Nigeria’s Electricity Regulator’s reduction of tariffs
Proem
It is the writer’s view that the Nigerian Electricity Regulatory Commission (“NERC”) has performed its duties admirably in the last five (5) years. NERC has for example, worked very hard at forging a good balance (which is a delicate one) between consumer protection and investment attractiveness of the sector. In the year 2014, for instance, NERC issued enforcement regulations for the electricity industry, together with administrative sanctions (including fines) available to the commission against any operator (being a licensee in the power sector) found liable for breaching any of the sectorial rules. Just this year, the Commission also approved the Nigerian Electricity Supply and Installations Standards Regulations which specify standards for installations in the electric power industry.
Interestingly, those regulations work in such a way that efficiency and consumer satisfaction are improved and inextricably, revenue generation of the distribution companies (“Discos”). An analogy is where transformers get damaged such that consumers cannot use electricity and hence, are not obliged to pay and then the relevant Disco does not generate revenue from such consumers. With the Disco completing the repairs of such a transformer promptly, both the consumers and the relevant Disco would be glad as one party enjoys electricity and the other generates revenue.
Further, there was also an increase across board of the tariffs payable by various classes of consumers, through the issuance of the Multi Year Tariff Order (“MYTO”) 2.1 to ensure that tariffs are cost-reflective and investing in the sector is profitable; although, there was a suspension of the payment of the tariffs by certain customer classes for a six (6) month period.
It is the case that the principal legislation which governs the sector obliges NERC to ensure the full recovery of prudent costs for efficient operators and the commission is further mandated to ensure that only prudent and efficient costs are passed-on, to consumers. The ideal, therefore, is to ensure that the relevant Disco operates efficiently and provide quality and affordable services to consumers.
However, on March 17, 2015 NERC issued a notice stating that “henceforth, collection loss, which is defined as the ‘amount billed but not collected’, will not be automatically passed on to consumers of electricity. Consequently, the collection loss for all DISCOs is set at zero”. NERC then specified that the removal of collection losses from customer tariff had reduced tariff by more than 50 percent in some places. The question this writer attempts to answer is whether this setting of losses at zero does not amount to changing the rules mid-way into a game, especially considering that the Discos have only recently been privatized with agreements largely hinged on the MYTO provisions.
Privatization of Discos & Adoption of ATC&C Loss Criterion
For the privatization of the Discos, the Bureau of Public Enterprises (the “BPE”) and indeed the National Council on Privatization (“NCP”) chose to go the way of a combination of financial bid and core investor with the best service/ efficiency program. The efficiency bid parameter in this case, was the reduction of the Aggregate Technical Commercial and Collection (“ATC & C”) Losses; with premium placed on this bid parameter.
The decision to place premium on reduction of ATC & C as a bid parameter was largely because Discos are to a large extent, natural monopolies whose privatization did not immediately make the setting up of alternative firms by the private sector, viable. In the view of both the BPE and the NCP, the privatization of the Discos, as a result of their monopoly status in their operating areas, posed a different challenge from routine privatization programs, which would be difficult to address using the usual highest bidder parameter model, as the key bid parameter. This was particularly the case because it was thought that it was not sufficient to choose the preferred bidder based on the highest financial bid as that alone would not reduce the ATC & C.
In designing the model for the selection of the preferred bidder for the Discos, therefore, the BPE and the NCP took into consideration, the fact that the ATC & C losses sustained by the various Discos had been at between 40 and 50 percent of the power wheeled to them through the transmission system. This level of losses was regarded as unsustainable and if not halted will continue to render the sector absolutely unviable for full and unsubsidized private sector participation.
Consequent upon the foregoing, the value of the service/efficiency parameters was considered viz-a-viz the investment proposals made by bidders aimed at reducing ATC & C losses over a five (5) year period. This option was aimed at catering to the identified principal needs of the distribution segment of the sector, that is; rapid reduction in the current levels of ATC&C losses and sustainable investment in system rehabilitation, upgrade and expansion.
Under the Disco privatization strategy, a private sector operator acquired controlling equity interest in a relevant Disco with a view to rapidly improving its operational efficiency. So, unlike the traditional transaction approach where bidders merely bid on price for the equity shares, bidders bid on the basis of a trajectory of technical, commercial and collection loss improvements, usually during the first five years of post-privatization operation.
Additional, this method was built around the Multi Year Tariff Order (MYTO) 2 issued by the Nigerian Electricity Regulatory Commission (NERC). The idea of a MYTO 2 was to ensure in the first place, that cost reflective tariffs are charged in the NESI, and came into effect in June 2012. MYTO 2 basically set out the commercial and economic indices that provide the financial model for the entire electricity industry in Nigeria. MYTO 2 also stipulated the yearly investment requirements, allowable operational expenditure, approved rate of return on equity and other allowable expenses for each Disco. The valuation of each Disco was obtained from the regulated asset base contained in the MYTO 2 assumptions. This method, NERC and the BPE believed, eliminated the problem associated with undervaluation or overvaluation of the assets.
To emerge as a core investor, a bidder was required to submit a proposal aimed at reducing the ATC & C losses over a five (5) year period. The level of losses that a bidder proposes to reduce was to be incorporated in the Multi Year Tariff Order (MYTO). MYTO was also to (and did) stipulate the annual investment requirement, allowable operational and capital expenditure, approved rate of return on equity and other allowable expenses for each Disco. Hence, the selection criterion sought to appoint an operator with the best technical, financial and managerial qualification for reducing ATC&C losses.
Removal of Collection Losses and the Investor
NERC has restated that the Electric Power Sector Reform Act (the “EPSRA”), the principal legislation which regulates the electricity industry, “commits the Commission to ensuring full recovery of prudent costs for efficient operators”. NERC has also stated that “the Commission is obligated to make sure that only prudent and efficient costs are passed to consumers”. Hence, in the commission’s view, “the principle is to ensure that the distribution company operates efficiently and provides quality and affordable services to consumers”.
The foregoing argument of NERC does apparently make sense especially when one looks at the clear provisions of the EPSRA and one looks at it from a consumer’s point of view- yours truly for instance, is a consumer. However, a number of pertinent questions/ issues come to mind which answers to, I do not really have; but which Dr. Amadi and his team should have or need to now consider. There is first the fact that the owners of the distribution companies had specified clearly in their bid documents, the percentage rate at which the entirety of the losses (ATC&C) in the power industry would be reduced over a 5 year period and would legitimately expect that this would be honoured as same affects other fundamental matters such as financing, and expected revenue to meet expenditure.
The foregoing is particularly the case, as the verified and revalidated loss levels were highlighted and same formed a core part of the updated financial model for MYTO 2 and 2.1 (and MYTO 2.1 in particular restates the percentage rate of loss reduction committed to by each Disco). Wouldn’t this seem like changing the rules of a game mid-way into same? Did NERC utilize a scientific approach such that the ‘collection losses’ component of the ATC&C losses was hived-off the aggregate, without a possibility of distorting the ATC&C losses reduction levels agreed to by the new owners of the Discos? Did NERC (and indeed the BPE) carry the new owners of the Discos along without any reasonable and justifiable objection? Were any permutations or models adopted before announcing the changes? Did NERC consider that the pre-paid metering system being introduced would almost entirely solve the problem?
What compounds matters, in the writer’s view, is the fact that there is a provision for repayment of the interim period shortfalls via a commercial loan facility from the federal government/CBN in the MYTO 2.1. Further, in the analysis of how repayment would be made in connection with the said facility, the review that had been done to the ATCC baseline was a key constituent. A removal of the collection losses component of the ATCC could then potentially be a serious problem.
Further, under MYTO 2.1, in addition to the four (inflation, generation capacity, forex and gas price) minor review variables, collection losses for the Discos is now a minor review variable. The intention as stated in MYTO 2.1, is to incentivize Discos to secure more efficiency by increasing their respective revenue collection and to pass the benefits of such increased efficiency to the customers.
Conclusion – Compatible or Politics?
It is the view of the writer that speaking from a strict legal point of view, NERC would appear empowered to effect the changes in the tariffs. However, there are questions which border around fairness, legitimate expectation (which may be a good cause of action in dispute resolution) and investor confidence that may be adversely affected. Further, it is pertinent to note that there is a strong argument that if NERC goes on with its changes (with the concurrence of BPE), the federal government is effectively reducing its equity interest in those distribution companies. The fairness and ‘rightness’ of what NERC seeks to do; and whether what the commission seeks to do is merely political would, in the writer’s view, be dependent on whether NERC thought through the issues raised above and their answers to the specific queries also raised above.
For more details about the power sector, do pick up a copy of the text on the power sector written by Ayodele Oni.
Ayodele Oni {ayodeleoni@outlook.com}, a solicitor, specializes in international energy (oil, gas and electricity) investment law and policy. He holds a mini-MBA in power & electricity. Follow me on twitter @ayodelegoni.