The de-escalation, by the current Government, of the power tariff reductions that were effected in January 2022, while extremely unpopular, could be positive for future private sector investments in the energy sector.
Private sector investments in the energy sector are underpinned by Power Purchase Agreements (PPAs), which, by definition, are the primary contract between an "offtaker" (often a state-owned electricity utility, in jurisdictions where the power sector is largely state operated such as Kenya) and a privately-owned power producer.
In PPAs, the wholesale offtake tariffs are typically set with a view of long-term revenue generation and most PPAs are for around 20 years.
Essentially, investors in energy projects peg their investment decisions on projected cash flows and hurdle rate returns over the life of the contract.
And given that the tariffs are determined based on the prescribed feed-in tariff by the Kenyan Government or through open and transparent procurement processes, the 2022 tariff reductions proved to be a hard sell to existing PPAs.
In Kenya today, power generation is dominated by two entities, (i) the State-owned Kenya Electricity Generating Company (KenGen); and (ii) independent power producers (IPPs).
State-owned Kenya Power, the sole distributor of electricity in the country, is the only off-taker of power. In 2021, KenGen supplied 70 percent of electricity to the national grid while the 21 active IPPs accounted for the balance.
Additionally, KenGen’s supply tariffs to Kenya Power are much lower than the IPPs. In 2021, Kenya Power’s off-take tariff from KenGen was Sh4,872.9 ($44) per Gigawatt hour (GWh); while from IPPs was Sh13, 122.3 ($119) per GWh.
This difference in off-take tariffs is due to a number of factors, key among them being: (i) KenGen, being State-owned, enjoys a concessionary financing mechanism; (ii) KenGen’s power plants are mainly focused on renewable sources of energy and hence lower generation costs; and (iii) Most of KenGen’s power generation asset, especially hydro-generation assets, have been fully paid down and are thus able to charge lower tariffs.
The tariff reductions meant ongoing/incomplete negotiations with IPPs whose projects had already been procured under the Feed-in Tariff Policy were to be cancelled, which was negative for the sector.
According to a Presidential task force report on the review of PPAs at risk of cancellation were a total of 92 projects capable of generating 2,345.07MW (the equivalent of 58 percent of current installed capacity) that were unsigned as of March 2021.
Out of the 92 projects, 58 were awaiting PPA renegotiation while 28 projects were under negotiation with no commitment.
The cancellation of these projects would have bent an otherwise policy straight line that has been a strong magnet for investments in the sector since the early 2000s.
The tariff revisions were also negative for Kenya Power. Based on Kenya Power sales figures of Sh125.9 billion in 2021, a 15 percent reduction in the cost of power is equivalent to approximately Sh18.8 billion.
This coupled with a further 15 percent reduction in the first quarter of 2022 could widen the utility’s fiscal hole. Further, the take-or-pay arrangements also exacerbate Kenya Power’s situation.
Under these purchase agreements, a power producer gets paid for any electricity produced, even if Kenya Power is unable to sell it to consumers (especially during overproduction).
In summary, Kenya still needs IPPs. They are essential in any Government’s electrification agenda and they help to improve the energy mix and provide diversification on the utilisation of different sources of energy like geothermal, solar and wind among others in different locations.
The public sector alone cannot fill the large funding gap that holds back investments in new power projects.
Private participation is needed and as such the current de-escalation will be positive.