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In the past, Kenya’s power sector utilized concessional financing from development partners and financial institutions to obtain capital for the construction of large-scale energy infrastructure, from building power plants to installing transmission lines. However, two decades ago, Kenya began to effectively mobilize private investment to meet its financing needs. In contrast to most sub-Saharan countries, in which electricity is often 100% state-owned, generated and distributed, Independent Power Producers (IPPs) make up a sizable share of Kenya’s electricity supply mix, representing approximately 30% of generation capacity and 53% of incremental generation capacity since 1990.
Entering the market through a mix of directly negotiated and competitive bid projects, IPPs began under regulated power purchase agreements to supplement power production. IPPs are considered attractive due to their tendency to exceed the technical and operational performance of their public counterparts, to reinvest in technology and innovation, to recoup the cost of investment through the retail of electricity and to reduce the burden of public sector financing.
Through its initiative known as ‘Maximizing Finance for Development,’ the World Bank spearheaded the utilization of commercial financing, in partnership with the Kenyan government, to meet energy infrastructure needs in the country. Since 1997, this approach has resulted in progressive reforms in sector policies, laws, regulation and institutions to create conditions that foster private sector investment and establish effective planning, tendering and contracting capabilities.
The first phase of reform differentiated policy and regulatory functions from commercial interests, liberalized generation activities, unbundled generation from transmission and distributition activites, established the national sector regulator and introduced cost-reflective tariffs. Two major utilities in the country – Kenya Power and Kenya Electricity Generation Company – are now publicly listed companies that are able to tap into capital markets for outside investment. The second phase involved ameliorating the operational and financial performance of sector utilities, establishing a close relationship between generation and distribution utilities through dynamic power purchase agreements, and establishing new entities with directives for developing transmission, geothermal resources and rural electrification.
Roadblocks to Private Investment on the Continent
Challenges remain in driving private sector participation in building generation, transmission and distribution capacity. These include a challenging financial ecosystem for commercial capital, in which commercial banks are often crowded out by multilateral banks on both loan tenure and interest rates.
Processes related to project selection, negotiation of Power Purchasing Agreements, securement of land and the provision of Letters of Support by governments remain inconsistent and difficult to navigate, leading to increased costs and time delays, especially for private off-grid developers. For the public sector, state-owned enterprises often encounter inadequate financing models, and the government of Kenya, for example, continues to carry significant financial exposure when it comes to the energy sector. Once financing is secured, high infrastructure development costs are faced, and a long lead-time is required for implementation.
Despite these obstacles, one of the ways in which Kenya has succeeded in attracting private investment – and that other countries on the continent can follow – is by providing a financial backstop for independent producers. In Sub-Saharan Africa, governments often provide subsidies to offset the high cost of power generation. However, these subsidies make power projects less bankable, reducing returns on investment in the process. As a result, the Kenyan government has turned to alternative financing to back IPP projects.
For example, the East African country received a Partial Risk Guarantee from the World Bank to backstop IPP projects, and in April 2018, received an $180 million International Development Association (IDA) guarantee to mobilize private sector financing and strengthen the financial position of KenGen. Guarantee instruments from the IDA, the concessionary arm of the World Bank Group, promote private sector involvement in the generation sector, further enhanced by risk mitigation instruments from the Multilateral Investment Guarantee Agency and equity and debt support from the International Finance Corporation. With financial guarantees in hand and a stable, government-backed regulatory environment, Kenya has been able to draw substantial private investment into its power sector, with at least three billion dollars in private capital mobilized in the power sector between 1997 and 2018.