Nigeria has long needed investment in essential infrastructure, and reforms to its power sector have encouraged the local market to think that the country may start attracting the levels of financing it needs. The Nigerian government has rolled out a number of changes to how power will be generated, distributed and consumed in order to spur additional investment.

In response to the recurring inability of state utility Power Holding Company of Nigeria (PHCN) to deliver on its obligations under purchase agreements with suppliers, the government established the independent bulk trader NBET in 2010. This was the first of several reforms designed to give extra comfort to producers and convince them that it is possible to use regulation to mitigate some of the risks previously inherent in the Nigerian market.

Private power pipeline

Earlier this year the 10 newly-privatised power distribution companies (Discos) and five generating companies (Gencos) took over the remaining functions of PHCN. One of the five Gencos – Sapele – remains unsold because its preferred bidder did not make its required payments. Over the last year government can claim some success in the power privatisation programme, as its reforms start to draw equity into the sector.

In June 2013 Nigeria began a series of road-shows for the privatisation of another 10 state-owned power plants that were developed under the 2004 National Integrated Power Project (NIPP) programme. The plants have a combined capacity of 4,800MW, and should bring in proceeds of around $3 billion.

The country has also launched an greenfield independent power plant procurement programme, with the new Azura-Edo, Exxon and Chevron Agura plants, which require a combined total of $1.5 billion of private investment, set to account for a further 1,300MW of new capacity. The 450MW Azura-Edo is the most advanced of these deals and its sponsors – Amaya Capital, African Infrastructure Investment Fund 2, Aldwych International and Asset & Resources Management Company – hope to reach financial close before the end of this year.

In July 2012 Manitoba Hydro International won a three-year management contract to run the country’s state-owned transmission operator – Transmission Company of Nigeria (TCN). The national transmission system is thought to require about $5 billion in investment to improve its wheeling capabilities. Most of the proceeds of the power plant privatisation programme are expected to be used to finance transmission grid improvements. The government also raised a $1 billion Eurobond in July 2013 to part-fund the transmission works, help capitalise NBET and invest in improvements to the country’s gas supply infrastructure. Gas infrastructure will be as important as regulatory infrastructure to the smooth operation of the new fleet of plants.

Debt determination

Along with the bond and privatisation proceeds, the power sector improvements will require substantial investment from the private sector. In his presentation at Project Finance and FBN Capital’s Project & Infrastructure Finance Forum in Lagos in October, Femi Akinrebiyo, senior investment officer at the International Finance Corporation (IFC), said that there is a high level of interest from development finance institutions (DFIs) in supporting the power reforms. He also said that the level of participation from international and local equity investors in the recent privatisations was an encouraging sign.

Attracting international commercial lenders to the country appears to be a harder sell. Standard Chartered is mandated lead arranger on the Azura-Edo IPP, but many other international banks remain unconvinced as to whether the sector will be viable in the long term, and want the sector to produce some successful financings to create comfort at their respective credit committees. This may cause liquidity issues in the near future because local banks already have high exposures to the sector. The Genco/Disco acquisitions were financed with a debt/equity split of 70/30, with local lenders providing practically all of the debt. Following their privatisations, several of the 10 privatised NIPP plants will need expanding and upgrading, requiring even more private investment.

Akinrebiyo finished his presentation by highlighting the remaining market uncertainties that Nigeria needs to address if the newly restructured power sector wants to attract the additional investment it requires. Payments to NBET are chief among his concerns. NBET’s current level of capitalisation covers nine months of obligations to generators, assuming it receives no payments from Discos during that period. But its payment obligations will rapidly increase to about $3 billion each year, once Nigeria’s installed generating capacity reaches 10GW. Akinrebiyo argues that NBET will need to establish a reputation for reliability of payments over the next few years to increase investor comfort.

Following Akinrebiyo’s presentation, several offshore debt and equity providers formed a panel to discuss the health of the Nigerian project finance market. Roland Janssens, deputy head of the Frontier Market-managed Emerging Africa Infrastructure Fund, said that there was definitely interest from an equity perspective in assets in Nigeria, but long concession lengths were an important requirement. “People look for a bit of a tail. If that is present, then generally you can finance, but the length of the finance you can obtain is clearly dependent on that. I would cautiously say that in Nigeria things are going in the right direction,” he said.

It is not always easy to match long concessions with long-dated debt, however. Olivier Follin, country manager for Nigeria at Proparco, said that as a development finance institution his organisation could go up to 20 years in the country. But as Nicolas Pitiot, FBN Capital’s London-based head of project and structured finance, explained, commercial lenders struggle to go out that long. DFIs are stepping up their participation in Nigerian debt financings, particularly in the power market, but both Follin and Akinrebiyo stressed that the function of their organisations is not to compete with commercial banks but enhance financings sufficiently to attract other lenders.

One way DFIs can offer comfort to other lenders is through partial risk guarantees (PRGs). The sponsors of Azura-Edo have been negotiating a PRG with the World Bank and separate coverage from its subsidiary the Multilateral Investment Guarantee Agency. The World Bank is also providing a PRG in connection with the gas supply and aggregation agreement between supplier Chevron and the country’s largest power plant, Egbin.

Benito Grimaudo, associate partner at the ARM Infrastructure Fund, was critical of how many projects have to rely on PRGs, and insisted that they were no substitute for full government backstops against default or non-payment. “These are often short-term patches. The true test is the government standing by the obligations on the contracts, short-term and long-term.” And Akinrebiyo notes that a liquidity PRG is only designed to offer limited protection. “The intention with the liquidity PRG is to ease temporary liquidity and payment issues to allow the project to continue to operate while the source of these issues is resolved, thus avoiding unnecessary termination. So, when we talk about PRG for a specific number of months of billing this is related to the specific liquidity risk identified in the transaction and the funding needed to keep the project operating while temporary payment issues are addressed.”

Despite being cautious about the level of coverage offered to the private sector by the government, Grimaudo admitted that ARM was among a handful of private equity firms interested in the Nigerian power sector. “The name of the game is power and everyone from an equity perspective wants to get hold of an asset, whether through privatisation or IPP,” he said. “I think the power sector will be a driving force in the economy, and investors recognise the returns are going to be substantial.”

Power and beyond

The IFC’s Akinrebiyo is clear on why investors have become much more comfortable with power risk. “The focus on power is because we have visibility. We know where the transactions are coming from. If we had a clear framework for the other sectors of the economy we would be able to put our resources behind them.” Although a clear structure is in place, Follin is concerned about resources. Follin notes that when governments design power market reforms they often forget to ask whether the country has the adequate number of technicians and engineers, or other skilled workers, to undertake a large expansion to the grid’s capacity. Follin said: “Nigeria has been through a complete restructuring of the sector, which means that there are now huge needs. We have resources here at the moment but not for the size of Nigeria’s demands or requirements.”

Away from power, the government is also looking to develop its PPP market. The recent Calabar hospital development in Cross Rivers state was originally launched as a PPP. All of the project costs for that development are to be met through a state government grant, however, giving an indication of the level of comfort lenders have with social infrastructure projects. The IFC is advising the central government on its PPP pipeline, which, while small, also includes the second Niger bridge project. That project’s developers are Julius Berger and Africa Infrastructure Management and it will cost around $425 million. Earlier this year the government increased its funding commitment to over half of the total cost.

Commenting on the environment for PPP financing, Proparco’s Follin said: “I would say the politics and the environment involved pose a challenge. When you look at PPP, every state has got its own policies, which means that, when going into it, you have to analyse what specific consequences there are for the lenders.” A more viable sector for investment may be transport, however. Pitiot says that “as a priority it would be ports and airports, as they tend to actually generate revenues in hard currency, so it’s easier for offshore lenders to structure financing around them.”

The most advanced of the pipeline of transport deals is Tolaram’s $1.5 billion greenfield Lekki port development, located 65km east of Lagos, which is nearing financial close. The project company holds a 45-year concession from the Nigerian Ports Authority, with the option of extending its term by another 25 years. The financing has heavy DFI support, with the Islamic Development Bank, African Development Bank, European Investment Bank and the IFC all looking over possible loans to the project, while a number of export credit agencies, international and local banks are also expected to participate.

Nigeria has a healthy pipeline of road projects, but these have proved more problematic to structure. FBN’s Pitiot explained: “The fact that there is very little track record for toll roads projects in Nigeria makes it difficult to conduct accurate due diligence.” The collapse of the Lagos Ibadan expressway project casts a shadow over road financings in the country. Bi-Courtney Nigerian won the project in 2009 but lost the concession after the government claimed it had failed to fulfil its obligations under the agreement. The Lekki-Epe Expressway project also acts as a cautionary tale. The sponsors were forced to delay the introduction of tolls shortly before an election was due to take place, thus interrupting the project’s anticipated revenues, and the project is being restructured.

Pitiot believes that many of the proposed roads could yield higher tolls than projected in traffic studies, but without similar projects in operations, commercial lenders are always going to be wary. “There are some ways to mitigate this risk” he said. “You could structure the revenue generation of a project so that the government takes some or most of the traffic risk by agreeing on a minimum traffic amount. Another way may be to collect all the revenues from the road and then pay the concessionaire a fixed capacity fee“. Whether either option is attractive to the central government remains to be seen.

Institutional comfort

An alternative source of funding for all Nigerian projects could be the capital markets, with EAIF’s Janssens suggesting that the country could be an ideal home for a bond deal. “In the long-term, and especially for an economy of the actual and potential size of Nigeria, the capital markets, in the form of equity issues and bond issues, will become one of the prime, if not the prime, source of funding infrastructure in the country.” Institutional investors are some way from being entirely comfortable with the market, however, and Janssens conceded that government guarantees would probably need to stretch to at least 15 years before Nigeria enjoys a healthy long-term bond market.

Pension funds are increasingly interested in the market, according to Pitoit. “There are only a handful of players in Africa at the moment but there is a lot of appetite. Infrastructure projects have very long tenors and strong cash flows, and this is very attractive to pension funds. Not only Nigerian pension funds but also other African pension funds and international players are interested – PIC in South Africa for example has a lot of appetite for infrastructure projects.” Finding ways of making those funds more comfortable with Nigerian project risk could go some way towards bridging the country’s liquidity gap.

Nigeria has a rapidly increasing population, with a recent UN report estimating that it could have the third largest population in the world by 2050. If it is to meet the demands this growing populace will place on its infrastructure, it needs to set a precedent of successful infrastructure financings to boost investor confidence.