Powering Up: the Urgent Need to Close Africa's Energy Gap

Background

The picture below of Earth at night tells a powerful story about human development: The vast expanse of the African continent is dark, except for parts of South Africa and the population centers along the Mediterranean. Indeed, only about 30 percent of Africa’s population has access to electricity, and just about 40 percent is expected to have access by 2050, according to the World Bank. 1 The electrification rate of rural populations is only a quarter of that enjoyed by urban counterparts, making life difficult, particularly for women who spend time collecting firewood or inhaling smoke from inefficient cookstoves and for children who cannot study at night.

Mind the gap!

Africa’s energy sector is fraught with challenges. There is a gap between electricity supply and demand, a gap between revenues and expenses of the power utilities, and a gap in overall investment in the sector. If sub-Saharan Africa was to meet individual national electrification targets, which currently is at the bottom of the per capita consumption rate, about $40 billion would be needed annually for new generation, transmission and distribution networks, rehabilitation of plants and equipment, and operation and maintenance. 2

Unfortunately, only about a third of the capital needs are met annually, leaving a large, unfulfilled investment gap of about $30 billion. The investment need is approximately 4.2 percent of gross domestic product (GDP) with a wide disparity between countries, and the percentage goes up if countries are not allowed to trade power with each other. For countries in the South African Power Pool, the cost represents about 3.7 percent of GDP, while for those in the East African Power Pool, the cost represents about 5.7 percent. However, in a post-conflict country like Liberia, the investment represents a staggering 30 percent of GDP. Bridging the energy gap will require time and deliberate effort by African governments.

Need to reduce power subsidies

While bridging the investment gap using domestic resources clearly looks daunting for countries like Liberia, most other countries can and should be able to meet a significant portion of their investment needs. Starting with the costs of rehabilitating plants and equipment and of operations and maintenance these countries can do this by reducing energy subsidies. In other words, by just closing the gap between the tariffs that utilities charge in comparison to their true cost of service, African countries can relieve some of the self-inflicted pain.

A recent International Monetary Fund report on energy subsidies points out that, on average, electricity tariffs in Sub-Saharan Africa cover only 70 percent of the cost recovery price. This level of subsidy for electricity represents close to 2 percent of GDP, or close to 4 percent of government revenue (electricity represents 70 percent of overall energy subsidies in sub-Saharan Africa). If African governments were to let electricity tariffs rise to the cost of service level, almost half of the power sector expenditure needs could be self-financed by the countries themselves, leaving the balance for multilateral donors or the private sector.

As part of MCC’s power sector investments in Malawi and Tanzania, for example, the respective governments agreed to gradual tariff hikes that are necessary to bring tariffs closer to full cost recovery and to reduce or remove subsidies. ESCOM, the Malawi utility, recently applied for a 59 percent increase in tariffs with its regulator, who approved a 37% increase. This tariff increase, according to the regulator, should allow the utility to cover expenditures for its operations, maintenance, capital replacement, and a limited amount of capital expansion. Similarly, in Tanzania, the regulator recently approved a 39 percent tariff increase, which falls short of what is ultimately required but is a positive step forward that nonetheless will improve the utility’s financial situation.

Improving the tariff regimes in Malawi and Tanzania, combined with MCC’s investments in infrastructure and sector reforms, have sent powerful signals to the private sector that the countries and their power sectors are ready for business. Both countries have seen increased interest from private power project developers.

Cause vs. effect

Addressing the problems of the power sector in Africa is challenging because of both a lack of understanding about the root causes and a lack of serious effort to fix them. Without distinguishing between a symptom and a cause, the underlying problem cannot be attacked. For example, lack of generation is not a problem but a symptom of an underlying cause, which is the lack of investment in the sector.

The lack of investment itself raises the question of why there is no investment. If the utility is supposed to be investing, why aren’t they? The answer often is that the utility does not generate enough cash, and the reason it does not generate cash is often because tariffs are too low—in fact, so low that they do not even cover the costs of serving customers. Consequently, the cause of underinvestment in generation may be rooted in the lack of political will to raise tariffs rather than any particular technical issue. This is unfortunate because there are smart ways of designing electricity rates such that the poor and vulnerable are protected while ensuring the service provider’s financial solvency. With proper understanding of ability and willingness to pay, utilities can design programs to help the disadvantaged, including lifeline tariffs, prepaid meters and payment strategies for connection costs.

The ability to attract private investment is also affected by the creditworthiness of the off-taker, namely, the utility. Private investors are not going to build new power plants unless they are confident the utility has the ability to pay for the purchaseed power. Here again, tariff rates play an important role because the creditworthiness of the utility depends on its ability to charge customers a tariff that at least covers its cost of service. Private investors look at the country’s political and macro-economic factors, such as ease of doing business, level of corruption, state of infrastructure services, human capital, rule of law, and sanctity of contracts.

Improving the investment climate

The electricity business is a complex one. Once electricity is generated, it cannot be stored economically. Consequently, the supply and demand must be matched constantly and that requires technical expertise, lots of capital, and trained and dedicated staff to manage and maintain the system. The entire value chain is capital intensive, yet capital is in short supply. Bridging this investment gap requires significant sector reforms and political will on the part of politicians and bureaucrats, who all should help attract private capital.

What can African economies do? For starters, they can make doing business easier for investors. Control of corruption, ease of doing business, honoring sanctity of contracts, clarifying sector policies and laws, and independence of the regulator are just some of the things that governments can help fix. Most if not all of these actions have low to no cash cost, other than political will. MCC’s eligibility requires “passing” indicators that track such issues. Eligible countries rightly feel they have received a “seal of approval,” which helps them market themselves as good investment destinations. Allowing tariffs to rise to cost recovery level, open access to transmission lines with transparent and non-discriminatory pricing and payment assurance, where necessary, should further encourage private sector participation. In return, the private sector can bring capital, commercial discipline, know-how, and efficiency, which all should help partner countries.

Competition where it makes sense

Over the last two decades, the concept of economies of scale and scope in the power industry has been dismantled. Vertically integrated monopolies are unacceptable as they have proven wasteful and inefficient. Although no particular power market model has been proven to be better than the other, a theme has evolved: Let competition take hold in segments of the power market that can accommodate more economic actors.

The generation sector is often the first target of competition, followed by distribution, provided the right conditions of scale and efficiency exist. Transmission has generally remained under the control of governments as a parastatal or a not-for-profit organization.

There are signs of progress in the African power sector. 3 For example, after many years of trying to make the power sector more efficient and of half-hearted attempts at reforms, Nigeria recently privatized its power industry, selling off $2.5 billion worth of assets. Other African countries have not been as ambitious, but many, including South Africa, Kenya, Ghana, and Zimbabwe, have tried different flavors of market restructuring and reforms.

A particularly interesting market model that has evolved is what is called an independent system and market operator (ISMO), which is formed by carving out the vertically integrated utility’s system control and transmission business. This model or a variation of it is attractive to many countries because it allows the incumbent utility to operate without much disruption, while introducing competition in the generation sector and making individual business units more transparent and efficient.

In this model, the ISMO becomes the bulk buyer of power from incumbent generators and independent power producers. It also does the transaction accounting for bilateral power transactions between independent power producers and large customers. The ISMO then sells power to distribution companies. For the entire power sector to be financially viable, distribution companies have to be financially and operationally healthy. They need to bill for and collect from every unit that is sold, reduce theft and technical losses and operate as efficiently as possible. Without a healthy distribution sector, the ISMO cannot be creditworthy; and if the ISMO is not creditworthy, private generators will not sell power to it. As part of MCC’s compact with Malawi, the government is exploring various structures for the power market, including the ISMO model. Whichever way the government restructures the power market, Malawi can expect to be on a path where the private sector supplies more of the capital for system expansion, where there is more independent regulation and where the power market operates with more transparency and efficiency.

Looking forward

MCC has a track record of successful interventions in the power sector in Africa; to date approximately 10 percent of its worldwide investments have been in the power sector. Its first African power sector investment was a $205 million program in Tanzania that focused mostly on building infrastructure and strengthening utility capacity. The $350 million single sector compact in Malawi is more comprehensive and expects to strengthen the physical infrastructure, improve the sector policy environment and build the capacity of sector institutions. MCC recently signed a $498 million program in Ghana, fully dedicated to the power sector. MCC is actively developing programs in Tanzania, Benin, and Liberia that are likely to include investments in the power sector. Of these, Tanzania, Ghana and Liberia are Power Africa countries, and its compacts with these countries will be MCC’s contributions to President Obama’s Power Africa initiative. Through sector reforms, infrastructure investments and improvements in institutional capabilities, MCC’s engagement should help partner countries move up the energy ladder, allowing women and their families to breathe cleaner air, children to study at night and businesses to function more productively, thereby creating more jobs, reducing poverty and generating economic growth.