Things appear to be going from bad to worse in Nigeria’s power sector. Just last week, a Federal High Court sitting in Lagos annulled the recent increase in electricity tariffs, threatening billions of investments in the sector, and billions more in potential investments.
Background of the Issue
For decades, Nigeria’s power sector has been operating on a tariff structure that does not reflect the true cost of what it takes to generate a kilowatt of electricity. Prices for cost inputs in the power sector value chain were mostly fixed by the government and did not reflect market realities. For example, gas, which is a major input used by power generating plants, was set at a price below the market price.
Despite these facts, the government went through with the sale of power companies, selling them to Discos for a reported sum of about $2.5 billion. The new owners part funded these acquisitions via medium term bank loans estimated at about $3 billion, in the hope that with time they would attract longer term funding from foreign lenders.
Soon after the new owners took possession of the assets in 2014, they started looking for funding from local and international banks to enable them refinance acquisition loans as well as invest in network expansion, metering, power generation and transmission. Things started to change in 2014 when it became apparent that the funding wasn’t coming as expected. Fund providers had a clog in the wheel they wanted the Discos to fix. The tariff was not cost reflective.
They now started lobbying the government and the Nigerian Electricity Regulatory Commission (NERC) to introduce a tariff that was cost reflective. The lobbying took much longer than was expected with NERC expectedly reluctant to increase tariffs in the midst of a feisty election that could go against the incumbent. By the time the hike was eventually approved in January this year, the tariff increased by as much as 45%. To add salt to injury, the electricity situation in the country had worsened due to arenewed militancy in the Niger Delta which is affecting the gas supply. This makes for a cocktail of trouble that will have wider implications for the power sector.
What Cost Reflective Tariffs Meant for Discos and Nigerian banks
Post privatization had two major challenges. The first was to refinance loans obtained from local banks. These loans were medium term (about 5 years) and denominated in US dollars, presenting an exchange rate risk and unstable interest rates that was unsustainable for the new Discos..
The second was to raise money to invest in network expansion, buy meters, increase generating capacity, buy new transformers and replace an aging workforce. These would cost billions of Naira, and require between 10 to 15 years before the money can be paid back.
However, to attract these funds at an appreciable tenor, the matter of a cost reflective tariff remained a huge source of concern for investors. A cost reflective tariff meant that the Discos were in a position to recover their investment costs, while also making considerable profits. No one will invest in a business that does not generate enough revenue to cover cost.
Chicken and Egg Situation
For the new owners of the Discos and the Gencos, a cost reflective tariff was no silver bullet as they knew it will not immediately solve the problems of power in Nigeria. They also knew getting Nigerians to accept it amidst a poor power situation was a huge task. For Nigerians to accept this tariff increase without complaints, power supply had to improve. A case in point was the disappearance of the long queues following the increase in the price of fuel. Nigerians bluntly ignored a call for strikes by labour.
Who do you satisfy first? Investors or consumers? If you increase tariffs you will attract funding that will be required to invest in projects that will increase power supply in Nigeria. However, such a move would offend consumers who would then be expected to wait for two to three years before seeing an improvement in the power situation despite paying at cost reflective tariffs.
Since the Discos couldn’t force money out of the pocket of potential fund providers, or get the government to continue to subsidize tariffs, they expediently passed that burden to consumers. Most of the owners of the newly privatized power companies cited the privatization of the telecoms sector as a case in point. Tariffs were high in the early years of GSM in Nigeria and have now crashed considerably in real terms. Unfortunately, this was a bad comparison as telephony under the GSM companies was as clear as night and day when compared to what it was under Nitel. There was no chicken and egg situation in this case.
Implication for Discos
For Discos, the implication is that months of work put into negotiations with potential fund providers is now likely to be jettisoned. A lot of the concerns showed during negotiations have basically played out, essentially breaching what little trust they had with fund providers.
As explained earlier, a cost reflective tariff is not a silver bullet for the power sector, but rather a means to an end. The end being a path towards sustainable investment that will help reduce the losses that were predominant in the sector. With this court order, Discos now face a dilemma of whether to bill next month using the old tariffs or whether to defy the court order and continue billing using the cost reflective tariffs. Whatever they decide to do will impact heavily on collection losses. In fact, whether they obey the court order or not, their collection losses are more likely to be impacted by improved power supply than by any increase or decrease in tariffs.
With the exchange rate now depreciated by about 80% and inflation rate above 16%, discos are faced with a double whammy of higher debt and debt servicing cost and an erosion of the purchasing value of their income.
Implication for Commercial Banks
Commercial Banks in Nigeria played a major role in providing funding for the acquisition of the Discos and Gencos in 2013. They did this by providing loans and bank guarantees to the newly privatized companies. Estimated loans of about $3 billion are now at risk of default. According to banking sources, some of these loans are already going bad with the banks hoping that a possible investment from potential investors such as the IFC could help bail them out. But with potential investors adamant on getting cost reflective tariffs, it is likely that these loans will remain with the banks increasing the risk of further write downs this year.
Implication for Government
The Buhari Government is already under intense pressure for some of their wobbly economic policies. The decision of the court helps them as much as it hurts them. The court has basically given them an escape route to get out of an unpopular tariff hike decision that was hurting their ratings in the eye of Nigerians. On a flip side, it has further puts them in a precarious situation as the trust deficit with foreign investors continues to deteriorate. They will juxtapose this with the efforts of the government to attract foreign investment knowing fully well that this will alienate investors even more.
The government via the CBN could also be at risk of losing over N300 billion in loans extended to the power sector via the Power Sector Intervention fund.
Implication for Nigerians
For Nigerians, they will expect their electricity bills to drop drastically considering the poor state of power supply in the country. However, on the path towards stable electricity, this sets the country back as funding required to invest in the sector will remain firmly in the hands of potential investors. The little investment being seen in the sector will gradually reduce, affecting the service extended to customers. Common services such as replacing transformers, poles, conductors and metering will be severely impacted. How this could play out in the coming months is unclear. Power supply could worsen as gas producers will rather flare than sell at prices below cost. Add that to the continued bombings of oil installations by militants in the Niger Delta, and we could be faced with a period of darkness.
All Nigerians want is stable power supply backed by metering. Unfortunately, this cannot happen with a tariff that is not cost reflective and the heightened activity of militants in the creeks.