Nigeria: Nigeria's Power Privatisation Reaches Final Act

Last Updated: 21 February 2014
Article by Sola Arifayan and Chukwbuike Onwuzurumba

The privatisiation process, initiated in 1999 and reaching a definitive milestone in 2013, has been one of the most talked about developments and investment opportunities in the region. In placing all power generation and distribution infrastructure in private sector hands, the reforms hope to completely reshape the industry. Sola and Chukwubuike discuss the process, its success so far, remaining risks and what it might mean for Nigeria's diesel and petrol generator-dependent economy.

When did you begin working on power sector laws and regulations and how has your practice developed since then?

I started in 2000 with Arthur Andersen. Arthur Andersen was part of a group that was engaged by the government to do the work that resulted in the passage of the Electric Power Sector Reform Act (2005). I joined when that bit of work was running from 2000-02 and the Act was drafted as part of that exercise, although it did not get passed until March 2005.

By mid-2005, the Bureau of Public Enterprises (BPE), the entity largely responsible for driving the reforms, felt a need to fast track the reforms provided for in the Act. I think the background to that was that the end of the administration of former president Olusegun Obasanjo was approaching and BPE was under some pressure to implement the Act. This resulted in the legal work for the corporate restructuring of the PHCN (Power Holding Company of Nigeria), the legal drafting of the market rules for the sector (based on a draft prepared by BPE's market design consultant) and the legal work for the transfer of the assets of the PHCN. I led the engagement while at my former firm. This also led to my serving on a committee set up by the then Minister of Power and Steel to coordinate the initiation of the Transitional Stage of the competitive market in the NESI. I went into partnership at Ikeyi & Arifayan in February 2007 and I have since spent about 50% of my time doing legal work in the sector, advising various parties on sector rules and regulations, as well as contractual and other legal matters.

What's your evaluation of the power sector privatisation process so far? What stage is it at, has it achieved what you hoped it would?

I am somewhat surprised by how well the transactions have turned out. Starting in 2011, the government of Nigeria has been trying to privatise its entire power sector infrastructure apart from the transmission system, which is going to remain owned by the government through the Transmission Company of Nigeria Plc (TCN). Transmission here is defined as the conveyance of electricity at voltage levels equal to or more than 132kV. All assets for the generation and distribution of power below 132kV and delivery to customers are being privatised to strategic investors through a sale of majority shareholding. Nigeria's three hydroelectric dams are being concessioned.

Over the last year and a half the government has gone through the process of privatising, essentially offering up for sale as separate companies entities in the power sector that up to this date have operated as a single, integrated company. Although the successor companies that are being privatised were all registered in November 2005, they continued to operate as one "PHCN". The arrangements stipulated in the Market Rules for a shadow market were never implemented. It is not clear that the commercial and communication infrastructure required for these entities to operate independently in a functional power market are in place or have been adequately tested. Potential investors have raised many issues about the transactions and industry contracts and many of these issues remain unresolved. Yet on the February 21 2013, winning bidders for virtually all the companies offered for privatisation paid the initial 25% of the consideration. I find it surprising – if you had asked me three years ago if it was possible to privatise the system so quickly, I would have said no, we are not ready.

Hopefully the system will be able to accommodate the inevitable shock that will come from the transition from a vertically and geographically integrated monopoly to a sector with multiple players across various aspects of the value chain.

What measures did the government take to provide security to investors and incentivise bidders?

There are two aspects to that. On incentives, investments in power utilities attract what in Nigeria is called 'pioneer status'. This is a tax holiday for the first three years of a company commencing business renewable for up to five years. What that means is that essentially there should be no taxes to be paid by those companies for the first five years, including dividends paid out to shareholders. There are also other fiscal incentives for gas-fired generation and tax and duty exemptions for downstream gas-to-power generation.

Beyond the incentives, the government also tried to put together a credit support or risk mitigation package, particularly for IPPs and power generation companies. The government set up the Nigerian Bulk Electricity Trading Company Plc (NBET) to purchase power generated by the privatised generation companies, what we call the 'Gencos', as well as IPPs. NBET will buy power from the generation companies and sell to the distribution companies (Discos). Government has made efforts to mitigate risk of payment defaults (by NBET and Discos) by arranging for a Partial Risk Guarantee (PRG) with the World Bank. The initial plan was for the PRG package to be ready and in place for the privatisation. I am not aware of any company or investor for which the PRG is in place at this time and investors have been told to approach the World Bank and negotiate PRG's directly. The process is likely to take about 18 months at the minimum.

What are the issues that private investors in the power sector or in any other project might run into?

Generally, if you are developing a new project or for the privatised entities, you are expanding capacity (and this applies to other energy investments) then you have to get the relevant regulators to approve your investment programme or issue the necessary permits. As expected, bureaucracy can get in the way. Regarding the power sector, NERC's processes have improved significantly but we still find that the licensing process may take more than the six month statutory limit. The regulator's view of this is that most delays are attributable to incomplete or deficient documentation by applicants.

Beyond that, when we come to the power sector specifically, I think, and let me be colloquial, that the elephant in the room that hasn't been addressed is transmission. Right now, we have less than 4,000MW of power on the national grid system and everybody agrees that that's way too small for the power needs of Nigeria. The government is currently in the process of completing ten power plants, comprising what is called the National Integrated Power Projects (NIPP). Those ten power plants have a cumulative capacity of about 4,770MW. Add to that the various Greenfield IPPs (independent power producers) being promoted as well as brownfield expansion of newly privatised plants and we are going to see generation almost triple over the next few years. On the distribution side also we are seeing private investors coming in to ensure that the power delivered into the distribution system is delivered to the consumer, but what of the transmission system that remains owned by the government of Nigeria? The Roadmap for Power Sector Reform issued by government in 2010 indicated that transmission capacity just about matched existing generating capacity. Right now, we're about to see anything from double to triple generation capacity through the system. So my view is that this is one key risk factor in the industry.

We've already mentioned the credit enhancement for investment in the sector on the generation side. There is a lot of uncertainty as to how it will work. And then there is the issue of fuel for power generation. Most of Nigeria's power generation capacity is natural gas based. There's been some talk about more hydropower plants (government has actually recently contracted for the 750MW Zungeru Power Plant) and also there are one or two coal-fired power plants that have been discussed, but by far the majority of new power generation is gas based. While Nigeria is a very gas rich territory – we have the eighth biggest reserves of natural gas in the world – not a lot of work has been done to develop the gas fields, particularly for domestic use. The petroleum companies are refusing to sign gas sale agreements with a term that exceeds ten years. The argument is that if they are going to sign gas supply agreements for longer than ten years, they need to take investment decisions as regards drilling, exploring and exploiting of additional fields. Many IOCs are not making such assurances because of all the uncertainty relating to the passage or non-passage of the Petroleum Industry Bill (PIB) that is meant to reform the petroleum sector.

Is there any indication on when the PIB might be passed?

Last year the new executive bill was introduced and that appears to have been making its way through the National Assembly, slowly. If we go by what we hear from government it does look to me as if there is an indication that it will actually be passed into law sometime over the next few months. But it has been that imminent in the past.

[Chukwubuike]: Yes, and I think what you find now is that it appears to be getting even more complicated because of what you might call a north-south divide right now in the National Assembly as far as the PIB is concerned. It appears that opposition to the bill is coming from the northern part of Nigeria and that may well be a major issue, given the balance of the Nigerian political system.

Is there any room for renewable energy in power generation?

It's not a question that's easy to answer. First, regarding hydro, it is renewable energy but it's so conventional that very often when we think of renewables we don't think of hydro. The good thing about hydro that I would mention is that right now about a quarter to a third of Nigeria's power comes from the three large hydro plants. Government is building another large plant and is talking about numerous small hydro plants.

Beyond hydro, we could look at wind and then solar which have generated some discussion in Nigeria. The problem is that there is no special tariff or regulatory framework for such renewables in Nigeria. The regulator, NERC, has a unit responsible for renewables, but it does not appear very active. We have not seen a major move towards creating a space for renewables. About two years ago, the regulator licensed a (5MW) solar plant in a northern state in Nigeria but I'm not quite sure how that project has gone... the sense we get is that NERC is more concerned now about getting some stability into the system before focusing on renewables. Around 2000, the government engaged a German firm, Lahmeyer, to undertake wind mapping and preliminary studies across Nigeria to determine optimal locations for wind generation projects. But as we speak there is no special regime that has been put in place to ensure those projects get developed and right now everyone is focused on getting the system stabilised through conventional projects.

Why is reform of the power sector so important to the Nigerian economy?

Nigeria's per capita consumption of electricity is one of the lowest in Africa. Industrialisation is impossible without power. We're not quite sure how any significant economic activity can take place in an organised manner without proper supply of electricity. Most businesses run on petrol or diesel generators, which is not efficient for the economy. Between 1979, when the most recent power plants were built, and the year 2000, when the AES Barge Project in Lagos was started, there wasn't any significant investment in power infrastructure in Nigeria. Our population has almost doubled in that period. Even the existing systems weren't properly maintained.

An example I can give is in a different industry: telecommunications. In the early 1980s through to the 1990s if you wanted a telephone line you applied and queued up at the national monopoly provider, but in 1999-2000 we liberalised the system and now Nigeria is probably the largest telecoms market in Africa. We are going to see this kind of explosion in power but it will be in a different way, because the fundamentals are different. We are already beginning to see a lot of innovation. Now we are seeing innovation in terms of small decentralised plants that take gas and deliver power literally next door. So I think that without a doubt the sector could grow in a tremendous way and I think there is sufficient space for that growth.

[Chukwubuike]: And similar to what you had in telecoms, beyond the evolution that you see in the sector itself there will also be in the future some kind of spill-over effect, if you like, in professional services, even in all kinds of support businesses. The potential is great.

On your website you mention that you provide "innovative practical solutions". Could you elaborate on what that means in the Nigerian context?

There are two aspects to that – one is that we do more than just pick up the law and read it. Because of our knowledge of the industries in which we practice, we're able to find solutions that fit within the law but also push the envelope to accommodate the peculiar circumstances of the client. We're also able to hold the conversations that are needed to clarify legal and regulatory uncertainties in new areas. Because of our multidisciplinary backgrounds and practical knowledge of what regulators and other counterparts think, we are able to innovate and to help design new structures beyond traditional ways of thinking.

And what is the main piece of advice you would give to prospective investor in the power sector or in any other sector?

I think it is similar to what we would say to anyone looking to invest in Nigeria generally, you need to do a rigorous due diligence of the asset you are looking to invest in as well as of your partners. It goes without saying that you have to understand the sector and the rules that guide it and more importantly understand the asset you are investing in and understand the people you are looking to partner with locally to make the investment. For a power generation project you need to be sure of the source and the reliability of gas supply and related to that issue, that you are sourcing gas in a manner that allows you to enjoy the optimal price for power generation. It also goes without saying that you need to look at your funding sources and confirm that with your technology and the pricing that the economics of your transaction works. So essentially, look before you leap and do as much due diligence as possible on your asset and on your partners.

Previously published by IFLR.com

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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