A Review of the Nigerian Energy Industry

How to resolve lingering gas-power crisis – NERC boss

Sam-Amadi, NERC24 August 2014, Abuja – Dr. Sam Amadi is the Chairman and Chief Executive Officer of the Nigerian Electricity Regulatory Commission (NERC). He obtained various degrees from various institutions, which includes University of Calabar (LLB), Harvard Law School (LLM & SJD), and Kennedy School of Government, Harvard University (MPA). He was a fellow at the Carr Center for Human Rights Policy, the Edward Mason Fellowship in Public Policy and Management, Kennedy school of Government, Harvard and also Reginald Laws Fellow at the Harvard Law School. He has served in a wide array of governmental and non-governmental institutions which includes: US-Nigeria Bi-National Commission, Presidential Committee on Review of Reform Processes in the Public Service in Nigeria, USAID and OSIWA.

He was a Special Adviser to the Senate President (2005-2007) and Special Assistant to the Nigerian Foreign Affairs Minister (2007-2009). He was also a defense counsel to the famous environmentalist and writer, the Late Ken Saro Wiwa and other Ogoni activists. In this interview with EMEKA ANUFORO, he speaks on the task of regulating the electricity sector, how state of emergency can work in the power sector and other pertinent issues of the moment. Excerpts:

There are huge expectations out there that the sector should have moved on more than where it is since the privatization. The teething problems seem to be taking forever. What, in your assessment, is responsible for this seemingly set back? People think that the regulator is looking the other way while consumers are abused.

THE privatization is gone, over. We now have the assets handed over to the successful bidders. If you ask me, the focus should be on managing expectations and managing the crises and managing the issues that arise as a result of privatization. But then, we also manage systems by understanding how they are set up, and underlining causes of issues so as to address them, resolve them in a lasting and sustainable way.

Taking about the privatization. Are there things that we should have done in a different way, of course, yes! In privatization, you build a model and if that model is close enough to relating, and if that is robust enough, then the outcome would be much more sustainable and you achieve objectives. Maybe if we look at the problems, or issues that we are addressing now. I use the word issue because we expect that there would always be issues. Even in the more advanced market, there are always issues. But we look at those issues. Some of them relate to the mode of privatization. For example, some people are telling us that it was an ambitious project. Yes, it is.

We privatized the entire sector basically, minus the Transmission Company of Nigeria. What that means in effect is that the two ends of the market are now going to be very conscious about financial viability. If we sold one, we would still have kept the inefficiency of one, which means that we will outsource the financial risks to the one that is still in the public sector, and that would have huge impact for public sector financing, public budget, government budget and the borrowing requirement, which is one of the reasons why government always opt for privatization. This is to reduce the public sector borrowing requirement.

If we had not privatized both end, that is distribution and generation, there would be some moral hazards, because the distribution companies who may be seeking powers to consumers may feel slightly justified not to pay the full cost of their energy to publicly owned generators. That is one. The panic, the contrived panic of some people who are saying that illiquidity is high, and that there may be crises, debt overhang, would have been minimized because they would out source it, or offshore it to government owned/ public Gencos.

Now, we don’t have that luxury of a line. And it is a good thing that we need to enter the market in a truly fundamental way, in that every entity in this market must be in a position to, in day one, be responsible for its bills, its cost, and day one be efficient, and run efficiently in terms of governance structure, in terms of incentivizing efficiency, also in terms of complying with the regularity framework of the market.

Another issue about privatization also is that, perhaps, if we had raised the benchmark for asset ratio, in terms of equity ratio, if the asset requirement into the market had been, maybe larger, all things being equal, the entities in the market would have been much more, they would have had deeper pockets to finance improvements in network from their own equity for a longer period before the market begins to return profit to them. The model of the privatization and some of the guidelines are things that, from hindsight, we would change.

But that does not mean that it was a wrong move. It only means that seeing the sector as it evolved, you could build better models. For example, if we are doing it again, for subsequent ones, we might raise the threshold of asset that each company can have before they can bid.

We might require that each company should now have to show capacity to either contract gas before they are allowed to acquire generation assets. And then, government may be in a position to either guarantee in a better way gas supply, or provide bonds to deal with gas related shortfall in revenue. So, these are some of the models or things that we could have done better. On the whole, if you manage this process very well, and we are doing that, we might be happier that we took the short therapy.

It is a question of gradualism or short therapy. I think we took the short therapy. We put all fries into the flying pan. It saves time. It means that if we keep concentrated attention we will keep all our fries out. If you create a weak link in this value chain, it is possible that over time, the incentives for the discos to be efficient would have been less, because the generation companies owned by government would not have been able to absolve the inefficiency. And then that guides government back into the game in a way that is not good for overall economic development and undermines the whole idea of reforms.

You have been interacting with the chief executives of these assets for months now, what are the reoccurring problems that they are facing?

One of the strategic moves we have made was to have these monthly CEOs meeting. It does two things for us. One is that at the beginning of this market, there was some sense of fright and anxiety that could lead to a contagion. These meetings provide opportunity for the CEOs to open up. It is like a therapy. They come there, level all the allegations, weep and cry. At the end of the day, we are able to control everybody, give assurance, and then develop a collective approach to solving this problem. First of all, it is therapeutic, in terms of people opening up instead of running upstairs and downstairs and crisscrossing everywhere and pressurizing political leaders to make mistakes in terms of panicky interventions.

We have taken off that panicky intervention. We have created opportunity for them to sit together and raise problems and we try to solve those problems within a peer review and collective process.

The second issue is that it has given us the opportunity to put in some managerial regulations. So, the idea of a distance regulator who consults and then issues regulations is now modified. We now have quickly, hands on, close regulator who hears issues, retunes interventions, re-calibrates, and then essentially, self-regulation. So, people get to the table, they understand the problem and they pledge to do things that collectively helps to solve the problem by mitigating the impact.

It has helped us in a way to deal with those problems that require much more closer managerial attention. And in those meetings, the issues that cropped up often, as expected, were issues of how each of the utilities will be dealing with cash collection, financial viability, liquidity, grappling with change management. In this market, from the utility point of view, there are three critical things. For generating companies, they would be keen about gas shortage and how it would be affecting their production, how it would be affecting revenue from capacity payment, as well as energy charge.

For Discos, they are concerned about revenue shortage arising from shortage in the sale of gas, some revenue shortfall fall arising from fixed pricing that, in some sense, in their view, not aligned with Aggregate Technical and Commercial losses and the shifting fundamentals of the market.

The third issue, from the regulator’s point of view, is to benchmark these guys and pressure them on meeting quality of service requirement, even in the context of a constrained market environment, in the context of significant drop in electricity sale and other factors in revenue collection. These are the three basic issues that you see are arising in these meetings.

The issue of gas has remained reoccurring. In fact, in an interview with The Guardian, the late President Musa Yar’Adua, promised a state of emergency in the gas to power sector, but he never did. Do you share the view that a state of emergency in the gas sector could be the way out?

If a state of emergency means that there would comparative attention, there would be intensity, wrapping up of action in the execution of policies in the sector, of course, we need a state of emergency. But if it is a nomenclature for abuse of procedure, because one of the things that we should be careful in policy making is people using the guise of urgency to derogate from process, derogate from procedure, and critical safe guides and then overall you discover that the solution being bandied about, quick win that may be very expensive would actually compound the crisis.

For me, a state of emergency exists when we summon intensity, resources, everything is summoned urgently to address an issue, and then focus in that issue and take extra ordinary actions. So, a state of emergency would mean, perhaps, extra ordinary action, and for the gas sector, I think there is already need for that. I think somehow, the President, the Ministers involved, and all the stakeholders appreciate the need to flag gas as a priority. When I mean priority, I mean just one priority because the major urgency, the major structure issue for this sector, is mitigating the risks around gas, allowing the incentives in the gas sector to the electricity sector.

This is one of these things that our meetings with the CEOs give us. Recently, we had a meeting with gas suppliers, and for the first time, we closed down on identifying what their concerns are. If we really want to get this sector moving, we must align, we must create incentives to mitigate for fuel shortage. When you look at the underlining causes of the shortage, there are three majors. One is availability, limited availability arising from limited investment in the past in gas processing and infrastructure, and now, gas sabotage and vandalism.

People in gas have actually made the case that theft of oil correlates in the long time to shortage of gas, because becomes from the processing of oil. So, if there were thefts of oil in a sustainable and significant manner, it would affect available gas. You have to look at how then to look at availability in terms of ensuring sustainable investment for more gas, for gas infrastructure. That heats to the issue of pricing.

Now, we don’t think that price is the problem, because supply pricing to power is comparable to the pricing for alternatives. But, outside the framework, the real assurance of gas supply that we need, which we are addressing now, is to have a sense that willing buyer, willing seller framework would be all mandated and effectively applied by NERC. And we have said that the domestic methodology for gas as a pass through, is that is a benchmarked price for DSO pricing for those gas…that are really committed. There is also what we call Open Boom Pricing for gas, among others. So, if any contractor buys gas at a price that is prudently incurred, it will pass through. NERC, the regulator, will allow it pass through to consumers, as long as it is prudently incurred. I think, with that understanding, the issue of commercial incentive for sustainable investment in gas infrastructure and gas processing can be taken care off.

The other issue of gas supply that we are worried about is debt, mounting debts not paid. So, we are also working on ensuring that those debts are paid. And then confidence restored to gas suppliers that payment will be paid in the future. That means that we want to establish confidence in the market, in the electricity gas supplier, and the electricity producers such that they do know. That is based on the gas supply agreement that we are now working on to ensure that it is fair on all the parties, and enforceable, clearly enforceable. The process of gas supply is based on best endeavor. It is not good for power. It means that the supplier of gas will be at liberty not make very good effort to remove all constraints to the supply of gas. So, they could easily pull out whenever there is any small impediment to meeting their gas obligation to power. That is why we are focusing on contract.

The three things we are looking at are: first, allowing incentives for gas availability, looking at pricing and looking at debts, and that means looking at creating confidence on payments, structuring financial and contractual agreements that would give confidence that this sector will sustainably make payments and sustain investment in gas.

The critical thing is that we need to really understand that gas will undermine everything we are doing if it is not available. If we are talking about 75 to 80 per cent gas capacity as part of our energy portfolio, then we should place gas as top. But the answer to gas requires a lot of policy change in a sustainable manner. It requires political will at the highest level. It requires changing the structure of gas and of gas regulation substantively. For example, the interface between gas power generators and gas supplier is through the gas transporter. This is not good enough. There should be a straight dealing between gas suppliers so that when they don’t supply, they can be responsible. That would also allow the Power Purchase Agreement (PPA) that power generators signed with the Bulk Trader to be properly incentivized, because that means that if there are strategies arising from failure of gas, then the generator will be made good, and the generator is made good because there is an obligation on the gas supplier as well to supply gas. So, these are the some of the changes that are important.

Some of these new operators complain that government should have sold off to them, perhaps at a high shares level. For instance, government still retains 40 percent in the distribution companies and government is accused of not contributing to investments to expand network, among other requirements. Government is not co-investing. As a regulator, have you looked at such issue or have they complained to you?

They have not brought complaints so to say. But essentially, government’s stake is ideal now. I do know that the National Council on Power (NCP) and the VP are working to conclude the asset evaluation of states, allocate shares to states. At that stage, the states can engage the new owners, and two things can happen. Those shares are jointly owned by workers and the states. The ones that states have can now be used to engage the new owners in some kind of discussions around, maybe financing. The new owners can then ask them to cash back their stake. The states can also divest.

But we think more that the first divestment should go to institutional investors, like pension funds, and others, because they will have the incentives to also improve the governance framework of these utilities. Afterwards, they can be IPOs for public to buy. At this stage, the operators may be right to say that the government stake is not performing, in terms of either input in governance or financial support. But once the shares are well distributed to states, they can get to full involvement. Ultimately, when the shares are allocated to states the new owners can probably approach the states and have a clarity about who their partners are, and the new concomitant requirements would be made in terms of financing or corporate governance.

In the mean time, there was supposed to be an intervention fund which government was supposed to give as palliative?

Those ones are discretional funds that government dedicated being administered by the Central Bank of Nigeria. But those funds are not commitments made to the owners that they are going to have funds. The new owners had a Multi Year Tariff Order (MYTO). The MYTO is a governing instrument. They bided on MYTO as a major tool for recovering investment. Now, any other financial commitment by government could be two ways: general funds for the development of capacity like the aviation-power fund is to enable renewable power, micro grid and all kinds of things. These are macro financial support for the sector as a whole, to necessarily commitments government made to new owners to support financially.

Having said that, people are also looking at the liquidity issue and canvassing for some bond based intervention fund, but those have to be properly considered and targeted to deal with underlining causes, and ensure that they do not crowd out, as it were private sector investment. For example, if you look at the whole issue of the so called liquidity crisis, which is not a crisis really, the revenue gap in the industry arises from three major areas: the shortage of gas means that the energy generated will be less, and the expected revenue from sale of electricity will be less.

That has implication. If there is going to be intervention fund, that for us, should be dealing with shortage of fuel for power generation. So, government can put in that kind of funding to cushion the impact of revenue on generators. Who are no longer going to recover all their projected capacity cost. That is one. Two, there are problems arising from fixed charge, the tariff. Now, the assumption is that the tariff is not yet cost reflective. There is no certainty as to that. What we are doing, and to prove that the tariff is not that cost reflective, we have asked that the new owners present their technical aggregate commercial collection losses study and we verify. After that verification, we have issued a timeline for consultations and consequential actions to review the revenue requirements of the industry. That simply means that if, because of the assumptions in the tariff methodology losses are now higher, then it follows that the consequence will be that the regulator would try to re-fix the tariff to respond to the reality of the market.

We do that within some constraints. The other component of it is that if the revenue shortage is arising from their own failure, what they fail to do in terms or reducing their losses, maybe lack of metering, aggressive metering, lack of investment in the network to ensure that they are able to serve their customer and receive their money, inability or failure of change management to ensure that power theft and all that doesn’t happen. Those ones are not going to be mitigated by public sector funding intervention. That means that we cannot reward inefficiency by giving public money. Any intervention that government is going to do must be targeted at addressing underlining causes. So, those causes that arise, that are attributed to inefficiency or the fault of the operators would not, should not be indemnified by government financial support.

But those faults that are extraneous, that are not related to their own faults, like shortage in gas, project management slippages in the gas sector have to be mitigated by some forms of financial support either in terms of bond, or subsidy or other instruments. Essentially, the design the regulator would prefer is one that incentivizes the operators to be efficient, but same time protects them against regulatory failure, budget failure that belongs to government and not their own.

What do you made of the impression that the sector is heading to a full crisis because of the seeming liquidity issues?

There is a scenario being painted by some self-acclaimed experts in the sector about the future of electricity reforms in the country. I want to say that the people are doing some kind of amateurish strategic thinking around the sector. It is a typical case of thinking crises. The sector is very good, as far as I am concerned.

The regulatory system is stronger. The utilities themselves have issues, and they do acknowledge that. But they are also learning fast to deal with those issues. They are learning if any one had come to this sector with a certain preconceived notion or asset striping or perception of windfall profit, they now know that they are in a regulated market. Meaning that they returns are regulated, and that therefore, the only way they can improve their revenue and profit is by increasing their efficiency and doing more.

For the distribution companies, for example, who hold the purse of the sector, they are learning fast. They are learning that they need to reduce their losses quickly, they need to sell power and they need to collect their money and make remittances. The most urgent one to do in the sector is ‘ software’, if you like, creating new understanding, new perspective. Fro. That premise, I want to say that the idea of an illiquid sector is exaggerated. There is obviously an issue around the revenue gap, but we cannot behave as if it is unanticipated. That is why NERC developed an interim rule.

We had predicted, we know that the morning after handovers, for some months, there would be shortfalls. Those shortfalls would arise as consequence of many factors, one of which is the factor that the projected electricity sale in MYTO is now far behind because of problem with gas supply, vandalism of gas pipeline. The other is the possibility that the tariff that has been set for them as a means of recovering their investment may not be all that totally cost effective, meaning that in some areas, if the tariff has been benchmarked a certain available capacity, and that capacity didn’t happen, it means that there should be automatic adjustment. They should be adjusted to reflect the actual capacity. That itself will consist of some degree of revenue gap.

So, we had known how this would turn out. The interim rule had provided a mechanism to look at how to incentivize the utilities to close those gaps that are attributable to their own, that requires low investment from their part and their own change management strategies, and then provide mitigation strategies in terms of financing, maybe public financial interventions for those risks and underling causes that lie thoroughly outside their control. That would be for example, government finances, maybe bond, to cover for shortage of gas so that these generation companies can be made good on the gas aspects of it.

These are some of the issues for which we can now do strategic analysis. But to say, or to take the story round that the sector is illiquid is thoroughly false, and to exaggerate the problem of liquidity is also too bad. In other markets in the world, it is necessary. If you look elsewhere: India, Chile, Argentina, Uruguay, and other places where this kind of reform has happened, you will realize that there is significant shortfall for a period of time.

The most important thing is the exit strategy. How do you discount, how do you create confidence in the market and allow those shortfalls to translate to legal and financial commitments and which will allow those companies involved to continue to do business, and over come those debts? That is really the focus. And therefore, it is false to suggest that there is a degree of serious financial illiquidity that would threaten confidence in the reform.

Looking at the local content policy that you are finalizing, what would it cover when you compare it with that of the petroleum industry?

The local content regulation has been passed, but the methodology has not fully taken off. But it presupposes some kind of coordination committee that would be drawn from the industry that would be responsible for assessing and updating on the framework that would be required. Essentially, it looks at localization from three points. One is employment, and you can see that the new entities, even after sales, have almost all Nigerian Chief Executive Officers. The major chieftains are Nigerians. At the level of employment, localization has happened automatically. At the level of technology, with our meter certification, and all that, we have also licensed many Nigerian meter manufacturers and installers. We want to see a gradual transfer of technology to Nigerian companies. We are giving assurance to Nigerian companies that we will, without violating Nigeria’s commitment to free trade or restricting our commitment to free investment in the sector, we will try as much as possible to provide incentives for localization of technology.

The other in-services: auditors, lawyers, and all kinds of professionals, have a disproportionate impact on the works economy. This is going to be a huge market. And the implication is that if Nigerian professionals, competent professionals play in this market, then they we capturing more values. We are looking at the value addition competent of it, and we believe that we should start making headway.

We have learnt from the petroleum sector where we started very late with local content and we have seen the massive gain that we have achieved within a short period of implementing local content regulation. We believe that borrowing from there, we are doing well on creation day. The implication is that this industry will evolve and the heart of it would be localization of employment, technology and services.
*Emeka Anuforo – Guardian

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