Nigeria: Of Cost Reflective and Service Reflective Tariffs

On September 1, the regulator of Nigeria’s electricity sector – NERC, announced a new tariff regime dubbed Service Reflective Tariff with some attendant increase in rates paid by some consumers. Going forward, rates paid by consumers will be tied to the level of service provided to them within a cluster. This tariff review is consistent with the federal government’s target to transition the industry to a full cost reflective tariff, eliminating the need for the government to provide subsidies to the sector. It is also intended to provide a basis for a higher minimum remittance by the DisCos to market accounts.

Ever since we privatised the power sector, two major issues seem to have dominated the interactions between the operators and consumers; these are retail tariffs charged consumers and metering. The operators always maintained that it is impossible to improve service without tariffs that incorporate all the cost of production and delivery including profit margin.

Consumers, on the other hand complain and insist that any further tariff increase must be preceded by provision of meters and improved service. A vexatious issue for consumers is the Estimated Billing which some DisCos have used to exploit consumers with implied grossly inflated tariff in excess of what is approved by the Nigerian Electricity Regulatory Commission (NERC)

There are other key conversations in the industry; experts, especially in the financing space believe that a cost reflective tariff and metering combination is the silver bullet to transform the industry to bankability, while some stakeholders believe that electricity is a social service that should be subsidized especially at a time like this.

The right end of the conversations is firmly occupied by the neoclassical economists, who believe that the best way to administer the sector is for government to step back and allow the forces of demand and supply to determine the market processes. They fail to appreciate that prevailing technology supporting electricity distribution makes it a natural monopoly.

In these discussions, what had been absent is the clear relationship between service delivery and rates. So, while that mass metering and cost reflective tariff are important in the industry, I have argued in the past that a missing link in all these contentious debates is the definition of service or more appropriately the product sold to consumers at cost reflective tariffs (CRT).

Consistently, I have maintained that cost reflective tariff is a meaningless concept to the consumers in the absence of acceptable minimum service level or well-defined product. Further, I hold the opinion that tariffs with predictable service delivery value hold stronger incentives for payment compliance than metering. I believe that without predictability of service, consumer satisfaction will remain low and so will be compliance to payment.

It is therefore a welcome development that after many years of advocacy, NERC on September 1 mandated the DisCos to tie their tariffs to service level dominated by daily hours of supply and by less, as well as service interruptions and fault response time.

Indeed, different products should attract different prices and NERC has come up with five distinct tariff bands in descending order of hours of service and rates: Band A for customers who get minimum of 20 hours of power daily; Band B for customers who receive service for a minimum of 16 hours daily; C-band has customers who enjoy power for minimum of 12 hours daily; Band D customers enjoy a minimum service for 8 hours daily, and finally, Band E has customers who only get between 4 hours and 8 hours daily. Consumers who are enjoying more hours of service will pay higher prices.

This is good, most practical and fair for the industry. And, the key factors that support the transition to Service Reflective Tariffs are:

Diversity and Fairness – as I argued in an article in 2017, DisCo footprints are too large with diverse customer clusters for any DisCo to offer same product at the same tariffs for all customers across its geographical spread. I made the case that if we take the case of any of the two Lagos DisCos – Eko or Ikeja, the consumers in Ikoyi have different paying capability and utilisation characteristics (Willing to Pay and Load Profile respectively) from the consumers in Iyana Ipaja or Okokomaiko or Epe. Therefore, it is sub-optimal to approve the same tariff for two very different consumer clusters, and with this, the DisCo is economically incentivised to provide its Ikoyi customers with more hours of service at same price as is offered to Okokomaiko and Iyana Ipaja consumers with less hours of supply. This is not equitable and fundamentally poses a challenge to efficacy of government interventions with regards to subsidies. If DisCos are divided into different tariff jurisdictions, it would allow governments to target subsidies to poorer districts ending the current practice where subsidies end up supporting the rich who consume most of the power generated.

Predictability – a second fact that is often overlooked in this argument is that the worst attribute of grid power supply is neither high tariffs nor estimated billing but the erratic supply. Erratic supply, not high tariffs, is the driver of expensive self-generation and captive power. Indeed, when pundits or passionate promoters of CRT make their point, they compare self-generation cost of N100/kwh to CRT of N50/kwh. What is not addressed is the reliability premium due to the generator being fully reliable based on its predictability.

Utility – a third fact is that the value of electricity is directly proportional to time of use and length of non-interruptible hours of service especially in a supply constrained environment such as ours. As an illustration, imagine an 8-hours/day service delivered to consumers in outskirt of the city between 4am and 8am, and between 6pm and 10pm compared to a service between 10am and 2pm and again, 10pm to 2am. Intuitively, the former offering has higher utility and value because service is delivered at periods when residential consumers are likely be home to use power. Now compare issues with hours of service to electricity-dependent operations and existence, the longer the service, the lower the cost of alternative supply. Therefore, an 18-hour service is more valuable than a 6-hour service on a unit per unit basis for those who are likely to crank up their generators.

Limited Capacity – a fourth set of facts is Discos do not have enough capacity to serve every consumer at the same time, more specifically, service cannot be offered to every cluster at the same time. Because of this limiting factor, service must be rotated among clusters in order to maximize the utilization of available capacity. In a related manner, power cannot be efficiently stored, therefore it is most economical to deliver power at a time and place where it can be used. Let us attach to this, that because of technology limitation in the delivery of electricity through distribution networks, DisCos cannot offer individualized services as TelCos can through airwaves. Product differentiation in electricity supply at present can only be by clusters or electricity tariff jurisdictions.

Trade-offs – relating to consumption, we recognize that resources are hardly limitless and that there are competing needs for each individual and societies.

Therefore, according to the dictates of economics principles, there must be trade-offs between needs based on available resources. This is a very key point as some pundits have alleged that it is unfair to individuals in clusters with less hours of supply but are willing to pay for longer service hours. It is presumed that in setting the tariffs, the relevant DisCo would have consulted with the cluster consumers and to the extent that a minority hold alternative views, they may wish to relocate to clusters of higher service. Again, as mentioned, the technology and capacity currently does not support individualized service.

Some Industry Arguments

Issue of Service Discrimination: Some experts have argued that Service Reflective Tariff is discriminatory to consumers in less affluent neighborhoods by depriving them of service levels offered affluent neighborhood consumers even if at different per unit costs. They posit that what is fair is for the government through NERC to prevail and compel the DisCos to provide meters to all consumers and then, allow each to consume as they are willing and able to pay.

Unfortunately, they miss the point that there must be some rotation because we do not have available capacity to serve all customers simultaneously, not at 5,000MW for the 100 million people connected to the grid. For comparison, Egypt at about 100 million has an installed capacity of 42,000MW while South Africa with a population of 60 million has a capacity of 51GW. Therefore, service rotation, is a must.

Unfair Pricing of Units and Continued Cross Subsidisation: This argument says that each unit of electricity cost the same and that charging some consumers a higher price implies that the affluent are subsidising the less affluent. While cross subsidies are common in utility economics, it is important to point out that this is mitigated by two factors; the first is utility as mentioned earlier which is defined by time of use and length of supply, the second, is source of generation.

An analysis of data obtained from the NBET indicates that the wholesale cost of power per the power purchase agreement with NBET shows that the cheapest sources of power are the NNPC-Shell Afam 6 power plant, followed by the NNPC-Agip Okpai power plants, then the hydros that do not require gas for running, and at the most expensive end is the Azura-Edo power plant. If we assume an economic merit order dispatch of the power plants, consumers with lower hours of service who invariably consume less power per capita, will majorly be served with the lower cost generation, while consumers in clusters of higher supply will be served by a combination dominated by the more expensive outputs.

Implementation Challenges: Experts are rightly concerned that without clear delineation of clusters and effective mechanism for both monitoring service and effecting sanctions, some DisCos under the regime may take consumers to the cleaners, billing at the rate of a premium service band while delivering less to consumers.