Analyzing The Effect Of Electricity Tariff On Economic Growth (Article)

By: Paa Kwasi Anamua Sakyi,

Electricity is widely regarded as a major determinant of economic prosperity of any State. It is the force that propels any economic activity, and indeed the pillar of wealth creation. Onakoya et al. (2013) finds the output of the energy sector (electricity and the petroleum products) usually consolidating the activities of the other sectors which provide essential services to direct the production activities in agriculture, manufacturing, mining, commerce et cetera.

Electricity according to Kumi (2017), plays a significant role in undertaking daily activities from cooking, lighting, heating to powering machines in the industrial sector. It is also essential for quality healthcare delivery, education, transport, effective communication, mineral exploration and many more.

While the relationship between electricity consumption and economic growth has been extensively analyzed in empirical literatures, little studies have been conducted on the relationship between electricity tariff and economic growth. Today a growing body of research is examining the impact of electricity tariffs on behavior of electricity consumers at all levels of usage (Newsham and Bowker, 2010; Stener, 2015; Abeberese, 2016), particularly industries and the service sector, which produces goods and services within the global economy.

It has become imperative since business performance is sensitive to the cost of indirect inputs, and energy bills have been found to constitute 30 percent of operating costs for an average company (Eifert et al., 2008; Jewell, 2006). Therefore, it is conceivable that electricity tariffs impact firm behavior and performance.

For instance, Abeberese (2016) contends that electricity tariffs hinders a firm’s productivity where prices are high relative to income levels.

Also a report from the U.S. Department of Energy, finds that customers adjust their consumption patterns to changes in price as well as to changes in the structure of tariffs. Meanwhile a 2013 global review by the International Labour Organization (ILO) confirms that increases in labour productivity within economic sectors is the main driver of economic growth. Based on these, one can conclude that the fixing of electricity tariff is relevant as a catalyst for economic growth.

A Balanced Idea

Fixing electricity tariff itself must be seen as a “balanced idea”, where the supply and demand side of the equation must balance. According to a renowned Economist and Investment consultant Mr. Kwame Pianim, electricity must be appropriately priced in order not to encourages waste, and promote supply inefficiencies.

His advocate for fair pricing of electricity is to ensure producers are able to cover their costs and make a fair return on their investments, while on the consumption side waste is contained.

He contends that power utilities (producers, transmitters, and distributors) must be given tariffs that reflect a fair risk-adjusted rate on their investments, so they can generate sustainable business with strong balance sheet, to pay their suppliers, to maintain equipment, and plan to meet projected future demand; while consumers’ expectations are to have an uninterrupted and reliable supply of electricity, and tariffs that are not necessarily affordable but reflect the scarcity value of the product.

Demand-side Expectations

The expectations from electricity consumers are; to have uninterrupted and reliable supply of electricity with minimal downtime, and a competitively priced electricity vis-a-vis regionally, so that customers get value for money and industry can compete globally. Of all the strategic development leveraging growth driven infrastructure that nations require, efficient and reliable supply of adequate electricity at competitive prices is probably the most critical. We know what happens when we are in a state of unreliable electricity.

Studies have established that the absence of electricity service quality undermines firms in less developed countries, in relation to productivity. Bhuvaneswari and Singh (2012) conducted a power quality survey in various industrial sectors in India and finds that power quality is a matter of concern especially when the interruption of grid supply occurs in a plant resulting in downtime.

Their studies establishes that “with the extensive application of sensitive power electronic equipment and non-linear loads in industrial and commercial/domestic sectors, various problems like power surges/sags, poor voltage and frequency regulation, harmonics, switching transients, electrical noise and electromagnetic interference (EMI) effects are frequently encountered which leads to poor power quality.

This according to their work, results in damage of capital-intensive appliances, safety concerns, loss of reliability and above all a huge economic loss. Barnebeck et al (2012), estimate that the annual economic growth drag of a weak power infrastructure is about 2 percentage points in Sub-Saharan Africa.

Aside service quality, high end-user tariff have been found to have adverse consequences for business, employment, social welfare, and investment decisions. Abeberese (2016) studied on the effect of tariff changes, using panel data on Indian manufacturing firms to see how they respond to exogenous tariffs increases, and concludes that firm performance is impacted as businesses reduce their electricity consumption and switch to less energy-intensive industries, reduce their machine intensity, and have lower output and productivity growth rates.

Akuru et al. (2011) infers that the closure of manufacturing firms in Nigeria can be partly attributed to high energy costs. It literally means that electricity constraints may limit a country’s growth by leading firms to operate in industries with fewer productivity-enhancing opportunities. Boonzaaier et al (2015) however find that, in South Africa, electricity demand is becoming more elastic in the wake of tariff surges, and eroding profits may lead to a change in investment decisions.

Supply-side Expectations

Power generators would want to have a contractual arrangements that is able to allocate risks during the operating period, of which take-or-pay, throughput, and contracts are perhaps the most commonly applied. They wish to have an off-take contracts including the take-or-pay contract that is widely recognized by lenders in securing large external debt financing on limited recourse terms that energy projects typically require. The predictability of revenue flows from the project according to Vinter (1994) minimizes the lender’s worry over potential risk of non-payment of the project debt, and strongly influencing the lender’s judgment in respect of the bankability (i.e. acceptance) of the project structure.
For instance, take-or-pay for generators guarantees a supply capacity capable of meeting at least a 120 percent of projected demand so that customers are paying for smooth supply with disruptions easily and promptly remedied through stand-by capacity.

Power utilities also look forward to a cost-reflective tariffs plus a fair margin that provides a fair risk-adjusted rate on their investments into power generation, transmission, and distribution. This is to ensure that they can generate sustainable business with strong balance sheet, to pay their suppliers, to maintain equipment, and plan to meet projected future demand – in a bid to provide consistent and reliable power to consumers. Cost-reflective tariffs according to Umachagi et al., (2015) benefits energy utilities, in that it stimulates exploration and development of additional resources, create incentives for innovation and efficiency improvements, and attract new investment. Economic fundamentals also confirm that from a macro-economic and allocative efficiency perspective, cost-reflective tariffs are the most economically efficient and provide the optimum price signals.

It must be emphasized that without adequate and reliable supply of electricity no nation can build a sustainable and transformational economy to produce goods and services, and be globally competitive. The economic cost of unreliable power supply regime which ends up blowing out our electrical appliances and equipment, and weakening operational life of power generation and supply equipment are very expensive, while the cost of running stand-by generators is not only uneconomic, but hazardous to human health; thus increasing health bills.

Trade-off

Analyst hold the view that fixing electricity tariff itself must be seen as a “balanced idea”, where the supply and demand side of the equation must balance.

In the final analysis, cost-reflective tariff benefits power utilities (supply side), stimulating reliable power generation and distribution, developing additional capacity, creating incentives for innovation and efficiency improvements, and attracting new investment (all things being equal). Suppliers of power demand tariffs that reflect their cost so as to guarantee access to reliable and consistent supply of power to consumers to undertake various economic endeavors that contribute to economic growth. It is also to generate sustainable business with strong balance sheet, to pay their suppliers, to maintain equipment, and plan to meet projected future demand.

In summary, the consumers of electricity (demand side) hold the view that energy prices influence consumer choices and behavior and can affect economic development and growth. Their argument is that high energy prices can result in high energy bills, with adverse consequences for business, employment, and social welfare. They contend that electricity tariff should provide appropriate economic signals to the consumer; suggesting that a lower tariff would stimulate electricity consumption for production purposes, instead of a higher one that raises prices of goods and services; and reduces economic growth.

To balance the equation, consumers must expect to have tariffs that are not necessarily affordable but reflect the scarcity value of the commodity called electricity. The word “affordable” must be entirely treated as a non-scoring variable in the energy tariff equation or vocabulary. Because in the final analysis, so called affordable but erratic unreliable and unsustainable supply have been economically more. Power utilities must equally be prepared to receive tariffs that are just enough to cover cost and reflects a fair risk-adjusted rate on their investments, so they can generate sustainable business ― that which guarantees consumers of competitively-priced power supply that is consistent and reliable, for purposes of productivity.

Written by Paa Kwasi Anamua Sakyi, Institute for Energy Security (IES) ©2019
The writer has over 22 years of experience in the technical and management areas of Oil and Gas Management, Banking and Finance, and Mechanical Engineering; working in both the Gold Mining and Oil sector. He is currently working as an Oil Trader, Consultant, and Policy Analyst in the global energy sector. He serves as a resource to many global energy research firms, including Argus Media and CNBC Africa.