Electricity tariff hike: A double- edged sword

ELECTRICITY tariff has just been increased by 240 per cent, although the hike applies only to a small, albeit significant segment of the electricity consuming population. Over time, there have been increases to address low and unbalanced tariffs, and other interventions. These, however, have had little impact on poor electricity services or improved the parlous financial state of the industry.

The reason is simple: The key issues that have turned the electricity crisis into an intractable problem do not stem simply from a lack of costreflective pricing. Rather, they originate in systemic challenges that have not received the necessary attention. Insights from economic regulation and the adverse macroeconomic environment point the way to a holistic approach to improve electricity supply.

Background

The tariff hike of 240 per cent for Band A customers has affected different stakeholders, and commentators have highlighted the dire consequences it will have on individuals, businesses, and the economy, coming on the heels of petrol subsidy removal and exchange rate reform, and the combined impact on both inflation and the cost of living.

The hike was portrayed as necessary to cover the federal cash injections necessary to offset the revenue shortfalls that arise due to the imposition of a tariff set by the regulator that is lower than the costs utilities need to recover. The subsidy, which stood at approx. N130 billion per month as at the time of its removal, was, simply, unsustainable given the fiscal challenges with which the government must contend. Because of government’s indebtedness to the industry, and untimely payment of shortfalls, the lack of liquidity has wreaked havoc on the financial position of service providers and worsened the Nigerian Electricity Supply Industry’s ( NESI) operational performance.

While increasing the tariff to a level that is, ostensibly, cost- reflective may appear an appropriate intervention, it is arguable that this increase has little to do with what economics dictates as best practice with respect to appropriate and efficient cost pricing or avoidance of the excesses of consumption subsidy.

There is very little to suggest that the fundamental, underlying issues, which make costs deviate from appropriate pricing, are being addressed. Thus, the concerns that the increase may not only fail to deliver sufficient revenue to make up for the withdrawal of government support, but also that the hike will spur more inflation and adversely affect the competitiveness and output of the economy, are valid.

Two sets of factors relating to NESI and the economy, are significant in undermining the industry’s ability to supply electricity reliably and adequately. The first set are sector- specific issues and include high technical and commercial losses, and the high cost of producing and supplying electricity. With respect to the latter, two key factors stand out: ( i) the high cost of natural gas, the main fuel for power generation, inappropriately denominated in US dollars; and ( ii) low generation capacity utilisation. On balance, these factors lead to a reduction in the aggregate supply of electricity.

The second set of factors are economy- wide issues and include volatile exchange rate, high interest rates, high inflation, and a weak economy that adversely impact financing for operations and infrastructure investment, and consumption; this, in turn, has negative consequences for aggregate supply and demand. The combined impact of these factors is exacerbated by the rising scourge of vandalism to electricity facilities.

The sector is simply not working

Despite the restructuring of the electricity industry from a centralised to a market- based system, establishment of a sector regulator, private sector participation, and the introduction of an appropriate pricing methodology, NESI has witnessed increasing tariffs, revenue shortfalls, and increasing government support, all of which were contrary to the industry envisaged at the onset of the reform programme.

Many observers have concluded the sector is simply not working as expected. The high inefficiencies associated with poor electricity supply mean more resources are used than should be required, and, in some cases, cross- ownership of generation and distribution assets stifles choice and competition, and thereby worsens electricity supply.

The reform, comprised of horizonal and vertical unbundling, creation of a market system, and privatisation of PHCN successor companies carved out of the former NEPA, ostensibly to enhance efficiency by leveraging the forces of demand and supply, has failed to force private investors to render operations efficient, mobilise investment to address infrastructure gaps and expand the grid with electricity supply worse today than ten years ago. Electricity tariff is also higher, yet government has been compelled to commit more scarce public resources to NESI than it had to when the industry was solely publicly- owned and controlled.

This is primarily the result of inefficient operations characterised by high system losses and high cost of services. Although these problems may predate privatisation, the private investors have not tackled them and have instead prioritised short- term profit over long- term investment in infrastructure, a strategy that serves to reduce capacity and limit the industry’s contribution to wealth and job creation.

In such a situation, rather than tackling the underlying issues that have compounded inefficiency, the increase in tariff simply shores up revenues, and profits. However, those very costs are attributable to the inefficiencies and distortions to operations and market structure that have combined to blunt competition and choice rendering NESI wholly inefficient. The new tariffs simply worsen the problem thereby engendering a vicious circle. The reality is deteriorating energy security as well as a lack of competitiveness of commercial and industrial consumers. Logically, this has adverse consequences on domestic production and the economy.

Regulation, which in principle is meant to be light- handed and performance- based, has failed to deliver improvements in services and mobilise investment. Indeed, it could be argued that regulators have not taken full cognisance of the inefficiencies when setting the goalposts. Consumers are of the view that there is regulatory capture as only interests of the private investors are advanced with constant tariff increases without commensurate contribution to improving electricity supply. Addressing these issues will require a multi- pronged approach that goes beyond tariff increases.

Impact of volatile macroeconomic indices and inefficient operations on tariff

The Minister of Power in a recent interaction with the National Assembly said, “Power sector crisis has defied all solutions”. This statement, perhaps borne out of exasperation, can only be ascribed to lack of tangible results after numerous interventions by government. It is also tantamount to abdicating responsibility as the solutions proffered have not been based on a detailed analysis of problems and measures adopted. As indicated above, the interventions target symptoms and not the root causes of the problems.

Failing to take cognisance of the panoply of issues and challenges that undermine the mutually- reinforcing flows of energy and money ensures the failure of any tariff increase to constitute a costreflective tariff. As things stand, such an increase cannot improve sector liquidity, mobilise investment, improve electricity services. In other words, without a comprehensive grasp of the systemic and sector issues, and full understanding of the mechanics of the tariff model, where the issues come together, tariff increases will not address NESI’S problems. On this trajectory, more tariff increases may follow for the generality of consumers.

The variety of endogenous and exogenous factors that affect production and supply of electricity services converge in the electricity pricing model. The model itself, a synthesis of cost recovery and profit maximisation objectives with consideration given to efficiency improvement and investment mobilisation, is quite sound.

However, two things go against it: regulatory laxity and adverse macroeconomic conditions. The model does what it is meant to do but less than rigorous application of sector regulation and the noise introduced into pricing by a volatile exchange rate, inflation, and interest rate, together combine to cause costs to diverge from set tariff.

Persistent variations of the underlying parameters necessitate constant review of the model, causing tariff to be unstable. Unstable prices and the consequential revenue shortfalls negatively impact operations and financial performance, making it difficult to mobilise investments thereby causing a vicious circle. Thus, without addressing the sources of the industry inefficiencies, tariff increases will not work, and the electricity problem will only be compounded.

Tariff model and elusive cost- reflective tariff

Prices have been increased on numerous occasions since the introduction of the MYTO in 2008, yet cost reflectivity remains elusive. Understanding the tariff model gives an insight into why the attainment of cost reflectivity is largely impossible as long as the industry is inefficient and macroeconomic indices remain unstable.

The model provides for the recovery of the operating and capital costs incurred by the generation, transmission and distribution of electricity. Operating costs include personnel, O& M, and energy costs. Capital costs are comprised of the return on investment and return of investment, which provide for profit and depreciation, respectively.

Other assumptions include operational characteristics such as losses, grid stability, etc. After arriving at a tariff, an uplift is added to the tariff to allow for regulatory and other sector- related costs. Macroeconomic variables are factored into the model to ensure economic reality. Rather than ensure stability, these variables cause price instability.

First, electricity tariff is set ex ante, in other words before expenditures are incurred. The nature of NESI and the need for price certainty mean the price must be determined ahead of operations to enable the mobilisation of funding for operations and grid development.

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