Africa's electricity crisis: how the private sector can help

Africa is without doubt the world's new growth frontier, yet the electricity crisis faced by many countries on the continent poses a serious risk to its development. The argument for private sector investment in the power generation industry is gaining momentum.

Africa is the latest and most attractive market for businesses both globally and within Africa. Its economic potential is immense and unrealised. It has managed to survive the recession of 2009 and is expected to grow faster than any other region or country (except India or China) in 2012. The favourable outlook is based on modest inflation, steadier exchange rates, a smaller debt burden and untapped market potential. However, the risks of investing in the continent can be extremely high making the returns less attractive.

A serious risk to development is the energy crisis faced by many of the countries on the continent. Approximately two-thirds of sub-Saharan Africa is experiencing an electricity crisis. The drivers seem to be strong economic growth and increased urbanisation. In addition, poor planning for expanding populations, transmission and distribution capacity as well as the maintenance of existing infrastructure is preventing an effective resolution to the power problem.

It is estimated that a US$ 40.8 billion per annum investment is required to effectively respond to the needs of the power sector, yet the resource requirement is greater than the combined capacity of both public and development partners to address. The inability of governments to fund the necessary build programmes has created a potential investment opportunity for the private sector – given the credit crunch and volatility of traditional investment markets based in Europe, America and Asia, the power industry in Africa is slowly emerging as a significant investment option.

The argument for private investment in the power generation industry in Africa is strong and gaining momentum, but there are a number of constraints as well as factors promoting private sector involvement that should be considered.

The private sector has a significant role to play in addressing the power crisis on the continent. The sector's involvement is essential considering the extent to which governments have struggled to address the underlying reasons for the power crisis.

These include the following:

Increased Consumption and Urbanisation

The average rate of urbanisation on the continent now stands at 3.5% p.a. and is fuelling an increased demand for electriticy.

Inadequate and Poorly Maintained Infrastructure

Transmission systems lack sufficient back-up lines and do not function efficiently due to poor maintenance regimes.
Potential energy sources such as river basins are under-utilised with only 20% of the potential hydro power plants being used.
Illegal connections are rampant.
Only 12% of rural households have access to electricity due to their location from existing transmission networks.

Access to Required Funding

African governments have been unable to raise sufficient investment funding. It is estimated that US$ 26.76 billion and US$ 14.08 billion are required for power sector CAPEX and Operations/Maintenance respectively
Power sector spending is only 6.35% of overall GDP in sub-Saharan countries.

Government is aware of the potential for the private sector to provide sustainable solutions and a range of opportunities exist for private sector in this regard:

a) Closing the funding gap for power projects - the private sector is able to access financing from a number of sources to ensure project implementation. The region is a hive of activity for development finance institutions (DFIs), multilateral investment institutions and commercial banks that are becoming more open to lending to private institutions and project developers with bankable projects.

b) Creating a more competitive environment – the focus of private firms to optimise profits and reduce operating costs is essential for the financial viability of power projects.

c) Providing technical and managerial expertise – many private firms have worked in other sectors, countries and contexts and can bring this knowledge to bear in the power sector.

The key issue for many private firms is how to enter the market in view of the fact that privatisation of the power sector is relatively new on the continent. A number of governments have been proactive in anticipating potential investor barriers and have introduced innovative solutions such as the use of Management and Lease Contracts; Concession Agreements; Divestiture from power parastatals as well as IPP (Independent Power Producer) arrangements.

Challenges facing the private sector

There are a number of impediments to private investment in the power market, but those most difficult to overcome are associated with financial, regulatory, capacity and efficiency issues.

Financial

Projects carry significant fixed as well as operating costs making power projects a highly risky and "un-bankable" prospect.
Domestic capital markets are limited and weak i.e. posses low liquidity, resulting in a low approval rate for energy infrastructure loans to the private sector.
Private sector access to alternative international markets is limited since most countries on the continent do not have strong credit ratings. This increases the risk perception of foreign investors and contributes to higher interest rates for project loans.
Innovative financial instruments (such as project bonds) are either not well developed or are unavailable to private investors.

Regulatory

Regulations with regard to the setting, monitoring and enforcing of tariff structures; the quality of service standards; automatic pass-through and adjustment mechanisms; network access as well as entry and exit conditions for participants can be too complicated and dissuade investment.
Many regulatory reforms are often incomplete due to shifting political agendas.
Corrupt and uncompetitive bidding processes exist and tariffs are often set in an inflexible way (i.e. tariffs do not adequately account for the recovery of investor costs).

Capacity and Efficiency

Local institutional stakeholders possess limited skills for managing Private-Public Partnerships resulting in low levels of investor confidence in the market. This relates in particular to the handling of competitive international bids and negotiating and enforcing contracts.
The large number of disparate government bodies/institutions involved in the power sector are not well coordinated leading to internal discord and duplication of functions within these institutions.

A number of African governments have reviewed the limitations on private investment with the view to changing the prevailing market conditions. The impact of these changes in certain countries was positive and provides a best-practice model for other governments attempting to reform their own power markets. The most significant of these government interventions have assisted in the restructuring of major state power enterprise monopolies into competitive entities through vertical and horizontal unbundling; improved performance of national power companies in certain countries and the emergence of privatisation as a power crisis management tool.

Best-practice examples

The power crisis across the continent has motivated a number of countries to reform their power markets in order to encourage private investment. In most cases the reforms have been specific to the needs of individual government or the prevailing socio-economic conditions in that country. Nevertheless, each case presents a good example of how government can lift barriers and thereby encourage private sector investment in the power market.

Financial Reforms

Kenya decided to unbundle its state-owned utility into two separate entities: KenGen (Generation) and KPLC (Transmission & Distribution) with the intention to disinvest part of its ownership in the parastatal. In order to ensure that disinvestment would lead to a financially stable KenGen, the government offered 659 million KenGen shares to the public. This constituted 30% of the existing ordinary share capital of the company. The share offer was a success leading to the effective privatisation of the parastatal. The transition was marked by a number of critical success factors, leveraged by the government:

The Kenyan government was clear about the need to develop KenGen on a commercial basis.
KenGen was profitable for at least 3 years prior to the IPO and sale of its shares.
Most of the proceeds from the sale were reinvested into the sector raising investor confidence.
Policies were coherent and consistent and tariffs were set at a level to cover KenGen's costs.

Tanzania set itself a target to increase rural access to electricity through the use of private capital, but without any subsidies. The use of subsidies is a common practice employed by poor countries trying to incentivise private investment in capital intensive infrastructure projects, so the decision to operate without subsidies was brave considering that only 17% of the entire population and 6% of the rural population had access to electricity.

This problem was addressed by creating opportunities for SPP (Small Power Producers). The latter were defined as plants using a renewable energy source, waste or co-generating heat and electricity with a capacity less than 10MW. In support of SPPs the government established light regulation and promoted standardised IPP arrangements. These interventions had a two-fold impact: they simplified the project development process for private investors and strengthened the business case for power generation projects in rural areas.

The critical success factors in this exercise are instructive:

An institutional and regulatory framework was established for the supply of a viable power service in rural areas based on renewables.
The project was designed to be flexible in its implementation procedures and allowed initiatives from alternative players such as NGOs.

Capacity and Efficiency Interventions

Egypt sought to achieve the lowest cost per kWh to increase affordability of electricity through greater private involvement in the power sector. The government was highly committed to making market conditions fair to all participants. It introduced competitive bidding for IPPs and incentivised foreign investment through ‘take-pay' agreements, guarantees and international arbitrage terms. In addition, it set-up a joint venture between a local and international engineering company to ensure increased local involvement in power plant construction and purchases.

Crucial to the success of this intervention was the positive management of the process by the government:

It created a business climate that was positively perceived by all stakeholders.
Put in place a strong technical and negotiating capacity among local managers that was critical in dealing effectively with IPPs and public lenders.
It established a local engineering firm to strengthen the local components industry and this was invaluable in ensuring local participation in the power market's reorganisation.

Regulatory Reforms

This is probably the most onerous one for governments wishing to shift market conditions. It is complicated and the long-term implications are often shaped by changing political and socio-economic conditions that not easy to predict.

Algeria embarked on a long process to ensure institutional reform of its energy sector. Anticipating many institutional and external barriers to change, the government here pursued competitive free market mechanisms and developed a legislative and regulatory framework based on an existing European Union model. It also ensured implementation was completed in a gradual and continuous process to allow stakeholders time to address changes.

The important lessons from the Algerian experience are instructive for other governments faced with the same obstacles:

Institutional players must remain focused on the project objectives even in the face of cyclical constraint changes.
Competitive conditions must be created in all or part of the activities in generation, transmission and distribution related to the energy sector.
Understand that it might be a long process to obtain the willing participation of relevant stakeholders as well as to ensure the regulations are complete and suited to the prevailing environment.

The initial step however for any government seeking to reform the power sector and attract private sector participants, is the unbundling of state-owned assets.

Uganda needed to ensure the successful unbundling of its state-owned utility and establish an attractive tariff structure to attract private sector funding for its new build programme. Consequently, the government created a legal framework for the unbundling of its Utility with the Electricity Act and created an Electricity Regulatory Agency. It effectively used multi-year tariffs with adjustment clauses for inflation and changes in costs to draw investor interest and established a differentiated tariff structure for generation, transmission, distribution, isolated grid and feed-in conditions. This strengthened the business case for private participation in the local power sector.

The effective unbundling of state-controlled assets is not the only challenge facing governments involved in power sector reform. The protection of the public interest can be a crucial barrier to privatisation. The decision to encourage private ownership is complex because affordability of electricity usage must be balanced against the capital and long-term maintenance cost of new power generation, transmission and distribution infrastructure.

Conclusion

Africa needs to grow its electricity supply if it is to realise its potential as the world's next growth frontier. However, in order to achieve this, governments must be proactive in lifting potential barriers to private investor involvement in the power market. The rule book, or at least part of it, will have to be rewritten if any meaningful or large scale private sector involvement is to be realised. Some of the best pointers can be gleaned from those African governments that have already grappled with public-private partnerships while the best practice initiatives adopted by others can help close the supply gap and improve services in the energy sector. However, the bottomline is that for the private sector to become part of the Africa energy solution, governments will have to make it easier, safer and more financially attractive for private players and this will have to become a key part of their institutional strategy going forward.

REFERENCES

Muzenda, D. (2009). Increasing Private Investment in African Energy Infrastructure. NEPAD-OECD Africa Investment Initiative.

Economist Intelligence Unit (2012). Africa: Open for Business – The Potential, Challenges and Risks. The Economist.

Pauly, B. et. al. (2009). Best Practices - Power Sector Reform in Africa. Union of Producers, Transporters and Distributors of Electric Power in Africa

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