Electricity! Seems like the problem with epileptic power supply never goes away. Governments come and go. From Military dictators to civilian dictators, NEPA to PHCN, Minister to Minister. All have failed to figure out how to provide stable power supply. Yes it could be that they were all corrupt and selfish individuals who made no effort to try to fix the power problems but it could also be that they tried and failed.
It would be useful to start our journey with some basic facts on the production and consumption of electricity in Nigeria over the last couple of years. The first chart shows total net electricity generated per person in Nigeria from about 1980. A look at the graphs show three striking things. First of all nothing has really changed since 1980. We still produced just as much electricity per person as we did in 1980 as we did in 2007. The second thing you notice is that we are far behind South Africa, Tunisia and neighbours Ghana and we have always been with the exception of the spike in 2006. This will seem to suggest that the root causes of our epileptic power supply are not new. It is an issue that has been present for 20 years and counting. Finally one more striking feature is that Ghana, who most Nigerians look up to now as a good example of efficient power supply, doesn’t really produce that much more electricity per person than they did 20 years ago but have been able to somehow achieve stable power supply.
Total electricity generated doesn’t paint an adequate picture of the production side of things though. The second set of graphs show installed capacity per person for the same set of countries. It shows a measure of the ability to produce electricity for each of the four countries. Once again a look at the graphs shows that the installed capacity in Nigeria has remained about the same since the 80’s and may even have been declining per person. That is probably because the installed capacity has remained the same even though the size of the economy has increased steadily. Ghana also has the same declining installed capacity but have somehow managed to achieve stable power supply. The graphs also show we are way behind South Africa and Tunisia in installed capacity per person. The facts to take away from the two graphs is that we seem to be stuck at some kind of unproductive equilibrium and this has persisted from the 80’s until today.
It might be useful to take a step back and look at the history of the electricity sector in Nigeria. NEPA was established by decree in 1972 to “ maintain an efficient, coordinated and economic system of electricity supply for all parts of Nigeria“. It was initially set up to meet the rising demand for power as a result of the national development plans. NEPA was also given a virtual monopoly status which means they controlled the entire industry and excluded most other participants. They were given some autonomy and the mandate to be self-sufficient but still had the same monopoly status. This would imply that they set all the prices across the various subsectors of the industry. Information on NEPA during this period is not readily available so it is difficult to figure out exactly what was going on. In 2005 The Electric Power Sector Act was signed into law and attempted to restructure the Power Holding Company amongst other things and create of a regulatory body that will license and regulate the generation, transmission, distribution and supply of electricity. The key change in this regime is that private businesses are allowed to generate power and sell to the PHCN. The pricing is still determined by the PHCN though and the PHCN still controls the transmission and distribution of electricity.
We can point out two regimes in our recent history and can also provide some economic intuition about the stagnant nature of electricity generation. The first regime was one in which NEPA was a virtual monopoly controlling everything from production to distribution, arbitrarily setting prices. The analysis with monopolies is pretty simple. Monopolies will always choose to produce to “below the equilibrium”, i.e if they behave optimally they will be more efficient producing less than the required amount to meet demand. Another area in which the negative effects of a monopoly on power can be seen is in the decision process of accommodating an increase in demand. A monopoly faces the option of raising prices and increasing production and subsequent supply or raising prices and rationing current supply. Monopolies are more likely to choose rationing current supply especially if they set the price of the good they are selling. Increasing supply translates to having to reduce the price which translates to lower revenues. This implies that a monopoly faced with this decision will consistently choose to ration supply and by implication has no real incentive to boost production. This seems eerily familiar to the power outage, low voltage and rationing strategies of NEPA over the years. What this translates to for the consumer is less than required supply of electricity even though they are willing to pay for it. It is important to note that this situation arises even without corruption and mismanagement and is simply a symptom of monopolies.
The second regime is a bit more complex with the introduction of private producers of electricity or independent power projects (IPP’s) as they are commonly called. It would be useful to break up the electricity sector into its subdivisions at this point, namely production, transmission, distribution and consumption. The producers feed electricity into the grid which is the transmitted to the various distribution centers which eventually pass it on to the final consumers. The IPP’s have pre-arranged contracts with NEPA (now PHCN) and decide on the price at which PHCN would purchase generated electricity from the IPP’s. The PHCN then handles the rest of the industry transmitting and distributing electricity to the final consumers. The implications of this new regime are similar to the previous regime. In terms of the market between PHCN and the final consumers the outcomes are still the same. The PHCN is still a virtual monopoly and still arbitrary sets prices between the two parties. There is still rationing and a less than adequate supply of power. The PHCN still has no incentives to expand production or in this case make deals with the IPP’s unless the costs are extraordinarily low. The PHCN is also a virtual monopsony in terms of its dealing with the IPP’s being the only buyer of electricity. This implies that the PHCN will settle at a price for electricity that is below what is required for the markets to clear and as a result a smaller quantity of electricity will be supplied by the IPP’s. The IPP’s faced with less than adequate pricing conditions do not have the required incentives to boost production when faced with a monopsony. Again it is important to understand this final outcome of rationing and a lack of increase in production of electricity will arise even without corruption or mismanagement and is simply a result of the set up of the system.
Does the PHCN respond to incentives or is there some unknown “Nigerian Factor” at play here? Well one implication of the introduction of private electricity producers is in the handling of transmission losses. Recall that the PHCN is a virtual monopsony in its dealing with the IPP’s. The contracts on prices are made before the actual supply of electricity into the grid and because the PHCN owns and runs the grid and cannot easily transmit these losses to the final consumers they have the incentives to reduce transmission losses to a minimum. Indeed the transmission losses by the PHCN is lower or comparable to most of the countries we compared Nigeria to earlier on. Transmission losses have dropped from highs of about 45% in the mid 90’s to about 13% in 2007.
From our analysis above it however seems that the presence of a PHCN monopoly is the root cause of the power problems and this is without corruption and mismanagement thrown in the mix. What are the alternatives though and will a completely privately run system solve the problem? Probably not. There are two structural problems with electricity markets around the world. The first of these is that there is a natural monopoly in terms transmission. It simply does not make sense to have multiple companies having multiple grids all over the place. The second problem is that the final consumers of electricity cannot be wholesale purchasers of electricity and producers cannot sell electricity directly to consumers.
The key to long run success will be ensuring that the major players in this sector, the producers and consumers, have the right incentives to produce as much as possible and to consume as little as possible through a system which determines a fair price for electricity between the two parties.
To deal with the problem of a monopoly on transmission the pricing decisions could be made between the many producers of electricity and the distribution companies (every local government could have its own distribution company) with an after the transaction flat rate or tax to fund transmission of electricity. You can think about it like the decision made between a buyer and a seller on ebay. The price is determined between the parties buying and selling and after an agreement a standard charge for getting the good to the consumer is then settled. There should be enough wholesale buyers and sellers of electricity to make this feasible. That’s what commodities exchanges are for, and goods don’t come in a more universal form than electricity. electricity trading on commodity exchanges is not uncommon in some parts of the world. I will write more on trading electricity at a later date but the basic idea pretty simple. It’s a market for buyers and sellers of electricity and by-passes the market disrupting transmission problems.
It is not as easy to deal with the problem of adequate feedback between the distribution companies and the final consumers. There are ways in which some kind of competitive structure can be blended within a single distribution network. One popular way is to split up the domestic market into a number of sectors and have a company run the infrastructure in each sector but mandate all the companies to share their assigned sectors with each other. Consumers will choose which electricity supplier to sign up with each period so that there is some competition between distribution companies. This model will require a lot of regulation though but if the size of each company is small enough then it should not be a very difficult task.
These suggestions still require a bit of work and I’ll try to lay down the ideas clearly in another post. The point of this post was to show that corruption and mismanagement alone might not be responsible for the long-lasting power problems. More structural problems might be at play. Figuring out way to deal with these structural problems is the key to ensuring a stable and efficient power sector in the long run.