Things appear to going from bad to worse for the Nigeria’s Power Sector. Just last week, the Federal High Court in Lagos annulled the recent increase in electricity tariffs threatening billions of investments in the power sector and billions more of potential investments.
Background of the Issue
For decades, the Nigerian Power sector has been operating on a tariff structure that does not reflect the true cost of what it takes to generate a kilowatt electricity. Prices for cost inputs in the power sector value chain was mostly fixed by the government and did not reflect market reality. For example, Gas which is a major input used by Power Generating Plants, was set at a price that was below market price.
Despite these facts, the government went through the sale of the Power companies selling it 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 hoping that with time they will attract longer term funding from foreign lenders.
Soon after they took possession of the assets in 2014, investors who acquired the assets started looking for funding from local and international banks to enable them refinance acquisition loans as well as invest in the network expansion, metering, power generation as well as 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 government and the National Electricity Regulation 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 President Jonathan if a tariff hike is allowed. By the time it was eventually approved in January 2016, the tariff increased by as much as 45%. To make it worse, electricity situation in the country had worsened due to a vicious combination of pipeline bombings and vandalization. These made for a cocktail of trouble that will have wider implication 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 dollars presenting an exchange rate risk and unstable interest rates that the new Discos new was unsustainable.
The second was to raise money to invest in their network expansions, buy meters, increase generating capacity, buy new transformers and replace the aging workforce. These would cost billions of Naira and will require between 10 to 15 years before the money can be paid back.
However to attract this 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 cost of investments while also making considerably profits. No one will invest in a business that did 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 new it will not immediately solve the problems of power in Nigeria. They also new getting Nigerians to accept it amidst a poor power situation was a huge task. For Nigerians to accept this tariff increase with less complaint, 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, they will offend consumers who will be expected to wait for two to three years before they see an improvement in the power situation despite them 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 has now crashed considerably in real terms. Unfortunately, this was a bad comparison as the 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 breaching the little trust that they had with fund providers.
As explained earlier, a cost reflective tariff was not a silver bullet for the power sector but was rather a means to and end. The end being a path towards sustainable investments that will help reduce the losses that was 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 court order by continuing to bill 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 15%, 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. The estimated loans of about $3 billion is now at risk of a 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 pit them in a precarious situation as the trust deficit with foreign investors continue to go deeper. They will juxtapose this with the efforts of the government to attract foreign investments 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, this sets the country back on the path towards stable electricity as funding required to invest in the sector will remain firmly in the hands of potential investors. The little investments 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 a price 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.
The post above and its ensuing comments, if any, is purely the opinion of the writer(s). It therefore should never be considered as an investment advise of any sort. If required, readers should please consult a competent professional financial adviser for any investment decision.