ERA responds to Social media critics

Electricity Regulatory Authority (ERA), Uganda has responded to social media criticism over increased electricity tariffs and its operations. Below are the responses;

There have been comments on social media critiquing different practices in the electricity supply industry. It is in order to provide information, further explanations and correct misinformation aimed constructive engagements.

Below are some of the structured comments raised to which response is accordingly given.

1. That Umeme charges customers for connection poles, cables and even transformers but lists them as its own assets and investments – for which the consumer tariff is then hiked to sustain the guaranteed ROI. That this unreasonably raises tariffs by approximately 18%.Comment: Investment in the Electricity Supply Industry are managed in accordance with the Investment approval and verification guidelines.

Every year, Umeme submits investment plans to the Electricity Regulatory Authority for approval. Upon approval, Umeme executes the approved investments and submits them to the Authority for verification and incorporation into the Asset base. It is not until investments are executed that they qualify to earn a return on investment. Any investment executions that may be found non-compliant with the Investment approval and verification guidelines issued by the Authority are struck of the Rate Base and any amounts earned by Umeme in respect of those assets are clawed back(reconciled and taken away from the company revenue). Investment verifications are undertaken by joint teams from ERA, Umeme and UEDCL. There is, therefore, a proper framework for approving and verifying investments to ensure among others; (1) electricity consumers are deriving benefit from the executed investments, and (ii) investments funded by consumers are not included in the Assets Base for computation of the return on investment due to the utility. It is important to note that investments range from extension and construction of medium voltage and low voltage lines, injection of transformers, construction of substations among others. It should be noted that whereas some consumers pay for mostly non-shared lines and transformers, most of the line extensions, transformers and all substations are not consumer financed. In addition, Umeme also invests into customer connections. Currently, domestic consumers on the Umeme network pay only Ush 98,000 for a no-pole connection compared to the actual cost of Ush 332,525. This means that for every no-pole connection executed by Umeme at Ush 98,000, the company injects Ush 234,525 as an investment. Once again, fore mphasis, a utility does not and can never earn from an investment paid for by the consumer. The investment verification reports showing executed and verified investments undertaken by Umeme are shown on the ERA website. Sample Investment reports showing investments undertaken by Umeme;a) http://era.or.ug/index.php/newsletters/doc_download/47 9-umeme-2014-investment- verification-report b)  http://era.or.ug/index.php/newsletters/doc_download/47 2-umeme-s-additional- investment-verification-report-2015 c) http://era.or.ug/index.php/newsletters/doc_download/47 1-umeme-s-additional- investment-verification-report-2014

2. That Umeme claims back Corporation Tax paid this year as lost revenue next year, as a result of having failed to acquire an investment licence waiver for corporation tax, for which the tariff is increased annually. And that this unreasonably raises tariffs. 3% of the tariff is Corporation Tax refund for prior year. Comment: It is not true that Umeme claims back Corporation Tax paid because it failed to acquire a tax waiver. Whereas it is true that Umeme is allowed costs for actual taxes paid, it is a global practice for regulated enterprises. Globally, regulated enterprises are allowed recovery of all reasonable costs including; costs of operation and maintenance, return on invested equity and taxes. There are specific references from the Public Utilities Research Centre (PURC) (Page 4 to 6): https://www.researchgate.net/profile/Mark_Jamison/publication/228720046_RATE_OF_RETURN_REGULATION/links/0912 f50f57793c83ea000000/RATE-OF-RETURN-REGULATION.pdf and the Pwc report on Guide to Accounting for utilities and power companies(https://www.pwc.com/us/en/cfodirect/assets/pdf/accounting-guides/pwc-utilities-power- 2016.pdf) (Page 19-2 or 642 of 766) which lend credence to this regulatory practice (of allowing costs of actual taxes paid).

It is important to note that, for utilities that have only O&M service contracts, only recovery of approved of costs is allowed and is based on efficiency targets. Under such contracts, companies can only make any profit (cost saving) on account of efficiency gains but no funds are allowed as mere profits or mark-up. However, under incentive-based regulation, companies may make efficiency gains and/or cost savings and therefore make a profit. In this circumstance, the company would pay applicable income taxes on its profit made. On the other hand, for investing utilities, it is common for companies to require that the return on investment is protected since the reflects a reasonable cost of capital (reasonable cost of capital varies from industry to industry, country to country and reflects risks prevailing at a point in time). For contracts where utilities are allowed to invest and earn a return, the rates of return are negotiated as either net of tax or otherwise. Therefore being allowed a rate of return that is net of tax is not unreasonable and is a global best practice for regulated utilities. Under the current tariff methodology, the Electricity Regulatory Authority (ERA) undertakes a reconciliation between the Corporation Tax allowances used in determination of the tariffs and the actual taxes paid by Umeme Limited to URA during the Tariff Year.

3. That with commercial losses at 1% and technical losses at 18%, totaling 19%, a whole 24% of Umeme’s sales tariff is loss refunds. Just 1% = $4 million.

Comment: At a time when Umeme inherited the electricity distribution grid, energy losses were in the upward of 38%. The electricity industry was also faced with other challenges including; limited investment in generation, transmission and distribution infrastructure, low levels of revenue collection and high debts including debts for public installations and institutions. The inefficiency challenges greatly informed the decision to unbundle the sector (form different separate entities for distribution, generation and transmission) and instituting the regulator under the Electricity Act, 1999. In addition, the low levels of investment coupled with treasury constraints to address investment needs greatly informed the decision to concession generation and distribution segments. Therefore, concessioning of the industry was purely an investment decision. Having concessioned the segments, there was a need to set targets for loss reduction and revenue collection among others. Umeme has, therefore, been operating against a loss targeting framework whereby the consumers pay only for target losses as opposed to actual energy losses. The loss target for 2018 is at 14.7%. This loss target compares very well with benchmark networks in the region. For example, loss targets for Kenya and Tanzania remain above 16%. It may be important to emphasize that all utility networks incur network losses and reasonable commercial losses (from thefts, leakages) and loss targeting is a prudent practice in electricity networks. This based on the understanding that, globally, even a perfect network will have losses and therefore in is not unreasonable to allow reasonable energy loss levels.

4. That the contract is therefore bad for Uganda because Umeme therefore has only a limited interest in lowering technical losses to zero since the consumer refunds this inefficiency in the tariff. That instead of making the technical investments to wipe out the technical losses, Umeme claims customer-funded poles and cables as investments for tariff-increase-compensated ROI protection. This excess ROI is driven by unreasonable claim of losses as revenue, instead of investing adequately to further lower the losses – and to stop claiming Corporation Tax as a refundable expense.

Comment The tariff is determined based on Target energy loss factor and not actual energy loss factor. Under the incentive based economic regulation framework, a utility takes a financial loss when the actual loss is higher than the target loss factor used in tariff determination. A utility, therefore, has an incentive to reduce energy losses. Electricity consumers do not refund a utility for failure to achieve the target energy loss as set by the regulator. The framework for managing investments in the Electricity Supply Industry has already been discussed above.

5. That the contract with GOU provides for planned revenue but Umeme has been claiming excess revenue from sales surplus to plan, as its income (this matter as in litigation further to ERA waking up to disallow the practice).

Comment: In 2012, the ERA amended Umeme Limited Licence for Supply of Electricity and provided for among others; reconciliation between the projected energy purchases by Umeme Limited (used for tariff setting), and the actual energy purchases by the company during any given Tariff Year. This was done based on the fact that revenues accruing from the energy purchased (and therefore sold) by the company beyond what was used for tariff determination should benefit the consumer and not the company since sales level does not constitute a performance incentive in the licence. Following the amendment of the Licence, Umeme Limited appealed the decision of ERA (to amend the Licence) at the Electricity Disputes Tribunal. Following the hearings at the Electricity Disputes Tribunal, in 2016 the parties settled the matter out of court through a consent judgement. The consent judgement provided that the ERA will continue to implement the reconciliations as provided in the amendment to the Licence. The excess energy purchased (and sold) by Umeme Limited arising from the reconciliation is invested by the company, on behalf of the consumer, in projects approved the ERA. Investments so executed attract no return to the company. Given that industry development and balancing of consumer, investor and public interests remains a major pre-occupation of Government through the regulatory authority, Licence modifications take place as and when protecting the consumer or any other stakeholder is required to promote sustainable electricity supply.

6. That subsequent to the above and a generally bad contract, Umeme buys power from UETCL at an average weighted Bulk Sales UETCL Tariff of Shs 260.9 and makes an exorbitant markup by selling at Shs 800+. The purchase price of Shs 260 is one of the four lowest in Africa but the sales price of Shs 800 is one of the 10 highest in the world. That this massive markup far exceeds the 10-15% gross markup that most utilities charge, worldwide.

Comment: It is not true that the energy tariff is above Ush 800. It is important to note that tariffs are levied on the basis of cost causation in line with the Electricity Act and the Tariff Code. For this reason, tariffs defer by customer class (domestic, commercial and industrial customers) and by time-of-use (peak, off peak, shoulder). The highest tariff is for domestic consumers at Ush 718.9 which was until December 2018 at Ush 685.6. The lowest tariff is for extra-large industrial consumers at Ush 246.5 at off-peak time (0000hrs to 0559hrs-given that manufactures are able to utilize the night shift). Given that more than 75% of the energy is consumed by industrial consumers who consume at a low tariff, the weighted average tariff is way below the domestic customer tariff (below Ush 718.9). Currently, the weighted average tariff (averaging all customers at all times of the day) is Ush 520.3 The weighted average Bulk Supply Tariff for Q1 2018 is Ush 289.6/kWh and not Ush 260/kWh. The weighted average Bulk Supply Tariff is adjusted for Target energy losses and Target revenue un-collection factor thereby increasing to Ush 345.6 /kWh before adjustment for distribution costs. Further, rather than implying that any tariffs above the Bulk Supply Tariff (BST) is a markup, it is prudent to look at it as reasonable costs of distribution. Any costs (and therefore tariff)above the Bulk Supply Tariff are on account of approved distribution costs including: reasonable costs of energy losses as approved, reasonable costs of operation and maintenance, recovery of funds invested into the distribution network and returns on equity invested. It’s important to note that any costs included in the tariff is deemed reasonable and it remains the pre-occupation of regulation to ensure that all approved costs enable the company operate on the efficiency frontier and represent value to the consumer. 7. That instead of the contractually agreed and protected 20% ROI, Umeme makes a 43% ROI.

Comment: Umeme Limited is licensed under a hybrid of; Rate of Return Regulation and Incentive Based Regulation economic regulation frameworks. Under this framework, Umeme Limited earns are turn on investment on the approved, executed and verified investment, and the ERA sets tariff performance parameters of; energy losses, revenue collection, operation &maintenance costs. The return on investment is guaranteed to the extent that Umeme Limited achieves/outperforms set tariff performance parameters (targets). Therefore, the level of actual return on investment may be below 20% or above 20% depending on the performance of the company against the set targets. For example, if the Target energy Loss factor is 14.7%and the actual loss by Umeme Limited is 13%, then the effective return on investment shall be higher than 20% on account of more revenue arising from exceedance of the energy loss target. On the other hand, if Umeme actual loss is 16% (against a Target of 14.7%), then the effective return on investment will be less than 20% because the company will sell less energy(and therefore revenue) than was envisaged at tariff determination. It works similarly with other performance targets. 8. That lowering the Bujagali sales tariff is therefore not the primary solution to unaffordable power because the Bujagali tariff is already accommodated in the very acceptable Shs 260Bulk Sales Tariff. It is true that there is no single button to lowering tariffs. However, it is also good to note that the public expectation of tariff levels is normally always be below the most reasonably efficient levels. Continuous cost analysis at generation, transmission and distribution may always deliver efficiency gains which may help reduce tariffs. Therefore, any intervention that contributes to tariff reduction is appreciated though it may require external financing interventions, beyond ordinary efficiency gains, to deliver significant tariff reduction beyond. Contrary to public expectations, an affordable tariff may usually be well below the lowest cost-reflective tariff possible and therefore stretching to achieve.8. That the fact that large Ugandan manufacturers buy from Umeme at Shs 490 per unit does not make that tariff reasonable when purchases from UETCL is at only 260/-. That the margin is still too high. That large manufacturers like BIDCO find it cheaper to use furnace oil HFO. Importantly claims Patrick, 66%, according to ERA, of total demand in Uganda is household consumers buying at800/- plus VAT. He says in China and India, 58% and 68% of industrial demand is from cottage industries that are billed as domestic users. To bill them at 800/- plus VAT in Uganda is a major contributor to cottage de-industrialization in this country and choking of non-manufacturing SMEs. Comment: For a country importing HFO, it may not be easily possible that the cost of thermal generation, even at micro/firm-level, can be below the grid tariff for manufacturing. In practice, industrial consumers may utilize thermal generators mainly as back up supply when there are grid limitations to deliver power. It is, therefore, unlikely that any grid connected manufacturer in Uganda replaces thermal generation for the grid supply. Contrary to what is indicated (that 66% of the energy is consumed by Household),household/domestic consumers account for only 23% of the energy consumed in Uganda. In addition, unless it’s by choice, a cottage industry would be billed as a medium industrial consumer or a commercial consumer, as a worst case scenario, which is lower than the domestic tariff. In the recent past, small industries have been encouraged to aggregate loads through bulk metering and enjoy lower tariffs in line with the law and regulations. Outside the mainstream cost reflective tariff determination realm, government policy in different countries may facilitate industrial development through subsidies to specific or all industrial consumers. From the China example given, it’s a surprising revelation that cottage industries contribute up to 68% of industrial demand and yet billed under the domestic customer category.9. That Umeme’s exorbitant sales tariff creates a strategic constraint on national demand for power. And that constrained power consumption is, as per World Bank study, a constraint on GDP growth. And that from ERA’s experience, as seen when commercial losses came down, a 1% cut in the consumer tariff increases effective demand for power by 2.7%, and that every 2.5% increase in effective demand for power increases GDP by 1%.

Comment Classifying a tariff as exorbitant is not fair until; a tariff in a country is benchmarked against comparable peers and most importantly against the reasonable/actual cost of service in a country. How low or high a tariff is depends on the comparators and several factors inconsideration by an analyst. In conclusion: that Uganda although initially good contract in 2005 ,a bad contract with Umeme came about that included all the above costs in the tariff after it was amended in contravention of the Electricity Act cap 145 of 1999, which illegality needs to be addressed to reduce the end user tariff by 44%.Let me raise an additional question. If the effective demand for electricity is constrained by the high consumer tariff, who will purchase the 1,000 MW due in the next 12 or so months from Karuma, Isimba and Ayago? Remember that since losses are now paid for by the consumer then every megawatt added to the grid will attract an increase of 18%the cost of that megawatt in the end user tariff. Taking into account that big potential export clients like Kenya have already plugged their supply gaps with long term take-or-pay contracts with bigger producers like Ethiopia, why not address the constrained demand for electricity here by removing from the tariff the illegal costs since for every 1%age reduction in tariff leads to a 2.7% increase in effective demand for electricity in Uganda. Imagine if 44% was reduced…… and LEGALLY SO. Comment: It is true that tariff levels affect industrial competitiveness just like tax regimes and other forms of infrastructure. As a country, our competitiveness should be driven by efficiency and infrastructure development. Affordability of utilities depends on efficiency management as well as targeted subsidy programmes in areas where there are no immediate efficiency gains. For example, Uganda may necessarily have to subsidize certain utilities if neighboring countries do the same in order to enable competitiveness of local manufacturers. For the case of power, it is not envisaged that consumption can move ahead of supply. It is a classic case of supply creating its own demand. The scoping, appraisal and construction lead time for a power plant may range from a year to 10 years (or beyond) depending on technology and external (stakeholder) concerns. It can, therefore, growth-constraining if demand outstrips supply. It is common that infrastructure development (infrastructure supply) leads (and not lags) its demand in order to stimulate productive sector development. Industries establish production centers in areas based on market, available infrastructure, access to market and, most importantly, availability of power. It is, therefore, expected that increased generation, supply stability and quality of supply will play a big role in attracting industrial consumers. Admittedly, load and demand growth remains one of the greatest tasks to ensure optimal demand-supply balance, ensuring that additional generation gets absorbed as quickly as possible hence creating jobs and aiding national development.