Power sector revenue shortfall, illiquidity – Need for local PRG solution

The privatisation of the power sector has exposed the inherent structural weakness in the sector. A key structural weakness undermining the privatization is the revenue shortfall and consequential poor liquidity and credit risk across the entire power value chain (inclusive of the gas sector). This is despite the N213 billion intervention fund to the power sector by the Central Bank.

A study that was recently conducted put the revenue shortfall in excess of N12 billion monthly. The illiquidity and revenue shortfalls stem from a combination of technical and non-technical losses at the distribution and transmission value chain and inadequate generation capacity as a result of poor gas supply and insufficient investments in new generation capacity.

Data from distribution loss studies recently conducted by DisCos and provided to NERC show that average aggregate technical and non-technical losses across all DisCos are in excess of 50 percent. No industry in whatever sector can sustain these high revenue losses and still be expected to stay afloat as a going concern.

While it seems like a classic chicken and egg situation in deciding on specific structural weaknesses to first address by way of investments, without a cohesive and well though through approach to addressing the revenue conundrum in the power sector, particularly to GenCos, any plans by the government to address structural weaknesses in other areas of the power sector value chain, including the gas –to – power aspect may be unsustainable and short lived.

The Role of NBET

In anticipation of, and to address revenue shortfalls and short term illiquidity that is characteristic of a transition market, the Nigerian Bulk Electricity Trader (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.

To underscore the importance of NBET’s role in a transition market, President Goodluck Ebele Jonathan, while incorporating the board of the NBET, is quoted as saying “I have every confidence that you will faithfully execute this mandate of serving as a Bulwark against the potential payment default by distribution companies until they become financially strong to directly enter into power purchase agreement on bilateral basis”.

More than three years after the establishment of the NBET, what is evident to international and local Investors in the power sector is that NBET, despite its current capitalization of over US$800million, is seriously deficient in the required capitalization to meet its obligations to generation companies and do not have the full support of the Federal Government in form of adequate payment securities backed by the Federal Government. Investors in the power generation sector and also gas-to-power sector must be firmly assured of NBET’s ability to meet its payment obligations under power purchase agreements and gas sales agreements. Thus, international organizations like the World Bank and the African Development Bank have had to create credit enhancement instruments in the form of partial risk guarantees to protect investors in greenfield power generation plants against NBET’s potential inability to meet its payment obligations under the power purchase agreements (PPA) and gas supply agreements.

Addressing the revenue risk

One way to address the current market liquidity challenges and revenue risk to GenCos, TCN and gas producers is by way of a power sector credit enhancement structure (“local PRG”) to support NBET’s obligations under respective power purchase agreements. A local PRG mechanism and/or instrument will enable NBET to meet payment shortfalls by DisCos to generation companies and gas producers during the transition stage of the electricity market. With such credit support instrument, NBET would also be able to meet its obligations to the Transmission Company of Nigeria (TCN) thus providing the much needed capital for TCN to embark on strengthening the transmission grid leading to improved grid stability. In the case of TCN, such a structure will enable the TCN implement PPP arrangements with Investors to build new transmission lines badly needed to wheel power efficiently.

Long term viability

Regardless of the local PRG solution mentioned above, the ultimate solution to address the revenue shortfall and credit risks in the sector lies in ensuring that DisCos ultimately reduce their technical and non-technical losses within a reasonable period. DisCos must be held accountable for loss reduction as per their loss reduction plans which were the basis the companies were sold to new owners. Mindful of the fact that the new owners of the Discos committed to a loss reduction plan for five years, it is reasonable to expect that distribution losses will not disappear overnight as many people unreasonably expect and there will still be significant revenue shortfalls arising from these losses. Indeed, there are distribution losses even in the most advanced electricity markets. If given the right financial assistance under a carrot and stick approach, Discos should achieve significant loss reductions, particularly their commercial and collection losses, which account for over 70 percent of aggregate losses, within three years.

However, Discos need to start to make necessary capital investments now in readiness for increased power generation to see tangible and significant loss reductions. One way Discos can achieve significant reduction in non-technical losses particularly in the area of customer metering and revenue protection is to adopt off balance sheet financing solutions to fund and implement key CAPEX programs such as their metering plans. An example of such off-balance sheet financing solution is the Nigerian metering initiative championed by the Accenture-GMSI collaboration in partnership with local meter manufacturers, which plans to address the metering gap by financing the procurement, roll-out and installation of more than two million residential energy meters across Discos nationwide at no upfront cost to Distribution companies and their customers.

The power sector conundrum, particularly the market revenue shortfall, credit risk and gas supply constraints under this transition period is to be anticipated. However, Government, through its respective agencies and parastatals such as NBET and the Ministry of Finance, must stand ready to firmly assure investors across the power value chain and the banks who are behind these investors that such investments will be fully recoverable. One such assurance is providing credit enhancement support to NBET through local banks and the Capital Markets by way of a local PRG structure. But ultimately, all stakeholders, including the new owners of GenCos and DisCos, NERC, Ministry of Petroleum, CBN, Nigerian banks and Capital Market Operators, will have to think outside the box to ensure the overall success of the power sector reforms.

Wesley Omonfoman

Wesley Omonfoman is an Energy Analyst and the Chief Executive Officer of New Hampshire Capital Limited, an energy advisory firm based in Lagos.

orionomon@yahoo.com