Executive Summary

This Note assesses the scope of the regulatory intervention in the Nigerian Electricity Supply Industry ("NESI") and the ensuing license cancellation proceedings instituted by the Nigerian Electricity Regulatory Commission ("NERC" or the "Commission") against Kaduna Electricity Distribution Company ("KAEDC" or "Company"). In the exercise of its statutory powers as clearly stipulated by the Electricity Act 2023 (the "Act") and the repealed Electric Power Sector Reform Act 2005 ("EPSRA" or the "Repealed Act"), the Commission conducted a detailed performance review of the Company in response to KAEDC's protracted and systematic inability to meet its minimum outstanding financial obligations to the Nigerian Bulk Electricity Trading Plc ("NBET") and the Market Operator ("MO") as well as its apparent inability to articulate a cogent and viable plan for its enduring financial and operational sustainability.

By way of background, the Note proceeds by first examining i) the extent of the regulatory powers of NERC under the Act and the Repealed Act and ii) the scope of obligations imposed on Distribution Companies ("DisCos") under the Performance Agreement (the "PA" or "Agreement") executed with the Bureau of Public Enterprises ("BPE") and the Market Rules (the "Rules") as well as the extent of its obligations to NBET under the extant electricity regime in Nigeria.

The Extent of NERC's Regulatory Powers under the Act

Notably, the NERC is the apex regulator of the Nigerian Electricity Supply Industry ("NESI")1. In addition to other specified functions, the NERC is empowered to issue licenses and oversee entities involved in electricity generation, transmission, system operation, distribution, supply, and trading in Nigeria.2 Specifically, NERC has the authority to oversee the functioning of the NESI, impose sanctions on licensees under appropriate circumstances, and seal or access the premises of individuals/entities operating without a license or suspected of violating the Act. In addition, the Commission is also empowered to ensure compliance with the laws, control tariffs, and efficiently resolve sector-related disputes. Furthermore, the Commission is permitted to delegate its regulatory powers to state regulators once they are established.

To the extent the licensees may fall short of its obligations under the relevant licenses or be in violation of the Act, the Act reserves to the NERC certain regulatory intervention powers it may invoke. These powers may be invoked in the following specified circumstances:

  1. The licensee informs the commission that it is unable to carry out its functions;
  2. Inability of the licensee to carry out its functions required by the Act;
  3. The licensee is faced with management crisis that is against the interests of its shareholders, consumers, and its operations; and
  4. The assets of a licensee are insufficient to cater to its liabilities to lenders and it may likely face or under Receivership.3

Obligations of the DisCos to NBET

The NESI operates as a contract-based electricity market, with NBET acting as the bulk purchaser from the successor generation company (the "GenCos") through the Power Purchase Agreements ("PPAs"). Fully owned by the Federal Government, NBET serves as the wholesaler, selling power to DisCos through Vesting Contracts("VCs"). DisCos, in turn, distribute electricity to end-users.

The transaction cycle in NESI commences with the GenCos producing electricity which is sold to NBET and injected into the National Grid. The cycle involves monthly invoicing and settlement processes overseen by the MO. The NBET receives a Final Settlement Statement ("FSS") from the MO, encompassing the traded quantities for capacity and energy for the GenCo, DisCos, and other participants in the NESI. DisCos are mandated to collect revenue based on approved tariffs, which is an embodiment of a subsidized tariff by the government to transition towards cost-reflective tariffs4. Notably, there is Minimum Remittance Orders ("MRO") that determine the percentage of the invoice to be paid by DisCos to NBET. NBET facilitates the payments by setting up a committee that will assist in channeling payments to GenCos to maintain the transaction cycle and ensure liquidity in the market.5

The transaction cycle structure aims to ensure the financial flow within the NESI and facilitate the transition to sustainable tariffs. In a situation where a DisCo fails to meet its payment obligation to NBET, the cycle breaks, and this prompt NERC to invoke its regulatory intervention powers upon receipt of a complaint.6

Obligations of the DisCos under the Performance Agreement

Following the privatisation of the power sector in or around 2013, each of the successor DisCos executed Agreement with the BPE for a term of 5 (five) years (the "Timeline")7 pursuant to which the core investors in the DisCos committed to meet certain performance targets or indicators within the Timeline. The underlying rationale behind the execution of the Agreement was to ensure accountability and track the DisCos' performance in furtherance of the commercial objectives of the privatisation. Notably, the Agreement imposes core obligations on the DisCos, including but not limited to:

  1. Reduction of Aggregate Technical Commercial and Collection ("ATC&C") losses within its franchise area;
  2. Widespread metering of the DisCos franchise area with a view to bridging the metering gap;
  3. Connection of new customers to the distribution network; and
  4. Prompt remittance of payments due to NBET.

The Agreement contemplates a call option arrangement which grants the Federal Government of Nigeria ("FGN") the option to buy back the Investor's shares in the Disco for a reduced sum (preferably a $1 consideration) in the event the DisCos default or fail to meet the obligations in the Agreement.

Obligations of the DisCos under the Market Rules

Importantly, the Rules established both the System Operator and a Market Operator. Whilst the former typically issues and implements the operating procedures in relation to the implementation of the Grid Code, power system, and amendment of operating procedures (as required), the latter formulates and creates the market procedures for the implementation of the Rules and the administration of the Wholesale Electricity Market.8 The Rules define a Participant as a person who has entered into a market participation agreement with the Market Operator, including but not limited to holders of license in respect of the generation, distribution, or trading of power. The DisCos, who are participants, are required to connect their Distribution System9 to the Transmission System10 at the Connection Point11 for the purpose of extraction of power, market settlement and energy metering.

Accordingly, the Rules imposes on the DisCos a number of obligations, including but not limited to the prompt payment of any charges that become payable as a result of the Wholesale Electricity Market's settlement and billing process in accordance with the Rules.12 These charges include a) Transmission Use of System or "TUOS" being charges approved by NERC for the use of the Transmission System, b) System operator and market operator administration charge, being charges established and imposed by the market operator for the recovery of administration costs relating to system operation and market operation and incidental damage and c) payment for any applicable ancillary services directly provided by the system operator ("Market Operator Charges"). Given the DisCos' obligations to discharge the Market Operator Charges, the Rules mandates the DisCos to provide and maintain security cover13 of an amount not less than the quantity notified to the DisCos by the Market Operator.14 Failure of the DisCos to pay the Market Operator Charges often prompt the market operator to call on the security cover to cover the outstanding obligations. In the event the security cover is not sufficient to fully discharge the obligations due, the DisCos will remain in default and may therefore be exposed to such regulatory actions, including the payment of penalty, a suspension or disconnection order by the market operator15 and an intervention by the commission into its business and affairs.

The Case of KAEDC in Issue

Following the foregoing background, it is now imperative to examine the case of KAEDC in the context of the NERC's regulatory intervention. Notably, the Commission conducted a detailed review of the performance of the KAEDC for the period of January – December 2022 in January 2023. The Commission discovered that KAEDC only achieved a combined average of 13.85% of their minimum payment obligations (as discussed above) to NBET and the MO and recorded an underpayment to the tune of NGN 4.33 billion. Consequently, the Commission made requests to the management of KAEDC, to present a robust and viable financial sustainability plan to revitalize the KAEDC in order to meet its above-stated obligations.

The Commission noted that KAEDC, because of its underperformance, has not been able to recover the needed liquidity required for its optimal functioning. The Commission noted that i) KAEDC under-recovered its revenues, ii) there was a market shortfall of NGN 88.75 billion, iii) capital investment allowance was under-recovered to the tune of NGN 25.33 billion and iv) allowed operating expenses to the tune of NGN 11.46 billion. Over the period of 12 months from January 2022 – December 2022, KAEDC accrued a total liability of NGN51.93 billion to NBET and MO. Notwithstanding the recent nature of this liability, KAEDC also accrued a historical debt from 2015 – 2022 valued in the sum of NGN 41.49 billion.

In response to the manifest inadequacy of KAEDC's management and the African Import and Export Bank ("Afrexim"), Fidelity Bank Plc16, and the BPE (the "Core Investors") to furnish a plausible plan for financial sustainability, a formalized 14-day notice dated 23rd March 2023 ( the "Notice") was duly issued to KAEDC and the Core Investors. The Notice carried the implicit consequence of a possible invocation of regulatory intervention in the event the Core Investors fail to furnish a plan deemed satisfactory to the Commission within the stipulated time frame.

Upon receipt of the Notice, the Core Investors articulated their pleas for a temporal reprieve by petitioning for extensions, citing a) complexities associated with the divestment process and b) a compelling exigency for an extended temporal ambit to address the intricacies inherent in their efforts. Further, an all-party meeting was subsequently held with representatives of the Core Investors and the Commission pursuant to which representatives presented their proposal to the Commission for consideration. However, the Commission reviewed the Core Investors' proposal and concluded that the proposal failed to address the critical concerns about KAEDC's financial sustainability.

The Commission therefore issued the Order of Regulatory Intervention which took effect from 1st January 2024 and shall remain in force until amended or revoked by subsequent orders issued by the Commission.

License Cancellation Proceedings

The Commission stipulates that, where "the financial position of the licensee is such that he is unable to fully and efficiently discharge the duties and obligations imposed by the License17, the Commission shall cancel the Electricity Distribution License (the "License") after granting a window for the affected licensee to show cause. On 15th May 2023, the Commission cancelled the license of KAEDC. The cancellation came after the issuance of a 60-day notice to show cause, challenging the cancellation of the license.

Following the requests of the representatives of the Core Investors at the meeting held with the Commission, the Commission made considerations and resolved to extend the License cancellation notice for a final period of 30-days with effect from 20th July 2023 (the "Final Extension"), failing which the Commission would proceed with the cancellation, after the Core Investors have failed to provide any reasonable and sufficient justification.

Extension, Further Requests and Non-Compliance

On 17th August 2023, Afrexim specifically requested for an extension to conclude the divestment process, citing impediments stemming from ongoing negotiations with potential buyers and challenges associated with the provision of requisite guarantees.

The Commission acceded to Afrexim's requests for a) further extension to finalise the divestment process with a final deadline of 31st December 2023 and b) approved the appointment of 3 directors to KAEDC's Board - George Elombi, Abiodun Odubola and Chudi N. Ojukwu - to the Board.

Regulatory Intervention Order

Upon conclusion of the evaluation, the Commission invoked its powers under section 75 of the EA due to KAEDC's prolonged default, insufficient assets, and failure to discharge its due obligations. Accordingly, the Commission ordered the removal of KAEDC's directors, appointment of an administrator, and initiation of the sale process based on the highest and best price offered.

Under the authority of section 75 of the Act, the Commission issued an order for regulatory intervention into KAEDC. The order resulted in the:

  1. Removal of all directors and dissolution of the board.
  2. Appointment of Dr. Umar Abubakar Hashidu as administrator/de-facto Chief Executive Officer (CEO).
  3. Establishment of special directors and the executive management team. The special directors are:
    • Alex A. Okoh – Chairman
    • Kabir Adamu
    • Sharfudeen Zubair Mahmoud
    • John Ayodele
    • Rahila Thomas
  4. Administration of the sale of the undertaking based on the highest and best price offered.

The regulatory intervention timeline indicates that the Commission made a number of concessions and granted numerous extensions, coupled with a painstaking evaluation of the financial affairs of the KAEDC. This regulatory approach undoubtedly demonstrates the Commission's commitment to striking a judicious balance between accommodating legitimate requests and upholding stringent regulatory standards. Notwithstanding the foregoing approach, it is indisputably clear, given the timeline of events in the KAEDC's case, that the NERC is willing to wield its regulatory sword to penalise any licensed entity who fails or is failing in its statutory obligations in the NESI.

Key Takeaways

In light of the underlying challenges faced by KAEDC and the consequential regulatory consequences, we expect that similar DisCos will be proactive to address all existential fundamental and business issues currently impacting their business. It is undoubtedly evident that the core issues impacting KAEDC revolved around its financial obligations and regulatory compliance, thereby underscoring the critical importance of these dual matters. Consequently, the DisCos must put in place sustainable business models, including efficient financial management and governance, sustainable debt financing strategies, diversification of funding sources, optimization of costs through initiatives (like technology adoption and automation), improvement on revenue collection and metering efficiency and maintenance of transparent financial reporting.

Given that the challenges also revolved around regulatory compliance issues, we also expect that the DisCos should adhere strictly to regulations, regularly review their internal procedure reviews and stay abreast of evolving regulatory requirements.

Footnotes

1. Section 33(3) of the Act

2.

3. Section 75(3) (a-d) of the Act.

4. The cost reflective tariff is set by the NERC and allows DisCos to fully recover the efficient cost of operation, including reasonable return on invested capital. It is expected to reflect the key economic fundamentals such as inflation, exchange rate and gas price, and it is to be reviewed on a regular basis. Notably, the NERC last reviewed the tariff structure on 28th December 2023 to be effective on 1st January 2024.

5. https://nbet.com.ng/distributiondata.html

6. Section 75(1) of the Act

7. The timeline was subject to being extended as may be determined by the BPE.

8. NERC-–-The-Market-Rules-for-the-Transitional-and-Medium-Term-Stages-of-the-Nigerian-Electricity-Supply-Industry_SLRG.pdf (electricitylawyer.com)

9. Section 1.1. of the Grid Code defines Distribution System means all electric lines used for distribution of energy to final consumers and includes any structures and equipment used for that purpose which is connected to the Transmission System.

10. Section 1.1 of the Grid Code defines Transmission System as the system or network of electric lines comprising wholly or mainly high voltage lines and electric plant and which is used for transmission of energy from a power station to a substation, from one power station to another, from one substation to another or to or from any interconnector or to final consumers, including any structure and equipment.

11. Section 3.1 of the Rules defines Connection Point means a point of connection between the Transmission System and a generation facility or load facility where a participant connects to the system to inject or extract, and which will be considered its wholesale electricity market entry or exit point for the purpose of market settlement or energy metering.

12. Section 17.1.1(d) of the Rules

13. The Security cover will typically take the form of a) cash on deposit in an interest-bearing escrow or trust account maintained with a bank or other financial institution, providing a direct transfer of funds to market operator on demand b) an irrevocable direct pay Letter of Credit or other guarantee of payment and c) an unconditional and irrevocable guarantee of payment on demand to the Market Operator by any financial rating agency.

14. Section 17.1.1.(e) of the Rules

15. Section 45.3.1(c) of the Rules

16. Relatedly, Afrexim and Fidelity Bank effectively took over 60% ownership initially held by the initial investors in KAEDC pursuant to their acquisition debt facility instruments, given their failure to repay the principal and the interest on the acquisition debt instruments.

17. Section 74(1)(d) of the EPSRA.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.