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Buying back Bujagali is an extra burden on Ugandan taxpayers, blow to investors

Saturday May 16 2015

Recently, media reports indicated that the government of Uganda would like to buy back Bujagali dam from Bujagali Electricity Ltd. This follows recent move by the state to own the main electricity dams. Bujagali was tendered internationally to private companies to build, operate and transfer to the government after 30 years.

However, Karuma and Isimba dams are being constructed and will be owned and managed by the government through Uganda Electricity Generation Company Ltd (UEGCL).

READ: Uganda in secret plan to buy back Bujagali hydropower project from investors

It has been the policy of the Ugandan government over the past 20 years to withdraw from those sectors where private investors are willing to venture.

Uganda was the first country in Africa to conduct a comprehensive privatisation programme. It privatised and liberalised sectors traditionally considered the monopoly of the state, among them electricity generation and distribution. This was preceded by privatisation and liberalisation of the broadcasting, banking and telecommunications sectors, which had been the monopoly of the state.

This policy has been very successful. The government used to own and manage Uganda Commercial Bank. Riddled with politically inspired loans, it had a huge non-performing assets portfolio and was relying on the state for bailouts. The government sold it for $19 million to Stanbic Bank.

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Thirteen years later, it has a value of $700 million on the stock exchange, made Ush135 billion ($45 million) in profits in 2014 and paid Ush110 billion ($37 million) in taxes. The state was also saddled with a moribund electricity distribution network that was inefficient and loss making.

It concessioned it to Umeme, which now has a value of $380 million on the stock exchange, profits of $60 million in 2014 and credibility in the market that is attracting top investors and creditors.

The government of Uganda is moving towards the privatisation of major highways. The first private toll road is going to be the Kampala-Jinja highway. This will be constructed and operated by a private investor in partnership with government.

This trend has been successful because it addressed the core limitations of the state in Uganda, which include corruption and the inefficiency that results from political contestations in the process of government procurement.

It has also released government resources to invest in those areas where the private sector is not willing to venture. This is the broader context in which government plans to nationalise Bujagali should be seen. Those advocating this policy reversal argue that it is the best way to reduce the electricity tariff.

This is a powerful argument. The tariff is both economically and politically fundamental.

Uganda is beginning to attract investors especially in its manufacturing sector. The tariff impacts on competitiveness of manufactured products. As more Ugandans connected to the grid, the electricity tariff has become a basis for political agitation. Therefore, the only justification for buying back Bujagali would be that such a move would reduce the electricity tariff.

Theoretically, then the argument for buying back Bujagali sounds attractive. The state would avoid two costs that contribute to the tariff.

The first is that private investors borrow at expensive interest rate of 6-8 per cent, which is transferred to the final consumer through the tariff. The government borrowing is either concessionary (0.78 per cent for 40 years with a 10-year grace period) or commercial (at 3.5 per cent).

With loans forming 70 per cent of the construction costs, interest costs have a big effect on the tariff. The second cost is return to private capital, which in the Power Purchase Agreement (PPA) for Bujagali is 19 per cent per year. Government owned and operated dams are expected to have low tariffs because of low interest rates and zero return on equity.

If the electricity tariff is the fount and matrix of this debate, we need to compare the cost of electricity from Bujagali with the cost of electricity that is going to be generated from the two dams the government is building at Karuma and Isimba.

One of the factors that influence the tariff is something called “plant factor” — the average capacity utilisation of a dam. For example, although Bujagali has an installed capacity of 250MW, its does not operate at 100 per cent capacity throughout the day. It only reaches full capacity from 7-10pm when electricity consumption is at its peak. Today, Bujagali’s plant factor is 62.5 per cent.

Therefore when you compare Bujagali with Karuma and Isimba on the same parameters, Bujagali comes out with a better tariff than these two dams.

Cost of power

Right now, the price of electricity from Bujagali is 11 cents per kilowatt-hour (kWh). If capacity utilisation at Bujagali were 100 per cent, the tariff would fall by 33 per cent to 8 US cents per Kwh. The 11 cents per kWh is also because BEL has a corporation tax holiday for five years.

When it kicks in in 2017, the tariff will increase to 14 cents per Kwh. The tariff drops to about 8 US cents in 2022 when the senior debt is retired and then drops to 7 US cents in 2027 when the subordinate debt is paid off. In 2042, when the dam is transferred to government, the tariff falls to 1 or 2 US cents per Kwh. Over the period of 30 years of the PPA, the average tariff for Bujagali is 10.1 cents per kWh.

It has been argued that Karuma will have a tariff of 5 US cents per kWh. But this can only be possible if the capacity utilisation of the dam is 100 per cent, which is impossible. Dam utilisation at Karuma, when commissioned, will be 40 per cent for the initial years.

This is because electricity demand in Uganda will be too low to consume all the power that is generated. At 40 per cent dam utilisation in the initial years that grows to 60 per cent over seven years, the effective tariff would be 20 US cents per kWh over 30 years — the same period as Bujagali.

This is because the loan repayment period would be shorter and capacity utilisation would be lower. Stretched to 50 years at capacity utilisation of 62.5 per cent, the Karuma tariff would be 12.5 centres per kWh. Therefore, Bujagali, which was built and is operated by a private investor, is competitive on the tariff.

The construction costs for Karuma dam are $1.4 billion for the dam alone. If you add the cost of the transmission line for 600MW, which is also part of the contract, the total bill goes to $1.7 billion.

This makes the cost of a kilowatt of power $2,333. Isimba will cost $530 million to construct the dam, which will generate 187 MW. This makes the cost of a kilowatt of electricity $3,000. The cost of a kilowatt of electricity at Bujagali is $2,450. Karuma is cheaper because at 600MW, it enjoys economies of scale.

If the aim of the government in seeking to buy back Bujagali is to reduce the tariff, there are better ways to do this without altering government policy towards private investment. For example, the government can remove taxes on electricity generation, which contribute 23 per cent of the Bujagali tariff. The investor would not be asked to calculate this tax into the tariff.

If this happened, the tariff would fall to 7.5 US cents. Indeed, over the period of the PPA, government of Uganda will earn $1.8 billion in revenue from taxes and fees from BEL. For a government that needs cash to do a million things, it would be foolhardy to borrow $1.5 billion to buy back Bujagali from the current owners.

The effect of government ownership of the dam on the tariff would be negligible yet the opportunity cost of $1.5 billion will be massive. For example, the government can use such money to build another dam of 600MW (250 per cent the size of Bujagali).

It can train 180,000 doctors, build 225,000 primary school classrooms, tarmac 2,000km of roads (more than two-thirds of the total Uganda has right now and build three brand new international airports in each region of the country — west, east and north.

There are so many alternative uses of this money that one wonders why the government should think of buying back a dam whose tariff is competitive and whose service is paid for by the consumer, not the government.

However, the most important thing with plans to nationalise Bujagali is the reputation of Uganda as a destination for private investment. At the time of tendering Bujagali for private development, the government of Uganda did not have money. Its debt sustainability position did not also give it much room to borrow and invest in a dam.

It therefore put out an international tender that BEL won competitively. It offered to build the dam at $565 million against the second bidder who had bid to build it at $746 million. The second major issue was the internal rate of return, and again BEL gave the best bid. This means that at the time of securing the PPA, BEL had the best offer for Uganda.

It would therefore be a serious breach if the government turned around and sought to nationalise Bujagali. We all know what this policy did to Africa in the 1970s. It greatly undermined our countries’ reputation as destinations for foreign investment. One hopes that those in government arguing for nationalisation see the facts.

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