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Ensuring the success of energy auctions in Kenya

By Beatrice Nyabira and Fred Kibagendi

Countries across the world are increasingly moving towards energy auctions as the preferred method for procuring renewable energy.  In fact, according to the International Renewable Energy Agency, the number of countries using energy auctions rose steadily from six in 2005 to sixty seven in 2016.  The shift has largely been attributed to the benefits of power auctions, including their ability to assist governments with price discovery, lower costs of power generation and flexibility.

Following the recent publication of the Renewable Energy Auctions Policy, 2021, Kenya is set to join the ranks of countries such as South Africa, Uganda and Zambia, which have already embraced power auctions.  The Policy comes at a time when there has been a lot of debate regarding the state of the power sector in Kenya, with one of the pertinent issues being that of the high cost of power purchased by KPLC from Independent Power Producers under the Feed-In-Tariffs Policy.  

While implementation of the Policy will be subject to the report of the Taskforce appointed by the president to review Power Purchase Agreements and approval by the National Treasury, the hope is that if adopted, power auctions will help to drive down the cost of power, particularly when coupled with the technological advancements and increased competition between project developers and manufacturers of renewable energy technologies such as wind and solar.

In preparation for a possible rollout, it is important for us as a country, to draw meaningful lessons from the experiences of those that have dared venture into these waters before us, as power auctions are not quite the silver bullet they may appear to be.  They are wrought with risks which if not properly managed, can hinder the achievement of the desired objectives.  

To begin with, since power auctions work as reverse auctions - in that the bidder submitting the lowest offer wins, bidders tend to be very aggressive in their pricing strategy.  This has in some instances led to the proverbial “winner’s curse” where the successful bidder’s price turns out to be unrealistically low, rendering delivery of the project difficult or even impossible.  Measures must therefore be put in place to guard against such situations. Potential solutions include government having a realistic understanding as to the kind of pricing that would be viable and the imposition of severe penalties e.g. enforcement of bid bonds and blacklisting (as is the case in the UK and Netherlands) of bidders who are unable to deliver on account of unrealistic pricing.  The penalties should be made known to potential bidders from the onset to discourage them from submitting unrealistic bids.

Auctions can also face the risk of underbidding.  For power auctions to yield the desired results, they should be designed in a manner that allows for maximum participation such that the bids received exceed the capacity available for auction.  Simply put, healthy competition is required for an auction to be effective.  A number of measures can be put in place to attract good bids.  First, there should be clear communication of the auction rules and the qualification criteria. In France for instance, 40% of the bids submitted during the auction rounds conducted in 2011 and 2012 were ineligible, largely on account of unclear documentation requirements.  Second, the Government should avoid unnecessary barriers to entry and onerous qualification requirements.  For instance, while bid bonds and performance bonds are necessary to secure the commitment of bidders, they should be sized appropriately so as not to discourage potential bidders.  The government could also consider allowing bidders who were eligible for one round of auctions but ended up losing to other bidders, to be automatically prequalified in subsequent auctions.  This would help to reduce the administrative costs involved for both the government and bidders.  Additionally, the auction rules should be comprehensive - covering possible scenarios such as tied bids or insufficient competition. This will enhance certainty and transparency and in turn, the commitment of potential bidders.  Transparency will also help reduce the possibility of actions challenging the auction process and thus avoid implementation delays.

Finally, there is always the risk of collusion among bidders with a goal of controlling the prices. This can be partially addressed through ensuring maximum participation as evidence from other countries suggests that the higher the number of bidders involved, the lower the chances of collusion.  The use of a ceiling price above which bids will not be considered may also help to mitigate the risk of collusion by ensuring that even in such event, the prices will not exceed the ceiling price.  Further, the government may opt for static auctions whereby bidders submit sealed bids and are not made aware of the prices submitted by other bidders.  This is in contrast to dynamic auctions where there are multiple rounds and bidders are made aware of the prices submitted by other bidders.  

Undoubtedly, energy auctions have the potential to solve some of the challenges facing the Kenyan power sector.  Nonetheless, they are not a perfect solution and should be carefully rolled out if the government is to achieve its objectives.  Simultaneously with this, the government should aim to address some of the other challenges facing the power sector such as land acquisition and the extensive licensing requirements.  

The article was written by Beatrice Nyabira(Partner) and Fred Kibagendi (Associate) and was featured in the Business Daily on 30 August 2021 and can be accessed here .