Power reforms thus far: mammoth investments; puny impact…

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Thursday, January 21, 2016 10:04 AM / ARM Research

 

Today’s focus is on issues bothering on fuel subsidy and power reforms over 2015 and ARM’s outlook on same for 2016. Recall that the FGN spent over N1 trillion on subsidy claims for oil marketers over 2015, an amount that also reflected subsidy backlog from prior year as well as adjustments for currency and interest rate changes. Given the current downturn in oil price, FG may have concluded plans to gradually deregulate PMS prices given its resolve to allow components of PPPRA pricing reflect current economic realities. 

 

With regards to the power sector, CBN disbursed 30% of its N213 billion power intervention fund earmarked for turnaround maintenance of facilities, capacity recovery at power stations, among others in 2015. Importantly, the new Minister of Power, Works and Housing sanctioned the long-dragging upward review of electricity tariff in the country.

 

We expect the recent increase in electricity tariff to cascade to improved margins for Discos who have previously struggled with cost of electricity due to second order effect of higher gas prices.  However, with only 15% of TCN’s ongoing projects due for completion in the next one year and with embedded power supply option yet to attain significant progress, transmission challenges are likely to persist in 2016.

 

Subsidy in the spotlight

 

Over the last 12 months, FG has spent over N1 trillion on subsidy claims for oil marketers—with the amount also reflecting subsidy backlog from prior year as well as adjustments for currency and interest rate changes. The expensing of this sum at a time of severe financial challenges, with state governments already clamoring for a downward review of the N18,000 minimum wage barely 3 months after receiving FG’s bailout funds, posed questions on the overall reasonability of the subsidy regime. In particular, the World Bank noted that current declines in oil prices to multi-year lows present the Nigerian government a clear opportunity to get rid of the contentious oil and gas regulation. To be clear, last updated information on PPPRA’s PMS pricing template also puts current subsidy payment at N6.18 per litre (vs. ~N32 per litre in the first 10 months of the year), which based on current consumption of about 40 million litres, would imply annual subsidy budget of N90 billion for 2016 — a relatively small figure.

 

Thus, sensing the opportunity to transit into deregulation with minimal threat of backlash from the populace, FG may have concluded plans to gradually deregulate PMS prices. As premise for this surmise, we note that the government recently communicated 2016 budget with a resolve to allow components of PPPRA pricing reflect current economic realities.

 

However, the minister of state for petroleum fell short of describing this FG’s agenda as a subsidy removal tagging it price modulation instead. According to him, in view of the new pricing strategy, the Petroleum Products Pricing Regulatory Agency (PPPRA) has been directed to adjust its pricing model to reflect competitive and market driven components. In contrast to previous cases of adjustments (most notable in January 2012) though, the new arrangement is unlikely to lead to higher PMS prices with oil prices still significantly subdued (and other hitherto fixed components likely to be revised lower). In this arrangement, PMS prices would not be fixed but possibly banded by an upper interval of N97 per litre, according to the minister. Importantly, government’s current posture is now considerably closer to global realities where countries—including India, Ghana, Egypt, and Argentina—that faced twin deficits  over the last couple of years commenced gradual phase out of subsidy on petroleum products. In any case, with regulation a bit more relaxed and expected further declines in oil prices pointing to sustenance of the current trend, private investors look set to find a more benign business environment come 2018.    

 

Power reforms thus far: mammoth investments; puny impact…

 

Since February 2015, CBN has disbursed 30% of its N213 billion power intervention fund earmarked for turnaround maintenance of facilities, capacity recovery at power stations, purchase of meters, rehabilitation of transformers, procurement and construction of new distribution substations, among others. According to the apex bank, the disbursements of the funds has allowed Discos purchase 171,071 prepaid meters, and rehabilitate over 332 kilometers of 11KV lines as well as 130 kilometers of 0.45KV lines since the commencement of the programme.  In addition to CBN’s efforts, a number of Discos have entered into partnerships with global ICT firms to increase meter production and distribution in 2016. More importantly, the new Minister of Power, Works and Housing—Babatunde Fashola—went ahead to sanction the long-dragging upward review of electricity tariff in the country despite patches of public agitations to the contrary.

 

The review effectively scraps out fixed charges (an approved amount of money that consumers pay whether or not electricity was consumed over the period) while instituting ~70% and 52% increases in variable cost of electricity for residential and commercial customers respectively.

 

According to NERC, the new tariff is structured to incentivize investors across the power value chain while guaranteeing fairness to end users. To the former, higher tariff is expected to boost Discos who had hitherto seen margins shrink due to ~120% increase in cost of gas per unit to $3.30.  Benefits to the end users were linked to the removal of the controversial fixed charges as well as the opportunity provided prudent consumers to be in full control of their electricity expenses through a more economic use of prepaid card meters.

 

The new tariff system was also structured to take account of CBN’s power sector funding, current levels of energy output, baseline gas prices and other variables that more closely reflect the true cost of running electricity businesses in the country. Despite FG’s best efforts at rationalizing the decision, agitations from agencies such as CATEIN and The National Association of Chambers of Commerce and Industry, Mines and Agriculture (NACCIMA) continue to linger.

Specifically, NACCIMA faulted the tariff review on the grounds that consumers have hitherto overpaid for electricity due to inefficiencies in the system that have often take the form of outrageous bills.

 

Table 1: Changes in variable cost of electricity per KWh 



At another level, following relatively more stable gas supply over H2 15, power generation has since moved from a low of ~3000MW in May to an average of 4600MW over the last six months of 2015. Without much ado, FG was quick to pin the improvement on its progressing clamp down on pipeline vandalism as well as infrastructure upgrade—partly a fall out of CBN’s power fund allocation. FG has also hinted at the possibility of further northward review of gas prices to increase influx of private investment resources into gas infrastructure while reportedly intensifying plans to boost NNPC’s investment in critical gas infrastructure over the coming 18 months. The latter investment is expected to enhance gas supply to associated power plants and generate an additional 2000MW of power in the process.   

 

In addition to the developments at both the distribution and generation phases, Transmission Company of Nigeria (TCN)—owned by government but managed by Manitoba of Canada—noted that its capacity (5300MW) remains a nudge ahead of power supply (with peak at 4662) over most of 2015. According to its management, TCN was successfully wheeling out 4662MW of power supplied over the latter half of 2015. However, slower speed of progress on transmission projects may make it difficult to keep pace with developments in power generation, highlighting potential complications in the process of transporting purchased power from GENCOs to sub stations of Discos in the coming periods. To proactively combat this, TCN recently shortlisted 30 local and foreign investors willing to invest in transmission infrastructure as it steps up plan to expand capacity to 8000MW by end of 2016. Highlighting the scale of the funding challenge—especially amidst stifled FG revenues, TCN noted that a minimum of about N15 billion annual private funding/investments over the next three years would be required to push transmission capacity to the 8000MW mark. Whilst TCN is yet to give full clarity on modalities for repayment to the potential 30 transmission investors, it however made it explicit that there would be no form of sovereign guarantee for the funding from the private participants. Repayment for their investment is billed to stem from wheeling charges which is part of TCN’s internally generated revenue. Regardless, as has been the situation over the years, bureaucratic process involved in obtaining government approval would have to be scaled to determine government’s readiness for this investor finance scheme. The potential bureaucracy would be particularly regrettable considering TCN’s assertion that government’s failure to meaningfully improve its funding to the transmission segment caused a number of projects to stall in the pipelines.

 

Nonetheless, a greater allocation of planned capital expenditure (i.e. 24% of total N1.8 trillion earmarked; 2015: N55billion 8% of proposed capital expenditure) to the ministry of Works, Power, and Housing appears to signpost better intent from government going forward.   

 

In contrast to TCN’s more optimistic standpoint, the new minister subsequently declared that transmission capacity is currently unable to support all generated power in the country, unveiling greater depth of concerns at the transmission end in the process. Additionally, the minister hinted that, of the entire 142 identifiable transmission project in pipeline, only 22 can completed within the next 12 months, implying a possible protraction of the noted transmission concerns when weighed against further additions to generation capacity already mentioned. Perhaps also buttressing the minister’s view point is NERC’s support for embedded power supply across the country as a near term solution.  This process will enable GENCOs supply electricity directly to Discos without going through the transmission system networks. The urgency to address transmission issues is mainly re-enforced by an expected ramp up in power generation in the next 15 months that could mount more pressure on the current transmission facilities. 

 

Figure 1: 142 TCN Projects and Status 


Going forward, we expect the recent increase in electricity tariff to cascade to improved margins for Discos who have previously struggled with cost of electricity due to second order effect of higher gas prices.  In addition, with Discos largely sorted, both GENCOs and TCN look set to enjoy a more improved cash flow position in 2016 in view of an expected improvement in payment turnaround time for power generated and transported. Away from these positives though, the disbursement of CBN’s power fund appears to have assumed a much slower pace over the last 9 months. Specifically, whilst in the first month of implementation a total of N58 billion was disbursed to selected GENCOs and Discos, the subsequent 9 months only saw an additional N7 billion allocated to power companies nationwide. This translates to an average monthly allocation of N778 million over the period and signals an obvious temperance in power fund allocation. We believe this reflects stringent key performance indicators (KPIs) attached to the fund by the CBN as well as delays in scheduled implementation of commercially viable tariffs. Additionally, with only 15% of TCN’s ongoing projects due for completion in the next one year and with embedded power supply option yet to be attain significant progress, transmission challenges are likely to persist in 2016.

 

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