Dentons would like to thank John Chibueze, from ACAS Law in Nigeria, for this month’s contribution to the Africa section of the Dentons South Africa Newsletter. In this article, John discusses solar and thermal power projects in Nigeria.

The Nigerian Electricity Supply Industry (NESI) is currently experiencing critical financial and operational hurdles which significantly affect ongoing and prospective renewable and non-renewable power projects. This paper seeks to highlight certain key (red flag) issues which any prospective investor in the NESI would need to consider in its investment due diligence.

Liquidity

The NESI is currently in the Transitional Electricity Market phase, at which stage the National Bulk Electricity Trader (NBET) is still the bulk buyer of power from generating companies and Independent Power Producers (GenCos), and reseller to power electricity distribution companies (DisCos). This creates a financial value chain linking the gas suppliers (for thermal projects) to GenCos, GenCos to the NBET, NBET to the DisCos and the DisCos to end user consumers. Consequently, any financial disruptions will cascade across the entire value chain. Payment securities were put in place in the value chain (from the NBET to the GenCos and from the DisCos to NBET), but these have proven grossly inadequate to cover the payment obligations in the value chain. Presently, DisCos are extensively exposed to cash deficits and losses due to poor collections from end users and their inability to pass on real costs to end users. This cashflow deficit trickles down to the NBET, GenCos and gas/feedstock suppliers.

The Federal Government of Nigeria (FGN) has in this regard initiated the Power Sector Recovery Program (PSRP), which is a series of bail out and intervention policy steps to be executed over a five-year period, aimed at restoring financial viability and improving services across the NESI value chain. Under the PSRP: (i) the FGN has provided a NGN 701 billion Payment Assurance Guarantee as an intervention fund to the NBET to mitigate its payment obligations; and (ii) the World Bank is in talks with the FGN to support the FGN’s PSRP with as much as US$2.5 billion. The trickle-down effect of these intervention funds to existing or potential power projects is not yet clear, but an investor would need to enquire as to the application of any of these funds to its target project.

Tariff

Another major issue plaguing the NESI is the non-commercial end user tariffs chargeable by DisCos, which creates losses to the DisCos and entities further down the value chain. The Multi-Year Tariff order (MYTO) was established in 2008 to provide a market-based and reflective end user tariff trajectory. However, the end user tariff has not been cost reflective of the investors’ capital and does not pass through costs to the end user (for reasons discussed below). This issue will be exacerbated where the DisCos offtake solar power which has a higher tariff than the thermal and hydro power currently distributed by the DisCos.

Following a declaration by the Minister of Power, Works and Housing, GenCos in Nigeria would (effective from 15 May 2017) be able to generate and sell power directly to end users who qualify as “eligible customer”. This measure was instituted to evacuate stranded capacity generated by GenCos but are not otherwise totally absorbed by DisCos. This development is immensely beneficial to a GenCo/investor, which can now enter into a bilateral offtake agreement with its preferred end user (who qualifies as an “eligible customer”) and thereby disentangle its project cashflow from the loss-impaired value chain in the NESI.

Political will

One of the commercial incentives for privatisation of the national electricity utility assets was that tariffs would be market based and reflective of investors’ capital. The typical Nigerian power consumer/end user has (up until the privatisation of the sector) always been a beneficiary of subsidised tariffs and has never really been exposed to market based tariffs. As a result, there have been massive nationwide protests against the attempt by the FGN to set cost - reflective end user tariffs. These protests have been supported by trade/labour unions, by the Nigerian legislature and even by judicial orders. The massive unpopularity of tariff adjustments has caused the FGN to backtrack on its agreement with investors (leading to declarations of force majeure by some operators). This seeming lack of political will by the FGN to adjust the tariff has significantly affected investors’ return on investment in the NESI and also negatively affected investor confidence.

Another political issue investors should consider is succession in government. While project terms remain binding on subsequent administrations, a prudent investor would however need to be sensitive to the political disposition of the government of the day to the project. As such, sovereign immunity clauses and sovereign guarantees need to be tactically negotiated for long - term durability of the project terms.

Financing

The payments for the asset acquisition in the privatisation of the NESI was largely locally financed by local lenders – these  loans and facilities are all largely non-performing loans at this point given the severe liquidity crisis in the NESI. This has left the local lenders extensively exposed to toxic debt in the NESI. Furthermore, the acquisition financing was disbursed in US Dollars while the acquired assets book cashflow was disbursed in local currency. This has also caused adverse foreign exchange exposure to investors following the gross decline in exchange rates. An investor seeking to establish a power project may find securing local financing an uphill task – funding would need to be sought internationally or from foreign direct investment and multilateral financial institutions.

In addition to the financial bail-outs and interventions being considered under the PSRP, there would need to be a comprehensive foreign exchange policy which takes currency risks in the NESI into special consideration and creates lower access rates to foreign exchange for investors in the NESI. This would not only help in alleviating the current exposure of local lenders to the NESI, but would also incentivise foreign investors and financiers in the NESI.

The authors acknowledge and thank John Chibueze, Eniola Sadare and Peter Aisagbonhi from ACAS Law for their contribution in the writing of this article.