Power sector hiccups: IMF throws hat into the ring

1 Comment » September 5th, 2008 posted by // Categories: Energy Development Project

Power sector hiccups: IMF throws hat into the ring – Guardian
By Bukky Olajide

THE International Monetary Fund (IMF) having taken a look at the power sector in Nigeria and other sub-Saharan African countries and having concluded that the models employed have yielded disappointing results may have assumed the front seat in redressing the situation.

The Regional Economic Outlook on Sub-Saharan Africa, a publication of the IMF for 2008 observed that the policy choices- the tradition that predominates in the sub-Saharan African power sector-vertically integrated, state-owned monopolistic utilities has yielded disappointing results.

It was also observed that reform to increase efficiency and boost competition through private participation had in many cases failed to deliver the expected results: unbundling is limited, failure of transactions and projects have been frequent and there has been minimal additional investment.

The IMF noted further that the lack of strategic policy and planning for the electricity sector at the central government level was a critical weakness because interventions had been piecemeal rather than integrated.

For example, many countries have focused on generation without investing in efficient transmission and delivery of power.

According to the report, a well-articulated plan for the sector will allow government to move beyond the “firefighting” that has reduced their ability to plan for exogenous shocks, such as drought or high oil prices.

The IMF continued to observe that past efforts at improving utility management focused too heavily on technical issues to the exclusion of governance and accountability.

Good governance practices in sub-Saharan African utilities are often observed in the breach. Yet transparency and accountability depend on solid financial management, procurement and management information system.

This, for example, will require the auditing and publication of financial accounts and the use of comprehensive cost-based accounting systems that allow functional unbundling of costs and a clear.0er sense of cost centres.

Talking about the way forward and the overall development of the power sector in the sub-Saharan African, the IMF said that the lesson that emerged from failure of the power sector was that tackling the challenges was not a simple function of the models adopted.

Therefore, the power sector in Africa needs to move to a “mixed economy” characterised by a range of structures, regulation and technologies adopted to each country’s context.

Accordingly, successful intervention will tackle several problems simultaneously to put the sector on a positive trajectory of improved sector and utility management, financial viability, new investment and better customer service.

This means recognising that the power sector has quasi-monopolistic characteristics – particularly in grid based distribution and to a lesser extent in transmission – and in that incumbent utilities will continue to be the largest players in the sector for the foreseeable future.

But, according to the IMF, interventions also need to be innovative and ambitious, recongising that meeting customers’ needs means multiple providers, financial viability, and new forms of external financial assistance.

“Where certain preconditions are in place – including appropriate regulatory frameworks for public-private partnerships, reformed tariff frameworks and sufficient security of investment for investors – sector reforms can do much to facilitate the entry of strategic private partners,” said the report.

Consequently, the starting point is sustained and concerted action on three-strategic priorities namely, regional scaling-up of generation capacity, improving the effectiveness and governance of utilities and expanding access through sector-wide engagement.

“The three are interdependent and must be tackled together,” said the report, explaining that efforts to boost generation and regional power trade will stumble if the utilities, which will continue to be central actors in the sector, remain inefficient and insolvent.

The report warned that expanding electricity distribution systems without taking measure to tackle the shortages in generation and to improve transmission capacity would clearly be futile.

“And focusing exclusively on utility reform would be fruitless unless a start is made on substantial, long gestation investments in both generation and access to improve quality of service and render the utilities viable,” the report added.

In short, noted the report, these strategies priorities must progress together saying while at the same time, the time required to yield results from these actions is such that they need to be complemented by such short-term measure, including demand-side management (for example, the introduction of energy-efficient bulbs) and loss reduction programmes (such as enhanced bill collection and initiatives to tackle electricity theft).

Talking about regional scaling up of generation capacity, the report reasoned that the first strategic priority was to tackle the generation capacity deficit head-on, because Africa’s considerable hydro, gas and coal resources remain under exploited.

According to the report, the best way to scale up generation in the lowest unit cost is to develop a new generation of large-scale generation projects.

“An initial wave of projects could include the Temane gas-powered plant in Mozambique (750 MW) Gilbe hydropower in Ethiopia (1,800 MW) and further development of generation capacity based on natural gas from Nigeria,” it said.

However, it said, individual countries do not have the necessary investment capital, or even the electricity demand to move forward with these large projects.

“A project finance approach predicated on regional power off-take, in which private sector participation and donor funding are blended is needed,” it said.

The IMF observed that expanded generation capacity was redundant unless the power could be transmitted to users, saying that this was where regional power pools play a critical enabling role.

The report stated that challenges common to all the pools were rehabilitation and expansion of the cross-border transmission infrastructure to increase the potential for trade and harmonisation of regulations and system operating agreements.

Equally important is the formulation of market trading mechanisms so that the additional energy generated from large projects can be priced and hence allocated in an efficient and fair way (for example, via competitive pool arrangements).

The report said further that while the economics of regional large scale generation projects were convincing, they might give rise to significant political challenges, saying that the gains from trade were much larger for some countries than for others, and considerations of self-sufficiency sometimes had more political weight than access to low-cost power.

“These factors need to be addressed early in the project development cycle,” it said.

The IMF also observed that large-scale regional energy schemes had deep financing requirements.

For example, capital expenditure for power projects in the Democratic Republic of Congo is estimated at $4 to $5 billion, which is beyond the capacity of concessional financing from development partners, even after significant increases in aid.

Private participation will be pivotal, said the IMF, yet successful private investments in energy projects have been rare in Africa, and increased private investment will not materialise simply because of large infrastructure financing gaps.

“The lesson learned from past failures need to be addressed, as private investment will only flow where rewards demonstrably outweigh risks,” said the report.

Large-scale regional generation projects would have several attractions in this respect: Large investments benefit from economies of scale: for a given amount of generation capacity, the total costs (design, engineering, capital items, civil works, safeguards and others) for one large plant are lower than for several smaller plants with the same aggregate capacity. All else being equal, investments in larger projects are therefore likely to be more profitable.

The investments would primarily be in standard alone generation projects that present fewer risks than investments in vertically integrated utilities whose operational and regulatory risks (organisational inefficiency, lack of financial transparency, geographical distribution of personnel and assets, governance, risks, political interference and contingent risks like an uncertain legal framework) are far harder to price.

There is increasing realisation that investment in new generation capacity cannot be undertaken in isolation from other efforts in the sector. Capital is more likely to be forthcoming in an environment where other factors-such as the tariff structure, power purchase agreement and reliable transmission interconnections-have been addressed. Utilities that are better run will eventually be able to move beyond covering operating expenses to invest in system expansion, making the whole sector more viable. Public sector financiers like the World Bank are also becoming more nimble in their deployment of tools to help crowd in the private sector, such as risk-mitigation instruments.

The report also talked about improving the effectiveness and governance of utilities saying that tackling shortcomings of the power sector would require improvements in the regulatory and tariff framework at the sector level, as well as better management in utilities.

According to the report, financial viability of incumbent utilities and hence credit-worthiness and access to domestic and international private capital is important for the overall development of the sector.

It demands that utility revenues allow at least the recovery of operating cost and ideally some contributions to capital costs.

“That means that in many cases tariffs need to be gradually adjusted to levels that will allow these goals to be met, while remaining sensitive to the needs and capacity to pay, of poorer households,” said the report.

It explained that the corollary of tariff adjustments was the need to significantly reduce operating costs to lessen the financial burden on consumers of efforts to recover costs.

Therefore, operational efficiency programmes are needed to reduce the high rates of technical, non-technical (electricity theft) and collection losses and these can include capacity building and technical assistance to improve management, business practices and planning.

According to the report, priority areas are improved load management (to better match supply with priority customer needs) theft reduction initiatives, and increased revenue collection (though enhanced metering and better-run customer service units).

It stated that using low-cost technology standards, as undertaken in Mali and Guinea, could also drive down capital expenditure.

“Innovations have included adjusting technical design standards to meet the reduced requirements of low-load systems, maximising the use of material provided by local communities (such as locally sourced wooden poles) and the use of local employees and supervisors recruited from the community,” it said.

According to the IMF, oversight and transparency also need to be enhanced by better corporate governance (for example, by reforming how senior managers are appointed, insisting on conflict of interest disclosures and making staffing practices more transparent and effective.

“Many of sub-Saharan Africa’s newly established energy regulators can play an important role in this area, even in the absence of private participation in the sector,” it said.

In practical terms, the IMF observed, even with appropriate tariffs, reduced operating costs and better governance, the combination of experience, maintenance intensive equipment and the inability of even moderately wealthy households to pay for the full capital costs of domestic grid extension means that full cost recovery in Africa was not yet possible.

“Governments must therefore be able to articulate, in their strategic policy framework, the economic benefits of subsidies to the sector, as well as the path to eventual full cost recovery,” said the report.

The IMF also expressed concern about the fact that power was often unavailable to lower income groups which means that those who did not have access were not benefiting from government or external finances.

According to the report, from a social, poverty reduction and political perspective, it is therefore imperative to expand access, saying that given the scale of investments acceded, a systematic approach to planning and financing new investment is critical.

Its words: “The current project-by-project, ad hoc approach in development partner financing has led to fragmented planning, volatile and uncertain financial flows and duplication of efforts.

“Engagement across the sector in multi year programmes of access roll-out supported by multiple development partners as part of a coherent national strategy will channel resources in a more sustained and cost-effective way to the distribution sub-sector,” it said.

The IMF also said that since universal household electrification was still decades away in many countries, it was equally important that sector-wide programmatic approaches ensured that the benefits of electrification touched the poorest households, particularly deep in rural areas.

Finally, it is important to recognise that most of these measures are medium term in nature and cannot be implemented overnight.

The IMF said that as strong economic performance continued to escalate power demand, many sub-Saharan African countries would continue to face a very tight demand-supply balance in the coming years.

Its words: “It is therefore critical that that longer-term efforts to redress the underlying structural caves of sub-Saharan Africa’s current power supply crisis to be complemented by short term measures to soften the economic and social impact of power scarcity.

“Recent experiences from countries such as Brazil show that well-designed demand side management measures (for example, a quota system with price signals, combined with a public energy efficiency campaign) can go a considerable way toward trimming peak demand, thereby substantially reducing the extent of power rationing at a relatively low economic and social cost,” said the report.

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One Response to “Power sector hiccups: IMF throws hat into the ring”

  1. Gordon says:

    This is a wonderful opinion. The things mentioned are unanimous and needs to be appreciated by everyone.I appreciate the concern which is been rose. The things need to be sorted out because it is about the individual but it can be with everyone.A very smart and diplomatic answer. It

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