WHAT THE ELIGIBLE CUSTOMER REGULATION MEANS FOR NIGERIA S POWER SECTOR

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1 December 2017 Newsletter Detail Commercial Solicitors WHAT THE ELIGIBLE CUSTOMER REGULATION MEANS FOR NIGERIA S POWER SECTOR A. Introduction On 15th May, 2017, the Federal Minister of Power, Works & Housing, Babatunde Raji Fashola, declared four categories of eligible customers in the Nigerian Electricity Supply Industry (NESI). By the declaration, electricity customers who fall within any of the four eligibility categories would now be permitted to buy power directly from Generation Licensees and Trading Licensees (also known as Suppliers). Prior to the declaration of the eligibility criteria, customers were only permitted to purchase electric power from licensed distribution companies (Discos); save for industrial, commercial, and residential customers (off-grid IPPs or captive generators) who generate their own power. Following a nationwide stakeholder consultation held by the Nigerian Electricity Regulatory Commission ( NERC / the Commission ), the Commission issued the Eligible Customer Regulation ( Regulation ) on the 6th of November, This article will discuss the impact of the Regulation on the power sector, and key considerations to be made by NERC towards the successful implementation of the Regulation. B. Key Highlights of the Eligible Customer Regulation, 2017 a) Categories of Customer Qualification Criteria Eligibility and Pre- Source: NERC Note: A comprehensive description of each of the eligibility categories is provided in Section 5 of the Regulation. To qualify as an eligible customer, the Regulation requires that customers should execute a Power Purchase Agreement (PPA); Transmission Use of System Agreement (TUoS); Distribution Use of System Agreement (DUoS); Market Participation Agreement; and Bilateral Agreement with Discos for the construction, installation, and operation of a distribution system, where applicable. (Section 8 of the Regulation).

2 b) Phasing of Implementation The Regulation provides that the eligibility framework will be introduced in two phases, subject to fulfilment of certain conditions set out in Section 34 of the Regulation. emergence of new businesses (especially amongst the youth) and further assuage some of the challenges plaguing the industry. It is expected that these incentives would: i. Phase 1 - Implementation of categories 2, 3, 4 and part of category 1 (i.e., those connected to a metered 33kV delivery point). ii. Phase 2 - Implementation of the second part of category 1 (i.e., those connected to a metered 11kV delivery point). c) Site Aggregation The Regulation (Section 6) allows for site aggregation by end users. This will allow a group of end users to combine multiple sites to meet the eligibility criteria and apply to the Commission for eligibility status, provided that: i. Each of the customers is connected to the same Disco network, Independent Electricity Distribution Networks (IEDN) or off-grid licensee, and are connected to the same feeder. The foregoing appears to imply that IEDNs and off-grid projects could potentially supply power to eligible customers, if they are connected to a distribution or transmission network; ii. The applicant is a single legal entity applying on behalf of the group of end-users and shall be responsible for executing the transaction documents; iii. There is a minimum consumption of 500KVA at each site; and iv. All the end-user sites must be located within the same geographical network as may be determined by the Commission from time to time. d) Financial Requirements The Regulation (Section 9) requires applicants to provide payment security in the form of a Letter of Credit or Bank Guarantee in favour of the Market Operator. This is required to cover market administration, TUoS, and DUoS charges as required in the Market Rules. The Commission may also introduce other charges to be paid by the applicant. It is, however, not clear why the Regulation would require a Letter of Credit or Bank Guarantee to be issued to the Market Operator with respect to the Duos charges, which should be to the benefit of the Discos. e) Supplier Choice Eligible customers are permitted under the Regulation (Section 15(2)) to freely choose between Suppliers; and contract on the pricing, quantity, and time of supply. There must, however, be adequate infrastructure available for the System Operator and Market Operator to reliably account for the energy quantities. f) Switching Rules The Regulation (Chapter VII) further accords eligible customers the right to switch between Suppliers provided that the current supplier is given a minimum of three months notice in writing, of the date of the intended switch. Where there is a switch, the eligible customer will be required to submit the PPA with the prospective Suppliers to the Commission. If the eligible customer intends to reconnect with a previous supplier, the eligible customer will also be required to provide a minimum of three months notice to the initial supplier. The tariff for such reconnection will be at the prevailing tariff rates for customers in the same tariff class. g) Metering Obligations The Regulation (Section 7) mandates end users seeking to attain the eligibility status to procure and install appropriate metering infrastructure at all trading points in compliance with the Metering Code.

3 h) Access to Networks The Regulation (Section 27) allows an eligible customer or its Supplier access to Transmission and Distribution Networks, subject to compliance to applicable standards. The application for access shall be in writing and a decision will be communicated within 30 days of submission of the application. i) Tariff Methodology The Regulation (Section 28) provides for the category of charges to be embedded in the operative tariff methodology for the supply of electricity to an eligible customer. The components of the tariff include: Regulatory Fees, Ancillary Services Charges, Market Administration, and System Operation Charges. The Regulation also provides for TUoS and DUoS Charges to be included in the methodology, where applicable. C. Foreseeable Impact of the Eligibility Framework on the Power Sector a) Healthy Competition for the Sector One of the objectives of the Regulation is to facilitate competition in the supply of electricity and to promote the rapid expansion of generation capacity. In an ideal world, competition in the sector will help improve the quality of supply, increase efficiency, and liquidity for generation companies. However, this would be quite a challenge given the impact that the Regulation could have on the Discos revenues. b) Power to the Eligible As indicated above, the Regulation provides eligible customers fair and non-discriminatory access to Transmission and Distribution Networks, and the freedom to switch Suppliers. The eligible customer regime is not unique to Nigeria, as there are similar regulations in force in other countries. For example, in Brazil, the introduction of free and special consumers regime (synonymous with eligible customers) helped to boost competitiveness in the Brazilian electric power market. c) Supplier of Last Resort (SOLR) Although the Regulation introduces alternative supply options for eligible customers, it is important to note that the current suppliers still have a crucial role to Image courtesy nigeriaconsumers.com play as suppliers of last resort. For example, where a contracted Supplier has failed to supply an eligible customer, a Disco can step in as a supplier of last resort, provided the eligible customer is within its network coverage area. The SOLR service is to be provided under a provisional arrangement at a mutually agreed price. d) Reduction of Discos Revenues The Regulation may result in a loss of majority of Discos highest-paying customers, including industrial clusters and residential estates; leaving them with lower-demand customers, who have minimal willingness to pay for electricity. This could potentially reduce Discos revenues, given that the market is insolvent with tariff shortfalls. As of Q2 2017, the power sector had received over N466 billion worth of credit from banks. (National Bureau of Statistics) This is in addition to the tariff shortfalls estimated to be up to N460 billion (between January 2015 and December 2016). It is, therefore, not surprising that just a few days after the release of the Regulation, the Discos issued a notice of force majeure to the Bureau of Public Enterprise (BPE), arguing that the impact of the Regulation has resulted in a change of law that prevents them from fulfilling their obligations under the Performance Agreement. Although the BPE has rejected the notice, it remains to be seen how the next couple of months will pan out in the sector.

4 e) Possible Increase in Tariffs There is a high likelihood of a hike in retail tariffs, as was the case in some other jurisdictions. For example, in Spain the introduction of eligible customers resulted in a 9% increase in end-user tariffs. In Nigeria, the tariff structure envisages different classes of customers, with revenue from high-paying customers helping to subsidize tariffs from low-paying customers. Where there is a reduction in the percentage of high-paying customers, the Discos may push for an increase in tariffs, a move that is already overdue. Section 28 of the EPSRA provides for Competition Transition Charge (CTC) to be determined by the Minister in consultation with the President. The CTC is required where the impact of the eligible customer regime significantly affects the ability of a Disco (or a trading licensee) to satisfy its committed expenditures or earn permitted rates of return. It is expected that the CTC, when determined, would help to cushion the effect of the potential loss of customers by the Discos. D. Key Considerations for the Implementation of the Eligible Customer Regulation a) Release of third-party access rules by the Commission Pursuant to the Regulation, NERC is expected to release a set of compliance rules to govern the nature of thirdparty access to transmission and distribution networks. It remains to be seen how this will fare with the Discos especially with respect to the determination of fees payable for access. Delays in the release of the rules may affect the implementation of the eligibility regime, as open access to networks will be crucial to efficient supply of electrical power to the eligible customers. b) Credit worthiness of eligible customers While the Regulation allows the eligible customers to contract directly with the Gencos, a possible issue that may arise is the ability of the eligible customers to commit to long-term PPAs (which is often required by Suppliers), and provide the requisite payment security to the Suppliers. c) Eligibility application process The Mini-Grid Regulations released earlier this year provides for template contracts and a simplified application procedure. It is important for the Commission to continue this trend by providing standard documentation to ease the process and ensure the 30-day timeline for the Commission s approval as provided in the Regulation is achieved. d) Establishment and contributions to the Power Consumer Assistance Fund The Regulation makes provisions for contributions to the Power Consumer Assistance Fund as provided in Section 84 of the Act. However, the fund is yet to be established. It is important to note that the primary essence of the Fund is to subsidise underprivileged power consumers. This will be very crucial towards helping Discos manage the potential loss of revenue. e) Electricity theft As the power sector continues to strive towards attaining competitiveness, it is important that NERC and the Federal Government work together towards tackling the crippling effects of electricity theft in the power sector. It is recommended that the speedy enactment of an electricity theft legislation should be prioritized.

5 E. Conclusion It is a widely known fact that the power sector is still in the early stages of attaining actual competitiveness, and some may argue that the introduction of the eligible customers Regulation is pre-mature. However, the power sector requires such initiatives that will help ease the barriers to entry by interested third parties, which in turn could help drive more investment into the sector. In its transitional phase, the dividends of this Regulation may not be easily quantifiable. It remains to be seen how the market will adjust as the implementation of the categories progress. The fact, however, remains that the sector is in dire need of more investment and flexibility, and this Regulation may be the trigger to propel the industry towards the desired competitiveness. Image courtesy financialtribune.com Detail Commercial Solicitors is distinct as Nigeria's first commercial solicitor firm to specialize exclusively in non-courtroom practice. Based in Lagos, Nigeria s business capital, DETAIL is totally committed to its clients business objectives and reputed for dealing with the minutiae. info@detailsolicitors.com Detail Commercial Solicitors DCS Place, 8, DCS Street, Off Remi Olowude Way Lekki Phase 1, Lagos, Nigeria +234(0)