How flagging shilling fuels spike in your power bill

Introducing local currency tariffs can disrupt the power sector in the short term. [File, Standard] The weakening of the shilling over the last year has meant that electricity consumers have to contend with a higher cost of power. This is as the foreign exchange adjustment component of the power bill goes up. The forex adjustment is a pass-through cost that consumers bear to cushion power sector players from the weakening of the local currency. This has, however, not been the case for the better part of this year. Despite the shilling dropping to record lows against the dollar, the forex adjustment remained at the same levels from January through August this year. This was to support the 15 per cent reduction in power prices effected early in the year in line with a directive from retired President Uhuru Kenyatta. Also suppressed was the fuel cost charge, which should have gone up in line with higher oil prices in the global markets. The impact of the weakening of the shilling and leaving the pass-through cost unchanged between January and August is now evident in Kenya Power's books. The utility firm has to convert some of its earnings to foreign currency, mostly US dollars, for the repayments of foreign currency loans as well as paying the power producers that sell electricity to it. Foreign currency The Power Purchase Agreements (PPAs) that the company has with most of the electricity producers are also settled in foreign currency, mostly US dollars and euros. Kenya Power reported a 40.2 per cent increase in finance costs, attributing it to the depreciation of the shilling against major world currencies. The weak shilling partly had the impact of reducing its tax before profit, which dropped 37.5 per cent, although a lower tax expense resulted in an increase in its net profit. Finance costs increased from Sh9.05 billion to Sh12.69 billion, which the firm attributed to the depreciation of the local currency against major world currencies. The forex component of the power bill has remained constant at 73 cents per unit of power consumed between January and August this year, after which it rose to Sh1.37 per unit in September and Sh1.48 in October before easing slightly to Sh1.40 in November. The higher forex charge has been due to the weakening of the shilling against the US dollar, dropping from Sh107 early last year to Sh113 in January this year and Sh120 in September. Among the proposals to cut power bills that have been fronted in the past include increasing the number of shilling-based contracts with power producers. The Energy and Petroleum Regulatory Authority (Epra) did a study on denominating PPAs in local currency in 2017. The study, according to the electricity sector regulator, recommended that Kenya could begin to introduce local currency-denominated PPAs for small renewable energy projects or have a hybrid of local and foreign currency-denominated PPAs. With time, these can be scaled up to include large power-generating projects. The government is, however, yet to come up with a policy on the former. Epra said denominating PPAs in local currency can protect Kenya Power and electricity consumers from the volatility of the shilling. "Local currency tariffs will reduce exposure to adverse impact of forex adjustment shocks in power bills. They will also promote local content and entrepreneurship," said Epra. But the regulator cautions that putting a sudden stop to foreign currency-denominated PPAs could have a major disruption in the power industry. This is because it could see a surge in power prices, negating the idea of protecting consumers from higher power prices whenever the shilling weakens against major world currencies. It could also inadvertently repel investors from putting up power plants in the country. "Introducing local currency tariffs can disrupt the power sector in the short-term due to uncertainty that comes with a new tariff regime. The study recommends a gradual transition to local currency PPAs to minimise risk and increase the likelihood of a successful transition," said Epra. "If set at the wrong level, local currency tariffs run the risk of either reducing the interest of foreign investors and IPPs (independent power producers) or increasing the cost of power beyond a sustainable level for the off-taker and the consumer. This, however, can be mitigated by putting in place a well-structured tariff." Full transition to local currency tariffs over a short period, the regulator further noted, exacerbates the downside of those risks. "To mitigate the unintended consequences, moving gradually, with local currency tariffs for certain technologies or below a specific project size (for example, less than 10 megawatts (MW), provides an opportunity to assess tariff attractiveness and feasibility on a small scale, allowing for adjustment before rolling out across the sector." The Presidential Task Force on PPAs, set up in March 2021 to look into ways that the country can bring down the cost of power, noted that denominating PPAs in foreign currency is among the factors driving up the cost of power. Epra said it shared the recommendations of the study on local currency PPAs with the task force, which recommended that all future IPPs be in Kenya shilling. The task force analysed different PPAs that Kenya Power has signed with the IPPs and noted the immense strain that both the company and the consumer have to bear due to the denomination of the agreements in foreign currency. It noted that Kenya Power has to collect money from electricity consumers in the local currency and then convert the money into either the US dollar or euros to pay the power producers. The task force noted that acquiring US dollars whenever Kenya Power has to pay the IPPs had the tendency of driving up demand for the dollar and in turn further weakening the shilling. "KPLC (Kenya Power and Lighting Company) had contracted about 30 PPAs with IPPs and the payment was denominated in either US dollars or euros. Denominating the IPPs' tariffs in foreign currency is bound to weaken the Kenyan shilling against the foreign currency in line with the law of demand and supply," said the task force in its report published in September last year. "KPLC as the off-taker will continue to incur significant foreign exchange losses given that the tariffs are agreed at the signing of PPAs and review of the foreign exchange losses has not been timely or has delayed at times beyond the one year due to delays in the review of retail tariffs." The life of a PPA averages 20 years, and the exchange rates between the Kenya shilling and the US dollar or euro are bound to change significantly over the 20 years. "These costs are passed on to customers every month as pass-through costs in the electricity bills, that is, KPLC passes the exchange rate risk to consumers. This has a high negative impact on the consumers." In reviewing the different PPAs that Kenya Power has with IPPs, the task force noted that owing to the volatility of the shilling, the firm pays billions of shillings more today compared to the years when the contracts were signed. In one instance that the task force looked into, a PPA between Kenya Power and one IPP was signed in October 2009 when the exchange rate stood at Sh75 to the dollar. At the time of doing the report last year, the shilling had weakened to Sh109 against the dollar. It observed that Kenya Power "would require an extra Sh34 today for each US dollar it buys compared to what it would have spent in 2009 for the same dollar." Euro-denominated PPA The shilling has since last year further weakened to upwards of Sh120 to the dollar this year, which means that the company is spending over Sh44 in buying the US dollar compared to what it would have spent in 2009. In another case, a euro-denominated PPA was signed in 2010 when the shilling to euro rate was Sh107.63. The shilling had, however, weakened to Sh130 to the euro as of 2021 when the task force did its analysis. This meant that Kenya Power spent an extra Sh22.40 for each euro it bought to pay the power producer last year compared to what it was spending in 2010 when the PPA was signed. "The task force recommends that all future PPAs should be denominated in Kenya shillings. The monetary policy implementing agency will be required to ensure stable macroeconomic stability to avoid fluctuations in the local currency and erosion of the real value of money. Stability of local currency will enhance bankability of projects," said the report. It added that IPPs, just like other multinationals operating in the country, should take payment in local currency. "There are many multinational companies who have invested in Kenya and all their transactions are in Kenya shilling. These multinationals invoice their customers in Kenya shillings. These companies include Diageo, Toyota and Vodafone, among others," said the task force.

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