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Monday, 22 June 2009

Paying the price for unreliable power..

A new paper explores the costs and benefit of generation of electricity by private firms in Africa:
The decision of a firm to maintain its own-generation capability is driven by a variety of factors. In firm surveys, firms in countries reporting more than 60 days of power outages per year tend to identify power as a major constraint to doing business, and present relatively high rates of generator ownership. However, more rigorous empirical analysis shows that unreliable public power supplies is far from being the only or the largest factor driving generator ownership. Firm characteristics such as size, age, industrial sector and export orientation all have a major influence. In particular, the probability owning a generator doubles in large firms relative to small ones. Moreover, the behavioral model predicts that the percentage of firms owning their own generators would remain high (at around 20 percent) even if power supplies were perfectly reliable, suggesting that other factors such as emergency driven back-up requirements or export driven quality regulations play a critical role in the decision to own a generator.

The costs of own generation are high, driven mainly by the variable cost of diesel fuel. In most cases they fall in the range US$0.30-0.70 per kilowatt-hour, which is often three times as high as the price of purchasing electricity from the public grid; although the latter is typically subsidized. Nevertheless, in most cases, this does not hugely affect the overall weighted average cost of power to firms given that own generation is only used during a relatively small percentage of the working year.

At the same time, the survey evidence shows that the benefits of generator ownership are also substantial. Considering only lost sales resulting from periods of power outages, firms with their own generators report a value of lost load of typically less than US$50 per hour, which is only a fraction of the value of lost load in excess of US$150 per hour that is reported by firms in the same country that do not have their own generators.

Nevertheless, when costs and benefits are considered side by side, the balance is not found to be significantly positive; a pattern which holds across countries, industrial sectors, and business scales. This may simply be because the analysis is only able to capture one dimension of the benefits of generator ownership – namely reduction in lost sales – but fails to capture many other important aspects – such as reduced damage to equipment, higher quality of production, and meeting reliability criterion for access to export markets.

A number of policy implications emerge from these findings.

First, while the overall scale of own generation in Africa is not that substantial overall, it plays a very important in a number of countries in the region, including some of the larger countries. This suggests that there may be some strategic value for these countries to think about the role that this significant additional generating capacity could play in national power supply. In many countries, own-generators are not allowed to sell power into the grid, even though this could make a valuable contribution to improving the availability of power in the country as a whole.

Second, while improvements in the reliability of public power supplies would reduce the extent to which own generators were used and hence the level of variable costs incurred, it would in many cases not alter the firm’s basic decision to maintain its own back-up generation facilities. The reason is that there are other important motivations for holding these assets, including meeting international quality standards for participation in export markets, and dealing with critical sensitivities in the production process (for example, maintaining ventilation of mines).

Third, through own generation the majority of large formal sector enterprises are able to effectively insulate themselves from the impact of unreliable power supplies. Although the cost of running such generators is high (typically US$0.25–0.45 per kilowatt-hour), given that outages are only intermittent, the overall impact on the weighted average cost of power supply to these firms is relatively small: of the order of a few cents per kilowatt-hour. The major victims of unreliable power supply are in the informal sector, where the limited survey evidence available suggests that generator ownership is an order of magnitude less prevalent than in the formal sector. The other major casualties are the formal sector firms that simply never open-up in countries where power supply is a constraining factor.


  1. Some equipment is very simple to manufacture and easy to operate, while others are much more complicated not only to create, but their operation many times requires skilled personnel who have been required to acquire specialized training to run the equipment.

  2. The only solution I can think off is for businesses to come together and form industrial parks with its own captive power generating capability, probably in the form of power stations using natural gas. This should cut down losses in the form of theft and political pressure to maintain uneconomical rates that a public supply would be subject to. It would be very useful in countries facing acute power shortages such as Nigeria.

  3. The national energy strategy should include provision, if not direct incentive, for both own-generation of electricity and re-tooling of the transformer grid to allow private generators to contribute their excess power to the general supply. It seems to me that there could be a healthy balance created between tariffs sufficiently high to recover generation costs within a reasonably short time period, and competition between wholesale generators to sell power into the transmission grid (probably to remain a parastatal monopoly), as well as between distributors to buy and sell retail power from the transmission grid to homes and businesses. Even small but geographically spread out generators can contribute significantly to the reliability of the grid and help stem losses due to line resistance over long distances, which can help over time to offset the cost of advanced transformer equipment to allow for two way transmission for retail customers.

    More importantly, it will encourage those homes and businesses with own-generator capacity for emergency purposes to employ their generators during peak hours more often, even when their own part of the grid is not experiencing an immediate shortage. Without the technical mechanisms in place to transform the generator loads and pay the owners for their kilowatt contributions, there will remain no significant available return on investment from own-generation facilities. We have seen that regional and domestic economic growth has resulted in populations and industries prepared to consume as much electric power as can be generated, and then some. It only makes sense to encourage whatever generation capacity that the private sector is willing to install in addition to the large Zesco and CPC generators.


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