POWERING TANZANIA’S INDUSTRIALISATION

Songas is an Independent Power Producer (an IPP). An IPP is a private company which owns and operates electrical generation facilities and sells the electricity it produces, usually to a utility for subsequent sale to consumers. Songas sells all the electricity it produces to TANESCO. The electricity TANESCO buys from the gas- red Songas plant is much cheaper than TANESCO’s tari to its electricity consumers . By purchasing electricity in bulk for sale to its customers, TANESCO is saved from making the massive nancial investment (hundreds of millions of US dollars) necessary to develop, build, own and operate its own power stations. TANESCO also bene ts because additional electricity purchased from IPPs costs less than it would if it expanded its own capacity. This article brie y explains the IPP electricity charging structure and how the charges are designed to ensure that much-needed new electrical generation capacity can be economically and e ciently constructed and operated. Songas is the cheapest supplier of thermally-produced electricity in East Africa. Therefore a properly managed IPP process has been, and can continue to be, an important factor in providing low-cost and reliable electricity to Tanzania. Electricity cannot be reliably stored on a large scale. Electricity must be produced as and when it is needed. There must be su cient electrical generation capacity available to meet the peak demand for electricity on a system; otherwise power outages will occur when demand is high. Therefore not all power stations need to generate electricity all the time. The energy generated varies as the demand for energy varies. Demand is high during daytime working hours and lower overnight and at weekends. In Tanzania, TANESCO is the grid operator and controls the electrical grid system. TANESCO monitors the system and turns generating equipment on and o as required; which is referred to as dispatching. TANESCO has control over when, and at what level, IPPs run. TANESCO will normally dispatch generators with the cheapest variable cost to meet the base load, with more expensive generators being used only to meet the peak demand. Most consumers in Tanzania buy power from TANESCO. IPPs, including Songas, sell all their electricity output to TANESCO. Songas has only one customer. Long-term contracts are necessary to provide a stable cash ow and allow investors to make investment decisions and to fund operations. If IPPs were allowed to sell electricity directly to the thousands of industrial, commercial and domestic consumers in Tanzania, a di erent form of contract would be more appropriate. However, this is not the case and therefore the form of the Power Purchase Agreement, between TANESCO and IPPs, is based upon a tried and tested model used successfully throughout the world. Capacity Charges and Energy Charges are a common feature of almost every power contract in developing markets. A Capacity Charge is a xed monthly amount, the value of which depends on the available generating capacity of the power station. This charge is intended to meet the xed costs incurred by the IPP, including the cost of constructing and nancing the power station, repayment of loans and interest, sta costs, insurance and administration costs and xed operating and maintenance costs. These costs are incurred whether or not the power station is running. The PPA will normally specify a guaranteed availability and the charges will be reduced if the IPP fails to meet this availability guarantee over a period. An Energy Charge is designed to cover the variable costs of running a power station. The charge is usually a sum per unit of electricity (known as a kilowatt hour or kWh). The chief variable cost is fuel but it also includes variable operating and maintenance expenses which are signi cantly a ected by production levels. A capacity charge is not unique to the electricity industry and is actually a very common commercial arrangement when a supplier is selling to a single customer. A single customer will have exclusive use of the service even if he chooses not to use that service all the time. In such cases the customer will pay a xed cost (i.e. capacity charge) plus a variable cost when he uses the service. Common examples include: Renting a house (you pay for a whole month even if you go away on holiday); Leasing a car (you pay for when the car is parked outside your home and not just when you are driving); Occupying a hotel room (you pay for a whole day and not just the time you are asleep). In such cases the customer will also pay a variable cost when he actually uses the service; the customer will pay separately for fuel when he drives the car he has leased or he pays separately for any food he eats in the hotel. This is di erent from using a bus or a taxi, where the customer only pays for the time he is in the vehicle. This is because when you rent a house or a car or a hotel room, no-one else is allowed to use it. You are the only customer and you have exclusive use of the service. When you use a taxi, other people can use it when you have nished your journey. You are not the only customer. An investor, whether it is a state-owned utility or an IPP, wants to be sure that its funds will be paid back over time (plus a reasonable return on that investment). As an IPP does not control its own production levels, it needs a way of making sure there is a stable cash ow coming from the project. A stable cash ow can justify the construction of the project and ensure the project can pay the xed costs of its operation. Under the terms of a PPA, these xed costs are reimbursed through a Capacity Charge. As noted above, the Capacity Charge is a xed payment each month, regardless of whether TANESCO chooses to run the plant or not. However the Capacity Charge is only fully paid if the IPP meets its guaranteed availability targets. The payment will be reduced if the plant su ers reduced availability. This incentivises an IPP to maintain a high availability, typically well above 90%. In addition to xed costs, a project will incur variable costs when it is actually running. The major variable cost item is fuel. Under the terms of a PPA, these variable costs are reimbursed through an Energy Charge which is paid in accordance with the amount of electricity delivered per month, measured in kilowatt hours (kWh). The all-in cost of electricity is the total cost billed (Capacity Charge + Energy Charge) divided by the amount of electricity delivered. This is typically expressed in terms of USD/kWh or TZS/kWh. The all-in cost of electricity provided by Songas will vary slightly, depending on the amount of electricity delivered each month, but is typically around US 6 cents per kWh (TZS 140 per kWh). This is much less than the TANESCO’s average selling price of US 12 cents per kWh (TZS 280 per kWh). Songas is therefore delivering a valuable service to TANESCO and Tanzania, in providing a reliable source of cheap electricity. Songas invested USD 320 million in its project. It built the gas extraction plant on Songo Songo Island, laid the 225 km pipeline carrying gas to Dar es Salaam and upgraded the Ubungo Power Plant to its current capacity of 180 MW. Songas invested in the gas infrastructure in addition to the power station and the charges are designed to recover that investment. These costs are slowly recovered over a long period during the term of the PPA and are funded by customers buying electricity. If electricity tari s are cost-re ective, these charges do not impose a burden on TANESCO or its customers.

POWERING TANZANIA’S INDUSTRIALISATION ...through the supply of safe, reliable and cost-effective energy Songas is a leading Tanzanian gas-to-power company generating 180MW (approxi- mately 20%) of Tanzania’s electricity. It also supplies natural gas to industrial custom- ers to use in manufacturing processes. The company is a strategic partner with the Government in meeting the growing demand for energy and includes ownership by Tanzanian sector entities such as TPDC, TANESCO and TDFL. By utilising the country’s own natural gas resources, Songas offers an alternative and affordable form of energy, and positions Songas as an important regional energy producer. Songas’ contribution to Tanzania includes: Saving the Tanzanian government billions of TZS by using a domestic fuel supply over imported fuel Supplying reliable and cost effective electricity and natural gas since 2004 Investing US$320 million in infrastructure Running a successful Tanzanian business and paying taxes and dividends to the Government of Tanzania Creating long term employment and development opportunities to more than 100 people Raising the standard of operations through world class technical performance Improving livelihoods through ongoing investment in health, education and community development programmes. T: +255 764 701 000/1 www.songas.com TANESCO itself also incurs xed costs for its own plant. TANESCO incurs such costs even if its plant is not available. Availability of TANESCO’s plant is normally lower (typically 60-70%) than an IPP, it is likely that the e ective capacity charge for TANESCO’s own plant is higher than that of Songas. Capacity charges therefore help ensure new generation capacity is built in a market where a single electricity purchaser purchases all the electricity produced by generators. In Tanzania these charges are negotiated and agreed by TANESCO and also have to be approved by EWURA (the Electricity and Water Regulating Authority). Capacity charges do not mean that an IPP is paid to do nothing. The IPP is paid to make electricity generation capacity available (it must be ready if needed by TANESCO) and to respond to instructions from TANESCO. If the IPP is not available or if it unduly fails to respond to a request from TANESCO to generate, then there are penalties imposed. These contractual targets are there to make sure the IPP is doing a good job. Songas maintains world class levels of availability (above 95%) at Ubungo Power Plant and generates at the request of TANESCO as and when required, which is almost all of the time. Songas is certainly working hard on behalf of TANESCO and electricity consumers. Alternatives to capacity charges can be used but in reality they often result in the same outcome, which is a predictable level of payment from the utility to the IPP. Other structures include having only a variable charge (a per unit charge), but with a “must run” level. This is called a “take or pay” arrangement, whereby the utility guarantees that it will take a certain amount of production and, if not, the supplier is paid anyway. Wind farm projects charge only a variable fee but require the utility to take whatever electricity is produced, regardless of whether it is required. In such circumstances TANESCO loses the ability to dispatch the electricity provider (except in emergencies) and must pay for whatever energy is produced. Due to its nancial di culties, TANESCO will struggle to nd the money to build the new large scale power generation capacity necessary to keep up with the growing electricity demand in Tanzania. Even if the huge funds were available, funding power generation projects may require the Government to divert these funds from other urgent projects. IPPs are therefore an attractive option to build new power stations, as TANESCO would then pay a xed agreed monthly charge to the IPP instead of making a huge capital investment. The IPP developer will raise the necessary funds for the cost of constructing the new power station. In order to obtain the necessary funding for building IPP projects, lenders and investors require assurance that a project ts in well with TANESCO’s system expansion plans (and therefore is very likely to be needed in the long term). Investors rely upon, that when TANESCO signs a contract to build an IPP, TANESCO wants that project to be built. It would be unfair (not to mention a breach of contract) for TANESCO to change its mind and say it no longer needs it and so refuse to pay for it anymore. If tari s are set correctly, the charges paid by TANESCO to IPPs are o set by the revenues TANESCO receives from its customers. TANESCO also uses these revenues to maintain its transmission and distribution infrastructure (poles and wires) and to connect new customers. This arrangement promotes improving the nancial health of the electricity sector, including TANESCO pro tability, and customers receiving reliable, a ordable electricity. Since the project start in 2004, the Songo Songo gas and power project has saved Tanzania in excess of USD 6 billion, by substituting local gas instead of expensive imported oil. Songas is a Tanzanian company. The Government of Tanzania owns 46% of the shares in Songas through shareholdings by TANESCO, TPDC and TDFL. Globeleq owns 54% of the shares in Songas. Globeleq is a UK-based IPP company developing and operating power projects throughout Africa. The shares of Globeleq are owned by CDC (70%) of UK and Norfund (30%) of Norway. CDC and Norfund are institutions promoting investment in developing countries.