Pricing Mechanisms for Energy Markets in East Africa: An Exploration of Challenges and Opportunities for Energy Development
Historically, energy has driven gross-domestic-product (GDP) growth due to natural resources' need for power generation, but increased reliance on renewable resources is decoupling this relationship. As a developing region, East Africa still maintains a strong link between energy use and GDP growth, but it is actively working to make energy production more efficient. This is primarily through investments in renewable energy, which offer more sustainable and cost-effective solutions to meet growing demand.
Figure 1. A graph comparing energy demand and economic development.
However, the region struggles to deliver affordable and reliable electricity to its growing population due to a combination of financial, infrastructure, and policy challenges. Effective pricing mechanisms are crucial to overcoming these challenges, ensuring markets are sustainable and enhancing affordable power availability.
Pricing mechanisms in energy markets are used to determine the cost of electricity. These mechanisms influence energy generation, distribution and consumption. In East Africa, most electricity markets use government-controlled tariffs to ensure affordability for consumers, though they do not adapt well to market fluctuations or external factors affecting energy costs. While cost-plus pricing and regulated tariffs dominate in the region, developed economies often use more dynamic methods like time-of-use pricing, which treats electricity as a commodity and better reflects real-time supply and demand conditions.
East Africa falls behind in the global transition to market-based energy pricing due to challenges such as infrastructure limitations, regulatory hurdles and socio-economic factors. Although countries within the continent offer models for addressing energy challenges, Kenya excels in renewable energy integration and the Southern African Power Pool in regional collaboration.
Current Energy Landscape in East Africa
East Africa is endowed with geographic features with the potential to offer a variety of energy sources and significant advantages in renewable energy development. Hydropower, for instance, is East Africa’s largest source of electricity generation thanks to the Great Lakes, the Great Rift Valley, the Nile Basin and the dams built to harness their power. However, the natural advantages of the region remain largely untapped, with the International Renewable Energy Agency (IRENA) estimating the potential for solar energy at 1,067 gigawatts in comparison to hydropower’s potential at 263 gigawatts (GW).
Figure 2. A graph showing the energy source distribution across East African countries.
The energy market is currently dominated by government entities across countries within the region. Burundi’s energy sector is a state monopoly under REGIDESO. Kenya’s energy sector is unbundled, meaning it is separated into different state-owned and private entities for generation and transmission - notably the Kenya Power and Lighting Company (KPLC) and KenGen. Rwanda, Tanzania and South Sudan’s energy sectors are run by state-owned entities, EUCL, TANESCO and SSEC respectively. State-owned entities are largely outperformed by private entities, especially in Africa, due to factors like bureaucratic inertia, weak incentives and the lack of competitive pressure.
Traditional Pricing Mechanisms
Cost-plus pricing and regulated tariffs are methods used to set energy prices, with the former transferring electricity generation costs to consumers. Cost-plus pricing ensures cost recovery with a fixed markup, but on top of being unaffordable for most consumers, it is also inflexible to market conditions. Regulated tariffs involve government or regulatory bodies setting energy prices to ensure affordability for consumers while aligning with the cost of supply to avoid market distortions. Traditional pricing models tend to maintain stable electricity prices, allowing relative predictability in energy costs, which is crucial for supporting consistent economic development and planning.
Figure 3. A graph portraying average electricity prices in East Africa across time.
Both pricing mechanisms rely on government-dominated models built on historical data, often failing to account for market fluctuations and external factors, which can lead to underinvestment and, therefore, financial strain on utilities. Additionally, they exclude end-users from the pricing process, leading to a lack of transparency and limited consumer engagement. This compels the consideration of private investment to catalyse development and bridge the financing gap.
Market-Based Pricing Mechanisms
In the interest of fostering competitive pricing environments and entertaining divestment from government intervention, marked-based mechanisms can be considered to facilitate sellers and buyers influencing energy prices. The US Federal Energy Regulatory Commission (FERC), for example, facilitates auctions where electricity suppliers bid to meet demand, ensuring cost-effective rates and providing real-time price signals. East Africa can adopt this wholesale electricity market to improve efficiency in the industry and lower costs. Power Purchase Agreements (PPAs) and feed-in tariffs for renewable energy can accelerate this transition by enlisting necessary stakeholders, such as businesses seeking to offset their carbon emissions. PPAs are contracts between electricity generators and power purchasers that can draw in private investments for large-scale renewable projects. Feed-in tariffs for renewable energy can incentivise local and regional developers to generate clean energy by providing a guaranteed price for the electricity fed into the grid.
Regardless, if the policies facilitating the transition into a wholesale market are not carefully designed and implemented, there are risks that could result in higher energy prices. These include spikes during peak demand periods and the potential for system abuse. For instance, in Alberta, Canada multiple firms coordinate to produce a unified pricing strategy, allowing them to raise electricity prices to increase their profits - a collusion that leaves the end consumer with higher bills to pay.
Emerging Trends and Innovations
Recent developments in the energy sector are reshaping how electricity is priced and produced. Time-of-use pricing, for example, determines prices based on the correlation between the time of the day and levels of usage. Consumers are thereby encouraged to reduce electricity consumption during peak hours, balancing demand and reducing strain on the grid. Dynamic pricing takes this a step further by adjusting the prices in real-time based on supply and demand, providing more flexibility and efficiency. As smart grid technologies develop, blockchain and smart contract integration is also gaining traction. Blockchain secures energy transactions, whereas smart contracts automatically enforce agreements, such as payments, without needing intermediaries. Together, these technologies enhance efficiency, reduce errors, and speed up processes, fostering a resilient energy system.
Challenges in Implementing Pricing Mechanisms
The fundamental challenges East Africa faces are the same drivers fuelling the global transformation of the electric industry: infrastructure limitations, regulatory hurdles and socio-economic factors. Infrastructure challenges span across enablers, the power sector, and end-users, making it difficult to achieve efficient energy production and distribution with limited available funding. Developers are often hesitant to invest in infrastructure due to the absence of attractive incentives, such as cost-plus pricing models and a lack of reliable data on current electricity tariffs and consumption patterns.
Figure 4. An illustration of the complex power system due to 6 additional domains of influence.
Current regulatory frameworks across East African nations struggle to keep pace with global trends, constraining the flexibility required to move towards competitive energy markets. Socioeconomic barriers also play a role in limiting end-user engagement. When consumers are disconnected from the pricing mechanism, their behaviours are not fully reflected in price-setting models, leading to increased price volatility. Evidence from Germany shows that consumers unaware of energy pricing are more likely to favour traditional models, which may limit the adoption of more dynamic pricing mechanisms. In East Africa, where socio-economic barriers are more pronounced, this disconnection could further hinder the development of flexible, market-driven pricing mechanisms and the benefits that accompany them.
Outlook Through Case Studies
Despite the limitations East African countries may face in implementing efficient pricing modules, notable case studies highlight the potential for success. Kenya has made significant strides in the integration of geothermal energy into its national grid, making it the 8th ranked producer worldwide and a top producer in Africa. As of 2023, 47% of Kenya’s electricity comes from geothermal sources, making it less dependent on fluctuating fuel prices and external energy imports.
Figure 5. A graph showing the top geothermal power producers on the planet.
Despite these successes, there have been significant challenges. Initially, feed-in tariff rates were perceived as insufficient by early investors, conflicting with Kenya Power's mandate to maintain affordable electricity prices for consumers. In response, the Kenyan government revised the feed-in tariff policy to include geothermal energy in 2010 and restructured the Power Purchase Agreements (PPAs) as recently as 2022. These mechanisms ensure attractive purchase prices for geothermal energy over extended periods (15-20 years), set high enough to offset substantial capital costs while remaining sufficiently low to maintain consumer affordability.
Figure 6. A graph showing Kenya’s investment history in geothermal energy.
The sector's growth is expected to yield economies of scale, potentially lowering production costs and improving investor returns. This positive feedback loop could further stimulate investment and drive a sustained expansion of the geothermal sector.
Kenya’s feed-in-tariff policy, PPAs and public-private partnership (PPP) models for infrastructure development can be replicated to attract investments across East Africa. Kenya’s flexible approach to pricing has allowed it to maintain its momentum in renewable energy development while serving investor interests and consumer needs.
Additionally, East African countries could benefit from adopting the Eastern Africa Power Pool (EAPP) to mirror the Southern African Power Pool (SAPP), which successfully integrates regional power grids. SAPP is made up of 12 countries connected to a single power grid, allowing countries with surplus electricity to benefit countries with shortages, optimising the region’s balance between power generation and consumption. The EAPP can adopt a similar regulatory framework by ensuring legal transparency and establishing a reliable trading platform.
Conclusion
East Africa has made significant strides in expanding electricity generation, particularly through integrating renewable energy sources. However, the region continues to face challenges such as infrastructure inefficiencies, pricing inconsistencies and limited investment, which hinder progress, energy inefficiencies, and affordability.
Potential solutions include innovative pricing mechanisms like time-of-use and dynamic pricing, which are key for efficient and transparent energy markets. Regional efforts, such as the Eastern Africa Power Pool (EAPP), can optimise power distribution and stabilise prices. In acknowledgement of the region’s limitations, East African nations can adopt pragmatic methodologies and frameworks proven feasible. Frameworks such as cautiously procured PPP investments in renewable energy. All in the name of enhancing efficient, available and reliable energy provision.