A Cost Reflective Tariff: Damned if we don’t

The Energy Regulation Board recently held public hearings for different stakeholders to weigh in on ZESCO’s application to revise electricity tariffs upward by a weighted average rate of 113%.  According to ZESCO, this adjustment is necessitated by, among other reasons, the changes in prevailing macro-economic conditions and the increase in the cost of generating electricity, both from ZESCO’s own plants and from the Independent Power Producers (IPPs). ZESCO further argues that increased tariffs will lead to improved service delivery. This tariff application has further been motivated by the immediate need to finance power imports aimed at reducing the long hours of load shedding.

The importance of reliable electricity supply for economic growth cannot be over-emphasised. For instance, the droughts witnessed in 2015/16 and 2018/19 seasons led to the failure of the electricity sub-sector (84% hydropower dominated) to generate sufficient electricity required to sustain economic growth. Particularly, as a result of the 2018/19 drought and in part, the electricity deficit, Zambia’s economic growth has slowed down considerably and estimated at 2% in 2019, which is far much lower than the average growth rate of 4.6% recorded over the period 2011 to 2018.

In the 2020 National Budget, the Government recognises the critical role a cost reflective tariff would play in attracting investments and diversifying Zambia’s energy mix. Both new investments and diversification are critical in ensuring reliable supply of electricity. However, the Zambian electricity market has struggled to attract investments in new capital power generation projects despite its liberalisation in 1995. According to ZESCO, the current average tariff at US$0.064 per kilowatt (kWh) is well below the full cost associated with service provision of electricity. At that level, the tariff is below the rate of return required to attract new investments in the industry, both from ZESCO and the private sector. Furthermore, on the regional scene, Zambia’s tariff is below the Southern African Development Community average of US$0.099 per kWh.

Notwithstanding the public demand for a Cost of Service Study (CoSS) to substantiate these views, the arguments have merit. Zambia has been charging a sub-economic tariff for years and this is recognised as far back as the 2006 CoSS and also shown in many other electricity sub-sector focused research and technical reports. This is further supported by technology focused levelised cost of electricity estimations. Given that new investments and a diversified energy mix are critical in ensuring reliable supply of electricity, migrating towards a cost reflective tariff is therefore a necessary condition for stimulating increased investments in the sub-sector.

Beyond the need to attract investment, in the short term, a cost reflective tariff confers other benefits. Firstly, it will increase ZESCO’s liquidity. This would enable ZESCO to dismantle the arrears owed to the IPPs and the back-log of arrears accrued as a result of electricity importation during the 2015/2016 drought season. Aside from clearing of arrears, a higher tariff will cushion the financial burden on ZESCO and allow for importation of electricity from the region. This could ease the hours of load shedding and the impact that it has on economic and social activities.

A counter argument to tariff increment however, is the resultant increase in the production costs of various industries, particularly micro, small and medium enterprises (MSMEs); making them less competitive. Inadvertently, a higher tariff is likely to be passed on to the consumers by producers of goods and services thus increasing inflationary pressures and thereby negatively affecting welfare. Additionally, for households, a cost reflective tariff may present new challenges of increased deforestation through increased consumption of charcoal and firewood. This would exacerbate the effects of climate change and erode progress in attaining access to clean energy

Notwithstanding these valid counter arguments, in the face of current fiscal constraints, the Government can no longer afford to subsidise electricity. In view of this, firms are already facing high production costs owing to unreliable electricity supply and the additional costs of mitigating measures such as back-up generators. A 2019 study by the International Growth Centre found that larger firms paid high costs during outages for backup generation. The paper thus concludes that it makes economic sense for ZESCO to charge cost recovery tariffs if it results in more reliable electricity supply;

Ultimately, a cost reflective tariff is needed for Zambia’s electricity market to thrive. However, its impacts on welfare and firm production costs cannot be ignored. As such, mitigation measures such as continued implementation of the life line band, phased implementation of the tariff adjustment to reduce shocks to the economy will be critical. Additionally, the market also faces many other challenges that need to be addressed such as poor working capital management, an inadequate regulatory environment, operational inefficiencies at ZESCO and poorly negotiated power purchase agreements. Evidently, a cost reflective tariff is the bitter pill we need to swallow to make significant strides in addressing Zambia’s electricity woes.

The authors are researchers at the Zambia Institute for Policy Analysis and Research (ZIPAR). For details contact: The Executive Director, ZIPAR, corner of John Mbita and Nationalist roads, CSO Annex building, P.O. Box 50782, Lusaka. Telephone: +260 211 252559. Email: info@zipar.org.zm.

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