President Uhuru Kenyatta recently appointed a 15-member task force to comprehensively review all power purchase agreements that different producers have with Kenya power, with a view to realising value for money to the public in the form of reduced tariff. One critical aspect up for review is the take-or-pay approach.
Notably, take-or-pay clauses have dominated power purchase agreements in the electricity generation sector for the longest time in Kenya. A power purchase agreement (PPA) is both a legal and a commercial document between a power producer as seller and the wholesale electricity buyer or off-taker.
Therefore, a PPA is at the heart of any power generation project . An essential component of a PPA is the pricing, which ensures cash flow projections, allows forecast of revenues over project’s lifetime and hence determine the viability and profitability position.
As such, the economics of the project inherently revolves around the terms and conditions of the PPA, which go way beyond the mere purchase and sale of energy.
A shift towards the pay-when-taken approach will look unattractive to prospective lenders, and investors in the electricity generation sector, potentially hindering the promotion of future energy and infrastructure projects.
INVESTOR APPETITE
Take-or-pay clauses serve as the type of commercial guarantee, without which investors and funding bodies would be reluctant to finance energy infrastructure projects and thus reduce the ever growing investor appetite that is evident in the country.
Merchant power plants, which sell power into a competitive wholesale market and are financed by investors under the pay-when-taken regime, are exposed to a different kind of risks both in terms of the volume of electricity they sell, referred as demand, and the price of that electricity at a given point in time.
This is in contrast with rate-based financed power plants under take-or-pay approach. However, take-or-pay clauses are not always commercially viable when the position of the purchaser or off-taker is considered, as the purchaser such as Kenya power is required to pay for electricity that it does not intend to use without any option. Take, for instance, the period ended June 2020.
Kenya power paid Sh82 billion in non-fuel cost — which is basically power purchase cost — to different electricity producers. This further retrogrades when demand uptake fails to match the electricity supply. Not to mention the Knock-on effects on consumer price of electricity.
Historically, pricing has been at flat-rate or in a more desirable term, power plants under the current power purchase arrangements are rate-based financed, which are paid off through utility bills over a long time. Such an approach is aimed at cost recovery, not efficient pricing. There is need to begin to look at market reform that reflects real-time pricing.
An interesting trend is emerging in the sector, especially with the advent of renewable energy. Countries are embracing the pay-when-taken approach.
HIGH FIXED COST
The rationale for the shift is to reduce the high fixed cost associated with the contractual obligation that a utility company has to power producers, which has been portrayed by some as a reward to investors in electricity generation while neglecting value for money to the public in the form of reduced tariff.
The task force must therefore navigate through some complex decision-making process in trying to strike a balance between that which will bring about value for money to the general population as well as guaranteeing what certainty that comes along with investor confidence in the electricity generation market.
PAY-WHEN-TAKEN
Ghana is the only country in Africa at the stage of implementing the pay-when-taken approach in power purchase agreements, while South Africa is considering adopting it. Kenya and South Africa should follow Ghana’s lead.
The Ghanaian government cited perennial financial challenges that has affected utility companies as having informed the regime change. It is imperative that African economies rethink power contractual arrangements that are critical to midwifing their development agenda.
Njoroge is an energy economist & director of policy and research at The Africa Utility Forum
PAYE Tax Calculator
Note: The results are not exact but very close to the actual.
