Does government need to buy back Bujagali?

Recently, media reports indicated that government of Uganda would like to buy back Bujagali dam from Bujagali Electricity Limited (BEL). This follows recent trends by the State to own and manage the main electricity dams. Bujagali was tendered internationally to private companies to build, operate and transfer to 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 Limited (UEGCL).

It has been the policy of government over the last 20 years to withdraw from those sectors where private investors were willing to venture. Uganda was the first in Africa to conduct a comprehensive privatisation programme. It privatised and liberalised sectors traditionally considered the monopoly of the State, such as electricity generation and distribution. This was preceded by privatisation and liberalisation of the broadcasting, banking and telecommunications sectors that had been the monopoly of the State.

Successful policy
This policy has been very successful. Government used to own and manage Uganda Commercial Bank (now Stanbic Bank). Riddled with politically inspired loans, it had a huge non-performing assets portfolio and was relying on the State for bailouts. Government sold it for $19m (about Shs57b today) to Stanbic Bank. Thirteen years later, it has a value of $700m (Shs2 trillion) on the stock exchange, made Shs135 billion ($45m) profits in 2014 and paid Shs110 billion ($37m) in taxes.

The State also was saddled with a moribund electricity distribution network that was inefficient and loss making. It concessioned it to Umeme, which now has a value of $380m (Shs1.1 trillion) on the stock exchange, profits of $60m (Shs180 billion) in 2014 and credibility in the market that is attracting top investors and creditors.

As I write this article, government is moving towards the privatisation of major highways. The first private toll road is going to be the Kampala-Jinja express. 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 i.e. corruption and 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 Dam should be seen. Those advocating for 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. And as more Ugandans get unto 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, 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 expensively an interest rate of 6-8 per cent, which is transferred to the final consumer through the tariff. 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 to the cost of electricity that is going to be generated from the two dams government is building at Karuma and Isimba. One of the factors that influence the tariff is something called “plant factor” i.e. the average capacity utilisation of a dam. For example, although Bujagali has installed capacity of 250MW, its does not operate at 100 per cent capacity throughout the day. It only reaches full capacity from 7 to 10pm when electricity consumption is at its peak. Today, Bujagali’s plant factor is 62.5 per cent.

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

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 eight 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, tariff will increase to 14 cents per Kwh. The tariff drops to about eight cents in 2022 when the senior debt is retired and then drops to seven cents in 2027 when the subordinate debt is paid off. In 2042 when the dam is transferred to government, the tariff falls to one or two 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 five 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 the electricity demand in Uganda will be low to consume all 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 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 cents 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 (Shs4 trillion) 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 (Shs5 trillion). This makes the cost of a kilowatt of power $2,333 (Shs7 million). Isimba will cost $530m (Shs1.5 trillion) to construct the dam, which will generate 187 MW. This makes the cost of a kilowatt of electricity $3,000 (Shs9 million). The cost of a kilowatt of electricity at Bujagali is $2,450 (Shs7 million). Karuma is cheaper because at 600MW, it enjoys economies of scale.

Altering government policy
If the aim of government in seeking to buyback Bujagali is to reduce the tariff, there are better ways to do this without altering government policy towards private investment. For example, government can remove taxes on electricity generation, which contribute 23 per cent of the Bujagali tariff (corporation tax and withholding tax on dividends). The investor would not be asked to calculate this tax into the tariff. If this happened, the tariff would fall to 7.5 cents. Indeed, over the period of the PPA, government of Uganda will earn $1.8 billion (Shs5 trillion) 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 (Shs4.5 trillion) 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, 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 government thinks of buying back a dam whose tariff is competitive and whose service is paid 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 which BEL won competitively. It offered to build the dam at $565m (Shs1.7 trillion) against the second bidder who had bid to build it at $746m (Shs2.2 trillion).

The second major issue was the Internal Rate of Return (IRR), 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, a factor that precipitated our continent’s economic collapse. One hopes that those in government arguing for nationalisation see the facts.

About the Plant factors at 62.5 %

Dam Plant Factor at 62.5% Plant Factor at 100%
Bujagali under PPA 10.1 cents per kWh 6.31 cents per kWh
Bujagali over 50 years 6.6 cents per kWh 4.13 cents per kWh
Karuma over 50 years 8.52 cents per kWh 5.33 cents per kWh
Isimba over 50 years 10.55 cents per kWh 6.60 cents per kWh