Why Parliament and government should be kept out of business to allow private investors to deliver electricity
Two weeks ago, an ad hoc committee of parliament recommended government cancels its contract with Umeme for the distribution of electricity in the country. The committee raises many complaints against the concession agreement and Umeme’s performance; a few correct, some legitimate, others completely wrong, many erroneous and most of them ill-informed.
In fact, by relying on many erroneous and ill-informed arguments to recommend an arbitrary cancellation of the concession, the committee inadvertently demonstrates why it was vital for Umeme to insist on the very provisions in the concession that parliament feels are unfair to the Ugandan people.
The background: when government decided to unbundle Uganda Electricity Board (UEB) into three separate entities to manage electricity generation, transmission and distribution, it hired an international company called Fieldstone Private Capital Group Limited to help handle the matter.
After two years of work, government put out a tender for generation and distribution concessions. Five companies expressed interest and came to Uganda to do a due diligence on the sector. After studying our political and regulatory framework all of them pulled out without submitting a bid.
What were the issues? They are largely of a political nature. Uganda had subsidised the electricity tariff for a very long time. The electricity tariff had remained unchanged from 1993 to 2002. The prevailing price then was far below the actual cost of generating, transmitting and distributing electricity; it’s value having been eroded by inflation and foreign exchange depreciation.
The country had also ignored or condoned rampant power thefts. Thirdly many people who were in default were not being taken to task. Note: in Kenya, for example, the electricity tariff is subject to constant adjustment every year to both domestic inflation and foreign exchange depreciation.
Consequently, Ugandan electricity consumers took it for granted that electricity was cheap and that its price could not change. Secondly, there had grown and consolidated a culture of impunity where thieves and defaulters could steal and/or refuse to pay and remain untouched.
These were causing high nontechnical losses in the sector. To compound this, UEB had spent decades with little or no investment in improving the distribution lines, transformers and meters. This had led to high technical losses making the sector unattractive to investors. UEB was a government parastatal and no one cared whether the tariff covered the costs of electricity production.
The solution to this conundrum was doubled edged: to reduce technical losses would demand heavy investment in upgrading the power lines and transformers, meters and even more investment in human resource. If any private investor did this, they would have to charge this cost through the tariff.
Second, to reduce nontechnical losses required that the investor would have to ruthlessly clampdown on power thefts by raiding homes and small businesses to apprehend illegal connections, hire a security force to curb thefts of power lines, transformers and tampering with metres and finally ruthlessly cut off power to many defaulting customers to force them to pay. This operation would destroy the image of any investor before his customers.
Besides these measures had political implications. Potential investors feared that the public would not accept increases in the tariff because a culture of consuming cheap electricity had penetrated the political consciousness of consumers. Investors complained that the regulator did not have capacity to make the independent decisions.
This is because the Electricity Regulatory Authority (ERA) had once increased the tariff and government intervened and suspended it. Indeed, if you look at the books of UEDCL, you will find a back-to-back debt it owes generation and transmission companies which has never been recovered. UEDCL could not collect money because the minister stopped it from doing so for political reasons.
The Commonwealth Development Corporation (CDC) put these issues in writing, rising issues of political risk, foreign exchange risk and revenue collection risk. However, they said that if these issues were addressed, they could bid. Government decided to talk to them.
After the bidding, they formed a consortium with Eskom, one of the other bidders. Both are parastatals, one owned by the British government, the other by the South African government. No private investor was willing to risk their capital in such a tense political climate.
The negotiations between government on one had and CDC and Eskom on the other lasted three years. Government promised to protect the investor from regulatory and political risks and the concession was designed by escalating the penalties government would pay in case of a breach.
This was the first distribution concession in Africa. CDC and Eskom feared that if anyone attempted to increase the tariff, especially at a steep rate, it would cause thefts, defaults and illegal connections. So the concession made it clear that government could not increase the tariff for more than 10% in any given year and not more than 20% in any three consecutive years.
Thus, although the public and parliament accuse Umeme of seeking to increase the tariff rapidly, Umeme has been against it and this is enshrined in the concession agreement. In fact rapid increases in the tariff are a violation of the concession, which should force Umeme to pull out.
The question then was: if the tariff was going to remain stable and change only by not more than 20 percent every three years, who was going to pay for the mismatch between the existing tariff and actual cost of production, transmission and distribution? The answer is government through the subsidy.
Even after government had agreed to these demands, Umeme was reluctant to join and asked for an 18 months concession as a trial run to see whether government would honour its word. They agreed to invest a nonrefundable $5 million in these 18 months.
Five months to the end of that period, in March 2005, power supply declined by 50 percent due to low water levels in Lake Victoria. This forced government to bring in thermal generators, a factor that escalated the cost of electricity, thus making increasing the price of subsidies.
To avoid bankruptcy, government decided to increase the tariff by 22 percent in March 2005, then 35 percent in May 2006 and another 43 percent in November 2006. Thus, in less than two years, government increased the tariff by 98 percent contrary to the concession agreement. Again, Umeme had all the rights to terminate the concession. Government would have been forced to compensate them fully. Indeed they threatened to do exactly that, a factor that triggered negotiations with government.
Umeme argued that such a sudden hike in the tariff was going to increase illegal connections and defaults, making it difficult for the company to reduce nontechnical losses. The result was that government suspended the loss reduction targets to keep Umeme involved. It is only after electricity supply constraints were eased in 2009 that ERA began to set collection and loss reduction targets. In 2009, losses fell from 35 percent to 30 percent and in 2010 they fell to 28 percent. This year the losses have fallen to 24 percent and in 2018, Umeme has a target to have reduced them to 14 percent.
Given that technical and non-technical losses in Kenya are 17 percent, Tanzania 20 percent, Rwanda 22 percent and Burundi 25 percent, the targets set for Umeme by ERA are going to make Uganda have the least losses in the region by 2018. Parliament should seek to hold Umeme to account on these targets rather than seek to cancel their concession.
But political interference in the tariff market has not gone away. Over the last one year, there has been no approved tariff. Why? Because ERA drew a new tariff which it asked government to approve. Yet ERA is not obliged to seek such approval. This means that ERA is not or does not feel independent, the very factor that scared away investors in the sector in 2001.
You cannot judge something that you cannot measure. That is why in all serious companies and contracts, parties are given clearly defined performance targets against which to measure the results of their work. In the case of the Umeme concession, they have five targets set by ERA: on connections, collections, loss reduction, investment and operation and maintenance costs.
On each of these targets, Umeme has either achieved them or surpassed them. This is not to say Umeme has no problems. One can find one million and one faults with Umeme. However, judgment of its performance can only be based on set targets – otherwise we risk subjecting it to the arbitrary whims of individual consumers and politicians.
Under the concession agreement, Umeme was supposed to have reduced electricity losses from 38 percent to 28 percent in the first seven years of the contract. They have reduced them to 24 percent by end of this year – four percent above target.
They were supposed to have invested US$65 million in the first seven years; they have invested $130 million. They were supposed to make 60,000 new connections in the first seven years; they have made 220,000 connections. They were supposed to increase collection of revenue from 75 percent to 95 percent; they are collecting 98 percent of total electricity sold as per 2013. They have exceeded their operation and maintenance costs because over achieving their connection and collection targets.
As I write this article, the Uganda electricity distribution network is still poor and in urgent need of massive investment. Heavy rain is enough to make some lines go off. There is still rampant theft of transformers and electricity wires. Even though Umeme has been investing in these lines and new transformers much more needs to be done.
Uganda has a distribution network of 26,000km of lines, with 67 substations, 8,000 transformers (of which 7178 have been installed by Umeme) and 370,000 poles. Of these, Umeme has replaced 200,000 poles and there are 60,000 more poles urgently needed to replace those that are in bad shape.
Secondly, 16 percent of the network needs replacement. It is not practically possible to finish this work in one or two years, even if one had the money and desire to. Currently, the estimated cost to fixing these problems is US$500 million.
Assuming Umeme invested this money in just two years to solve these distribution network problems; who would pay for it? Of course it is the consumer through the tariff. Is the Ugandan consumer willing to accept another tariff increase? If the tariff were increased, what would be the response of parliament, the mass media and the political marketplace? Is it not possible that we would see demonstrations in Kampala? Is the Yoweri Museveni administration, already beset by constant public demonstrations in the city willing to suffer the political costs of increasing a tariff?
Again it is politics stupid. Politics demands that there should be a balance between the rate of investment in improving the network and the tariff Ugandan consumers are willing to pay. If you are Umeme, you know that your customers are angry with you for all the wrong reasons.
First, Umeme contributes the least to the tariff. Out of the total price for electricity paid by consumers, Umeme takes only 15 percent – 85 percent goes to generation companies and the transmission company. Yet the consumer, largely because he/she pays this money to Umeme transfers all their frustrations onto the distributor.
One would suggest that government helps Umeme get concessional loans – or government makes the investment in the distribution network in order to subsidise the consumer. This is because the medium term reliability of the business of electricity distribution depends on ensuring that the consumer can afford the service. For now, the threats by parliament to cancel the Umeme concession are counterproductive.
For example, right now Umeme is in negotiations with the International Finance Corporation (IFC) and other banks to raise US$470 million over the next four years to invest in refurbishing the network. The aim is to correct existing network problems and reduce power outages.
Yet at the same time, these negotiations and plans are being undermined by threats from parliament to terminate the contract. And this is in circumstances where parliament is ignoring clearly defined performance targets given to Umeme by the government all of which Umeme has not only met but in many cases actually exceeded.
According to a PriceWaterHouseCoopers report into the utility company, Umeme’s performance has contributed to savings for the customer in the form of reduced tariffs (otherwise they would have been higher) and to the Government in reduced subsidies.
In real terms, between 2005 and 2012 Umeme has: Saved the Ugandan electricity consumer approx. Shs808 billion as a result of reducing revenue collection losses; paid Shs2,024 billion to UETCL through the costs of buying electricity; generated Shs125 billion in direct taxes and Shs99 billion in indirect taxes to the government of Uganda; directly employed over 2,000 people through permanent and/or contracted positions; made payments of Shs194 billion to UEDCL for renting the distribution network; spent Shs 278 billion through wages, staff costs and dividends; invested US$166 million into the electricity distribution network. This investment will revert to UEDCL at the end of the concession. What more do these MPs need?
written by D.Oduki, December 01, 2013