DELIVERING ACCELERATED INVESTMENT IN LEAST COST POWER

GENERATION AND SUPPLY AS A MEANS OF ENHANCING COMPETITIVENESS

OF BUSINESS IN ZAMBIA

1.0 EXECUTIVE SUMMARY

Zambia, like other countries in the region is experiencing a power supply deficit. This has mainly
been as a result of increased economic activity. The deficit has also been as a result of inadequate
maintenance or lack of it and system faults. This has brought about the efficiency of the Zambia
Electricity Supply Corporation (ZESCO) being questioned resulting in the resistance to proposed
tariff increments.

The electricity sector has been unable to attract new investments in the form of new power
generation capacity plants which has been attributed to low tariffs. ZESCO has made two
applications for increase in tariffs in the last 2 years in a quest to improve its operations. The
government has in the past suspended import duty on energy saving and generating equipment in
an effort to address issues of demand side management. The country has also seen reforms in the
electricity sector in an effort to make the sector handle the challenges that it faces.

Forecasted demand for 2010 stands at 2,200 mega watts giving a deficit of about 600 mega
watts. If the forecast demand does not match the installed capacity the load shedding will be
increased. The load shedding will result in reduced production. This will affect the productivity
and the profitability of firms mainly in the manufacturing sector. The under-utilised capacity that
may result will lead to these firms laying off excess staff causing an increase in unemployment.

This policy brief paper has recommended measures geared towards improving efficiency in
service delivery in the energy sector and efficient energy usage by consumers of electrical
energy. Measures recommended include the implementation of an energy efficient policy and the
implementation of a debt management contract for ZESCO. Other recommendations include the
establishment of a framework to spur investment by government through Public Private
Partnerships (PPP) for the construction of power generation plants and the reduction of VAT on
electricity. The other recommendations include the abolishing of cross subsidy regime across the
different tariff groups and investment in other source of energy production.

2.0 INTRODUCTION

2.1 Power Deficit

The entire Southern African region is experiencing a power shortage. The South Africa Power
Pool (SAPP) Planning Data indicated that SAPP would run out of generation surplus capacity
after the year 2007. The forecast for 2007 indicated that actual generation reserve capacity would
be lower than normally planned. Even though this was known way before 2007, steps were not
taken in good time to effectively address the problem. As a result the country experienced power
deficits in 2008 and had to undergo load shedding. The country has a total generation capacity of
1,600 megawatts while the peak consumption is at 1,400 megawatts. Forecasted demand for
2010 stands at 2,200 megawatts. Below is a graph for forecasted demand.

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 Demand Forecasts for Zambia

3000
2500
2000
W 1500
M
1000
500
0
0 1 2 3 4 5 6 7 8 9 0 1 2
0 0 0 0 0 0 0 0 0 0 1 1 1
0
2 0
2 0
2 0
2 0
2 0
2 0
2 0
2 0
2 0
2 0
2 0
2 0
2
Years

Demand Installed Cap acity

Figure 1: Demand forecast – (source ZESCO)

In 2008 as a result of increased demand and rehabilitation of the power infrastructure the country
experienced a power deficit of 450 mega watts. This led ZESCO Ltd to institute scheduled power
rationing. Huge investments in the mining companies led to the rising demand for electricity in
the country. ZESCO lost approximately 30% of its annual revenue due to the load shedding.
450MW is about a third of its total capacity. The Copperbelt Energy Corporation (CEC) that
transmits and distributes power to the mines has predicted a 40% rise in consumption of
electricity by the mines in 2010/2011.

The generation mix is 99% hydro, with 1% thermal. Hydro installed capacity is at 1,672MW and
thermal installed capacity is 8MW.

The country’s hydro power potential is about 6 000MW. The installed capacity is 1,672 MW
with identified potential standing at 4,358 MW. This hydro power potential is far from being
realised. A number of sites have been identified for hydro power generation through the Office
for the Promotion of Private Power Investment (OPPPI). However investment in the sector has
been non-existent. The table below gives the sites with identified potential for hydro power
generation.

Table 1: Major potential sites for hydro power development

Potential Site Estimated Capacity (MW) Estimated Investment Cost –US $ Million
Original Revised
KNB Extension* 300 360 300
Itezhi-Tezhi* 80 120 117
Kafue Gorge Lower* 450 750 750
Batoka Gorge 800 800 860
Devil's Gorge 800 800 1,430
Kalungwishi* 114 163 210
Mpata Gorge 320 320 770
Lusiwasi Extension 40 40 92
Kabompo Gorge 34 78
Chavuma 1.2 15.0 20
West Lunga 1.2 2.5 7.2

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 Chikata 1.2 3.5 13.1
Luapula River 1,550 950 1,305
TOTAL 4,457.6 4,358 5,952.3

The country has been unable to attract private investment in the sector which has been attributed
to Zambia having one of the lowest tariffs in the region. It is estimated that an investment of $6
billion is needed in the next 5 years to attain a generation capacity of 4,500MW. (Zesco 2009/10
proposed tariff advert)

2.2 Rehabilitation, Faults and Maintenance

Power deficits have also been caused as a result of maintenance works being carried out and
system faults that have caused country wide blackouts. Country wide blackouts were
experienced in January 2008 and June 2009 giving a total of 4 nationwide black outs in a one
year period. ZESCO has an infrastructure development plan of about $1 billion. The
infrastructure development includes the upgrading of existing transmission lines, extension of
existing power stations and construction of new transmission lines. However the utility does not
have sufficient internal resources to support the programme and is constrained to borrow as a
result of its institutional viability. The table below gives a rundown of the planned $1 billion
infrastructural work.

PROJECT SCOPE COST US$

KARIBA NORTH BANK 360MW Extension of power station 420M

EXTENSION

ITEZHI TEZHI New 120MW power station at ITT dam 200M

KARIBA -KAFUE WEST 135km 330kV line 80M

ITT-MUMBWA-LUSAKA NEW? 220kV & 330kV 300km line 150M

WEST

HWANGE/ LIVINGSTONE 330kV line 42M

KAFUE WEST/ 400km Upgrade of 220kV to 330kV line 80M

LIVINGSTONE

DISTRIBUTION Rehabilitation Reinforcement & Expansion 300M

INFRASTRUCTURE of networks (eg Mine Township networks)

Table 2: Rehabilitation Projects (Source ZESCO)

2.3 Utility Inefficiencies

ZESCO has been unable to invest in new generation capacity as they do not have the resources to
do so. The utility has been run inefficiently and finds it difficult to borrow from international
financial institutions. The inability to access funds and not being able to generate sufficient
internal resources has led to the delay in maintenance programmes which has affected the quality
of supply. This has resulted in the persistence of the power deficit. ZESCO costs have been

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escalating over the years with the highest portion of their cost of distribution being staff costs as
see in the table below.

Figure 2: Cost Distribution (Source IPA Study)

Therefore the efficiency and accountability of the firm has been questionable. This has resulted
in the resistance to an increase in tariffs by the business community. IMF has indicated that
ZESCO is financially unviable and unable to mobilise resources due to its track record and even
if it managed to increase its tariffs it would still be unviable. Total receivables for ZESCO seem
to be increasing year after year. Total receivables increased from 35% of turnover in January
2008 to 61% of turnover in September 2008. The target for transmission losses was not been met
for 20008. Transmission losses are at 4.5% while distribution losses are above 33%. Though the
utility has been commercialised its internal operations leave much to be desired. As a result
ZESCO is perceived badly by the business community who feel that the utility should first clean
up its act before requesting for any increase in tariffs.

2.4 Cross Subsidisation

The World Bank has warned against government using ZESCO to give subsidies to classes of
customers like the mines. In a cost of service study done on ZESCO by IPA Energy Consulting it
was noted that if under pricing of the mining load was allowed to continue, a $926 million deficit
relative to ZESCO’s revenue requirements would likely accumulate over a 10 year period. This
is depicted in the graph below.

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 Mining Deficit/Subsidy Requirement at PPI Escalator of 3% Per Annum

200 177
180 164
160 152
140 123
US$ (Mill)

120
95
100
73
80
55
60 41
40 31
20
20
0
2006/07 2007/08 2008/09 2009/10 2010/11 2011/12 2012/13 2013/14 2014/15 2015/16
Figure 3: Mining Deficit/Subsidy Requirement (Source IPA Study)

While the perception on increase in tariffs by the business community has been that ZESCO
should first clean up its act, increments are also opposed as they have a direct bearing on the cost
of doing business especially for those businesses that are energy intensive.

2.5 Demand Side Management

Demand side management is lacking as consumers have not adapted their behavior to conserve
energy. ZESCO has indicated that the country can save up to 145MW a year from the use of
energy efficient bulbs by consumers. ZESCO provides energy audits free of charge to consumers
and has lamented industries low use of these services. The country does not have a deliberate
policy on energy efficiency.

ZESCO has introduced a Time of Use (TOU) tariff for Maximum Demand (MD) consumers.
However the tariff is not widely being used. The TOU tariff is not mandatory for MD consumers.
Under the TOU tariff all electricity consumed/used during the standard time period is charged at
the rate indicated in the tariff schedule. All electricity consumed/used during the off-peak time
period is charged with a discount of a 25% discount on energy charges and a 50% discount on
capacity charges. All electricity consumed/used during the peak time period attracts a surcharge
of 25% penalty on both energy and capacity charges.

3.0 EXPLAINING THE IMPORTANCE OF THE ISSUE

3.1 Economic Background

The Zambian economy is driven by the mining industry which consumes 60% of the total
electricity generated in the country. The mining sector was privatised in 1991. In the last couple
of years investment in the sector has been on an increase resulting in a strain on the country’s
electricity supply. Infrastructure development in the electricity sector has not matched the rapid
expansion of the mining sector which has tremendously increased demand. Gross Domestic
Product (GDP) real growth between 2005 and 2008 has been increasing at an average rate of 6%
per annum. As at December 2007 a total of $3 billion had been invested in the mining sector.
While the privatised mines were being recapitalised and reopened; Lumwana mine in the North
Western Province a green field project, was officially opened in 2008. Some other notable
investments in the sector have been the Konkola Copper Mine smelter, Mopani Copper smelter

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and the Chambishi Copper smelter. These investments are heavily reliant on electricity. The
global economic crisis has resulted in the reduced industrial activity and as a result power
consumption by the mines registered a decline of 15% in 2009. The power deficit turned into a
power surplus of 200 megawatts as a result of the reduced economic activity since late 2008
when a number of mines either closed or scaled down operations as global metal prices lowered.
The surplus was short lived as demand has increased as the economy recovers and more mines
come back on stream. This has necessitated the rationing of power once again.

3.2 Economic Implications

The government was expected to collect $415 million from mining taxes introduced in 2008.
However as a result of the disruptions in power supply which cut production in the copper and
cobalt mines the target was not met. The copper mines resorted to diesel-powered generators to
meet production targets and to keep sensitive mining equipment running without disruptions.
Figures released by the Ministry of Energy and Water Development indicated that diesel
consumption had risen to 1.6 million litres a day from the previous 1.0 million while petrol
consumption was up to 1.0 million litres from 750,000 litres a day. It was expected that there
would be a further increase in national fuel demand as the mines turned to using generators to
avoid the load shedding. The Economic Association of Zambia attributed the non attainment of
the Gross Domestic Product (GDP) and inflation targets for 2008 to severe flooding which
affected most parts of the country and the power outages.

During the deficit period the quality of the electricity was not assured. A load shedding schedule
was drawn up but was not always adhered to. Power would be cut unexpectedly without a clear
indication of when it would be restored. These disruptions on supply resulted in the damage of
equipment and loss of man hours of production. The loss in man hours of production affected
profitability in a lot of industries and affected budgeted production especially for industries that
operated on a 24 hour basis.

The country wide blackouts affected the mining sector with some underground mines flooding as
they had no power to pump out the underground water thereby cutting production. One mine
quantified its net loss after one day of a blackout to $2 million last year. In the most recent
nationwide black out in June this year another mine quantified its loss in revenue of $1.8 million
after having been off supply for 18 hours. Copperbelt Energy Company (CEC), which buys
power from ZESCO Ltd for distribution to the copper mines, said the company had been
importing power and using diesel generators to supply power to the country's copper mines in an
effort to prevent flooding during the black out.

ZESCO has indicated that it needs to increase their tariffs to cost reflective levels. In 2007 the
energy regulator granted ZESCO a three year multi tariff increment of 27% in 2008, 16% in
2009 and 11% in 2010. ZESCO this year again applied to the energy regulator to have the multi-
year tariff increment adjusted upwards asking for an average adjustment of 59% across tariff
groups with domestic consumers having the highest proposed increase of 80% for 2009. The
proposed average tariff increments are as follows; 51% in 2009, 21% in 2011, 21% in 2012 and
7% in 2013. The Energy Regulation Board (ERB) granted ZESCO an average increase of 35%
for 209/10 and 26% for 2010/11. The increment of an average of 59% that ZESCO was asking
for was too high for the industry to absorb especially with the reduced economic activity as a

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result of the global economic crisis. The awarded 35% average increment is still a bit on the high
side as Zambia has a high cost of doing business making companies uncompetitive.
The graph below shows the cost associated to starting a business as a percentage of income per
capita.

Figure 4: Cost to Start a Business (Source Doing Business Data Base)

Below is a graph that shows the minimum capital required to start a business as a percentage of
income per capita. In both cases Zambia ranks midway of the countries in the study indicating
that the cost of doing business in the country is higher than average.

Figure 5: Minimum Capital to Start a Business (Source Doing Business Data Base)

In a study done by Zambia Association of Chambers of Commerce and Industry (ZACCI) other
factors like infrastructure, access to credit, cost of petroleum products and corruption have an
adverse effect on the cost of doing business in Zambia. Tariff increments would work towards

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further increasing the cost of doing business.

3.3 Policy
The electricity sector has undergone a number of policy changes in the last decade so as to meet
the challenges of having adequate and sustainable supply. This began with the energy policy of
1994. The Electricity Act was then revised in 1995 which removed the monopoly of ZESCO and
provided for the entry of new players. The three main players in the power industry are: ZESCO
Limited, Copperbelt Energy Corporation (CEC), and Lunsemfwa Hydro Power Company
(LHPC). ZESCO Limited is a vertically integrated state owned utility which owns and operates
the bulk of the generation, transmission and distribution infrastructure in the country. CEC is a
privately owned generation and transmission company which owns and operates the 220kV &
66kV transmission network, plus 80MW gas turbines to supply power to the copper mines.
LHPC is a privately owned generation company which operates Lunsemfwa and Mulungushi
hydro power stations with a total installed capacity of 38MW. All power output from LHPC is
contracted to ZESCO Ltd.

In 1995 The Energy Regulation Act was enacted creating the Energy Regulation Board (ERB)
which regulates the energy sector. In 2002, the Energy Regulation Board (ERB) proposed a
program to restructure the Electricity Supply Industry (ESI) through the unbundling of the
generation, transmission and distribution functions, placing them under private management.
Privatisation of ZESCO was one of the objectives set in agreement with the International
Monetary Fund (IMF) in order to reach the Highly Indebted Poor Country (HIPC) completion
point. However, in April 2003, the government announced that ZESCO would be
commercialised, leaving aside the proposal of unbundling the company. Further, in 2004, the
government merged ZESCO with the Kariba North Bank Company.

In response to trying to address the deficit the government removed import duty on energy
saving equipment and energy generating equipment in 2008. In addition a Time of Use (TOU)
tariff was introduced. Industry can subscribe to the tariff on a voluntary basis. The subscription
of industry to TOU has been very low.

An office to look at the private investment in the energy sector has been opened up, this is the
Office for Promotion of Private Power Investment (OPPPI). The office has been instrumental in
identifying possible sites for hydro power generation in the country. The International Finance
Corporation (IFC) is currently carrying out a feasibility study for development of Kafue Lower
power station which will have the capacity to produce 750MW. Fifteen companies showed
interest in developing the $1 billion plant which will be a Public Private Partnership (PPP)
project. The project will take six years to build once the construction commences. Therefore in
the medium term a power deficit is still looming. It is essential to look at measures that will
ensure improved quality and supply of electricity in order to meet the ever increasing demand.

4.0 POLICY RECOMMENDATIONS

The power deficit is bound to continue as the economy grows since new generation has not been
growing at the same rate as the economy. A few recommendations have been made to address
the power deficit in the short, medium and long term.

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1. Investment in New Power Generation
There is need to invest in new power generation plants. Investment in these plants is a costly
venture. These projects should be Public Private Partnership (PPP) projects. The government
should make commitment to sourcing at least 40% of the funds required from international
financial institutions in order for the projects to take place. These investments are large
strategic investments and need the backing of government. The private sector can raise finance
for such projects through the issuance of energy bonds that can either pay out quarterly
dividends once the power generation plant is up and running or it can be a zero coupon bond
paid back after a specific period. The investment should be backed by government who should
guarantee repayment. Investment in this sector will not be possible without government
involvement.
Zambia needs to attain international credit rating which had been suspended at the onset of the
global economic crisis. This will enable the country access funds from international
commercial sources for such projects.

2. Policy on Independent Power Producers

A policy to encourage independent power producers which should take into account a
framework that clearly specifies market structure and roles and terms for private and public
sector investments. The policy should also provide for transparent and predictable licensing
and tariff framework to improve investor confidence.
The energy regulator Energy Regulation Board (ERB) should ensure that tariff adjustment is
fair to both the utility and the consumer.

3. Maintenance and Capital Projects for ZESCO

The government being the sole shareholder of ZESCO should source and lend money to the
company to assist with maintenance and expansion projects. Investment in transmission and
distribution is critical for ensuring quality of supply and reduction in technical loses.
Government interference in ZESCO should be removed to enable the firm operate efficiently
and effectively. The regulation of ZESCO should be left to the Energy Regulation Board and
not the Ministry of Energy and Water Development.

4. Management Contract
In order to maximise the strides made through commercialisation of ZESCO a management
contract should be entered into with a company that can assist the firm in revenue collection.
This is an effort to turn ZESCO into a more efficient and viable company. This will assist the
company in raising funds in the future.

5. Energy Efficiency Policy

An energy efficiency policy should be developed to address demand side management. The
policy should address use of energy saving equipment. In the policy the following should be
mandatory:
1. use of energy efficient bulbs
2. energy audits for energy intensive industries by ZESCO.
3. incentives for use of energy efficient equipment and removal of duty on such equipment
4. awareness in energy efficient practices and training by ZESCO and ERB and
5. threshold on Power Factor control with punitive penalties for defaulters.

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 The Time of Use (TOU) tariff should not be mandatory for all MD customers. Shifting from
the regular operation hours to other hours may be difficult for companies that are not running
24hr operations. Therefore the TOU tariff should be attractive enough for companies to
subscribe to. Awareness of the tariff should be intensified for users to see the benefit.

6. Mining Tariffs
The mining companies being the largest consumers of power should be made to pay cost
reflective tariffs. The mines currently have tariffs lower than other consumers. The Bulk
purchase agreements between ZESCO and Copperbelt Energy Corporation should be
renegotiated to facilitate this. The table below gives a comparison of the price per kilo watt
hour.

Customer Category K/Kilo Watt Hour

Mining 103.22
Residential 170.27
Large Power (MD3 and MD4) 110.19
Small Power (MD1 and MD 2) 107.08
Commercial 184.31
Services 128.38
Table 2: Tariff structure (source Energy Regulation Board)

7. VAT on Electricity Consumed

VAT on electricity should be reduced from 16% to 11%. This will be in an effort to reduce the
burden of increments on consumers and reduce the cost of doing business. ZESCO tariffs are
the lowest in the region and will continue to increase over time until a time when they will be
cost reflective or in line with the rest of the region. It is therefore essential that while tariffs are
being increased the impact on the economy is minimal.

8. Tariff Revisions
As there need to reach cost reflective tariffs, increments should be gradual so as not to
adversely affect the consumer. In addition ZESCO employees should be made to pay for their
electricity like every other consumer. The ZESCO staff tariff should migrate to the normal
domestic tariff.

9. Distribution Loses
Government ministries and departments should settle all their outstanding arrears and should
remain current with payments. There should be no discrimination between government and
private customers when it comes to disconnection as a result of non payments.
Government needs to implement a mechanism for the speedy recovery of debt to electricity
utilities.

10. Regulation
Regulation of the energy sector should be left to the Energy Regulation Board (ERB). The
proposed performance contract between government and ZESCO should fall under the
direction of ERB and not as proposed to be monitored and executed by the five man minister
committee. ERB already has Key Performance Indicators (KPIs) by which it measures
ZESCO’s performance.

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 The Energy Regulation Board should handle all aspects of regulation including the mining
tariffs which should not be left to government.

11. Investment in Alternative Sources of Energy

Other sources of generating electricity should be encouraged with the necessary policy
incentives. There is need for the country to diversify from the dependence on hydro power
which is prone to adverse weather conditions such as drought. Already existing power
producers such as Lunsenfwa Hydro and Copperbelt Energy should be encouraged to invest
in alternative sources of energy.

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