COMPETITION IN KENYA’S ENERGY SECTOR

INTRODUCTION

Competition in supply and consumer choice is the hallmark of a competitive market.

These are relatively new concepts in power sector in Kenya. Power industry
worldwide has undergone significant changes paving the way for creation of a power
market and introduction of competition in wholesale and retail trading of power.

Over the last two decades electricity sectors in both developed and Kenya have been
subject to restructuring to introduce private capital and increase competition.
Although the effects of such reforms in a number of the developed economies are
now well documented, apart from a few case studies the experience of Kenya is
much less well researched. This paper provides an econometric assessment of the
effects of competition on the prices of the electricity generation and supply industry in
Kenya.

The Kenyan Power sector is undergoing important transitional changes after the
introduction of reforms and restructuring in the Communication Sector. With the
introduction of reforms and restructuring in the power sector, the generation of
power, which was a Government monopoly, was thrown open to private sector in
order to bring in private investment.

The domestic players having savored success in the capital markets and foreign
investors eying the Kenyan power market with renewed interest, the sector is on a
massive investment drive. With the sector moving from monopolies to competitive
markets, diverse competitive scenarios are likely to emerge.

The Governments is undertaking several initiatives to reform the power sector by

providing appropriate financial, structural as well legal framework to make the sector
financially viable and self-sustaining with the ultimate objective of providing reliable
and quality power to the consumers’ at most reasonable and competitive rates. The
Energy Regulatory Commission has been mandated to develop the electricity market
with a view to ensure availability of power at competitive rates and also to provide
choice of power suppliers to the consumers.

This discussion paper seeks to analyze the effects of competition on pricing at the
Kenyan power supply and distribution industry.

DEMAND AND SUPPLY SCENARIO

The demand for power has always outstripped the supply. Substantial peak and
energy shortages prevail in the country. Currently, Kenya has an installed power
capacity of 1300MW against peak demand of 1200MW and projected 15000 MW
demand within the next 20 years. This means the reserve margin gap between peak
demands and available has shrunk to below 10 per cent compared to the optimum
limit of 15 percent. The problem of high cost is compounded by unreliability of supply.
The per-capita consumption in Kenya is extremely low as compared to other
developed countries. This is mainly due to the inherent perils of the Kenyan power
sector like monopoly control of power utilities by the government, operational
inefficiency, mounting technical and commercial losses, huge gap between the cost
of supply and the tariff and absence of competition leading to monopolistic
exploitations.

PROGRESS OF REFORMS:

Power sector reform has usually involved some combination of product market
competition, privatization and regulation. In developed countries, the process of
reform in the electricity sector has been well documented and appears to have been
reasonably successful.

The principal driving forces behind electricity reforms, the push includes the poor
performance of government-run electricity operators in terms of high costs,
inadequate expansion of access to electricity services and unreliable supply; the
inability of the government sector to meet the investment and maintenance costs of
the electricity industry associated with the increasing demands for power resulting
from economic development in other sectors of the economy; the need to remove
electricity subsidies so as to release resources for other areas of public expenditure;
and the desire to raise immediate revenue for the government through the sale of
government assets. The ‘pull’ factors include advocacy of reform by international
financial organizations and donor agencies such as the IMF and World Bank, through
their ‘lending for institutional reform’ programs; and rapid changes in technology in
both the generation of electricity and in the computing systems used to meter and
dispatch power, making new industrial structures possible.

In Kenya, however, the path to reform has been more difficult. Kenya can suffer from
serious institutional weaknesses, meaning that planned reforms may not produce
their intended benefits. In most Kenya the process of capacity building and
establishing adequate regulatory institutions has been a slow and complex one,
lagging behind the entry of private operators in the electricity sector.

The enactment of the Electric Power Act, 1997, facilitated the unbundling of
generation from transmission and distribution thereby creating a framework for
Independent Power Producers (IPPs) to sell electric power in bulk to Public Electricity
Suppliers (PES). ERB was empowered to set, review and adjust tariffs, for all
persons who transmit or distribute electrical energy for sale; and to ensure
competition in the power sub-sector, where this is feasible, in other words the
generation function. Currently, Kenya Power and Lighting Company (KPLC) is
engaged in the transmission, distribution and retail of electricity and is the only
licensed electricity distributor and supplier in Kenya.

In addition to this the Act led to the formation Kenya Electricity Generating Company
(KENGEN), which currently accounts for about 57% of the installed capacity
comprising a mix of hydro, wind, geo-thermal, and diesel power plants and the IPP’s
using geo-thermal and petro-thermal plants joined the market. More new entrants are
expected to enter the generation market in the next three years from IPP’s.
Eventually in pursuant to the Energy Act, 2006, led to formation of Energy Regulatory
Commission (ERC) to regulate the entire energy sector. ERC serve as a one-stop
shop for permitting and licensing of generation, and ensure transmission and
distribution, as well as environmental rehabilitation on project completion or
abandonment.

Lastly, the national energy policy enunciated in Sessional Paper No.4 of 2004 and
operationalized by the Energy Act No. 12 of 2006 to encourage implementation of
indigenous renewable energy sources to enhance the country’s electricity supply
capacity. The Sessional Paper incorporated strategies to promote the contributions of
the renewable energy sources in the generation of electricity. With respect to these
documents, the Ministry of Energy established a Feed-in Tariff policy (FiT) in 2008
covering wind, small hydro and biomass sources, for plants with capacities not
exceeding 50MW,10MW, and 40MW respectively. However, the Feed in Tariff has
not done enough to facilitate new entrants’ alternative energy sources as a results
there has been no threat of substitute products in power generation since the highly
unreliable and expensive alternative energy sources like wind and solar energy.

RETAIL SUPPLY MARKET IN OTHER COUNTRIES:

UK:

The retail supply of electricity has been separated from distribution function, by issue
of separate retail supply license through the existing distribution network. All gas and
electricity customers are allowed to change their suppliers. Since May 1999 over 19
million customers have changed their suppliers with savings up to 100 pounds in the
energy bills. Average energy prices have fallen by 30%. There are 17 Distribution
licensees & over 75 retail supply licensees who are supplying to various consumers
including domestic customers. With the issue of multiple licenses, consumers have
been provided with a choice of suppliers.

USA:

In Colorado, the retails supply of power has been deregulated. In order to provide
customer choice, all types of suppliers of electricity are allowed to compete for retail
customers. Suppliers are allowed non-discriminatory open access to the distribution
network. Except for requirement of universal service, exclusive monopoly in the
supply including metering and billing service is no longer recognized.

In California retail supply of electricity has three investor owned and two municipal
owned vertically integrated companies. Their service areas are discreet zones, and
as such they have not competed with each other except for new industrial customers.

Australia (New South Wales):

Retail competition in electricity supply was introduced in seven phases based on
annual electricity usage in 1996. Initially small number of large industrial customers
was allowed to select retail suppliers. By January 2002, all New South Wales
customers including household customers were having choice of retail suppliers.
There are four government owned suppliers and 17 other retail suppliers.

New Zealand:

Separate Retail suppliers & distribution licensees exist. There are 10 retailers & 30
distribution companies.

Japan:

In Japan, only extra-high voltage customers are allowed to choose their suppliers.

Croatia:

Croatia has recognized retail supply as an independent activity. Retail supply to

eligible consumers (annual minimum consumption of 40 MU or more) can be done
after obtaining a license.

COMPETITION ANALYSIS

Currently, KPLC which is a monopsoly buyer of electricity from power generator’s like
KENGEN and independent power producers and also a monopoly supplier of
electricity to the Kenyan market. This means that Kenyan’s continue to buy power
from single monopoly utilities without any choice of supplier. As long as there is a
single supplier, the consumer is not likely to get quality power at reasonable rates in
each area since there is no competition in that area.

The government is the majority shareholder of KPLC which means that KPLC not
only has an advantage of network infrastructure and but also government backing.
The supply and distribution market faces no threat of new entrants since KPLC owns
the current infrastructure of about 43000Kms. In order to introduce competition in
supply it necessitates the new entrant to create their own parallel network to compete
with KPLC. This means electricity consumer have no bargaining power and have to
depend on government regulator like ERC which regulates the Retail Tariffs.

Currently KPLC is in the process of applying for an upward review of the retail Tariff
due to additional operational cost and more so its need to acquire additional strength
to absorb the expected rise in bulk power purchase and transmission costs. KPLC
currently charges domestic consumers Sh.2 per Kilowatt hour (kWh) for the first 50
units, Sh8.10 per kWh for consumers a fixed charge of sh120 per month and other
items such as VAT 12.0 %, fuel cost charge 615.0 cents/ kWh, and foreign exchange
etc. Fixed charges take just a small portion of the bill and hence the effect of an
adjustment won’t be greatly felt by the final consumer.

COMPETITION MECHANISM
CASE 1

Currently the power generators include the Government majority KENGEN that has
bulk of its power from the cheaper hydro power sources and IPP’s like Aggreko and
Ibera Africa with huge investment on expensive diesel generators. KPLC buys power
at about ksh3 per unit from KENGEN and more than ksh6 per unit from IPP’S like
Aggreko and Ibera Africa to attain the country’s power deficit.

KENGEN’s Market share is about 57% down from 75% in 2006. The situation is likely
to continue, as bulk of new power plants expected to come up on board in the next
three years is from IPP’s. This means that the private investors look set only to gain a
larger market share but to tilt the scales in favor of higher bulk power buying prices.

Which means as market share of IPP’s increases so does the market prices
increase.

CASE 2

New entrant in the Energy Market use cheaper sources of energy like nuclear and
geothermal energy instead of diesel generators.

Assuming that KENGEN’s market share remains constant and IPP’s only provide
emergency backup power.

The market prices are expected to reduce as results of increased competition

between KENGEN and new market entrants who rely on cheaper sources of
electricity. This means that fuel cost charge of Ksh615 Cent/kWh is likely to go down.

CASE 3

Instead of parallel networks, multiple suppliers are allowed to supply through a

common network.

Assuming that the current existing transmission network is Government owned and
supply of electricity to the network is done through competitive bidding.

The no of supply companies in the market is likely to increase as a results the

Kenyan consumer will have some bargaining power. The supply companies will be
forced to adjust their consumption charges in order to remain competitive.

CASE 4

A combination of case 2 and 3 would mean we have multiple power generators and
suppliers in the country. This would be the best case scenario for Kenya’s energy
market since it will be very competitive.
CONCLUSION

Significant reduction in prices is to occur as a result of new market entrants who

invest largely on cheaper sources of energy like nuclear and geothermal energy
instead of expensive diesel generators. More so the Government has to facilitate the
competition in the power supply and distribution industry by separating the supplier
from the network.