Part 8: Industry Bundle- Tariffs, Subsidies, Distribution Franchising, and Electricity Theft
The Making and Evolution of an Electricity Market: Unpacking the Nigerian Electricity Bill, 2021
In the seventh part of the multi-part series that unpacks the Electricity Bill, 2021, the establishment of an Independent System Operator (ISO) within the Bill was highlighted alongside the implications for the industry.
In this eight part, a bundle of industry developments within the Bill are highlighted alongside the implications for the industry, in a bid to educate readers on the process, evolution and dynamics of electricity markets.[1]
Commendably, the Bill subjects additional activities to tariff regulation including supply, electricity distribution franchising, etc. In addition, tariff methodologies by the Nigerian Electricity Regulatory Commission (NERC) are to promote co-generation of electricity from renewable sources. Cogeneration (also known as combined heat and power, distributed generation, or recycled energy) (CHP) is the simultaneous production of two or more forms of energy from a single fuel source, typically mechanical energy, and thermal energy. Cogeneration is beneficial to the environment because the recycling of waste heat will save other high polluting fossil fuels from being burned. With the trend of lack of power generation capacity across Sub-Saharan Africa resulting in countrywide blackouts, cogeneration may be a viable option for industries. However, the right technologies must be in place and cogeneration projects usually require long offtake agreements, thus, they may place a burden on a company’s balance sheet, if the pricing dynamics are not favourable compounded with the possibility of low commodity prices globally. Nevertheless, with increasing gas availability on the continent alongside unstable domestic power supplies, the market for cogeneration technology may witness significant growth in the near future.
The Commission by the Bill is empowered to approve any willing-buyer, willing-seller ring fenced arrangement that allows licensees to enter bilateral contracts to offer premium services to a class or classes of customer at different tariffs, other than the approved tariff methodology. This speaks to bilateral contracting in the Nigerian electricity supply industry. Such bilateral contracts theoretically, may be agreed between the seller and buyer for any period, dispatch profile or price. Nevertheless, to prevent abuse of market power, restrictions may be placed upon the terms of the contract by the market rules. The aim is to improve efficiency through competition, promote better payment discipline and enhance power sector security of supply, generation adequacy and develop power sector sustainability in addition to ensuring accountability, transparency, and predictability in the market. However, consideration should be given to the possibility of higher transaction costs in terms of search costs for evaluating counter-party credit risk. In addition, because electricity production and consumption by sellers and buyers do not usually match contracted amounts, there is a need for a balancing mechanism for the system operator to maintain real time equilibrium. Also, there is a need to develop transmission access and pricing regime that reflects capacity constraints and loss factors in the high-voltage network. Institutional and technical constraints need to be addressed, as direct contracting between generators and distributors may lead to suboptimal dispatch schedules; although the structure usually anticipates the existence of a Balancing Mechanisms to settle deviations between contracted and actual amounts.
The Bill makes provision for the Commission to allow lifeline tariffs for some consumers. A lifeline tariff is a concessionary tariff for electricity that is usually granted to a section of a given population unable to financially afford to pay for basic electricity needs, at a rate that represents the true cost of supply. Such tariffs are targeted subsidies based on the consumption level of households. Although ideally, uniform tariffs should apply across all customer classes to ensure cost-reflectivity, lifeline customers are usually exempted from such provisions and several approaches can be adopted such as the increasing block tariff (IBT) approach, such that consumption up until the average consumption rate per month is set at a lifeline tariff and any excess above the average consumption rate in a given area is charged at a standard rate, in such a way that enables it cross-subsidise the lifeline tariff.
Regarding cross-subsidies, the Commission is to facilitate the gradual reduction in cross-subsidies and is to completely phase-out cross-subsidies before the declaration of the commencement of the Long-Term Market Stage anticipated within the Bill, to avoid the obstruction of competition in the retail supply of electricity, given the impact of subsidization, leading to economic distortions that will affect the supply and demand balance. Cross subsidization is the practice of charging higher prices to one type of consumers to artificially lower prices for another group of consumers. If not properly phased out, it may bring about rising price elasticity of electricity demand in industry and force the industry to seek energy alternatives. Cross subsidies should be financed in a way that imposes the least degree of distortions on the tariffs of other customer categories, pending phase-out. The Bill ought to clearly spell out the pre-conditions and timelines required for the complete phasing out of cross-subsidies within the market staging process.
The Bill allows for distribution or supply franchising arrangements or any other commercial arrangement between the distribution or supply licensee and third parties within the applicable distribution or supply licensees’ operations and coverage areas, in line with approved franchising terms, franchising models and tariffs as approved by the Commission.
Commendably, the Bill provides scope for punitive measures to be put in place against electricity theft and other offences peculiar to the power sector. Furthermore, the Bill establishes the Federal Power Task Force, responsible for the monitoring and enforcement of offences under the Bill including the apprehension and prosecution of persons suspected of electricity theft, meter tampering or bypass, etc. Nevertheless, the Bill fails to ascribe substantial weight to the theft of electricity with insufficient deterring sanctions. The Commission will need to put in place an Electricity Theft Regulation that will adequately curb the ongoing menace of electricity theft currently plaguing the industry. The judiciary will need to be acquainted with the commercial, legal, regulatory, and certain technical framework peculiar to the electricity industry as it relates to electricity related matters.
Concluding Remarks
The deluge of industry developments factored within the Bill can be viewed as commendable and futuristic. Nevertheless, several considerations must be borne in the mind of stakeholders for the success and attainment of cost-reflective tariffs factoring life-line tariffs and the phase-out of cross-subsidies, bilateral contracting, franchising arrangements and curbing the menace of electricity theft in the Nigerian power sector.
Key Takeaways
Ø With the trend of lack of power generation capacity across Sub-Saharan Africa resulting in countrywide blackouts, cogeneration may be a viable option for industries. However, the right technologies must be in place and cogeneration projects usually require long offtake agreements, thus, they may place a burden on a company’s balance sheet if the pricing dynamics are not favourable, compounded with the possibility of low commodity prices globally.
Ø Bilateral contracts theoretically, may be agreed between the seller and buyer for any period, dispatch profile or price. Nevertheless, to prevent abuse of market power, restrictions may be placed upon the terms of the contract by the market rules. Consideration should be given to the possibility of higher transaction costs in terms of search costs for evaluating counter-party credit risk. In addition, because electricity production and consumption by sellers and buyers do not usually match contracted amounts, there is a need for a balancing mechanism for the system operator to maintain real time equilibrium. Furthermore, Institutional, and technical constraints need to be addressed, as direct contracting between generators and distributors may lead to suboptimal dispatch schedules.
Ø Although ideally, uniform tariffs should apply across all customer classes to ensure cost-reflectivity, lifeline customers are usually exempted from such provisions and several approaches can be adopted such as the increasing block tariff (IBT) approach, such that consumption up until the average consumption rate per month is set at a lifeline tariff and any excess above the average consumption rate in a given area is charged at a standard rate, in such a way that enables it cross-subsidise the lifeline tariff.
Ø Cross-Subsidies, if not properly phased out, may bring about rising price elasticity of electricity demand in industry, and force the industry to seek energy alternatives. Cross subsidies should be financed in a way that imposes the least degree of distortions on the tariffs of other customer categories, pending phase-out.
Ø The Bill establishes the Federal Power Task Force, responsible for the monitoring and enforcement of offences under the Bill including the apprehension and prosecution of persons suspected of electricity theft, meter tampering or bypass, etc. Nevertheless, the Bill fails to ascribe substantial weight to the theft of electricity with insufficient deterring sanctions. The Commission will need to put in place an Electricity Theft Regulation that will adequately curb the ongoing menace of electricity theft currently plaguing the industry.
[1] Electricity markets in the context of this brief speaks to the sector view as a whole, as opposed to the trading of electricity which exists as an activity within the sector.