Ensuring Regulatory Independence In the Power Sector, By Odion Omonfoman
Electricity regulation is still at its infancy in Nigeria. Prior to 2005, there was no independent regulation of the power sector, as the National Electric Power Authority (NEPA) was both the operator and regulator of the sector based on the NEPA or Electricity Act, LFN 1990. The Ministry of Power and Steel had some level of regulatory oversight in the sector as well. The passage of the Electric Power Sector Reform (EPSR) Act in 2005, created the legal framework for electricity regulation as well as the regulatory instruments for the power sector. In 2014, the Nigerian Electricity Management Services Authority (NEMSA) Bill 2014, was passed by the National Assembly to take over the functions of the Electricity Management Services Limited, one of the successor PHCN companies created by the EPSR Act. The NEMSA bill established the Nigerian Electricity Management Services Authority to regulate and enforce technical standards in the power sector.
The EPSR Act and Establishment of NERC
The Nigerian Electricity Regulatory Commission (NERC) was established as an independent regulator of the power sector under the EPSR Act 2005 and was officially inaugurated on October 31, 2005. Section 32 of the EPSR Act lists the objects and functions of NERC. As sector regulator, NERC undertakes technical and economic regulation of the sector such as tariff regulation and fair pricing, licensing regulation, operating codes and standards regulations, approval of amendments to Market Rules and monitoring the operation of the electricity market. NERC also has the responsibility to promote competition and private sector participation in the power sector. The EPSR Act is the major instrument of regulatory control adopted by NERC in carrying out its regulatory functions, and section 96 of the Act provides for the drafting of secondary legislations in the power sector by NERC. Besides establishing NERC, the EPSR Act also establishes certain regulatory instruments in the power sector such as the Market Rules and the tariff regulation methodology. It needs to be stated that NERC is not responsible for policy formulation and directions in the power sector. That is the exclusive preserve of the Minister for Power.
The Market Rules
The EPSR Act established the development of a set of rules to be adhered to by participants in the electricity market, otherwise called the Market Rules. The Market Rules define the organisation of, and trading arrangements for the Nigerian electricity market and in addition, set out the conditions, general procedures and methodologies for the administration of the Electricity Market. The Market Rule is developed by the System Operator in consultation with Market participants and approved by the President upon recommendation by the Minister of Power. However, the Market Operator (MO), an entity not recognised under the EPSR Act, has been responsible for overseeing all market operation functions, including settlement functions, in the power sector. The Market Rules is a key regulatory instrument in the power sector. While NERC is not responsible for drafting the Market Rules, any amendments to the Market Rules has to be approved by NERC for such amendment to be effective.
The Tariff Regulatory Methodology
The Multi Year Tariff Order (MYTO) Methodology is a tariff methodology adopted by NERC to regulate wholesale and retail electricity prices in line with the provisions of section 76 of the EPSR Act. MYTO sets generation, transmission and distribution tariffs based on a number of tariff setting principles and assumptions developed and agreed between NERC and the licensees. MYTO provides for certainty of tariffs to licensees and investors in the power sector. The MYTO methodology was first introduced in 2008 and has undergone several revisions over time.
Regulatory Certainty in the Power Sector
A key aspect of the power sector reform is to ensure the perpetration and perpetuation of regulatory certainty in the power sector. Without doubt, regulatory certainty is germane to the attainment of the objectives of the power sector reforms. To ensure regulatory certainty, the EPSR Act made provisions for the following:
• An independent regulatory Commission with clearly defined regulatory functions and objects, backed by law;
• Clear process of appointment and removal of Commissioners and Chairman of the Commission outside of the normal civil service appointments;
• Isolation of the Commission from civil service rules, including its reporting structure, compensation structure and retirement benefits of its Commissioners and staff;
• Autonomous funding for the Commission with direct appropriations by the National Assembly, outside of appropriations to the Ministry of Power.
In summary, the regulatory environment under the EPSR Act is designed in such a manner to reduce the influence and interference of the Federal Government in the regulation of the power sector. The Act also takes away regulatory powers of the Minister and President in the power sector.
Regulatory Risk in the Power Sector
Despite the good intentions of the EPSR Act in instituting independent regulation of the power sector, the sector is still faced with regulatory risks arising from regulatory uncertainties, government’s continued influence in the affairs of the Regulator and ineffective regulation of the sector by NERC. Several instances abound.
The first appointed Chairman of NERC, Dr. Ransome Owan and his fellow Commissioners were casualties of government’s interference in the power sector as they were removed by the Yar’Adua administration without following due process (as set out by the EPSR Act), well before the expiration of their five-year terms. That misadventure by government, coupled with the appointment of an Administrator for NERC, stymied effective regulations in the power sector and stalled the power sector reforms for over two years, including the implementation of the MYTO tariffs, until the Federal Government, in tacit admission of its errors, reached out-of-court settlement with Dr. Owan and the other Commissioners.
The tenure of Dr. Sam Amadi as NERC chairman, was also not bereft of government’s undue influence over NERC’s ability to regulate the power sector effectively, particularly in the area of enforcing Market Rules and tariff setting. The run up to the 2015 general elections saw a partisan NERC. One recalls the inter-party live debate between the PDP and the APC on the power sector, organised by the Centre for Democracy and Development (CDD), and the participation of the former NERC Chairman in the debate. While the former Chairman of NERC was clearly ill-advised in his participation and may have participated in the live debate in his official capacity, he ended up speaking for, and defending the policies of the then ruling party against that of the opposition APC.
Perhaps no greater regulatory risk exists than that affecting and impacting the expected revenue requirement to a licensee. The recent stalemate between NERC and Discos on applicable electricity tariffs due to the removal of collection loss element in the MYTO 2.1 tariffs is an example.
Regulatory risks can also be attributed to the behaviour of Market Operators and licensees. A situation whereby Market Operators, Licensees and interested stakeholders seek to circumvent regulatory orders or do not agree with regulatory orders issued by the Regulator, but approach the Presidency or the Minister of Power to seek redress or circumvent such orders, increases regulatory risks to the sector.
Need for Regulatory Independence
Research has shown that regulatory independence is key to private sector confidence in the power sector and has a significant effect on the ability of government to attract and sustain investments in the power sector. Prof. Guy Holburn of the Richard Ivey School of Business notes that, “strong regulatory governance regimes consist of expert agencies that operate largely independently of day-to-day political control, but under legislative mandates and procedural requirements that safeguard the rights of stakeholders. Such regulatory regimes can provide credible assurances to industry and stakeholders that policies will not change in an arbitrary or unpredictable fashion, for instance in response to new political or economic pressures, after investments have been made. Regulatory governance regimes that enhance agency independence from political intervention in day-to-day decision-making have the benefit of encouraging greater levels of private investment and at lower cost, which benefits consumers, since perceived regulatory risks are reduced”.
He notes further that, “on the other hand, weak regulatory governance is characterised by a more politicised policy-making environment, where the government has greater control over regulatory policies. In this type of environment it is more difficult to achieve credible commitment to future investor and stakeholder protection, heightening perceptions of regulatory risk. In the absence of adequate regulatory governance, a jurisdiction may encounter multiple types of inefficiencies in its electricity sector – underinvestment, minimisation of maintenance expenditures and fluctuating rates of capital investment. Ultimately, the negative effects of non-credible regulatory governance can lead to government ownership becoming the default mode of operation…”
Without doubt, more needs to be done in terms of effective regulation of the power sector in Nigeria. While there is a need for the Regulator to interface with government in its function and duties within the limits of the EPSR Act and policy direction of the government, it should be made clear that the Regulator at all times, must be seen to have independently and transparently arrived at regulatory actions and orders. As we approach a critical phase of stabilising the power sector, the ability of the Regulator to regulate the industry without creating regulatory risks, following “orders from above” and caving in to the demands of Market Operators that are not fair to the consumer, is vital for the sustainability of the power sector reforms.
We propose the following steps, which are by no means exhaustive, to address regulatory risks in the power sector.
Appoint Experienced NERC Commissioners
The governance structure of the Regulator has as much of an influence on the operations and performance of the power sector as do regulatory policies. The expiration of the term of the Dr. Sam Amadi led Commission gives the Buhari Administration an opportunity to infuse new blood into electricity regulations and further regulatory strengthening of the power sector. Section 40 of the EPSR Act mandates the president to appoint a new chairman within three weeks from the date of the vacancy of the Chairmanship position, subject to confirmation by the National Assembly. The EPSR Act also prescribes qualifications or areas of competence that nominees for the position of Chairman and NERC Commissioners must possess. Under Section 34 of the EPSR Act, a drawback to the appointment of capable and competent individuals as Commissioners is that each of the six geo-political zones must produce one Commissioner. Considering that electricity regulation is still at its infancy, this requirement by the Act on political balancing, limits the pool of experienced and capable individuals that could possibly be appointed as Commissioners. An alternative is for the president to re-appoint some of the outgoing commissioners to provide some continuity in the Commission’s activities. This suggestion is more so as a new tariff regime is about to be implemented.
Besides appointing experienced Commissioners, the technical and operational capabilities of NERC need to be further strengthened to address obvious gaps in the Commission’s regulation of the power sector so far, which can be described as being reactive rather than proactive. This should be an immediate priority of the new Chairman and Commissioners when they are appointed.
Amend the EPSR Act 2005
Ten years after its passage, the EPSR Act may need to be amended by the National Assembly to address some of the shortcomings in certain provisions of the Act that curtail the independence of the Commission and provides opportunities for interference by government. An example is Section 51 of the EPSR Act that requires the Commission to submit its annual budget to the Minister of Power. Another example is Section 29 of the Act relating to the approval of the Market Rules by the President as recommended by the Minister of Power. In our view, NERC, not the President, should be the approving authority. Interestingly, the Act provides that amendment(s) to the Market Rules must be approved by NERC. Furthermore, the Act places a requirement on the Commission to submit reports to the Minister from time to time. In general, proposed amendments to the EPSR Act should impose limitations on the Minister to issue directives to NERC and should also constrain political and administrative actors from influencing regulations in the power sector.
Enable Market Based Framework for Dispute Resolution
The EPSRA should be amended to broaden the Hearings and Appeals section of the Act with a view to developing a clear market driven, appeals and dispute resolution framework for the resolution of disputes (particularly disputes about tariffs), between the Commission and Market Operators whenever such disputes may arise. Such appeals and dispute resolution framework should include the right to appeal the decisions of NERC as well as arbitration processes, and ultimately, court processes where interested parties remain unsatisfied. The Act may also need to be amended to address a number of challenges affecting the power sector that require legislative backing, based on the realities of a privatized power sector which were not envisaged when the Act was passed into law.
Resolve NEMSA and NERC Issues
The EPSR Act establishes NERC as the electricity Regulator, with broad functions and objects including defining technical standards and the regulation of such standards in the sector. With the passage of the NEMSA bill, there are fears that the power sector could be faced with over regulation. The NEMSA bill is structured as a bill for the establishment of a government agency for the enforcement of technical standards and technical regulations in the power sector. However, the composition of Board of NEMSA is devoid of such intent, lacks the technical depth required of the board of such a technical regulatory agency and panders to political exigencies. Besides, there seems to be a duplication and conflict in roles as the duties of NEMSA as earlier stated, are also being carried out by NERC. Moreover, there is also the issue of increased cost of regulation, which will be borne by electricity customers. Currently, NERC collects 1.5 percent of total market revenues. Nonetheless, NEMSA is a creation of the National Assembly. Thus unless the NEMSA bill is repealed or amended, it will be to the benefit of the power sector to set up an inter-agency committee to resolve over-lapping functions and harmonise technical roles between NERC and NEMSA. An ideal structure however, is for NEMSA to be a licensee of NERC as initially envisaged.
Establishment of the Independent System Operator
Besides NERC, the System Operator (SO) is perhaps the next important entity in the power sector, from a regulatory perspective. The EPSR Act designates the SO as the entity responsible for developing Market Rules and implementation and enforcement of the rules. As earlier stated, the Market Operator (MO) handles market operation functions. Both the MO and the SO are separate entities under the Transmission Company of Nigeria. However, the EPSR Act recommends the creation of the Independent System Operator (ISO) following from the declaration of the Transitional Electricity Market (TEM). Establishing and licensing the ISO, which will incorporate the functions of the MO as well as implementing the Grid Code function of the SO, is an important next step to further regulatory strengthening of the power sector. The ISO’s governance structure and funding must be independent of the Ministry of Power and the TCN to guarantee financial and operational autonomy.
Insulation of Regulatory Agencies from Politics
Mixing electricity regulations or regulation in whatever sector, with politics create significant regulatory risks for investors. Following from the 2015 elections, independent regulatory institutions such as the NERC should not be seen to be partisan, and must be completely insulated from the electioneering process, political institutions and political exigencies. The National Assembly must ensure that our regulatory institutions are protected from the political process and remain apolitical and independent at all times, irrespective of the government in power.
Odion Omonfoman is an Energy Consultant and the CEO of New Hampshire Capital Limited, an energy consulting firm based in Lagos. Please send comments to email@example.com.