Powering Africa How Captive Generation Can Electrify the Continent/ Foreing Affairs 16.09.16
Elisabeth Janaina
Powering Africa How Captive Generation Can Electrify the Continent/ Foreign Affairs 16.09.16
How Captive Generation Can Electrify the Continent
By Megan Reilly Cayten and Morgan D. Bazilian
Sub-Saharan Africa is living through a crisis in power supply. Thanks to decades of underinvestment in, and mismanagement of, electricity infrastructure, the region’s power grids are underpowered and dysfunctional. Sub-Saharan Africa today consumes 30 percent less electricity than South Korea, despite having 20 times its population, and on March 31 of this year, the entire country of Nigeria—population 180 million—generated no electricity for two hours. Even where electricity is available, it may be of low quality, which can be just as damaging. The cost of such dysfunction can be high: a 2014 report from the International Energy Agency (IEA) estimated that businesses in sub-Saharan Africa lost nearly five percent of their annual sales owing to power outages. No wonder unreliable power supply has been identified by business leaders as the single most pressing obstacle to the region’s growth, ahead of corruption, red tape, and access to capital.
Yet despite its energy deficit, the region’s growth, which averaged 5.1 percent annually from 2007 to 2014, still beat the global average. Such an impressive performance underscores what sub-Saharan Africa’s economy could achieve if liberated from the constraints imposed by its inadequate power supply. Lifting those constraints may prove expensive, however. According to a study by McKinsey & Company, the cost of the necessary investments in the region’s electricity grid is estimated at some $800 billion through 2040—a outlay that can be met only by attracting private capital from abroad. Historically, private investment in the region has been limited in scope because of political risk, economic uncertainty, and other challenges. But there are opportunities to supply reliable power to sub-Saharan Africa that, if properly structured, offer both compelling returns and a sure path toward development.
POWER TO THE PEOPLE
To date, investment in Africa’s power sector has tended to focus either on large, centralized generation projects (such as power plants) or on small-scale rural electrification schemes that service individual farms and households. Both are necessary. Yet large plants have encountered, among other challenges, diseconomies of scale due to fuel supply constraints, inadequate infrastructure, and a lack of viable customers. Rural electrification, meanwhile, is important for those who receive its benefits, but recent studies in India and Kenya suggest that its overall economic impact may be negligible. Between these macro and micro approaches, however, there is another method, captive power generation, which may offer a profitable means to quickly build capacity while stimulating broader economic growth.
Captive power generation refers to the installation of small power-generating units (or “assets”), often by businesses, in order to provide electricity for their own service or manufacturing needs. Powering an enterprise with a diesel generator, for instance, is a well-known example of captive power generation. Rather than relying on a large-grid infrastructure, a captive power delivery model allows assets to be strategically located in high-demand areas. In recent years, technology improvements have meant that captive power assets are now more affordable, efficient, and flexible than ever before, making them a more viable method for addressing the problems caused by low-quality electrical services.
In sub-Saharan Africa, poor infrastructure, a difficult operating environment, and a lack of local expertise have made grid maintenance difficult and led to high operating costs and wasted resources—three to five times more power is lost in transmission and distribution than would be normal in a well-run grid. As a result, this type of power development is often a losing investment: based on one analysis, to break even, the average power utility in sub-Saharan Africa would need to charge its users 72 percent more than users in a properly functioning grid; in reality, they are charged 50 percent less, largely for political reasons. In these conditions, private investors often require guarantees from governments or international financial institutions as a prerequisite for investment, which can increase complexity and overhead costs. In sub-Saharan Africa, poor infrastructure, a difficult operating environment, and a lack of local expertise have made grid maintenance difficult and led to high operating costs and wasted resources.
Captive power generation offers an attractive alternative. It improves reliability and quality of power supply (essential for manufacturing); reduces or eliminates reliance on transmission and distribution infrastructure; significantly reduces the time, planning, and investment capital required for new projects; allows projects to operate more independently of government; and makes it possible to add and subtract assets as demand fluctuates. When supply exceeds demand, the excess can, under certain technical and regulatory arrangements, be fed back into the grid. And because the power-generating units are typically small and mobile, they may be recovered in the case of contractual default.
Most important, distributed generation enables power supply companies to choose their customers based on their credit quality, rather than contract by necessity with a centralized grid’s single buyer—often a distribution company or government-owned utility with bad credit. This ability to choose more trustworthy customers makes it possible for third-party power suppliers to seek private investment for individual projects or portfolios, with limited or little need for institutional guarantees. Giving growing companies access to reliable power, moreover, allows them to expand their business, stimulating broader economic growth.
In fact, some in sub-Saharan Africa already use a form of captive power. In the absence of effective centralized grids, those with the need and the ability to pay (mostly businesses) rely on diesel generators. According to the IEA, in 2012, privately owned diesel generators supplied nearly five percent of the region’s total electricity, with 80 percent of that diesel-generated power sold to businesses. The capacity of Nigeria’s diesel generators is estimated at 12 gigawatts—four times the installed capacity of the grid—and the country’s businesses generate 59 percent of their own electricity. As a result, in Nigeria power accounts for four to eight times as much of the manufacturing production costs as in other similar economies. In sub-Saharan Africa more broadly, the cost of running backup generators is equivalent to anything from one to four percent of GDP.
Still, businesses that generate their own backup power are able to mitigate less than 50 percent of the costs of poor electricity supply, and diesel fuel, as an import, is expensive and vulnerable to supply shocks—as when an April 2015 strike by diesel importers crippled the Nigerian economy. Fortunately, technological and cost improvements mean that small generation units are now available using a wide variety of fossil and renewable fuels, including natural gas and solar, depending on what is locally available. And expanded to an industrial scale, such captive generation would provide a cleaner and more efficient alternative to the raft of existing diesel generators, improving local power generation as well as cutting down on air pollution. Captive generation would thus help “green” the continent’s industrialization, a task that African leaders have already recognized as a priority. Reducing reliance on diesel would also strengthen the entire economy’s resilience to fuel supply shocks, whether from natural or man-made disasters.
An unreliable power supply is bad for nearly every sector of an economy, but it does not affect all of them equally. In sub-Saharan Africa, as in most regions, it is the largest firms that suffer the most from power outages and voltage fluctuations. These large companies often operate in sectors such as technology or manufacturing, which are widely seen by development economists as the backbone of a country’s economy owing to their contributions to employment, productivity growth, and high living standards. Very few countries have escaped poverty without first developing a strong manufacturing economy. But in sub-Saharan Africa, manufacturing’s proportion of overall GDP has shrunk over the last two decades, and manufacturing productivity is 30 percent lower than in other developing regions. Lack of affordable and reliable electricity is one of the major reasons for this stagnation. Improving the quality and quantity of electricity supply for commercial and industrial users will allow businesses and entire economies to expand.
STEPPING UP
Captive power generation offers a scalable platform capable of reducing the typical risks associated with emerging markets power investment. But to be successful, it requires a number of conditions, including a favorable policy and regulatory environment, an established local industrial base, a reliable fuel supply, the technical know-how to install technology and maintain it over time, and the business skills to negotiate the many small contracts involved in a distributed power platform. Nor is it a panacea. Although providing electricity to businesses will undoubtedly have a positive effect on regional development, it will not turn the lights on for the 600 million residents of sub-Saharan Africa who currently lack access to modern electricity services.
Yet captive power generation offers the most scalable, bankable investment in power supply today, as well as the one most capable of catalyzing wider economic growth. To support the model as well as enhance its development impact, power sector policymakers should prioritize the generation of high-quality power for productive use in targeted industries such as manufacturing. They should also encourage regulations that permit private entities to self-generate and contract with each other for the sale and purchase of electricity, and that allow captive assets owners to sell their surplus back into the grid. For those projects relying on natural gas supply, the development and liberalization of local gas markets and enhancement of gas-processing and transportation networks are vital.
Private enterprise has a long tradition of going where government cannot or will not go. International investment typically brings with it a range of positive externalities, such as transparency, standardized accounting, pollution control, workplace safety, and other best practices from around the world. Sub-Saharan Africa’s power needs are vast, and to provide the necessary billions in investment, the region will have to attract private capital. A well-executed captive power strategy, which offers investors returns even as it delivers major developmental benefits for the region, offers a promising solution. Success will not come easily, but the upside is great: a more modern, prosperous, and dynamic sub-Saharan Africa.