January 24, 2025

UNLOCKING THE FUTURE OF NIGERIA\’S POWER SECTOR: APPRAISING NERC\’S BILATERAL TRADING ORDER VIS-À-VIS THE APPLICATION BY NBET FOR THE RENEWAL OF ITS LICENSE

by AO2LAW

Introduction

On July 25, 2024, the Nigerian Electricity Regulatory Commission (“NERC” or the “Commission”), pursuant to Section 7(2) of the Electricity Act, 2023 (“EA” or the “Act”), introduced a revolutionary Order for the transition to bilateral trading in the Nigerian Electricity Supply Industry (“NESI”) (the “Order”). By the Order, NERC directed the Nigerian Bulk Electricity Trading Company Plc (“NBET”), as the trading licensee for bulk procurement and sale of electricity, to cease entering into new contracts for the purchase and resale of electricity. The Order facilitates the transition from a centralized trading model dominated by NBET to a more decentralized structure that encourages bilateral trading between generation companies (“GenCos”) and distribution companies (“DisCos”).

The Order is seen by industry stakeholders as a significant departure from existing practices, promising to bring substantial changes to trading within the NESI. Notable among the many impacts the Order has, is that it signals the end of NBET’s role as the sole trading company. In response to the Order, which aims to unbundle trade activities within the NESI, NBET has applied for a renewal of its license. Despite the Order, NBET has provided several reasons justifying why its license renewal should be granted.[1] This briefing note offers an analysis of the Order as well as an examination of the challenges and opportunities associated with either the approval or rejection of NBET’s license renewal application, and its implications for the NESI.

NBET’s Role as Sole Electricity Trader

NBET was established in 2010 as a crucial intermediary in the NESI[2], primarily tasked with facilitating the procurement and sale of bulk electricity from GenCos to DisCos.[3] Prior to the issuance of the Order, NBET operated as the sole bulk trader of electricity within the NESI, which meant that it held a monopoly over electricity trading, ensuring that GenCos received payments while managing the risks associated with energy sales. This role was essential for maintaining market stability, especially in a context where many DisCos lacked the creditworthiness to transact directly with the GenCos. However, NBET\’s centralized control has also resulted in significant challenges, including liquidity issues stemming from non-cost reflective tariffs and delayed subsidy payments.[4] These factors have hindered its ability to attract new investments and effectively support the NESI.

With the implementation of the Order, NBET\’s role is set to transform significantly. The Order mandates that NBET shall cease entering into new contracts for purchasing and reselling electricity, thereby shifting the market towards bilateral trading arrangements between GenCos and DisCos. This transition aims to foster a more competitive environment by allowing multiple traders to operate within the market, thus reducing the fiscal burden on the Federal Government of Nigeria (“FGN”) occasioned by NBET\’s monopoly.[5] While NBET will continue to administer certain existing contracts[6] during the transition period[7], its function will evolve from being a sole trader to acting more as a facilitator of market operations. This change is expected to enhance market discipline and efficiency, providing GenCos with guaranteed payments from the DisCos, greater autonomy in contracting directly with DisCos and improving overall service delivery to end-users in the NESI.

Objectives of the Order

The Order seeks to:

a. steer the electricity market towards bilateral contracting for energy and capacity between GenCos and/or trading licensees with DisCos, thus limiting the fiscal exposure of the FGN to market risks;

b. foster a more competitive market structure as envisioned by the EA by repositioning NBET from its current role as the sole bulk electricity trader in the NESI;

c. provide an equal opportunity for all hydro GenCos and thermal GenCos with existing “take-and-pay” contracts with NBET to reduce their contracted capacities by trading directly with DisCos on a bilateral basis;

d. transition the contractual framework for bulk energy trading in the NESI to “take-or-pay” contracts thereby fostering increased certainty and market discipline among market participants;

e. allow DisCos to explore opportunities for increased optimisation/firming up of their wholesale energy offtake, and a reduction of their vesting contract capacity with NBET for “take-and-pay” PPAs, thus providing certainty of availability of generation and the improvement in quality of supply to end-users.[8]

Key Features of the Order

a. Cessation of entry into New Contracts by NBET

The Order mandates NBET to cease entering into new contracts for the purchase and resale of electricity. The Order further provides that, any contract executed by NBET, in contravention of this directive, shall not be approved by NERC, and such action shall be treated as an infraction which is subject to regulatory sanction.

b. Interim Administration of the Fully Effective Power Purchase Agreements

The Order provides that in the interim, NBET will continue to administer the fully effective Power Purchase Agreements (PPAs) with the following five (5) GenCos: Azura Power West Africa Limited (APWAL); Omotosho Power PLC; Olorunsogo Power PLC; Nigerian Agip Oil Company Limited; and Shell Petroleum Development Company of Nigeria Limited, (“NBET Firm Contracts”).

The NBET Firm Contracts are to be administered based on the minimum \”take-or-pay\” capacities in relevant PPAs or the average available capacity of the GenCos specified in the Order (the “NBET Firm Capacity”).[9] The capacity from the NBET Firm Contracts will accordingly be vested to DisCos based on the guaranteed share of capacity outlined in their respective vesting contracts.[10] However, the Order does not specify the duration of this interim period, leaving it unclear whether it is intended for a specific time frame or will last until the expiry of the NBET Firm Contracts.

c. Bilateral Trading

A distinct key directive in the Order is the requirement for all other on-grid GenCos (“On-grid GenCos”) that have contracted with NBET based on “take and pay” PPAs or interim energy sales agreements (“Interim Agreements”) to negotiate and enter into bilateral contracts with DisCos for the sale and purchase of energy within sixty (60) days from the Effective Date.[11]

The GenCos are subsequently required to notify NBET of the capacities which have been traded bilaterally with DisCos and/or eligible customers, no later than 30 September 2024, and obtain NERC’s approval for all the relevant bilateral arrangements. This notification ensures transparency and allows NERC to monitor the new market contracts to be entered into vis a vis the capacity of the national grid.[12]

The residual capacity of the GenCos, which refers to the capacity not traded with DisCos (“Residual Capacity”), will be traded with NBET under an interim agreement, maintaining the same commercial terms as those in the current PPAs/Interim Agreements with NBET. This arrangement serves as a temporary solution for managing excess capacity, enabling NBET to distribute the energy to meet market demand. The total Residual Capacity from all GenCos will form the pool of energy to be traded through NBET on a take-or-pay basis (“NBET Interim Pool”). This mechanism ensures flexible energy procurement, allowing DisCos to access additional energy supply when required.

d. Maximum Bilaterally Tradeable Energy

By virtue of Paragraph 19 (h) of the Order, the DisCos have a maximum capacity that they can trade in the bilateral market (“Bilaterally Tradeable Energy”), which is the difference between its energy offtake as contained in the July 2024 Multi-year tariff order (“MYTO Allocation”), and its share of the NBET Firm Capacity. In the event that the total capacity contracted by the DisCos from the NBET Firm Capacity and bilaterally is lower than its MYTO Allocation, the deficit capacity is to be fulfilled from the NBET interim pool on a “take and pay” basis.

e. Firm GSA Requirements

Gas supply is fundamental to the supply of electricity.[13] To ensure greater predictability in generation and gas availability, the Order stipulates that within three (3) months of the commencement of bilateral contracting, all capacities of the On-Grid GenCos under the bilateral contracts must be backed by effective Gas Supply Agreements (“GSAs”) on a \”take-or-pay\” basis. Additionally, the GSAs must include provisions for the payment of liquidated damages if the gas supplier fails to meet the agreed supply terms, which will help maintain stability and reliability in the bilateral market.[14]

By requiring that all On-Grid GenCos\’ capacities under bilateral contracts be supported by effective \”take-or-pay\” GSAs, the Order minimizes the risk of gas shortages and generation disruptions. The inclusion of liquidated damages for non-compliance by gas suppliers further strengthens accountability and ensures that GenCos can maintain consistent power generation, ultimately supporting the stability and reliability of the bilateral market.

f. Priority in Revenue Allocation

Based on the directives set out in the Order and the proposed restructuring of the contracting model in the power sector, the disbursement waterfall from the escrowed DisCos’ revenue collections account for energy and capacity payments[15] has been amended according to the following priorities:[16]

I. Bilateral Contracts: escrowed DisCo revenue will first be allocated to payment for energy traded bilaterally between DisCos and GenCos.

II. NBET Firm Contracts: the next payment obligation to be fulfilled is from the capacity vested from the NBET Firm Contracts.

III. NBET Interim Pool: the last line item on the payment waterfall will be for the satisfaction of any payment obligations from energy contracted through the NBET Interim Pool.

This structure essentially means that payments under the bilateral contracts between DisCos will take precedence over the settlement of NBET’s invoices for energy delivered under the NBET Firm Contracts. However, this new payment hierarchy could pose challenges for certain GenCos under the NBET Firm Contracts, who previously enjoyed priority in payment. The shift in the payment waterfall may affect the financial and commercial arrangements of these GenCos, which depend on receiving full and timely payments from NBET each month.

NBET’s License Renewal Application

The buildup to NBET\’s application for the renewal of its license is rooted in a complex interplay of regulatory changes and market dynamics within the NESI. Following the introduction of the Order, NBET found itself at a critical juncture. The Order poses significant challenges to NBET\’s traditional role as the sole bulk trader. Despite this shift, NBET applied for a renewal of its license[17], citing its historical importance in ensuring liquidity and stability in the electricity market. It argued that its continued presence is essential for managing existing contracts and facilitating a smooth transition to the new trading arrangements.[18]

In its application for license renewal, NBET emphasized several justifications. Primarily, it pointed out that its role has been crucial in providing credit support and guaranteeing payments to the GenCos which has been vital for maintaining operational stability in the NESI.[19] NBET also highlighted its experience and established relationships with market participants as assets that could aid in navigating the transition period. Furthermore, it argued that granting the renewal would allow it to continue administering existing contracts while new bilateral arrangements are being established, thus preventing potential disruptions in electricity supply. However, stakeholders have expressed concerns that renewing NBET\’s license could hinder the intended reforms sought to be institutionalised by the Order, by perpetuating its monopoly over bulk trading, which could delay the benefits of increased competition and efficiency in the market. As such, NERC faces a challenging decision that balances immediate operational needs against long-term market reform objectives.

Challenges and Prospects in NERC’s Approval or Refusal of the Renewal Application

The renewal or non-renewal of NBET’s license presents both challenges and prospects for the NESI. If NERC grants the renewal, it could provide a temporary stabilizing effect for Nigeria’s evolving electricity market. NBET’s continued existence as a licensed entity may help maintain some level of liquidity and assurance for GenCos – who have historically relied on NBET for guaranteed payments. This could mitigate immediate disruptions in electricity supply and foster a seamless transition to bilateral trading by allowing existing contracts to remain in effect during the adjustment period. However, granting the renewal could also undermine the objectives of the Order, particularly if NBET continues to operate as a dominant player in the market. This may potentially result in stifling competition and delaying the anticipated benefits of a more decentralized trading system.

Conversely, if NERC refuses NBET\’s license renewal application, it will mark a significant shift towards a more competitive electricity market, aligning with the goals of the Order. This refusal could accelerate the transition to bilateral trading, allowing GenCos and DisCos to engage directly without NBET’s intervention. However, this scenario poses substantial risks; it could lead to increased instability in the short term as market participants adjust to the new trading landscape. The absence of a central trading entity like NBET might result in liquidity challenges for GenCos that depend on reliable payments for their electricity supply. Ultimately, NERC faces a complex decision that balances immediate operational stability against long-term market reform and competition within NESI.

Conclusion

The introduction of the Order undoubtedly poses a great deal of opportunities within the NESI, promoting competition, enhancing efficiency, and potentially reducing costs for end-users. This transition, as it were, challenges the traditional trading framework, particularly, the existence and operations of the NBET. NBET\’s license renewal application amidst these changes highlights the complexities within the industry. Granting the renewal could ensure continuity and stability, leveraging NBET\’s expertise, while its rejection on the other hand aligns with NERC\’s vision for a competitive and decentralized market, driving innovation and efficiency.

Considering the fact that the EA, envisages NBET\’s complete exit, NERC\’s phased withdrawal approach indicates that NBET will continue its operations for the foreseeable future. NBET has over time emphasized its role in fostering a credible market and pledged ongoing improvements. The decision on NBET’s renewal and operation now lies with NERC. The Commission in making its decision may have to consider NBET’s performance and commitment to reforms, while prioritizing the interests of electricity consumers and the overall development of the sector.

Please do not treat the foregoing as legal advice as it only represents the public commentary views of the authors. All enquiries on this should please be directed at the key contacts

[1] NBET applied for a renewal of its operational license on September 12, 2024. Its current license expired on November 21, 2024.

[2] NBET was incorporated on July 29, 2010, in line with the Nigerian government’s \”Roadmap to Power Sector Reform\” and, in fulfillment of the requirements of the repealed Electric Power Sector Reform Act (EPSRA), 2005.

[3] This is pursuant to the provisions of Sections 25 and 68 of the repealed Electric Power Sector Reform Act 2005 and NBET’s Bulk Purchase and Resale License issued by the Nigerian Electricity Regulatory Commission (NERC).

[4] Okwilague, S.A., Adat, L. and Edward, A. (2024) A review of the order on the transition to bilateral trading in the Nigerian electricity supply industry (NESI), Lexology. Available at: https://www.lexology.com/library/detail.aspx?g=c5912fac-7236-470e-a76c-8d3c8686bd41 (Accessed: 07 January 2025).

[5] NBET\’s monopoly in Nigeria\’s electricity market imposes a fiscal burden on the Federal Government of Nigeria (FGN) by creating revenue deficits and necessitating increased subsidies to ensure Generation Companies (GenCos) are paid for their electricity supply. This reliance on NBET as an intermediary limits competition and efficiency, resulting in financial shortfalls that compel the FGN to divert funds from other critical areas. Additionally, the regulatory challenges associated with NBET\’s monopolistic practices hinder the implementation of cost-reflective tariffs, further straining public finances and underscoring the urgent need for structural reforms in the sector.

[6] By NERC’s Order, NBET will continue to administer its existing contracts with Azura Power West Africa Limited (APWAL), Omotosho Power Plc, Olorunsogo Power Plc, Nigerian Agip Oil Company Limited, and The Shell Petroleum Development Company of Nigeria Plc. These contracts are administered on a “take or pay” basis. All other power plants with “take and pay” PPAs or interim energy sales agreements with NBET are granted 60 days from the commencement date of the Order to negotiate and contract with DisCos on a bilateral agreement basis using the capacity currently contracted with NBET.

[7] Under NERC\’s order on bilateral trading, the transition period for NBET is set at sixty (60) days from the effective date of July 25, 2024. During this time, Generation Companies (GenCos) must negotiate bilateral agreements directly with Distribution Companies (DisCos), moving away from NBET\’s role as an intermediary to promote competition in the electricity market.

[8] Paragraph 18 of the Order

[9] Pursuant to the Order, the firm capacity of NBET with respect to five GenCos are as follows: APWAL 416MW; Omotosho and Olorunsogo Power PLC 186MW respectively; Nigerian Agip Oil Company Limited 311MW; and Shell Petroleum Development Company of Nigeria Limited 314MW.

[10] Paragraph 19 (B) of the Order

[11] Paragraph 19(d) of the Order.

[12] Paragraph 19(f) of the Order.

[13] Most GenCOs within the NESI, supply electricity using gas-fired power plants.

[14] Paragraph 19 (l) of the Ordeer.

[15] The Central Bank of Nigeria had escrowed the accounts of the DisCos, with the bank accounts locked, with cash allowed to come in but withdrawals by DisCos blocked. The fund is thereafter allocated based on priority. Under the arrangement, the repayment of loans to the federal government was the first priority followed by the 100 percent payment of market operators’ invoices and the invoices from the NBET before others.

[16] Paragraph 19(N)(i) of the Order

[17] https://nerc.gov.ng/media/nerc-holds-public-hearing-on-nbets-license-renewal-application/

[18] https://businessday.ng/news/article/nbet-seek-operating-licence-renewal/

[19] ibid

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For further information on the foregoing (none of which is a legal advice) or related matters, please generally contact us at info@ao2law.com, or specifically contact the key contacts.

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