The privatisation of the power sector, while transparently conducted, was fraught with a number of missteps and set to go wrong from the start of the process. Four years after, the privatisation 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 privatisation of the power sector is not derailed.
In our last published article, we maintained our stance that reversing the privatisation of the PHCN successor companies (GenCos and DisCos) is not an option and should not be contemplated by the government. In this article, we highlight our thoughts on potential solutions that could be explored to correct some of the shortcomings of the privatisation outcome. Again we wish to restate our caveat – that the proposed solutions are to guide the current discussions and/or stimulate a broader debate on how to address the shortcomings of the privatisation process.
Privatisation vs. the Electricity Market
It is important to note that there were are transactions involved which, though power sector related, are quite different. The first was the sale of government shares in business entities i.e PHCN successor GenCos and DisCos, to investors (which we call privatisation). The second is the actual operations of the Nigerian electricity market, involving licensed market participants inclusive of the privatised GenCos and DisCos. Making the power sector work 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 distinction between the privatisation of successor PHCN companies and the operations of the electricity market is essential to understanding the context of the solutions we propose as a way to address some of the challenges of privatisation.
The Privatisation Transaction Documents
The privatisation, rather sale, of government’s shares in DisCos and GenCos was underpinned by the following transaction documents:
1. Share Sale Agreement (SSA)
2. Shareholders Agreement (SHA)
3. Performance Agreement
The parties to the three agreements are the core investors for each of the PHCN successor companies and the Bureau of Public Enterprises (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 documents are outside of the regulations of the NERC and the Ministry of Power. Corporate issues that arise, and which affect the operations of the business entities as going-concerns are designed to be addressed by the two shareholders in the privatised DisCos and GenCos.
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 asset 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 privatised companies, which are registered participants of the electricity market and licensees of the NERC and other market participants in the Nigeria Electricity Supply Industry (NESI).
Based on the provisions of the transaction documents cited above, we opine that there are four options available to the government to explore, should it decide to revisit the privatisation process for successor DisCos:
1. Dilution of core investor shares in DisCos to below 60 percent;
2. Declaring DisCos bankrupt and commencing bankruptcy proceedings against them;
3. The Nuclear bomb option – the BPE exercises its Call Option;
4. The passive, “do nothing” option.
Option One: Dilution of Core Investors’ Majority Shareholding In DisCos
The PUNCH editorial of May 24, 2017 forcefully argues that the federal government should dilute the shares of core investors in DisCos using the Central Bank of Nigeria (CBN) and Asset Management Corporation of Nigeria (AMCON) structures. According to the PUNCH editorial: “The government should review the privatisation and exert the leverage offered by its 40 percent stake in them. One way is to offer to raise its stake by buying out the current majority equity owners for resale. It should encourage the banks through the Central Bank of Nigeria and AMCON, the “bad bank”, to foreclose on the non-performing loans of the DisCos…”
Whilst not advocating for banks and the CBN to foreclose on the non-performing acquisition loans of core investors, if at all, diluting the shareholding of core investors is the most feasible way the federal government can revisit the privatisation process and take control of the DisCos. We would discuss in more detail the dilution option and the mechanism that could be structured to dilute core investor stakes in DisCos.
At the moment, DisCos have negative capital, if we consider the amount that they owe NBET and the Market Operator (MO). The dilution mechanism is based on converting the huge liabilities of DisCos to NBET and the MO into equity in the DisCos. The dilution mechanism we propose is that the federal government, through the BPE, would guarantee the DisCos’ payment obligations to NBET (under the Vesting Contracts).
Option Two: Declaring DisCos Bankrupt and Appointing a Liquidator To Run Them
A DisCo being declared bankrupt is an event of default on the part of the core investor under the Performance Agreement. Let’s face it: DisCos are “technically” bankrupt, based on their huge liabilities to the Nigerian Bulk Electricity Trading Plc (NBET), Market Operator (MO) and the CBN. In declaring DisCos bankrupt, to the extent that the core investors are unable to re-capitalise the distribution companies, then the government can take-over the shares and asset of the DisCos through a government appointed liquidator.
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) month Letter of Credit (L/C).
Option Two would however require legal expertise and the filing of court processes, the outcome of which may or may not favour the federal government. This option may likely do more harm to the electricity industry.
Option Three: The Nuclear Bomb Option
Under this option, the BPE can simply terminate the Performance Agreement and call the shares of the DisCcos. 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 percent 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 Four: The “Do Nothing” Approach
The other feasible alternative is for government to wait out the remaining term of the five-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 are not met at the end of this five-year period.
Given that the DisCos were handed over to core investors on November 1, 2013, the five-year period should elapse by October 31, 2018. However, the last NERC board, working on the advice of the BPE, reset and extended the five-year calendar for DisCos by another two years, owing to NERC, BPE and the 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 calender to October 31, 2020 should be voided if possible. 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.
Diluting Core Investor Shares: Proposed Dilution Mechanism
Our preferred option is clearly option one, which is to dilute the core investors’ majority stakes in the DisCos. But how would this work?
To achieve this, the federal government should rely on the further funding clause in the Shareholders Agreement. This clause allows the BPE as a 40 percent shareholder in the DisCos, to inject capital into these 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 the core investors’ equities in the DisCos through such funding.
At the moment, DisCos have negative capital, if we consider the amount that they owe NBET and the Market Operator (MO). The dilution mechanism is based on converting the huge liabilities of DisCos to NBET and the MO into equity in the DisCos. The dilution mechanism we propose is that the federal government, through the BPE, would guarantee the DisCos’ payment obligations to NBET (under the Vesting Contracts). Where a DisCo fails to meet its payment obligations to NBET, the BPE guarantee is called. BPE then converts the called portion of the guarantee to equity in the DisCo and dilutes the equity of the core investors.
However, core investors should be given a second chance as the liquidity crisis and other challenges in the power sector cannot be ascribed solely to DisCos non-performance. Government too must share in the blame.
Thus, our dilution mechanism is on a going-forward basis and proposes for NBET, the Market Operator (MO) and the DisCos to agree to a minimum industry payment threshold which individual DisCos must meet. The BPE guarantee triggers when a DisCo’s remittance level falls short of the agreed minimum threshold payment to NBET and MO. The BPE then converts the shortfall remittance as additional funding to the DisCo and dilutes the core investor’s equity stake by the shortfall amount. Where a core investor/DisCo refuses to agree to a minimum payment threshold, then BPE assumes the full existing liabilities of that DisCo to NBET and treats it as further funding to the DisCo, consequently diluting the core investor’s shares.
If government is going to commit to US$7.6 billion 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 the core investors accountable, with a view to making DisCos more efficient in their operations.
The dilution process restores the current negative balance sheet of DisCos’ 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. The dilution mechanism puts the core investors in DisCos on the straight and narrow path.
Nonetheless, government should not be in a rush to take-over the operations of DisCos. Before diluting the shares of core investors, the federal government must conduct a rigorous scenario analysis and have a game plan for the execution and subsequent take-over. Having diluted core investors and retained management control, what are the next steps? Thus putting a sound game-plan would be most useful before activating any shareholder dilution mechanism.
Caution! Achtung! Avertir!
As we earlier noted, the sale of the shares of DisCos and GenCos shares to investors was a distinct transaction from the operations of the electricity market. Thus we must sound a note of caution and warn that any government takeover of DisCos may not likely yield any better result 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 federal government hasn’t done anything “spectacular” in the 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 Transmission Company of Nigeria (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. The management contract with Manitoba Hydro was perhaps its best shot so far at becoming an efficient grid operator. 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 Federal Government Centralise and Escrow Discos Revenues?
Centralisation and escrowing of DisCos revenues, as being suggested by the minister for Power Works and Housing, is not a viable option in today’s privatised power sector industry. We’ve studied the Market Rules and there is no such requirement for drastic measures on the part of government. Under the Market Rules, the penalties for non-payment or partial payment are monetary penalties, not seizure of the revenues of DisCos. The CBN Nigeria Electricity Market Stabilisation Facility (NEMSF) structure, which we are quite familiar with, also 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 a federal government default event to include “the expropriation, nationalisation 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 the eleven DisCos is a violation of the terms of the sale of DisCo shares to core investors under the privatisation process. It is ironic that government, as the largest debtor to DisCos, is seeking to also control the revenues of DisCos as well.
The privatisation of the power sector, while transparently conducted, was fraught with a number of missteps and set to go wrong from the start of the process. Four years after, the privatisation 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 privatisation 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 sector.
If government is going to commit to US$7.6 billion 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 the core investors accountable, with a view to making DisCos more efficient in their operations. Otherwise, the proposed $7.6 billion 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 the government and the core investors as government seeks to exert more control over the operations of DisCos. 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 privatisation is to create a sustainable and viable electricity market.