The title of this piece, may ruffle some feathers. Nonetheless, the intent of same, is not to argue that the privatization of aspects of the electric power value chain, was a mistake. What the title seeks to do, is to ‘catch’ attention and the intent behind the article in its entirety, is to show in the writer’s opinion, the grave mistake- from hindsight, the government did make in the process of privatizing aspects of the value chain. The writer, however, does not (and never will) advocate a reversal of the privatization.
As a consultant to both the private and public sectors, the writer is of the view that the privatization of the sector had since become apposite. However, same could have been effected differently and in particular, the privatization of the electricity distribution aspect of the privatization.
The Privatization Strategy
There are eleven (11) traditional electricity distribution companies (“Discos”) in Nigeria operating across the thirty-six (36) states and the Federal Capital Territory Abuja. Apart from the Eko Distribution Company Plc. and the Ikeja Distribution Plc., about every Disco operates across three (3) to four (4) states. Each distribution network comprises of overhead lines, cables which are largely 11kV and 33kV, transformers, switchgears, service lines, meters, control equipment and other apparatus to support the distribution of electricity to industrial, commercial and domestic users.
The Discos are strategic because, characteristically, they serve as the mid-point between generators (who expect payment from the Discos) and final consumers who are supposed to make the payment expected from the Discos, by the generators. Where the Discos are unable to bill for electricity power received or indeed receive payment for the volume of electricity made available to final consumers, then, on-grid power generation will not be profitable.
The effect of this non-profitability is that there would be no private sector investment, because every investor wants to make profit and no one would want to engage in a business that such a one knows would be operating at a loss, no matter the effort put into it.
In other words, distribution companies play a tactical role because, through their ownership of the sector’s entire on-grid customer base, they are the sources of all the revenues that drive the Nigerian Electric Supply Industry’s value chain.
While, concessions and core investor sale have been used in the privatisation of distribution companies, world-over, core investor sale has been dominant. The dominance of core investor sale in the last few years shows that it is a more preferred option, globally. In addition, given the fact that a paramount objective of the reform programme is to encourage substantial private sector-led investments in the electric power sector, which would be uncertain under a concession because of the nature of a concession, a core investor sale becomes a lot more desirable. The core investor sale was, therefore, adopted for privatising the eleven (11) Discos.
Typically, the selection of preferred bidders in competitive privatisation transactions is based on pre-determined bid parameters. Usually these could take the form of selecting, as preferred bidder, the entity with the highest financial bid, after the final set of bidders had crossed the technical qualification hurdle. Another option could be to select a preferred bidder with the lowest lump sum subsidy for investing in and managing the assets; or the adoption of one or more quality of service/efficiency bid parameters.
The use of highest bidder for assets or equity on offer has been the strategy most used, in privatisation transactions across the world; Nigeria inclusive. Sale to the highest bidder is most useful when the government’s key objective is to raise money for treasury and open up the industry so that other private sector investors could set up similar companies and compete with the previously state-owned enterprise(s).
Other bid parameters would be given a premium where other objectives are placed ahead of just making money for the treasury. In particular, the Bureau of Public Enterprises and the National Council on Privatization chose to use the aggregate technical commercial and collection losses reduction mechanism and value provided by bidders, as a key bid parameter.
The Aggregate Technical Commercial and Collection Losses Reduction As Key Bid Parameter
For the privatization of the Discos, the Bureau of Public Enterprises (the “BPE”) and indeed the National Council on Privatization (“NCP”) chose to go the way of a combination of entity with highest financial bid and the Disco with the best service/ efficiency program. The efficiency bid parameter in this case, is the reduction of the Aggregate Technical Commercial and Collection (“ATC & C”) Losses; with premium placed on this bid parameter.
The decision to place premium on reduction of ATC & C as a bid parameter was largely because Discos were and still are, to a large extent, natural monopolies whose privatisation does not immediately make the setting up of alternative firms by the private sector, viable. The privatization of the Discos, as a result of their monopoly status in their operating areas, poses a different challenge from routine privatization programs, which would be difficult to address using the usual highest bidder parameter model, as the key bid parameter. This is particularly the case because it is not sufficient to provide the highest financial bid as that alone would not reduce the ATC & C. A bit more appeared needed.
In designing the model for the selection of the preferred bidder for Nigeria’s distribution companies, therefore, the BPE and the NCP took into consideration, the fact that the ATC & C losses sustained by the various Discos had been at between 40 and 50 percent of the power wheeled to them through the transmission system. This level of losses was regarded as unsustainable and if not halted will continue to render the Nigerian Electricity Supply Industry (“NESI”) absolutely unviable for full and unsubsidized private sector participation.
Consequent upon the foregoing, the value of the service/efficiency parameters was considered viz-a-viz the investment proposals made by bidders aimed at reducing ATC & C losses over a five (5) or so year period. This option was aimed at catering to the identified principal needs of the distribution segment of NESI, that is: rapid reduction in the current levels of ATC&C losses and sustainable investment in system rehabilitation, upgrade and expansion.
The Disco privatisation strategy, involved a private sector operator acquiring controlling equity interest in any of the distribution companies with a view to rapidly improving its operational efficiency. So, unlike the traditional transaction approach where bidders merely bid on price for the equity shares, bidders bided on the basis of a trajectory of technical, commercial and collection loss improvements, usually during the first five years of post-privatisation operation.
Additional, this method was built around the Multi Year Tariff Order (MYTO) 2 issued by the Nigerian Electricity Regulatory Commission (NERC). The idea of a MYTO 2 was to ensure in the first place, that cost reflective tariffs are charged in the NESI, and came into effect in June 2012. MYTO 2 basically set out the commercial and economic indices that served as basis for the financial model used across the entire NESI. MYTO 2 stipulated the yearly investment requirements, allowable operational expenditure, approved rate of return on equity and other allowable expenses for each Disco. The valuation of each Disco was obtained from the regulated asset base contained in the MYTO 2 assumptions. This method, NERC and the BPE believed, eliminated the problem associated with under-valuation or over-valuation of the assets.
To emerge as a core investor, a bidder was required to submit a proposal aimed at reducing the ATC & C losses over a five (5) year period. The level of losses that a bidder proposes to reduce will be incorporated in the Multi Year Tariff Order (MYTO). MYTO will stipulate the annual investment requirement, allowable operational expenditure, approved rate of return on equity and other allowable expenses for each Disco.
The selection criterion sought to appoint an operator with the best technical, financial and managerial qualification for reducing ATC&C losses.
The Final Selection
The NCP approved the sale of sixty per cent (60%) equity in the eleven (11) Discos. The approved preferred bidders posted Letters of Credit amounting to twenty-five per cent (25%) of the Share purchase price of the relevant Successor Company. That would be followed by the payment within fifteen (15) business days after signing of the Sale and Purchase Agreement or the Shareholders’ Agreement, of twenty-five percent (25%) of the Share purchase price. On November 1, 2013, these Discos and the generation companies were handed over completely to the new owners/concessionaires.
The Key Mistake and What Should Have Been Done
Despite the privatization of the Discos and formerly government-owned electricity generation companies, not much improvement has been seen in the electric power sector. The Discos have not been able to make substantial improvements to the distribution networks they cover due to the paucity of funds and the writer is of the view that the approach for the privatization, especially for the Discos should have been such that the core investors should have been required to deposit funds in escrow for the five (5) year upon which they undertook to reduce ATC&C Losses. In return, the government should not have received any upfront payment but should have waited to see these companies profitable and then receive a portion of their profits.
The government should simply have had ‘some skin in the game’ by deferring its receipt of payment especially because the country was in an era of surplus where other funds could have been used to settle labour and other matters,to be honest (especially when compared to this period). What should have happened ideally was that an escrow agent should have kept the money in interest yielding accounts and over the five (5) year period, the Discos together with the requisite government agency and relevant private sector expert/ consultant would have the funds channeled towards achieving the post-privatization plan already set out and agreed to by the parties specified above.
With the foregoing, then arrangements could have been made, to have vendor financing arrangements for materials, equipment and infrastructure such as meters etc. with the likely impact being that the sector would have improved much more than it currently has. Vendor financing was more likely to have succeeded because the vendors, particularly the reputable ones would have been aware that there was cash available. They also would have been able to provide the requisite equipment and infrastructure knowing that they would be paid at a premium. Further, there would have been more funds that could have been used to deploy technology to reduce electricity theft as is the case, elsewhere in the world.
Apart from the foregoing, the government also made the mistake of not keeping its own promises in terms of the grid capacity and not ensuring that its ministries, departments and agencies paid their bills as and when due.