The Declaration of Transitional Electricity Market (TEM) and Stakeholder Expectations for the Nigerian Electricity Supply Industry (NESI)

by | Dec 30, 2014 | Newsletters

A.      Introduction

One of the objectives of the electricity sector reform, which commenced in 2001, is to create efficient market structures, within clear regulatory frameworks, that encourage competitive markets for electricity generation and trading. In line with this objective, the Electricity Power Sector Reform Act 2005 (EPSRA) provides for a phased and strategic implementation of the power sector reforms until optimal capacity generation and a full competitive market is achieved. Implementation of the competitive electricity market will be through a gradual process of increasing competition designed as four market stages, namely: Pre-Transition, Transition, Medium Term and Long Term.
The Pre-Transition Stage kick starts the end of the monopoly in the power sector and the commencement of the unbundling and privatization of the Power Holding Corporation of Nigeria (PHCN). The Transitional Electricity Market (TEM), to be announced by the Minister of Power on the advice of the NERC[1], is expected to introduce competition into the market as it is the intermediate step to move the electricity market from an integrated whole utility to a full competitive market structure with more differentiated Market Participants. This phase was initially due to commence upon the handover of the PHCN assets on the 1st of November 2013 (Handover Date), but some of the conditions precedent to the declaration of TEM were still in the process of implementation (discussed below), in addition the lack of a cost reflective tariff and the much needed reset of the Discos baseline losses also needed to be resolved before the declaration of TEM. The Minister is yet to make this declaration. However in the short term after the Handover Date the Interim Rules were enacted to govern the electricity market between the completion of the privatization and the start of TEM; and these Interim Rules have been in force since the Handover Date. It is envisaged that TEM will commence on or before June 2015.
As the declaration of TEM is now imminent, this article focuses on the reasons for the delays to TEM, expectations of the stakeholders in this phase and the likelihood that these would be met with the current realities in the market.
 
B.     Delays to the declaration of TEM
The delay in the declaration of the TEM has been attributed to a number of reasons including the fulfilment of all the conditions precedents as provided in the Market Rules. These conditions include,[2] development, implementation and testing by the System Operator and the Market Operator, of the systems and procedures required to implement the Grid Code and the Market Rules; formalization of the trading arrangements (Vesting Contracts and the Power Purchase Agreements(PPAs)) between the companies that will participate in the Transitional Stage Market; publication of the Initial Transmission Usage Charge by NERC and constitution of the initial Dispute Resolution Panel (DRP) and the Initial Stakeholder Advisory Panel.
In addition to the conditions precedents, the deferment of the commencement of TEM has been attributed to other elements such as the lack of a cost reflective tariff and liquidity downstream with the Discos and gas supply challenges upstream in the sector.
In terms of gas supply, there is a shortfall of over one billion cubic feet of gas per day to run the available capacity in the privatised power plants (Gencos), as Gas Suppliers are not able to meet their contractual obligations, due to low gas prices, no guaranteed payments from the Gencos, inadequate gas infrastructure and security of such infrastructure. The regulated price of domestic gas has recently been increased to $2.50 for gas supply and $0.80 for gas transmission to encourage investment in gas. In spite of the increased gas prices there is still a clamour for about $5 or $7 to keep it at par with export prices.
The delay in the declaration of TEM has had an undesirable effect on market participants particularly for the investors in the recently privatized assets; the PPAs and the Vesting Contracts that have been signed are yet to be operational. Other industry agreements such as the Transmission Network Agreements (Use of Transmission Service Agreements, Grid Connection Agreements and Ancillary Services Agreements) are also yet to be effective. The principal effect here is that, until TEM is declared, the market participants have no enforceable and risk-allocated contractual basis for enforcing performance of the contractual terms. The ripple effect here is that, this has also stifled the inflow of the much needed financing in the sector which has increased the risk profile of the sector.  Investors and Financiers are now reluctant to release funds needed for the growth and expansion of the sector.

It has recently been reported that the last condition precedent, which is the constitution of DRP has been fulfilled. However work is still ongoing on implementing a cost reflective tariff that would ensure that the Discos are capable of paying for their operational expenses, the bills of the value chain upstream as well as a decent rate of return. This has resulted in another tariff increase effective from Tuesday 22nd of December 2014 applicable only to commercial customers and not residential customers.

 

C.      Interim Rules

 The Interim Rules came into effect on the Handover Date, with a first version published on the 3rd of December, 2013 and an amended version published on the 22nd of April, 2014. The Interim Rules apply to energy produced and delivered, associated services and cover all electricity taken from the transmission system by the distribution companies during the Interim Period.

Objective

The main objectives of Interim Rules are to establish a framework to govern trading arrangements during the Interim Period when the PPA’s between the privatised successor generation companies and Nigerian Bulk Electricity Trading Plc (NBET) and Vesting Contracts between NBET and the privatised PHCN successor distribution companies will not be effective; manage the revenue shortfall in the industry by determining the revenue allowable to participants and service providers; establish the payment arrangements and flow of funds from Discos through the Market Operator to all beneficiaries; and establish the sources of funds required to ameliorate the probable shortfall in revenues collected by the Discos during the Interim Period.

Market Structure

During the Interim Period, the Successor Companies and other electricity generators will continue the existing Pre-Transition Electricity Market trading arrangements whereby PHCN Successor Discos shall receive invoices from and will make payments to the Market Operator for power received from the successor generation companies and other Independent Power Producers. The Discos will also be required to make payments to the Market Operator for the regulatory charges as well as service providers’ charges (Market Operator, System Operator, Transmission Service Provider and NBET).

Cash Shortfall

Owing to the current cash shortfall in the electricity sector, which has resulted from an insufficient tariff, the cash collected during the Interim Period from end users is much lower than expected and inadequate to cover all the Discos costs. Inevitably, the current revenues of the Discos are lower than earlier projected, which prevents them from paying in full their bills to the Market Operator; and the Market Operator consequently cannot pay in full the bills to the Gencos, who will also be unable to pay Gas Suppliers in full. Therefore, the Market Operator has to apportion the allowable revenue to Market Participants and Service Providers during the interim period. This has culminated in a substantial amount of debt over 196 Billion Naira owed to the Gencos, Gas Suppliers and includes the shortfall in revenues to the Discos. The accumulated debt in the sector is one of the primary objectives for the intervention by the Central Bank of Nigeria (CBN) in the form of the CBN Nigerian Electricity Market Stabilization Facility (CBN-NEMSF) to pay off the existing debts up to December 2014 to ensure that TEM commences in a financially healthy and stable market.

Unenforceable Contracts

Another major challenge with the framework under the Interim Rules is that the Market Participants operate more on a best endeavours basis without any regard for the existing contracts. Currently, the Market Participants are not being sanctioned for being unable to meet their contractual obligations which will not be the case at TEM.

 

D.     The Transitional Electricity Market (TEM)
As stated above, this phase of the market is expected to introduce competition into the market and is characterized by the following:
  1. Contractual Arrangements: All electricity trading arrangements will be consummated through contracts and there shall be no centrally administered balancing mechanism for the Market. During TEM, Power Purchase Agreements, Vesting Contracts and Gas Supply Agreements which were executed during the privatization process which govern and support the purchase and sale of the electric power will become effective. Key to these Agreements being effective is the provision of Letters of Credit by the Discos to NBET which will in turn backstop the guarantees to be issued by NBET to the Gencos. The Gencos are also expected to provide guarantees for gas to Gas Suppliers.
  1. Market Structure: it is expected that the Market Operator shall develop a Market Procedure for the management of inadequate supply and shortage conditions during the Transitional Stage. The System Operator on the other hand  will allocate generation shortages proportionally among loads and will be tested and improved during the Transitional Stages, and shall become part of the Grid Code at the start of the Medium Term Market.
  1. Market Surveillance Panel: Under TEM, the initial Market Surveillance Panel will be constituted. The Panel shall amongst other things be responsible for monitoring the behavior of Market Participants and report acts of abuse or possible abuse of market power to the NERC.
  1. Dispute Resolutions Panel: Under TEM, a Dispute Resolutions Panel will be constituted to mediate on conflict of interests among Market Participants in the NESI.
  1. Novation of existing IPP PPAs: It is expected that by TEM the Legacy PPAs entered into by IPPs such as Shell and Okpai would have been novated to NBET who would take the place of PHCN as the off taker for the power generated.
  1. Effective and Operational NERC Codes and Rules: it is expected at TEM that NERC’s Codes and Rules would not only be effective but be operational amongst Market Participants and Service Providers. The Codes and Rules include: the Grid Code, Metering Code, Distribution Code, Health and Safety Code and Market Rules.
  1. Multiple Buyer Model: Subsequently after TEM is in place, it is envisaged that the Multiple Buyer Model proposed in the Roadmap to the Power Sector Reforms will take effect. This model provides for, not only NBET procuring power from the Successor Generation Companies and the Independent Power Producers, but to the extent that they are able to, the distribution companies and eligible customers will be allowed to procure power bilaterally alongside the Bulk Trader.
 
E.      Expectations of Stakeholders  for TEM
The following are some of the expectations of stakeholders. Stakeholders for the purpose of this article include the Federal Government, Regulators, Investors, Market Participants, Service Providers, Investors and Financiers and Electricity Consumers.
Enforceable Contracts

A fundamental expectation of TEM for all stakeholders is that this phase will ensure strict accountability of the Market Participants. Under TEM, the Industry Agreements[3] will become effective and Market Participants are obliged to commence full trading based on these agreements and will be sanctioned for failing to meet their contractual obligations to other stakeholders.  For instance, Gas Suppliers[4] will be penalized / sanctioned in the event of a failure to deliver on their gas supply commitments to the power producers, in line with the Gas Supply Agreement they have signed. Failure of the Gencos to meet their supply commitment obligations will also be met with consequences as provided for in their PPAs with NBET including non-payment for energy not supplied NBET. NBET would not be paid for power not supplied to the Discos, who will ultimately lose revenue for failing to supply improved electricity to the end users.

Full Cost Recovery

 It is also expected by the Investors that there would be a fully cost reflective tariff in place that would ensure investor full cost recovery and confidence for financing and investment in the sector.

Certainty of Revenues
Another expectation is the certainty of revenues. The letters of credit required under the PPA, Vesting Contracts and Gas Supply Agreements to backstop payment obligations under these agreements, are meant to serve as a form of guarantee of revenues for power supplied by the Gencos to NBET and NBET to the Discos respectively.

The above expectations are desirable, however, in light of the current realities, particularly the need for a cost reflective tariff and gas challenges; there is a need for a firm achievable strategy or plan to address these challenges highlighted.  Without cost reflective tariffs and sufficient supply of gas, the value chain will be stunted, and power delivery to the electricity consumers will be negatively impacted.

 

F.      Conclusion
Following the privatization of the PHCN Gencos and Discos in November 2013, the entry of the NESI into TEM has become imperative to unlock the much needed funding and growth in the industry. In spite of the myriad of issues plaguing the industry, steps are being made in the right direction by the Federal Government, relevant Ministries and Agencies in ensuring the stability of this very crucial industry that is key to Nigeria’s economic growth. A lot of work, as highlighted above, however still needs to be done by the NERC, Market Participants and Service Providers to boost investor confidence in the NESI.

 

[1] in accordance with section 24(3) of the EPSRA 2005
[2] See Appendix 2 of the draft Market Rules for all conditions precedent to declaration of TEM
[3] Vesting Contracts, Transmission Use of Service Agreements, Grid Connection Agreements, Ancillary Services Agreement, Power Purchase Agreements, Gas Supply Aggregation Agreements and Gas Transportation Agreement
[4] The current Gas Suppliers include Nigerian Gas Company, Shell Petroleum Development Company Nigeria, Chevron Nigeria Limited, ExxonMobil Producing Nigeria Limited, Total Exploration & Production Nigeria Limited, Nigerian Agip Oil Company, PanOcean Oil Corporation, Seplat Petroleum Development Company, and Nigerian Petroleum Development Company.