Energy auctions in Kenya may soon make energy cheaper, more readily available and reliable to individual consumers and businesses alike. The hope is that auctions may also spur significant growth in the renewable energy sector, particularly solar, which remains strangely under-developed in a country blessed with ample sunlight throughout much of the year. The new policy would see Kenya’s government buying electricity from independent power producers (IPPs) through competitive auctions. According to the Ministry of Energy and Petroleum, the auction system will allow the government to select interested power producers offering the lowest prices to build power generating plants which will be connected – either by the IPP or a government entity – to the national grid.
Kenya is by no means the first country to institute energy auctions. Indeed, for many countries hoping to promote their transition to renewable energy sources and related technologies, energy auctions for contracts to develop power-generation capacity have emerged as an essential policy instrument. South Africa and Zambia are two relatively successful cases in Africa, but energy auctions have also been usedfrom Denmark to Brazil to China.
FITs to Energy Auctions
Kenya’s auction system will replace its 2010 revised feed-in tariffs (FiTs) process. FiTs is a one-time, negotiated concession between an IPPand a government that allows the IPP to sell electricity generated by renewable energy to an off-taker (generally the state-owned electricity utility) at a pre-determined tariff for a given period of time.In Kenya, the FiTs policy has permitted a potential IPP to identify – at their own cost – a renewable energy site. This includes but is not limited to renewable energy sources such as wind power, small hydro, solar, biomassand geothermal. As part of the FITs process, the would-be IPP needed to provide their own pre-feasibility study to the Ministry of Energy and Petroleum for authorization by the FiTs Committee. If accepted, the potential IPPwas issued with an Expression of Interest (EoI) to develop the particular renewable energy project, vending the power produced therefrom to the national grid via 20-year power purchase agreements (PPAs).
According to reports the FITs process was flawed in Kenya. In particular, it has been blamed for delays in project development. This is because many IPPs are said to have signed PPAs at specific tariffs. However, the IPPs then opportunistically waited for drops in the price of renewable energy equipment thereby delaying the project exponentially. Kenya’s FITs system has furthermore been criticized for a lack of certitude in project pricing as well as transparency. Lastly, there have been claims that the current FITs system may snuff out competition thereby failing to lead to lower consumer prices.
In order to overcome these hurdles and push for lower or lowest-cost solutions through the development of renewable energy, Kenya will institute an energy auction system similar to that used by other countries. In a standard renewable energy auction the government puts out a tender and then chooses the cheapest bid from, ideally, a plethora of bids. In theory, energy auctions allow for an efficient use of public budgets.Additionally, the energy auctions set by the government should only auction identified needs. This is different from the FITs system in which private investors and would-be power producers have more opportunity to set the agenda, according to Joseph Njoroge, Permanent Secretary of the Ministry of Energy. Energy auctions also allow for an easy alignment between development of renewable energy and infrastructure planning. In general, as de Vos and Klessman noted, auctioning meets the principles of a liberalized market and free competition, assuming that cartels are avoided.
Potential and Problems
According to the popular narrative, Kenya suffers from the twin evils of electricity that is overly expensive and in short supply. Yet there are indications that Kenya may be paying too much attention to power production and too little to the grid and power distribution. Additionally, Kenya’s much-vaunted energy needs are not yet those of an industrialized country. Indeed, Kenya may eventually prove to be a country that leapfrogs not just technology but industrialization. While this is obviously the subject of some debate, a connection to every non-urban home in Kenya – given costs and logistics – is something that makes no fiscal or logical sense, particularly as self-consumption of households in Kenya is revolutionized by cheap solar solutions which do not necessarily require a connection to the grid. As such, the new energy auction system should be welcomed cautiously. True, it may potentially further drive down costs but that will only be the case if proper oversight and planning are instituted. As Andrew Dykes noted, “there is still uncertainty over what the new [Kenyan energy auction] policy will advise. [Kenyan] officials could not commit to any specifics, such as the capacity of projects which will qualify to participate in the auction, how many times the bidding process will be held in a year, the criteria for project developers to qualify to participate in the auction and under what timelines the preferred bidders would be allowed to develop their projects.”
At this stage, the government needs to work overtime to set the agenda and identify real versus perceived needs. This should not be another case of putting the cart before the horse; i.e. seeing Kenya’s electricity agenda driven by estimated consumption figures that fail to correspond to Kenya’s true energy needs. Additionally, Nairobi could look to South Africa for lessons learned in implementing energy auctions.
South Africa and the Case of Kenya
A recent article by David Tokefound that regulatory factors which promote certainty in energy deployment, including measures to ensure that projects achieve grid connection, are important in assuring delivery of the programs. Toke highlighted how the South African Department of Energy (DOE) required that there must be an agreement by bank(s) to underwrite any debt as a condition for a bid to be accepted by a potential power producer. In other words, if the DOE found the financial plausibility of the bid to be unsound it was thrown out.Toke’s research also pointed to three additional criteria necessary to achieve the coordination of a successful renewable energy program.
First, South Africa introduced a penalty system that ensures those who win bids at energy auctions and then accept government contracts are committed to project delivery. This requires money up-front in the form of a bid bond with the DOE to the tune of ZAR100,000 per MW (approx. KSH776,906). This is roughly 1 per cent of capital costs of the project. Crucially, the bonds are returned to the bidders if the government picks another company’s bid. That is, IPPs would not lose their loan and/or capital and would be able to use it again to bid for another project. The IPP wins the tender must then deposit a further ZAR100,000 per MW (approx. KSH776,906).
Once the development stage begins, the IPP is guided and monitored by a coordinating group of agencies composed of the Department of Energy, Eskom (the South African electricity public utility which has a near-monopoly of the electricity industry), the National Energy Regulator of South Africa, and the South African Treasury. This ensures more than a modicum of oversight and pressures the IPP to complete the project.
Should Kenya choose to follow this path, IPPs that win bids to develop renewable energy would then be guided and monitored by a consortium of stakeholders. These could include the Ministry of Energy and Petroleum, Kenya Power (KPLC), the Energy Regulatory Commission and the National Treasury. The point here is perhaps less about who is involved at the ministerial level and more about oversight of the IPP. This is particularly critical when it comes to connecting the source of renewable energy to the power grid. In South Africa, Eskomhas the job (not without some problems) of ensuring a cheap connection from the IPP into the electricity grid. As Toke noted, this iscritical to the program, especially as the prices for the projects have fallen in successive bidding rounds.In other words, Kenya should avoid a situation whereby the IPP is producing unutilized power because it lacks connections to the national grid.
Making Energy Auctions Work
Kenya’s move from FITs to energy auctions is certainly welcome and will likely lead to the development of its abundant renewable energy sources in the short term. However, Kenya’s government and renewable energy stakeholders need to understand that auctions themselves are not a panacea. Indeed, they will only work properly if demand for support exceeds supply. Scarcity is a crucial criterion for making auctions work efficiently. Additionally, as de Vos and Kelssman highlighted in the context of energy auctions, should Kenya institute a policy of high prequalification requirements leading to high upfront costs, say in the neighborhood of KSH700,000, the number of bidders may drop. This situation usually benefits larger market players with more robust financial capabilities. In other words, a process that ensures adequate oversight may end up favoring non-Kenyan bids as international companies with ready access to capital bid on projects. This would potentially deny would-be Kenyan IPPs the opportunity to develop Kenya’s renewables and grow their businesses in the process. However, without correct oversight and guarantees such as bid bonds, Kenya’s government and consumers may end up not only paying for projects and the development of unneeded energy but paying more for energy that never sees a connection to the grid. Kenya must balance oversight with local context and thorough planning to achieve successful energy auctions.
Finally, studies have shown that auctions themselves do not result in cost reductions to the consumer and the government. Rather they are associated with the overalldrop in the costs of renewable energy technologies over time. This means that the problem with Kenya’s previous FITs system may not have been costs but rather proper oversight. The case of South Africa certainly demonstrates the crucial importance of oversight from the bidding process to renewable energy development to the connection to the grid. Yet, as Toke highlighted, the auction system in South Africa has had the unenviable consequence of limiting renewable energy development. This is because the auction system – in South Africa and elsewhere – has the effect not only of reducing costs but rationing projects. In Kenya’s case this is likely a plus. That is, one of the government’s criticisms of the previous FITs system was that it was driven by IPPs rather than Kenya’s actual needs for power. If this was indeed the case, the acution process may benefit Kenya should the government truly and systematically plan the amount of capacity that is implemented. This would avoid the problem of paying IPPs to develop too many sources of renewable energy at too great a cost.
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