CASE STUDY JUNE 2018 - African Development Bank

CASE STUDY 2018GEOTHERMAL ENERGY POWERING KENYA’S FUTUREBOX 1At the power tariff offered by the government underits feed-in tariff policy, IPPs may not see the revenuestream from power sales as sufficient to reach theirrequired profitability while meeting the minimumlevels of debt service required by lenders. To addressthis, low-cost, concessional financing is anotherimportant ingredient in the financing package.Question 2What role do development finance institutions(DFIs) play in supporting the privateand public sectors in the development ofgeothermal steam fields and power plants?A relatively small and new organization withlimited financial and technical capacity, GDC faceda delivery challenge in developing a geothermalsteam and power project on the scale of Menengai.For this reason, GDC sought and received supportfrom the AfDB. In addition, GDC sought supportfrom development finance institutions to addresscreditworthiness risk. The PRG set up with AfDBsupport (and backed by the government) coversnon-payment by the power off-taker, KPLC, and nondelivery of steam by GDC.The challenge for IPPs is to achieve a sufficientlyattractive return on their investment to allow themto cover all capital, operational, and financing costs.In the case of Menengai, the CIF’s Clean TechnologyFund (CTF) provides the IPPs with a concessionalloan through AfDB to help improve the bankabilityof the power generation project.Question 3Does the Menengai Project provide a costeffective model for future geothermal energydevelopment?In the GDC model, the public agency, GDC, developsthe geothermal field and sells steam to a third party,such as one or more IPPs, for power generation.Assuming the IPPs successfully operate the plantsin the years to come, Menengai demonstratesthat public-private partnerships in geothermaldevelopment can be effective.Other public-private partnership models involvejoint development of the exploration and fielddevelopment phase or even full IPP developmentof the geothermal field and power facility. However,involvement in the earlier development phasecomes with higher costs that would have to bematched by higher tariffs or other public sectorsupport. Higher tariffs may not be a priority forKenyan policymakers, who are largely concernedwith ensuring power is provided to customers ataffordable rates. The GDC model tries to strike abalance. Public sector support plays a significantrole in covering the high cost and risks of theupstream geothermal development phase. Thiskeeps the cost of steam generation at a level thatmaintains the tariff paid to the IPP within the limitsset by the feed-in tariff policy.MENENGAI GEOTHERMAL PROJECT: MAIN KENYAN PROJECT PARTNERS AND STAKEHOLDERSand enter into PISSAs with GDC and PPAs with KPLC. Thethree IPPs were selected after a tendering procedure inwhich 12 firms expressed interest. Energy Regulatory Commission (ERC), NationalEnvironment Management Authority (NEMA), and NakuruCounty Council. IPPs must obtain power generationlicenses from the ERC, an environmental and socialimpact assessment (ESIA) license from NEMA, and localpermissions from the local county council. The Treasury/Ministry of Finance. The Treasury/Ministryof Finance issues tax and duty exemption licenses and,with the Ministry of Energy and Petroleum, backs theGovernment’s Letter of Support of the PISSA and PPA, inturn backed by the PGA that is supported by the AfricanDevelopment Fund. Kenya Forest Service and private landowners/communities. The land in the Menengai caldera, whichis nationally owned and administered by Kenya ForestService, is neither settled by people nor utilized forfarming or grazing. To gain access for roads and thewater piping system, some land was purchased fromindividual owners. The Geothermal Development Corporation (GDC).GDC is responsible for undertaking the integrateddevelopment of geothermal steam resources throughthe initial exploration, drilling, resource assessment, andpromotion of direct utilization of geothermal energy.GDC owns and operates the Menengai steam fieldand is the implementing agency for the steam supplyagreement (PISSA) with the IPPs. The Kenya Power and Lighting Co. (KPLC). KPLC isthe off-taker, buying power from the IPPs based onnegotiated power purchase agreements (PPA) for onwardsupply and distribution to consumers. The Kenya Transmission Company (KETRACO). Forthe first 105 MW, KETRACO has built a substation andtransmission line over 7 kilometers (km), connectingthe Menengai site with the main national grid (132 kVMenengai-Soilo line). Sosian Menengai Geothermal Energy Ltd, QuantumPower East Africa (QPEA) Menengai Limited, and theconsortium OrPower Twenty-Two Ltd. These threeindependent power producers (IPPs) were selected togenerate power from the Menengai field in Phase I. Theywill build, own, and operate three plants (of 35 MW each)Local permissionsIn the Menengai public-private partnership, DFIsupported investments by the public sector in theexploration and field development phase permittedan effective package of financial incentives andrisk assurance to get the private sector on board.Consequently, a number of stakeholders havebeen involved (see Box 1). While complex, thisway of doing business has provided an optimummix of knowledge, financing, and risk mitigationthat one party alone would not have been able toprovide. Over time, the track record of GDC andKPLC is expected to enhance the perceived riskprofile of future projects and allow concessionalfunding to be phased out. This Kenyan approach todeveloping geothermal energy has already sparkedinternational interest. The AfDB is using learningfrom the Menengai experience to contribute togeothermal planning in other countries in the regionwith similar power sector frameworks. 6Commercial lendersConcession loans(CIF-CTF/AfDB)Debt financeGeneration licenseESIA licenseLand assignment/acquisitionERCNEMAFeesKenya Forest ServicePISSAMinistry of LandCommunitiesNakuru CouncilMenengai IIPP consortia:Sosian QuantumOrPower22GDCDrawingfundsin case ofnon-deliverysteam or PPAnon-paymentPPAEnergySteamKPLCGovernmentletter ofSupportStandby L/CPRGAfDB CIF-SREPAfDB/ADFPRG indemnity agreementOthers partnersTreasuryCash flowPhysical flowMinistry of EnergyInteraction agreementSource: Drafted by author based on information provided by GDC, AfDB, and Quantum Power.PISSA: Project Implementation and Steam Supply Agreement; PPA: Power Purchase Agreement; IPP: independent power producer; L/C: Letter ofCredit; PRG: Partial Risk Guarantee; ESIA: Environmental and Social Impact Assessment;AfDB: African Development Bank; ADF: African Development Fund, CIF: Climate Investment Funds, CTF: Clean Technology Fund; SREP: ScalingUp Renewable Energy in Low Income Countries Program.7

CASE STUDY 2018This case study examines the experience of theMenengai Geothermal Development Project fromits launch in 2011 to near-completion of Phase Iin 2018 (see Box 2). The three-phase projectaims to contribute to an increase in Kenya’sgeothermal power capacity as a way to address amajor development challenge: securing a reliable,sustainable, and affordable power supply to meetcurrent and future demand for energy. It receivedsupport from the Climate Investment Funds (CIF)and the African Development Bank (AfDB) tofacilitate the entry of private independent powerproducers (IPPs) into subsequent phases of theproject. The study focuses on how Phase I ofthe project was implemented and the deliverychallenges it confronted during the implementationprocess.BOX 2The case study highlights lessons from theMenengai case by addressing the followingquestions: How does the Menengai public-privatepartnership model address barriers and challengesto attracting public and private investment? Whatrole do development finance institutions (DFIs)play in supporting the private and public sectors inthe development of geothermal steam fields andpower plants? Does the Menengai Project providea cost-effective model for future geothermalenergy development? TIMELINE OF THE MENENGAI PROJECT AND KEY EVENTS MENTIONED IN THE CASE STUDY1981–85:Olkaria I (KenGen)commissioned (45 MW)2003:Olkaria II (KenGen)commissioned2003 (70 MW)2010:Olkaria II–3rd unitcommissioned2010 (35 MW)1954:First drilling19551965197519851995201520052020Menengai II and III2006:Energy2008–12:FiT PolicyNov 2011:AfDB projectappraisal report2008/09:EstablishmentGDCSep 2010:SREP PlanKenya approvedOct 2014:Agreement (PISSA)between GDC and IPPs2009:Olkaria III (OrPower4)commissioned2009 (48 MW)Apr 2014, Nov 2015, Apr 2016:Steam reservoir capacity studies(by ElectroConsult) and GDCupdate (with well data)Mar–Apr 2012:Loan and grantagreement AfDBGovernmentJune 2017:PRGDrilling of wells20092010201120122013Mar 2013:First 14:Olkaria III (OrPower4)commissioned2014 (72 MW)Oct 2017:Update reservoirstudy (by WestJac, JICA)PISSA and PPA2018Feb 2018:SGS is 95% completeProcurement L/C bankongoing QPEAConstruction of steam gathering system (SGS)Dec 2017:Last AfDB/SREP disbursementSource: Own elaboration, based on information provided by GDC, AfDB and Quantum Power.82014:Olkaria I-AU and IVcommissioned2014–300 MWMenengai Phase I i I

CASE STUDY 2018GEOTHERMAL ENERGY POWERING KENYA’S FUTUREContextGeothermal energy can be extracted from hightemperature hydrothermal resources availablenear the earth’s surface. Drilling through cap rockallows pressurized hot water to vent in a mixtureof hot water and steam, which can be recoveredat the surface and piped to a power station togenerate electricity through a steam turbine. Lowpressure steam at the exhaust end of the turbineis condensed and returned underground, with thewater, via injection wells.In 2017, worldwide installed geothermal capacitystood at about 12,900 MW.1 Globally, geothermalenergy represents a small share of the powersupply, but countries like Kenya show that wherethe resource is available, geothermal power canhave a significant impact. Kenya generates nearlyhalf of its electricity from geothermal power.2 Itis the only country in Sub-Saharan Africa withoperational geothermal power plants, with some660 MW of installed capacity as of 2018.3Traditionally, Kenya’s electricity supply has beendominated by large hydropower resources. The1 Globally, USA leads in geothermal power with 3,591 MW installed,followed by Indonesia (1,809 MW), Philippines (1,868 MW), Kenya,Mexico (951 MW), New Zealand (980 MW), Iceland (710 MW), andItaly (944 MW) (Omenda, 2018).2 In 2015, 4,059 gigawatt-hours (GWh) of geothermal energy(generated with 598 MW) out of a total generation of 9,201 GWh(system total of 2,299 MW) and a domestic supply of 8,138 GWh.(ERC, 2015).3 Own estimates, based on information in Karingithi, 2018.Information on KenGen is available at www.wikipedia.org and Matek,2016.country faces frequent power cuts, partly dueto dependence on rain-fed hydropower whichis affected by climate change impacts. Moresevere cuts have been avoided through increasedreliance on emergency, diesel-based powergeneration, but this has pushed operating costsup sharply.4 The Government of Kenya’s longterm national development strategy, Vision 2030,identifies the need for reliable and affordableenergy as an enabler for the country’s socioeconomic development. Securing a reliable,sustainable, and affordable power supply tomeet current and future demand is a majordevelopment challenge for the country.(Olkaria I, with a 45 MW capacity) and another 30years before KenGen, the state power company,brought its geothermal power plants in the Olkaria I,II, and IV fields to their currently installed capacityof about 516 MW.6Geothermal energy can play an important roleas a cost-effective alternative to expensive fossilfuel power. Moreover, it is a renewable, greenenergy source that produces no greenhousegas emissions.5 The Kenyan government hasundertaken detailed surface studies of the mostpromising areas for geothermal development inthe country (Simiyu, 2008). With more than 14potential high-temperature sites in the Rift valley(see Box 3), Kenya’s estimated overall geothermalenergy potential is between 7,000 and 10,000 MW.Vision 2030 sets out the government’scommitment for “continued institutional reformsin the energy sector, including a strong regulatoryframework, encouraging more private generatorsof power, and separating generation fromdistribution.”7 Reforms of the legal, regulatory,and institutional framework, including establishingclear policy targets, well-defined tenderingprocesses for IPPs, and feed-in tariffs, have been akey enabler for private sector involvement. Thesereforms (described in more detail in Annex A.2)have provided a framework for independent energyproduction, including geothermal power.Until recently, geothermal energy deployment hasbeen slow. Kenya began geothermal exploration inthe Great Rift Valley’s Olkaria area in the 1950s,but it was another 30 years, 1985, before thefirst geothermal power plant was fully developed4 The capacity in 2017 (2,370 MW) supplied the peak demand of2,000 MW but taking into account suppressed demand (340 MW) anda 30 percent reserve margin (660 MW), the true peak demand wascloser to 3,00MW (Karingithi, 2018).5 For comparison, average electricity generation cost in Kenya’sgrid was USD 0.113/kWh (2014). Feed-in tariffs for other renewableenergy projects (above 10 MW) are USD 0.0825/kWh for hydro,USD 0.12/kWh for grid-connected solar PV, USD 0.10/kWh forbiomass and USD 0.11/kWh for wind (Feed-on Tariff Policy; MEP2015; CPI (2015a).10make it difficult. A look at the main phases ofgeothermal project development (explained inmore detail in Box 7 in Annex A.1) illustrates theserisks. The three phases are:1.As part of its Vision 2030 national developmentstrategy, Kenya has set an ambitious target ofincreasing geothermal power capacity from 660 MW,the capacity in 2017, to 5,000 MW by 2030. Thecountry’s Energy Regulatory Commission reportsthat this would represent about a quarter of Kenya’stotal installed power capacity, which is projected togrow to 19,200 MW by 2030 (ERC, 2011).Exploration and field development (upstreamphase), consisting of a) surface exploration andappraisal drilling, and b) drilling of productionwells, c) logging and testing of wells, and d)construction of the steam gathering system;BOX 3GEOTHERMAL AREAS IN KENYAAdditional investment from developmentpartners and the private sector is needed tospeed up Kenya’s geothermal power generationdevelopment. But, the inherent resource andexploration risks of geothermal energy projects6 2017 figure from Karingithi, 2018, including well-head generationof about 75 MW; and en.wikipedia.org/wiki/Kenya ElectricityGenerating Company. Adding the privately-owned capacity of144 MW at Olkaria) gives a total national geothermal installedcapacity of 660 MW.Source: GDC, Kenya7 Government of Kenya, Vision 2030 (abridged version);paragraph 3.5.11

CASE STUDY 2018GEOTHERMAL ENERGY POWERING KENYA’S FUTURERisks in the first phase relate to uncertaintiesabout resource size, steam temperature, where todrill, drilling success rate, and well productivity.Substantial investment is required to prove thesteam resource in the field development phase,which can involve long lead times of five to 10 years.Other types of renewable energy projects do notrequire such a time commitment.Rather than trying to replicate the Olkaria IIIpublic-private partnership arrangement, Kenyangovernment planners moved toward a moreformalized and streamlined approach to providingpublic sector support for financing geothermaldevelopment. In 2008, the government establishedthe Geothermal Development Company (GDC) toaddress resource and drilling risks in the steamdevelopment phase. The government hoped that bytaking on responsibility for proving the availabilityand suitability of geothermal resources, GDC couldfacilitate the entry of IPPs in the power plantdevelopment phase, and perhaps even facilitate jointdevelopment of the geothermal field with IPPs.As of early 2018, Kenya had only one privatelyoperated geothermal power plant: the 110 MWOlkaria III. Financed mainly by private actors,8Olkaria III represents an important first steptowards private sector investment in geothermaldevelopment; however, it involved lengthynegotiations and took more than ten years todevelop (1998–2009, see Box 2). Moreover,private investment in Olkaria III was limitedmainly to the power development phase, withminimal investment in field development(production drilling). Steam exploration and partof the field development were carried out byKenGen, which provided exploration data and thefirst production wells.Under this GDC model, GDC addresses theexploration and field development phase, while thirdparties (either KenGen or IPPs through competitivebidding) are responsible for developing thepower plants that use the steam. This approach issometimes referred to as the Project Implementationand Steam Supply Agreement (PISSA) model, inreference to the agreement the IPP signs with GDCto purchase steam. This model shifts explorationand resource risks away from private investors(the IPPs) that purchase steam from GDC at theofficial feed-in-tariff. Since the development of theMenengai geothermal field is the first major projectundertaken using the GDC public-private partnershipmodel, it is also known as the Menengai model. 2.3.Power development (downstream phase),consisting of the construction of the powerplant(s) and transmission substation(s); andOperation and maintenance of steam productionand power generation facilities.12 AfDB8 The plant is owned by the OrPower 4 consortium, led by theUSbased company Ormat, also a participating partner in one of theMenengai IPPs.13

CASE STUDY 2018Tracing theMenengaiImplementationProcessThe Menengai geothermal area, located in thegeothermal-rich Rift Valley (see Box 3), is the firstgeothermal site to be developed in Kenya outsideOlkaria. The Menengai Geothermal DevelopmentProject (hereafter “the Menengai Project”) is thefirst geothermal project that GDC has developedfrom exploration to production drilling and steamfield development. It aims to develop the Menengaifield to produce enough steam for at least 465 MWpower generation.9EXPLORATION AND FIELDDEVELOPMENT PHASEAs a new organization, GDC faced some challengeswith the Menengai Project in terms of its financialand technical capacity to undertake large-scalegeothermal field development. As it startedoperations in 2009, GDC’s financial base was stillrelatively small; its core funding came from thegovernment and the sale of steam to KenGen from26 wells it inherited from KenGen in Olkaria.109 Theoretical potential of the whole Menengai area couldbe 1,600 MW.10 After splitting up the state power utility into separate power,distribution, and transmission companies (see Annex A.2),GDC inherited the Olkaria geothermal wells from KenGen andsubsequently expanded to the current 59 wells it now operates in theOlkaria area. The steam is sold to KenGen for power generation.The government sought support from developmentfinance institutions (DFIs) to fill its financial gaps,and between 2011 and 2013 worked with the AfDB toformulate the three-phase Menengai Project. Phase Iwas designed to lead to the generation of 105 MW ofpower, Phase II 60 MW, and Phase III 300 MW.11The total cost of developing the Menengaigeothermal field was estimated at about USD847 million (GDC, 2018; AfDB, 2011). GDC receivedfinancial support from AfDB, CIF, other developmentpartners, and a local budget provided by thegovernment (see Box 4 for more on CIF and Box 1for more on partners).Initial CIF funding was provided through its ScalingUp Renewable Energy Program (SREP) to supportPhase I of the project. The funds were channeledthrough the AfDB as part loan (USD 17.5 million) andpart grant (USD 7.5 million), while the AfDB itselfprovided a loan equivalent to USD 120 million.12These resources partly covered the costs of drillingexploration and production wells, construction ofthe steam gathering system, equipment, consultancyservices, and social-environmental planning.Through the Menengai Project, the AfDB hasprovided support to strengthen GDC’s technical11 Tenders for the development of three modular power plants ofPhase I were issued in July 2013, on the assumption that all powergenerated by these plants would be purchased by Kenya Powerand Lighting Company (KPLC) under a 25-year power purchaseagreement, and that the private investors would be responsible forraising the equity and debt financing to implement the project under‘Build, Own and Operate’ schemes.12 An AfDB Project Appraisal Report (PAR) was drafted and thefinancing it proposed was approved, together with the SREP funding,in 2011. The AfDB’s SREP loan and grant agreements with theGovernment of Kenya were signed early in 2012. The PAR mentionsa SREP allocation of USD 40 million (see Box 4) with USD 25 millionthrough AfDB and USD 15 million through the World Bank. The 15million allocation via the World Bank will be not be used.14capacity. Other development partners, such asJapan International Cooperation Agency (JICA),13US Agency for International Development (USAID),the African Union, and Iceland, have also supportedcapacity building at GDC in such areas as technicalexpertise in the geosciences, drilling, and reservoirengineering; commercial negotiation skills; andlegal and contracting knowledge. This has helpedadvance a broader GDC aim to build its own staffcapacity and become a knowledge hub for the AfricaGeothermal Centre of Excellence (AGCE). Beingestablished in cooperation with KenGen, the Centrewill have Kenyan offices in Navaisha and Nakuru,and will feature labs and training facilities.14GDC faced steam development challenges duringphase I of the Menengai Project resulting in slowprogress in the completion of critical activitiesincluding drilling and construction of the steamgathering system.BOX 4CLIMATE INVESTMENT FUNDSThe Climate Investment Funds (CIF) provide 72developing and middle-income countries with urgentlyneeded resources to empower transformations in cleantechnology, energy access, cli- mate resilience, andsustainable forests. Financing is channeled through fivemultilateral development banks, including the AfDB andWorld Bank.The Government of Kenya has introduced several policiesto ex- pedite development of its renewable energyresources, and CIF funding is helping to remove someof the technical capacity, economic, financial and socialconstraints. Concessional funding from CIF’s Scaling UpRenewable Energy in Low Income Countries Program(SREP) and Clean Technology Fund (CTF) are particularlyfocused on de-risking geothermal power.For more information, see:www.climateinvestmentfunds.org/By early 2018, the Phase I steam gathering systemwas close to completion.15 A total of 42 of 50planned wells had been drilled, for a productioncapacity of 105 MW of steam, while 23 wells hadbeen tested for power generation (Af

A relatively small and new organization with limited financial and technical capacity, GDC faced a delivery challenge in developing a geothermal steam and power project on the scale of Menengai. For this reason, GDC sought and received support from the AfDB. In addition, GDC sought support from development finance institutions to address