 million (Sh36 billion) a year. Therefore, its construction cannot be justified for the next 14 years to 2030 for lack of adequate demand to operate the plant economically at base-load.

On July 27, State House hosted an Energy Summit, where President Uhuru Kenyatta fully supported efforts to raise electricity connectivity to about 70 per cent by next year.

He noted that while the cost of power has reduced significantly, manufacturers have not passed on these benefits to consumers by reducing the prices of their commodities.

The President directed the Ministry of Energy to review Power Purchase Agreements (PPAs) with all IPPs supplying MSD thermal plants, with a view to reducing the cost of power even further.

This week, I will look at the Government’s very laudable efforts to connect more consumers to the grid— and on the flip side, the challenges this has created in the quality and reliability of power supply.

I will also explain how contracts are signed with various IPPs, with regards to fixed capacity and pass-through fuel charges for thermal plants. The electricity costs policy will also be explained in some detail, and its effect on different categories of consumers.

CONNECTIVITY, AND THE TRANSMISSION AND DISTRIBUTION (T&D) NETWORK

Over the past three years, Kenya Power has added close to 2.6 million new consumers under the Last Mile project, which is largely financed by the World Bank, African Development Bank and the Government. This has raised connectivity levels from about 27 per cent in 2013 to about 60 per cent this year.

This is one of the highest levels in sub-Saharan Africa, and is truly commendable, both from a social as well as political point of view, in improving the quality of life for the masses.

However, the average consumption of these consumers is only about 20kWh per month — they mainly use power for lighting, charging mobile phones and maybe running a radio or small TV.

Hence, these tail-end consumers of electricity have not contributed much to the growth in demand of electricity for productive purposes, or in building up Kenya Power’s revenue base.

On the other hand, the sheer number of new consumers has placed considerable constraints on the power distributor’s technical, commercial and financial resources.

Table 1 gives the breakdown of system losses and number of line faults at different voltage levels for financial years 2009-10, 2012-13 and 2015-16.

System losses have gradually increased from about 16 per cent in 2009-10 to about 19 per cent in 2015-16. Most of these losses are at low-voltage levels.

Similarly, line faults have increased from about 6,000 per month in 2009-10 to about 16,000 monthly in 2015-16.

Over the past six years or so, transformer failures have increased from about 200 per month in 2009-10 to about 350 in 2015-16, mainly because of the poor quality of transformers — with a third of these failures due to vandalism.

It must, therefore, be emphasised that no matter how much new generation capacity is added to the system, it will make very little difference to the quality and reliability of supply.

This can only be achieved by a systematic reduction of system losses on a continuous basis, through system reinforcements, re-coductoring of distribution lines and regular maintenance.

INDEPENDENT POWER PRODUCERS

All power purchase agreements with IPPs supplying thermal plants usually have two distinct components.

The first is fixed capacity charges in dollars per kilowatt per year to cover the financial costs of the plant, including civil works and other fixed operation expenses.

The other component is variable energy charges in dollars per kilowatt-hour to cover the costs of fuel and variable operation and maintenance costs.

As the name suggests, fixed capacity charges remain fixed for the duration of the contract and must be paid at regular intervals. Variable energy charges, on the other hand, can vary from month to month, depending on the cost of fuel at a given time, and are passed on to consumers at actual costs.

For example, the fixed charges for the 250MW plants acquired recently, and which are now lying idle, are about $240 (Sh24,000)/kW/year.

This amounts to $60 million (Sh6 billion) per year, and must be paid every year for the duration of the contract, whether the plant runs or not.

Similarly, for the proposed 1,000MW Lamu Coal Plant, which has been committed to but is not yet under construction, the fixed charges are about $360 (Sh36,000)/kW/yr. This amounts to about $360 million (Sh36 billion) per annum, which will have to paid at regular intervals for the duration of the contract, again, irrespective of whether the plant runs or not.

This arrangement for fixed capacity and variable energy charges for a thermal plant is accepted internationally for all IPPs.

Principally, this arrangement is very similar to hiring a car which also has two components — you pay a fixed daily or monthly rate, whether you use the car or not, plus fuel charges in shillings per kilometre.

It is, therefore, extremely important that we plan in advance on the type, the size, the site and the timing of a particular plant to be installed. This will help us avoid entering into expensive renegotiations or termination of contracts at a later stage.

ELECTRICITY TARIFFS

In Kenya, we basically have a cost-reflective tariff, with all fuel costs passed through to consumers of electricity.

Table 2 gives the average electricity costs for the past nine years, split into fixed capacity costs for all generation plants (KenGen and IPPs); all fuel costs; and transmission and distribution costs, mainly for Kenya Power.

The overall electricity tariff has reduced from a high of Sh15.97 in the 2011-12 financial year to Sh14.50 in 2015-16, a reduction of Sh1.47/kWh, mainly because of reduced fuel costs.

This translates to an overall reduction of about 10 per cent in four years — not 25 per cent as has been erroneously announced in sections of the press.

In July 2008, when the electricity tariff structure was last adjusted, all Government subsidies were removed and included in the base tariff.

Since then, after the creation of new institutions, that is the Geothermal Development Company (GDC), Kenya Electricity Transmission Company (Ketraco) and Rural Electrification Authority (Rea), the Government has been directly subsidising the sector for the total operational costs of these new institutions.

The Government has also taken up part of the costs of geothermal drilling activities, transmission networks, street lighting and the Last Mile initiative. This has resulted in a direct subsidy of about Sh3/kWh in the last financial year, as reflected in Table 2.

Table 3, at the bottom of the page, gives the breakdown of various consumer categories, and the average cost of power as a percentage of their household income or total turnover.

As observed from this table, domestic consumers do not spend more than 1 per cent to 3 per cent of their monthly household income on electricity.

Similarly, average industrial consumers, who tend to complain about the high costs of electricity in the country, spend just 4-6 per cent of their total turnover on power. This is because most of their raw materials, plants and machinery are imported.

Hence, even a 20 per cent increase or decrease in their electricity tariff makes a marginal difference of only 1 per cent in their overall production costs.

It is only in energy-intensive industries, such as cement manufacturing, paper milling and mining industries, that the electricity bill can be as high as 20-22 per cent of turnover, since most of these sectors’ raw materials are obtained locally.

Finally, Table 4 gives the country’s estimated household income distribution, and the monthly power consumption for each income class.

As can be observed, almost 70 per cent of total domestic consumers — a majority of whom are in the lower middle class — use an average of 20kWh/month. And they all pay a subsidised ‘life-line’ tariff.

Another 25 per cent, mainly in the middle class, use an average of 80kWh/month.

It is only the top 5 per cent, mainly in the upper middle and wealthy class, who use an average of 500kWh/month.

Still, all these consumers spend less than 3 per cent of their household income on electricity.

It is clear from this table that it is not the cost of electricity per se that prevents the vast majority of domestic consumers from using more of it. It is simply that their low income levels prevent them from buying the modern gadgets and domestic appliances that the more affluent income groups can easily afford.

The writer is an authority on Kenya’s power sector, and a former chairman of the Energy Regulatory Commission (ERC). [email protected]

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