POWER PURCHASE AGREEMENTS A Yardstick for Decision Making in KenGen Presented by: Alfred Oseko 2018 G2G INNOVATION SEMINAR, PRIDEINN PARADISE 18TH JUNE - 22ND JUNE 2018

Manager, Regulatory Affairs - Head Office ALFRED OSEKO Manager, Regulatory Affairs - Head Office Bachelor of Laws (LLB) & Masters of Laws (LLM) from the University of Nairobi An Advocate of the High Court of Kenya Member of Chartered Institute of Arbitrators (MCIArb) Member of Law Society of Kenya Founding Member, Academy of Regulatory Professionals Mediator Responsibilities: Development and management of PPAs Managing the regulatory environment

What does the PPA say?

Presentation Outline Introduction Understanding PPA tariff formulation KenGen decision Making Processes: Scenario Analysis Budgeting Procurement Recruitment Project Management Operations and Maintenance Quantification of the Benefits Conclusion and Recommendation

INTRODUCTION: Overview Of KenGen PPAs JOH-JHO836-20070312-KT-P1 INTRODUCTION: Overview Of KenGen PPAs 12 PPAs executed and some more in different stages of development. The PPA Technical and Negotiation Teams are mandated with the exercise of developing the PPAs, formulating the tariffs and negotiating with KPLC. The PPA is supposed to be a fulcrum of decision making in KenGen. The Bible of KenGen-core business. Therefore, negotiation, development and implementation of PPAs is a paramount activity in electricity generation business.

INTRODUCTION: Definition JOH-JHO836-20070312-KT-P1 INTRODUCTION: Definition So what is a PPA? Power Purchase Agreement (PPA) is a long term contract (20-25) between a power generator and off-taker to buy electricity generated by a power plant. Power Purchase Agreements (PPA) have five critical functions: To secure long-term stream of revenue for the power projects through the sale of electricity generated (96% of KenGen Revenue) PPA is a critical consideration in financing of power projects Guide the relationship between the Generator and off-taker Stable consumer tariffs: hedge the risk of fluctuating energy prices Security of supply is secured by off taker

INTRODUCTION: Regulated Energy Sector Energy sector is regulated in Kenya Power Purchase Agreement-primary instrument of regulation on generation Least Cost Power Development Plan vs. Feed-in-Tariff Policy. Just and Reasonable Tariff-ERC Primary Concern: Maintain its financial integrity Attract capital Operate efficiently Fully compensate investors for the risks assumed. Cost Plus Pricing methodology Return on Equity -12.5% after tax

INTRODUCTION: My Thesis Statement 96% KenGen’s Revenue is secured under the PPA, therefore the PPA should be the primary yard stick for decision making.

INTRODUCTION: Decision Making in KenGen JOH-JHO836-20070312-KT-P1 INTRODUCTION: Decision Making in KenGen Key interrelated decision making processes in KenGen: Budgeting Process Procurement Planning Process Recruitment Process Project Management Process Plant Operation Process Currently, the decision making processes outlined above have minimal, close to no link to the PPA. At the time of making decisions in KenGen, the critical question to ask should be: What is the impact of this decision on the PPA? This question is rarely answered, let alone asked.

INTRODUCTION: Objective & Methodology JOH-JHO836-20070312-KT-P1 INTRODUCTION: Objective & Methodology Objective To ensure that key decisions made in KenGen, are made on the basis of the impact they will have on the PPAs. Methodology Data collection through a desk-top review of various documents including: Project reports Minutes of various decision making organs in KenGen PPAs and its financial models Interviews with members of staff including key decision makers. Data analysis: The data extracted was analysed to determine the extent to which the decisions made in KenGen have taken into account their impact on the PPAs. Ethical Considerations: Confidentiality, transparency

UNDERSTANDING PPA TARIFF FORMULATION Key PPA Development Principles: Our Strategy: G2G Good to Great – enough revenue to grow Generation to Generation –sustainable long term PPA Regulated Return of Equity: 12.5% after tax Transparent and Prudent Cost Estimation Risk Allocation and Mitigation

UNDERSTANDING PPA TARIFF FORMULATION Cost Plus Tariff Structure Capacity charge Energy charge (kWh TARIFF Capacity charge rate (CCR) Fixed O&M Revenue (FOMCR) Variable O&M Revenue (VOMCR) Chemicals Lubricants Costs Casuals Variable maintenance costs Make up well Power Plant construction Civil Works Consultancy Cost Land Costs Working Capital Transmission Lines Interest During Construction Financing costs: 30% Equity-Return on Equity 12.5% & debt 70% repayment & r% Staff Costs Insurance Costs Land Rents Fixed Maintenance Costs Budget Max

UNDERSTANDING PPA TARIFF FORMULATION How to make Money for KenGen JOH-JHO836-20070312-KT-P1 UNDERSTANDING PPA TARIFF FORMULATION How to make Money for KenGen Return on Equity

UNDERSTANDING PPA TARIFF FORMULATION: Key Considerations JOH-JHO836-20070312-KT-P1 UNDERSTANDING PPA TARIFF FORMULATION: Key Considerations The Cost Plus Pricing Strategy Demands three Critical Considerations: Accurate estimation of costs for construction, operation and maintenance of the power plants. The decision making processes in KenGen are anchored in the PPA threshold. KenGen’s return on equity is determined by Savings: KenGen should now start engaging in the business of making savings.

KENGEN DECISION MAKING PROCESSES: Scenario Analysis JOH-JHO836-20070312-KT-P1 KENGEN DECISION MAKING PROCESSES: Scenario Analysis An analysing of KenGen business shows the following as the main process decision areas with the greatest impact on the PPAs.   Budgeting Procurement Recruitment Project Management Operations and Maintenance

KENGEN DECISION MAKING PROCESSES: Budgeting, Procurement and Recruitment

Budgetary Proposals informed by the PPA CASE SCENARIO A: BUDGET, PROCUREMENT, RECRUITMENT AND EFFECT ON RETURN ON EQUITY YEAR REVENUE EXPENSES PROFIT % RETURN ON EQUITY 2013/2014 18,334,479,000 15,508,156,000 2,826,323,000 4 2014/2015 29,957,301,000 18,439,974,000 11,517327,000 8 2015/2016 38,609,556,000 31,866,064,000 6,743,492,000 2016/2017 35,440,067,000 26,382,936,000 9.057,131,000 5 Budgetary Proposals informed by the PPA

SCENERIO A ANALYSIS: Budgeting In the power business, the overall budgets are set at the time of developing a PPA and for the entire period of the PPA. Any annual budgeting process should draw from the PPA budgets thresholds. Currently, the budgeting process in KenGen is quite delinked from the expenses provided in the PPA hence likely to lead to a mismatch.   In any budgeting process, the critical question to ask is: are the identified needs substantially drawn from what was anticipated in the PPA? Any needs that cannot directly or indirectly traced to the PPA budgets are found not to be critical, hence should be dropped all together.

CASE SCENARIO B: RECRUITMENT PROCESS YEAR EFFECTIVE CAPACITY STAFF STAFF/MW CAPACITY GROWTH STAFF GROWTH 2012/2013 1285.7 2063 0.62   2013/2014 2209 0.58 146 2014/2015 1540.1 2407 0.64 254.4 198 2015/2016 1554.28 2406 0.65 14.18 -1 2016/2017 1556.5 2476 0.63 2.22 70 2017/2018 The Jury is still Out Rationalized Organizational Structure informed by the PPA

SCENERIO B ANALYSIS: Recruitment All anticipated fixed and variable operation and maintenance (O & M) costs are provided for in the PPA tariffs. The number of staff and their costs are provided in the PPA for its full life. Unless for genuinely unforeseeable costs, the procurement and recruitment processes should follows the O & M costs.   As at 30th June 2016: KenGen: 1 employee : 0.68 MW . Eskom: 1 employee : 4.70MW. UEGCL: 1 employee : 3.04MW Such benchmarks should be used in determining the number of staff provided in the PPA.

CASE SCENARIO C: PROJECT MANAGEMENT Scope: Contracted Capacity, Revenue Quality: Revenue, contracted capacity, reliability, increase O&M Cost Overrun: Increases capex, reduces RoE Time: Affects PPA timelines: TED, COD, recovery period, IDC.

SCENERIO “C” ANALYSIS: Project Management The main task on project managers: Manage projects constraints within the tendered cost, time and accomplish the scope to required quality.   Any variation/claims as to time and scope would lead to cost overruns and obvious revenue reduction, ab initio. With proper project management, contingency amount remains part of KenGen revenue. Example: in the 280MW geothermal project, the claims and variations are estimated at over Kenya Shillings 7 Billion. This means that KenGen revenue was reduced by similar amount, ab initio.

CASE SCENARIO D: OPERATIONS AND MAINTENANCE PROCESSES During plant operations, many decisions are made regarding dispatch, operation and maintenance, staff management etc. These decisions have a direct cost implication and penalty implications in case of dispatch management. So such decisions should be made diligently to avoid unplanned costs and penalties. Make power plants as a cost and profit centre Key Variable: Load Factors: Energy Revenues. Capacity availability: Penalties and Adjustments Effective and efficient maintenance practises Staff Management: Call outs and over time Other unplanned expenses

QUANTIFICATION OF BENEFITS Benefits: Likely change on profits if RoE changes from 5% to 12.5%: Kshs. 9, 057,131,000 to over 22, 000, 000, 000 Reinvestment of profits for the sake of increasing the value of stakeholders.

CONCLUSIONS AND RECOMMENDATIONS PPA Performance Tracking Tools: Development of PPA performance monitoring Tools: Weekly and Monthly Capacity & Energy Revenue Budget Performance report: Monitors annual budgets versus PPA provisions of revenue. Tracks variances and explains the causes of the variance and proposes mitigation measures. Revenue adequacy report: New and will track performance of each Power Plants. Revenue Loss Root Cause Analysis: Picking from PPA Performance Tracking Tools, a Committee comprising of Regulatory, Operations and other relevant departments should be formed to analyse the Revenue Loss Root Cause Analysis and make recommendations on how to fix them.

CONCLUSIONS AND RECOMMENDATIONS Make PPAs Centres for Decision Making: Use PPA Benchmarks/Thresholds. The bible governing day to day management of the company. PPA Awareness: The ongoing PPA awareness should continue in more structured way. This will make them aware of the consequences of their decisions. Swift Decision Making: The PPA anticipates quick decision making. This slow decision making attitude unnecessarily increases PPA related costs and loss of opportunities. Culture change: eliminate complacency, slow decision making and indecisiveness.

What does the PPA say?

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