The economic development and growth of a country are inextricably linked to its electric power sector. Until recently, the Nigerian electricity generation, transmission, and distribution was entrusted to a state-owned monopoly entity – National Electric Power Authority (later known as Power Holding Company of Nigeria). This monopolistic business model has led to capacity shortage, poor performance, and inefficiencies. The historic gap between the demand for electricity and available capacity has led to self-generation of power by industrial and residential consumers.
With the exception of a few developing countries, insufficient domestic capital to fund power plants has become a real challenge. Faced with the problem of domestic financing in the power sector, the Nigerian government, in inaugurating the Roadmap for Power Sector reform, conceded that the $35 billion investment needed to generate about 40,000 mw of electricity by the year 2020 can only be sourced in the international money market.
Financing for the development or exploitation of a right, natural resources, or similar assets is a complex and cost-intensive undertaking in which lenders or other deb-holders look principally to the revenues generated by the project alone as the source of funds from which project debt will be repaid. In sum, the collateral for the debt is confined to the assets of the projects itself and, in particular, the project’s revenue stream.
Project finance is, therefore, non-recourse or limited recourse financing predicated on the economic and technical merits of the project itself and not by any form of share capital. Because of the cost, complexity, and risks involved in financing gas power plants, traditional sponsors are unwilling to go it alone. Project finance has, therefore, become a crucial financial tool used in attracting capital to these types of projects.
Electricity is presently generated from either gas-fired or hydro power plants. Most assets are owned by the Power Holding Company of Nigeria - state-owned entities, and some private investors who have been able to establish independent power projects following recent legislative reforms.
Despite its abundant gas reserve of about187 trillion cubic feet, inadequate and inconsistent supply of gas to fuel the power sector has continued to be a major reason for the failure of power sector reforms in Nigeria.In response to gas supply problems and as a means to attract foreign investment,the government introduced a gas master-plan to address the issues of supply. A Gas Aggregator, the Gas Aggregation Company Nigeria Limited was established to manage the government’s domestic gas supply obligations and coordinate a streamlined process for wholesale gas supply from gas producers to eligible gas purchasers, including generation companies.
Structuring Project Finance
The most crucial issue in structuring a project finance transaction is the complex interplay among a wide range of project participants. The project sponsors are responsible for developing the project, which involves obtaining the necessary government approvals and permits, negotiating project documents, securing the financing and providing the technical, organizational, and financial resources to meet challenges that might affect the project. A project sponsor can be a single company in the business of project development or a consortium of interested parties, including developers, construction contractors, equipment suppliers and end-users of the projects products.
Since foreign investors are the focus of the Nigerian power sector, a greater return of investment is expected due to higher level of risk - including political risk. However, the level of equity returns has become a sensitive political issue since an increase in equity return will almost invariably translate to increases in power tariffs.
The project company is the central contracting party for the project documents and as the borrower under the financing agreements. Usually, the project company is a single purpose corporation, partnership or trust organized by the project sponsors with no assets other than those comprising the project itself and the financial resources provided by equity and debt investors.
The off-taker is the purchaser of power output generated by the power plant. Since the off-taker is the sole provider of the revenue stream on which the project financing depends, the competence and creditworthiness of the off-taker is crucial to the bankability of the project.
Where the off-taker’s balance sheet cannot support the project, guarantees from creditworthy entities, the government are needed to assure the lenders of repayment. The Nigerian government established the Electricity Bulk Trading Company Limited (“NEBTC”) as a government owned trader with bulk purchase and resale licences. NEBTC will enter into industry- acceptable and bankable power purchase agreements with generation companies, who will in turn sell electricity to the distribution companies until such time as the distribution companies are able to enter into direct purchase arrangements with the generation companies on market terms.
Debt has been the source of about three-quarters of all the money typically required for project finance in power plants projects. The majority of this debt has involved both commercial debt providers and credit-enhanced loans from mission lenders – e.g., Export Credit Agencies (“ECAs”) and Multilateral Development Banks (“MDBs”).ECAs and MDBs have made it easy for relatively high-risk countries like Nigeria to obtain financing at terms similar to those in developing countries with less risky project environments. The Nigerian government has thus entered into several agreements with MDBs and ECAs in financing these projects.
The role of the Nigerian government in gas power projects is seminal to the success of these transactions, and also needs its full support. For example,in a memorandum of understanding with General Electric, a United States corporation, the Nigerian government agreed to take an equity interest in the investment of a $10 billion power project. Also, the government has established a legal framework to issue licenses and operating permits, review tariffs, etc., by creating the Nigeria Electric Regulatory Commission (“NERC”) and entrusting it with these critical functions.
Mitigation of Risk
The most important factor in any successful project finance transaction lies in the identification, analysis, allocation and mitigation of project risks. A project risk relates to events that could affect the core objective of the project. Such events can occur during development, construction and operation stages. Project risks can be classified as commercial, political as well as force majeure events – natural disaster. Commercial risk includes cost overruns, delays and shortfall in project revenue caused by uncertain sales and prices. While political risk, on the other hand, involve the possibility of expropriation of assets, civil unrest, and change in labour policy and foreign exchange inconvertibility, change of administration, environment laws, and tax policies. Undeniably, the dearth of gas supply, opposition to increase ofelectricity tariff and labour unrest are clearly identifiable project risks associated with gas power plants development in Nigeria.
Project risks can be mitigated through a variety of measures including different forms of guarantees and the involvement of certain types of parties e.g. a key state entity. Formal guarantee can be provided by host government or by multilateral and bilateral agencies. The Nigerian government has recently declared a 12 month gas emergency timeline geared towards the speedy expansion of the country’s gas-to-power expansion.
Derivatives agreements can also be used to reduce or mitigate risks associated with price fluctuation, such as increase in gas prices. The finance package should include protection against fluctuation in gas price through hedging facilities such as forward sales and futures and options contracts.
Given the Nigerian government’s establishment of a clear regulatory and fiscal regime,regular good-faith negotiations with labour unions, the 12-month gas emergency declaration to meet gas supply demand, as well asthe Memorandums of Understanding entered into by the government with several multilaterals and equity investors guaranteeing the financing of the power sector projects, the author is of the opinion thatproject financing of Gas Power Plants in Nigeria are “bankable” transactions – and hence potentially attractive for financing by lenders or other debt holders.
* Felix Ayanruoh is a US energy attorney licensed in the State of New York and The District of Columbia