Kenya's Energy Future

UNCLAS SECTION 01 OF 04 NAIROBI 003188

SIPDIS

DEPT FOR AF/E, AF/EPS, AF/PD, EB/ESC/IEC, AND OES/ENV
USAID FOR AFR/EA

E.O. 12958: N/A
TAGS: ECON EAID EINV BTIO SENV KE ENGR
SUBJECT: Kenya's Energy Future

REF: 04 NAIROBI 1239 (NOTAL)


1. Summary: Kenya is facing a significant power shortage
and is being forced to turn to more expensive sources of
energy. Future production will come from increased
electricity generation from geothermal sources and likely
new coal-fired plants. A World Bank-promoted East African
regional electricity grid could also help Kenya meet its
growing demand, but is not an inexpensive solution. Recent
geological study of Kenya's oil-producing potential is
inconclusive. The privatization of the two dominant
parastals, KenGen, the state-run energy producer, and Kenya
Power and Light Company (KPLC),the electricity distributor
would be a near-term boost for Kenya's energy sector and
business climate. Creating incentives for Independent
Power Producers, especially in rural areas, should also be
a priority. End Summary.

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Kenya's Potential Energy Crisis
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2. Kenya is facing a potentially significant power
shortage and is being forced to turn to more expensive
sources of energy. Power outages (approximately 11,000 per
month throughout the formal system),extreme voltage
fluctuations, and inconsistent quality of electricity are
already significant problems for business and residential
consumers. According to Energy Permanent Secretary Patrick
Nyoike, widespread rationing of electricity could begin as
early as September 2006 if KenGen and Kenya Power and Light
Company (KPLC),Kenya's state-run energy producer and
distributor, do not address the problem with greater
effectiveness.


3. The current peak demand for power in Kenya is
approximately 900 megawatts (mw),and is increasing by
approximately twelve percent annually. Overall electricity
consumption is growing at seven percent per year. At this
time, the Kenyan power sector has an effective capacity to
provide 1,030 mw, barely enough to cover the demand. David
Mwangi, Chief Manager of Planning Research and Performance
Monitoring of KPLC, acknowledges that a 100 mw safety
margin is far too low -- the goal is to have at least 650
mw above the peak demand in reserve capacity. Kenya's
biggest source of electricity (providing 75% of output) is
from hydroelectric installations, which have limited
reservoir capacity and depend greatly on inconsistent
rains.


4. Compounding Kenya's energy difficulties, the
distribution and transmission systems are inefficient, or,
in many areas, non-existent. Distribution and transmission
systems are poorly designed and in need of repair. An
estimated 19% of net power generation is lost due to the
inefficiency of the power system and poor management (a
marginal improvement 2004's 20% loss). Each percentage
point of power loss translates to about $US2.5 million in
lost annual revenue for KPLC, who's (modest) goal is to
improve efficiency by one percent each year until only 15%
is lost, saving $10 million a year and increasing available
capacity. [Note: By comparison, the U.S. loses less than
10% in its electrical distribution. End note.] KPLC is
also hopes to decrease illegally-tapped power lines, which
cost the firm over a million dollars a year in lost
revenue, and exacerbates the on-going problems of frequent
power shedding and blackouts, according to KPLC's Mwangi.


5. Currently, only 15% of the population has direct access
to electricity. The government has promised to provide
electrical service to 150,000 new Kenyan households a year
for the next few years, increasing annual demand by 150 mw
per year, according to Mwangi. Most businesses, especially
manufacturing companies, are also demanding more
electricity and improved service. Kenya's near-term
electricity demand is likely to increase to at least 1,700
mw.

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Where Will New Capacity Come From?
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6. Kenya's electrical production comes from about 15,
fairly small power plants -- including its hydro network.
Kenya's biggest dam produces a maximum output of 250 mw,
compared to the world's biggest hydroelectric dams, which
produce in excess of 11,000 mw. Another hydro plant on the
Sondu-Miriu river system is under construction, with an
anticipated 60 mw coming on-line in 2006. Most hydro
potential and other "low-cost" options are already
developed, so Kenya must now pursue alternative and
potentially more expensive means of generating electricity.


7. Future production will likely come from new coal-fired
plants. Coal is found in small quantities in Kenya, and
the GOK intends to explore for additional sources. KenGen
and KPLC believe that imported coal prices will remain
lower and less volatile than oil, and so are committed to
exploring the possibility of new coal plants, whether or
not significant quantities are mined in Kenya. KenGen is
searching for sponsors to pay for a feasibility study on
establishing new coal-fired plants. [Note: The World Bank
discouraged USTDA from financing a similar study, and has
actively promoted geothermal power and a regional grid as
the best solution to Kenya's energy needs. End note.]
Environmental groups have already raised concerns about the
likely unwillingness of the GOK to invest in modern
pollution-reduction technology for any new coal plant.


8. At the same time, KenGen is in the process of
purchasing an old gas turbine plant from Independent Power
Producer (IPP) Westmont that will produce 44 mw when it
comes on-line and is considering additional oil-based
thermal plants. Existing oil-based thermal plants have
been able to increase capacity during times of drought and
most likely, oil plants will contribute to Kenya's power in
the future. Kenya also purchases electricity from the
Ugandan hydro system -- about 3% of Kenya's electrical
capacity in 2004 -- and hopes to count on this source for
years to come.

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Can Geothermal Grow to Meet the Demand?
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9. Geothermal plants currently are Kenya's second largest
source of electricity, producing 127 mw (115 mw from KenGen-
managed sources and 12 mw from IPPs). Kenya was the first
African country to generate power using geothermic
activity, and is still the only African country producing
significant amounts. As reported in Reftel, geothermal has
significant future potential. The Olkaria project adjacent
to Hell's Gate National Park, in the Lake Naivasha region,
hosts Kenya's two geothermal plants. A third phase of the
existing geothermal field is almost on-line. Donors,
including Germany and Japan, as well as the World Bank,
have focused most of their energy- sector assistance on
Kenya's geothermal potential, which is estimated at 2,000
mw within Kenya's Rift Valley. New geothermic exploration
is occurring at six new sites at present, including near
Lake Borgoria, an area outside of Olkaria.


10. However, KenGen and KPLC officials are guarded in
their assessment, noting that Geothermal power can be
`damned expensive' to develop to quote Mr. Wahogo, the
Chief Manager of Planning of KenGen. Identifying
geological structures with easily accessible heat
reservoirs is an imprecise science. At a cost of
approximately six million dollars to drill a test well, the
initial financial risk is significant. Furthermore,
individual wells tend to produce only 20 to 30mw worth of
steam each, not a significant amount unless a number of
wells can be economically linked together through above-
ground piping.


11. The current Olkaria development plan calls for future
initial investments to be done through partnerships with
IPPs, but to date there has been a noticeable lack of
interest by private firms. For the Olkaria III project,
only three companies bid, one of them was not serious and
another was under-qualified. The remaining company,
American-owned Ormat, has outlined a development plan that
is more expensive than initial estimates. KenGen's Wahogo
is not optimistic about the prospects of attracting
significant foreign investment for small-output geothermal
power plants in Kenya.

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Is There a Regional Solution?
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12. The World Bank has taken the lead on exploring the
possible creation of an East African regional electricity
grid. Such an improved grid could also facilitate power
imports from South Africa and Zambia, which are already
connected to Tanzania's grid. The energy-related Permanent
Secretaries from the East African Community (EAC) have

SIPDIS
endorsed the plan, and it may be on the decision agenda for
the next EAC summit. However, KPLC is not sold on the idea
of significant new investments into a regional grid, which
it views as not cost-effective due to energy losses from
distribution over such great distances. KPLC estimates
that electricity coming into Kenya from beyond Tanzania
would cost at least one-third more than domestically
produced electricity.
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Rural Electrification Going Slowly
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13. The GOK has an official policy goal of providing
electricity for the rural population, but the results have
been minimal. According to KPLC officials, the parastatal
has spent over $US 100 million on rural electrification
projects over the past 22 years, but to date can only offer
power to less than 4% of the rural population.
Increasingly, small rural communities, farming co-ops,
individual families, self-help groups, and isolated schools
and health clinics are pursuing various combinations of
solar, wind, and micro hydro systems to meet their own
needs, often with the financial and technical assistance of
NGOs or international donors. The GOK has encouraged this
trend by permitting energy production of less than 2 mw
(approximately enough to power 1,000 consumers) without a
license. Unfortunately, there is no systemic program to
promote small-scale energy production and the GOK offers no
tax incentives for small scale power producers. While such
localized production can be useful to those who can afford
it, even the most efficient alternate energy system has
start-up costs that make electricity at least twice as
expensive as in Kenya's major urban areas. MPs from areas
underserved by KPLC are considering legislative action
breaking KPLC's distribution monopoly and permitting IPPs
to compete in power distribution.

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Will Kenya Strike Oil?
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14. In recent years, significant geological study has gone
into determining Kenya's potential as an oil producer.
There have been recent oil discoveries in Southern Sudan
within 100 km of the Kenyan border, and although the
geography is the same, no commercial oil deposits have yet
been discovered in Kenya. The state-run National Oil
Corporation of Kenya decided to explore Kenya's coastal
waters for oil and invited the Australian firm Woodside, to
carry out the search. Though some news reports state
Woodside's investigations to "be encouraging," so far,
Woodside's CEO Don Voelte tells a different story. As
reported in Alexander's Gas and Oil website, Voelte noted
that "the venture in Kenya has just a 3% chance of success;
what we're trying to do is have a few home runs, a few huge
hitters out there." The company is planning to drill
exploratory deep wells (up to 3000 meters) off the Kenyan
coast in mid 2006. "If it hits, it will be huge," Voelte
reportedly said. "Don't go buy our stock for Kenya, but if
you own our stock and Kenya hits, you'll be very happy."
If a commercially-viable source is discovered, production
efforts would take at least four years before any Kenyan
oil would reach the local or international market.

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Privatization and the Role of IPPs
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15. Increased privatization is also expected to help
Kenya's energy sector. The World Bank, other donors, and
industry analysts have all promoted the privatization of
KenGen and KPLC, both of which are viewed as inefficient,
over-staffed, and significant hurdles to an effective
energy policy. In 2000, the World Bank threatened to
withhold three-quarters of a 75 million dollar loan to
Kenya unless the GOK enhanced private participation in the
energy sector. The GOK subsequently announced plans for
the partial privatization (30 percent) of KenGen, which the
government claims would have an estimated value of Ksh 10
billion (about $US132 million). A number of energy
analysts have disputed that estimate as over-optimistic
unless the deal includes management control, something the
GOK is currently unwilling to offer. As noted above, the
GOK is also counting new IPP investments. Since a 1997
regulation allowing IPPs to be licensed for power
purchasing agreements with KPLC, three IPPs have been
producing commercial quantities of power (about 145 mw in
total).

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Donors Are Active in the Sector
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16. Kenya's energy sector has long been a focus of donor
activity. Japan's Overseas Economic Cooperation Fund
provided Kenya with a $US63 million loan for the
Sondu/Miriu dam. The East African Development Bank has
recently funded a $US7 million power line project for KPLC.
Under an on-going $US405 million energy sector recovery
program funded by World Bank, the Nordic Development Fund,
and the French Development Agency, France recently loaned
Kenya $US34 million for improved electricity transmission.
UNDP and the World Bank have funded much of Kenya's
geothermic exploration and development in the past few
decades. The World Bank has also loaned over $US100
million for the Olkaria projects. The Federal Republic of
Germany, through Kreditanstalt fr Wiederaufbau (KfW) will
make an additional $US17 million available to the GOK to
lay the groundwork for developing another geothermal power
plant in Kenya. The new credit is in addition to KfW's
$US14 million loan for Olkaria II, and $US9 million for
Olkaria IV.

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Comment
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17. Unreliable electricity is now one of the most
significant drags on Kenya's business and investment
climate. The GOK is counting on the successful "fast-
tracking" of both the Olkaria III geothermal plant and the
Sondu-Miriu hydropower dam to inject another 95mw into the
system, but that is only a partial solution. It will take
a combination of more oil, gas and, likely, coal plants, as
well as new geothermal development, and a regional power
grid to come close to meeting Kenya's growing power demand
in the next few years.


18. As noted in the recent Foreign Commercial Service
assessment (http://www.buyusainfo.net/docs/x_80968.pdf),
there may be opportunities for American companies in what,
hopefully, will be Kenya's more open, private sector-driven
energy future. Privatizing KenGen and KPLC should be high
on the GOK's priority list of needed economic reforms. It
is unlikely that rural electrification will be
significantly improved without localized production.
Encouraging IPPs, including very small energy producers,
especially in rural Kenya, should also be a priority.
BELLAMY