US embassy cable - 05NAIROBI3188

UNCLAS SECTION 01 OF 04 NAIROBI 003188 
 
SIPDIS 
 
DEPT FOR AF/E, AF/EPS, AF/PD, EB/ESC/IEC, AND OES/ENV 
USAID FOR AFR/EA 
 
E.O. 12958:  N/A 
TAGS: ECON, EAID, EINV, BTIO, SENV, KE, ENGR 
SUBJECT:  Kenya's Energy Future 
 
REF:  04 NAIROBI 1239 (NOTAL) 
 
1.  Summary:  Kenya is facing a significant power shortage 
and is being forced to turn to more expensive sources of 
energy.  Future production will come from increased 
electricity generation from geothermal sources and likely 
new coal-fired plants.  A World Bank-promoted East African 
regional electricity grid could also help Kenya meet its 
growing demand, but is not an inexpensive solution.  Recent 
geological study of Kenya's oil-producing potential is 
inconclusive.  The privatization of the two dominant 
parastals, KenGen, the state-run energy producer, and Kenya 
Power and Light Company (KPLC), the electricity distributor 
would be a near-term boost for Kenya's energy sector and 
business climate.  Creating incentives for Independent 
Power Producers, especially in rural areas, should also be 
a priority.  End Summary. 
 
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Kenya's Potential Energy Crisis 
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2.  Kenya is facing a potentially significant power 
shortage and is being forced to turn to more expensive 
sources of energy.  Power outages (approximately 11,000 per 
month throughout the formal system), extreme voltage 
fluctuations, and inconsistent quality of electricity are 
already significant problems for business and residential 
consumers.  According to Energy Permanent Secretary Patrick 
Nyoike, widespread rationing of electricity could begin as 
early as September 2006 if KenGen and Kenya Power and Light 
Company (KPLC), Kenya's state-run energy producer and 
distributor, do not address the problem with greater 
effectiveness. 
 
3.  The current peak demand for power in Kenya is 
approximately 900 megawatts (mw), and is increasing by 
approximately twelve percent annually.  Overall electricity 
consumption is growing at seven percent per year.  At this 
time, the Kenyan power sector has an effective capacity to 
provide 1,030 mw, barely enough to cover the demand.  David 
Mwangi, Chief Manager of Planning Research and Performance 
Monitoring of KPLC, acknowledges that a 100 mw safety 
margin is far too low -- the goal is to have at least 650 
mw above the peak demand in reserve capacity.  Kenya's 
biggest source of electricity (providing 75% of output) is 
from hydroelectric installations, which have limited 
reservoir capacity and depend greatly on inconsistent 
rains. 
 
4.  Compounding Kenya's energy difficulties, the 
distribution and transmission systems are inefficient, or, 
in many areas, non-existent.  Distribution and transmission 
systems are poorly designed and in need of repair.  An 
estimated 19% of net power generation is lost due to the 
inefficiency of the power system and poor management (a 
marginal improvement 2004's 20% loss).  Each percentage 
point of power loss translates to about $US2.5 million in 
lost annual revenue for KPLC, who's (modest) goal is to 
improve efficiency by one percent each year until only 15% 
is lost, saving $10 million a year and increasing available 
capacity.  [Note:  By comparison, the U.S. loses less than 
10% in its electrical distribution.  End note.]  KPLC is 
also hopes to decrease illegally-tapped power lines, which 
cost the firm over a million dollars a year in lost 
revenue, and exacerbates the on-going problems of frequent 
power shedding and blackouts, according to KPLC's Mwangi. 
 
5.  Currently, only 15% of the population has direct access 
to electricity.  The government has promised to provide 
electrical service to 150,000 new Kenyan households a year 
for the next few years, increasing annual demand by 150 mw 
per year, according to Mwangi.  Most businesses, especially 
manufacturing companies, are also demanding more 
electricity and improved service.  Kenya's near-term 
electricity demand is likely to increase to at least 1,700 
mw. 
 
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Where Will New Capacity Come From? 
----------------------------------- 
6.  Kenya's electrical production comes from about 15, 
fairly small power plants -- including its hydro network. 
Kenya's biggest dam produces a maximum output of 250 mw, 
compared to the world's biggest hydroelectric dams, which 
produce in excess of 11,000 mw.  Another hydro plant on the 
Sondu-Miriu river system is under construction, with an 
anticipated 60 mw coming on-line in 2006.  Most hydro 
potential and other "low-cost" options are already 
developed, so Kenya must now pursue alternative and 
potentially more expensive means of generating electricity. 
 
7.  Future production will likely come from new coal-fired 
plants.  Coal is found in small quantities in Kenya, and 
the GOK intends to explore for additional sources.  KenGen 
and KPLC believe that imported coal prices will remain 
lower and less volatile than oil, and so are committed to 
exploring the possibility of new coal plants, whether or 
not significant quantities are mined in Kenya.  KenGen is 
searching for sponsors to pay for a feasibility study on 
establishing new coal-fired plants. [Note:  The World Bank 
discouraged USTDA from financing a similar study, and has 
actively promoted geothermal power and a regional grid as 
the best solution to Kenya's energy needs.  End note.] 
Environmental groups have already raised concerns about the 
likely unwillingness of the GOK to invest in modern 
pollution-reduction technology for any new coal plant. 
 
8.  At the same time, KenGen is in the process of 
purchasing an old gas turbine plant from Independent Power 
Producer (IPP) Westmont that will produce 44 mw when it 
comes on-line and is considering additional oil-based 
thermal plants.  Existing oil-based thermal plants have 
been able to increase capacity during times of drought and 
most likely, oil plants will contribute to Kenya's power in 
the future.  Kenya also purchases electricity from the 
Ugandan hydro system -- about 3% of Kenya's electrical 
capacity in 2004 -- and hopes to count on this source for 
years to come. 
 
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Can Geothermal Grow to Meet the Demand? 
--------------------------------------- 
9.  Geothermal plants currently are Kenya's second largest 
source of electricity, producing 127 mw (115 mw from KenGen- 
managed sources and 12 mw from IPPs).  Kenya was the first 
African country to generate power using geothermic 
activity, and is still the only African country producing 
significant amounts.  As reported in Reftel, geothermal has 
significant future potential.  The Olkaria project adjacent 
to Hell's Gate National Park, in the Lake Naivasha region, 
hosts Kenya's two geothermal plants.  A third phase of the 
existing geothermal field is almost on-line.  Donors, 
including Germany and Japan, as well as the World Bank, 
have focused most of their energy- sector assistance on 
Kenya's geothermal potential, which is estimated at 2,000 
mw within Kenya's Rift Valley.  New geothermic exploration 
is occurring at six new sites at present, including near 
Lake Borgoria, an area outside of Olkaria. 
 
10.  However, KenGen and KPLC officials are guarded in 
their assessment, noting that Geothermal power can be 
`damned expensive' to develop to quote Mr. Wahogo, the 
Chief Manager of Planning of KenGen.  Identifying 
geological structures with easily accessible heat 
reservoirs is an imprecise science.  At a cost of 
approximately six million dollars to drill a test well, the 
initial financial risk is significant.  Furthermore, 
individual wells tend to produce only 20 to 30mw worth of 
steam each, not a significant amount unless a number of 
wells can be economically linked together through above- 
ground piping. 
 
11.  The current Olkaria development plan calls for future 
initial investments to be done through partnerships with 
IPPs, but to date there has been a noticeable lack of 
interest by private firms.  For the Olkaria III project, 
only three companies bid, one of them was not serious and 
another was under-qualified.  The remaining company, 
American-owned Ormat, has outlined a development plan that 
is more expensive than initial estimates.  KenGen's Wahogo 
is not optimistic about the prospects of attracting 
significant foreign investment for small-output geothermal 
power plants in Kenya. 
 
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Is There a Regional Solution? 
----------------------------- 
12.  The World Bank has taken the lead on exploring the 
possible creation of an East African regional electricity 
grid.  Such an improved grid could also facilitate power 
imports from South Africa and Zambia, which are already 
connected to Tanzania's grid.  The energy-related Permanent 
Secretaries from the East African Community (EAC) have 
 
SIPDIS 
endorsed the plan, and it may be on the decision agenda for 
the next EAC summit.  However, KPLC is not sold on the idea 
of significant new investments into a regional grid, which 
it views as not cost-effective due to energy losses from 
distribution over such great distances.  KPLC estimates 
that electricity coming into Kenya from beyond Tanzania 
would cost at least one-third more than domestically 
produced electricity. 
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Rural Electrification Going Slowly 
---------------------------------- 
13.  The GOK has an official policy goal of providing 
electricity for the rural population, but the results have 
been minimal.  According to KPLC officials, the parastatal 
has spent over $US 100 million on rural electrification 
projects over the past 22 years, but to date can only offer 
power to less than 4% of the rural population. 
Increasingly, small rural communities, farming co-ops, 
individual families, self-help groups, and isolated schools 
and health clinics are pursuing various combinations of 
solar, wind, and micro hydro systems to meet their own 
needs, often with the financial and technical assistance of 
NGOs or international donors.  The GOK has encouraged this 
trend by permitting energy production of less than 2 mw 
(approximately enough to power 1,000 consumers) without a 
license.  Unfortunately, there is no systemic program to 
promote small-scale energy production and the GOK offers no 
tax incentives for small scale power producers.  While such 
localized production can be useful to those who can afford 
it, even the most efficient alternate energy system has 
start-up costs that make electricity at least twice as 
expensive as in Kenya's major urban areas.  MPs from areas 
underserved by KPLC are considering legislative action 
breaking KPLC's distribution monopoly and permitting IPPs 
to compete in power distribution. 
 
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Will Kenya Strike Oil? 
---------------------- 
14.  In recent years, significant geological study has gone 
into determining Kenya's potential as an oil producer. 
There have been recent oil discoveries in Southern Sudan 
within 100 km of the Kenyan border, and although the 
geography is the same, no commercial oil deposits have yet 
been discovered in Kenya.  The state-run National Oil 
Corporation of Kenya decided to explore Kenya's coastal 
waters for oil and invited the Australian firm Woodside, to 
carry out the search.  Though some news reports state 
Woodside's investigations to "be encouraging," so far, 
Woodside's CEO Don Voelte tells a different story.  As 
reported in Alexander's Gas and Oil website, Voelte noted 
that "the venture in Kenya has just a 3% chance of success; 
what we're trying to do is have a few home runs, a few huge 
hitters out there."  The company is planning to drill 
exploratory deep wells (up to 3000 meters) off the Kenyan 
coast in mid 2006.  "If it hits, it will be huge," Voelte 
reportedly said. "Don't go buy our stock for Kenya, but if 
you own our stock and Kenya hits, you'll be very happy." 
If a commercially-viable source is discovered, production 
efforts would take at least four years before any Kenyan 
oil would reach the local or international market. 
 
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Privatization and the Role of IPPs 
---------------------------------- 
15.  Increased privatization is also expected to help 
Kenya's energy sector.  The World Bank, other donors, and 
industry analysts have all promoted the privatization of 
KenGen and KPLC, both of which are viewed as inefficient, 
over-staffed, and significant hurdles to an effective 
energy policy.  In 2000, the World Bank threatened to 
withhold three-quarters of a 75 million dollar loan to 
Kenya unless the GOK enhanced private participation in the 
energy sector.  The GOK subsequently announced plans for 
the partial privatization (30 percent) of KenGen, which the 
government claims would have an estimated value of Ksh 10 
billion (about $US132 million).  A number of energy 
analysts have disputed that estimate as over-optimistic 
unless the deal includes management control, something the 
GOK is currently unwilling to offer.  As noted above, the 
GOK is also counting new IPP investments.  Since a 1997 
regulation allowing IPPs to be licensed for power 
purchasing agreements with KPLC, three IPPs have been 
producing commercial quantities of power (about 145 mw in 
total). 
 
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Donors Are Active in the Sector 
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16.  Kenya's energy sector has long been a focus of donor 
activity.  Japan's Overseas Economic Cooperation Fund 
provided Kenya with a $US63 million loan for the 
Sondu/Miriu dam.  The East African Development Bank has 
recently funded a $US7 million power line project for KPLC. 
Under an on-going $US405 million energy sector recovery 
program funded by World Bank, the Nordic Development Fund, 
and the French Development Agency, France recently loaned 
Kenya $US34 million for improved electricity transmission. 
UNDP and the World Bank have funded much of Kenya's 
geothermic exploration and development in the past few 
decades.  The World Bank has also loaned over $US100 
million for the Olkaria projects.  The Federal Republic of 
Germany, through Kreditanstalt fr Wiederaufbau (KfW) will 
make an additional $US17 million available to the GOK to 
lay the groundwork for developing another geothermal power 
plant in Kenya.  The new credit is in addition to KfW's 
$US14 million loan for Olkaria II, and $US9 million for 
Olkaria IV. 
 
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Comment 
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17.  Unreliable electricity is now one of the most 
significant drags on Kenya's business and investment 
climate.  The GOK is counting on the successful "fast- 
tracking" of both the Olkaria III geothermal plant and the 
Sondu-Miriu hydropower dam to inject another 95mw into the 
system, but that is only a partial solution.  It will take 
a combination of more oil, gas and, likely, coal plants, as 
well as new geothermal development, and a regional power 
grid to come close to meeting Kenya's growing power demand 
in the next few years. 
 
18.  As noted in the recent Foreign Commercial Service 
assessment (http://www.buyusainfo.net/docs/x_80968.pdf), 
there may be opportunities for American companies in what, 
hopefully, will be Kenya's more open, private sector-driven 
energy future.  Privatizing KenGen and KPLC should be high 
on the GOK's priority list of needed economic reforms.  It 
is unlikely that rural electrification will be 
significantly improved without localized production. 
Encouraging IPPs, including very small energy producers, 
especially in rural Kenya, should also be a priority. 
BELLAMY