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Electricity generation capacity may be moving towards excess supply, but a blend of technologies will be needed in the Kenyan system as auctions to allocate new renewables projects come into view. In one of the region’s most dynamic energy sectors, government officials, off-grid entrepreneurs, traditional developers and financiers all have ideas about the way forward, write Jon Marks and Dan Marks from the AIX: Nairobi meeting

Competitive auctions for renewable power projects are moving slowly towards becoming a reality in Kenya’s dynamic electricity supply industry. An encouraging number of projects are progressing, even while the government often moves with what one developer calls “glacial policy-making” speed. But the general direction of travel is clear, as off-grid programmes emerge as the technology of choice for remote regions, Kenya Power’s access programmes continue and more independent power producers (IPPs) move towards financial close and construction.

More private investment will be sought along the supply chain as the government struggles with rising debt and popular disquiet at the way taxes are spent. But the devil is in the detail. In two days of discussion, the Africa Investment Exchange (AIX): Nairobi event organised by CbI Meetings on 3-4 October revealed only limited agreement on how to create a diversified electricity supply industry. Private developers remain wary after several years in which the government has tinkered with investor protections and arbitration. Meanwhile, changes to technology and demand patterns are creating a very different investment environment for planners to work with.

There is some encouragement for investors, particularly if the much-anticipated draft energy bill is passed. One of the advantages of the new law would be to allow generators to supply consumers directly, rather than selling only via power purchase agreements (PPAs) with state utilities. But many uncertainties persist; developers who have already signed PPAs are concerned they will be pressed into renegotiating their tariffs downwards, to reflect changed market conditions.

The fate of solar and wind projects that have not yet signed a PPA is unclear. “One issue is that because of how long it has taken to develop these projects, a tariff that was reasonable is now very expensive. Is that fair on the consumer? No,” a senior official told African Energy. “But on the other hand you have developers who have incurred significant costs. So we have to think of a process that does not prejudice them and that gives them a good chance of developing their projects through a clear roadmap.”

An energy taskforce was established early in 2017 to propose ways to transition from the unsolicited bids that have so far dominated renewables development to an auction system. No decision has yet been made on which technologies will be procured, or the auction model, though the ministry is looking at auction models like Zambia’s with considerable interest. The taskforce’s final report was delivered to the Ministry of Energy in September – itself an illustration of the slow pace of policy-making. Taskforce members are optimistic that some of their recommendations will be adopted before year-end, but a government official told African Energy that real movement was unlikely before next year.

African Energy understands the report is likely to propose that projects in the pipeline are shortlisted and then offered a tariff according to a formula based on their costs, which delivers an internal rate of return of 12.5%. This could jar with the ministry’s current policy of capping the cost of new power at $0.08/kWh, making a hybrid approach to shortlisted projects a possibility. Failure to have a project shortlisted could be a significant problem for developers; some of the proposed auction models under consideration specify the location of projects, which would leave developers with pre-existing projects in other locations out in the cold.

As well as being a means of securing the lowest possible price and providing an indication of the government’s commitment, auctions are viewed as a means to streamline and order the development process. “The large number of projects in the pipeline means that people work to get ahead in the queue through a lower price,” one official said. “Or perhaps they say that they don’t need a letter of support, but then they come back later with the lenders and say that actually they do. This holds up other projects which could have moved forwards.”

The auction model poses other challenges. Unsolicited bids are comparatively riskless for governments, which do not commit to achieving milestones or going ahead with the project until relatively late in the process. Auctions imply a stronger commitment, which may in some cases be legally binding. There are challenges around the capacity of government to deliver an auction process, which requires careful management and oversight as well as transparency to attract the right bidders and prices.

Solar and wind advance

Added to the general policy questions are the technical and financial implications as wind and solar energy come onto the grid. One senior official attending AIX: Nairobi said the 310MW capacity Lake Turkana wind project, which is now supplying a little over 50MW to the grid, was unlikely to cause stability issues because of the remarkable predictability of the northern region’s wind resource; this will help Kenya Power manage its load profile and reduce its diesel consumption.

But the next batch of projects with signed PPAs do not offer such stability. These schemes include the 102MW Kipeto (AE 375/12) and 90MW Mpeketoni wind projects, and the 40MW solar photovoltaic (PV) Eldosol, Kesses, Kopere, Malindi, Midland, Radiant and Rumuruti projects.

Kipeto is close to reaching financial close. Bloomberg reported earlier this year that UK-based private equity investor Actis was acquiring an 88% stake in the project. Kipeto is receiving a bespoke liquidity guarantee from the African Trade Insurance Agency covering a loan from the US Overseas Private Investment Corporation (Opic), which could potentially cover multiple instances of non-payment. Normally liquidity guarantees only cover one time-limited period of non-payment.

Other projects with PPAs have started to make progress over the past year. UK-based developer Globeleq hopes to finalise its solar project in Malindi soon, after signing a financing agreement with the UK government-owned CDC Group in May (AE 374/8). The backers of the remaining three solar PV projects which signed PPAs at $0.12/kWh in 2017 are confident of reaching financial close. One banker told African Energy that Eldosol and Radiant Energy were both expected to close by year-end.

Balancing the grid

Bringing these intermittent projects online will require flexible capacity elsewhere on the grid. Kenya is also looking into importing liquefied natural gas (LNG) but although several oil majors have been looking into the possibility of an import scheme, gas-to-power is not for tomorrow. The usual challenges around aggregation, distance from the port in Mombasa and financing long-term contracts for peaking or mid-merit plants have all to be overcome.

One option being explored is to introduce LNG to the mix by converting existing thermal plants and potentially building new plants, with a 700MW combined cycle gas power plant at Wajir considered the least cost-option; Dongo Kundu remains another possibility. KenGen is looking to convert the 73.5MW Kipevu I and 120MW Kipevu II plants to LNG. South Africa’s AEP Energy Africa acquired the 103.57MW IberAfrica Power (East Africa) Ltd plant earlier this year with a view to converting it to gas after its PPA expires.

Kenya’s nuclear plans have been kicked into the long grass after Kenya Nuclear Electricity Board said its target of two 1GW units by 2027 had been scaled down to two 600MW plants by 2037, reflecting slower demand growth.

Neither is the controversial Lamu coal project doing so well. Government studies to date have shown the project is not a least-cost option. General Electric’s announcement in May that it intended to acquire a stake in the project prompted a considerable backlash from investors (AE 370/4, 332/8). A formal agreement has yet to be signed. A court order to prevent further development was granted late in September and one of the main sponsors, Kenyan company Centum, is looking to leave the project as it exits its energy sector investments. Centum is also a shareholder in the Akiira geothermal project.

KenGen sees a strategic opportunity to play a role stabilising the grid but is looking to be remunerated. As more solar and wind projects come online, KenGen will use its dams and thermal plants to balance generation. This will involve reduced production from its hydroelectric plants, which currently operate as baseload. It is in negotiations with Kenya Power to introduce capacity payments into its PPAs, so that it is paid for making capacity available even if it is not used. Kenya Power is less keen on the idea, which would increase the cost of some of its cheapest contracts.

Projects seek demand

Despite the stop-start nature of so many projects, Kenya has seen a major increase in the number of connections. The government is looking to its improved electricity supply profile to raise living standards and encourage new industrial investors, on a ‘build and they will come’ assumption. However, in a still heavily rural economy, demand doggedly refuses to grow in line with supply.

The prospect that supply will continue to outpace demand has put the government in a powerful position, where it is able to put pressure on tariffs from IPPs and step back to consider which direction it would like to take. It has also left projects that have been developed over the past few years in the lurch, as the case for adding more generation capacity has weakened. One official told AIX: Nairobi that “probably we have brought in an over-abundance of projects, and possibly bad projects crowding out good projects”.

Despite this, government officials have repeatedly stressed that they do not want to deter investment. “We already have 3,000MW in the system and we need to develop a process which is fair,” an official said.

While sponsors are adamant that contracts should not be renegotiated, some officials have expressed concern about pricing that was proposed during a different business environment. One official told African Energy the government could attempt to renegotiate the tariff of at least one PV project, although this seems unlikely once financial close has been reached.

As well as undermining the rationale for new generation, low consumption is putting pressure on Kenya Power. While the burden of connecting new customers has shifted since a major refinancing of Kenya Power’s debts in 2016 – with development finance institutions and the government bearing the cost of making connections – the utility still faces the cost of operating and maintaining the lines, as well as servicing (or disconnecting) new customers.

Recent studies have shown that increases in electricity consumption among new Kenya Power customers rapidly plateau, often at little more than 20kWh/yr, which makes servicing them highly unprofitable. Connections to poorer households can provide an unstable supply and commonly used electrical appliances such as lights, radios and televisions are not always available in a way that is affordable, such as on lease finance. As a result, many poorer households stop paying for grid power and are subsequently disconnected.

Tackling transmission

Transmission shortfalls are fast rising up the agenda across the continent, and in Kenya are the subject of a lively conversation with little clarity on policy direction. Whereas in the past, blackouts were usually the result of a generation deficit, now they are more frequently caused by issues with transmission and distribution. “Transmission has been a bottleneck for a long time,” a government official said. “There has been quite a lot of investment over the past few years and billions of dollars more is planned. That simply cannot be funded exclusively by the exchequer.” However, it is not clear how private involvement in transmission can be achieved.

The government has been looking at build-operate-transfer (BOT) projects, most likely with a wheeling tariff providing the return. Altering pricing to allow for a wheeling tariff for state transmission utility Kenya Electricity Transmission Company (Ketraco) is also being explored. This would allow Ketraco to build up an independent revenue source and to raise money itself.

However, wheeling tariffs and BOT arrangements pose significant problems for the private sector. Most investors do not want to operate transmission lines and co-ordinating the grid between multiple operators can be a problem. Privately financing transmission line development is further complicated by the need to reflect the cost in the tariff. Currently, investments into the transmission system are often financed by the government or donors.

Other structures are possible that might find applications in Kenya. The UK’s Private Finance Initiative has been used to build hospitals and other health infrastructure which are then leased to the National Health Service for a set annual fee. The initiative’s cost has faced considerable criticism, but such structures might apply to the construction of transmission lines, as investors receive a set return which is not reliant on changes to the energy mix or load profile; they would not operate the line, which would be leased to Ketraco.

 

Africa Investment Exchange: Power & Renewables

14 November 2018 to 15 November 2018, RSA House, London

Over the last five years AIX Power & Renewables has become one of the meeting places of choice for Africa’s power sector stakeholders, including leading private and public sector investors, African officials and project developers.

Last year KfW and the Africa Trade Insurance Agency chose AIX: Power & Renewables to launch their Regional Liquidity Support Facility, while the 2016 meeting was chosen for the launch of the Africa Infrastructure Development Association (AfIDA), a think-tank and network to promote and enable project development in Africa.

Co-produced by consultants African Energy and held under the Chatham House Rule, the meeting is structured around panel-led discussions with the participating audience, with the main meeting limited to around 180 to preserve the networking environment.

This year’s meeting is sponsored by Actis, DEG, Denham Capital, DLA Piper, ENGIE Africa, FMO, InfraCo Africa, Joule Africa and Themis Energy.

It features two main conference streams, additional break-out sessions and an evening reception and has been expanded to include additional side events:

• The third annual Off-grid Investment Exchange.

AIX: Gas 2018 Update.

AfricaHardball – a roundtable focused on political risks and governance issues that impact on projects and investment decisions.

Download the latest agenda - featuring more than 60 confirmed panellists

There is a 10% final discount which runs until 31 October.

Book online or contact Lauren Andrews for an invoice. Tel: +44 1424 721667.