Thursday, July 28, 2016

#TBT: Power Privatizations in Africa: Key Lessons


This post is part of an occasional series highlighting a project finance article or news item from the past. It is often interesting and thought provoking to look back on these items with the perspective of months, years or decades of further experience. 

With this installment, we turn to an article that was first published in the Project Finance NewsWire in November 2014 and written by Kevin Atkins and Ikenna Emehelu, partners in Chadbourne's Project Finance Group.



Power Privatizations in Africa: Key Lessons

Privatizations in sub-Saharan Africa offer key lessons for investors seeking to enter newly-deregulated power markets in Africa.


This article looks at the cases of Uganda and Nigeria where, in recent years, the governments have implemented privatization reforms aimed at increasing private-sector participation in power markets formerly dominated by state monopolies.

When a government monopolizes the power sector, a single entity usually controls generation, transmission and distribution. This can result in poorly performing management systems (with no competitors offering viable alternatives) and cross subsidization among the generation, transmission and distribution sectors leading to apparent support of one another when, in reality, risk is being passed to consumers through volatile pricing and power shortages. 

Privatization reforms are usually designed to stimulate competition and make the particular sector concerned a more financially viable and attractive environment for investment that can sustain itself without the need for government subsidization. Increased competition in the power marketplace offers consumers a number of viable alternatives for power supply and helps to stabilize prices through market forces. A competitive market for generation and distribution helps to increase power volumes and improve reliability and coverage to satisfy growing domestic demands of emerging economies, particularly in rural areas. In addition, a privatized and unsubsidized power sector is more likely to produce profits for investors who enter the market. The investors will pay taxes to the government, which will also have reduced its costs by no longer subsidizing a failing power sector with volatile price swings. 

Uganda 

The privatization of the Ugandan power sector took place within the context of widespread deregulation throughout the Ugandan economy. A national “Electricity Act” was passed in 1999, at a time when collection rates for electricity bills were approximately 50%. The Electricity Act ordered the power sector to be privatized through the unbundling of production, transmission and distribution systems, all of which were under the control of the Uganda Electricity Board. The Electricity Act also established the independent Electricity Regulatory Authority, which was created for the purposes of regulating the power sector, issuing licences, establishing tariff systems and enforcing codes of conduct for system operations.

In 2001, the Uganda Electricity Board was decentralized and unbundled into three separate specialist companies: the Uganda Electricity Generation Company Limited or “UEGCL,” the Uganda Electricity Transmission Company Limited or “UETCL,” and the Uganda Electricity Distribution Company Limited or “UEDCL.” While the UEGCL retained ownership of the Nalubaale plant and the Kiira plant (formerly the Owen Falls Dam hydro project), operations at the two plants were handed over to Eskom, the South African state-owned electricity company, in 2003 under a 20-year concession. All the power generated by the plants was then sold to the UETCL. In 2005, Eskom and Globeleq formed a joint venture that signed a 20-year concession with the Government of Uganda to assume UEDCL’s operations and sales to the retail market.

At the same time it privatized the power sector, the Ugandan government pursued development of the Bujagali and Karuma Falls hydro projects, which were awarded to AES and Norpak Ltd respectively. A World Bank report on the Bujagali project noted that a thorough examination of the institutional risk of a delayed or underperforming distribution system post-privatization was missing from the overall economic appraisal of the project. 
Certain reports have also commented that the privatization policies implemented by the Ugandan government proceeded largely without consultation with the private sector and those businesses and other consumers that would be principally affected. One example that has been cited in this regard was the introduction of a value-added tax in 1996, prior to which the business community was largely ignored and little to no effort was made to consult with business leaders and educate them on the implications of the tax and its rationale. 

Much like in the business community, there was a fundamental mistrust of the privatization process at the consumer level. The benefits of privatization were not explained to the general public, many of whom saw the process as a means of enriching government officials. 

Despite these criticisms, the Ugandan government remained committed to its course. The Bujagali project was successfully tendered in 2005 with new project sponsors (after the withdrawal from the project by AES in 2002) and eventually came on line and became fully operational in 2012.

However, despite improvements, 15 years after the privatization process started, rural areas remain largely without power and electrification to these areas needs to be fast tracked. Additionally, while transmission losses have been reduced from approximately 38% to approximately 26%, the figures are still high and lost volumes need to be addressed. One way of doing this could be to invest in smart metering and remote metering to prevent power theft.

Nigeria 

Nigeria launched power sector reforms in 2005 with enactment of the “Electric Power Sector Reform Act” that outlined a reform process to unbundle the state-owned power company, the National Electric Power Authority, into separate entities for generation, transmission and distribution. 

The unbundling process took place via a transition holding company, the Power Holding Company of Nigeria, and was designed to create a competitive market for power supply within Nigeria through private-sector participation. 

The government released a power sector roadmap in August 2010 that set a timeline for investors to bid to acquire separate generating companies (each owning a single power plant) and distribution companies (each servicing a particular region within Nigeria). The timeline was supposed to work as follows:

December 2010: Commencement of bidding process 
July 2012: Submission of bids 
October 2012: Approval of bids 
January 2013: Completion of negotiations 
March 2013: Payment of deposit
August 2013: Payment of balance 

In November 2013, the shares in 11 distribution companies and five generating companies were in fact sold to successful bidders for an aggregate price of approximately US$2.5 billion. The government is in the process currently of dealing with bids from potential purchasers of 10 newly-built national integrated power projects that are being sold by Niger Delta Power Holding Company. Preferred and reserve bidders for no fewer than seven of these projects have been selected with an aggregate purchase price of more than US$4 billion.

The privatization process took longer than expected because of labor unrest, with workers threatening to strike if their severance benefits were not met. The Nigerian government eventually set aside up to 50% of the proceeds from sales of the distribution and generating companies for the workers.

International lenders distanced themselves from the privatization process out of concern that the bidding timeline was too short to come to grips fully with the unpredictability and volatility of the Nigerian markets. As a result, local banks have provided close to 70% of the funds required to pay the purchase price for the distribution and generating companies. Absent wider international lender participation to refinance and syndicate these loans, it is unclear how successful bidders will be able to finance the capital requirements to build out generating and distribution facilities. 

The power sector is inextricably linked to the gas market as Nigeria possesses the world’s ninth largest gas reserves. Theft and vandalism remain rife and have led to lost gas and a lack of feedstock for new plants that, in turn, has led to a number of new gas-fired plants remaining idle after being commissioned. The government has responded by adopting the gas master plan to reduce gas flaring (which has halved over the past five years), to replace diesel, which is a more expensive alternative, as the domestic fuel of choice and to support the investment of capital into combined-cycle gas-fired power projects.

Lessons Learned

The experiences in Uganda and Nigeria suggest potential bidders in a privatization should look for four things before diving into a deregulating African power market. 
First, an independent regulator should be in place before privatization to oversee the market and enforce supply and demand economics. 

An independent regulator can also respond to market criticisms and issues as they arise, and avoid such mishaps as the Bujagali and Karuma Falls hydro projects, where the concessions were entered into before the Electricity Regulatory Authority was created. 
Market participants in a liberalized power sector will need robust guidelines, codes and regulations governing access to the market, service quality, pricing mechanics, nomination procedures and liability regimes. 

Next, concessions should be awarded through transparent and fair bidding processes, free of any allegation of corruption or political influence. To achieve transparency, governments should engage with business leaders, consumer groups and key stakeholders to ensure that the merits of privatization and the desired goals are understood by those who will be affected and there is general buy in for the reforms.

Transparency is also imperative to attract international participation as the international lender market will be vital in sharing funding risk and providing developers with access to much needed capital. 

Next, the market must be viable. International investors will need guaranteed access to fuel to ensure that power plants can run and bankable power offtake contracts to ensure a fixed revenue stream. Without guaranteed fuel and bankable contracts, the plant cannot generate revenue and, hence, service its debt. Long-term gas sales agreements will need to be secured and gas sellers may require credit support from generating companies for take-or-pay obligations (which may be more forthcoming if and when gas prices can be de-linked from volatile crude oil prices and tied instead to hub prices for which we are seeing pressure in Europe).

Tariffs must be set at an optimal level to enable consumers to pay and to enable generators and distributers to cover their costs and make a profit. Without an attractive power price, international investors are unlikely to be willing to participate unless the price to buy the privatized assets and ongoing operating costs are minimal enough to allow a profit. 
Privatization reforms require real-time nominations and balancing and settlement mechanisms to support transmission capacity and required demand, especially in times of unexpected shutdowns of generating facilities, which will create a robust trading platform for power where prices can be determined by the market forces of supply and demand. 
Balancing will allow generators, transmitters and distributers to submit bids to the power grid to sell power and offers by the grid to buy power to ensure the market is balanced. Settlement will allow monitoring and metering of actual positions compared to contracted positions.

Finally, there must be a strong political commitment to privatization. Privatizing an entire power sector and putting in place an investment climate that is suitably attractive to international investors will not happen overnight and requires a long-term commitment. Weak political support can lead to short-term fixes that lead, in turn, to longer-term problems, and it is unlikely to attract the international institutions whose participation will be needed to finance the privatization.

Privatization does not work without long-term certainty about fiscal terms as a stable economic base is fundamental for any successful project.