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Operational overview of captive power in Nigeria 13 Sep 2016

It’s no secret that the state of the Nigerian power sector is, shall we say, “not the best”. Whilst successive governments have promised power to the people, access to power for many Nigerians is as scarce, difficult and expensive today as it has been in the past.
    
It was with a mixture of angst and irony that a Nigerian friend once told me how Nigerian households and businesses are their own mini-governments. What he meant by this was that most households and businesses have to (like a government) self-supply all utilities. This is particularly true in the case of power where many households and businesses self-supply power through their own power plants.

If you live in or have been to Nigeria, you will be familiar with the background noise of the diesel or petrol generator. These generators range in size from large units used by businesses and hotels to smaller units used by households – who can afford it. They are not only noisy but also expensive to operate and produce non-environmentally friendly fumes.

The larger of these power plants can be significant in size and can range from 700kWs to tens of MWs.  These plants are sometimes referred to as ‘captive power plants.’ Whilst the term ‘captive power plant’ is often used to refer to an arrangement whereby a third party provides power to a customer or group of customers from a power plant dedicated to those customers, there is some confusion in Nigeria on what is and is not a captive power plant.

This confusion stems from the fact that; one, the Electric Power Sector Reform Act of 2005 defines “captive generation” (which does not require a licence) as “generation of electricity for the purpose of consumption by the generator and which is consumed by the generator itself and not sold to a third party”; and two, the power industry considers a “captive plant” to be a plant that is owned and operated by a third party who sells the power from the plant to a customer or group of customers (which is how this term is used in this article).

Why go captive?

Other than the obvious advantage of actually having access to power when there is none from the privatised distribution companies (discos), captive power plants have some other advantages over grid-connected power. These include:
•    security of power supply through self-generation (especially for industrial users, such as mines, steel mills, refineries, fertiliser plants which have significant power requirements);
•    greater control over increases and decreases in generation of power which can tie into the production cycles/runs of the industrial unit that is being supplied;
•    control over the capacity, specifications and operation of the power plant;
•    control on timing and speed of procurement and construction of the power plant;
•    reduced costs – which will vary depending on the captive solution chosen;
•    minimising losses associated with the distribution/transmission of electricity;
•    improved environmental performance;
•    ability to provide products associated with power (for example, heat/steam from a CHP plant, water from a power and desalination plant and carbon dioxide that can be used in the production of carbonated drinks); and
•    tariff certainty and not being subject to tariff increases of a grid-connected power supply.
In addition, the security of the supply of power from a captive plant and the fact that you are not being exposed to the vagaries of supply interruptions has a value/premium that often cannot be easily quantified.

Tariff

Probably, the most important consideration on whether to procure a captive power plant is price. Is the tariff that is proposed for the power plant more competitive compared with other alternatives? When there are no alternatives, this issue becomes more of a comparison of prices between different types of captive power solutions.  
    
The tariff will be a factor for a number of issues such as cost of construction and operation; the need to support financial covenants/cover ratios required by the power generator’s (the Independent Power Project Companies) financiers; and providing the IPP Co’s sponsors with their required equity returns.

The tariff for a captive power project is mostly structured in the same manner as a traditional Independent Power Project (IPP).  That is to say it includes a capacity charge (sometimes also referred to as an availability charge or a fixed charge) and energy charge. The capacity charge will usually cover the IPP Co’s fixed costs with all variable costs being covered by the energy charge.

Fixed costs will include debt service, equity return and fixed operation costs. Whilst variable costs will include fuel costs and other operating costs that vary depending upon the quantity of power generated. The capacity charge is payable for generating capacity made available, regardless of whether the customer actually takes power. This is also known as a “take-or-pay” arrangement.

In some cases (particularly smaller captive power projects), fuel costs can be categorised as a fixed cost despite the variable nature of the fuel provided. This is especially the case where the power producer is required to contract for enough gas to cover the capacity or expected power production of the plant.  Here, the contract quantity (or a high proportion of it) will be structured as a take-or-pay that is passed through to the customer, irrespective of actual power produced or consumed.

The tariff is usually also adjusted annually by reference to an indexation formula to cover issues such as inflation, foreign exchange movement, etc.

Types of captive power solutions

There are a number of captive power solutions available to consumers other than diesel/petrol generators. These include wind, solar, biomass, etc. But given Sub-Saharan Africa’s massive gas reserves, captive gas plants should be the main power solution in this arena.

Gas-fired power plants are a very competitive and attractive solution for a captive power plant. However, the slow pace of gas distribution network development and the lack of gas supplies is in many cases an impediment to a gas power solution. Nevertheless, smaller scale gas-fired plants fed by a “virtual” pipeline can overcome this impediment.

A “virtual” pipeline transports gas via land or sea and it can replicate the continuous flow of gas in a pipeline using storage and transportation logistics (e.g. using trucked or barged LPG). This is often a cheaper solution than an oil (whether heavy fuel oil [HFO], petrol or diesel) solution. For example, General Electric (GE) has stated that it is able to provide a virtual pipeline gas-to-power solution that will deliver power at 10 to 15 cents per kWh, which is often 30 to 50 percent below the cost of oil-fired power. A gas-powered power plant will also be “greener” by having lower associated carbon dioxide emissions.

Gas-fuelled captive power plants are most fuel efficient when used in a combined heat and power (CHP) configuration. Here, a facility can generate not only electricity, but also heat in the form of steam, which is required by petrochemical refineries and paper mills. This can be taken further with absorption chilling technology called tri-generation which produces cold water that can be used for chilling/refrigeration.

So you want a captive power plant?

Assuming that you have chosen the type of solution that you want for your industrial/manufacturing complex. Here are a few things to know and take into consideration.

Permits and consents

The plant will require various permits and consents. In Nigeria, these include:
•    a generation licence – (although power generation below 1MW does not require a generation licence);
•    if the plant is providing power to a number of sites (often referred to as “clusters) requiring a distribution grid, it may require an independent electricity distribution licence;
•    Certificate of Occupancy or Governor’s consent to the grant of an assignment or lease of title to land;
•    Development Permit;
•    Building Permit;
•    Environmental and Social Impact Assessment Certification;
•    Permit for Storage of Chemical and Petroleum Products;
•    Waste and Toxic Substances Permit;
•    Permit for Waste Disposal;
•    Fire safety report or certificate;
•    Air Quality Permits; and
•    Noise Permit.
    
It is probably worth mentioning that the permitting of captive power plants in Nigeria has some grey areas that are beyond the scope of this article. A power generator can also apply for incentives provided for under s. 5 of the Customs, Excise Tariff, etc. (Consolidation) Act, Cap C49, LFN 2004, by procuring an Import Duty Exemption Certificate. This legislation provides incentives for the utilisation of gas which exempts from custom duties, any machinery, equipment or spare part imported into Nigeria by an industrial establishment engaged in the exploration, processing or power generation through the utilisation of gas for its operations.

The contractual framework    

A captive power project will have a similar contractual framework as larger utility-sized IPPs.  At the centre of the project will be a power purchase agreement (PPA). Although the terms of the PPA will depend on the particular project and the bargaining strength of the parties, it will include the provisions dealing with the following key issues:
•    obligations to supply power and off take power;
•    any other products to be supplied by the plant, such as heat, steam or water,
•    payment/tariff provisions;
•    security for the customer’s payment obligations (including compensation on termination); and
•    metering provisions.
 
Multiple offtakers

Where the IPP Co is supplying more than one customer, there will be separate PPAs for each customer. However, there will also need to be an overarching “umbrella” agreement between the IPP Co and all its customers. This agreement will need to deal with issues such as:
•    the relationship between the customers; and
•    priority of supply/offtake between the customers (e.g. where output from the plant is reduced).
Consideration will also need to be given as to whether the terms of the PPA (including the tariff) will differ between small and large offtakers.

Fuel

Excluding renewable projects, the issue of fuel supply (whether its gas, diesel, HFO etc) will be dealt with in a fuel supply agreement (FSA). Fuel supply can be structured either as a tolling agreement (see below) or with the IPP Co being responsible for procuring the fuel as part its obligations under the PPA.

Tolling Agreement

Where a customer has access to fuel (e.g. an oil and gas company may have gas/associated gas that can be used for a power plant) and procures a captive power plant, it is usual to structure the IPP through a tolling agreement. In this case, the oil and gas company (the toller) will provide the IPP Co with gas that will be converted into power by the IPP Co. Here, the risk profile on fuel supply sits solely with the customer under a tolling agreement.

Security

As with any IPP (captive or otherwise), the creditworthiness of the customer will be a key consideration for the IPP Co. Therefore, the security package (e.g. letter of credit, parent company guarantee etc.) will need to be crafted carefully to ensure that the project is bankable.

It’s clear that captive power plants can play an important role in the energy mix of a country. As always, the challenge is about structuring the projects to be bankable within a clear and positive regulatory environment. The rest is all about execution to turn on the lights.