Trade is the lifeblood of any industry. It plays the all-important role of price discovery and setting and provides liquidity to an industry.
In a decentralised system, traders reap the benefits for their understanding of the market, but at other times, they run losses due to miscalculations or unforeseen circumstances. For instance, a trader in the reformed petroleum market decides to import a cargo of a certain amount of Premium Motor Spirit (PMS) (in Metric Tonnes) from a refinery in Vizcaya, Spain bound for Apapa port at an Expected Open Market Price of NGN140/litre. While the product is still en route, the Petroleum Products Pricing Regulatory Agency (PPPRA) increases the indicative price to NGN156/litre. This price change would mean a trading surplus of N16/litre of PMS.
Trading in Nigeria’s electricity market is not as decentralised or standardised as the refined petroleum market. The recent decentralisation in Nigeria’s refined petroleum market has enabled better price discovery, more efficient resource allocation and specialisation of skillsets amongst transporters, storage companies, finance houses and traders.
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Trading Backbones
The entire electricity market in Nigeria operates through custom-made ‘forward’ contracts system determined by power purchase agreements and vesting contracts. These agreements serve as designated contractual trading points on the nation’s electricity unfractured network, where there is a transference of ownership risks and payments obligations from one counterparty to another. So, a typical generation company (GenCo) Power Purchase Agreement (PPA) is 20 years and is agreed to in advance with specific obligations and covenants by the GenCo and the Nigeria Bulk Electricity Trader (NBET), otherwise known as the ‘Bulk Trader’. Similarly, distribution companies (DisCos) enter into agreements with NBET to purchase power through vesting contracts. The vesting contract is a documented agreement between the Bulk Trader and the DisCo, which authorises the DisCo to purchase electricity from the bulk trader. These vesting contracts have a lifespan up to the year of assessment of their performance agreements with the Bureau of Public Enterprises.
The Trade Chain
In the forward contracts system, a licensed DisCo nominates the quantity of electricity it requires a day ahead from the Bulk Trader, through a vesting contract. NBET, in turn, aggregates its nominations from the 11 Discos and nominates its quantity of electricity required through its Power Purchase Agreements (PPAs) with GenCos. The GenCos, in turn, nominate their desired level of gas supply to produce the required amount of energy through their Gas Supply Agreements with their fuel suppliers. The ideal contractual flow from downstream to upstream allows for occasional deviations. For instance, hydropower electricity generators do not have to enter into such agreements with a fuel supplier, since they do not purchase fuel.
On delivery day, the supplier channels gas through pipelines controlled by a gas transporter to the GenCo’s power plant. The GenCo combusts the gas to generate electricity and transmits to The Independent System Operator. The ISO ‘wheels’ or transmits this electricity through transmission lines to substations, where the power is stepped down to the DisCo’s voltage before supply to homes and businesses.
Until recently, the concept and process of electricity trade through contracts in Nigeria was restricted to the value chain from gas producers to the DisCos. However, for the first time and with the implementation of the service-based tariff model, customers are involved in a month-by-month futures contract. In the new tariff model, the DisCo pays liquidated damages through a reduced tariff if it fails to provide the minimum hours of supply agreed with a particular customer band. For purposes of this call to action, the focus will be on DisCos in consideration of the next stage of Nigeria’s electricity market.
A Proposal for Improving Trading
Something Stimulating at Magodo
Since privatisation, service-based tariffs have defined the upstream of Nigeria’s energy market through the contractually obligated purchase of natural gas and electricity. This obligation between parties comes with attendant liquidated damages for failure to deliver or offtake contractual quantities.
In 2019, Ikeja DisCo pioneered a previously unheard-of experiment for any of the 11 Distribution companies. Ikeja DisCo agreed with an entire resident’s association to provide a guaranteed minimum supply of 20-hours-a-day. After months of negotiations, the Magodo Residents Association formally approved a PPA with Ikeja DisCo. This agreement contained liquidated damages payable by Ikeja DisCo in the event the resident’s association receives less than 20hrs of daily power supply in any given month.
Ikeja DisCo can meet its commitment to Magodo because it established a bilateral agreement with Egbin Power to purchase electricity generated by its 6th turbine, which is not under contract to supply the national grid. Ikeja Disco consequently resells this power to Magodo at about NGN51 per kilowatt-hour. A key requirement of the agreement was the metering of every single house within the estate.
The true stress test of the agreement will present itself in two situations; aggressive devaluation of the naira forcing an explosive pass-through effect of natural gas prices in dollars. The second aspect will present itself at the point there is a contractual dispute to be resolved which will test the dispute resolution mechanisms instituted in the agreement. The success of such innovation was adopted by the Nigerian Electricity Regulatory Commission as a standard across all Discos through the new service-based tariffs according to customer bands.
Scaling What Works
But why stop there? Why should only one estate have 20 hours constant supply of 3electricity through a contracted service-based tariff?
Individual homes would have to aggregate into larger customers to replicate the Magodo model. This scheme is only viable with customers within well-demarcated, contiguous geographies. E.g., It is not possible to isolate the quality of service provided to a customer in Jalingo and a customer in Twon-Brass just because they are in the same customer pool.
A core barrier to having more players in the market is the demanding requirements to obtain a trading license; however, communities can merge with other estates and resident associations to obtain such. With more traders in the market, DisCos should be willing to auction capacity each year to its customers and other traders in the market. Each community will automatically have a strong incentive to grow its customer base because the larger its reach, the more ability it has to negotiate lower tariffs. The agreeing parties would set up a feasible dispute resolution system to handle and resolve issues. Infracredit or other infrastructure companies could provide a credit enhancement instrument for investors who wish to lease the income stream.
The DisCo’s role, therefore, transforms from one of selling units to managing portfolio of contracts with customers, clearing trades between counterparties and enforcing penalties. DisCos have always had more value as a clearinghouse for agreements and transactions because there is no other market entity with as much experience in the distribution costs for electricity.
How Do We Get There?
The market operator will need to revisit the requirements for becoming a market participant. Such a review should specifically recognise smaller entities with lower capital threshold requirements; something similar to the eligible customer policy.
Standardisation of PPAs is also essential. Standardising PPAs reduces the learning curve and switching costs involved in DisCo-community bilateral trading process. Standardisation provides a reference point for expectations between the parties.
Conclusion
The Nigerian Electricity Supply Industry has achieved some gains through market-based reforms amidst a turbulent business operating environment. At the downstream end, the lessons learnt from the pioneering agreement between Ikeja Disco and Magodo Residents Association encourage further decentralisation of the market. DisCos should focus on their comparative advantage in the provision of infrastructure and settlement of electricity transactions, and outsource other functions like loss reduction in collections and tariff negotiations to licensed independent traders.
