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Cost-reflective tariff in the Nigerian electricity supply industry (NESI)

One of the major responsibilities of the Nigerian Electricity Regulatory Commission (“NERC” or the “Commission”) is to ensure that the tariff charged by the licensees are fair and sufficient to finance their operations while still making reasonable profits from running efficient operations by Section 32 of the Electric Power Sector Reforms Act 2015 (“EPSRA”)

To achieve the above, the EPSRA further requires the tariff to be regulated according to one or more methodologies adopted by the Commission. In line with this, the NERC developed a methodology to be used via a Tariff Order known as the Multi-Year Tariff Order. The MYTO is a tool for setting cost-reflective tariffs which will enable improved funding and functioning of the power sector by providing a tariff path with minor reviews two times within a year on parameters that include generation capacity, inflation, gas prices, and exchange rates. In the event that the minor review reveals a change of +/- 5% (in any of these parameters) from values initially projected in the tariff setting, then a corresponding adjustment to tariffs will be applied.

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MYTO is required to be cost-reflective, meaning, expected to cover costs arising through all the power value chain from generation transmission and through to distribution. Examples of these costs include the cost of investing in the capacity to generate electricity, cost of using the transmission system, NERC’s cost of regulating the Industry, the Market Operator’s cost of administering the Market, costs incurred by the Distribution Company (DisCo) in upgrading its network etc.

The MYTO is also expected to undergo major reviews once every five (5) years The MYTO 2015 used in setting industry tariffs was based on assumptions that were far from reality and has become more unrealistic as generation levels drop. The macro-economic indices have significantly risen from what used to be, but no review has been done which has made the allowable revenue of DisCos fall far short of what it should be in reality thereby creating a huge Tariff shortfall. Tariff Shortfall is the deficit arising from what DisCos should have ordinarily charged to cover their costs and what they are mandated to charge.

The above notwithstanding, the wholesale cost of power which the Generation Companies (GenCo)charge the DisCos has increased and have been reflecting in the monthly bills forwarded to DisCos while the DisCos retail tariff remains the same. This has made it difficult for DisCos to pay the Nigerian Bulk Electricity Trading Company (NBET) and the GenCos their bill in full as DisCos’ collections do not cover the increased cost thereby occasioning what is referred to as Market Shortfall.

 

Differences in MYTO Tariff Assumption (Forecast vs Reality)

PARAMETER MYTO Projection Reality as of December 2019
Generation Capacity (MW) 5,465 4,952
Nigerian Inflation Rate (%) 8.8 11.98
US inflation rate (%) 0.20 2.3
Exchange rate (₦/$) 198.97 307
Generation Price (₦) 13.25 19

 

The above had since made it difficult for DisCos to fulfil so many of their obligations towards the improvement of the Industry including upgrading their network (whether by rehabilitating, repairing or replacing dilapidated assets), providing Meters to customers for accurate reading of their electricity consumption, procuring additional generation capacity off-grid, etc.

Addressing the Anomaly – Market Reset

In 2017, the Federal Government of Nigeria, through the Ministry of Budget and National Planning, launched the Economic Recovery and Growth Plan 2017-2020 (ERGP) to set out medium-term reforms to diversify the Nigerian economy. Following the ERGP, the Federal Government in collaboration with the World Bank Group created and launched the Power Sector Recovery Program (PSRP) to restore the financial viability of Nigeria’s power sector, improve the sector’s institutional framework, increase transparency, encourage investor confidence in the sector and generally reset the NESI for future growth.

A component of the PSRP provides for a market reset including tariff review process which entails two (2) phases comprising a Minor review of the MYTO to reflect changes in the economy and Extraordinary tariff review.

2016- 2018 Minor Review of the MYTO 2015 and Minimum Remittance Order of the Year 2019 

Pursuant to the above, on 19 August 2019, NERC came up with the Minor Review of the MYTO 2015 and Minimum Remittance Order for the Year 2019 for the 11 DisCos in Nigeria (2016-2018 Order).

The major goals of the 2016-2018 Order are, succinctly, to address the past revenue shortfall and develop a framework to manage and prevent future shortfalls.

This specific Order determined the tariff shortfall and market shortfall by taking into consideration the actual changes in the macroeconomic variables and available generation capacities from 1 January 2016 to 31 December 2018.  The Order further made projections for 2019 and beyond with a commitment to adjust same to reflect actual values at the time of the review which will take effect on 1 January 2020.

The 2016-2018 Order obtained data from relevant Government Websites and reflected the following values:

S/N Variables 2016 2017 2018
1. Inflation 15.6% 16.5% 12.1%
2. Exchange Rate N255.90 N308.80 N309.14
3. Gas Price US$2.50/MMBTU
4. Gas Transportation US$0.80/MMBTU

 

Further, the Aggregate Technical Commercial and Collection(ATC&C) Loss reduction trajectory are to be considered in the computation of the tariff, however, the Commission decided to leave this component out of the computation of tariff for years 2017 and 2018 because in its view, parties to the Performance Agreement (which sets out Loss Reduction targets) have all defaulted. Therefore, the years 2017 and 2018 were declared years of mutual non-performance to account for uncertainties on cost-reflective tariffs and revenue recovery.

The above indices were used to calculate the tariff shortfall during the extant years and the following summarises the Order:

The Tariff shortfall was used to determine how much of the NBET and Market Operator’s bills can be paid by the DisCo. Consequently, each DisCo was mandated to pay MO bill in full and given a percentage of the NBET’s invoice that should be paid based on consideration of parameters peculiar to each.

The remainder of the NBET’s bill caused by the tariff shortfall is expected to be moved off DisCo’s financial books and settled by the Federal Government in line with the financing plans stated in the PSRP. All such interest that has accrued on the remainder shall also be moved from the balance sheet of the DisCos.

According to the PSRP, the Government has included in the 2018-2020 Medium Term Expenditure Framework and Fiscal Strategy Paper approved by the National Assembly in December 2017, an estimated funding requirement for a total of N1,934billion/US$6.34billion for the period of 2017-2021 to cover the revenue shortfall for 2017-2021, clear historic revenue deficit in the Power Sector, and service the debt payments from the CBN Payment Assurance Facility during the period.

The funds are to be from a short term bridge financing from the CBN known as the Payment Assurance Facility to help NBET meet its financial obligations towards GenCos by covering the cost for energy produced and received, World Bank Performance-Based Loan and Federal Government Budgetary contribution to the Power Sector.

Where the tariff shortfall exceeds the Market shortfall, the DisCo will be compensated, but where the Market shortfall exceeds the tariff shortfall, i.e. where there is more money owed to Stakeholders which is not as a result of non-cost reflective tariff, such outstanding will be the responsibility of the DisCo to discharge together with any such outstanding that would have accrued on the amount.

 

2019 Minor review of MYTO 2015 and Minimum Remittance Order for the Year 2020 (2019 Minor Review

Further to the commitment to review the 2019 projections to reflect actual values as stated above, NERC issued the 2019 Minor Review to reflect actual values of 2019 and manage revenue shortfalls for the year 2020. The Order stipulates that same shall supersede previous Orders on the subject matter, hence all projections relating to 2019 contained in the 2016-2018 Order were replaced by the 2019 Order.

The following are the values considered as actual for 2019 and projected for 2020:

S/N Variables 2019 2020
1. Inflation 11.3% 11.3%
2. US Inflation 1.8% 2.1%
3. Exchange Rate N310 N310

 

Similar to the 2016-2018 Order, the above values were used to determine the Tariff and Market shortfalls for the extant years and again, the minimum remittance to be made to the Market Operator and the NBET.

Order on the Transitional Accounting Treatment of Tariff Related Liabilities in the Financial Records of Participants in the Nigerian Electricity Supply Industry (Transitional Order)

On 28 January 2020, the Commission issued this Transitional Order to clarify how the tariff-related liabilities in the 2019 Order are to be treated in the books of the DisCos and ensuring no future tariff-related liabilities accrue on the financial books of the DisCos for the purpose of ensuring a healthy financial book that attracts future financing.

Unlike the liabilities under the 2016-2018 that are immediately moved off the DisCos’ financial books,  under the Transitional Order, the remainder of NBET bills caused by tariff shortfall calculated under the 2019 Order are to be left on the DisCo’s books temporarily until same is paid to GenCos by NBET from the sources of finance under the PSRP, especially the Payment Assurance Facility.

Implication of the Orders

  • The Orders do not amount to an automatic increment of tariff
  • According to the 2019 Order, there will be no increment earlier than April 2020 and such increment would still not be the actual cost-reflective tariff
  • Government is allowing a transition period up to the end of 2021 (Transition Period) when the actual cost-reflective tariff will be fully implemented.

The above Orders no doubt are indeed a breath of fresh air and anticipation towards a better NESI which will ease the illiquidity within the Sector and place the DisCos in better credit standing that could attract capital raise either from investors or financier. However, as laudable as they are, there is a potentially tricky issue that may undermine the aim of the above Orders towards the reset of the Market which is the accuracy of the variables considered in determining each DisCo’s Tariff and Market Shortfalls.

Taking the Exchange Rate value, for instance, the CBN rates were adopted albeit, with a premium of 1% as transaction cost, but the question is whether these entities indeed purchased US Dollars from the official market at the official rate throughout the period under review, due to the scarcity occasioned by higher demand than supply. Where it is established that DisCos purchased same from sources other than the official market at higher rates, the Tariff and Market shortfall calculated and stated in the Orders would in actual fact not have reflected the reality to the disadvantage of the DisCos.

Otherwise, we look forward to a bright NESI while trusting that all relevant stakeholders will abide by their respective obligations and the Government will fulfil its commitments to the Sector.

Kofo Olokun-Olawoyin

Kofo is the Author of the fast selling book “The Nigerian Electricity Supply Industry- Post Privatisation Realities, Trends and Challenges”. She can be reached on ko@kofoolawoyin.com  or kofo.olokunolawoyin@gmail.com

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