Understanding new electricity tariffs: The case for and against retail electricity tariff increase
The revenues to cover the cost of the entire electricity sector come from retail electricity tariffs. Retail tariffs (Disco Tariffs) cover the following costs: Cost of generation of electricity (capital / capacity costs and fuel costs), Transmission charge for electricity wheeled by the grid to the Disco, Disco’s cost of distributing through its network, Retail costs of supplying electricity: marketing, metering, billing and collection, Capital expenditure for network reinforcements and new installations, Overhead and administrative expenses, Market Charges – fees to NERC, NBET, Market Operator, System Operator.
In summary, the electricity tariff increase is largely occasioned by a number of price inputs across the electricity value chain; Generation, Transmission and Distribution, and more importantly, an increase in the price of natural gas used as fuel to generate over 80 percent of available megawatts in Nigeria. Macro- economic indices such as inflation and exchange rate differentials also account for the tariff increase.
The new retail electricity tariffs are now in effect. It is important to state that the Honorable Minister for Power is not responsible for retail electricity tariff increase or tariff reversals. Neither is the National Assembly vested with such powers. The Discos are responsible for setting their tariffs, while the Nigerian Electricity Regulatory Commission (NERC) is solely responsible for approving such tariff reviews. Notwithstanding though, the Honorable Minister has been at the forefront of selling the tariff increase to Nigerians and has also (unfairly) taken the heat for the increase.
There are three main justifications for a tariff increase which electricity consumers and the general public must be made aware of.
Cost reflectiveness to the entire sector
Electricity tariffs need to be cost reflective for a viable and sustainable electricity sector. Meaning the tariffs we pay for electricity must cover all costs and losses across the entire electricity value chain – distribution, transmission and generation. For example, the electricity tariff paid by a customer in Kaduna for one kilowatt hour (kwh) of electricity consumed should be sufficient to cover the cost of generating the electricity from Egbin Power Plant in Ikorodu, Lagos State, transmitting the electricity generated all the way to Kaduna and the operational cost of supplying the electricity to the customer by Kaduna Disco.
The tariff should also cover technical and operational losses arising from wheeling and distributing the electricity to the customer in Kaduna to ensure that Egbin Power Plant is fully paid for the electricity it generated in the first place. In turn, the amount received by Egbin must be sufficient for Egbin to pay Chevron, Seplat, Pan Ocean or the Nigerian Gas Company (NGC) for the natural gas that Egbin used to generate the electricity as well as cover Egbin’s cost of operating and maintaining the power plant. Of course it is much more complex than this. Its only is a simple explanation of the meaning of cost reflective tariffs.
The absence of cost reflective electricity tariffs is a primary reason why NEPA, later PHCN failed. There were other factors as well. In the absence of cost reflective electricity tariffs, NEPA and PHCN depended on federal government appropriations for its operational and capital funding under subsidized electricity tariffs. In doing so, there were no significant investments in the electricity sector for decades. Thus, the objective of the tariff increase is to make the new tariffs cost reflective to cover all costs in the electricity value chain.
Stimulate much needed investments in the power sector
It is worth repeating that the power sector has been plagued with under-investments for decades, thus the sorry state of the sector today. Having made electricity tariffs cost reflective, Discos and Gencos are now in a much better position to make the necessary capital and non-capital investments to improve the power sector and meter their customers. A key component of the new tariff increase is the price of gas. With the new gas prices, oil and gas producers are more likely to make investments in developing new gas reservoirs and building gas infrastructure (gas processing facilities, gas pipelines, etc) to deliver more gas volumes to the power stations. Another key component of the tariff increase is the new transmission charges. Investments in the transmission grid, particularly increasing the transmission capacity of the grid and stabilizing the grid are now more bankable and will be supported by the new transmission charges, allowing for a recovery of these investments and providing the investor with a return on the investment.
Decrease the payment risk in the electricity value chain
The greatest risk faced by investors across the entire electricity value chain in a privatized power sector is payment risk. Today, the payment risk in the power sector is high. Discos, the primary revenue source of the entire power sector value chain, have been unable to meet their energy payments in full and other obligations to the electricity market. Thus Gencos, gas producers and gas suppliers are owed billions of naira in outstanding payments for power generated and sold to Discos. The CBN recently provided N213billion loan facility to the power sector to off-set these outstanding debts that have accrued since the completion of the privatization of the power sector in November 2013 up to December 2014. However, the CBN may likely step in again with more funding as more debt have accumulated in the power sector since then as a result of the resultant shortfalls in the revenue requirement for the entire sector using the old tariffs. The recent tariff increase is expected to significantly address the payment risk in the power sector.
The case against electricity tariff increase
There are strong and compelling arguments against the recent tariff increase, which have been put forth to NERC and the Hon. Minister for Power, Works and Housing. Some of the arguments and questions are presented below.
Tariff rate shock
In the first instance, the recent tariff increase is seen as a rate shock. A tariff rate shock is defined as tariff increases of above 25 percent. The new tariffs represent an average of 41 percent increase in retail electricity tariffs. Rate shocks do not help the electricity sector and the general economy. One of the factors attributed to the spike in inflation rates is the new retail electricity tariff that came into effect on February 1st.
Why increase electricity tariffs with poor supply?
Despite the conclusion of the privatization of the power sector more than two years ago, power generation and supply remain epileptic at best. As an example, the total number of hours of supply received by this writer in the month of March was not up to 24 hours! While the extremely poor supply in recent times is an abnormality arising from the destruction of the Forcados export terminal pipeline, which shut in production of oil and associated gas, it nonetheless presents an argument against the tariff increase.
Where are the meters?
Statistics provided by Discos to NERC show that up to 60 percent of electricity consumers do not have metered supply. Thus, the huge customer apathy to the new electricity tariffs. Already, we are seeing instances of extremely ridiculous bills being sent to unmetered customers despite the epileptic supply.
Why pass on the inefficiencies of Discos, TCN and Gencos to customers?
The MYTO tariff methodology as explained in the first two series of this article, factors losses – technical and non-technical losses in the electricity value chain, into the computation of retail electricity tariffs. Today, average aggregate losses at Disco level are in excess of 50 percent. The bulk of the losses are non-technical in nature. Two years after privatization, aggregate loss levels seem to have risen, rather than reduce. Due to the computation of aggregate losses in the retail tariffs, Customers are directly paying for the losses and inefficient operations across the electricity value chain. Unfortunately, there is no tariff-based incentive for the Discos to reduce aggregate losses as the higher the losses that can be factored into tariff calculations, the more revenue they realize.
Increase in non-technical losses and decline in revenues
In power markets with high losses and epileptic supply similar to the NESI, it has been proven that high tariff increases/rate shocks usually lead to a corresponding increase in non-technical losses and a decrease in revenues. This is so as customers who are unable to pay the new rates engage in meter bypass, theft and outright refusal to pay! Also, customers look for more reliable and stable off-grid alternatives. In a contested tariff situation such as the situation prevailing now, collection losses will significantly increase as Discos struggle to compel their customers to pay the new tariffs and also collect the tariffs. The sector should brace up for a sharp revenue decline in the first few months following the tariff increase. Already, from available collections data, there is a very sharp drop in February and March collections by Discos. Because of the poor energy situation experienced in these two months, it may be too early to attribute the drop in revenues solely to increased collection losses.
In a recent video posted on Youtube, the Honorable Minister for Power, Works and Housing tried to provide counter arguments and answers to some of these questions and arguments presented above.
The big question –Was the tariff increase necessary at this time?
In our view, the tariff increase was necessary and is the right step to take to stabilize the power sector and provide investor assurance. However, tariff increase alone will not address the liquidity challenges, which is the biggest problem in the sector. The liquidity challenges arise as a result of the huge aggregate losses in excess of 50 percent and inefficiencies across the entire power sector value chain. It is unrealistic to pass these losses and inefficiencies to electricity customers under the new tariffs. It just won’t work and it is a plan to fail.
We must however note that the new retail tariffs allow for an under-recovery period so as not to pass on these losses and inefficiencies at once.
Having successfully advocated and pushed through an unpopular but necessary tariff increase for the sector, the Federal government must now step in to provide liquidity support to the sector by way of liquidity support to the Nigerian Bulk Electricity Trader (NBET) as the central buyer and seller of power, as well as provide intervention facilities to the sector similar to the CBN Facility. But then, this begs the question – why was the power sector privatized if government is still directly and indirectly funding the sector?
Conclusion
The new electricity tariffs have been greeted with severe opposition. Beyond the natural opposition to the tariff increase, it is important for electricity consumers and the general public to understand the above justification for a tariff increase. The pedestrian argument that Nigeria has the lowest retail electricity tariffs in all of West Africa should not be one of the justifications for a tariff increase.
In conclusion, the new electricity tariffs should be allowed to stay. However, this time around, the Ministry of Power, NERC and the Bureau of Public Enterprises (BPE) must extract firm commitments on supply improvements with clear performance milestones from Discos, Gencos and TCN. Finally, the National Assembly must be mindful not to create additional regulatory risks by their pronouncements on tariffs’ reversal.
ODION OMONFOMAN