Macroeconomic Effects of a Low-Carbon Energy Transition in Kenya

This study provides a forward-looking simulation analysis of economy-wide and distributional implications associated with alternative pathways for the development of the electricity sector in Kenya. It is part of a wider research project that seeks to identify the binding constraints to economically viable investments in renewable energy and to analyse the political feasibility of a transition to a sustainable low carbon energy path in the two countries. From an economic perspective, significant shifts in the power mix of an economy as well as policy measures to induce or support such shifts are bound to affect the structure of domestic prices across the whole economy with repercussions for the growth prospects of different production sectors and for the real income growth paths of different socio-economics groups. Understanding these economy-wide repercussions is crucial for a study concerned with the obstacles to - and political feasibility of - adopting a low-carbon growth strategy. The analysis requires the adoption of a multi-sectoral general equilibrium approach that allows to capture the input-output linkages between the electricity sector and the rest of the economy as well as the linkages between production activity, household income and expenditure and government policy. Thus, the present study develops a purpose-built dynamic computable general equilibrium (CGE) model for Kenya with a detailed 'bottom-up' representation of the power sector to simulate the prospective medium-run growth and distributional implications associated with a shift towards a higher share of geothermal in the power mix up to 2025 A higher of share of low-cost geothermal in the power mix reduces electricity prices and mildly stimulates economic growth. The associated reduction in the fossil fuel import bill triggers a moderate real exchange rate appreciation. All household groups gain, but urban and rural higher-income households gain relatively more than urban and rural low-income households, as skilled real wages and real returns to capital rise slightly more than unskilled wages and returns to land. Impacts on the sectoral composition of real output and employment are generally small. In tendency, sectors with a higher baseline share of electricity costs in total production cost and lower trade shares expand relative to sectors with a low electricity cost share and with less exposure to international trade. Moreover, the results demonstrate that the size of the beneficial aggregate effects depends on the evolution of world market fossil fuel prices over the simulation horizon: Under a lower-carbon scenario with low oil prices, real GDP in 2025 is about 1.1 percent higher than in the baseline scenario. Under a lower-carbon high-oil-price scenario, real GDP in 2025 is more than 2 percent higher than in the corresponding reference scenario.