A Review of the Order on the Transition to Bilateral Trading in the Nigerian Electricity Supply Industry (NESI)

Introduction

Nigeria seeks to increase the effectiveness and reliability of its power sector. It has established a framework that aims to facilitate a more competitive environment by promoting direct contracts between Generation Companies (GenCos) and Distribution Companies (DisCos). This Order represents a strategic change from the previous provision, in which the exclusive authority to buy power from the GenCos and resale to the DisCos, so serving as a middleman in the Nigerian electricity trading, belonged to the Nigerian Bulk Electricity Trading Company (NBET) Plc. This regulatory initiative is expected to transform Nigeria’s electricity market by promoting bilateral trading, enhancing competition, and improving the contractual framework while providing clear directives to NBET regarding its role, responsibilities, and orders on energy invoicing and settlement. The “Order on the Transition to Bilateral Trading in the Nigerian Electricity Supply Industry (NESI)” (the Order), which came into effect on the 25th of July 2024, represents a significant shift in Nigeria’s approach to electricity market operations. It essentially provides the context of the Order. It comprehensively describes the Trends in the Wholesale Energy Trading Segment of NESI, the Administration of the Power Purchase Agreements (PPAs) with Omotosho Power Plc and Olorunsogo Power Plc; the current State of Energy Trading with NBET, Objectives of the Order and categorised the capacity of DisCos based on vesting contracts and GenCos contracted or vested capacities with fully operational agreements.

By analysing the regulatory changes and their anticipated impact on market dynamics, this review aims to provide a comprehensive understanding of the Order’s role in shaping the future of Nigeria’s electricity landscape.

Background of the Order

The Order is rooted in the broader context of Nigeria’s electricity sector reforms, which began with the unbundling of the Power Holding Company of Nigeria Plc. (PHCN). This unbundling was part of a strategic initiative to privatise the successor GenCos and DisCos to enhance efficiency and service delivery in the power sector. The Electric Power Sector Reform Act (EPSRA) established a framework to create a bulk trading company, tasked with serving as an interface for GenCos and DisCos. This was required to make it possible to buy capacity and energy up until the DisCos could get the necessary creditworthiness to enter into Power Purchase Agreements (PPAs).

Consequently, the NBET Plc was incorporated in 2010, with the mandate to serve as a credible off-taker, ensuring that GenCos received timely payments while enabling the development of bankable independent power projects. In August 2011, the NBET was licensed by the Nigerian Electricity Regulatory Commission (NERC), with a crucial part in acquiring and offering DisCos ancillary services and bulk electricity with a 10-year tenure license, subject to renewal, which NERC would determine. The energy and capacity contracted by NBET are in accordance with the proportion of assured capacity indicated in the completed Vesting Contract (“VC”) between NBET and the DisCos are vested in the DisCos. 

However, over time, it became evident that the NBET’s continued dominance and monopoly hindered the transition to an increasingly competing and decentralised electricity trading environment. Upon the expiration of the NBET’s initial 10-year license, NERC renewed its license for a period of three years only after consultations with stakeholders who highlighted the shortfalls associated with NBET’s role and cited that beyond tariff assistance, its ongoing involvement has served as a deterrent to bilateral contracting between DisCos and GenCos, thereby exposing the federal government to income deficits. In response to these challenges, the Electricity Act 2023 mandated NERC to guide the development of NESI towards more advanced market stages. This included directing NBET to stop executing new agreements to purchase and resell electricity and to leave its existing contractual rights and obligations to other licensees.

Trends in NESI’s Bulk Electricity Trading Division

The trends in  NESI’s bulk electricity trading are a significant evolution in the market dynamics, particularly in the transition towards bilateral trading, an increasingly competing and decentralised electricity commercial environment. Since 2022, NERC has actively encouraged the development of a more competitive trading environment, leading to several notable trends. There have been private trading companies, and ten private businesses who are interested in trading electricity bilaterally with DisCos and qualified consumers have been granted trading licenses by the Commission. This influx of private players indicates a growing interest in the wholesale electricity market outside the traditional single-buyer model dominated by the NBET, hence creating the possibility of wholesale electricity trading outside of the NBET’s exclusive clientele. Before this time, DisCos had usually requested regulatory approval from other parties for electricity purchases. At the same time, several DisCos stated that they would prefer to buy electricity from the GenCos directly or via other trading licensees rather than relying solely on NBET. 

On the other hand, NERC has gotten some notifications from a number of GenCos indicating their intention to exercise the partial or complete exit rights outlined in their PPAs with NBET to enter into contracts for the direct supply of electricity to DisCos, other bulk traders, and qualified customers. There is a growing willingness among GenCos to explore alternative trading arrangements that may offer better financial viability and operational flexibility.  GenCos entering into bilateral contracts with DisCos for electricity and capacity are primarily motivated by the desire to increase the predictability of production and the accessibility of gas to obtain satisfactory off-take commitments supported by some payment guarantee.

PPAs Administration with Omotosho Power Plc and Olorunsogo Power Plc

NBET and Pacific Energy Ltd (the operator of both power plants) contracted for a capacity of 304 MW for the Olorunsogo and Omotosho power plants under a PPA.  The PPA stipulates an arrangement to ensure a reliable electricity supply to the grid with a contracted capacity of 304 MW for each plant and a minimum guaranteed capacity charge of 186 MW. In 2023, the average availability of the Omotosho and Olorunsogo power plants was reported at only 106.6 MW, significantly below the contracted capacity.  However, operational records show a significant mismatch with the capacity payment of 186 MW. This shortfall was primarily attributed to gas supply shortages, which had hindered the plants’ ability to meet their generation obligations. A significant challenge was the need for bank guarantees to secure payment obligations under the PPAs, which created financial risks for Pacific Energy Ltd. To address these challenges, NBET waived the requirement for a firm gas supply agreement (GSA) through a supplement to the PPAs, providing some flexibility in meeting capacity delivery obligations. By signing an amendment to the PPA, NBET eliminated the requirement for a formal gas supply agreement.

NERC emphasises eliminating payments for undelivered capacity for all “take and pay” contracts. Therefore, this directive seeks to ensure that the plants operate at a minimum level to fulfil their contractual obligations. NERC has further mandated that the power plants be dispatched at no lower than their “take or pay” capacity of 186 MW. Thus, from 1^st October 2024, Pacific Energy Ltd will be held accountable for both plants’ combined mechanical and gas availability. Failure to achieve the minimum average availability of 186 MWh/h will result in liquidated damages, thereby incentivising improved operational performance.

Present Energy Trading Situation with NBET

The current state shows several challenges and developments within the NESI. Although the Power Sector Recovery Program (PSRP) has made progress in improving the sustainability of the national electricity supply, the difficulty of having insufficient income to meet funding needs has persisted since 2013. Factors contributing to this liquidity issue include non-cost reflective customer tariffs, untimely subsidy disbursement, and inadequate DisCo billing. NBET has always been dependent on PSRP funds and ad hoc payments from budgetary appropriations, and the Federal Government’s balance sheet. Only eight of the twenty-eight GenCos trading with NBET had fully functional contracts supported by payment guarantees as of June 2024. The remaining 20 GenCos operated. On a “take and pay” basis without such guarantees, they are leading to significant operational challenges and growing debt for electricity delivered to the grid. The average plant availability factor for GenCos has been low, with only 23.25% of the gross installed capacity available for generation quarter one of 2024. This introduced operational challenges due to debt growth, high plant unavailability and limited capacity availability. The mismatch between supply and demand on the national grid is made worse by this low availability, contributing to technical fragility and customer dissatisfaction. Consequently, the NESI continues to face liquidity challenges due to non-cost reflective end-user tariffs, delayed subsidy disbursements, and poor billing and collection practices by DisCos. These issues have hindered NBET’s ability to attract new Independent Power Producers (IPPs) and secure sustainable financing.

Objectives of the Order

The goal of the Order is to move the market for power towards bilateral contracts, reducing the financial risk exposure of the Federal Government to the market. It also seeks to promote a market structure that is more competitive. by repositioning NBET from being the sole bulk electricity trader in NESI, providing equal opportunities for thermal and hydro power companies to lower their contracted capacities, changing the NESI’s bulk energy trading contractual framework to “take-or-pay” contracts, to encourage more market discipline and clarity among players and allowing DisCos to optimise their wholesale energy off-take.

Nigerian Electricity Regulatory Commission’s Directives and Orders

NERC has directed by NBET to cease pursuing new NESI contracts for power and ancillary services. Any violation will result in regulatory sanctions. Meanwhile, NBET will in the meantime continue administering contracts with five GenCos, (Azura Power West Africa Limited (APWAL), Omotosho Power PLC, Olorunsogo Power Plc, Nigerian Agip Oil Company Limited and SPDC Company of Nigeria Limited) vested with capacity from these plants based on their vesting contracts in line with the capacities contained in Table 1 of the Order. The System Operator (“SO”) is directed to dispatch APWAL at a baseload equal to its lowest take-or-pay capacity of 360. Additionally, in the event that on-grid GenCos are unable to fulfil their contractual obligations, the SO may issue directives to APWAL to enhance generation and function as a supplier of last resort. After that, NBET will send an invoice to the impacted GenCo(s) for the energy that the APWAL provided on their behalf.  Within sixty (60) days of the Order’s inception, any other power plants that have interim energy sales agreements or “take and pay” PPAs, in addition to the capacity that is currently with the NBET (“Contracted Capacity”), must negotiate and enter into bilateral agreements with DisCos. NERC’s Q1/2024 review of GenCo’s performance showed an average plant availability factor of 23.25%. Contract capacity for GenCos as seen in the first Schedule of the Order. GenCos must inform NBET of any bilateral capacity exchanged with DisCos and/or eligible customers on or before 30^th September 2024. Thus, on the basis of an interim agreement, any residual capacity that is not exchanged with DisCos will be traded with NBET.

Furthermore, hydropower GenCos must equitably make available their contracted capacity to DisCos, provided the net capacity being traded is not less than the average capacity supplied in 2023. DisCo’s maximum bilaterally traded energy capacity shall be determined by the difference between its energy offtake in the July 2024 MYTO Order and its share of the “NBET Firm Capacity” in Table 2.  Where the committed capacity in the July 2024 MYTO Order is greater than the total capacity contracted from NBET’s firm capacity and bilateral contracts, the deficit capacity will be filled from the NBET interim pool on a “take and pay” basis. The SO will give NBET Firm Capacity and bilaterally contracted energy priority over residual capacity with NBET in the merit order dispatch of generation plants. GenCos capacity under bilateral contracts will be supported by firm GSAs on a “take or pay” basis within three months of contracting, with adequate provisions for supplier defaults. The administration of PPAs with Omotosho Power Plc and Olorunsogo Power Plc will follow certain guidelines. The payment waterfall will rank the payment obligation to Pacific Energy Ltd pan passu with the bilaterally contracted energy by DisCos as a proxy for payment assurance if a bank guarantee is not available to back NBET’s payment obligation under its PPA with Pacific Energy Ltd. The SO will ensure that Pacific Energy Ltd’s Olorunsogo and Omotosho power plants are dispatched at a capacity of 186 MW. Pacific Energy Ltd must secure a firm GSA covering its capacity delivery obligation of 186 MW for each power plant under its PPA with NBET within six weeks from the commencement of the Order. In addition, from 1^st October 1, 2024, Pacific Energy Ltd will be responsible for the plants’ combined mechanical and gas availability, with failure resulting in liquidated damages.

The procedure of energy invoicing and settlement will focus on bilateral contracts, NBET’s role in managing tariff subsidies and the distribution of waterfall DisCo revenue collection, which will ranked as follows: energy traded bilaterally between DisCos and GenCos, NBET firm contracts with five GenCos, NBET pool energy under temporary “take or pay” structures, and PPAs. Firm bilaterally contracted capacity will align with recoverable generation costs, reducing payment default risks and ensuring market discipline by all parties. NERC will review monthly tariffs to ensure that DisCo-permitted tariff is adequate to cover the agreed-upon BTE expenses. If a DisCo’s tariff exceeds BTE, NERC will provide regulatory direction. DisCos will be required to hire greater capacity if the Federal Government of Nigeria’s (FGN) tariff reform policies enable higher market revenues. NERC and NBET will collaborate with all government ministries, departments and agencies (MDAs) to develop a credible financing plan for any tariff policy approved by the FGN.

Conclusion and Recommendations

The successful implementation of the directive specified in the Order is crucial for Nigeria to achieve better service delivery, increased investment prospects, and increased consumer satisfaction as it navigates this critical phase of its reform in the power sector. In the end, cooperation between all parties involved will be necessary to reap the total rewards of bilateral trade and guarantee the country’s reliable and sustainable electricity supply. It also gives DisCos more freedom to manage their energy procurement strategy and bargain for improved terms and conditions in the NESI; this move aims to empower market players and promote a more orderly and transparent electricity trading environment. However, NERC has a huge responsibility to complete this shift ahead of time. Firstly, Regular audits of the agreements between GenCos and DisCos would help NERC prevent possible market abuses and preserve transparency while strengthening its enforcement and monitoring capabilities to guarantee adherence to the new bilateral trading regime.  In addition, NERC needs to set up the necessary tools and training so that GenCos and DisCos can successfully negotiate the new bilateral trade environment. Stakeholders can also benefit from these workshops and seminars by better understanding the nuances of risk management, contract negotiation and market operations. Again, NERC should also collaborate with financial institutions to create customised financing options for credit facilities or guarantees for GenCos and DisCos to facilitate the switch to bilateral contracts and enhance the creditworthiness of market players. Also, to foster confidence and promote market participation, there should be a greater understanding among all parties involved, especially consumers, of the advantages and operation of the new trading system. Lastly, NERC needs to proactively expedite the licensing procedure for novel trading enterprises while guaranteeing that current participants are not unfairly privileged.