Reducing risk: Guarantees are sought in the privatisation of state utilities

As privatisation of Nigeria’s power sector evolves, one of the most pressing concerns will be that of risk guarantees. Given the stuttered progress in attracting investment to the sector prior to 2013, finding ways to reduce the risk profile of projects is considered important. The privatisation process has been designed with a reliance on guarantees to support bidders for successor companies created by the unbundling of Power Holding Company of Nigeria (PHCN).

MECHANISMS: As of mid-2013, several mechanisms were being discussed, and there was no agreement on when a finalised risk guarantee system would be in place, with projections ranging from late-2013 to mid-2014. Options on the table included using the World Bank’s Partial Risk Guarantee (PRG) mechanism and government options, at several different points in the process. Guarantees are considered so important to the system that they have been a factor in designing it from the beginning. Because the PRG programme cannot be used to guarantee a private-to-private transaction, a public sector body, the Nigerian Bulk Electricity Trading (NBET) was created to make guarantees possible, by acting as a middleman between the privatised generation and distribution companies. The PRG programme has been running in a number of countries since 1994, in which time 33 guarantees have been successfully closed without recourse to World Bank funds.

The guarantees will go a long way to improve the attractiveness and upside potential of the successor companies, for while the power sector offers immense scope for growth, there are a number of risks inherent in its management. The first risk point in the process is gas supply. The Gas Aggregation Company of Nigeria, established as a market maker for domestic gas contracts, estimates that supplying all existing plants would require at least 3bn cu feet (bcf) of gas daily. Currently however, there are only 2 bcf available for domestic consumption. As a result, the owners of power plants will want to mitigate their risk of an unreliable gas supply while producers want guarantees that they will be paid for gas delivered. Other steps in the chain that could require guarantees are the power-purchase agreements between plant operators and the bulk trader, and the supply agreements between the bulk trader and the distribution companies.

PRG: Thus far there is one formal guarantee in place in Nigeria. A World Bank PRG was announced in April 2013, covering a gas supply contract between Chevron Nigeria and Egbin Power, the country’s largest power plant, located in the state of Lagos. The 10-year guarantee protects Chevron against payment defaults, formally through a letter of credit issued by Deutsche Bank for the duration of the guarantee. This agreement is specifically structured to pay up to 12 missed monthly payments from the plant to Chevron, and coverage would be exhausted after a 12th is made. PRGs are typically structured to expire after a set number of pay-outs – usually less than 12.

The World Bank has at least $400m in guarantee capital for the gas sector, and is working on another $800m facility to guarantee the process as it moves downstream. The World Bank’s Multilateral Investment Guarantee Agency, which provides political-risk insurance, has also been mentioned as a possible source for additional risk mitigation to stimulate investment.

OTHER GUARANTEES: Other ideas under consideration include letters of credit without a PRG backing them. The letters mean that PHCN successor companies would need to be seen as creditworthy with the stated support from the government. Another possibility was the use of escrow accounts, in which parts of the proceeds from the sale of assets could be set aside as funds to mitigate risks, such as a distribution company not paying NBET for electricity. As discussions continue between the government, the World Bank, the private sector and other stakeholders, one concern is that guarantees become desired in other areas of the economy. For example, Nigerian National Petroleum Corporation officials told OBG they had asked the World Bank about guaranteeing a pipeline to Kano, in northern Nigeria.