Working With Cost Reflective Tariffs-The Kenyan Experience Dr. Frederick Nyang Director, Economic Regulation Energy Regulatory Commission Kenya
INTRODUCTION Energy Regulatory Commission is a single sector regulatory agency, with responsibility for economic and technical regulation of power, renewable energy, and downstream petroleum sub-sectors, including tariff setting and review, licensing, enforcement, dispute settlement and approval of power purchase and network service contracts. The retail tariffs in Kenya are designed to satisfy three policy objectives namely; the economic objective, financial objective and the social objective. East African Power Industry Convention 2010, Nairobi, Kenya
LEGAL FRAMEWORK Sessional Paper No.4 of 2004 on Energyprovides that energy pricing in Kenya is determined by the market mechanism and the cost of supply. The Energy Act of 2006 requires the regulator to ensure that the rates and tariffs established in electricity sale contracts, transmission and distribution are just and reasonable. Of which a just and reasonable tariff means a rate that enables a licensee to: maintain its financial integrity, attract capital, operate efficiently, and fully compensate the investor for the risks assumed. East African Power Industry Convention 2010, Nairobi, Kenya
INDUSTRY INSTITUTIONS & STRUCTURE The Ministry of Energy (MoE) leads the Government s policy-making in the electricity sector. The Government established the Geothermal Development Company (GDC) in 2008 to take primary responsibility for the exploration and development of geothermal resources. The Rural Electrification Authority (REA) was established under the Energy Act, 2006 to implement the Rural Electrification Program. The REA is responsible for planning rural electrification according to guidelines provided by the Ministry of Energy, and manages the Rural Electrification Program Fund for these objectives. East African Power Industry Convention 2010, Nairobi, Kenya
TRANSMISSION & DISTRIBUTION Kenya Power & Lighting Company Ltd (KPLC) Its core business is transmission, distribution and retail of electricity purchased in bulk from licensed operators. These operators include; Kenya Electricity Generating Company (KENGEN), Independent Power Producers (IPPs), Uganda Electricity Transmission Company (UETC) and Tanzania Electric Supply Company (TANESCO) Ltd. Kenya Electricity Transmission Company Limited (KETRACO) KETRACO, a wholly Government owned state corporation was established in late 2008 to plan, finance, build and manage new transmission assets. Existing transmission assets will remain with KPLC. East African Power Industry Convention 2010, Nairobi, Kenya
GENERATION Kenya Electricity Generating Company Ltd (KenGen) KenGen is the largest electricity generator in Kenya producing about 75% of the electricity supplied to KPLC. KenGen s main sources for electricity generation include hydro, geothermal, petro-thermal and wind. Independent Power Producers (IPPs) Five independent power producers (IPPs) Iberafrica (thermal), OrPower4 (geothermal), Tsavo (thermal), Mumias (bagasse) and Rabai (thermal) account for about 25% of installed capacity as at 30 th June 2009. East African Power Industry Convention 2010, Nairobi, Kenya
Figure 1: Institutional Framework of Kenya s Electricity Sub-Sector Ministry of Energy Policy & Planning Licensing & Regulation Rural Electrification Planning & Construction ERC REA GDC Geothermal Exploration Development Electricity Generation Electricity Transmission & Distribution KenGen Power Purchase Agreements KPLC KETRACO IPPs CUSTOMERS East African Power Industry Convention 2010, Nairobi, Kenya
RETAIL TARIFF REGULATION Current retail tariffs (KPLC tariffs) have been in place since July 2008. The detailed mechanisms were drawn up following a (World Bank-financed) tariff study (Fichtner Study) A key feature is the automatic pass-through on a monthly basis, of generation related fuel costs, as well as of adjustments for exchange rate depreciation. In addition, adjustments for inflation take place every six months. The annual tariff revision also takes into account the target for annual system losses. KPLC has a strong incentive to improve its performance between tariff reviews. East African Power Industry Convention 2010, Nairobi, Kenya
RETAIL TARIFF REGULATION Any cost reduction or increase in sales will directly improve KPLC s operating income. At the same time, the tariff mechanisms adequately protect the company from most of the major risks it cannot control (variation in the cost of generation and exchange rate). The current tariff mechanisms have worked well. They have effectively protected KPLC s financial viability in a context of stress (drought, high oil prices) They have also created adequate incentives for the company to reduce its own costs and enhance its commercial performance East African Power Industry Convention 2010, Nairobi, Kenya
RETAIL TARIFF REGULATION It is also in KPLC s interest to source bulk power supply efficiently (in terms of cost and availability). The periodicity of tariff reviews (every three years) is considered optimum given the characteristics of the Kenyan power sector. The five-year periodicity for tariff reviews which is practiced in many developed countries would be excessive. This is because the utility is undertaking significant investments, expanding its customer base at a rapid rate, and operating in a less predictable environment than mature distribution utilities in industrialized countries East African Power Industry Convention 2010, Nairobi, Kenya.
RETAIL TARIFF REGULATION The next tariff revision is scheduled to take effect in July 2011. ERC will conduct a cost of service study in order to re-examine the tariff structures. Retail Tariffs are set to recover costs and there is a special feed-in-tariff to promote renewable energy generation. A Feed in Tariff is an instrument for promoting generation of electricity from renewable energy source (RES). A Feed in Tariff (FiT) allows power producers to sell and obligates the distributors to buy on a priority basis all renewable energy sources generated electricity (RES-E) at a pre-determined fixed tariff for a given period of time.
RETAIL TARIFF REGULATION FiT objectives are to:- (a) Facilitate resource mobilization by providing investment security and market stability for investors in Renewable Energy Sources (RES) electricity generation. (b) Reduce transaction and administrative costs by eliminating the conventional bidding processes. (c)encourage private investors to operate the power plant prudently and efficiently so as to maximize its returns. The Feed in Tariffs include interconnection coststransmission, substations and associated equipment
KENGEN & IPP TARIFF REGULATION Long-term Power Purchase Agreements (PPAs) with KPLC determine the company s prices. The PPAs for KenGen related to existing generation assets were signed and approved by ERC in June 2009. Under the earlier pricing structure, KenGen remuneration was entirely based on the volume of energy generated. Under the new PPAs, KenGen remuneration has three main components: the capital recovery charge (CRC), the fixed operation and maintenance charge (FOMCR), and the variable operation and maintenance charge (VOMCR).
KENGEN & IPP TARIFF REGULATION KenGen is entitled to receive the first two components in full as long as it meets the contractual target for generating plant availability. Only the VOMCR component is based on the volume of power generated. In addition, for thermal generation plants, fuel costs are automatically passed through. This pricing structure reflects KenGen s underlying costs. It is similar to the pricing formulas of PPAs with Independent Power Producers (IPPs).
KENGEN & IPP TARIFF REGULATION The structure provides incentives for KenGen to maximize the availability of its generation plants and reduce operating costs. This structure, remunerates KenGen on a plant by plant basis. It is also consistent with the fact that KenGen does not determine dispatch of its generation plants. KPLC is responsible for generation dispatching. The term of each PPA is variable and depends on the generation technology as well as the age of the plants concerned.
ELECTRICITY SECTOR REFORMS The Government established its long-term vision and policy framework for the sector in the late 1990s and early 2000s. This culminated in the 2004 Energy Policy and the 2006 Energy Act. These two milestones in sector development have established an effective framework for enabling the commercial viability of electricity companies and have opened the door for competition in the electricity market. These major reforms in the electricity sector have established an efficient, transparent, institutional framework to manage the program.
ELECTRICITY SECTOR REFORMS The guiding principle of the government s strategy for expanding infrastructure in the electricity sector is to: promote equitable access to quality energy services at least cost while protecting the environment. The strategy has three elements: a) an increase in electricity generation capacity to eliminate supply shortages; b) the expansion and upgrading of the transmission and distribution networks to enhance the quality and reliability of supply to customers; and c) the extension of affordable household electricity access, with particular attention to reducing regional imbalances in the country.
ELECTRICITY SECTOR REFORMS The reform program already has resulted in major operational improvements: The annual rate of new electricity connections increased from 43,000 per year in 2003/2004 to around 200,000 in 2008/2009. Kenya now has five Independent Power Producers (IPPs) that account for about 25% of installed capacity. Losses in the power system declined from 18.8% in 2003/2004 to 16.3% in 2008/2009.
CONCLUSION The independent Energy Regulatory Commission (ERC), has been very instrumental in ensuring that the three policy objectives have been met. The secret to maintaining Cost Reflective Tariffs is proper institutional framework, independent and transparent regulation and a dedicated workforce. The cost reflective electricity tariffs that are in place convey the right signals for efficient resource use by consumers and utilities.