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ERA chief explains why you have to pay more for power

Dr Benon Mutambi

The Electricity Regulatory Authority recently increased tariffs for the fourth quarter. DR BENON MUTAMBI, the chief executive officer of the authority, spoke to JEFF MBANGA about the fairness of the tariff, and whether other options could have been explored to save consumers from another cost burden.

This 19 per cent tariff increment: one would say it is unfair because with inflation still below 10 per cent and international fuel prices declining, you heavily based your calculations on the movements in the foreign exchange market to set the tariff.

We need to look at the major factors that drive the tariff. You have the exchange rate movement, inflation and international fuel prices. International fuel prices have been coming down; inflation has been going up.

But the impact of inflation in the tariff adjustment is very minimal. The impact may be less than 0.5 per cent. The fuel prices helped us to mitigate the impact on the tariff. We can, therefore, safely say that this adjustment is all about the exchange rate.
 
So, how fair is this tariff?

It depends on whether this cost is reasonable or not. The fundamental principle that underlies the setting of prices of electricity is that the cost that goes into the price [tariff] is reasonable and necessary for the companies operating in the electricity sector to carry out their mandate.

In this case, our shilling lost value of close to Shs 400 in a space of three months. We are operating in a capital-intensive industry. Much of the costs are capital costs, which are largely borrowed funds. And these borrowed funds are usually in foreign currency.

This means that these companies that borrow to establish power plants here have to be able to service those debts. This money has to come from the price of electricity.

Of the entire sector costs, 75 per cent of those costs are in foreign currency. And all those costs that are in foreign currency have to be adjusted according to the movement in the shilling against the dollar. Our total sector revenues or costs that need to be recovered through the tariff currently stand at about $420 million annually.

And of those costs, 75 per cent are denominated in foreign currency. So, our exposure, as a result of the shilling losing value, is about Shs 160bn every year. That is a significant exposure. If we don’t adjust these tariffs to recover those costs, it means the companies will be unable to service their debts, and they will be in breach of their own contracts.

That breach would spark off a crisis in the industry, and it could lead to some companies shutting off, and that would lead to load-shedding and its undesirable consequences on the economy. 

What about the thought of hedging to guard against foreign exchange fluctuations?

I personally tried to examine this matter of hedging about four years ago. As one of the managers, I identified foreign exchange risks as one of the greatest the industry faced.

We approached financial institutions that provided these hedging instruments, such as the Standard Bank of South Africa, PROPARCO in Europe, all of whom came here. But I think it is a much more complicated issue. First of all, the money at stake is quite huge. And if you are a hedging institution, you also take exposure on this money.

Then what solutions are available to reduce the risks posed by foreign exchange fluctuations? 

We should first of all appreciate that the foreign exchange risks are external, which we have no control over. One solution would have been hedging if at all the hedging markets were ready to take up the exposure.

The other solution, which is also not complete, is to see how we can encourage the pension funds to invest in some of the energy projects and invest in shillings. But we also need to recognise that most of the equipment has to be imported from abroad. So, the effect would really be partial, although it is much better than borrowing from international financial institutions.

Isn’t it better that ERA makes these adjustments on a monthly basis other than quarterly so that consumers are saved from the burden of shouldering a huge tariff increment?

When we were introducing these quarterly adjustments, one of our arguments was that it was important to smoothen these movements in the tariff by way of implementing more frequent adjustments.

Our proposal to the public was that let us have these adjustments done every month because that is what they do in Kenya and it helps. When you wait for a whole quarter, and you are faced with an unfortunate event like what has happened to our exchange rate, you will be required to implement a large adjustment, and that can be some kind of shock for consumers and could even face resistance.

However, when we consulted the various stakeholders, such as the manufacturers, they were also concerned that monthly adjustments would expose them to a higher degree of uncertainty and yet they plan to do other things like borrowing. So, this is how we settled for quarterly adjustments. We are going to certainly reignite this debate with our key stakeholders and consult the policymakers.

In setting your tariff, you also look at the investments companies make. You have an issue with Umeme’s investment numbers that it factors within the Power Supply Price.

For example, you have questioned about $8 million that Umeme says is part of its investment cost for the year 2013. How would you describe your relationship with Umeme? And how comfortable are you with Umeme’s financial submissions? 

Our relationship with Umeme is a normal arms-length relationship between a regulator and a licensee. It is a well-known fact that a regulator will always have to stand up sometimes and disappoint the various stakeholders.

It is not the intention of the regulator to disappoint but the regulator is accountable to the public and all the other stakeholders. Accountability requires that whatever I am going to allow is going to be supported by conceiving evidence.

Where the justification provided by a licensee is not convincing enough, it is the duty of the regulator not to allow that kind of cost to be paid by the consumers of the electricity.

In this particular case, we are not saying that the investments were not done; we are simply saying that we are not convinced by the justification, as of now provided by Umeme that those investments should be capitalized and should therefore find themselves within the tariff. Remember, for a company like Umeme, we allow it money for undertaking operation and maintenance, which includes money meant for repairs of the network.

When it comes to their capital investments, we always want to make sure that there is no double-counting; that the money we allowed for repairs is actually used for that purpose. In this case, much as we say we have not allowed the $8 million, we are not saying we shall never allow it. For us, when we examined that cost, we found out that they largely fall under the operational and maintenance.

But of course there are other arguments. One of the examples is a transformer blowing up before its useful life. So the question is: when it is replaced who is responsible? Is it a capital investment or a repairs and maintenance? Then we also have a debate of why didn’t the company comprehensively insure those assets so that when those unfortunate events happen, the company is compensated. Our argument is that the consumer is not an insurer to the company.

But of course they have also argued that such insurance markets do not exist. However, we need to see evidence that the company tried to insure those assets and that the insurance markets did not exist.

Perhaps one way of having a lower tariff would be to increase energy supply. The GET-Fit programme, where up to 18 projects have been approved, is one solution. What is the progress of that programme and how soon can the country feel the impact of those small energy plants?

One of the programmes I feel proud to be associated with is the Get-Fit product. The good news is that a number of those projects have entered the construction stage.

There is a lot going on in the renewable energy generation projects and soon the public will see what has been going on. About five are in the construction stage. About six of those projects are closing financing. I would say it is a very successful programme. If you look at a number of tariffs under those projects, they are quite competitive; tariffs of 9.8 US cents per kWh.

jeff@observer.ug

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