The Nigerian Power Sector Is In Crisis!

Date:

…the power sector reforms cannot and must not be allowed to collapse. There have been some progress to date. Allowing the reforms and the privatisation to fail would be far more costly for Nigeria and her citizens… The events that have led to this crisis, and which are continuing, have been in the works before the advent of the Buhari administration. However, we expect that the Buhari administration would take necessary steps to avert the crisis and impending collapse of the power sector.

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The power sector is in crisis. The crisis is not about the low generation output as a result of the extensive vandalism of oil and gas infrastructure in the Niger Delta, which has significantly curtailed gas supply to power generation plants. The crisis is about the weakening commercial structure and viability of the power sector.

Recently, two Federal High Courts granted separate restraining orders against the Nigerian Electricity Regulatory Commission (NERC) and the Nigerian Bulk Electricity Trading Plc (NBET) at the instance of some electricity distribution companies (DISCOs) who took both NERC and NBET to court. The DISCOs are praying the courts to compel NERC and NBET from enforcing the commercial terms of the various industry contracts they entered into at the conclusion of the privatisation of successor PHCN companies. According to the DISCOs, the electricity market has been badly managed by NERC, such that they are not able to meet their obligations under the various industry contracts entered into with various counterparties to facilitate their activities in the power sector.

If you are not familiar with the power sector, these events as reported may simply be irrelevant to you. However, these court cases and the injunctions expose the soft and vulnerable underbelly of the entire power sector. By going to court to seek protection from meeting their contractual obligations, the DISCOs have demonstrated that all is not well with the power sector.

Since being privatised, the power sector has been plagued by structural challenges that have hindered the progress of the sector. We enumerate a number of these challenges below.

DISCOs as the Weakest Link

In our view, DISCOs have proven to be the weakest link in the entire value chain and the underlying cause of the crisis. The privatisation of DISCOs in 2013 has not achieved the intended objectives so far. The much needed improvements and investments haven’t happened and may not happen anytime soon, despite an adjustment of electricity tariffs three times since the conclusion of the privatisation process in 2013. The latest adjustment was a 45 percent tariff increase in February 2016.

The DISCOs were sold to core investors based on their proposal to reduce aggregate technical, commercial and collection (ATC&C) losses. Two years after, ATC&C losses seem to be increasing, rather than reducing.

More troubling for the power sector is the fact that DISCOs are cash strapped and now laden with huge debts to the electricity market. In filing the court cases against NERC and NBET, DISCOs openly admitted that they have cash flow problems. Most of the core investors who took over the DISCOs lack the financial capacity to inject funds into them. The CBN had to inject N213 billion into the power sector to address the market debt between 2013 and 2014.

Lack of Effective Contracts In the Market

The power sector is yet to attain a contractual market status. Under the Electric Power Sector Reform Act (EPSRA) 2005, the electricity market in Nigeria would be administered by a number of industry contracts and market rules. The declaration of the Transitional Electricity Market (TEM) would signal the commencement of these contracts. In 2015, TEM was declared but the conditions for declaring it are still far away. Without effective contracts – Power Purchase Agreements (PPA), Ancillary Agreements, Gas Supply Agreements (GSA), Vesting Contracts between DISCOs and NBET and other industry contracts, TEM cannot be said to have taken off.

Mr. Babatunde Fashola’s roadmap on incremental, steady and reliable power is hinged on bankable, commercial and enforceable framework contracts to procure additional generation capacities (greenfield and brownfield). The non-effectiveness of key industry contracts could torpedo these aspirations.

One of the key requirements for the declaration of TEM was the posting of payment securities in the form of back-to-back letters of credit (L/C) between DISCOs and NBET under the Vesting Contracts, and between NBET and GENCOs under the PPA. To date, a number of DISCOs have not posted their payment securities. This is a fundamental breach of the Performance Agreement between the Core Investors and the Bureau of Public Enterprises (BPE) as it is a clear indication of the lack of financial capacity of Core investors in DISCOs to adequately provide capital (equity and/or long-term debt) to fund DISCO operations.

In addition, NBET is yet to activate the PPAs with GENCOs. However to its credit, NBET has just completed a securitisation process that would enable it post its own L/Cs to GENCOs. Hopefully, that would lead to the activation of the PPAs soon.

Mr. Babatunde Fashola’s roadmap on incremental, steady and reliable power is hinged on bankable, commercial and enforceable framework contracts to procure additional generation capacities (greenfield and brownfield). The non-effectiveness of key industry contracts could torpedo these aspirations.

Huge Industry Revenue Shortfalls

DISCO remittances to NBET for energy consumed has fallen from an average of 65 percent in February 2015 to less than 36 percent in February 2016. The table below shows the payment trend by DISCOs over the last one year. Other than Eko DISCO with an average monthly energy payment performance of 80 percent, most DISCOs actually remit less than 40 percent of their energy invoices to the market. One DISCO remitted 10 percent of its energy invoice for February!
DISCO payments Trend
Monthly revenue shortfalls in the power sector have increased from an average of N9 billion in 2015 to more than N20 billion every month. To give an idea of how bad the revenue shortfall situation is, the total energy invoice to the market for the month of February 2016 was N30.5 billion. The total amount received from DISCOs was only about N10 billion, leaving a revenue shortfall of more than N20 billion owed to GENCOs and other market participants.

While the privatisation of the PHCN Successor GENCOs has been relatively successful when compared to the DISCOs, the fact that GENCOs are owed billions in energy sold to DISCOs threatens their ability to recover more generation capacity, their credit worthiness and their continued existence as going concerns. The revenue shortfalls threaten the survival of the entire power sector.

An Ineffectual Regulator

Since the completion of the privatisation process, NERC has, in our view, been ineffectual in discharging its regulatory functions. The power sector is still faced with regulatory risks arising from regulatory uncertainties, government’s continued influence in the affairs of the regulator and ineffective regulation of the sector by NERC.

The technical and operational capabilities of NERC need to be further strengthened to address obvious gaps in the Commission’s regulation of the power sector so far, which can be described as being reactive rather than proactive. For instance, NERC has no means of independently validating ATC&C loss reductions achieved by DISCOs (if at all).

According to the DISCOs, the electricity market has been badly managed by NERC. They also accuse NERC of introducing unwholesome regulations in a manner that frustrates the efforts of the private investors.

The technical and operational capabilities of NERC need to be further strengthened to address obvious gaps in the Commission’s regulation of the power sector so far, which can be described as being reactive rather than proactive. For instance, NERC has no means of independently validating ATC&C loss reductions achieved by DISCOs (if at all). This perhaps is most crucial when one realises that ATC&C loss levels form a critical component of electricity tariffs and, in addition, is the main criteria for measuring the performance of core investors in DISCOs. In this regard, the Bureau of Public Enterprises (BPE) has been complacent in its monitoring of the terms of the performance agreements with DISCO core investors.

Leadership Challenge

There is also a leadership challenge in the industry. There are too many agencies in the power sector without substantive leadership. NERC, for instance, has an acting Chairman and no Commissioners since the tenure of the Sam Amadi Commission ended six months ago in December 2015. Without a substantive chairman and commissioners, NERC is a toothless regulatory body. The continued absence of a substantive Chairman and Commissioners is also an anomaly, as the EPSRA did not envisage an acting Chairman with no Commissioners.

Besides NERC, other agencies relevant to a sound power sector also have leadership issues. The Bureau of Public Enterprises (BPE) has an acting Director General since Mr. Benjamin Dikki, its former director general was fired in February 2016. Mr. Rumudaka Wonodi just finished his tenure as the managing director and CEO of NBET. Ditto with Mr. James Abiodun Olotu, the pioneer managing director and CEO of the Niger Delta Power Holding Company Plc (NDPHC). In their stead, very competent hands have been appointed to head these agencies, but in acting capacities. In addition, these agencies have no constituted boards.

To make progress, we recommend either the new appointees are made the substantive MD/CEOs (this is our preference, given their industry experience) or new MD/CEOs are appointed without further delays. These institutions, particularly NERC, require firm and decisive leadership to guide the power sector out of the present crisis.

Insufficient Capitalisation of NBET

In anticipation of, and to address revenue shortfalls and short-term illiquidity that is characteristic of a transitional market, NBET was created to act as a credible and credit worthy off-taker of power and seller of power to DISCOs. NBET’s key role is to generate market confidence through well negotiated and well aligned contracts with fair risk allocation that protects market participants from credit risks and systemic risks. NBET, which was established in 2011, is one of the many interim measures put in place to address market weaknesses during the transition period and has a life span of 10 years.

A capitalised and credit worthy NBET, fully backed by the Federal Government is what is most required in this transitional period to ensure there is liquidity and market confidence across the power sector value chain.

More than four years after the establishment of NBET, what is evident to both international and local investors in the power sector is that NBET is deficient in the required capitalisation to meet its obligations. It also lacks the ability to provide adequate and sustainable payment securities backed by the Federal Government under PPAs. In the light of these glaring deficiencies, international organisations like the World Bank and the African Development Bank have had to create credit enhancement/payment support instruments in the form of partial risk guarantees to protect investors in greenfield IPPs against NBET’s potential inability to meet its payment obligations under PPAs. Keep in mind these instruments and interventions are not free and come at a cost to the Nigerian government.

NBET has a capitalisation of about US$800 million dollars to meet its obligations under the PPAs. In our view, should average DISCO monthly remittances remain at current levels, NBET’s current capitalisation would only be sufficient to meet eleven months of revenue shortfalls. This is without adding new generation capacity or triggering availability events under the PPAs.

A capitalised and credit worthy NBET, fully backed by the Federal Government is what is most required in this transitional period to ensure there is liquidity and market confidence across the power sector value chain.

What Are the Solutions to the Crisis?

The privatisation of the power sector has exposed the inherent structural weakness in the sector and is unfortunately creating doubts about the wisdom of the federal government in privatising the entire sector in one fell swoop. In fairness to the federal government and its agencies who were responsible for midwifing the unbundling of the power sector and its eventual privatisation, these structural weaknesses were actually anticipated to arise under a transitional electricity market and several measures were indeed put in place to address them if and when they materialise. Unfortunately, the government, having sold off the DISCOs and GENCOS seem to have suddenly taken its foot off the pedal and is yet to demonstrate sufficient willpower to ensure these structural weaknesses are addressed during the transition period.

Without any equivocation, there will be significant revenue shortfalls (hence payment risks) across the entire power sector value chain for the next three years as DISCOs try to address their distribution losses and become more efficient. DISCOs can’t also be expected to pay 100 percent of their energy invoices as well. Thus government must go back to the drawing board to support the power sector.

The AMCON Model for the Power Sector?

The Power Sector needs the AMCON Model. The Asset Management Company of Nigeria (AMCON) has recently been in the news because of its renewed recovery efforts of bad debts owed by chronic debtors. AMCON raised N5.6 trillion naira in five tranches between 2010 and 2011 to stabilise the financial system by purchasing bad debts owed by less than 500 fat cats and businesses to the banking sector, and bailing out banks who, in some instances, were extremely reckless in their lending processes. AMCON issued zero coupon bonds that were fully guaranteed by the CBN and the Federal Government, thus were investment grade instruments. Today, because of AMCON’s efforts, the financial system in Nigeria continues to be healthy and stable.

NBET should be looking at a N2 trillion bond issuance programme to shore up its capitalisation over the next five years in order to address present and future revenue shortfalls. Such a large bond programme size will also provide confidence and firm guarantees of payments to investors in GENCOs (particularly for new capacities) as well as proposed investors in TCN, without exposing these investors to DISCO payment risks.

In our view, to avert the impending collapse of the power sector, NBET needs to play the role of AMCON and stabilise the power sector by providing sufficient liquidity and confidence to market participants. NBET is planning a N300billion liquidity bond to address some of the liquidity issues in the sector. While this is a step in the right direction, we are nevertheless uncomfortable with the pronouncements from the House of Representatives stopping further work on the NBET Bond.

We are also not very comfortable with the structuring of the proposed NBET bond. First, the planned sizing/bond amount of N300 billion is clearly insufficient to address revenue shortfalls and provide market confidence on NBET’s ability to stabilise the power sector. In our considered view, NBET should be looking at a N2 trillion bond issuance programme to shore up its capitalisation over the next five years in order to address present and future revenue shortfalls. Such a large bond programme size will also provide confidence and firm guarantees of payments to investors in GENCOs (particularly for new capacities) as well as proposed investors in TCN, without exposing these investors to DISCO payment risks. Secondly, the proposed NBET bond is rather short term and seems to only be focused at sorting out present liquidity issues with respect to DISCOs paying their full energy payments to NBET for less than a year. It doesn’t seem to take into cognisance the fact that aggregate losses, as well as revenue under recovery, by DISCOs would take close to two or three years to address (assuming a sincerity of purpose by DiSCOs). In this period, there has to be some form of market intervention.

The proposed NBET bonds will be fully repayable by DISCOs and should not be treated as free funds to them and their core investors.

Business Continuity Planning

A number of DISCOs are currently not viable commercially. If and when the DISCOs fail – and several of them would likely fail – BPE and NERC must commence business continuity plans to take back potentially failed DISCOs from their core investors in order to salvage the companies and the entire power sector. The court cases instituted by DISCOs gives the BPE, as the custodian of the Performance Agreements, the rare opportunity to re-open the Performance Agreements and re-negotiate the terms thereof, with specific emphasis on sanctions on core investors who are unable to fulfill the performance terms, as well as sanctions for core investors who can’t inject equity into the business.

Conclusion

In conclusion, the power sector reforms cannot and must not be allowed to collapse. There have been some progress to date. Allowing the reforms and the privatisation to fail would be far more costly for Nigeria and her citizens. This article is not an assessment of the management of the power sector so far by the present administration. The events that have led to this crisis, and which are continuing, have been in the works before the advent of the Buhari administration. However, we expect that the Buhari administration would take necessary steps to avert the crisis and impending collapse of the power sector. The present crisis is a good opportunity to do so!

Odion Omonfoman is an energy consultant and the CEO of New Hampshire Capital Ltd. He can be reached on orionomon@outlook.com

Babatunde Akinsola
Babatunde Akinsolahttps://naija247news.com
Babatunde Akinsola is aNaija247news' Southwest editor. He's based in Lagos and writes on the Yoruba Nation political issues, news and investigative reports

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