4 January 2013

Nigeria: Power Supply - Prediction Comes True (II)

The Harvard Business School has developed a case study on the privatization as part of its teaching materials for Business Management students. Similar case studies in the past either highlighted the failure or success of a grand reform effort.

In the case of Nigeria, it is increasingly becoming a success story. Not just that the bidding process was transparent, but the background regulatory and policy framework of post-privatization is strong to withstand any subversive conduct of new entrants into the electricity market.

I am a student of Public Sector reform and have written a book on privatization that highlights where it had failed in the past and why. One reason for failure is that the privatization ends up as sweetheart bazaar sale. Another reason is the reckless optimism of the reformers who believe that without doing more, a private electricity market will cure all the pathologies of the public electricity market.

These sanguine reformers discount the obvious fact that the principal-agency problem that undermines public enterprises is also rife in private enterprises. Both reasons for failure derive from incomplete diagnosis of the nature of the pathologies and insufficient institutionalization of effective market governance. The transparent bidding process set up by the BPE took care of the first cause of failure. The regulatory framework established by NERC hopefully takes care of the second cause of failure.

The bidding was conducted in the context of the structure of regulations and industry agreements which the regulator helped to put in place. These documents effectively allocated risks in such manner that investors were encouraged to bid for the PHCN successor companies. The MYTO model which the regulator published is the peg around which the long term investment plans and loss reduction strategies of the bidders are based.

With the backing of President Jonathan and the support of the Ministry of Power, NERC put out a tariff structure that promised cost recovery for investors without compromising efficiency and fairness in electricity supply. With a cost-reflective tariff in place, bidder crossed the threshold of fear.

The lack of financial viability that plagued the industry in the years before President Jonathan is being cured. Then electricity tariffs did not cover the costs of electricity supply. The distribution companies were supported by federal budget and never bothered about collecting tariffs from customers.

Federal budget provided personnel cost and nothing was spared for investment in maintaining and expanding the network. post-MYTO, the story is changing. Market discipline is being introduced. In November, the Eko Electricity Distribution Companies reported that it collected enough money to settle all its obligations in the market and finance improvement of its network. Other distribution companies are fast on the heels of Ikeja to achieve 100% financial viability.

The evidence is clear that MYTO has worked to put electricity operators on the path of financial viability. The price of electricity recovers the costs of electricity supply in Nigeria. The would-be investors can do the back-of-envelop calculation and be assured that he can recover his costs and earn decent profit from the business. This removes a major risk in the electricity market.

What is left now is to drastically improve collection and strengthen the integrity of the settlement system such that cost of energy billed to customers is recovered and the monies are prudently used to finance investments that improve the capability of the networks to deliver safe, reliable and adequate electricity. This is the next focus of NERC for 2013

The MYTO does not only assure investors of strong prospect of cost recovery, it also provides a definitive regulatory framework for ensuring continuous investment in the network by the new entrants such that efficiency can be improved dramatically. The MYTO signals viability for both Greenfield and Brownfield investments. Since the launch of MYTO 2, a lot of transactions are going on in the finance market such that there is greater hope that both the preferred bidders and the licensed independent power producers will be financially bankable.

Financial bankability is partly a function of predictability. And predictability depends on regulatory certainty. If financiers know what to expect in the event of a breach, or know what risks their clients carry at the end of transaction they are more willing to assume risks, all things being equal.

This certainty comes because the regulatory framework is transparent, durable and sensible. The greatest achievement of President Jonathan in the power sector reform is that he has created, through the work of the regulator, a more predictable, stable and transparent electricity market that is safe and profitable for investment. He has not fallen to any temptation to scramble or distort the regulatory framework. And in Africa, that temptation could be overwhelming.

To further solidify the predictability and reliability of the electricity market, NERC has put out a 'fit and proper' test criteria that ensures that any of the preferred bidder who gets to be authorized to manage any electricity network in Nigeria has the technical and financial capability to meet its responsibility to generate, transmit or distribute adequate, safe and reliable electricity in Nigeria.

NERC is releasing other regulations ahead of the entry of the preferred bidders, so that the electricity market in Nigeria is designed against the lessons of failures and shortcomings observed in other sectors. For one, there will be no Nigerian model of family business in the electricity industry that NERC is constructing. The technical and financial nature of the market militates against that. But additionally, the corporate governance post privatization second-guesses the assumptions of perfect rationality and the self-correcting market.

-Dr. Amadi is Chairman and Chief Executive Officer of the Nigerian Electricity Regulatory Commission (NERC)

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