pproaches J a n u a r y 2 0 0 5 N o t e N u m b e r 0 0 3 Output-based aid in Mozambique Private electricity operator connects rural households By Mark Cockburn and Caroline Low M ozambique's first privately operated concession to EdM has focused much of its recent investment on generate, distribute, and sell electricity is now up extending the grid, which will provide northern prov- and running in a rural area of Inhambane Province inces and other outlying areas, now powered by stand- isolated from the country's main transmission grid. The contract alone diesel generators, with cheaper and more reliable was won through competitive bidding by a Mozambican and power purchased from Cahora Bassa or South African South African consortium and leaves the private operator free generators. But this focus on grid expansion leaves to develop the power system in the concession area in the way fewer resources for building local distribution networks most cost-effective. Designed to tackle the extremely low levels and for improving the performance of isolated systems of connectivity, the concession uses output-based aid subsidies to while they await the grid. close the gap between what new infrastructure costs and what Meanwhile households without access to electricity households are willing and able to contribute. Payment of the typically pay as much as 40¢ per kWh for energy from subsidies, made available through an International Develop- alternative sources such as kerosene or batteries--far ment Association credit, is contingent on physical verification of more than the 7¢ per kWh charged by EdM (which households being connected. Encouraged by early success with nearly covers costs) or the 15­20¢ in areas relying on the concession arrangement, the government is identifying areas diesel-generated power. That suggests that, once con- for similar schemes. nected, these households would be willing and able to pay for their electricity use. But the up-front cost of With per capita income of $210 and an estimated connection is out of reach for the typical household. 55 percent of the population below the poverty line in Nor is it realistic to assume that an investor might fi- 2002, Mozambique is one of the world's poorest coun- nance new distribution assets with the idea of recover- tries. In recent years, with strong growth in the ing the full investment through tariffs over time, since economy, poverty levels are believed to have fallen many households, at least initially, would probably sharply. Yet enormous deprivation remains in infra- consume only enough electricity to power a radio and structure, with the country needing to rebuild what one or two lightbulbs. was destroyed during years of civil war (1977­92) and Thus financial viability ultimately depends on to provide those living outside the urban centers with higher levels of demand from commercial customers access to modern energy services. Although and richer households. But output-based aid (OBA) Mozambique generates more than 7 billion kilowatt- offers a way to connect households that otherwise hours (kWh) of electricity annually, much of it from the would not be, without undermining the economics of Cahora Bassa hydro station in the western province of the system as a whole. Tete, about 80 percent of this production is exported to South Africa. Fewer than 6 percent of Mozambican Mark Cockburn and Caroline Low of Cambridge Economic Policy households are connected to the main grid operated Associates (www.cepa.co.uk) are advising the government of by the national utility, Electricidade de Moçambique Mozambique on four more rural electricity transactions. (EdM), or to isolated mini grids run by local munici- Special thanks for comments and contributions by Wendy Hughes, palities. The country's low population density makes it Task Team Leader on the Mozambique Energy Reform and Access costly to connect new customers. Project. Supporting the delivery of basic services in developing countries pproaches sity, the area was extended to include Machanga, in the neighboring province of Sofala. The increasing eco- nomic activity in the area, particularly in Vilankulo, promises strong demand from hotels and other busi- Cahora Bassa Hydro Station nesses as well as wealthier households, providing assur- ance that potential bidders would be able to sell enough electricity to create a viable business. Lying beyond the reach of the EdM grid, these Pilot Concession towns have generated their own electricity using diesel Area or gas from the nearby Pande gas field. The existing set-up offered an advantage in designing a concession that would interest private investors: the distribution assets were relatively new and, since they were owned by the Ministry of Mineral Resources and Energy, could be transferred to a concession without charge and without the need for complex negotiations with EdM. The towns' power systems had been operated by a private company under a management contract. While the contract allowed some adjustments to the monthly The government of Mozambique, committed to pri- management fee to penalize or reward performance, vate participation in infrastructure provision as a these provided too little incentive for the contractor to means of securing the investment needed for economic improve collection rates, connect new customers, or and social development, has sought to combine con- communicate and coordinate with customers and the cessions with output-based aid to expand access to local authorities (figure 1). Responsibility for invest- electricity. The Electricity Law of 1997 lays the founda- ment remained with the central government, leading to tions for privately operated electricity concessions, au- delays in providing new generating capacity so that de- thorizing the minister of mineral resources and energy mand exceeded supply. to award such contracts and setting out some of the terms of concessions. An energy fund, set up to finance By transferring payment and investment risks to the rural electrification schemes, has been given responsi- private sector, a concession contract will considerably bility for monitoring the payments of OBA subsidies. sharpen incentives to expand the system and improve So far, output-based aid in the Mozambican electricity its operation. That outcome would have been more dif- sector has been targeted at all households, not just the ficult to achieve under a management contract, even if poor, in part for simplicity and also because of the performance-related payments had been increased. need to establish a sustainable base business in areas with low connectivity. Figure 1: Household connection rates extremely low under the management contract in 2003 5,000 Choosing a pilot site 4,500 The government chose to pilot its concession approach 4,000 to electricity supply in Inhambane Province, an attrac- Unconnected 3,500 households tive site for several reasons. A key factor is the local Target economy. The unspoiled islands of the Bazaruto archi- 3,000 Connections, pelago, which lie in the Indian Ocean off the coast of 2,500 2008 the province, have become an international destination Households 2,000 Connections, for luxury ecotourism, and the high-end tourism has 2003 1,500 spurred economic growth that has spread to the nearby mainland. The concession area was initially de- 1,000 signed to include the three district capitals along this 500 stretch of coast: Vilankulo, Inhassaro, and Nova 0 Mambone. Following detailed studies of the project Vilankulo Inhassaro Nova Mambone and Machanga economics, including aerial surveys of household den- Source: World Bank. 2004. Supporting the delivery of basic services in developing countries pproaches Designing the contract largest. The bank, whose services were competitively procured, administers a letter of credit, guaranteed by The concession agreement gives the concessionaire the a special commitment from the International Develop- right to generate, distribute, and sell electricity through- ment Association, to be drawn on as subsidy payments out the concession area. The contract is relatively become due. simple, reflecting the government's intention to regu- late with a light hand, but it sets out clearly the rights This mechanism assures the concessionaire of being and responsibilities of each party and allocates risks ap- paid the subsidy following verification of connections by propriately. The concessionaire is not exposed to unrea- an independent engineer, whose services are now being sonable business risk; for example, no rival company competitively procured. The subsidy agreement provides can sell electricity within the concession area. Nor is the remedies for material breach by the concessionaire (for concessionaire rewarded for poor performance; it will example, claiming subsidies for connections not made). bear the full costs of technical and administrative losses But it is structured with "tolerance limits" relating to the and receive subsidy payments for new household con- cumulative number of qualifying connections that can nections only after they have been verified. be in dispute at any one time--to avoid contractual breach procedures being called for trivial reasons. The concession contract and supporting agree- ments have the following key provisions: · The base tariff and indexation rules are fixed for five Bidding the project years, after which they may be amended according The first stage of the bidding was a prequalification to agreed principles. round, designed to ensure that the consortia invited to · The role of the local authority in managing and moni- submit full proposals had the financial and technical toring the concession contract is clearly recognized capacity to operate the concession. Most consortia through the inclusion of the municipality of combined the local expertise of a Mozambican com- Vilankulo as a signatory. pany with the experience of a company from elsewhere · State ownership is limited to 25 percent of the issued in Sub-Saharan Africa--such as Namibia or South Af- share capital of the concession company. rica--in delivering new investment and operating con- · The contract term is 20 years--shorter than the 25- cession contracts. year maximum allowable under the Electricity Law In the second and final round two bidders submit- but judged sufficient to allow the concessionaire to ted fully priced bids against a fixed concession con- make an acceptable return on its investment. tract, ensuring competitive pricing and limited · The concessionaire has exclusive generation rights for renegotiation of the contract terms after selection of 10 years and exclusive distribution rights for 20. But if the preferred bidder. cheaper electricity becomes available--such as Bidders were required to state the tariff at which through the EdM grid--the concessionaire is they would supply electricity given a fixed subsidy pay- obligated to pass some benefits on to consumers. able for each new residential connection. This structure · The concessionaire must pay penalties if supply is gave bidders a strong incentive to design a distribution interrupted or if it responds to problems more system allowing the connection of the largest number slowly than the agreed standards. of households possible. Apart from this incentive and · The concession area may be extended by agreement of the service requirements of the contract, bidders had the parties to the contract. complete freedom to decide how to develop the power system most cost-effectively. The winning bidder has · The concessionaire must pay the government a chosen to connect the major towns in the concession concession fee of 2.5 percent of gross revenue billed. area and build a large central generator to replace the · A subsidy agreement between the concessionaire and existing decentralized arrangement. Its bid assumed the government provides for payment of a $400 that all residential customers would be switched to subsidy for each new residential connection made. prepaid metering, with the aim of significantly improv- No subsidy is paid for business connections. ing collection rates. The winning consortium of ElectroTec (Mozambi- To protect the concessionaire from late payment or que) and Rural Maintenance and Siemens (South nonpayment of subsidies, claims for subsidy are made Africa) bid an average tariff of 18¢ per kWh. Although through a local commercial bank, one of the country's this tariff is higher than the previous tariffs, commu- Supporting the delivery of basic services in developing countries pproaches nity members agreed that they were willing to accept While the winning bidder's proposed tariff has now higher charges in return for much better service. The been accepted by the community, concern about the tariff, though quoted here in U.S. cents, is set in increase over the EdM tariff, especially among local Mozambican meticais, with a formula for adjustments businesses, led the concessionaire to attempt to rene- following changes in fuel costs or exchange rates. gotiate the tariff. Fixing the tariff rather than the sub- sidy should avoid such pressure. It would also allow greater equity in tariffs across the country and the in- Next steps and lessons learned clusion of a lifeline tariff, with very low charges at low The pilot scheme promises about 3,000 new connec- levels of use. tions (see figure 1). That represents 50 percent connec- How successful will the Inhambane concession be? tivity in the four towns in the concession area--but a It remains too early to judge: the contract was signed mere drop in the ocean given the more than 3 million in mid-2004, and operational control has only recently households still to be connected countrywide. As been transferred to the new operator. But for might be expected for a pilot scheme, the transaction Mozambique to have reached this point--with a signed costs per connection are high. To deliver real benefits, contract awarded through real international competi- the concession model, once proven, needs to be rolled tion and giving the private operator strong incentives out rapidly to other parts of the country. The challenge to deliver--represents an enormous achievement. The is to identify other rural areas with a household density country is ready to build on this success. and strong local economy like those in Vilankulo--fac- tors that, along with cheap local gas for generation, were vital in attracting private sector interest. Future References concessions may need to include grid-connected periurban areas, to allow the use of cheap hydropower Tobich, Ralf. 2002. "Concession Approach for Private delivered through the grid and ensure sufficient de- Participation in Electricity Supply: Mozambique mand to create a sustainable business. Case Study." Paper presented at Global Forum on Future concessions are likely to be bid on the basis Sustainable Energy, Third Meeting, Graz, Austria, of the proposed subsidy per connection, with the tar- November 27­29. EMCON Consulting Group, iff fixed--in contrast with the Inhambane pilot Windhoek, Namibia. project, where the subsidy payments were fixed by the World Bank. 2004. World Development Indicators government and bids were based on an average tariff. 2004. Washington, D.C. About OBApproaches OBApproaches is a forum for discussing and dis- The case studies have been chosen and presented seminating recent experiences and innovations for by the authors in agreement with the GPOBA man- supporting the delivery of basic services to the poor. agement team, and are not to be attributed to The series will focus on the provision of water, en- GPOBA's donors, the World Bank or any other af- ergy, telecommunications, transport, health and filiated organizations. Nor do any of the conclusions education in developing countries, in particular represent official policy of the GPOBA, World Bank, through output, or performance,-based approaches. or the countries they represent. Global Partnership on Output Based Aid World Bank Mailstop: H2-202 600 19th Street, NW Washington, DC 20433, USA To find out more, visit www.gpoba.org The Global Partnership on Output-Based Aid Supporting the delivery of basic services in developing countries