Risk and Return in Africa Power

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Getting the balance right between responsibility for risk and returns to the private sector goes to the heart of power policy in Africa today. Ashley Brown, Executive Director of the Harvard Electricity Policy Group, talks to AOP about transparency, government guarantees and risk in national electricity sectors.

Broadly speaking, how can African countries improve their regulatory frameworks to increase power access?

It is vital to develop and implement processes that are transparent to everybody, in order to give people confidence. That confidence has to go two ways: to the investors, that they will have ample opportunity to recover their investment, including a return commensurate with the risk undertaken; and to the consumers, that they will get fair value for what they are paying. That is the critical element in the policy decisions.
A number of countries have independent regulating agencies, but a couple of issues come up. One is how independent they are and another is how transparent they are. Those vary greatly by country. Ideally, you want everything to be upfront. You want the regulator to be participatory so the processes are open; that the information being used to make decisions is open; and that the regulatory process is in fact where decisions are made, as opposed to some “backdoor, off the record,” processes or transactions.
If a country is going attract private investment, and this applies whether it is domestic or international or some combination, the government really needs to sort out who takes what risks. That needs to be very clear. You have to develop the right equilibrium between risk and return, which can be difficult. A lot of investors demand risk premiums, and for the host countries, that may or not be appropriate; and certainly the level of risk premium needs to be evaluated very closely. Finding the right symmetry between risk and reward is essential.

What types of guarantees from the government are private investors looking for before they invest in power generation in a country?

Let me give you the extreme poles in terms of examples, because ultimately, this is an issue for negotiation. If you are an investor, your ideal world is you privatize all the gains and socialize all the risk. From the consumer (and perhaps the government) standpoint, you would want the opposite: privatize all the risk and socialize all the gain. So that is the range of options, but neither of those arrangements are sustainable. It is important to find the right equilibrium. Investors should have the opportunity to get their capital investment returned and also earn a reasonable return on their investment. You need to figure out how you are going to do that, and a subset of that issue is state guarantees, which socialize risk. If the government reduces the risk for the investor, then they should also reduce the rate of return for the investor. The flip side to that is, if the investors have no government guarantees and they are taking more risks, then they need more returns. The issue for the government is this tradeoff, where the state takes some portion of the risk off the investor, which may mean lower prices in the power sector. If a government wants to take less risk, then prices are likely to be higher.
The second issue is, if you privatize and allow private actors in the market, but then government gives loan guarantees and takes the risks, then there is a real question as to whether that is privatization. What is that, really? You have to be careful to avoid crony capitalism, because if you are going to have private investment, you do not want to socialize the risk and privatize the gains. Governments need to find this balance.
The other big issues for the government and for the regulator is going to be to define the market rules. For example, are you going to have a monopoly on the market where the state-owned electric company buys all of the generation? That is one set of rules. You need a clear market design and clear rules if you expect to attract investment.

How has the development of power in Africa been impacted by the drop in oil and gas prices?

It impacts it in different ways, depending on the location. For example, if you are in Nigeria or Equatorial Guinea, which are producing countries, the impact is quote different than if you are in a country that is largely a consumer, like Uganda or Malawia. For countries that are largely reliant on hydro, such as Zambia, the impact of gas and oil prices on electricity is much less significant. For consuming countries that are relying on oil and gas for power, when prices go down it may make it easier for them to expand the grid. If you are a producing country, your market has less money when prices go down, so it is more difficult to finance projects. It varies widely as what the impact is going to be. If you are a consumer, though, it should be helpful.
It also depends on how the power generators cover their costs and how they structure rates. If you are a power generator, you are really selling two products: energy and capacity. So if your main function is selling capacity, the price of fuel does not affect you that much. If, on the other hand, you are collecting your revenues through variable rates, then the degree to which fuel costs decline could have a beneficial effect if it reduces prices and you can sell more, or it could have an adverse affect if the rates aren’t structured appropriately. How the rates are designed really has a big impact on whether or not fuel prices have an adverse or positive impact on electricity generation.
Ashley Brown will be joining us for our Power Policy panel at AOP 2017. Take a look at our other speakers and get your delegate pass here.

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