CHALLENGES IN THE DEVELOPMENT OF GEOTHERMAL POWER TO MEET INDUSTRIALISATION NEEDS OF KENYA Henry K. Ogoye Kenya Electricity Generating Company Limited, Stima Plaza, Phase, P.O. Box 47936, Nairobi E-mail hogoye@kengen.co.ke ABSTRACT Kenya targets industrialisation status by the year 2020. Adequate, reliable, affordable and environmentally friendly electric power is a critical input in meeting the Government goal. Geothermal power can provide the requisite input. Its development, however, faces many challenges. They include funding resource preparation and plant construction, determining the optimal plant size to secure economies of scale gains, competition from relatively cheaper alternative sources of energy such as oil and gas, long development period leading to high development costs, scarcity of long term concessional funds and absence of cost effective appropriate technology and equipment in drilling for enhanced success rate in harvesting the resource. Other challenges include contract assembly to minimise administration expenses, skill deficiency in certain tasks, unstable macroeconomic environment that weakens the need for capacity expansion and placement of logistical issues of Geothermal Resource Assessment (GRA) in the new industry order. This paper highlights these challenges and proposes possible solutions. Some of the recommended solutions are mutually reinforcing while others are mutually exclusive with the objective of affordable tariff. GRA is found to be the most critical. Key Words: Challenges, Geothermal Power, Industrialisation, Kenya 1. INTRODUCTION The current installed capacity of power in Kenya is about 1157 MW with KenGen and IPPs accounting for 80% and 20% respectively (Ogoye, 2002). KenGen s generation mix is made up of Hydro (72%), Geothermal (5%) and Thermal (23%). Similarly, the IPP s mix is in the order of Hydro (14%), Geothermal (5%) and Thermal (81%). The annual increment in the demand for power is estimated to be about 6.5%. Meeting this demand growth requires least cost capacity expansion to make the final product affordable. Developing geothermal power is one of the ways of meeting this goal. The focus on geothermal power is driven by diversification needs besides concerns to expand the least cost base load mode of power generation. Geothermal resource in Kenya is found in Olkaria near Lake Naivasha, approximately 100km northwest of Nairobi and other locations in the Rift Valley. The key activities in the development of geothermal power involve GRA to confirm the resource and its quantity and the appropriate plant size to develop. 1.1 Geothermal Resource Assessment (GRA) Geothermal Resource Assessment (GRA) encompasses resource investigation, site development, exploration drilling and appraisal drilling. Resource investigation involves selecting prospects for detailed surface studies and may cost about US$ 365,080 per prospect. Site development prepares the selected area for exploration drilling to secure key scientific information for steam production. A minimum of three exploration wells are drilled each to a minimum depth of 2200m. Each exploration well may cost about US$1.2 million. Testing each well to determine its capacity may cost about US$40,000. Six appraisal wells are drilled and tested to confirm the resource and its size for purposes of determining suitable power plant type, size, attendant costs and requisite production wells. Each well costs about US$1.24 million to drill and test. GRA is meant to confirm availability of adequate quality steam to sustain a power plant at its rated capacity over the design life, usually 25 years. Completion may take about three to four years or less subject to availability of funds. A pre-feasibility study may be undertaken, at a cost of about US$120,000, to simulate certain parameters of interest. Environmental Impact Assessment is also necessary to evaluate the environmental effects of the development and how to mitigate against them. EIA may cost about US$ 60,000. 1.2 Construction of Power Plant Once the GRA gives a favourable report on the resource availability, adequacy and quality, construction of the power plant may commence. Production drilling is necessary here to prepare enough wells to meet the capacity of the power plant and some extra reserves in the range 8% - 15% above the station capacity. Each well may cost about US$ 1.4 million. Other major activities include design, construction of the plant and steam gathering system and interconnecting transmission line. 174
Developing a geothermal power plant in Kenya may cost about US$ 150 million. 1.3 Status of Geothermal Power Development to date The first geothermal unit at Olkaria commenced operation in July 1981 with a net installed capacity of 15 MW. Two more 15 MW units were added in 1983 and 1985 raising the total capacity to 45 MW. Up to March 2003 the plant has generated 6939 million units at load factor of 98%, utilisation factor of 101% and availability factor of 96%. KenGen is adding a 64 MW unit (Olkaria II) while Orpower4, an IPP is putting up a 48 MW plant (Olkaria III), 12 MW of which are already fed to the national grid. Olkaria II and the remaining unit of Olkaria III are expected to be operational by October 2003 and 2006 respectively. To date, 86 wells have been drilled at a cost of about US$ 100 million. United Nations Development Program co-funded GRA with the Kenya Government to support the operations of Olkaria I. International Bank for Reconstruction and Development (IBRD), European Investment Bank (EIB), Commonwealth Development Corporation (CDC) and KenGen have funded the appraisal drilling in the geothermal area. International Development Agency (IDA) and KenGen have funded the GRA for Olkaria II and III with the latter still supporting similar activities for Olkaria IV. The least cost power development plan, under review, projects geothermal resource to supply additional 420 MW by the year 2023. Conventional methods estimate geothermal resources potential in the Kenyan Rift to be 2000 MWe. Binary cycle methods estimate is 3000 MWe. Converting this potential to meet the power demand encounters financial, socio-economic, technological and logistical challenges. This paper highlights these challenges and proposes ways of addressing them. 2. CHALLENGES 2.1 Financial High initial capital cost impedes the development of geothermal resources in Kenya. For instance meeting the additional 420 MW requires that about 105 wells be drilled, on schedule, at a cost of about US$ 226 million. Mobilising this amount is not easy since the World Bank deferred supporting the GRA activities in July 2000. KenGen for reasons of budgetary constraints cannot fund the entire amount. Even its bulk supply tariff does not cater for GRA funding requirements. The Government of Kenya (GoK) may not chip in either due to reasons of scarcity of funds. IPPs are unwilling to spend on GRA due to exploration and commercial risks Other reasons have to do with country risk and the short-term nature of their funds whereas GRA requires long term funds. IPPs may therefore not bid for a project without proven adequate and quality steam. Thus GoK has to undertake upfront resource drilling and reservoir testing. Discussions are in progress to secure funding from KfW of Germany for GRA activities. However, KfW pegs the credit to beneficiary geothermal projects being developed by IPPs. The credit also has certain risk mitigation provisions that may not guarantee a retail supply tariff of below US cents 5 targeted by GoK. With respect to development, the concessional funding from development partners led by the World Bank is declining. The argument is that the power sector may attract commercial funding including direct foreign investments (through IPPs). Kenya has 4 IPPs out of 14 in Africa. The IPPs use commercial loans and equity to develop projects. Iberafrica and Westmont used balance sheet financing and completed the developments in time. Project financing adopted by Orpower4 and Tsavo has taken a relatively longer time in financial closure. These IPPs ask for numerous payment guarantees including escrow accounts and standby letters of credit, overemphasise country risk and demand skewed sale agreements with the distributor based on take or pay arrangements. This sale agreement is supported by the current single buyer structure in Kenya. These taken together result in bulk supply and retail tariffs above US cents 5. The main alternative sources of funding such as corporate bonds, suppliers and buyers credits and syndicated loan facility are equally offered at commercial terms and redeemed inside 15 years and hence have similar effects as IPPs. Appendix I shows indicative capacity charges of a geothermal power plant at 8% and 12% discount rates with and without expenditure on GRA. The annual capacity charge ranges between US$251/kW -US$331/kW far below US$502/kW charged by one of the existing IPPs. The annual capacity charge declines by about 9% without expenditure on GRA. The corresponding per kilowatt-hour charge is between (3 4) US cents. The IPP s charge is about US cents 5.8 rising to about US cents 7 after accommodating energy charge and consumer price adjustments. Overall, IPP bulk supply tariff takes about 72% of the current retail tariff of about US cents 9.7, the Kenya Power and Lighting Company Limited (KPLC) charges, thereby diminishing its profit margin. This retail tariff compares unfavorably with the average per kwh tariffs for Egypt (US cents 3) and South Africa s (US cents 2), the major competitors of Kenya for the Common Market for Eastern and Southern Africa (COMESA). 2.2 Plant Size Olkaria I is rated at 45 MW while Olkaria II and Olkaria III currently under implementation in Kenya are rated at 64 MW and 48 MW respectively. This is due to inadequacy of proven and developed resource to support larger capacity, partly due to scarcity of funds to allow large scale GRA. Foreign investors consider projects below 100 MW financially unattractive due to inherent high cost of energy. is considered suitable minimum rating for economies of scale benefits to be realised (Kenya Electricity Generating Company (2002)). It is estimated that total operation and maintenance (O&M) cost of a geothermal plant would be about 45% of O & M for Olkaria I (US cents 0.4774/Kwh). 175
2.3 Competition Table 1: Unit Sales and GDP Growth Year 1997 1998 1999 2000 2001 A medium speed diesel (MSD) plant costs about US$ 1 million per MW at 85% load factor. Instead of using US$ 226 million to Unit Sales 3,651 3,718 3,470 3,148 3,091 undertake GRA, it may be used to develop a 226 MW MSD (Million) plant with immediate benefits, more so during periods of critical GDP Growth 2.4% 1.8% 1.4% -0.2% 1.2% capacity deficit. Return on exploration risk capital ranges Source: KPLC Annual Reports & Economic Survey, between 8% - 12% for geothermal and in excess of 20% each Various Issues for oil and gas, making private investors opt for the latter. 2.4 Lead -Time It takes about 5-7 years to develop a geothermal plant in a new field. GRA alone may take between 3-4 years with plant construction accounting for the balance. The long lead-time may raise development costs arising from penalties related to delays, inflation and allied factors. For instance, Olkaria II is estimated to cost 6% more due to penalties related to delays in disbursement. 2.5 Capital Costs versus Operating Costs Operating cost is about 2.5% of the capital cost of investing in geothermal plant. The higher ratio of capital cost to operating cost requires long term financing at reasonable rates. This is not easy to mobilise externally in the face of lucrative alternatives, such as oil and gas, with shorter pay back periods. 2.6 Technology New technologies in well drilling have introduced flexibility (vertical/directional) leading to higher success rates. However, procurement of the emerging technology is expensive. 2.7 Project Implementation A project like Olkaria II is implemented on a multi-contracting basis with inbuilt extra expenses on contract administration. The economic growth in Kenya has not been attractive enough to warrant substantial investments in additional capacity. With this growth, investment in additional capacity may be unnecessary. Instead reduction in system losses could assist in meeting additional demand at peak times. 2.10 Environmental Concerns Environmental issues also impact on geothermal power development. Gaseous emissions, surface disturbance during site development for roads, drilling pads, buildings and hot or cold geothermal brine flowing on the surface affect vegetation cover. Soil erosion at the resource area, demands of Kenya Wild Life Service as the resource area is within the Park, health risk associated with hydrogen sulfide (H 2 S) at the steam field during drilling or during maintenance work at the power plant. Environmental Management and Coordination Act requires an EIA to be undertaken to mitigate the effects. The Act penalises non-compliance. 2.11 Executing Agency for GRA With the liberalisation of the power industry, it is not clear who is to undertake the GRA work. Even if KenGen were to continue with GRA and also tender for the same for power generation, it would have more inside information than her competitors. As mentioned earlier, IPPs are unwilling to invest in GRA for reasons of costs, resource and country risks and scanty information on the geothermal prospects. 2.8 Skills 3. ADDRESSING THE CHALLENGES KenGen has 59 graduates well equipped with skills in exploration, appraisal and production drilling, well testing, plant commissioning, operation and maintenance. The Company, however, experiences skill deficiency in reservoir evaluation and modeling and feasibility study in appraisal, preliminary design in steam field development, detailed design and construction of power plant and reservoir management under resource utilization. There is need to address the skill gap in key staff. The estimated cost is about US$ 70,000 per annum. 2.9 Economic Performance Electric power is an intrinsic input in nearly all economic activities. Hence positive economic growth spurs consumption of electric power and the need for capacity expansion to eschew power outages. Table 1 shows the actual gross domestic product (GDP) growth and the corresponding net electricity sales. 3.1 Financial Financing GRA a) GoK may consider establishing GRA fund financed by the exchequer. b) Incorporating GRA levy in the retail tariff. This may raise the tariff by about US cents 0.3 per kwh (see Appendix I) assuming KPLC net annual sales of 3500 million units. c) KenGen and KPLC dividend payments to GoK may be used to fund GRA. d) Selling steam to the generators and the proceeds used to fund GRA. e) Interest differential levied by GoK on on-lent loans may be used for GRA. f) GoK to secure KfW funds, currently under negotiations, for GRA but at terms favorable to the domestic economy as well as without strings attached on the developer to use the resultant fuel. 176
g) GoK may seek grants from bodies that promote clean energy production e.g. Clean Development Mechanism financed by Global Environment Facility. h) Using tax incentives to make developers undertake their own GRA. 3.7 Project Implementation Future power plants to be implemented on Engineer, Procure and Construct (EPC) basis to save on contract administration expenses. EPC contracts entail: - Equipment Detailed Design except for the steam field i) Selling proven productive fields and the proceeds used to development explore other fields. - Equipment Procurement - Civil Works j) KenGen and IPPs may form a joint venture to undertake - Equipment Installation GRA. - Commissioning Financing Construction 3.8 Skills a) Negotiating with the development partners like the World Bank, EIB, KfW, Japan Bank for International Cooperation and others to continue supporting geothermal power development. b) Negotiating for direct foreign investments in geothermal development but at terms favorable to the domestic economy. a) Seeking training grants from bilateral sources. b) Introducing geothermal development training levy on the geothermal power generators. c) Subscribing to reputed journals on geothermal power development d) Organising seminars and conferences to exchange ideas e) Limiting turnkey contracts to enhance transfer of technology. c) Encouraging local investors to fund geothermal power development. d) Working with the Capital Markets Authority, Central Bank of Kenya and the Nairobi Stock Exchange to develop a reliable yield curve to assist in pricing long term debt instruments that may be used to fund geothermal power development. 3.2 Plant Size Future geothermal plants may be developed with a minimum capacity of to benefit from economies of scale in terms of lower O&M. 3.3 Competition a) Early generation through well head projects 3.9 Economic Performance a) GoK to create favorable macroeconomic environment to attract local and foreign investors to spur economic growth and ultimately consumption of electric power. b) Negotiating with development partners to resume lending to Kenya. This would give confidence to international investors. 3.10 Environmental Concerns a) Continue implementing appropriate mitigation measures identified in the EIA reports of future geothermal projects. b) Regular Environmental Audits c) Budgetary support for activities targeting a clean environment in the project area. 3.11 Executing Agency for GRA b) Raising return on exploration risk capital to above 12%. E.g Philippines 16%. a) GoK to undertake GRA work. b) GoK to form geothermal development company (GDC) to 3.4 Lead Time undertake GRA and allied activities. GDC may initially be a) Adopting suitable technology to crush certain activities of funded by the Exchequer or by levies from power generators and later by the proceeds from the sale of steam. the GRA to shorten plant development period. c) GoK to retain KenGen to do the GRA work. b) Ensuring availability of adequate funds for the development to avoid delays triggered by scarcity of funds. d) Allow private developers do GRA work and sell steam to the operators. e) GoK may provide incentives to make each developer undertake GRA. Such incentives may include though not limited to: 3.5 Capital Costs Vs Operating Cost - tax holidays for say 5 years from commencement Seeking concessional funding with longer repayment periods of of operation as is practiced in Philippines; say 25 years. - reimbursing at least 70% of expenditure on unsuccessful wells or at least 20% incase of a well 3.6 Technology with poor quality steam. Applying appropriate technology and equipment in drilling to enhance success rate. 177
4.0 CONCLUSIONS For geothermal power to supply clean, reliable, adequate and affordable electric energy required to spur industrialisation in Kenya, the challenges identified need to be addressed prudently. Of critical importance is GRA that provides the requisite fuel for geothermal operations. 5.0 REFERENCES 1. The Government of the Republic of Kenya: Economic Survey, Various Issues, Government Printers, Nairobi. 2. Kenya Electricity Generating Company Limited: Data Reference Manual, Geothermal Projects. A Manual Prepared for Least Cost Power Development Update, July 2002. 3. The Kenya Power and Lighting Company Limited, Annual Reports, Various Issues. 4. Ogoye, H. K (2002). Alternative Sources of Funding KenGen Investments. In Gearing up for Competition. Proceedings of the 2 nd KenGen Technical Seminar, Safari Park Hotel, Nairobi, Kenya, 13 th 15 th November. Appendix I: Indicative Capacity Charge Scenario I (8%): With Investments in GRA Capacity: Investment Cost US$/kW: 2,143 Discount Rate: 8% Equipment Life: Capital Recovery Factor: 9.37% O & M as a % of Investment Cost: 2.5% Annual Charge US$: 2,143 @ 12% Capacity Charge: US$/kW 273.22 Scenario II (12%): With Investments in GRA Capacity: Investment Cost US$/kW: 2,143 Discount Rate: 12% Equipment Life: Capital Recovery Factor: 12.75% O & M as a % of Investment Cost: 2.5% Annual Charge US$: 2,143 @ 15% Capacity Charge: US$/kW 331.50 Capacity Factor Assumed: 98% Without Investments in GRA 1,969 8% 9.37% 2.5% 1,969 @ 12% US$/kW 251.06 Without Investments in GRA 1,969 12% 12.75% 2.5% 1,969 @ 15% US$/kW 304.62 178