KEY REGULATORY ISSUES AND CHALLENGES CONFRONTING THE NIGERIAN ELECTRICITY REGULATORY COMMISSION

1. KEY REGULATORY ISSUES AND CHALLENGES CONFRONTING THE NIGERIAN ELECTRICITY REGULATORY COMMISSION A Presentation to the NERC-NARUC Workshop By Market Competition and Rates Division JULY, 2008

2. INTRODUCTION • Even though electricity generation in Nigeria began in 1896, the country has not made much progress in the sector commensurate with the age of the industry. • The sector witnessed no new investment for over a decade, between 1980 – 1990. Generation capacity remain at about 6,000MW with actual generation most often below 40% of the capacity. • Proper maintenance and replacement of obsolete equipment was not accomplished, leading to a progressive drop in supply. • The long years of neglect and inadequate investment resulted in dilapidated, weak, and obsolete transmission and distribution network. • Tariffs were below cost, metering was grossly inadequate, billing was poor, revenue collection very low, and power theft rampant. • It was against this background that the Nigerian Government commenced the reform of the electricity sector in 2000.

3. REFORM OF THE INDUSTRY The Nigerian electricity sector reform process commenced in 2000 and was given a legal backing in 2005 with the passage of the Electric Power Sector Reform Act (2005). It involves the following: • Structural reform which involves separating the potentially competitive functions from the existing vertically integrated monopoly (NEPA) and establishing a competitive industry structure for commercial functions • Competitive neutrality - establishing corporatised governance structures for the unbundled entities  • Privatisation - of distribution and generation companies with only the transmission company retained under Government control • Immediate opening - of the generation sector and later the distribution (retail sector) to new entrants  • Regulatory authority- establishing the Nigerian Electricity Regulatory Commission (NERC) to regulate the industry • Access- enabling new participants especially the generators access to monopoly infrastructure. With NERC overseeing prices and terms of engagement • Market design-establishing a national electricity market with associated institutions to oversee the rules and manage the market.  The overall objective of the Government policy as enshrined in the National Electricity Power Policy (NEPP) is ultimately to “establish a long term electricity market structure in Nigeria in which multiple operators provide services on competitive basis to the broadest range of customers”

4. KEY REGULATORY ISSUES AND CHALLENGES The principal objectives of NERC as enshrined in the EPSR Act (2005) includes: • To create, promote, and preserve efficient industry and market structures, and to ensure the optimal utilization of resources for the provision of electricity services • To ensure that the prices charged by licensees are sufficient to allow the licensees to finance their activities and to allow for reasonable earnings for efficient operation • To ensure the safety, security, reliability, and quality of service in the production and delivery of electricity to consumers

5. REALISING NERC’S OBJECTIVES To realize the objectives, key regulatory issues must be resolved, some of which includes: • How to develop a competitive wholesale and retail electricity market (where the private sector will be the key driver) out of an existing monopolistic entity • How to establish a pricing mechanism that will provide incentive to investors as well as protect consumers. • How to ensure a level playing field to all operators, both new and old as well as ensuring access to transmission and distribution facilities • How to ensure reliability and security of supply • How to monitor service quality and ensure that consumers get value for their money • How to integrate the country into the proposed regional pool The next few slides will show NERC’s responses to resolving the issues raised and those that still remain a challenge.

6. THE DEVELOPMENT OF A WHOLESALE AND RETAIL MARKET • NERC has identified the following elements as necessary in the development of the Market: • Presence of many buyers and sellers- (lack of market power on both sides of the market) • Demand and supply responsiveness to price • Liquidity in the market place • Equal access to essential facilities (transmission, distribution wires and system operations) • Management of subsides and environmental controls so that they do not interfere with the workings of the market • The EPSR Act (2005) recognised three distinct stages in the development of the wholesale electricity market: • Transition Stage • Medium Term • Long Term • Commencement of each stage will be triggered by a declaration by the Minister that a more competitive market is to be initiated • This declaration is predicted on a report by NERC indicating the potential for competition in the Nigerian Electricity Supply Industry (NESI).

7. TRANSITIONAL STAGE • The Transitional Stage commenced with the passage of the EPSR Act 2005, which made the following possible • Incorporation of an initial holding company i.e the Power Holding Company of Nigeria (PHCN) to take over the Assets and Liabilities of NEPA • Full unbundling of PHCN into successor Generation and Distribution Companies as well as the creation of a single Transmission company • Creation and institutionalization of new market structures and trading arrangements including the following • Operationalization of the Transmission System Provider (TSP), Market Operator (MO), and System Operator (SO) functions, within the Transmission Company • Implementation of the Grid Code and the Market Rules • Licensing of IPPs and other operators/service providers • Development of an appropriate tariff regime • Establishment of performance indicators, requirements and reporting formats for market monitoring • Establishment of a trading arrangement and financial settlement system • Establishment of various panels for market monitoring and dispute resolution.

8. MEDIUM TERM • The management and ownership of substantial parts of the DisCos will be in the hand of the private sector • Thermal plants are either sold or concessioned to private sector • Bulk trading licensee commences the novation of its existing rights and obligations for the procurement of electricity and ancillary service • Power will be traded on the basis of bilateral contracts • Generators and distributors will be able to trade power and capacity in the contract market • Generators

9. LONG TERM – (Retail Electricity Market) • End user customers can choose their supplier from competing electricity retailers. • Customers will have the power to choose their energy supplier • Possibility for lower prices and new service offerings for small customers • More efficient electricity market • Retail reforms are traditionally follow ups from the electricity wholesale reform. • The NESI also intends to follow the same route for the creation of the REM

10. TARIFF AS A TOOL FOR INCENTIVE REGULATION AND PROMOTION OF INFRASTRUCTURE INVESTMENTS • Central to the resolution of the problems of the power sector in Nigeria is the issue of commercial viability of the industry. The industry is barely able to generate enough revenue to cover its operating costs let alone meet its considerable capital expenditure needs • The Commission developed a new Multi Year Tariff Order (MYTO) for the industry predicated on revenue requirement and sustainability of the incumbent operators and new entrants • At the centre of the new tariff order is a multi-year tariff model, which calculates electricity prices based on revenue requirements of the whole industry. This approach is aimed at ensuring the necessary support for operating and capital expenditures of the various sub-sectors i.e. generation, transmission and distribution • The tariffs are set at levels that support the viability and growth of the Nigerian Electricity Supply Industry (NESI) • To avoid rate shock, the tariffs paid by consumers will be less than cost reflective values over the first three years of the introduction of MYTO. However, the Federal Government support will provide subsidy to make up the difference between actual and cost reflective tariffs over three years

11. THIRD PARTY ACCESS AND A LEVEL PLAYING FIELD TO ALL OPERATORS • A single Transmission Company will co-ordinate the system on an open-access basis • NERC will continue regulate transmission and distribution tariff • The transmission company will be responsible for all power lines of 132Kv and above • Transmission company will neither buy nor sell electricity • Transmission company will not own or have ownership stake in generation, distribution or sales • Distribution companies will manage all power lines below 132Kv • Distribution companies will not own or have ownership stake in generation and or transmission

12. RELIABILITY AND SECURITY OF SUPPLY • The ESPR Act (2005) provides NERC with the power to ensure adequate, safe, reliable and affordable electricity supply. • The National Electric Power Policy (NEPP) has also identified the protection of life and property rights as well as the promotion of national security as vital for overall economic development. Accordingly, Government shall ensure that electricity operators comply with generally accepted standards for provision of special services for safety, emergency and national security. • Central to the concept of reliability is the issue of security of supply and NERC considers security in two distinct areas: • The risk or likelihood of cessation of provision of electricity, for whatever reason, to any party who uses and needs it. • The current or prospective absence of provision, for whatever reason, of electricity to a party whose welfare and effectiveness would be enhanced by it. • In pursuance of the EPSR Act (2005) mandate and the NEPP, the Commission has established the following regulations to ensure safety and reliability of supply: • Grid Code • Metering Code • Distribution Code • The Commission is also working towards the following: • Plant siting guideline • Sensitizing State Governments on the requirements for setting up power plants. Emphasis is for each state to utilize its natural resources endowment for generation and thus set up small off grid Hydro, Wind and Solar to electrify rural communities. • NERC is also encouraging potential investors to diversify into renewable energy.

13. ESURING SERVICE QUALITY AND VALUE FOR MONEY TO CONSUMERS • Customer Service Standards of Performance For Distribution Companies: These are minimum service standards expected from distribution companies in the provision of electricity supply to customers. They cover issues of time allowed in attending to faults, obligations with respect to replacement of faulty equipment, installation of equipment such as meters, minimum duration for attending to other technical problems that may impinge on the provision of uninterrupted electricity supply to customers. • Meter Reading, Billing, Cash Collection & Credit Management For Electricity Supplies: Provides procedures concerning accurate meter reading by distribution companies, correct billing, adjustment of bills where overcharges and undercharges exist and processes for payment of bills. This ensures that customers are spared the vexed problem of estimated bills.

14. INTEGRATING NIGERIA INTO THE WEST AFRICAN POWER POOL (WAPP) • In West Africa, economic growth is currently being stifled by insufficient supply of electricity to meet burgeoning demand. • As a whole, the region is an energy surplus region. • Each national utility works independently of its neighbors, evaluating its operation and expansion options on a project-by-project basis. But the cheapest energy source for a country might well lie just across the border. • With cross-border energy networks, countries with surplus power could run their stations at optimum output without risking oversupply. • Countries with limited generation capacity could access affordable power without building costly facilities. Power pooling also diversifies energy sources. • In October 2000, 14 members of the Economic Community of West African States (ECOWAS) signed an agreement to launch a project to boost power supply in the region. The scheme known as the West Africa Power Pool (WAPP) is planned as a joint power pooling mechanism to help integrate the various national power systems into a unified electricity market. • The major sources of electricity under the power pool would be hydroelectricity and gas to fuel thermal stations. • In February 2003, the Presidents of Ghana, Nigeria, Benin and Togo signed a treaty providing for a comprehensive legal, fiscal and regulatory framework to build a joint gas pipeline. The 620 km pipeline is set to run from Nigeria's Escravos oil field, where it will capture gas flared by Chevron, to Ghana. It will also provide gas to Benin and Togo and may eventually pass through Côte d'Ivoire before finally terminating at Senegal.

15. INTEGRATING NIGERIA INTO THE WAPP (2) • The West Africa Gas Pipeline (WAGP) delivered its first volume of gas from Nigeria to Tema last December. • WAGP is expected to be a feeder project for WAPP which benefits are expected to be spread to the whole Gulf of Guinea in the long term. It is hoped that WAPP would assure the sub region with a stable and reliable electricity supply at affordable costs by creating a sub regional energy trade and cross-border exchange between national utilities. • The ECOWAS vision is to: • Develop and put in place a “cooperative power pooling mechanism” with a view that such mechanism would reduce the sub region’s vulnerability to drought–induced power supply disruptions, diversify supply sources and spur on economic growth. • Assure national power utilities of mutual assistance to avoid a sub regional power system collapse, or in the latter case, rapid restoration of interconnected regional power. • Foster sub regional economic and political integration that would support economic growth, based on reliable, continuous quality electricity service

16. REGIONAL ISSUES • Common Market Rules • Tariff • Open access to network • Standardized codes • Regional regulator • Relationship between regional regulator and national regulator

17. CHALLENGES • Even though the generation sector of the industry has witnessed the licensing of over 20 firms since the commencement of the reform none of the licensed generators has commenced operation. Timely intervention in generation is therefore a major challenge. Without adequate generation there can be no competition in the market. • The industry is  still predominantly public and even the licensed generators upon commencement of operation may have to do business with mainly government owned companies and  thus be exposed to the usual  tension and friction in the  relationship between public owned and purely private owned business. • The appropriate frame work for ensuring optimal national transmission investment is lacking and transmission is now considered as a major bottle neck in the industry. It may therefore pose as a barrier to entry for prospective generators. • The distribution/retail sector is still under the control of government and thus shut from competition. • With the increasing importance of natural gas in the energy mix there will be a need for better price transparency to enhance competition and to provide appropriate signals for new investment.

18. CHALLENGES - 2 • The proposed wholesale market unlike the market in most developed economies that have excess capacity and is usually an ‘Energy-only’ market (meaning generators are only paid for producing energy) will likely be an energy and capacity market. This means generators may be paid for not only providing energy but simply for making capacity available. • A uniform pricing arrangement is expected to subsist nationally within the National Electricity Market (NEM) despite the cost differential associated with transmission and distribution among the various distribution zones. This will result in cross subsidies. • Proper coordination between competitive entities and essential facilities - coordination that was previously provided by NEPA – is replaced by new institutions, and new agreements and rules. This is posing serious challenge and was said to be the major reason of the present decision to provide a new transition Board for PHCN • Ensuring that the market prices that will eventually replace regulated prices are set in a market that is truly competitive • Galvanising public confidence in the activities of the Commission due to perceived policy failures in the past

19. CONCLUSION • The Commission expects new issues and challenges to constantly crop up in the execution of its assignment • The industry is at its infancy and a lot of the challenges will mainly arise from the inadequacies of the system • Need to build confidence and hope on the reform process amongst the population • An open and transparent consultative process in addressing issues and challenges • Industry is gradually on the path to sustainable development • The Commission believes that its success will to a large extent depend on the quality of its manpower and is therefore intensively training staff to meet with the challenges of this dynamic industry