With a population of over 180 million, Nigeria is the most populous country in Africa. Nigeria currently has installed capacity to generate approximately 8.6GW of electricity of which only about 4.1GW is actually operational. With trends from developed nations indicating that approximately 1GW of generating capacity is required for every one million inhabitants, electricity demand in Nigeria far outstrips supply.
The Federal Government of Nigeria (the Government) aims to increase generating capacity of the country to 40GW by 2020. The scope for development in this sector is tremendous and the support provided by the Government presents significant opportunities for investment in Nigeria, particularly in light of the ongoing privatisation of the power sector.
In November 2012, Standard & Poor’s upgraded Nigeria’s long-term rating to ‘BB–’, based in part on ‘sustained reform momentum in several key areas including reforming the power sector’. The Government decided to privatise large portions of Nigeria’s power sector in 2014. In addition, there are also currently a number of independent power projects (IPPs) under development in Nigeria and a number of these are expected to reach financial close in 2015 or 2016.
Historically, the Government, through the state-owned National Electric Power Authority (NEPA) had a monopoly over the generation, transmission and distribution of electric power in Nigeria. Due to its poor performance in accommodating the growing demand for electricity in Nigeria, the Government decided to remove this monopoly and to encourage private sector participation. This was initially done through the National Electric Power Policy in 2001 which specified the reform agenda, and then through the Electric Power Sector Reform Act 2005 (EPSR Act) which provides the legal basis for the replacement of NEPA with the Power Holding Company of Nigeria (PHCN), and the subsequent formation and privatisation of four thermal and two hydroelectric generation companies (Gencos) and eleven regional distribution companies (Discos), each technically a successor company to the PHCN with respect to their relevant assets or district.
The Bureau of Public Enterprises (BPE) was the representative body overseeing the privatisation process, which was structured in the following broad stages:
- the establishment of an independent electricity regulator, the Nigerian Electricity Regulatory Commission (NERC), combined with a reduction in the Government’s direct involvement in the power sector
- the unbundling of NEPA into distinct business units
- the privatisation of the Gencos and Discos by way of:
- the sale of all of the shares in the thermal Gencos
- the sale of the majority of the shares in the Discos
- entry into a concession agreement between the successful bidder and the BPE for the hydro Gencos
- the development of industry-standard template documents which deal, as applicable, with matters including:
- gas sale, purchase and transportation
- power sale and purchase
- management and control of the Gencos and the Discos
- performance targets for both Gencos and Discos in the first five years following privatisation.
In 2012, following an initial submission of approximately 330 expressions of interest in the privatisation tender rounds, 207 bidders were pre-selected. Through the subsequent bidding process, five preferred bidders for the Gencos and ten preferred bidders for the Discos were selected by the BPE. On February 21, 2013, the BPE (on behalf of the Government) and the preferred bidders executed transaction documents to implement the first stage of the privatisation process. Completion under the Share Sale Agreements occurred in August 2013 and control over the successor company Gencos and Discos passed to the successful bidders in November 2013.
Broadly, the Government’s primary objective was to privatise the power generation and distribution sub-sectors of the Nigerian power sector, but to retain ownership and control over the transmission of power and allocation of power to the Discos. Government participation in the power sector therefore varies by sub-sector as follows:
Generation and distribution of power
For hydroelectric Gencos, the BPE has entered into Concession Agreements (entered into between the BPE, the Genco and the relevant concessionaire). For the Discos, the BPE and the relevant successful bidder, together with the Disco, entered into Share Sale and Shareholders’ Agreements. The thermal Gencos were transferred in their entirety to the private sector, which is consistent with existing government policy which seeks to encourage the private sector to develop greenfield thermal IPPs, in which the Government will not hold an equity stake.
The ongoing role of the BPE as a shareholder in the Discos and as the grantor of the hydro concessions means that the Government retains the ability to exert considerable influence over many of the Gencos and Discos internally, through retaining shareholdings and concession arrangements.
Power sale and purchase
The Nigerian Bulk Electricity Trading Company plc (NBET), a Government-owned public company, will initially act in an aggregator capacity as a bulk power trader. NBET:
- buys all power generated by the Gencos under separate power purchase agreements (PPAs) entered into by NBET with each of the Gencos, both thermal and hydro
- resells that power on an allocated basis to the various Discos under individual but standard Vesting Contracts, which will allocate a percentage of the capacity and energy output from one or more Gencos to the relevant Disco.
The tariff structure for each type of power sale contract incorporates the provisions of the Multi Year Tariff Order (MYTO) (see section 4 below).
NBET also enters into PPAs with IPPs.
Ultimately, it seems the Government intends for NBET’s role to diminish over time. Once the Discos have demonstrated their medium-term commercial viability, they will be expected to purchase power directly from the Gencos in a competitive market and NBET’s role will be scaled back. However, the timeframe for this development remains uncertain.
Transmission and system operation
The Transmission Company of Nigeria (TCN), which is the monopoly transmission service provider, remains fully Government-owned and controlled, although full management of the TCN and the operation of the transmission network has been sub-contracted to Manitoba Hydro, a Canadian electric power utility company under a management contract. In an operational sense, therefore, Manitoba Hydro is responsible for wheeling power generated by the Gencos to the Discos subject to the allocations specified under the Vesting Contracts.
Delivery of power occurs by the Gencos to the Discos at the Genco connection points to the transmission network at which point the risk of power losses then passes to the Disco. This risk is apportioned between the TCN and the relevant Disco under a standard Use of Transmission Network System Agreement, which imposes availability and loss reduction targets on the TCN, which are backed by a liquidated damages and bonus regime.
The TCN also holds roles as the System Operator and the Market Operator under key regulations including the Market Rules and Grid Rules and enters into Connection Agreements with both Gencos and Discos which regulate their connection to the transmission network.
As regards IPPs, the TCN will typically enter into a grid connection agreement and, if applicable, an ancillary services agreement with IPP developers.
Generation and Distribution Licence Terms
NERC has the primary licensing function in relation to the Nigerian power sector. This includes the licensing and regulation of persons engaged in the generation, transmission, system operation, distribution and trading of electricity, in order to ensure that regulation is fair and balanced for licensees, consumers, investors and other stakeholders.
Generation and Distribution Licences have been limited to a period of ten years. NERC has indicated it may extend the licences for additional five year periods beyond the initial ten years; however the short duration of the licences constitutes a significant risk for power projects that are likely to require major project and/or finance documents to be in place for periods exceeding ten years.
NIPPs and IPPs
In 2005, the Government announced a ‘fast track’ project for the development of seven new power stations as part of the National Integrated Power Project (NIPP). The two-fold objective of the NIPP is to improve electric power generation and reduce gas flaring from oil exploration in the Niger Delta region. After an interruption of a few years from 2007, the program was revitalised and currently includes eleven new plants, the development of which is ongoing. At the same time, as mentioned, a number of IPPs are being developed in Nigeria, including embedded generation projects and some projects which also involve direct participation by local State governments. The Government is currently running a process to privatise the NIPP assets.
The Government has also established the Nigerian Electricity Liability Management Company Ltd (NELMCO) to assume the historical liabilities of the successor Gencos and Discos, incurred prior to the completion of the privatisation acquisitions.
In 2008, NERC introduced the MYTO to further its objective of facilitating the introduction and management of competitive, safe, reliable and fairly priced electricity in the country. The main aim of the MYTO is to ensure that the prices charged by licensees are fair to consumers and sufficient to allow the licensees to finance their activities and to benefit from reasonable earnings for efficient operation.
MYTO I was issued in 2008, with the aim of protecting consumers against excessive pricing and to eliminate pricing uncertainty for consumers and investors by the establishment of a long term tariff path. However, approximately within a year of introducing MYTO I, it became apparent that two of the fundamental inputs used in the model – gas prices and exchange rates – had changed substantially from the assumptions used, which made the rates unattractive to prospective participants. NERC also realised that there were potential investors wishing to enter the market using other sources of fuel, such as coal, wind or solar, which MYTO I did not envisage.
MYTO I was therefore reviewed and MYTO II was subsequently introduced in June 2012, and intended to be more cost-reflective and to provide financial motivations for instantly needed incremental investments in the industry. These investments are expected to lead to a significant improvement in the quantity of energy and quality of service enjoyed by the consumer.
The MYTO II retail tariff schedule will be reviewed biannually and variations effected thereto, if any (or all) of the generation wholesale contract price, Nigerian inflation rate, US$ exchange rate, daily generation capacity and accompanying capital expenditure or operating expenditure requirements varies significantly from that used in the calculation of the tariff.
As noted in section 2, the BPE has also developed template gas supply and gas transportation agreements as part of the privatisation process under which the Gas Aggregation Company of Nigeria Limited (GACNL) fulfils a commercial role which is similar to that of NBET, acting as a buyer intermediary between upstream gas producers and the downstream Gencos.
Thermal Gencos are required to assume take-or-pay risk for fuel supply under their gas sale and purchase arrangements. This risk is then passed through to NBET by way of a specific take-or-pay charge under the PPA. This reflects the Government’s policy position that, to encourage the development of the power sector and to advance the privatisation process, the Gencos should not take material fuel supply risk. However, in practice, difficulties in implementing the Government’s gas development initiatives have resulted in considerable uncertainty in relation to the gas supply arrangements for the power sector.
Given the structure of downstream power sales between NBET and the Discos as outlined in section 3 above, the fuel supply risk absorbed by NBET under the PPAs is (based on the current draft Vesting Contracts circulated) effectively diluted between and transferred to the various Discos. However, because of the percentage allocation of capacity and energy output under each Vesting Contract, this is not a direct pass through. It has been noted that this pass-through of fuel supply risk to the Discos is inconsistent with the Government’s stated position of ensuring that the commercial participants in the power sector privatisation are protected from fuel supply risk.
Following the privatisations, the focus has very much been on IPPs. NBET is currently negotiating PPAs with IPP developers on a large number of projects, including gas-fired IPPs, solar PV IPPs and coal-fired IPPs.
NBET has also signed a more limited number of PPAs and it is expected that some of these IPPs, such as the Azura gas-fired IPP, is expected to reach financial close imminently.
NBET has developed a standard form of PPA for use by the IPPs. Although it has many similarities to the PPAs used for the privatisation process, the risk allocation is less favourable than under those PPAs, for example in relation to gas supply risk. The rationale for this distinction is because NBET believes that a privately developed IPP should be able to mitigate fuel supply risk, whereas in the context of the privatisation, bidders were being offered a set of pre-agreed contracts that the Gencos has already entered into, with no scope to re-open those contracts.
Partial risk guarantees from World Bank entities and/or guarantee support from organisations such as the Multilateral Investment Guarantee Agency are commonly used in African IPP transactions to reinforce the creditworthiness of government offtakers and/or the relevant governments themselves in relation to payments under PPAs, sovereign guarantees or other government support arrangements.
While the Information Memorandum released to potential bidders in the privatisation process indicated that NBET’s obligations would be backed by a partial risk guarantee regime provided by the World Bank, the privatisation transactions closed with no such support being provided.
In the context of IPPs, the government has indicated that it will provide a support agreement which will pay out a termination amount when the PPA is terminated under certain circumstances. In addition, the World Bank is also providing IDA partial risk guarantees, as a credit enhancement measure for NBET.
The Nigerian Investment Promotion Commission (NIPC) is a Government agency established by the NIPC Act N0. 16 of 1995 to promote, co-ordinate and monitor all investments in Nigeria. The NIPC has overseen a range of initiatives, including:
- the liberalisation of exchange control regulations to ensure free flow of international finance and investment capital
- capital allowances and exemptions for duties on equipment imports
- the establishment of the ‘pioneer status’ regime, which provides tax holidays to eligible industries, including IPPs utilising gas, coal or renewable energy sources.
The structure of financing arrangements and security packages is likely to differ between projects involving the privatised Gencos and Discos on the one hand, and any IPPs on the other.
For the Gencos and Discos, the standard transaction documents contain detailed provisions regarding the permissible debt financing structures that can be adopted by the successful bidders. These include restrictions on the ability of the bidder to place charges over the Genco’s or Disco’s assets or shares in the Discos, and the BPE’s approval will generally be required before any financing structure can be adopted.
In relation to IPPs, it is anticipated that producers will be able to enter more customary assignments of interests and security arrangements with their lenders. This would include placing charges over shares in the relevant project company, and assigning or transferring rights in underlying project documents as part of a conventional project finance security package.
Finally, it should be noted that land title in Nigeria is obtained under Certificates of Occupancy which effectively grant usage rights for long periods (e.g. 99 years), but which do not grant freehold title. There is currently some legal uncertainty concerning the ability of holders of these certificates to effectively mortgage the relevant underlying land, and in relation to the effectiveness of enforcement processes should a default occur.
The Government has already indicated, as noted in section 3 above, that NBET’s role will diminish over time and that Discos will be expected to purchase power directly from the Gencos in a competitive market once the Discos have demonstrated their medium-term commercial viability. For IPPs, the implication of the Government’s policy is that long-term, Government-backed PPAs (to which NBET is the counterparty) may not be available for developers who enter the market once a certain degree of maturation has occurred, following completion of the privatisation process. However, given the Government’s ambitious plans to increase Nigeria’s generating capacity to 40GW by 2020, it is clear that significant progress will need to be made by both the NIPP program and through the development of new IPPs. Assuming that the first IPPs reach financial close in 2015 or 2016, it could be expected that these will pave the way for a large number of IPPs to be developed over the coming years.