As the Electric Power Industry (the Industry) announced yet another review of electric tariffs in January 2021, after much deliberation and delays, a critical question that comes to mind is ‘will a rise in tariffs result in a better power supply?’ To answer this question, it is imperative to examine the state of the Industry post-privatization.
Since the privatization exercise that commenced in 2013, the Nigerian Electric Power Industry has remained fraught with many of the same challenges ranging from unreflective tariffs to high loss levels, obsolete infrastructure, weak policy implementation and gas shortages. These have culminated in a weak and erratic power supply and a dependence on self-generation by many businesses and households. Furthermore, electricity distribution in Nigeria remains plagued by high technical, operational and commercial inefficiencies. In 2020, the country’s 11 Distribution companies (DisCos) only billed for 74% of the energy received from the transmission company, below the 81% reported in the prior year. Billing efficiency, which has historically been impaired by a low metering rate and energy theft, with only 37% of registered electricity customers metered in 2020, was severely impacted by the Covid-19 pandemic. Agusto & Co believes the impact of the pandemic was more visible amongst consumer groups with post-paid meters and estimated bills, given that the social distancing rules and movement restrictions established to curb the spread of the virus impaired the physical billing process. Collection efficiency also fell marginally to 66% from 68% one year prior. Consequently, the aggregate technical, commercial and collection (ATC&C) losses for the 11 DisCos rose to 51% in 2020 from 45% in 2019. This high loss level remains one of the many reasons for the kickback from electricity consumers on tariff increases, especially in the absence of a significant and immediate improvement in power supply.
Agusto & Co notes that these challenges have weakened the ability of operators to meet electricity demand and threaten their financial viability, with significant implications for the country’s fiscal health. Despite the series of amendments to the tariff structure, cash flows from MYTO (the Multi-Year Tariff Order) have remained insufficient to cover the costs of electricity supplied fully. The fear of the impact of a ‘rate shock’ on consumers and the accompanying loss of “political capital” has prevented the effective implementation of necessary amendments that will align the MYTO’s assumptions with economic realities. Electricity has thus consistently been sold at a discount, with end-user electricity tariffs much lower than the cost of electricity supplied.
The shortfall from unreflective tariffs has been borne in large parts by the Federal Government of Nigeria (FGN) through multiple intervention funds and payment assurance facilities from the Central Bank of Nigeria (CBN), totalling close to â‚¦2 trillion (US$4.9 billion) as at the end of 2020, equivalent to c.6% of CBN’s balance sheet. Despite this level of intervention, the generating companies had estimated receivables of over â‚¦400 billion in 2020 alone. While the interventions have been central in ensuring operators’ profitability along the Industry’s value chain, they remain insufficient and unsustainable.
More recently, there have been notable efforts by the primary regulator – NERC – to minimize the challenges faced by operators in the Industry. In particular, tariffs have been raised to near cost-reflective levels and adjusted to match consumption via Service Reflective Tariffs (SRT) initiative. As the name indicates, the new tariff model is expected to reflect and match the quality of service received by the ultimate electricity consumers. Therefore, distribution companies will discriminate in the application of tariffs; consumers who enjoy longer daily supply will be expected to pay higher rates and vice versa.
The SRT, like other MYTO models, has critical estimates (and projections) for macroeconomic and industry-specific indicators, including inflation, exchange rates and electricity generation. Other company-dependent factors considered in the determination of tariffs include the amount of electricity received and the aggregate technical, commercial and collection (ATC&C) losses. Ultimately, tariff shortfalls (the difference between end-user tariffs and cost-reflective tariffs) are expected to taper off by the end of 2022, with tariffs fully reflective and sufficient to cover the cost of production.
While several assumptions align with market realities, we note that the SRT model’s inflation and electricity generation estimate is much higher than the actual entries reported for the corresponding periods. In our view, these disparities have the potential to impair the attainment of cost reflectiveness. Agusto & Co believes adopting scenario analysis and modelling will provide a more robust framework to determine an appropriate tariff structure for the Industry in a dynamic macroeconomic environment such as Nigeria’s.
In addition to the SRT, the primary regulator – the National Electricity Commission (NERC) – introduced a minimum remittance threshold for each distribution company which stipulates a mandatory payment made to the bulk trader for electricity received. Furthermore, in February 2020, NERC introduced guidelines for ‘Merit Order Dispatching’ which involves ranking electricity generation and dispatch by the transmission company of Nigeria (TCN) in ascending order of costs with the cheapest electricity – such as those from Hydro plants with no fuel cost component – ahead of more expensive plants. The order also provides guidelines on the alignment of invoicing for capacity charge and energy delivered and a framework for the settlement of any imbalance between DisCos and TCN. The Merit Dispatching Order should eliminate the shift of responsibility for load rejection prevalent between DisCos and the TCN and improve these operators’ technical and operational efficiencies.
In August 2020, the Central Bank of Nigeria issued a circular that all deposit money banks are expected to warehouse and manage collection inflows from all distribution companies – DisCos (including the collection agents of these DisCos) under specific guidelines as contained in the document. The objective of this ‘ring fencing’ is to secure cash collected from the DisCos and ensure that these distribution companies meet their mandatory obligations.
While operators are generally optimistic that the new tariffs and accompanying regulations would enhance efficiency and position the Industry on the trajectory towards achieving financial independence and ultimately improvements in electricity supply volume and quality, Agusto & Co remains cautious. In our view, to truly achieve the objectives of privatization, reforms need to be accompanied by a robust and enabling regulatory environment. Furthermore, improved access to finance, efficiency in billing and metering, and consistent and secure gas supply are vital to reap the benefits of privatization in the long run. While the journey to constant electric power supply remains far and long-winded, Agusto & Co believes the initiatives undertaken by the primary regulator – NERC- if consistently enforced have the potential to move the industry forward in the right direction.