Explainer: How foreign exchange may affect service reflective tariffs implementation

If all goes according to plan, tomorrow, the new service reflective tariffs will take effect, a review that is many years overdue but the Central Bank of Nigeria’s foreign exchange rate management may throw spanners in the works.

The ultimate goal of electricity tariff review is to develop a credible market where value creators across the chain, such as gas, generation, transmission and distribution companies, can recoup operational costs in addition to some reasonable profit for services provided. The value chain is so interwoven that any weak link disrupts value creation and the reward for value created in the form of tariffs.

Since the power sector privatisation in 2013, the Nigerian Electricity Regulatory Commission (NERC) has failed to review electricity pricing at least six times under the Multi-year Tariff Order (MYTO) it instituted to price electricity, a failure that has discouraged new capital injection into the sector and caused shortfalls of nearly N1.40 trillion.

A tariff order dated March 31st and published on the Commission’s website had booked April 1, 2020, for the takeoff of the new electricity tariff by electricity Distribution Companies (Discos). This was later postponed and July 1 is now the new date.

The recent commitment of the NERC to push through with the tariff review is connected with the $ 3.40 billion emergency financial assistance that Nigeria received from the International Monetary Fund ( IMF). The Bretton Woods institution demanded that the fund be judiciously used and that both oil and electricity subsidies need to be removed.

One factor which may constitute a major setback to this is another form of subsidy, this time on foreign exchange. There is huge foreign exchange exposure that the gas sector is exposed to. The gas sector is also exposed to the power sector.

The gas sector is generally a dollar investment sector and takes hundreds of millions of dollars and in some cases billions of dollars invested in a gas production system and when it is time to sell, the gas is paid for in naira.

“You are not paid in naira at the market rate; you are paid at the CBN rate. Generally, most people lose 20 to 30 percent of their invoice value on forex exposure,” Dada Thomas, chief executive officer of Frontier Oil Limited said. “This is not an incentive for investing in gas in Nigeria and the power sector is the biggest off-taker of gas, accounting for up to 80 percent.”

Although Godwin Emefiele, governor of the Central Bank, has said that the CBN will continue to pursue unification around its Nigerian Autonomous Foreign Exchange Rate Fixing (NAFEX) rate. The CBN has a long history of defending the naira and has been slow to let the currency float, in its effort to manage price stability.

Three months ago, Emefiele stated that the adjustment of the naira from N307/$1 to N360/$1 at the official window was not devaluation. Whatever this is called it shows the naira has lost significant value against the greenback. But the naira sells at N460/$1 at the parallel market. This creates arbitrage opportunities and discourages foreign investors from bringing in fresh investments.

The gas to power sector is an interwoven and intrinsically dependent chain, if there is a weak link in that chain, then the entire system collapses. There is no problem for anyone investing in gas export (Liquefied Natural Gas), the reason is simple. The investments are done in dollars, the LNG is sold in dollars to credible, bankable off-takers who will pay invoices as when due. Service reflective tariff review that ignores the impact of foreign exchange on gas investments and gas pricing misses an important part of the power jigsaw puzzle.