Electricity Retail Tariffs and Cross-subsidization in Nigeria

25 November 2019 * 3 min read

Written by Ayodeji Okunlola

It can be argued that one of the weakest links right now is electricity distribution; this doesn’t mean that the transmission and generation value chains haven’t been lagging behind, but arguably not as bad as the “end” segment of the chain.

Multiple solutions have been suggested of late on how to restore confidence and liquidity to this segment of the value chain. Many have suggested a government reversal of the privatization plan while some also assert the need for speedy metering of customers. The most predominant thought echoed by professionals in the sector is the need for increased retail electricity tariffs; the multiples of increase is still a moot point. Associated with this thought is the application of a cross-subsidization model, whereby the “rich/commercial users” subsidize the “poor/lower-residential user”, which is almost the case as shown in NERC’s amended MYTO; the tariff order also shows some DISCOs offering near equal tariff for residential and commercial users. Though this sounds laudable and altruistic, this shouldn’t be the case in this non-liquid segment. Why? With increasing electricity retail tariffs, self-generation with solar PV becomes competitive and gradually attains grid-parity for higher energy consumers (thus, easing the business model of PV companies vis-à-vis customer acquisition).

Energy cost (N/kWh) for a typical DISCO in NERC‘s amended MYTO

“Grid-parity is achieved when an alternative energy source can generate power at a cost that is less than or equal to the price of purchasing power from the electricity grid”

Applying this model of cross-subsidization of retail electricity tariffs suggested by many development professionals in Nigeria (I read quite a lot of their submissions on Twitter) makes it technically easy for many commercial, industrial, and some high residential energy consumers to go completely off-grid using either solar or liquefied gas technologies. The reality is such that for a distribution company (DISCO) to be profitable it has to retain as much higher energy consumers on the network and prevent them from going off-grid either partially or completely; Mr. Andrew Alli (former AFC CEO) couldn’t have explained it better in the article he wrote for quartz about Africa’s electricity shortage needs and higher power tariffs.

To prevent this expected outcome, some countries in Europe (especially Germany and Belgium) have adopted an alternate cross-subsidization model whereby the lower consumers (residential users) considerably subsidize the higher consumers (small & mid-size commercial and industrial users) and provide enough capital to maintain the grid infrastructure. Households pay higher rates for electricity than commercial and industrial consumer does, one reason is that bulk power purchases generally make item prices cheaper. Sounds strange right -observe the segmentation in the chart below.

Retail electricity tariffs per customer segment in Germany, UK, France, Belgium, and Netherlands

Implementing this approach ensures that the “consuming” class which drives productivity and economic growth in the country have “cheap enough” electricity to remain competitive and sustainable in the market. Though not the best, DISCOs are forced to weaken those in-house generation prices to win over the higher energy customers who drive economic growth. The margins may be slim for DISCOs supplying the higher energy consumers, but greater returns can be achieved from smaller consumers who do not have the option to self-generate their own electricity (if constant electricity is the goal!!!). By so-doing, residential consumers would be forced to be energy efficient and DISCOs will be compelled to improve service quality for consumer retention.

Applying this alternate cross-subsidization model in the next MYTO review should eventually lead to a win-win-win situation for the DISCOs, consumers and the government regulator if economic growth and liquidity of the power sector is the goal. The social implications and spatial arrangement for applying this model are debatable. Ultimately, this model needs to be worked out for an equilibrium but fair electricity tariff-point to be attained.

• This analysis of the power sector was based on the year-end 2018*

Ayodeji Okunlola is an Energy Systems Professional/Engineer working in the intersection of energy systems research, and power sector de-carbonization advisory. Skilled in solving complex problems related to energy system transition management, data gathering, rapid-prototyping, stakeholder management, and system solution design applying proven methods and tools.