The PAG is a bold step in the right direction to developing a sustainable liquidity solution for the power sector. The CBN and the Ministry of Power must be commended for putting the intervention in place. However, it does not address some of the fundamental structural challenges in the sector…
Recently, the Federal Executive Council (FEC) approved a N701 billion payment assurance guarantee for the power sector, to be provided by the Central Bank of Nigeria (CBN) as part of measures to solve the liquidity problems in the power sector.
According to the minister for Power, Works and Housing, Mr. Babatunde Raji Fashola, who made the announcement on behalf of the FEC, “the liquidity problems that have characterised the market have affected the Nigeria Bulk Electricity Trading (NBET)’s ability to deliver on its PPA obligations to the GENCOs. So going forward, in order to strengthen the NBET, CBN is providing a payment assurance guarantee for energy produced by any GENCO, so that GENCOs can pay their gas suppliers when they are paid, and so that the hydros can continue to operate.”
The N701 billion Payment Assurance Guarantee (PAG), is the latest intervention by the CBN in the Nigerian power sector. Other interventions by the CBN are the N300 billion, Power and Aviation Intervention Facility (PAIF) and the N213 billion, Nigeria Electricity Market Stabilisation Facility (NEMSF).
The Payment Assurance Guarantee is for a two-year period, beginning in January 2017 and will guarantee NBET’s payment obligations to GENCOs up until December 2018. The PAG isn’t focused on addressing the existing liabilities to GENCOs and gas producers prior to January 2017. The guarantee will only apply to GENCOs who generate power to the grid (including Hydro-power Gencos) and their gas suppliers.
Objectives of the Payment Assurance Guarantee
From the minister’s statements, the PAG has the following objectives:
• Bringing stability to the generation side of the power sector value chain i.e stabilising the level of generation to the grid;
• Enabling NBET as the off-taker of electricity, to meet its payment obligations under the Power Purchase Agreements (PPA) with GENCOs;
• Giving assurance of payment to GENCOs and their gas suppliers for energy generated;
• Giving confidence to investors in GENCOs and gas producers who supply gas to the power sector to continue to make investments in both sectors.
Is the PAG a step in the right direction?
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In our previous articles focusing on solving the liquidity crisis in the power sector, we have consistently proposed the implementation of a liquidity and payment support mechanism for the Nigeria Electricity Supply Industry (NESI), which should achieve the following objectives:
• Supporting NBET’s payment obligations to GENCOs under respective PPAs, which, in turn, would enable GENCOs meet their payment obligations to their gas suppliers under respective GSAs;
• Settling outstanding debts to GENCOs and their gas suppliers;
• Covering anticipated revenue shortfalls which threaten the stability and sustainability of the NESI;
• Guaranteeing full payment to market participants (GENCOs, gas suppliers and other market participants);
• Providing re-investible funds for DISCOs to fund their capital programmes to reduce distribution losses and improve collection;
• Providing market confidence to investors in the NESI.
In our view, the CBN Payment Assurance Guarantee is a step in the right direction to address the liquidity challenges in the power sector. The PAG can be considered as a local partial risk guarantee (PRG) solution by the CBN, similar to PRG instruments issued by either the World Bank or the AfDB to support the development of greenfield Independent Power Plants (IPP).
The CBN, the power ministry, as well as all those involved in putting together the PAG must be commended for initiating a bold intervention that partly addresses the liquidity crisis in the power sector.
The PAG is actually a credit facility by the CBN to NBET. It is important to educate the public and market participants that the PAG is not a grant to NBET, nor is it a grant to GENCOs and their gas suppliers. This seems to be the perception by a few market participants who we have interacted with on the PAG.
However, the PAG doesn’t completely solve the liquidity crisis, nor does it address the fundamental structural challenges in the power sector. The liquidity crisis is only a symptom of these structural challenges. Nonetheless, it is a good foundation to build further solutions that, hopefully, would address the structural challenges and arising liquidity issues.
Structuring the PAG, What Are the Terms?
There is very little public information about the terms of the PAG and how NBET will access the guarantee to pay GENCOs. Expectedly, the CBN, NBET, and their advisers must be working out these terms. Our focus is on highlighting our views on potential terms that would aid the CBN in putting together an appropriate transaction structure for the attainment of the objectives of the PAG.
1. Eligibility Criteria – Enforcing a Contract Driven Market
The Nigerian Power Sector is in the Transitional Electricity Market (TEM) stage. TEM is expected to see a contract based market. So far, a number of key market contracts, particularly PPAs and Vesting Contracts are yet to be activated. As part of its objectives, the PAG should be a mechanism to activate some of these key market contracts with NBET. Any proposed eligibility criteria should consider this objective and be focused on enforcing a contract driven market. Following from this objective, eligible GENCOs and gas producers should be:
• GENCOs who have met all requirements to be valid market participants and are registered with the Market Operator;
• GENCOs who have activated their PPAs with NBET;
• GENCOs who have activated firm Gas Supply Agreements (GSA/GSAA) with a gas producer;
• GENCOs who actually generate power to the grid;
• Gas Producers with firm gas commitments and activated GSAs with GENCOs.
2. Setting Market Expectations – No Free Lunch!
The PAG is actually a credit facility by the CBN to NBET. It is important to educate the public and market participants that the PAG is not a grant to NBET, nor is it a grant to GENCOs and their gas suppliers. This seems to be the perception by a few market participants who we have interacted with on the PAG. Their belief is that the CBN, as a government owned entity, is guaranteeing the payment obligations of NBET, another government owned entity, and thus it’s free money!
DISCOs, in particular, need to be made aware that the PAG does not, and will not, absolve them of their obligations to pay 100 percent of their NBET invoices under the vesting contracts. Nor should DISCOs hide under the PAG to further remit less of their collections to NBET.
To avoid this misconception, which may adversely affect the effectiveness of the PAG, the terms of the PAG must be clearly stated by the CBN and NBET.
3. Clear Credit Terms – Transaction Costs and Interest Rate
All costs and credit terms to the power sector arising from the PAG must be known and understood. The terms of the PAG should provide information to some of the critical questions, such as: What is the cost of the guarantee to NBET? How will NBET repay the drawdown portion of the PAG? What would be the interest rate on the drawn down amounts under the PAG? Which party bears the transaction costs and interest payment? Is it the CBN, NBET, GENCOs, DISCOs or paying customers? Under the existing N213 billion NEMSF, the transaction fees incurred by the CBN, plus an interest rate of 10 percent per annum have been directly passed on to electricity customers by NERC. We do not advocate that the transaction costs, as well as the interest costs on the PAG, be directly passed on to paying electricity customers who currently sustain the power sector and bear the brunt of an inefficient sector.
The above credit questions are not exhaustive and are illustrative only. The key point being made is that the CBN and NBET must ensure that the Market is fully conversant with the credit nature and terms of the PAG, including the costs and interest charges, as well as who bears the costs.
4. Sizing and Tenor of the PAG
The sum of N701 billion seems quite huge. However, we are of the view that the PAG should actually be above N1 trillion, particularly if the intention is to assure capacity and energy payments to GENCOs, as well as provide confidence to investors in the generation segment of the value chain. Also, the tenor should be extended to at least five years, to provide the much needed stability in the power sector, whilst the structural and revenue challenges within the sector are being addressed with other measures soon to be rolled out.
5. Setting Minimum Payment Obligations of Discos to NBET
Our understanding is that the PAG will cover 90 percent of energy payments and up to 75 percent of capacity payments to GENCOs, in the event of a payment shortfall from DISCOs. Currently, DISCO payment performance is below 25 percent, meaning there is a shortfall of 75 percent, which the PAG is expected to cover. For the PAG to be appropriately sized over the life of the guarantee, DISCOs must commit to a minimum payment threshold, adjusted upwards periodically, over the life of the PAG. The PAG should only cover any shortfall amount above the minimum payment threshold agreed with DISCOs.
It is highly improbable that NBET would be able to repay any drawdown amount under the PAG by 2019, solely from market revenues. Thus we advocate that the PAG should be followed up by the NBET bond issuance programme, which should actually be the first line of payments to GENCOs in the event of continued DISCO revenue payment shortfalls.
While advocating for a minimum payment threshold for DISCOs, at the same time, the tariffs must be made cost reflective as well. The current MYTO 2.0 tariffs should factor the inflation rate, foreign exchange rate, generation levels and any adjustment in the price of natural gas, through a minor or major tariff review by NERC, at the time of setting the minimum payment threshold by DISCOs. The PAG can be utilised as a form of “recoverable subsidy”, to ensure that the full tariff adjustments aren’t passed to electricity consumers immediately. The effects of tariff adjustments and setting a minimum payment threshold for DISCOs would help in the final sizing of the PAG.
6. Risk Allocation
Risk allocation under the PAG (potentially in line with the risk allocations in the PPAs and GSAs) should be clearly spelt out. Such risks are mainly transmission and gas supply risks. For instance, would the payments to GENCOs and gas producers under the PAG cover for Availability Events due to transmission grid instability, or gas supply constraints caused by pipeline sabotages?
7. How Would NBET and GENCOs access the Money?
Perhaps, this issue needs to be given more attention so as to ensure smooth and efficient access to disbursements by GENCOs under the PAG.
Rather than the CBN developing a new structure to manage the disbursement of the PAG to NBET, we would recommend that the PAG is integrated into the existing NESI payment security structure so as not to distort the structure already established and in place.
Under the existing payment security structure for the Industry, NBET has directly assigned its rights to drawdown on the payment guarantees in the form of Letters of Credit (L/Cs) posted by DISCOs to GENCOs, to cover any shortfall PPA payments by NBET. Unfortunately, GENCOs have been unable to drawdown on the DISCO payment guarantees till date. In terms of drawdown and disbursement, the PAG should operate like the World Bank PRG drawdown structure. The PAG should act like a top-up mechanism to top-up DISCO payment L/Cs to NBET, when GENCOs draw down on the payment L/Cs to cover shortfall payments from NBET.
However, considering that only eight (8) DISCOs have so far posted their payment guarantees to NBET, with no clarity if and when the remaining three DISCOs would post their own payment guarantees to NBET, perhaps a better payment security structure for the power sector would be to convert the PAG into NBET direct payment security to GENCOs, in the form of unfunded Standby Letters of Credit (SBLCs), as opposed to the quasi-payment security structure established by NBET as described above.
Adopting existing payment security structure for PAG allows for the sanctity of the terms of the PPA and GSA contracts to be maintained under TEM. It is also much less costly from a transaction cost perspective. GENCOs are able to drawdown on the existing L/Cs and can access their payment quicker and more efficiently without meeting additional drawdown conditions outside of the PPAs, which may likely be set by the CBN if a new payment mechanism is adopted. Lastly, adopting existing payment security structure would improve the liquidity position of DMBs who are the L/C banks.
8. Repayment of the CBN Guarantee
It is highly improbable that NBET would be able to repay any drawdown amount under the PAG by 2019, solely from market revenues. Thus we advocate that the PAG should be followed up by the NBET bond issuance programme, which should actually be the first line of payments to GENCOs in the event of continued DISCO revenue payment shortfalls.
Conclusion
The PAG is a bold step in the right direction to developing a sustainable liquidity solution for the power sector. The CBN and the Ministry of Power must be commended for putting the intervention in place. However, it does not address some of the fundamental structural challenges in the sector, such as the absence of appropriately priced electricity tariffs, and DISCOs’ inability to significantly reduce their aggregate distribution and non-distribution losses as envisaged under privatisation. But approving the Payment Assurance Guarantee is one step to solving the liquidity crisis. The most critical step is ensuring that this guarantee does not create a N701 billion debt on the balance sheet of the Federal Government.
DISCOs alone account for revenues of the power sector. Thus it is imperative for the Federal Government, through the BPE and NERC, to ensure that they become more efficient in their operations and also improve their revenue collection as well. This won’t happen overnight or miraculously, and it would require huge capital investments by Discos, as well as changing their present business models to attain operational efficiency and reduce their ATC&C losses.
If DISCOs do not reduce their ATC & C losses and become more efficient in their operations, Nigeria would have successfully created a circa US$2.3 billion debt profile on the books of the CBN by 2019. This is not counting the N213 billionn intervention already on the books of the Bank.
Odion Omonfoman is an energy consultant and the CEO of New Hampshire Capital Ltd. He can be reached on orionomon@outlook.com.
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