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Energy

12/16/2013

An inconvenient truth

By Bertrand Heysch de la Borde, Manager, Infrastructure Africa,International Finance Corportation¹, Dakar, and Yasser Charafi, Investment Officer, Infrastructure Africa, International Finance Corportation¹, Dakar

© GlobeleqRaising sub-Saharan Africa’s electricity availability per person to the level of lower middle-income countries would potentially cost an unaffordable USD 400 billion. Private capital could help contribute to expanding the region’s generation capacity cost-efficiently and rapidly. The African governments can do a lot to create a climate favourable to these private investments. One of the main measures to be taken is to strengthen their electrical sector. Charging the real price of electricity is a first step to achieve this goal.


Few things are more important for economic progress and development than access to electricity. Today, for the 80 % of the world’s population that has access to power, the magic of simply flicking a switch to light their houses or power their tools is long gone. But for more than 69 % of sub-Saharan African citizens, some 585 million people (IEA, 2011), access to electricity is still a distant dream. Excluding South Africa, the region’s total installed capacity is only 28 gigawatts (GW), the same as the Netherlands’, a country of just 17 million people (Foster, V., Briceño-Garmendia, C. 2010).

This reality elicits much hand wringing from the development community as the scale of the challenge is indeed daunting. Sub-Saharan Africa’s annual electricity consumption per person stands at about 200 kilowatt hours (kWh)2; raising it to the level of lower middle income countries – typically about 700 kWh per year – would require at least 125 GW of additional generation capacity and the building of the associated transmission and distribution networks, at the cost of about USD 400 billion. Closing this gap in a decade would thus require investments of roughly USD 40 billion per year. As that is equivalent to 7.5–10 % of the continent’s GDP, such an annual investment for each of the next 10 years is, at best, unlikely.
Grants and development loans will not be enough either: total official development assistance (ODA) for infrastructure in Africa is about USD 3.5 billion per year (Foster, V., Briceño-Garmendia, C. 2010), while development banks and similar institutions provide around a further USD 30 billion3 of loans annually. Even if a third of these flows of approximately USD 35 billion were allocated to power – an unlikely scenario – that USD 10-15 billion for power would still only be a third of what is needed.

So from where could the investment come? From the private sector naturally: in 2012, the leading 20 commercial banks arranged loans of USD 21.5 billion to power projects around the world; pre-crisis, in 2007, it was USD 45.5 billion. Closer to home, in the past year alone, the International Finance Corporation (IFC) arranged about USD 1.5 billion of financing for power projects in sub-Saharan Africa, catalyzing more than USD 3 billion of total investment, most of it jointly with Proparco, one of IFC’s closest partners.

Private sector: a source of funds

It is clear that private capital should be a part of the solution for Africa to improve its citizens’ access to power. Private capital could predominantly be directed towards more independent power producers (IPPs) whose role is now well established.

Independent power producers are more efficient. On average thermal power plants operated by state-owned national utilities in Africa rarely exceed 65% availability4 while IPPs often exceed 90% – as private operators have clear incentives, they relentlessly focus on operational performance. Independent power producers also save governments large upfront costs allowing precious resources to be deployed elsewhere – the price tag of a 100 MW heavy fuel oil-fired plant is the same as that of about 50 well-equipped health clinics. They also deliver adequately priced power – the average cost is less than USD 0.05 per kWh5 for thermal plants excluding fuel – and transfer construction and financing risks away from governments.

Yet, over the past three years, only about 10 private power projects were implemented in sub-Saharan Africa, excluding South Africa: less than one IPP per country per decade, with only nine countries out of 48 resorting to IPPs.

What holds private investment in power in Sub-Saharan Africa back?

While many reasons are often cited, we shall remain faithful to the principle of Occam’s razor and postulate just two root causes that hold back private investment in power generation in sub-Saharan Africa, and particularly in IPPs. Firstly, governments seem reluctant to embrace the transformational impact of private investment in power generation; and, secondly, governments fail to ensure adequate cost recovery in and financial sustainability of their power sectors.

Before expanding on these two root causes, we must emphasize that good governance is a key precondition if IPPs are to thrive. By this we mean both governance in general terms – investors value visibility and clear rules – and also governance of the electricity sector. This is a complex sector in which finance, economics and social considerations mix, and for which competent management is an essential if private investment is to be attracted. Independent power producers cannot exist in a vacuum: they need favorable initial conditions.

Governments across the region remain reluctant to fully leverage the private sector’s capital and capabilities for a number of reasons. In some instances, they still consider power generation a strategic sector that should remain in the state’s hands. In some other countries, previous experience has led to negative perceptions of the private sector. Then, at times, governments see retaining public control of the sector as a way of postponing painful reform. And in other cases, governments are tempted by attractive concessional lending rates, grants or export credit terms, and become persuaded that IPPs could, comparatively, increase costs.
Further, a lack of acceptance of the fact that, in essence, power is a commodity and there is nothing really special about it lies behind an unwillingness to charge the true cost of power. It should be remembered that the capital cost of a power plant is roughly the same the world over, while variable costs, mainly the cost of fuel, depend on natural endowment and national availability. It is no cheaper to build a power plant in Africa than in Asia, Europe, Latin America or North America. Rather, the opposite is the case due to factors including a lack of economies of scale and the cost of transport and finance. Thus it follows that, after discounting the differences in natural-resource endowments, the cost of generating a kilowatt hour of electricity in Africa is at least as much as one generated in richer countries.

Pricing to match incomes

Since income levels are not the same everywhere around the world, affordability becomes a concern. In Africa, governments have responded to this by setting low tariffs and as a result, in many countries, the power sector has rapidly become financially unviable, dependent on large government subsidies to continue operating. This story is, sadly, unfolding across the continent: a recent International Monetary Fund (IMF) report on energy subsidies indicates that in sub-Saharan Africa electricity tariffs allow the recovery of only about 70% of costs (IMF, 2013), whereas subsidies to the electricity sector represent on average 2.0% of GDP and 9.0% of total government revenues (IMF, 2013) – by contrast, spending on both health and education sectors in the region totals about 8% of GDP.

This focus on affordability, while legitimate, is too often approached narrowly and the allocation of such large subsidies to power is, simply put, questionable. Indeed, the affordability issue is fraught with misconceptions. It is worth remembering that when end-users lack electricity they resort to much more expensive alternatives such as kerosene at a cost of something in the region of USD 0.75 per kWh for lighting6. Or consider the considerable cost of a lack of power to the economy – that’s why both businesses and private individuals that can afford it have private generators – usually producing power at a cost of more than USD 0.50 per kWh. And the price per kilowatt hour is not as relevant as many believe – yes, a kilowatt hour at USD 0.20 sounds a lot for the average African citizen, but what really matters is the total spend on electricity as a share of income. Because the average OECD citizen uses about 20 times more electricity than the average African citizen while having an income about 20 times higher, as a share of income, the two spend about the same proportion of their income on power. That is the real issue.

Subsidizing power is not good policy for two main reasons. Firstly, such subsidies are inequitable and socially regressive: they overwhelmingly benefit the rich – the IMF reports that the poorest 20% of the population typically only receives 9% of total electricity subsidies (IMF, 2013). And secondly, these subsidies divert scarce budgetary resources from more pro-poor spending – money spent on subsidizing power does not go, for example, to health care or education.

Africa’s power-failure trap

The result of government unwillingness to make people pay the true cost of power drives credible investors away, especially IPPs. Why would they invest hundreds of millions of dollars when the off-taker – the utility or the government to whom power will be sold – does not collect enough from end-users to cover costs, leaving the investor with a significant risk of not being paid?

The central role that utilities play must also be highlighted. The failing power sector across Africa is largely alike: an underperforming utility is, almost without exception, at the heart of the failure, and all too often, alas, it is state-owned. A good utility plays a central role in helping stabilize a power sector, as the examples of Compagnie Ivoirienne d’Electricité (CIE) in the Ivory Coast, Umeme in Uganda, the Kenya Power and Lighting Company (KPLC), and to some extent AES-Sonel in Cameroon demonstrate. The professional management of these companies and their relentless attempts to reduce losses, collect from end-users and advocate financial sustainability have been instrumental in keeping their respective power sectors afloat. It should not come as a surprise that these four countries have also seen significant levels of IPP activity, including a few landmark projects – the Bujagali hydropower project in Uganda, the CIPREL thermal-energy development, the Azito natural-gas plant in the Ivory Coast and the 87 megawatt Thika power plant in Kenya.

The two fundamental factors – a government’s lack of a pro-private sector stance for power generation, and a financially unsustainable electricity sector – often interact to create a power-failure trap, which leads to a deteriorating quality of service, increased costs and the adverse selection of good private investors (Figure 1). And all start with a vulnerable utility.

Figure realized by the authors for Private Sector & Development

The way forward

How can we get out of this trap? Fundamentally, by ensuring cost recovery in the sector: there is no escaping the simple but inconvenient truth that end-users should pay the real cost of power; and by recognizing that power generation is an activity best left to the private sector – just like telecommunications.

Independent power producers, by and large, hold out the best hope of expanding sub-Saharan Africa’s generation capacity cost-efficiently and rapidly. They are the low hanging fruit of public-private partnerships in infrastructure as IPPs are, in relative terms, easy to tender and structure; there is an ample supply of best-practice contractual arrangements that have stood the test of time and are well understood by both investors and financiers; there is no shortage of financing for well-structured IPPs promoted by reputable sponsors; and they (usually) deliver.

All IPPs require is a welcoming host country and the reasonable certainty they will be paid. If these two conditions are met, the private sector will help power Africans – just as private mobile operators have connected them.

Examples from Cameroon, Ivory Coast, Kenya, South Africa and Uganda all illustrate this. The Ivory Coast has attracted more than USD 1 billion of investment in 18 months to increase the country’s generation capacity by 30%. Uganda halved its cost of power and tripled its access to power rate thanks largely to Bujagali and Umeme, the privatized utility. Kenya is massively increasing capacity, both thermal and renewables thanks to a slew of new IPPs – more than five in the past two years – and South Africa leveraged IPPs to rapidly ramp-up its renewable solar and wind capacity through more than 12 IPPs. If countries build the investment fundamentals for IPPs, the investors and financiers, will come. 

Footnotes

¹ The views and judgments contained in this article should not be attributed to, and do not necessarily represent the views of, IFC or its Board of Directors, or the World Bank or its Executive Directors, or the countries they represent
² Excluding South Africa.
³ Authors’ estimate (includes development banks and leading Exim banks)
4 Authors’ estimate (proprietary data). ‘Availability’ refers to the proportion of the time when a power plant is able to generate electricity.
5 Select sample of projects from authors’ data
6 Authors’ estimate on the basis of a liter of kerosene at USD 0.5/liter, 10 kWh/liter of kerosene of calorific content and an efficiency of about 0.1 lumens/watt.

References / IEA, 2011. World Energy Outlook. OECD/IEA, Paris, France. // IMF, 2013. Energy Subsidy Reform: Lessons and Implications. IMF Policy Paper, Washington D.C, March. //
Foster, V., Briceño-Garmendia, C. 2010. Africa’s Infrastructure: A Time for Transformation. A copublication of the Agence Française de Développement and the World Bank, Washington D.C.

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