Measuring IPPs' tariffs to KenGen is to compare oranges to apples

Published on The Star Newspaper

29th November 2021

There have been multiple recent reports in the media and in KPLC financial reports, as audited by the Auditor General, about the discrepancy in power costs charged by power generators in Kenya.

The claim has been that the payments to Independent Power Producers(IPPs) have been disproportionately high compared to payments made to KenGen.

The often-quoted statistic is that KenGen is paid on average Sh5.3 per unit of electricity sold, while IPPs were on average paid Sh15.3 and the contradiction that IPPs account for 47 per cent of procurement costs and 25 per cent of energy sold, while KenGen accounts for 48 per cent of cost but 72 per cent of energy sold.

At face value, one can question the fairness of tariffs being charged by IPPs.

However, what we must ask is why are the prices different? The figures as analysed and presented do not scratch the surface in this regard but appear to paint a narrative seeking to portray IPPs as ripping off KPLC and ultimately the consumer.

What is not being said is that the majority of KenGen’s fleet of generation plants have fully recovered their costs, thus the comparison being made is not of similar plants in terms of age.

At least 60 per cent of KenGen generation plants were built pre-2000 representing 831MW of their 1,400MW installed capacity.

These plants were either built through concessional and public funds or entirely granted as in the case of the first phase of the Ngong Windfarm, and transferred to KenGen at its formation at no cost.

Why is the age of a plant significant? For power projects, the investment costs and returns for funders are recovered over 20 years in a regular power purchase agreement (PPA) with Kenya Power.

The tariff charged by power projects must ensure that the project can cover both operational and finance costs.

The old KenGen plants, have fully recovered their investment costs more than 20 years ago and therefore should have a tariff that only needs to cover the operating costs of the plant and any improvements. This implies a low tariff.

To compare such plants to IPPs whose operating plants are all less than 20 years old, and therefore still have capital costs to return to funders, is to compare apples to oranges.

IPP projects represent a private investment made in the last 20 years using commercial funds and thus are still recovering capital costs and earning funders a return on their investment in exchange for the risk that they took.

Since the year 2000, IPPs have contributed 688.5 MW in new investments in addition to KenGen’s 570 MW. The second reason why KenGen tariffs appear to be low is access to cheaper financing.

KenGen, as a majority public sector institution, is able to access much cheaper financing on-lent by the government. KenGen’s cost of capital is significantly lower than that of the IPPs.

According to KenGen’s 2020 financial statements, the weighted average interest rate of the company’s Sh145 billion debt was two per cent.

The borrowing cost from Independent Power Plants (IPP) is more comparable to KenGen’s direct borrowing at 7.5 per cent.

Some of these loans have a grace period of ten years and repayment periods of up to 30 years compared to one year and 15 years for IPPs, and so naturally the tariffs of IPPs will be higher due to a higher cost of financing.

This fact is also well corroborated in the PPA Taskforce report. The cheaper financing for KenGen may reduce the cost of the power sold but adds to the overall debt of the state.

This is not the case with IPPs which do not benefit from sovereign-backed loans. Given the strong pressure on Kenya’s sovereign debt and the need for public funding in numerous sectors, it is not sustainable for Kenya to keep dedicating large volumes of its debt capacity to future power generation when competitive private alternatives are available through IPPs and PPPs.

The third reason why KenGen has lower tariffs is the shorter development process that KenGen goes through compared to IPPs.

KenGen projects take on average 2-3 years from conception to start of construction as compared to an IPP average of 6-8 years.

KenGen, for example, accesses land and licenses much more easily than private-sector entities due to state backing and often operates outside of dates of commissioning as foreseen by Kenya Power.

A good example of this is noted in the PPA Taskforce report, where KenGen is alleged to have built two power plants without a signed PPA, and that these PPAs were then signed after the plants were completed.

The normal process followed by IPPs involves negotiating a PPA with KPLC and receiving approval from EPRA, well before any financing is raised or construction commences.

This process, in addition to the licensing and permitting process, can take over eight years for IPPs which has a serious implication on the costs of these projects and therefore the tariffs required to recover these costs once the projects are operational.

IPPs concur with the Taskforce’s recommendation that all projects must adhere to one process regardless of the origin, otherwise planning becomes further complicated and competition, which should ultimately lead to lower prices for consumers becomes a mirage.

Fourth is that IPPs have a defined 20-year lifespan during which they must recover their investment and make a return.

On the other hand, KenGen in most of its plants is not limited by time in their operations and can, therefore, spread the recovery of their investments over a much longer period than the IPPs allowing the generator to achieve lower tariffs.

Finally, KenGen plants are allowed to supply more energy as per the economic merit order and are used more as baseload plants, while a significant percentage of the IPP plants are used to supply power during the peak demand periods thus running for shorter periods, supplying less energy.

Peaking plants the world over are more expensive than baseload plants, therefore, adding to the average IPP cost per unit of energy. With the above reasons in mind, and the decision to take even less energy from thermal plants in the energy mix, it then explains the widely referred to the contradiction that IPPs account for 47 per cent of KPLC procurement costs and 25 per cent of energy sold, while KenGen accounts for 48 per cent of the cost but 72 per cent of energy sold.

The more accurate way to compare is to compare the tariff of new KenGen plants (post-2000) to those of IPPs of similar age and technology.

Of the plants-built post-2000, KenGen geothermal plants are reported in the Taskforce report to have an average tariff of USc 8.5 per unit (including Olkaria 1 units from 1985) and their Wind plant has a tariff of USc 8.6.

From the report, the tariffs for IPP plants are USc 9.6 for geothermal and USc 11.4 for wind.

This clearly shows that the tariffs for IPPs and KenGen are comparable, particularly once you consider KenGen raises, on average, financing that is threefold cheaper than the private sector.

KenGen thermal plants (Kipevu I & III) also have comparable variable costs to the IPP thermal plants only having efficiency related to the costs of moving fuel through the pipeline as opposed to trucks for IPPs.

Without a doubt today KenGen plays the main role in the supply of electricity in Kenya and has continued to successfully build and run powerplants.

We should all applaud these efforts as a nation. The company will continue to be a key pillar of the energy sector in Kenya as envisioned in its good-to-great transformation plan.

Directly comparing tariffs with IPPs without considering the different playbooks that the two parties operate from is however a misrepresentation of facts.

To bring us back to why there is a complaint, the tariff costs for IPPs have been on the decline over the last 20 years, while the consumer tariff has been heading upwards.

Today, the average generation cost on the grid including KenGen and IPPs is approximately Sh9 per unit. The Taskforce report notes this as being 0.084 USD in 2018 and 2019, and 0.079USD in 2020.

Adding adjustments with some relation to generation of approximately Sh2 per unit brings us to Sh 11 per unit.

The question we should be asking is why is the effective domestic consumer tariff Sh25 per unit and the lowest commercial tariff Sh17?