What can Nigeria learn from the previous mistakes in electricity liberalisation - Research Paper Example

What Can Nigeria Learn From the Previous Mistakes in Electri Liberalisation? In the current world, electricity liberalization is a global phenomenon, though only a handful of nations have achieved considerable liberalization. Perhaps, liberalization in the electricity industry has unique challenges. The industrial policy decisions and public finances, the physical characteristics of supply, the magnitude of capital requirement and size of industry, and the complex and close relationships between the industry and other significant economic elements all combine to impose challenges to the liberalization process. During electricity industry the liberalization in Brazil, Argentina, and Peru, various mistakes occurred, though these industries are the road to set successful models. Currently, Nigeria is liberalizing her energy industry, and may draw upon the earlier flaws of these models to fortify the sector. This paper seeks to present a discussion on the fundamental mistakes and discuss the way forward for Nigeria. Table of Contents Abstract 2 Table of Contents 3 Privatization 4 Introduction 4 Reasons for Privatization 4 Privatization System in the Energy Sector 5 Public Interest and Privatization 6 Legal Mechanisms for Privatization 7 An Analysis of Privatization Vis-A-Vis Competition Policies 8 Performance Levels of Government Enterprise and Public Companies in the Energy Sector 9 Energy Conservation Measures 11 Discussions 12 Price Control Regimes in the Energy Sector 12 Economic Objectives of the Energy Sector 13 Possibility of Implementation of Competitive Regimes in the Energy Sector 13 International Trends Concerning Privatization of the Energy Sector 14 Comparative Study among the Following Countries 14 Colombia 14 Lessons for Nigeria for Colombia’s Mistakes 15 Peru 15 Lessons for Nigeria from Peru’s Mistakes 16 Argentina 16 Lessons for Nigeria from Argentina’s Mistakes 17 Brazil 18 Lessons for Nigeria from Brazil’s Mistakes 18 Conclusion 18 Privatization Introduction Privatization is a term that evokes sharp political reactions. The concept covers a great range of policies and ideas, varying from reasonableness to impractical. Despite the variation and the somewhat unclear meaning, privatization has unequivocal political objectives and origins. Proposals for privatization not only return the service to the original private sphere but also seek to create new types of market relations and assure results superior or comparable public programs. In essence, privatization refers to the transfer of government assets or services to the private sector. The state may sell some of its assets to private investors, or alternatively lift statutory restrictions on competition between publicly and privately owned enterprises. Furthermore, by the state may be contract out services that it initially provided. The primary objective of privatization is to increase government efficiency1. Nonetheless, implementation of this concept may result in either negative or positive effects on government’s revenue. Essentially, privatization is the opposite of nationalization. Reasons for Privatization In general, privatization of the electricity industry in Nigeria was a result of the desire to increase efficiency and competitiveness, as well as the belief that the market place powers can achieve this more efficiently and effectively than state control. Nonetheless, given the previous history of government participation in services and goods production in Nigeria, and the prevalent history of crisis in these public enterprises, the process of privatization in Nigeria has various expected objectives. First, privatization is a way to inject market discipline to the board members, as the board must reflect the interests of shareholders, primarily the private sector investors whose interest lie with profit maximization. Second, the process results in closer monitoring of management performance. Third, the process results to greater revolution and accountability of better management practices. Fourth, privatization acts as a catalyst for revitalization of the capital markets by availing substantial amounts of shares in the capital market. Fifth, the process is a great attraction to foreign capital and transfer of technology and skills to the country. Sixth, privatization deepens the domestic market, subsequently resulting to earning and productivity improvements, profitability, efficiency, employment opportunities, and growth2. Privatization System in the Energy Sector The Nigerian electric power industry was its lowest point in a century at the commencement of the democratically elected civilian administration at the end of the twentieth century. The situation was really worse, with only 19 operation generation units out of the 79 in the country. The average daily generation was about 1750MW. To worsen the situation, there had been no new electric power infrastructure successfully commenced and completed between 1989 and 1999. The completion of the most recent plant was in 1990, with the last transmission line built in 1987. By then, more than 90 million people had no access to the national grid electricity. Reliable and accurate estimates associated with industry losses were unavailable, but projections show that they were in excess of 50%3. The reform and subsequent privatization of the energy sector was due to a number of reasons, including the need and desire to upgrade to global standards, the growing demand for reliable and stable power that requires heavy investment, and the need for improvement in generation, transmission, and distribution efficiency, which was in an exhausted state. The chief reason for reform was the need to reduce business operational costs in the country to attract new investment through provision of reliable and quality electricity supply to the economy for socio-domestic, industrial and commercial activities. Privatization of the energy sector will perhaps achieve this by promoting financial discipline and good corporate governance and, competition, effective use of resources and social accountability, and a sustainable environment capable of meeting the needs and demands of the citizens4. Public Interest and Privatization For its long run market design, Nigeria adopted a wholesale competition framework. The country’s electricity market will perhaps revolve through two major stages: pre-transitional and post-transitional. The pre-transitional stage refers to the current position of the electricity industry in Nigeria, or the natural stage of the energy sector during the early implementation of reforms. On the other hand, the post-transitional stage refers to where the sector is about to move. According to specialists in the field, this stage will experience greater demand than supply, with all trading occurring through contracts. Essentially, trade at this stage will by physical through contracts, and existing power plants will trade through vesting contracts. Another important feature of this stage is that the prices and conditions for vesting are not freely negotiable, as competitive and transparent mechanism will be in place for new entrants into the market5. The new privatization system will have two stages: medium term stage and long-term stage. In the medium term stage, competition will enter the market, affecting both the demand and supply. Initially, contracts will be negotiable, and there may be introduction of financial contracts. Generators will submit dispatch nomination, including constraints, prices, costs, and availability, to a central merit order dispatch controlled by the system operator. These will assist security constrained economic dispatch. Additionally, generators must submit contract nomination to the market operator. The long-term stage is similar to the medium term stage, but with greater freedom and more competition by eligible consumers with the power to choose their suppliers6. Legal Mechanisms for Privatization Privatization legal basis in Nigeria is present in the Privatisation and Commercialisation Decree Number 28 of 1999, propagated by General Abdulsalami Abubakar, the leader of the last military regime. The present civilian government subsequently adopted this Decree. Essentially, the legislation accommodates further commercialisation and privatisation of Federal Government partially and wholly owned enterprises to smooth the progress of economy liberalisation, as well as enable the private sector to compete with the public sector in all economics aspects. The legislation further establishes the National Council of Privatisation with the responsibilities of determining the political, social, and economic objectives of commercialisation and privatisation of public enterprises. It further establishes the Bureau of Public Enterprises primarily responsible for the overseeing the actual implementation of the privatisation programme7. Privatisation in Nigeria also adheres to regulations made from time to time by the National Council of Privatisation as empowered by Section 31 of the Act. The fact that most foreign investors are aliens under the Nigerian law and that the possibility of the government divesting some of the shares it holds on the international capital market to attract investors, understanding the laws governing alien participation in privatisation in important to foreign investors. The important statutes include the Companies and Allied Matters Decree of 1990, the amended Nigerian Investment Promotion Commission Decree 16 of 1995, the Foreign Exchange Decree 17 of 1995, the Investment and Securities Decree 45 of 1999, the Immigration Act, the Industrial Inspectorate Act, and the National Office of Technology Acquisition and Promotion Act8. An Analysis of Privatization Vis-A-Vis Competition Policies In principle, privatization may result in the creation of a more competitive environment. Nonetheless, the economic legacies of some pervasive monopolies owned by the state cause some economists to question the effectiveness of such competition. In other words, privatization may essentially imply the move from a state-owned to a private monopoly, or perhaps decrease competition when it occurs because of acquisition and mergers. Analyzing the resultant competition, it is evident that competition policy implementation is positively and significantly correlated to a more competitive market structure. Privatization, however, either negatively correlates or not significantly correlates to intense competition in the energy sector. With emphasis on privatization of electricity in Nigeria, the process link with intense competition is ambiguous, as privatization by itself is an insufficient condition to enhance competition9. In other words, the concerned market structure may remain unchanged, in the case where a private monopoly takes over a public one, or may alternatively be concentrated if privatization occurs through acquisition and mergers of existing enterprises. Furthermore, privatization may either open new market segments to new suppliers or altogether restrict access to specific assets of the privatized enterprise to the detriment of competitors. The current regulatory and competition policies in Nigeria recognizes that creating competition is the raison d’etre of privatization. Currently, all anti-competition laws in power and communication are non-existent. For efficient consolidation of deregulation and competition as the vehicles for making privatization of the electricity industry attain liberalization of the economy, the regulatory institutions are gaining strength with expanded scopes, setting up from scratch new and existing ones when they fail10. Performance Levels of Government Enterprise and Public Companies in the Energy Sector The energy sector in Nigeria is probably the most inefficient globally in meeting the needs of its customers. This is evident particularly from the persistent disequilibrium in the electricity and petroleum markets. The inadequate energy provision, especially of electricity, has adversely affected the standards of living in the country, subsequently exacerbating energy and income poverty in the country’s economy. One of the dimensions of the energy crisis in Nigeria is illustrated by the brownouts, blackouts, and reliance on self-generated electricity. The state-owned Power Holding Company of Nigeria, which dominated the electricity market, was unable to provide the minimum acceptable international standards of electricity availability, accessibility, and reliability for over three decades11. The poor record of electricity supply is evident from the double-digit distribution and transmission losses, extremely huge by international standards, accounting for five to six times what well-run power systems obtain. The unstable and low capacity utilization evidenced by the average capacity utilization below 40% shows the huge difference between installed and actual operational capacity. This reflects the gross technical inefficiency in the state-run power system. It is evident that the insufficient operational capacity results from ageing facilities with poor maintenance services. Astonishingly, no new plant was added to the national grid despite the high inoperable capacity. The state-run power system has a power generating capacity of 6000MW, but the operable capacity is less than 3000MW. The operable capacity comprises of gas-fired and hydroelectric power generating plants. Nonetheless, gas-fired plants dominate the plant mix12. The peak demand has been less than half of the installed capacity, but load shedding occurs regularly. The manufacturing sector experience significant power outages, which only represents another dimension of the energy crisis in the public sector. In 2004 for instances, there were 316 outages experienced in the manufacturing industry. This increased in 2005 by 26%, then a sharp increase of 43% between 2006 and 2007. Despite the lack of published data, the near collapse of eth power system to below 2000MW for long periods indicates that in future, the outages will be high. The poor service delivery render the public supply as a standby source as most businesses cannot afford poor quality and irregular service, thus substitute more expensive supply alternatives to minimize the negative consequences of supply interruptions on profitability and production activities13. According to estimates, more than 20% in investments in the industrial projects reflects allocation to alternative electricity supply. Thus, public companies and the government owned power system are inefficient, resulting from a number of factors including the prevalent regime of price control and governance and institutional failures that induce gross inefficiency and distortion in investment choices, production, and high production costs, as well as cost overruns, expensive delays, and low return on investment. Other causal factors include the lack of adequate economic incentives to motivate state-owned companies in engaging in efficient investment and production behaviour and the weak concern for cost recovery. Furthermore, the multiplicity of non-economic and economic objective without identification of associated trade-offs is also a significant factor, this leads to implicit pricing policies in the electricity products14. Energy Conservation Measures The state-owned power system did not incorporate adequate energy conservation measures, leading up to energy losses of double-digit percentages of generated electric power. Liberalization of the electricity market may significantly improve electricity power efficiency and conservation measures through a number of ways. First, the privatization of the market will introduce the development of an adequate database, which will generally reduce unnecessary energy costs through elimination and identification of points of inefficiencies. Proper analysis of the collected data will indicate the need of improvement in electricity use15. This is possible, as the databank will also include other energy conscious and efficient measures and devices. The electricity sector is in great need of funding for research in the current institution, which will appropriate into the various electricity uses that allow for passive energy longer periods of use than presently obtained. Only recently did outreach programmes and awareness campaigns begin in Nigeria, educating people on the efficient ways of using electricity energy in conservative ways. Introduction of competition in the market through electricity liberalization will further this outreach strategy, leading to meaningful conservation efforts16. Lastly, there is need for regulatory and legislative support to promote energy conservation in the country. The government should institute standards and codes, as well as motivation and incentives to enhance energy conservation nationally. Discussions Price Control Regimes in the Energy Sector Nigeria has been under military rule for 25 of its 41 years of independence. The military overthrew the last elected civilian government in 1983, with a subsequent ousting of a civilian interim government in 1993. The main political instability in the country results from the lack of a forged national identity that transcends across religious, ethnic, economic, and regional interests. The military intervention was very important, but it resulted to negative economic impacts with time. The military regimes became strict with economic policies, imposing high protective tariffs, import licensing scheme, import bans, and export bans. The propagation of the government control was evident after the establishment of the price controls by the Price Control Decree of 1971, marketing boards, state trading corporation, and the nationalization of all land, which meant that all land was under the government’s control. The military regimes inherited these control policies and further propagated them, thus controlling the prices in all economic sectors, including energy17. However, the rise of a civilian administration to power sought to attract foreign investment, thus abolishing or reviewing majority of the price control legislation from the military regimes. Economic Objectives of the Energy Sector As far as liberalization of the electricity industry is concerned, the energy sector seek to achieve a number of economic objectives, including reducing the costly electricity losses during transmission, attract foreign investment through provision of quality and reliable power supply, promote efficient management of government investment for national economic benefits. Others are to ensure equitable and adequate generation dispatch based on sound regulatory principles, and provide revenues to the government18. Possibility of Implementation of Competitive Regimes in the Energy Sector It is possible to implement competitive regimes in Nigeria’s electricity sector. The liberalization process has so far seen 207 prequalified bidders, with selection of 11 distribution firms, 6 generating companies, and 1 transmission company. This will significantly introduce competition in the sector, with the firms trying to outdo each other19. International Trends Concerning Privatization of the Energy Sector Comparative Study among the Following Countries Colombia Drawing upon a feasibility of deregulation done in 1993, a number of reasons led to the liberalization of the electricity industry, including the two major blackout periods in 1983 and the second between 19920 and 1993. There were two approaches to solve the problem: either increase capacity of the power system, or increase efficiency of the system through deregulation. Since deregulation was working in England and Wales, the government adopted it. However, the Colombian government only deregulated the electricity industry, rather than privatizing and deregulating, thus allowing a mixed ownership20. Moreover, there were provisions for subsidizing low-income consumers as before deregulation. The technology mix of generation in the country has since decreased from 87% hydroelectric power in 1995 to less than 70% in 2002. The drive for thermal capacity was the limited amounts of water for hydroelectric production during the Nino period and the extra incentives from the regulator. After the deregulation process, the electricity industry has recorded significant efficiency improvements, with a reduction of the labour for producing 1GWh down to 0.49 in 1999 from 0.58 in 1997. Additionally, the castor has recorded system loss reduction of about 8%. Columbia has never experienced blackouts since deregulation in 199521. Lessons for Nigeria for Colombia’s Mistakes The first lesson draws principles from the economic theory that decrease in demand results to a decrease in supply, and this imbalance inevitably results to hike in prices, particularly due to the consistent increase in demand for electricity. This is why electricity prices increased in 1995 in Colombia. Considering the high percentage of population that lacks access to electricity, Nigeria may potentially face the same problem. Currently, the generating plants are gas-fired dominated, and this may cause a problem in the future. There is need to focus on hydroelectric power generation to reduce the prices of electricity. The Columbian case also offers valuable lessons to Nigeria concerning poor market design combined with inappropriate political intervention and regulatory structure, as these may lead to flaws in the process of liberalization when the capacity is low and shortages are unexpected. Moreover, the deregulation process is not adequate: effective liberalization of the electricity industry needs both deregulation and privatization efforts22. Peru In the early 1990s, Peru implemented neo-liberal market reforms for its electricity sector, as part broader economic restructuring and response to the electricity crisis between 1986 and 1990. In 1990, restructuring of the state electricity utility and increase in electricity rates occurred. Several state-owned companies were privatized, though later renationalized in 2002. The reforms focused on attracting private capital to fund expansion of power supply, particularly in the generation sector. Subsequently, electrification levels increased to 75% in 2002 up from 45% in 1992. Moreover, service quality improved significantly23. However, an examination of the counterfactual and actual operating costs and an analysis of each company based on the differences in market structure and economies of scale shows that the producers and the government benefitted the most and consumers the least because of the increase in price. Lessons for Nigeria from Peru’s Mistakes Nigeria needs to understand the concepts of economic theory, as they seem to pervade most governments during the process of liberalization, as is the case with Peru and Colombia. The imbalances created by forces of supply and demand may result to significant increase in prices, which may adversely affect the living standards of the citizens. Another important lesson for Nigeria from Peru’s case is that good distribution and transmission network regulatory institutions are very important, but at times neglected components of the reform process24. During the initial stages of the liberalization process, Peru had somewhat neglected these regulatory frameworks, a mistake that would have cost the success of the entire reform process. After reviewing the framework, however, the high-powered regulatory mechanisms led to improvement in service quality and labour productivity in electric distribution system in the country. The importance of regulatory frameworks cannot be emphasized enough. Argentina The Argentine government privatized and unbundled its electricity system in the 1990s, as part of a restructuring agreement with the World Bank and IMF. The state privatised most distribution and generating companies, creating a wholesale power market. Subsequently, retail competition entered the market, but restricted for households. Unfortunately, the country experienced a major economic downturn in 2001, resulting to significant devaluation of the peso. In response, the government froze power prices to protect the interests of households, leading to a serious dispute with the private companies over the impacts on profits. This led to a halt on further liberalization and privatization since then. The country now requires investment in new generating capacity, especially renewable, and anticipates this to come from the public finance25. The state also uses public finance to subsidize poor consumers, particularly in rural electrification, renewable, and investment in transmission. Lessons for Nigeria from Argentina’s Mistakes Based on the Argentine electricity liberalization model, Nigeria needs to emphasize on the operation of the market, the regulatory system, and the structure of the industry. Therefore, regulation needs to be properly designed and strong. Nonetheless, regulation should not be too rigid such that it scares away investors, like the Argentinean case. In this regard therefore, Nigeria should introduce regulation prior to competition to avoid the implications that come with liberalization. In an electricity industry, the cost of competition is different and usually very high. In Argentina for example, before the introduction of retail competition, about 5% of the domestic consumer bill accounted for services such as metering, billing, and maintenances. After the introduction of retail competition however, costs of switching, marketing, and incentives for switching account for 30% of the consumer bill26. Power suppliers in Nigeria should understand that competition is costly and thus profits are not a guarantee. Brazil Electrobras, a state-controlled firm, has historically dominated the electricity system in Brazil. The firm operated and owned the transmission system and a huge share of the generating capacity of the country. Following the advice of the World Bank in 1990s, the federal state privatized a number of its distribution companies as well as establishing a regulator to introduce and manage a liberalized electricity market. The process was successful in the initial years, but faced significant challenges in 2001 due to shortages in generating capacity because of the failure of the new liberalized market to stimulate investment in new generation. Subsequently, most multinational companies withdraw, and a further blow by the scrapping of the liberalization and privatization programme by Luiz da Silva27. Consequently, the state renationalized some of the distribution companies back into the public sector. Lessons for Nigeria from Brazil’s Mistakes The political mistakes of Brazil are an important lesson to Nigeria. The country must understand that a strong political commitment to energy reforms is very important. In almost all electricity liberalization cases, some unanticipated policymaker problems emerge, thus requiring minor or major refinement to the initial reform plan. Therefore, Nigeria must align its reform programme with the present development of competitive markets to enhance the probability of success28. Conclusion The liberalization efforts in Nigeria may bring along significant improvements to the quality and efficiency of electricity, as well as build the industry and reap the rewards of success. Power is essentially the heart and soul of modern business, and by far, the foundation of a country’s economy. However, high demand and supply gap and inefficiencies in the supply service have led to increased business operation costs and losses beyond reasonable standards. Availability, reliability, and efficiency of electricity are among the things that require perfect integration and implementation in the world today. Policymakers must realize that electricity is a profound factor that determines the current and future economy29. Drawing from the mistakes of Colombia, Peru, Argentina, and Brazil, Nigeria will perhaps revive its electricity industry to meet the national demands and needs of its citizens as well as attract private investment in the sector. Bibliography Anaya, K. L. 2010. The Restructuring and Privatisation of the Peruvian Electricity Distribution Market. EPRG Working Paper, No: 1009. Cambridge, UK: University of Cambridge, Electricity Policy Research Group. Bacon, R. W. & Besant-Jones, J. 2001. Global Electric Power Reform, Privatization and Liberalization of the Electric Power Industry in Developing Countries. Annual Review of Energy and the Environment, 26, 331-359. Clarke, G. (2005) “Do Government Policies that Promote Competition Encourage – or Discourage – New Product and Process Development in Low and Middle-Income Countries?”, World Bank Policy Research Working Paper, 3471. 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Obadan, M.I. 2000 Privatisation of Public Enterprises in Nigeria: Issues and Conditions for success in the second round. First edition, Ibadan, NCEMA, Monograph series No 1. Read More