Cost-reflective Tariffs: What approach should African Economies embrace?

Cost-reflective tariffs have been a much talked about topic – why does this continue to be problematic and what are the possible solutions?

Policy makers and actors have always found themselves faced with a Policy dilemma, trying to trade-off between cost–reflective tariff and subsidized tariff or what political class will refer to as pro-poor tariff.

I subscribe to the school of thought that argues that by the end of the day every single citizen in an economy should enjoy access to affordable electricity, which can only be achieved through cost-subsidizing tariff by government.

The entire discussion on whether cost–reflective on one hand or cost-subsidize tariff on the other, revolves around first power purchasing agreements which governments enter into with the energy investors. What one needs to understand is that the manner in which purchasing power agreements are drawn, is long–term say for a period of between 20 and 25 years, so the agreements dictates are that you pay as much say 10 billions of dollars. What this does therefore is to lock down costs during this period of time which means no adjustments can be made hence the tariffs will not be cost–reflective over this period of time.

The other aspect is that in Kenya for example electricity end user’s bills – that is both domestic and industrial consumer have not captured what I will refer to as pass–through charges. These are charges such as adjustments that involve inflation rate, exchange rates and Cost of living, which periodically keep changing. In other words there is very little adjustments that are drown and captured in the power bills and this does not mean that infrastructural and high way costs were not incurred but since most African Governments are perusing a subsidized tariff regime, meaning somebody else pays for you, this aspect is not reflected in the customers’ bills.

Now suppose this costs were passed on in form of High tariffs to consumers, it would be chaotic, making few persons or entities access electricity and most of the economy redundant. Again, not many consumers understand the nitty–gritty or the components in the bills, for them, high bills translate to affront or being defraud by grid connectors.

A recent scenario in Kenya is that electricity generators incurred 10 billion KES Kenya shillings ($100m) and the Kenya Power and Lighting Company KPLC which is the grid connector and a retailing and distribution company wanted to pass on this cost in form of high tariff charges with them being backdated for 3 months, this attempt brought about an uproar among the general public. What the government did then was to direct KPLC to suspend the pass-through charges and levy the lowest tariff possible with the government reimbursing and offsetting the balance, this is clear not a Cost–Reflective.

The down side of this is that since the consumers of power are aware of this subsidy programmes, they tend to be extravagant and not efficient in their use of power, which should not have been the case if the cost was passed to consumer in form of high tariffs given that they will feel the pinch.

The Southern African land scape is an interesting one. In SADC region for example, the 5 year period through which all member states were supposed to have transitioned to cost-reflective tariff by end of 2013 set out by the ministerial council, saw only Namibia and Tanzania attain this and so to me, this aspect or rather this thematic issue needs to be looked at in greater perspective of the Entire Economy and not in Isolation.

South Africa for instance, National Energy Regulator [NERSA ] among its mandate as envisaged in the Energy white paper 1988 is to improve Social Equity and address the requirements of low–income Households, this is not going to be achieved if governments of Africa will embrace Cost-reflective tariff rather the governments needs to embrace Cost–Subsidy tariff and grants programmes.

Countries such as Germany, China and most of the OECD countries in Europe apart from Australia are pursing a subsidy tariff regime especially in Renewable Energy. It is Only Australia and parts of USA, some federal states like New York, Virginia which have walked away from the Cost–Subsidy Tariffs.

The Way Forward

In my view, to start with, Developing Economies are totally not ready for CostReflective Tariff, therefore governments ought not to rush on this issue. The following approaches can be adopted:

There should be a mechanism on how to encourage individuals or rather consumers of electricity to be aware of the tariffs they pay vis–a–vis what governments pays for them, so as to really understand the value they get on their power or rather electricity bills, by understanding the cost allocated to them in relation to the cost Government pays, that way they will be more efficient, more vigilant and effective in managing their power use and avoid extravagance at all cost.

Another approach is to adopt Cost-subsidy, which can be partial, or full, depending on case–by–case scenario but mostly Partial Cost-subsidy is highly recommended due to the above mentioned reasons.

Thirdly governments, on the other hand need to be very sincere with themselves, because again, with issues of Cost-subsidy tariffs, they bring with them serious budget constraints given that they constitute a greater proportion of country’s budget. Economies such as Germany and China have heavily felt the burden in respect to this issue, therefore they is a need to allow government through their regulatory agencies do cost adjustments on pricing, and detach politics as well as introduce Legal mechanism so as to carefully balance the need for Universal Access to Energy by all and Cost issues on the other side.

For instance there is need to address, encourage and initiate legal reforms that make it possible to address contemporary dynamics within the Energy industry in our countries. In this, there should be legal provisions that make it possible to have energy generators as well as independent power producers sell electricity directly to Grid Connectors, that way the issues of efficiency and affordable power to end users on service provider’s part will be attained and achieved. This way, grid connectors will have discretion on which energy power source they should buy from which will translate to affordable tariff to end users.

Delocalisation and deregulation of the energy markets is a perfect approach as well, here there is need to have one central control unit, maybe the Grid connectors, but there should be a revision in existing laws to allow energy investors and generators, sell direct energy to Grid connectors as well as provide means to how that electricity gets to the end users. Remember the contention has always been that producers want cost to be reflective but the end users want cost to be subsidized and in many countries, the issue of electricity generation, transmission as well as distribution and the entire supply chain ought to be borne by the Investors. This has not been the case in most African Economies, given that these infrastructural arrangements have always being treated as highways which belong to governments and are borne by the Governments.

In addition, the conversation around these issues ought to be looked at in a bigger picture. Which is what the role on Energy in an Economy is, does it spur the economy for instance? Does Access to affordable energy lead to additional two firms being established in the manufacturing industry for example, does it lead to increased employment in various sector of the economy as a result of many Small and Medium Enterprise are established, what’s the effect of power in the Agriculture industry? Does affordable power encourage and motivate Foreign Direct Investments (FDI) as well as spur or act as catalyst in increasing domestic investments? And of course the political constituents of support which model when adopted will bring you additional two votes, which will get governments out of power? The political variable is a component that is still and will remain at play and cannot be washed away.

Therefore, I chose to look at this issue from a point of how does Access to energy Plug into the mainstream economy. It is all about what is the Multiplier effect of Access to affordable Energy

Take a look at the real issues around the manufacturing sector in South Africa for example. Why didn’t the conversation around Mineral beneficiation actualise? It is all about Access to affordable power and making it available, which will motivate and encourage FDI.

If Governments look at it that way, it should be able to navigate around this issue perfectly and competently.