Solutions to Addressing The Challenges of the Power Sector Privatization

ELECTRICITY

In recent times, there have been strident calls for the privatization of the power sector to be revisited or reversed. The latest to join the call is the Nigerian Senate which debated the privatization of the power sector and the seeming failure of the power sector, particularly the Discos.In this article, we highlight our thoughts on potential solutions that could be explored to correct some of the shortcomings of the privatization outcome for Discos.It is our hope that the proposed solutions will guide the current discussions and stimulate a broader debate on how to address the short comings of the privatization process.

Privatization vs. the Electricity Market

It is important to distinguish between the privatization of PHCN Successor Companies and the efficient operations of the electricity market. The first relates tothe sale and acquisition of government shares in business entities i.e. PHCN Successor Gencos and Discos, to private sector Investors. The second is the actual operations of the Nigerian electricity market, involving licensed market participants inclusive of the privatized Gencos and Discos. Making the power sector work more efficiently by resolving the numerous challenges in the electricity market is far more complicated and goes beyond simply reversing the sale of government’s shares in Discos and Gencos.

The privatization transaction documents

The privatization of PHCN Successor companies was a key plank of the power sector reforms. The objectives of the privatization were to promote efficiency, increase private sector funding of the power sector, increase power generation, and make the power sector more viable under private sector management.The privatization, rather sale of government’s shares in Discos and Gencos was underpinned by the following transaction documents (i) Share Sale Agreement,(ii) Shareholders Agreement and (iii) the Performance Agreement. The Parties to the three agreements are the Core Investors for each of the PHCN Successor Companies and the BPE acting on behalf of the Federal Government. These agreements relate to the rights and obligations of the shareholders (the Core Investor and the Federal government) in the Successor Companies. These three Agreements are outside of the regulations of the NERC and the Ministry of Power.

The Performance Agreement documents the Core Investor’s obligations made in the bid proposals, upon which the Core Investor was declared the Preferred Bidder for the successor company. It also documents the terms which a Core Investor can either handover or put the shares or assets of the Successor Company to Government (Put Option) or the terms on which Government can take back or call the shares of the Company from the Core Investor (Call Option).

The Industry Agreements are primarily (but not limited to) the Vesting Contracts and the Power Purchase Agreements (PPA). The industry agreements define the relationship between the privatized companies who are registered participants of the electricity market and licensees of the NERC and other market participants in the Nigeria Electricity Supply Industry (NESI).

Should the power sector privatization be reversed?

We share the views by H.E Babatunde Fashola, SAN, that the reversal of the power sector privatization is not an option. We must also state that the privatization of the power sector has not been a complete failure; there have been immeasurable gains such as the creation of NBET, increased average generation capacity from pre-privatization levels, government’s firm commitment to make investments in the TCN, new practices in Discos and general increased investment across the power sector value chain.

Way forward

Based on the provisions of the Transaction Documents cited above, we opine that there are four options available to the Government to explore, should government decide to revisit the privatization process for Successor Discos:

  1. Dilution of Core Investor shares in Discos to below 60%;
  2. Declaring Discos bankrupt and commencing bankruptcy proceedings against Discos;
  3. The Nuclear bomb option – the BPE exercises its Call Option;
  4. The passive, “do nothing” option

Option 1 – Dilution of core investors’ majority shareholding in discos

Diluting the shareholding of Core Investors is the most feasible way the FG can revisit the privatization process and take control of the Discos.To achieve this, the FG should rely on the further funding clause in the Shareholders Agreement. The further funding clause allows the BPE as a 40% shareholder in the Disco, to inject capital into the Discos in the event that there is a requirement for further funding which the Core Investor is unable to provide. The clause allows the BPE to dilute Core Investor’s equity in the Disco by such funding. At the moment, Discos have negative capital if you consider the amount Discos owe NBET and the Market Operator (MO). Thus the dilution mechanism is based on converting the huge liabilities of Discos to NBET and the MO into equity in the Discos.

The conversion of existing liabilities of Discos to the market, restores Discos’ current negative balance sheet to positive capital. The argument has always been that Government should be able to hold Core Investors to account where they fail to meet their committed obligations. Hence, the potential dilution of their majority shareswould put Core Investors in Discos on the straight and narrow path.

Option 2 – Declaring Discos bankrupt and appointing a liquidator to run the Discos

A Discobeing declared bankrupt is an event of default on the part of the Core Investor under the Performance Agreement. Today, Discos are “technically” bankrupt, based on Discos huge liabilities to the NBET, Market Operator (MO) and the CBN. A practical way to force Discos into bankruptcy and eventual receivership is for NBET to trigger the activation and drawdown of the Discos’ payment security to NBET/Gencos in the form of a three (3) months Letters of Credit (L/C).In declaring a Disco bankrupt, to the extent that the core investoris unable to re-capitalize the Disco, then the Government can take-over the shares and assets of the Discos through a government appointed liquidator. However, Option 2 may likely do more harm to the electricity industry.

Option 3 – The nuclear bomb option

Under this option, the BPE can simply terminate the Performance Agreement and call the shares of the Discos. However, if the Performance Agreements are terminated in this manner, the Federal Government would have to pay core investors their invested equity plus a 20% return on their equity over five years. It is a steep price that the Federal Government would pay, should it go with this option.

Option 4 – The “do nothing” approach

The other feasible alternative to government is to wait out the remaining term of the five (5) year performance period for Discos to achieve their ATC & C targets documented in the Performance Agreements, then buy out the Core Investor for USD$1.00 where the agreed ATC&C loss reduction targets were not met at the end of the five-year period. This option would necessitate the BPE and NERC to either assess or verify ATC&C loss reduction targets by Discos in line with their bid targets.

Given that the Discos were handed over to core investors on November 1, 2013, the five-year period should have elapsed by October 31st, 2018. However, the last NERC board, working on advice from the BPE, reset and extended the five-yearcalendar for Discos by another two years, owing to NERC, BPE and Core Investors’ inability to carry out the mandatory baseline ATC&C loss studies within the specified timeframe under the Performance Agreement. Given the present scenario, the reset of the five-year performance calendar to October 31, 2020 should be voided if possible.

Caution!

The liquidity crisis and other challenges affecting the power sector cannot be ascribed solely to Discos non-performance. Government too must share in the blame. Thus, we must sound a note of caution and warn that any government takeover of Discos may not likely yield any better results in terms of improvements and efficiency in the power sector. Nor would it address the liquidity crisis. As an example, Yola Disco is currently run by the Ministry of Power, having been handed back to the government by the Core Investor based on the Boko Haram insurgency in the North East. However, more than one year after taking over the operations, the FG hasn’t done anything “spectacular” in Yola Disco in terms of achieving faster metering, network upgrade and ATC&C loss reduction. Yola Disco is still unable to meet in full its payment obligations to NBET and also to the Market Operator. The TCN, under the full control of the Federal Government, is another example. To date, TCN has been unable to attract the needed quantum of funding, as well as managerial and technical expertise required to operate and improve the national grid. However, the recent drive by the Minister for Power, Works and Housing in securing funding for the TCN has started yielding positive results.

Should the FG centralise and escrow Discos revenues?

It is ironic that government, as the largest debtor to Discos, is seeking to also control Discos’ revenues as well. Centralization and escrowing of Discos revenuesas being suggested by the Minister for Power Works and Housing, is not a viable option in today’s privatized power sector industry. Under the Market Rules, the penalties for non-payment or partial payment are monetary penalties, not seizure of Disco revenues. The CBN Nigeria Electricity Market Stabilization Facility (NEMSF) structurealso does not create a single central revenue account for all Discos. In any case, NERC and the Ministry of Power should be mindful of the default event clause of the Performance Agreement which defines an FG default event to include “the expropriation, nationalization or compulsory acquisition by any Regulatory Authority of any constituent element of the Business other than under the terms of any of the Transaction Documents, provided such element is of a nature such as to materially affect the performance by the Purchaser of its obligations under this Agreement or the exercise of its rights”.

Creating a central revenue account for all eleven Discos is a violation of the terms of the sale of Disco shares to Core Investors under the privatization process.

Conclusion

The privatization of the power sector, while transparently conducted, was fraught with a number of missteps and was set to go wrong from the start of the process. Four years after, the privatization of the power sector has proven to be problematic, and may result in a sovereign debt burden for Nigeria and Nigerians. The time has come for government to be strict on the ensuring that the privatization of the power sector is not derailed.Decisive, bold, and well thought through plans to rescue Discos is what is now required to save the impending collapse of the power sector.

If Government is going to commit to US$7.6bn of investments in the sector under the power sector recovery plan, then urgent, radical changes in the operations and management of Discos need to happen. Government needs to either exert control of the Discos or hold accountable their Core Investors with a view to making Discos more efficient in their operations. Else, the proposed $7.6bn funding for the power sector may turn out to be a mirage with the current state of affairs and management of many of the Discos. It’s a potential debt trap for Nigeria.

Lastly, there will be legal fallouts between Government and the Core Investors as government seeks to exert more control of Discos operations. As they gear up to lace their boots in preparedness to handle briefs, the lawyers on both sides should remember that the goal of the privatization is to create a sustainable and viable electricity market.

Source: BusinessDay

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