New policy promises even higher power bills

The government has signed off a new energy policy that allows power producers to pass on to consumers all losses arising from their foreign currency-denominated transactions in a move that promises to add impetus to the recent escalation in electricity bills countrywide.

The new billing formula ticked off by the energy sector regulator in July last year plugs every electricity consumer’s costs to the turbulent world of currency markets where the shilling has ceded a lot of ground in the past 24 months.

Under the deal, electricity generating companies have a set exchange rate and are allowed to pass on to consumers any losses arising from a weakening of the Kenya shilling beyond the point.

That exchange rate threshold is currently set at Sh64 to the US dollar for the next three years and with the shilling priced at Sh76.04 to the dollar, Kenyan consumers are taking in a whopping Sh11.12 in exchange rate losses passed on by the power producers.

Manufacturers say the policy that came into effect mid last year has further eroded the country’s competitiveness as a regional manufacturing hub and may reverse the recent gains made in connecting the rural population to the national grid.

The deal — a major win for power companies — means that consumers stand exposed to huge volatility in their power bills especially in times of major economic downturns or political upheavals such the January 2008 electoral dispute when the exchange rate plummeted from a high of Sh80 to the dollar from Sh64 in just a couple of months.

The Energy Regulatory Commission (ERC) has in the past allowed power companies to recover from consumers currency exchange losses based on fluctuations of the Kenya shilling to the dollar in any given year but the new formula allows them to recover foreign exchange losses arising from transactions done in all other foreign currencies including the Japanese Yen and the Euro.

ERC fixed—for the next three years — the applicable Kenya shilling exchange rate to the dollar at Sh64.92, Sh130.07 for the Sterling pound, Sh100.79 for the Euro and Sh64.04 for the Japanese Yen.

The immediate effect of this change that was magnified by a larger than usual purchase of diesel-powered electricity generation equipment last year has been an almost threefold increase in the foreign exchange adjustment (FERFA) charge on consumers’ power bills since July 2008 when the new formula came into effect.

It also explains why the recent surge in power bills overshot ERC’s conservative estimates by wide margins.

The ERC had promised electricity consumers that power bills would increase by just about 24 per cent when the new tariffs came into effect only for consumers to see a near doubling of their bills in 18 months.

Last year, the Kenya Power and Lighting Company (KPLC) passed on to consumers foreign exchange losses of Sh2.3 billion, up from Sh568 million in 2008.

The money was shared by KPLC, KenGen and other smaller power generating companies that produce about one fifth of the country’s total electricity demand.

KenGen, Kenya’s biggest power producer, reported that foreign exchange losses shot up by 278.6 per cent last year to Sh5.3 billion from Sh1.4 billion in 2008.

A fraction of this loss - which was unrealised as at the end of the year - will however remain in the firm’s reserve account to be passed on to consumers in future.

Eddy Njoroge,the KenGen managing director, confirmed that the company will in future pass on to consumers all foreign exchange losses from its operations.

The losses arise from all commercial transactions, including asset valuations and borrowings that are done in currencies other than the Kenya shilling.

“The amount passed on each year will depend on the exchange rate volatility fluctuation above or below the ERC approved rates, which again is a function of the performance of the economy,” said Mr Njoroge.

A survey by consultancy firm PricewaterhouseCoopers (PwC) released last week found that most Kenyan chief executives see escalating cost of energy as the biggest threat to their businesses this year.

Chief executives of manufacturing companies said the cost of electricity has risen by nearly 60 per cent since March last year (and this after the July 2008 tariff review), as the intake of the more costly diesel powered electricity also took its toll on production costs.

“From our survey about 52 per cent of 178 CEOs in East Africa told us that they are concerned that high cost of power was going to affect their businesses,” said the PwC Kenya senior country partner Kuria Muchiru during release of the survey.

Consumers connected to the national power grid are as a result already paying for the exchange rate differential above the now gazetted exchange rates, which are reflected in the bills sent by Kenya Power and Lighting Company (KPLC) as pass-through costs.

The bulk of commercial transactions and loans held by Kenya’s main power generating firm KenGen and transmission company KPLC are denominated in dollars and Japanese Yen, making power bills highly sensitive to the exchange rates of the two currencies to the shilling.

KenGen for example has total long-term loans of Sh27.2 billion in its books, 73.5 per cent of which are denominated in Japanese Yen, while the rest are in euros and dollars.

The power generator’s books show that last year the Kenya shilling depreciated by about 32 per cent to the Japanese Yen, 19 per cent to the dollar and about seven per cent to the euro.

Power consumers will however have to brace for even further escalation in currency fluctuation costs as numerous power generation projects that are lined up over the next five years will have to be financed in foreign currencies, increasing the country’s exposure to exchange rate fluctuation charges.

A ministry of energy power generation financing plan published last year shows planned power generation projects in the next five years will require a total investment outlay of about Sh114 billion ($1.5 billion) and only about Sh57.7 billion ($759 million) can be raised locally.

“The reality is that we either source for the funding externally which will increase our foreign exchange loss exposure or we fail to invest in new generation capacity which will effectively hold back all our economic development plans,” said Mr Njoroge.

But analysts reckon that Kenya’s high energy costs are also the result of inefficiencies associated with the monopolistic generation and distribution companies KenGen and KPLC respectively.

The international best practice is for companies that face high foreign exchange fluctuation exposures to take to take up forward currency hedge contracts, but neither KenGen nor KPLC have such safeguards in place.

Sudath Perera, the general manager of apparel manufacturer Alltex EPZ says Kenya’s relatively high production costs which are mainly driven by energy costs have made locally manufactured goods less competitive when compared to peer countries such as Bangladesh, Egypt, India, Indonesia, Madagascar and Sri Lanka.

Mr Perera says though pass through costs and thermal generation are common features in these peer countries, the fraction of operating costs passed on to Kenya’s consumers appear to be much higher.

“Unfortunately KenGen and KPLC are both monopolies and that is why it is easy for them to pass on all costs to consumers,” said Mr Perera.

Mr Njoroge however reckons that by locking the exchange at a particular level, KenGen hedges its foreign exchange rate exposure on the overall economic performance.

Some forward currency contracts also require that companies taking them must have a substantial fraction of their income in the hedged currency.

“It would probably have been even much more expensive to take out a hedge with a private company,” says Mr Njoroge.