Electricity Distribution Companies – The Challenges and Way Forward, By Odion Omonfoman
Electricity Distribution Companies (Discos) provide last mile services in the electricity supply value chain. Discos provide the connection between customers and the electricity grid and as such, are plagued with the “last mile problem” of high costs and quality of service similarly faced by last mile service providers in the telecoms industry. Discos are responsible for transforming or stepping down electricity from the high voltage of 132 kV at the transmission level, to the lower voltage levels of 33kV/11kV/0.415kV depending on the category of customer. Electricity in most residential homes is supplied at voltage level of 0.415kV. Discos are also responsible for the marketing and sale of electricity to customers. This is an extremely important function in the electricity value chain as Discos are the cash boxes of the entire electricity value chain. All the revenue needed to sustain the electricity industry is earned through the distribution sector.
Privatisation of Discos and Issues Arising
There are eleven successor Discos in Nigeria, arising from the unbundling of the Power Holding Company of Nigeria (PHCN). The Discos and their coverage states are listed below.
|Successor Disco||States Covered / Franchise Areas|
|Abuja Disco||FCT, Niger, Nassarawa, Kogi|
|Benin Disco||Edo, Delta, Ekiti, Ondo|
|Enugu Disco||Imo, Anambra, Ebonyi, Abia, Enugu|
|Eko Diso||Lagos State (Victoria Island, Lekki, Lagos Island, Apapa, Epe, Ikoyi, etc)|
|Port Harcourt Disco||Rivers, Bayelsa, Cross Rivers, Akwa Ibom|
|Ibadan Disco||Oyo, Ogun, Osun, Kwara|
|Ikeja Disco||Lagos State (Ikeja, Surulere, Ikorodu, etc)|
|Jos Disco||Plateau, Bauchi, Benue, Gombe|
|Kano Disco||Kano, Jigawa and Katsina|
|Kaduna Disco||Kaduna, Sokoto, Kebbi and Zamfara|
|Yola Disco||Adamawa, Borno, Taraba and Yobe|
The eleven Discos have been fully privatised and are private sector operated and managed, with the exception of Yola Disco, where the core investor declared force majeure arising from the continued insurgency in North-Eastern Nigeria. The Bureau of Public Enterprises (BPE), on behalf of the Federal Government and Labour, own 40 percent of the shares of all the eleven Discos, while various Core Investors have a 60 percent shareholding in the respective Discos.
ATC & C Loss Reduction
The privatisation of Successor Discos was done using the concept of Aggregate Technical, Commercial and Collection (ATC&C) loss reduction. Under this methodology, the investor that proposed the highest ATC&C loss reduction (in absolute percentage terms) over a five-year period was deemed to have won the bid for the shares of the Disco. The ATC&C loss reduction concept was preferred over other sale evaluation methodologies to ensure that core investors addressed the fundamental issues of high losses in the operations of Successor PHCN Discos. Before going on, it is important to explain these losses, as it is fundamental to understanding the issues faced by Discos.
Technical (distribution) losses are electrical losses arising from the transformation of electrical energy into heat energy as it flows through conductors. As electricity flows through wires and transformers, some electricity is lost as it changes into heat and sometimes, light energy (electrical sparks) and is dissipated. All electrical systems and conductors have technical losses. Commercial losses are revenue losses arising from electricity theft, poor billing practices, cash theft or diversion, inaccurate customer database, wrong tariff classification of customers, unmetered customers and unaccounted energy. Collection losses are simply revenue losses arising from discos’ inability to collect revenues for energy billed to known customers. Discos’ inability to collect billed energy could be as a result of poor billing data, revenue collection inefficiencies, customer default or recalcitrance in paying their bills. Commercial and collection losses are usually collectively referred to as non-technical losses. The importance and impact of ATC&C losses in determining electricity tariffs under the current MYTO tariff methodology will be discussed in a future paper.
Core investors who posted the highest ATC&C loss reduction percentages effectively promised to reduce ATC&C losses by making the necessary capital investments in network improvement and metering infrastructure to address these losses, and in addition, optimise the operations of the Disco, which they bid for. This promise was captured in a Performance Agreement with the BPE. Core Investors who do not achieve the promised ATC&C loss reduction at the end of five years, would effectively lose their investments and will only be entitled to receive a one-dollar compensation from the government.
However, the major drawback to the ATC&C loss reduction methodology is the absence of credible baseline loss data to ascertain the existing loss levels at the point of handover of the Discos. Two years after the Discos were handed over to Core Investors, there is still no credible baseline data establishing loss levels. Without a credible baseline data, it has proven quite difficult to measure the level of ATC&C loss reduction so far achieved by Core Investors since handover in line with the Performance Agreement.
Two years after the conclusion of the privatisation process, Discos are faced with huge operational challenges, which are clearly visible in their operations and service delivery. Some of the challenges include a lack of sufficient energy supply from grid; old, obsolete networks; lack of maintenance of network equipment; poorly trained manpower; poor customer data; low meter penetration; health, safety and environmental issues; and a near absence of investments due to poor revenues, inadequate tariffs and external funding constraints. These challenges could be summarised into the following broad categories:
• Grid energy insufficiency and instability;
• Network infrastructure challenges (overloaded transformers and feeders, obsolete equipment, limited network, lack of automation, etc);
• Tariff challenges and revenue shortfalls (non-cost reflective tariffs, low collection efficiency, etc.);
• Metering challenges (huge metering gap, estimated billing, poor meter maintenance, etc.);
• Operational challenges (long feeders, quality of workforce, large operational areas, etc.);
• Energy theft;
• Funding challenges (absence of long term “patient” capital (equity/debt) to fund capex investment, high cost of borrowing, poor credit history of Discos, etc).
While these challenges may have severely constrained the operations of Discos and thus, the non-realisation of the supposed gains of the privatisation of the power sector, it is important to state that these challenges were precisely the reason why the privatisation of the power sector was done in the first place. The broad objective of the privatisation was for the private sector to address these challenges that had plagued successor Discos while under government ownership. The reality is that these challenges were underestimated and in some instance, completely overlooked, by the BPE, NERC, core investors and their financiers. Notwithstanding, we must emphatically state that this is not a rush to judgment about the power sector privatisation process. These challenges are teething challenges that core investors are faced with, and would eventually overcome with the right investment and reasonable time.
Arising from the above summary of the challenges, a central theme underpinning these challenges is the revenue and funding challenge. Without funding or improving the revenue profile of Discos, there is a certainty that these operational challenges would continue to subsist. Thus our proposed way forward deals largely with addressing the tariff, revenue and funding challenges to Discos. Other ideas are proposed as well.
Capitalisation of Discos
One of the myths in the privatisation of discos is that Core Investors injected millions of dollars paid as acquisition price for 60 percent shareholding into the Discos. This myth is false as the acquisition price for the shares was paid directly to the Federal Government and not a penny was injected into the Disco operations. It is also important to state that the Core Investor and the Disco are two separate and distinct entities. A lot of people including industry experts confuse the core investor entity with the Disco. As a first step towards resolving the financing challenges facing Disco operations, Core Investors, in line with their performance agreements, need to urgently capitalise disco operations by the injection of “patient” capital by way of long-term debt or equity. It is imperative that Core Investors inject significant patient capital to address the challenges mentioned above. Short-term debt or borrowings will not suffice and will only serve to exacerbate the financing and operational challenges. Irrespective of the downward trend of the All Share Index, the Nigerian Capital Market is ripe for equity capital raising by Discos and their Core investors via IPO and listing of shares either at the disco level or at the core investor entity. Nevertheless, there is a significant reluctance by Core Investors to go the way of an IPO and list Disco shares, as this would dilute their shareholding. But the greater constraint to equity capital raise by Core Investors is the anti-dilution restriction placed by the BPE on Core Investors, which effectively constraints them from diluting their shares at Disco level and the acquisition vehicle by no more than five percent for the next five years. The BPE needs to immediately relax this onerous requirement to enable Core Investors raise the much needed equity financing.
Access to Long Term Debt Financing
In the absence of equity injection, Discos are left to raising debt for their operations. Unfortunately, these debts have been largely expensive and very short tenured from commercial banks. Given that return on investment for Disco utilities are long term, Discos must be able to raise matching long-term debt to fund their operations and realise their investment. Nigerian banks, having supported the privatisation process by providing acquisition financing to Core Investors, must now take up the more important responsibility of providing long-term debt financing and working capital finance to Discos for their operations. The Central Bank of Nigeria (CBN) is instrumental in nudging commercial banks in this direction and also setting up some minimum power sector lending guidelines for banks (which could stipulate minimum interest rates, tenor, moratorium, loan provisioning vis-a-viz prudential guidelines, special CRR provisions or other reliefs to banks, etc.) that would stimulate banks to lend to Discos and the power sector in general. Kudos must be given to the CBN on account of the CBN sponsored Nigerian Electricity Market Stabilisation Facility, a 10-year intervention facility to the power sector, which has helped to provide low cost, long-term debt financing to Discos. Only recently, Kano Disco unveiled over 62,000 energy metres financed using the CBN facility. Some discos have made moves to raise long tem debt by way of debt securities issuance and listing and quotations of such securities on the OTC market. This should be encouraged and looked at with a view to getting more Discos to adopt this strategy.
BPE as an Enabler of Financing to Discos
BPE as a 40 percent shareholder (and effectively the largest investor in Discos) also has a role to play in enabling the provision of long-term capital to Discos. The BPE is in a position to leverage its shareholding in all eleven discos under a structured financing, to raise long-term debt capital on behalf of Discos. In addition, the BPE must be ready to also dilute its shareholdings in Discos as well should the need arise. This may not be the BPE’s core role but it needs to look at taking on this mandate for the privatisation process to be successful in the long run.
Implementation of a Cost Reflective Tariff
Underpinning any debt or equity capital raise is a sustainable and cost reflective electricity tariff and a long-term tariff path. Without cost reflective electricity tariffs, the electricity sector is not likely to attract and sustain the much needed investments. The Minister for Power, Mr. Babatunde Raji Fashola gets it. However, there is a conundrum. Should there be tariff increases before customers enjoy better services in terms of regular and stable power supply? By regular and stable power supply, we do not mean customers having 24-hour power supply but simply an improvement in the hours of supply and the quality of power supplied. The case for electricity tariff increase is strong and compelling. While we believe it is imperative that there should be a tariff increase as canvassed for by the Minister and NERC, we are of the view that customers need not bear the impact of increased tariffs prior to experiencing an improvement in supply. Any immediate increase in electricity tariffs to be passed on to ratepayers, without an improvement in the hours and reliability of supply will lead to greater revenue losses. This is a fact. Tariff increases cannot also be passed on to ratepayers when more than 60 percent of electricity customers do not have metres. Our view is that there should be tariff increases, but such tariff increase should not be immediately passed on to ratepayers. Ratepayers should not bear the immediate impact of such tariff increase without any commensurate improvement in supply.
Addressing Fixed Charges
A contentious issue is the issue of fixed charges. The rationale for fixed charges must be understood by electricity customers. Regardless of energy flow, there are huge fixed costs to the sector, which must be recovered through fixed charges. Fixed charges also provide some level of guaranteed revenue to the sector. However, fixed charges promote moral hazards as well, and are not fair to ratepayers who have to bear the fixed charges, irrespective of the quality of electricity supply. Thus the agitation by customers for the removal of fixed charges and transposition of fixed charges into energy charges based on supply. While this is the way to go, we must point out that, to the extent that grid supply (at approximately 4,500 MW) still remains inadequate and unreliable, revenues to the electricity industry will be impacted negatively. The onus will now rest with the entire electricity value chain, from generation down to distribution, to improve power supply to electricity customers to ensure revenue adequacy in the sector.
Adopting Off-Balance Sheet Funding Solutions
Discos are encouraged to adopt off-balance sheet funding solutions to fund key capital items such as metering, network expansion and embedded generation. Off-balance sheet funding solutions include outsourcing metre financing and operations and vendor financing. Discos also need to start looking at franchising opportunities, particularly in rural areas or areas with high losses.
Funding On-going Revenue Shortfalls
The entire electricity sector is faced with huge revenue shortfalls. The implementation of cost reflective tariffs, access to long-term debt capital and equity injection, will still not address the revenue shortfall to the system in the short term. It must be understood that there is a lag time between the period these investments are made and the accrual of benefits. Even if all the required financing were available today, it would take time for technical and non-technical losses to be addressed. For instance, it takes between 9 to 12 months to build injection substations. It will take at least 2 years for a disco address its metering gap. Also, there is a time lag for additional generation and transmission capacity beyond the 4,500 MW, to the grid. Electricity customers cannot be made to pay increased electricity tariffs in the interim and there is no guarantee that they will pay the increased tariffs. Thus it makes sense for the system to plan for how the revenue shortfalls will be addressed on an on-going basis. Simply pushing for full implementation of the Transition Electricity Market (TEM) without a methodology to address the revenue shortfall is planning to fail. Again we emphasise the local PRG solution underpinned by a debt issuance programme by NBET, earlier mentioned in previous write-ups, as one of the solutions to funding the revenue short fall to the system in the short to medium term.
Odion Omonfoman is an energy consultant and the CEO of New Hampshire Capital Ltd. He can be reached on email@example.com