THE SOLUTION


'MYTO'll Encourage Investors, Correct Pricing Of Electricity'
Last week, the Federal Executive Council approved a new tariff regime for the nation's power sector, the multi-year tariff order (MYTO) introduced by the Nigerian Electricity Regulatory Agency (NERC). Prior to that, NERC Chairman, Dr. Ransom Owan and other members of the power sector regulatory agency have been sensitising key stakeholders on the make up of the new arrangement. ASSISTANT BUSINESS EDITOR Bassey Udo attended one of the sessions held in Lagos. Excerpts:

How did NERC arrive at MYTO?

We have been working on MYTO since November 2005 to determine what is the correct pricing policy for electricity. As a commission, NERC has four areas of its mission. How do we provide adequate electricity for Nigerians? How do we make electricity safer for our use? How do we improve reliability of power supply? How do we encourage affordability?

In 2005, PHCN submitted a request for increase in electricity rate by 60 percent. It was rejected, because with the sector regulator in place, the proper way to do it was not to take consumers by surprise.

The way forward is to give NERC a chance to review all the methodology for determining all the revenue for the sector. What is it that is actually needed to run the sector? And given any level of output of power, what is it that would be needed to support it, before one begins to talk about correct or appropriate pricing?

It has taken two years since then. But, we have reached that point that one can discuss the issue of correct pricing of electricity.
What does that mean to both the consumer and those who wish to come and manufacture and sell electricity?

But, the difference was that government did not quite care how much it actually cost to make electricity available to the people, so that even if the operators were to give a budget on what is actually needed in a year to provide electricity, they would simply have given a little money for them to go and manage.

That is why most of the operators are just managing to pay a small fraction of their operating cost. That is, they have been running a deficit in perpetuity. If one says the private sector should come in and one is not ready to support their coming in, how can they produce power?

The issue of correct pricing is faced by all utility industry regulators the world over. It is not only in Nigeria. Whether in pricing telephone, cable services, water service, electricity, natural gas, the question is: What is the correct pricing for all those utility commodities?

Power generation began way back in 1929 when NESCO began producing power from tin mines in Jos to even a larger population of the people. It was not as if one could produce, make money and support the system. But, when there is misallocation between what is needed and what is given, one cannot perform a miracle.

Electricity is like building a bridge, once one begins building it, if one does not complete it, no vehicle would go through. So, when one begins a power project, one must continue until it is finished. Electricity is something everybody needs, but nobody wants to talk about the cost. In the past, it was a case of one making a proposal to the President and in one meeting a tariff increase is signed. Consumers would not even be told. The next thing one knows is the discovery that the tariff has increased. Everyone thought it was a sensitive subject. But, NERC aims at changing that, and that is why we came about MYTO.

Is MYTO going to be different from the arbitrary price fixing era?

The way the nation had gone in pricing power had been for the price to be fixed, and because it is government-owned it would continue to be subsidised.

So, today 45,000 employees of PHCN are all owned by government, which also owns generation of electricity, transmission and distribution. Though it has now been broken into 18 companies, because those companies have not actually changed hands to commercial sector, they are still owned by federal government. The price that consumers pay today for power had been fixed since February 2002 at an average of N6 per kilowatt-hour. (outrageously low)

In any business that one is into, one needs to determine profit, which is made up of what is the fixed price multiplied by the quantity sold. When one gets that, one begins to determine what the revenue would be.

But, in Nigeria today, because price for electricity had been fixed, nobody bothers to find out about a couple of things, if the price goes up.

Usually, the producer can hold the quantity, to drive the price, or they may not be able to carry out maintenance, because the revenue is not coming in, and the quality of service would be reduced. That is precisely what has been happening in the nation's power sector. Because everything had been fixed for so long, PHCN was not getting enough money to operate efficiently.

To make matters worse, electricity sector is an increasing cost industry. One cannot say the more one produces, the lesser the price, according to economy of scale. For electricity, the more one produces, the more people hire and other costs incurred.

So, because it is an increasing cost and declining revenue industry, what one would have is a deficit. This gap has been ignored in the nation's power industry for all these years.

We now have a situation where government decides to open up the business and change the way these things are done. And in 2005, government agreed that public-private partnership (PPP) is needed to bring investors into the sector.

To create the legal framework, government brought the Electricity Act in 2005. It formed a regulator (NERC), with a mandate to attract businesses to help develop the system.

NERC has attracted over 20 private/independent power producers so far, who are ready to produce over 10,000 mega watts (MW) of electricity. But, they have not yet moved their projects to conclusion, because they are still asking the questions about the price of power. What happens, since PHCN is very weak in terms of revenue? If they produce power and consumers refuse to pay, because there is no money, who is going to back them up?

They are saying: If answers are given to these questions, they can go to the banks, bring their projects to financial closure and actually order the operational equipment. So, the key question the financiers of power projects are asking is for the power producers to show the price they would sell their commodity to recover money to repay their loans.

Gas is a major component of power production, with electricity using more than 80 percent of the volume. The recent decision to gazette the pricing policy for gas in the country is a good development. This has been a major issue. At least one would know what the price would be in the next several years.

To find a way out of this problem of appropriate pricing for electricity, NERC was empowered to look at the various ways to price electricity in the country. The law says if NERC selects any method, it should be gazetted for the public to see; leave it for 30 days and get public comments. If the public is okay with it, the method could be adopted for the country and then begin to work with the numbers.

So, last year NERC published the gazette on the multi-year tariff order (MYTO).

The other methods, such as cost of service study (CSS); locational marginal pricing (LMP), which makes a preferential customer in Lagos, Sokoto, Kaduna or Calabar to pay the same price of electricity, regardless of where he is coming from.

The national policy says there should be uniform pricing for electricity across the country. Elsewhere, electricity is priced depending on how close one is to the location of supply, that the closer one is to the supply, the lesser one pays for electricity, because there are less line losses. But, in Nigeria, every consumer is put in the same spot and come up with average pricing.

So, the only way out of the situation was the MYTO, which is an instrument that allows the total revenue required for electricity production to be captured throughout the country, whether it is government or private sector.

With the data, one would say on the average, whether one's power plant is located in Lagos, or anywhere, what is the average cost in terms of the transmission and distribution network, cost of equipment, the retirement plan and the number of workers?

Once the total revenue that is required is understood, one would know the level of electricity to be produced for the year. If the total revenue is divided by the volume of electricity to be produced for the year, one would get the unit price, all things being equal.

If the volume increases by next year, that would also be divided by the revenue, and so on every year.

What happens if people do not perform, to give the revenue figure for the year?

Under MYTO, a regime of incentives, benchmarks and targets have been built in, so that when things change, operators would not become wary about it. Today, the nation's power sector is full of losses or leakages through illegal connections, stealing or refusal by consumers to pay their electricity bills.
As at September last year consumers of electricity were owing PHCN over N90billion in unsettled electricity bills. Residential and commercial customers owe about N71billion. The rest are parastatals and government agencies as well as security services.

So, we do not have a perfect system. We have to allow some losses, but it should be declining over the years. Therefore, NERC had to capture what are technical and non-technical losses. But, the methodology NERC is using is very transparent. NERC met with all operators, be it PHCN or the new IPPs, National Labour Congress (NLC), Trade Unions, NACCIMA, MAN, and other stakeholders to consult with them on what is being done for us to be able to address the question of correct pricing for electricity.

Everybody is saying: Give us power and we will pay the price. But, NERC is saying: Let us address the two issues at the same time, because if one is asking for power first, before the price, the person who is coming to build the power plant would say that the bank they would take the loan are asking for the price it would charge before lending the money. It is a chicken and egg situation. But, NERC has decided to tackle the two issues together at the same time through MYTO.

How would MYTO work?

Because the revenue is subject to leakages, it is either government continues to fund the sector 100percent in perpetuity, or a way could be found to allow the private sector come in. In business, one cannot suffer losses in perpetuity. At some point one has to cut the losses. But, one would still need to find a way to allow producers, suppliers and consumers benefit.

NERC believes that if these problems are put out, MYTO will help the process of power generation in the long run. The process of setting tariff gives room for the next 15 years to look at prices, which is good for operators, since it takes 3-4 years to construct the power plants and another 10-12 years to recover the debt and equity put in to construct the plants.

So, when one is talking about 15 years, the producer would need to see ahead, so that they can do their cash flow analysis. On annual basis, they take into account issues like inflation, foreign exchange rate and other things they do not have control over. This will allow them to forecast and set a ceiling in the wholesale price. That will also take care of the point that anybody coming to the country to generate electricity would not need to know anybody in government to know the price.

Everybody is a price-taker, which is used to work into the financial analysis to ensure that one does not charge more than the approved price. The model is driven by what is called efficient technology, which is a gas turbine simple open cycle, because everybody know how much it would cost to build the same plant.

In other places of the world, it would cost about $400-$500 per mega watt. But in Nigeria, the operators are allowed over $800. There is at least $300 head room for the operators to be more efficient in their services, considering certain peculiarities of our country, especially where these power plants are going to be located. (very Good)

Sometimes the sponsors have to put in place the pipelines to bring the gas themselves. They have to pay compensation to land owners and communities where the projects are to be sited. If one is building a power plant in the Niger Delta, reclaiming the land alone by sand filling and preparing the ground for foundation laying, takes quite some time and resources.

NERC believes that MYTO will encourage investors, including the licensed independent power producers, to go ahead with the execution of the power projects.

How would the consumer fair under MYTO?

As one would be aware, the Presidency constituted the committee on accelerated power generation, to supply about 6,000MW of electricity within the next 18 months. The committee has been doing the due diligence on how to help the present administration realise its aspiration to produce 10-15,000MW during the first term. The data so far gathered have been plotted into the tariff scheme after making two propositions.

One, that the regulator needs to announce MYTO so that investors can make their financial and investment decisions; two, that having taken the pulse of consumers, if electricity prices are increased today, people are going to be very unhappy, because the level of electricity supply is still very low.

The best approach was for NERC to look t electricity prices and march that with when power will be stabilised, and then begin to reflect minimal increases.

In doing this, NERC proposed that one thing that cannot be compromised is covering the revenue required each year to make the sector viable.

But, to achieve this objective without government support, because though government has been subsidising the power sector 100 percent, no one seems to know where the money is going.

In line with this, NERC announced a new tariff structure that would take effect from July 1, this year, though the freezing of prices that have been in existence since 2002 will continue until July 2009. That will give the Federal Government some time to improve the level of power generation and supply beyond 4,000MW this year to close to 5,000MW by year end and 6,000MW next year. But, NERC has asked government for some subsidy to cover the shortfall in revenue as a result of the continued charge of the old tariff regime.

For the first time, government is being shown what it takes to run the power sector, though NERC is sensitive of the fact that with lack of power, if we increase prices this year and power is still not available, nobody will like it.

But, the investors need to know up to five years and beyond what the path is for prices, so that they can make their investment decisions that will take between 3 and 5 years. So, even operators with license, their plants are not going to come on stream immediately. It might take them 3 or more years. But, at least it would have given them some comfort to know, by the time their power is coming on line, what is likely going to be the price, subject to the correlations with inflation, fuel and other issues they do not have control over.

In return, NERC asked government for approval to create the Electricity Equalisation Fund (EEF) for the next three years, under which government will fund the first year 100percent, considering that there has been no increase in tariffs. At 4,000MW, whatever the shortfall is, in terms of the leakages, loses and everything else, the price will remain unchanged, while concentrating effort on fixing the system to stabilize the power supply.

Next year, July 1, 2009, the price will be topped up with about N1, raising it to N7, though the actual price would have been over N11. The following year, it would be raised to over N8, and then year 4 and 5, N10 on the average from the initial N6. That is what is called moving to correct pricing of electricity.

What happens with the equalisation fund?

The fund will be for three years, which will be declining by the third year and no more henceforth. After three years, government will not be throwing money into a black hole. It will pay the difference between what the consumer can pay and what is being lost through other systems, though within those three years, there would be a whole roll out of prepayment meters, repair line losses, set up better systems in revenue collection and step up the level of efficiency in providing more electricity. So, the more power availability is increased, revenue would go up and government support will go down.

Once the equalisation fund is approved by the Federal Executive Council, NERC believes that it would give comfort to both the consumer and investor, because government is not distinguishing between government-owned power plants and the joint venture companies. Whether one has a prototype agreement everybody needs to be paid. Government money is not free. Even when the 11 government-owned power plants are completed, MYTO would recover them, because government can use the money to build roads, hospitals, etc. Therefore, there must be a reasonable rate of return on investment and cost recovery as stated in our law.

How would MYTO take care of the interest of the poor?

There is a provision that takes care of the interest of the poor, though the suspicion is that its implementation would encourage fraud. But, NERC has proposed that the implementation would be later. Since prices are to be saved in the next one year, the period could be used to put final touches on the power consumer assistance fund, which is identified in the law.

There is a provision that calls for the setting aside of a certain amount of money to pay for the poor. It also calls for the Federal Government to contribute by going to the National Assembly to ask for appropriation for that purpose.

NERC will go ahead to design it and try to identify under residential customers - R1, R2, R3, R4 and R5 - who they are. Whether government says the first 50units of electricity is free to the consumer, because even where one is consuming low now, when power becomes more available, the consumption will increase. Therefore, if government does not do something, the poor will get poorer, and might just drop off and return to using firewood and kerosene, which is where NERC does not want to go. This happens in every society, where the poor are given subsidy to survive.

The power distribution companies would supply those classes of consumers identified as legible and the first units of electricity approved for that purpose will go to them, and when the bill for their consumption comes, they can go to the fund to draw money to settle it. The objective is to ensure that everybody who works in the system - GENCOs, TRANSCOs and DISCOs - gets paid.