Why the country and its president are fighting the wrong enemy on electricity tariffs
A large cross section of Ugandan elites is angry, very angry. It thinks the price (tariff) it buys electricity at is too high. So it has been looking for a villain to blame and has identified Umeme, the private utility licensed to distribute electricity. President Yoweri Museveni, who many Ugandans accuse of owning the company, has also joined the anti-Umeme coalition. Last year his villain was Bujagali Electricity Limited (BEL), the largest hydro electricity generator in Jinja. So the villain is a moving target and this explains why the debate on causes of high electricity tariffs is a toxic combination of high emotion and little knowledge.
The villain in the electricity tariff is not a person (Museveni’s critics would want to blame him, he likes to blame civil servants who negotiated the licenses). Neither is it a company (Umeme or BEL who have recently become the punching bags). It is our government policy on pricing electricity consumption. Our government, based on advice by World Bank and IMF, decided that it does not have enough money to invest in generation and distribution of electricity. It sought private investors into the sector.
Private investors were reluctant to invest in Uganda’s electricity sector because our country’s risk profile was high, the market uncertain. These fears were not unfounded but delving into them now will divert us. So for today let us say that they demanded government guarantees three things: a fixed rate of Return on Investment (ROI), bears the foreign exchange risk and agrees to bulk-purchase all the electricity generated and bulk-supply all electricity needed for distribution.
In a normal market, an investor identifies an opportunity, raises capital and takes the necessary risk to turn into a profitable investment. If she produces a product consumers do not like or produces more than what the market can take, she suffers the consequences of her decision. The electricity sector has many structural circumstances that make it impossible for private capital holders to venture into it without the aforementioned government guarantees.
Hence, for those who produce electricity, government signs a Power Purchase Agreement guaranteeing to buy all the installed electricity capacity at a fixed price over say, 30 years. If water levels in Lake Victoria fall and the dam at Bujagali produces only 100MW government guaranteed to pay BEL for the entire 250MW installed capacity. This is the infamous “hydraulic clause” we fought ferociously in the late 1990s and succeeded at foiling AES Nile Power from developing Bujagali dam. It delayed the investment for 10 years with heavy costs in blackouts that still haunt my conscience. Now I appreciate the necessity of certain provisions that sound obnoxious to the uninitiated.
If wires collapse and all the electricity cannot be transmitted and/or distributed, government still pays BEL for a full 250MW. The same applies to Umeme. If consumers demand less electricity than BEL is producing, government guarantees to pay the company for 250MW. The same applies to Umeme. To an ordinary mind these guarantees sound an unfair bargain. But they are the unavoidable and necessary cost a poor country with a high-risk profile pays to attract private investors into its electricity sector.
Private investment comes with other costs. First, it borrows expensively compared to government; the high interest on their loans is transferred to the consumer through the tariff. For example, most of the private generation facilities are just coming on board. The investors are still servicing these high interest loans and are also doing accelerated depreciation, which is all billed to high tariff.
Secondly, private investors demand a high ROI in countries with a high-risk profile. In our case, it is 20% for Umeme and 19% for BEL. Third, investors raise capital in dollars but electricity in Uganda is sold in shillings. So the foreign exchange risk for the depreciation of the shilling is born by the consumer through the tariff. All these costs are a result of government policy, not private companies that generate and/or distribute power.
This path of using private investment to generate and distribute electricity has paid off for Uganda. It has lowered the country’s risk profile and attracted private capital into our generation and distribution market. However, it has also led to high tariffs that stifle investment in manufacturing and inflict untold damage on the environment as people cut trees to burn charcoal for cooking. The blunder is to threaten such investors the way Museveni recently did with Umeme. It raises the country’s risk profile making it expensive to attract private capital from debt and equity markets.
How does Uganda price electricity without increasing her risk profile? Government has already returned to building and operating dams beginning with Isimba and Karuma. Yet we need massive investment in transmission and distribution to evacuate and supply the 800MW of electricity coming on the grid at the end of this year. That requires investment of $800m in transmission and another $1.5 billion in distribution. Does government have this money? Recently the central bank was complaining that our debt is about to reach the proverbial 50% of GDP.
There is a second risk: if Karuma and Isimba power is not consumed (because we haven’t invested in distribution or don’t have buyers) government pays. So the choice in getting cheaper electricity is between a government subsidy or a high tariff or a combination of both. Government will be driven by politics to prefer subsidies to a high tariff. Once you begin subsidies, they are difficult to remove. But either way the final cost is born by the taxpayer/consumer.
The real challenge of Uganda is one of policy attitude towards electricity. Our government can look at electricity as a service like any other such as air travel, telecommunications, data, etc. and price it using market mechanisms. Here it would let the tariff reflect the cost of investment and a risk adjusted rate of ROI. This decision will discourage manufacturing and inflict damage on the environment.
However, government can look at electricity as a public good or service like roads, recognizing it has powerful implications on manufacturing growth and environmental sustainability. Thus it can use taxes and borrowed funds to build dams, transmission and distribution lines and connect everyone to the grid. There would be no direct financial ROI. Government would bear the interest and depreciation costs, so the tariff would only reflect operational costs of running the system. Ethiopia is doing this and China did it. As the South Africans would say, we can also “did it”.