Electricity tariff: A day after another devaluation

Absence of cost-reflective tariff has been one of the banes of the Nigerian electricity supply industry and this is the reason why the recent pronouncement of the new minister of power (MoP) offers some ray of hope. But as the naira exchange rate continues on its downward path at the parallel market without an end in sight, one is compelled to ask a fundamental question that may not have been sufficiently broached in policy discourse: what will happen to electricity tariff and the entire electricity sector if the government and the Central Bank of Nigeria (CBN) give effect to the sliding value of the naira and decide to converge the official and parallel market rates? Investors in the electricity sector are not unlikely to request for an upward review of tariff that is consistent with rising cost profile. We may then see proposals for tariff in the region of N100 per kilowatt, possibly more, in an environment where purchasing power may have been severely eroded by weak domestic currency and its inflationary impact. This question is worthy of interrogation because of the central role that exchange rate plays in tariff setting, and informedly, with the Argentine electricity crisis of 2001/2002 in rear view. I will suggest that our policy makers study the economic and currency crisis in Argentina and its net effect on the country’s electricity sector in order to craft appropriate mitigating strategies because the unfolding events in Nigeria bear some semblance to what happened in Argentina at the time.

The role of exchange rate in electricity tariff is better understood in the context of the provision in the Multi-Year Tariff Order (MYTO) which identifies four triggers as requirements for bi-annual review (either upwards or downwards) of electricity tariff to reflect prevailing economic realities. The four triggers are exchange rate, gas price, inflation and generation capacity. Given that exchange rate is an omnibus or a “grandfather” variable amongst the other variables earlier mentioned, a significant change in exchange rate will impact negatively on the others and, of course, electricity tariff. In clear terms, if and when there is a change in exchange rate, the other variables are likely to head in one direction. A significantly devalued naira will not only trigger an upward spike in naira equivalent of dollar-denominated gas price but will equally exert pressure on inflationary index and generation capacity.

To put the likely impact of devaluation in perspective, should the official exchange rate converge at today’s interbank rate of N267/US$1 and assuming an average annual CapEx requirement of US$700 million for infrastructure upgrade at the transmission and distribution segment of the electricity value chain, additional cost burden to operators as a result of exchange rate movement is estimated at over N50 billion per annum. Also, because gas price is dollar-denominated, the incremental naira cover required to meet gas obligations by electricity generation companies (or Gencos) is at least N56 billion per annum using an average gas consumption quantity of 840 mmscf per day and based on a paltry annual sent-out capacity from gas-fired generators of 30,660GWh. This amount will easily double if electricity generation increases to 61,320GWh or 7,000MW. Consequently, combined incremental annual impact is projected to exceed N100 billion per annum even without considering additional cost burden of dollar CapEx spend by Gencos, existing legacy debt and outstanding obligations during and after the interim period. Who will bear these costs if the naira is officially devalued?

It is good to know that government is, at last, willing to consider a cost-reflective tariff aimed at incentivizing investment for improved industry performance and overall social gains. But my fear is that another review that is not implementable may be imminent in view of uncertainties surrounding naira value. It is therefore worthwhile to examine the range of options available to the regulator if the worst happens. Perhaps market forces will be allowed to prevail with “automatic” adjustment to tariff under a full cost pass-through but this may not be tenable if the purchasing power of most consumers is severely weakened. Government may choose to freeze tariff (exactly what Argentina did) but for how long and with equally disastrous consequences. Maybe some form of subsidy could be introduced at the upstream level to cushion the impact of rate shock on consumers. On this, government clearly lacks the capacity for and is indeed wary of another “subsidy disco or reggae” in view of the current fiscal crunch and subsidy abuse. At the end of the day, even the marginal gains recorded so far in the sector may be lost.

Weighing these scenarios and their consequences on various stakeholders is one area where the loyalty of the regulator and the minister of power will be put to test. As a regulator especially in a sector like electricity, “may our loyalty not be tested” is a supplication that is not likely to be answered even by the most benevolent Supreme Being because it will surely be put to test, one way or the other. The regulator is always in search of that almost elusive and delicate balance that seeks to align the interest of various stakeholders. The unfolding economic situation in Nigeria and its probable impact on the electricity sector calls for close watch and proactive strategies.

I saw this coming. After a detailed study of the macroeconomic outlook in Nigeria and drawing on the experiences of other countries, I wrote, sometime last year, in one of my articles titled “Price and prize of privatized power plants in Nigeria”, on the urgent need for lenders and new investors in privatized electricity assets to convert their acquisition facilities, procured in dollar, to naira. Perhaps because the advice was offered pro bono and just like the “water-diamond paradox”, it appeared the message did not strike a chord with those concerned. Perhaps some felt the risk profiling was overstretched but today’s economic realities in the country have clearly shown that “abundantia cautela non nocet” (abundance of caution does not harm).

In that article, I posited – “Consequently, lenders and borrowers in the Nigerian power sector may need to re-assess their risks and possibly convert a substantial part of the dollar-denominated loans to local currency loans since industry cash flow is denominated in naira anyway. Is this exchange rate scenario far-flung? Perhaps, but not without precedent – macro-economic crisis in Argentina did lead to  about 70 percent collapse of the peso in 2001/02 which subsequently triggered electricity tariff freeze and the resulting crisis in the power sector.” Today, the Nigerian economy is not only contending with exchange rate volatility but dollar illiquidity is even a harder nut to crack. As at the time of writing this article, the naira has effectively depreciated by about 70 percent.

I concluded that write-up with a warning shot – “Though we may dwell on the argument that economic structures and relations differ and therefore such an exchange movement as witnessed in Argentina is highly unlikely to replicate itself in this environment, it is nonetheless probable. That there is no absolute certainty in foresight is an unimpaired truth but the consequences for not appropriating the benefit of hindsight has the capacity to fatally incapacitate.”

Glenn Ubohmhe