The energy sector is a highly lucrative industry requiring regulation to keep pace with developments and specifically to promote and safeguard local content and jobs. In Nigeria’s latest regulation update, anticipated for publication in its government gazette in the first half of 2019, we consider some of the direct implications that the Regulations & Minimum Specifications have for key stakeholders across the value chain.
As of 2018, the implementation of local content legislation in Nigeria’s oil and gas industry has created over 30,000 jobs and delivered project-based training for up to 5,800 young Nigerians, according to data from the Nigerian Content Development Monitoring Board. Also, the total value of contracts awarded to Nigerian companies operating in this industry has risen to 83% while average Nigerian content retention has moved upward up to 28%.
When viewed from this perspective, stakeholders in the power sector would easily understand how the Nigerian Electricity Regulatory Commission (NERC) is thinking about driving a deliberate utilisation of local human and material resources. The primary objective of the updated regulation on National Content Development for the Power Sector (Regulations) and the Minimum Specification of Nigerian Content
(Minimum Specification) is to promote the use of local goods and services and Nigerians within the power sector.
NERC is hoping to replicate the success of similar local content legislation in Nigeria’s oil and gas industry.
For core investors
The Regulations stipulate a maximum of 5% of management positions within licensees for expatriates. This provisioning will have implications for core investors, (and investors generally) although the extent of those implications will depend on a number of variables, which include:
• whether the core investors are investors in the primary licensees of NERC (i.e. Gencos, Transco, Discos),
• whether the core investors are investors in Meter Service Providers (MSPs),
• whether a power sector contractor firm is a resident Nigerian company or not, and
• whether the core investors invested in independent distribution or generation projects (Independents).
It is useful to note that ‘management’ will typically be interpreted in terms of not only the board and senior management but all the persons in the leadership of a licensee who cannot belong to any labour union or association by reason of their seniority.
It appears that the 5% cap may be contrary to the spirit of the shareholders’ agreement between Discos and the Federal Government of Nigeria (through the Bureau of Public Enterprises and the Ministry of Finance Incorporated), and the respective core investors. For instance, based on the shareholder’s agreement for the Discos, the core investor in the Discos have a contractual right to nominate six out of the contractual maximum of seven directors on the board of a Disco, whilst the government nominates one member of the board.
The respective core investors also typically have shareholder rights to nominate the chairman and CEO of the relevant Disco. It appears that the basis of this arrangement was to recognise the typical diversity of interests in a core investor and to give a certain level of comfort to core investors by providing them with a majority of board positions and also with the flexibility and optionality to deploy the highest possible quality of management necessary to deliver returns and efficient service delivery.
Although there is currently, in our view, a fair distribution of Nigerians across the board and management of Discos locally, the 5% cap does appear to be contrary to the spirit of the shareholders’ agreement that Discos signed with the government and should be a concern for core investors, especially in the light of the persisting operational and liquidity issues in the distribution sub-sector. The primary focus of the Commission should therefore be on ‘stabilising’ the industry at this time. The 5% cap may actually be more stifling for MSPs and some Independents who typically have more compact boards and foreign presence.
A substantial amount of the acquisition and operational financing deployed by core investors to acquire target shares in the primary licensees was sourced from a combination of local and international debt providers. Whilst lenders are not the immediate focus of the regulation, there are a number of points that lenders need to pay close attention to.
Firstly, lenders need to take note of increasing regulation in the sector and consider the extent to which appropriate language can be introduced in loan documentation to mitigate and/or compensate for the effect of a regulatory breach by power sector obligors, to the extent that such breach materially affects the ability of the obligors to repay.
It does appear that template language will not suffice for all situations. Although there would typically be a standard ‘compliance with laws’ undertaking within loan documentation, this provisioning, considered alone, may be of limited utility in certain circumstances, especially given the standard requirement under such undertakings, for such breach to be of a material nature as to impair the relevant obligor’s ability to perform its contracted obligations or where the breach has a material adverse effect in itself.
It will be useful, going forward, for lenders to also specify key regulations of concern within loan documentation, in view of the evolving fine and sanctions framework in the power sector and the effect that regulatory action can have on the ability of the obligors to repay.
At the least, specific mention of such regulations, which should be flagged during a lender due diligence, should serve the purpose of emphasising the importance of compliance by obligors with such regulations of concern. In many respects, we consider the regulation to be within this category of key legislations in the power sector.
Secondly, the regulations have now provided that finance and capital market services are now to be rendered by Nigerian firms which show evidence of good standing with the relevant regulators. The regulations only allow engagement of foreign firms to provide services in the power sector when such foreign firms show evidence that the services will be provided in collaboration with a local firm.
This requirement should generally be a matter for due diligence for local and international lenders to the power sector. Another point, which also comes up for consideration for lenders, is a provision in the Minimum Specifications for a business activity referred to as ‘funding’.
It is not exactly clear what the regulatory intention is here; however, it would appear, subject to further clarification from NERC, that the Commission is seeking to specify a minimum level of financing that must be provided by, presumably, local debt providers to licensees. The local content spend permissible under this category by licensees is a minimum of 10% in 2019, 15% between the 2020–2023 corridor, and 20% between 2024 and above.
For the Commission
The concern here for stakeholders, really, should be whether NERC, as presently constituted, is properly and efficiently staffed and organised, in view of the increased level of regulatory interaction from the power sector that the regulations will require. It is our view that the reason for the success of local content legislation in the oil and gas industry is in part the enactment of specific local government legislation by the National Assembly and the implementation of that legislation by a separate local content management and development corporation created by legislation for that purpose.
Prior to this time, the approach to local content regulation had been for the Nigerian National Petroleum Corporation (NNPC) to set up a Nigerian Content Division and issue Nigerian Content directives to the industry. This appears to be similar to the current approach in the power sector as of date. It is our view that NERC should consider a structure that allows its local content desk/team to operate with more independence, less bureaucracy, and the commercial efficiency necessary for the smooth operation of the sector.
For financial, strategic promoters and investors
There is, in our view, a sense in which the Regulations will attract foreign direct investment in Nigeria’s power sector. There are at least 28 distinct business areas within the electricity generation stream, 30 within the transmission stream, and 34 within the distribution stream that have been opened up to local participation by regulatory fiat.
It is anticipated that discerning Nigerian promoters/businesses, and licensees where considered strategic, will take advantage of these opportunities to foster technical collaborations with willing foreign technical partners, by implementing a variety of legal structures that are available for the execution of such technical collaborations. This will extend to a number of the existing licensees/power sector contractors who will also leverage these opportunities for expansion capital.
For prospective licensees
The regulations make wide-ranging provisions that impact key aspects of the operations of licensees covering employment, procurement, management, technology transfer, project staffing, engagement of professional services (lawyers, insurance, engineers, etc.). At the minimum, it is expected that licensees will now begin to put compliance structures in place, possibly starting with the setup of a local content desk or working with external counsel to design a local content compliance strategy.
Licensees take note
While it is highly recommended that stakeholders obtain advice that is specific to their operations, below are outlined some of the key legal issues that licensees should pay attention to.
Who does the regulation apply to?
The regulation applies generally to NERC’s licensees. Although NERC typically uses ‘licensees’ when referring to persons engaged in the generation, transmission, system operation, distribution, and trading of electricity, NERC appears to have taken a wider approach to the definition of ‘licensees’ regulations, which define a licensee as “any person who holds a license issued under the Act to carry on any regulated activity”. The conclusion is that the primary scope of the Regulation covers not only Gencos, Discos and the Transmission Company of Nigeria but also includes Meter Service Providers, including Nigerian Bulk Electricity Trader (NBET), Meter Asset Providers, and all other persons carrying out a regulated activity pursuant to a licence from the NERC.
Note too that both local and foreign non-licensee contractors in the power sector also have obligations under the regulations, to the extent that they execute projects on behalf of a licensee.
The regulations make it compulsory for licensees to ensure that non-licensees comply with the regulations and the Minimum Specifications. It would be standard for a licensee to
What is a Nigerian company?
The regulations state that licensees are now to give first consideration to “Nigerian Companies” / “Nigerian firms” or “Nigerian Professional Companies”, for the supply of goods, works and for the provision of services, in particular for goods made in Nigeria and services provided by Nigerian firms, in the award of contracts. Note that not one of these phrases, although used, is defined in the regulations.
The regulations, however, recognise a “Nigerian Operator” as “a company incorporated in Nigeria with the object of providing goods and services for the NESI [Nigerian Electricity Supply Industry]”. On this basis, it is reasonable to conclude that NERC does not intend to set shareholding thresholds for local participation on a shareholder level for Nigerian companies which are subject to the regulations, because the of registration in Nigeria at the Corporate Affairs Commission will satisfy the requirements of the Regulation.
This is a welcome departure from the local content legislation applicable in the oil and gas industry, which defines a Nigerian company as one with not less than 51% equity by Nigerians. We consider this concession to be in the interest of investors across the board, in the power sector
Joint Qualification System
At the time of going to print, there is no evidence that the Joint Qualification System (JQS) has been set up; however, the JQS will be a critical pre-condition to the enforcement of the regulations. By design, the JQS is an online platform for Nigerian content registration, prequalification, and verification of capacities and capabilities.
The regulations now require NERC’s approval for the employment of expatriate by a licensee, alongside a requirement for licensees to employ only Nigerians in all junior and intermediate cadres or corresponding grades. The importance here is the need for licensees to review existing HR and employment strategy in view of the increased spending that will now be required on capacity training and building for Nigerian employees. For instance, on the basis that Nigerian employment law recognises that training bonds are a legitimate strategy for protecting employer interests, a licensee may consider a structured training bond programme within the context of compliance with the regulations.
Major project threshold
The regulations require licensees to submit a Nigerian Content Plan for Major Projects, which by definition are projects that exceed a financial threshold set by NERC. The specification of the threshold for major projects is anticipated to be specified and operate as a pre-condition to the full operation of the regulation.
Existing local content legislation
NERC will need to clarify certain provisions of the Regulation and Minimum Specification within the context of existing legislation on local content. For instance, pursuant to the 2018 MAP regulations, companies are required to source at a minimum 30% of their contracted metering volumes from local meter manufacturing companies.
Based on the provisions of the Minimum Specification, it would appear that this amount has been increased to 40%. We expect that NERC will clarify its position on this point prior to full-scale enforcement of the regulations.
The regulations allow licensees to obtain a waiver for no longer than a 3-year period where there is inadequate local capacity. A waiver may also be obtained where losses incurred by the licensee as a result of using local capacity will be imprudent or where the use of such local capacity will lead to an increased cost of doing business. It is assumed that these grounds have been introduced to further protect the interest of investors; however, it is felt that NERC should also consider providing the details on the acceptable documentation upon which the Commission will grant a waiver on these two latter grounds.
The need to use regulation to drive the deliberate use of local human and material resources is appreciated and, through this latest update, it is expected that NERC will continue to be sensitive to the interests of both foreign direct investors and industry partners. ESI