Solving the Electricity Puzzle1
The fiscal cost of the electricity sector continues to weigh heavily on the government’s budget. As a result, there is an opportunity cost for development spending, while the economy still faces significant bottlenecks with high electricity costs and insufficient electricity production. Cross-country experiences provide useful guidelines on successful reforms, particularly on the fiscal front. Senegal also has an opportunity to lower tariffs, eliminate fiscal subsidies and expand coverage, provided it accelerates the introduction of new low cost generation. Moreover, this can be done at low cost to the government budget through the use of power purchase agreements that could be reached through transparent tenders.
A. The Electricity Sector Represents both Challenges and Opportunities for the PSE
1. Limited access to affordable electricity is a significant impediment to private sector development. Electricity is generated primarily by oil-fired plants. As a result of this limited access to electricity, Senegal suffers from one of the highest production costs in Sub-Saharan Africa (SSA): about US$ 30 cents per kWh. To situate how bad this is, power tariffs in most parts of the developing world fall in the range of US$0.04 to US$0.08 per kilowatt-hour. Even relative to Sub-Saharan Africa Senegal scores badly; its tariff is over twice the average tariff of US$0.13 per kilowatt-hour.2 In parallel, its electricity prices that are among the highest in SSA, set at about 30-40 percent below cost recovery. Overall, access to electricity remains low because of high costs and insufficient generation. Senegal receives its lowest score in the World Bank Doing Business indicators for the access to electricity: 182nd country out 189.3
2. In addition, Senegal allocates a significant portion of its budget to support the electricity sector, which represents a major opportunity cost in terms of forgone development spending. In order to limit the pass-through of production costs to retail prices, the government subsidizes the electricity sector. It results in an explicit tariff compensation of about 1–1½ percent of GDP in recent years. These direct transfers also complicate budget management, as they are usually higher at the end of the year than initially budgeted (Figure 4). In addition to the explicit fiscal transfer to compensate for tariffs, the electricity company, Senelec, has also accumulated tax arrears (0.7 percent in 2013) and benefited from government financing for some of its investments (0.3 percent in 2013). Thus, the total fiscal cost of the electricity sector is significantly higher than just the direct transfer, and amounted to 2.5 percent of GDP in 2012 and 2.0 percent in 2013. Additionally, empirical evidence on Senegal and elsewhere from the mid-2000s suggests that tariff subsidies do not benefit primarily the poor, since most of them are not connected to the power grid as a result of either unavailability or cost (World Bank, 2008, Arze del Granado and others, 2010). Even if subsidies were benefiting the poor in absolute terms, their distributional effects have been regressive since electricity consumption is itself unevenly distributed across regional areas and income groups. Finally, subsidies to the electricity sector divert important resources needed to finance pro-poor and priority spending. For example, annual transfers to Senelec were comparable to or higher than the resources allocated for capital spending in the health or education sector (Figure 1).
Figure 1.Senegal: The Fiscal Costs of the Electricity Sector
Sources: Countries authorities, World Bank, and IMF staff estimates and projections.
3. However, the electricity sector represents an opportunity for Senegal, as investment in more efficient plants will eventually solve these issues. The authorities have adopted an investment plan to reduce production costs and increase capacity, but recurrent delays and changes to the plan hamper its effectiveness. The plan relies on more efficient power plants (Sendou, Tobène, Africa Energy) and imports from Mauritania. Eventually, electricity production would combine coal, natural gas, hydropower and renewable energy. This program would not only increase production, but also substantially reduce unit production costs. While the plan is in line with successful reforms in SSA, it has been revised frequently, and its implementation has incurred recurrent delays. As a result of these delays, three issues mentioned above (electricity cost, lack of generation, and high budgetary costs) continue to weigh negatively on Senegal growth potential. Against this background, successful experiences in implementing energy sector reforms in some SSA countries could help Senegal in ensuring that reforms could move forward, and subsequently make the PSE growth objectives a reality.
B. Successful Electricity Reforms
4. Successful electricity reforms in Sub-Saharan African countries can help understand how Senegal could address its own challenges (IMF, 2013). Low access, high costs and unreliable supply plague much of the continent, so although Senegal is amongst the outliers, it is not the only African country to face this challenge and can build on the experience of other countries’ past reforms. Successful reforms incorporate price adjustment, investment in cost reduction, proper outreach to users, and a strategy that includes social safety nets.
5. Investing to reduce cost and increase generation is the right strategy. Senegal’s strategy fundamentally is the right one. All successful cases of energy reforms have indeed implemented investment to improve the energy mix, thus reducing electricity costs, improving generation capacity and phasing out budgetary costs. What is peculiar in Senegal’s situation are the recurrent delays in implementing the investment plan. An avenue that could be explored is finding ways to strengthen credibility in the plan, by demonstrating commitment to implement it. To do so three avenues could be explored, which have been used by other SSA countries: (i) establishing a public debate with the view of creating a large political and social consensus on all aspects of the reforms (i.e. not just the investment plan), (ii) considering tariff adjustments to mitigate the budgetary impact of potential delays and preserve room for development spending in the budget, and (iii) developing social safety nets that can be more efficient in reaching the poor. These three points are discussed further in the following paragraphs.
6. Strengthening support for reform. Electricity subsidies are a highly visible way for governments to benefit their people, even if, overall, they benefit the rich the most. Strengthening support for subsidies reforms would typically involve communicating on their redistributive implications and convincing the population that overall reforms would benefit the majority by better targeting the poor and by unleashing the country’s growth potential. In this respect Senegal could consider using elements of communication strategies used in Ghana and Kenya, two countries that achieved successful reforms.
Ghana’s 2005 reform included an active campaign, using media and consultations with the civil society to communicate about the benefits of the reform and to involve all stakeholders (IMF, 2013).
Kenya consulted with stakeholders early in their reform process, allaying concerns of staff working in their utilities, culminating in their 2004 energy policy which increased tariffs to match long-run marginal costs. Costs increased concurrently with improvements in quality of service, placating consumers (IMF, 2013).
Senegal’s authorities could communicate the potential gains from a reallocation of government spending away from electricity subsidies. A convincing argument could be made about the opportunity cost of subsidizing electricity in terms of forgone development spending and/or tax cuts targeted to crowd in private investment, particularly FDI. Furthermore, consumers may become aware that reforms which improve the financial position of Senelec would also lead to better electricity service and access. In order to be effective, the support for the reform could rely on two specific initiatives related to fiscal transparency. First, the fiscal cost of the electricity sector could be presented in its entirety in budget documents, i.e., covering not only the direct transfer but also tax arrears and investment financed by the government. For example, a welcome development is the inclusion of some estimates in the 2015 budget. Second, the fiscal cost would not be considered "given" but would be set as a complement to Senelec’s own efforts to reduce its operating costs. In this context, Senelec’s performance contract is likely to adequately complement the efforts of fiscal transparency, by providing more information on Senelec own efforts.
7. Developing social safety nets to protect the poor. Successful reforms have included programs targeting the poor through two actions: maintaining cheaper electricity for them and improving their access to electricity (notably by the electrification of rural areas). For example, Kenya maintained lifeline (below cost) tariffs to households consuming less than 50 kWh per month which was cross-subsidized by higher rates on larger consumers. In addition, access was improved for the poor, using subsidies financed by donors to invest in infrastructure. Gabon adopted a similar approach, allowing households with extremely low electricity bills to have access to free electricity up to a certain amount. Senegal has made efforts to move in this direction. Specific investments are planned in electricity distribution through the strengthening and modernization of networks, stations and power lines. To achieve the target of 60 percent of rural electrification by 2016, a priority rural electrification three-year program (2014–16) has been developed. In parallel, efforts have been made to revamp social safety nets, with the view of better targeting the poor. The authorities have worked closely with development partners, notably the World Bank, on this issue. However these efforts will take time to bear their fruits, notably in terms of electrification of rural areas.
8. In parallel to cost-reducing investments, price adjustments are usually necessary. This is particularly relevant when the utility company needs the tariffs to cover not only its operating costs, but also the cost of its investment. Kenya has undergone reforms which began in the 1990s and continued into the 2000s. At present, this utility company has some flexibility to invest (Ajodhia, Mulder, and Slot, 2012). The price adjustment mechanism includes a pass-through of fuel price and exchange rate fluctuations. Senegal already has high electricity tariffs compared to the region. As such the scope for an across-the-board price adjustment is limited. However, options could be considered to increase tariffs temporarily and selectively, in order to reduce the fiscal burden. However, Senegal may be able to avoid price adjustments if it can rapidly expand low cost generation from coal to replace the existing high cost fuel plants. Moreover, if the majority of the investment is undertaken under power purchase agreements, there would be no need for the State (or Senelec) to borrow to finance the expansion plans beyond the cost of the distribution network. In turn, grants from the EU and other donors for infrastructure targeted to the poor could finance a significant share of this spending without generating financial pressures on the Budget, Senelec or electricity consumers.
9. Overall, Senegal’s strategy to address electricity sector issues is sound, and in line with international successful experiences. In particular, the investment plan, as well as efforts to improve Senelec financial transparency go in the right direction in terms of reducing costs and improving access to electricity.
10. In order to strengthen the effectiveness of their strategy, the authorities could consider continued efforts in building consensus, especially if difficult decisions, such as price adjustments, were to become necessary. In this respect, an active communication strategy on the gains from a reallocation of government spending away from electricity subsidies would be helpful. This could also positively contribute to the population accepting costs, in exchange for improved accessibility and further down the road reduced costs. Additionally, continued efforts in developing social safety nets would also help mitigate the social costs during the transition.
AjodhiaV.W.Mulder and T.Slot2012 “Tariff Structures for Sustainable Electrification in Africa” (Arnhem, Netherlands: KEMA). Available athttp://www.ecowrex.org/system/files/documents/2012_tariff-structures-for-sustainable-electrification-in-africa_kema_0.pdf
Arze del GranadoJ.D.Coady and R.Gillingham2010 “The Unequal Benefits of Fuel Subsidies: A Review of Evidence for Developing Countries” IMF Working Paper 10/202. Available athttp://www.imf.org/external/pubs/ft/wp/2010/wp10202.pdf.
IMF2013Energy Subsidy Reform: Lessons and ImplicationsIMF Policy Paper (Washington: International Monetary Fund). Available athttps://www.imf.org/external/np/pp/eng/2013/012813.pdf
Prepared by Olivier Basdevant.
According to the World Bank Fact Sheet: The World Bank and Energy in Africa at http://web.worldbank.org.