When you first arrive in Lagos, the noise of Africa’s largest city is overwhelming. Horns blare in the endless traffic, vendors bark at passersby, clubs blast music onto the streets, and churches and mosques appeal to the faithful around the clock from public loudspeakers. Worried that the din is damaging the health of the city’s 17 million inhabitants, the state government recently launched a crackdown, closing more than 100 clubs, hotels and places of worship earlier this year.
There is another, more insidious sound that you gradually notice once you’ve been on the ground. It’s a low-level hum, the chorus of the thousands of diesel generators that keep the city going in the face of a chronic electricity shortage. At shopping malls and hotels, generators the size of shipping crates sit in parking lots, often secured in locked cages; on the streets people carry briefcase-size models. At outdoor markets such generators are passed from stall to stall as the need arises, which is often: Nigeria gets an average of three hours of electricity a day from the national grid, usually in short bursts. The average Nigerian uses barely one hundredth as much electric power as the average American — just enough to keep a lightbulb on. When the grid goes dark, the generators fire up with a loud roar before settling into a steady background drone.
Solving the power shortage is arguably the biggest development challenge for Nigeria, and for much of the African continent. Now, after years of talk, there are glimmers of progress. In a field of red dirt halfway between Lagos and the country’s main oil and gas fields, a consortium of local and international investors is building a gas-fired plant. The $877 million Azura-Edo Independent Power Project, as it’s called, is modest in scale, with an expected generating capacity of 459 megawatts when it comes on line in 2018. (By comparison, China installed 33 times as much capacity just in solar power last year.) Yet the project, which brings together an array of Nigerian entrepreneurs, foreign infrastructure investors and multilateral development banks, promises to have a much bigger impact by creating a financial and regulatory model that can be replicated elsewhere.
The principal equity investors include Amaya Capital, a Mauritius-based firm founded in 2008 to invest in energy projects in West Africa; American Capital Energy & Infrastructure, an Annapolis, Maryland–based private equity fund headed by Paul Hanrahan, former CEO of U.S. utility operator AES Corp.; and Aldwych International, a British developer of African power projects. A variety of public and private lenders are providing $622 million of debt finance. They include International Finance Corp., the for-profit lending arm of the World Bank, and Netherlands Development Finance Co.; such foreign banks as Standard Chartered and South Africa’s Rand Merchant Bank; and Nigeria’s state-owned Bank of Industry, which is providing funds in naira to cover the project’s local currency costs. The World Bank Group has provided a political risk guarantee that has been crucial for attracting private investors.
“This transaction has managed to get about 20 investors comfortable with participating in the Nigerian power sector, and we expect most of them will look at more transactions,” says Richard Arkutu, manager of the IFC’s Africa Special Initiative for Infrastructure. Indeed, some of the participants in the Azura-Edo plant have been working to get a similar project, a 550-MW plant in the country’s oil-producing Niger Delta region, off the ground; the backers are already in negotiations to sell the project to Black Rhino Group, a Blackstone Group vehicle created to develop infrastructure projects in Africa. Black Rhino hopes to reach a gas-supply agreement with the government and begin construction later this year.
Extending power in Nigeria, Africa’s largest country, will be a major achievement. Roughly 42 percent of the population of 180 million has no access to the electricity grid. Such collaborative efforts could have a far wider impact across the continent, where the needs are, if anything, even greater: The World Bank estimates that as many as 600 million of Africa’s 1 billion people lack access to electricity. The Power Africa initiative, launched by President Barack Obama at a Washington summit meeting two years ago, set a target of adding 30,000 MW of new generating capacity across the continent and connecting 60 million more homes and businesses to the grid by 2030. Overseas Private Investment Corp. (OPIC), a U.S. government agency that’s playing a key role in Power Africa, has provided $50 million in loans to the Azura-Edo plant. The hope is that when enough power plants are built, grids rehabilitated and payment-collection systems overhauled, investors will no longer ask for help before committing to build. The result will be more power, more jobs, faster growth and higher living standards.
“Power is the missing link in Nigeria,” says Brian Herlihy, CEO of Black Rhino. “It’s going to create huge productivity gains once it’s there.”
The country badly needs the push that projects like the Azura-Edo plant can provide. Muhammadu Buhari generated high hopes for change last year when he became the first challenger in the country’s history to defeat an incumbent president in an election, but Nigeria’s woes have intensified since he took office in May 2015. The collapse in global oil prices has undermined the country’s biggest source of hard currency earnings and government revenue. Exports plunged by 40 percent last year, pushing the current account from a slight surplus to a deficit of 2.4 percent of gross domestic product and causing the government budget deficit to double, to 3.7 percent of GDP. The Central Bank of Nigeria initially spent a chunk of its foreign reserves to defend the naira, then let the currency depreciate by about 20 percent in late 2014 and early 2015 before targeting a fixed exchange rate of 199 to the dollar and imposing capital controls in April 2015.
Oil production has fallen further in recent months, touching a 22-year low of about 1.7 million barrels a day in early May, because of a resurgence in violence by militant groups in the Niger Delta region. These groups had been quiet in recent years thanks to an amnesty program that provided stipends and job training, and a government initiative that gave them security contracts to guard the pipelines they used to attack. But Buhari has adopted a harder line, canceling the security contracts, cutting funding for the amnesty program and prosecuting a former rebel leader known as Tompolo, who may be linked to the Niger Delta Avengers, the group behind several recent bombings.
Contrary to the advice of the International Monetary Fund, Nigeria refuses to let its currency float and has rebuffed the Fund’s offers of financial assistance. Finance Minister Kemi Adeosun defended the government’s stance at a panel discussion during the IMF’s spring meetings in Washington. “If we are sick, we have our own local medicine,” she told the audience. IMF deputy managing director Mitsuhiro Furusawa responded: “We aim to be a good doctor to you. It’s better to have many doctors.”
Buhari has introduced some much-needed reforms, notably at Nigerian National Petroleum Corp., the state’s famously opaque oil arm. When Lamido Sanusi, former governor of the central bank, alleged two years ago that NNPC had failed to turn over nearly $20 billion in revenue to the Treasury, he was removed from office by then-president Goodluck Jonathan. Buhari has injected transparency into the oil company. It now publishes a monthly newsletter with production and revenue updates. A full audit and annual report, the first since 2005, are expected later this year, says Alexandra Gillies, director of governance at the George Soros–funded Natural Resource Governance Institute. The president has led a military campaign to reduce terrorist group Boko Haram’s impact and has consolidated cash from the various bank accounts held by ministries and other agencies into a single one at the Central Bank of Nigeria, making financial flows easier to track.
But in many areas the pace of change is slow because Buhari appears reluctant to delegate matters to anyone he doesn’t trust, says Soji Apampa, a businessman who helped found a Nigerian anticorruption group called the Convention on Business Integrity. If the president has a wider plan beyond intervening in areas where he sees a need, he has yet to share it. “The campaign machine repackaged someone considered to be a brutal old soldier into the statesman Nigerians sought, but he seems to have jettisoned that persona,” Apampa says. Instead, Buhari is now popularly known as Baba Go Slow, a play on the term Nigerians use to describe traffic jams.
Nigeria’s electric plants have the capacity to generate up to 6,000 MW of electricity, or about 80 percent of what it takes to power Los Angeles. The system rarely runs at full capacity, though, typically generating less than 3,000 MW. Dilapidated power plants and an aging and inefficient power grid are major shortcomings. Roughly 35 percent of the power generated is either lost in transmission or effectively given away. Distributors in many cases either fail to bill customers accurately or can’t collect payment from them, a problem common to much of Africa as well as to other developing countries, such as India. In addition, the state regulator usually sets tariffs at levels too low to leave room for investment, even if the operators could collect all their revenue. Unpaid bills pile up, usually on the balance sheets of state-owned utilities, crippling their ability to borrow or attract outside investment.
The economic and social costs of this backward system are manifest. Nigerian businesses suffer an average 239 hours a month without power, according to the World Bank. The lack of a reliable supply of electricity impedes efforts to develop manufacturing industry, which Nigeria, home to Africa’s largest pool of workers and consumers, would otherwise be well placed to attract. In 2014 roughly 76 million Nigerians lived in households that were not connected to the grid, according to Copernicus, an Africa-focused geospatial data-analytics platform. Those who can afford them use diesel-powered generators — Nigeria is the world’s largest market for them, with total capacity of 5,000 MW, according to the IFC. But generators are expensive, producing power at a cost of at least 40 cents per kilowatt hour, compared with about 15 cents for grid power.
The environmental costs may be as great. In the average home energy use means cooking over an open fire. According to the U.S. Department of Energy, 80 percent of the country’s energy consumption in 2012 came from burning charcoal, wood, manure or other foraged matter. Household air pollution caused by cooking fires causes some 4.3 million premature deaths worldwide from pneumonia, strokes and heart and lung diseases, estimates the World Health Organization.
Nigerians’ daily frustration is compounded by the knowledge that their country is so rich in energy resources. It has the world’s 11th-largest oil reserves and the second-largest reserves in Africa, after Libya, according to the 2015 BP Statistical Review of World Energy. Nigeria ranks No. 9 globally in natural-gas reserves, just behind Venezuela, and first in Africa. The country also has potential to develop renewables, with several working hydroelectric plants and some solar power projects in development.
The government aims to increase generating capacity to 20,000 MW by 2020 and to 40,000 MW by 2040. That would give a massive boost to the economy and greatly improve the lives of ordinary citizens. “Reliable power makes more investment possible,” says Suresh Samuel, a structured-finance specialist at OPIC who focuses on lending for large infrastructure projects. “Power to homes allows people to have light at night and own a fridge.”
To reach those goals, Nigeria will have to overcome a legacy of neglect and missed opportunities, and enlist a full range of actors, from multilateral and national development agencies to foreign and local banks and equity investors. All these groups are involved in the Azura-Edo project, making it an important test case. Nigeria’s natural gas is a key piece of the power puzzle: Local companies are getting more involved, reviving fallow fields and investing in pipelines and gas-processing plants that provide the connective tissue that’s been lacking in the power sector. The local players include Amaya Capital — one of the firms backing Azura-Edo — and Aliko Dangote, Africa’s richest person, whose Dangote Industries has secured financing to build what will be Africa’s largest oil refinery.
Nigeria has been trying for years to attract big foreign investors to develop its power infrastructure. The efforts began under former president Olusegun Obasanjo, who served two terms, from 1999 to 2007, following the restoration of democracy after 16 years of military rule. The government signed a deal with two Chinese state-owned corporations — Sepco Electric Power Construction Corp. and China National Machinery and Equipment Import and Export Corp. — to build two 335-MW plants. The companies are operating those plants with a Nigerian partner, Pacific Energy.
The Obasanjo government also built ten plants itself, but just one of those is currently producing power; the others couldn’t obtain natural-gas supplies. In 2005 the government restructured the industry, breaking the state-owned electricity agency into individual companies, each holding a power plant or a distribution territory, in preparation for eventual privatization.
In the energy sector Obasanjo sought to boost domestic participation in the oil and gas industry by encouraging oil majors to relinquish acreage they considered too small or depleted to be commercially viable and redistributing it to local outfits. The thinking was that small start-ups with lower overheads could turn a profit from these properties. In nine cases that’s what happened. The Uquo field, for example, discovered in 1958, was in an area licensed to Royal Dutch Shell but never developed. Lagos-based Frontier Oil won the rights in a 2003 auction and brought in a partner — Seven Energy, which is controlled by Amaya Capital — to provide capital. According to a 2014 bond prospectus, the field generated $4.4 million in revenue in the first half of 2014. That would hardly qualify as a rounding error at Shell, which had revenue of $421 billion in 2014, but for Frontier and Seven it was enough to justify building a gas-processing plant and pipelines to reach customers.
“Gas is the issue that was holding up the power sector, so for smaller entrepreneurs there was a real market opportunity,” explains OPIC’s Samuel.
Obasanjo’s successor, Umaru Yar’Adua, focused his attention on the energy sector. He introduced legislation to restructure state-owned NNPC, taking away some of its operations to boost its efficiency and increasing the state’s cut of oil and gas revenue. The bill was never brought to the National Assembly, however; since 2007, various versions have been proposed that would raise the state’s share of revenue from 61 percent to as much as 73 percent. Foreign oil companies delayed new investments until they had clarity on the issue; they’re still waiting. Production, meanwhile, has languished. Oil output has fallen by a third since peaking at just over 2.5 million barrels a day in 2005, while gas production has fallen by about 10 percent from its peak in 2012. The U.S. Energy Department estimates that new fields ready to be tapped could produce an additional 875,000 barrels of oil a day, or more than 50 percent of the current total, and could boost gas output by roughly 10 percent.
When Yar’Adua died in May 2010, vice president Goodluck Jonathan took over and quickly announced that power would be his top priority, starting with the privatization process designed by Obasanjo. Amaya Capital’s Ladipo helped draft Jonathan’s plan, called the Road Map for Power Sector Reform, and devoted himself full-time to getting Azura-Edo off the ground.
In 2012 the government sold controlling stakes in four natural-gas-fired power plants, as well as distribution rights across the country, divided into 11 different districts. It also auctioned off concessions to operate three hydropower plants, with the government retaining ownership. The winning bidders were consortia dominated by local investors, including former military dictator Abdulsalami Abubakar, former United Bank for Africa CEO Tony Elumelu and Femi Otedola, the third-wealthiest Nigerian. The transactions netted $2.9 billion for the Treasury.
Privatization alone failed to provide the magic solution, though. One key problem was that the government didn’t follow through on its promise to increase tariffs to boost profit margins and encourage new investment. In fact, president Jonathan slashed tariffs by half in a bid to win reelection in the spring of 2015. The ploy failed — he was soundly defeated by Buhari — but low tariffs have left the power industry’s overall generating capacity stuck at 6,000 MW.
Under Buhari the state is now loosening control. In February 2016 the government boosted electricity tariffs to a level considered high enough to justify investment. The Senate unsuccessfully attempted to block the move. Starting with Azura-Edo, gas contracts for new plants are now negotiable.
During Jonathan’s administration local investors stepped up their acquisitions of oil and gas fields from multinationals, beginning with Seplat Development Co.’s purchase of three blocks of drilling rights from Shell in 2010. In the largest transaction ConocoPhillips Co. sold its entire portfolio of gas interests to Oando, a Lagos-based energy outfit, in June 2014 for $1.5 billion. By May 2016, Nigerian companies had acquired at least 19 properties from major foreign companies. From 2004 to 2014 the combined share of production held by marginal-field owners and independents (the category in which NNPC captures local production) more than doubled, to 9.8 percent.
Dangote Group, businessman Aliko Dangote’s holding company, took minority stakes in some of these fields. But the group is focusing its efforts on building a refinery that will be Africa’s largest, with a capacity to refine 650,000 barrels of oil a day. The complex, located in a free zone on the southeast edge of Lagos, will also produce fertilizer and petrochemicals. Dangote has been able to leverage his own net worth — which Forbes estimates at $17 billion — to raise $3.3 billion in financing. He has said proceeds from the refinery will help in his quest to buy England’s Arsenal Football Club, archrival to Roman Abramovich’s Chelsea, Mansour bin Zayed Al Nahyan’s Manchester City and the Glazer family’s Manchester United in English soccer’s Premier League.
The gas activities by Nigerian independents have spawned additional investments. Seven Energy built pipelines to supply gas from its Uquo field to two power plants and a cement factory. Seplat’s acreage provided an opening for the Azura-Edo power project, which signed a 15-year gas-supply agreement in May 2014. “The supermajors still control the vast bulk of production, but the independents are building the infrastructure,” says Amaya Capital’s Ladipo. More blocks are for sale, but at this point local buyers may be tapped out, says Dolapo Oni, a Lagos-based energy analyst for Ecobank, a regional lender based in Lomé, Togo. Most of the sales took place when crude prices stood at $100 a barrel or higher, more than double today’s level. The local companies relied heavily on local banks to finance their purchases, and they are now struggling to service those debts. Several banks already have warned the market about the outlook for earnings and defaults. “There’s capital available for specific gas projects, but right now the banks aren’t likely to lend for oil or power,” Oni says.
The final elements that got the Azura-Edo project rolling started falling into place in 2014. These included a unique form of insurance: a put-call option agreement negotiated with the Ministry of Finance. It releases Azura-Edo from its obligation to sell power to the state if Nigerian Bulk Electricity Trading, the state-owned body that buys electricity from plants, doesn’t pay for the power it takes or if there are gas supply interruptions. If one of those things happens, Azura-Edo can force the government to buy the plant from its investors through a standard arbitration process. The agreement helps set guidelines on how to value the plant in such a situation.
“Both sides would get something, and that makes it different than a government guarantee,” says Justin DeAngelis, a senior member of the power deal team at Denham Capital Management, an energy and resources private equity firm that develops African power projects through a subsidiary, Endeavor Energy. DeAngelis says the firm is evaluating multiple power projects in Nigeria. “This structure is part of what makes Azura-Edo a template, as it is already being considered elsewhere in Africa,” says Ranjani Sankaran, director of project and export finance at Standard Chartered in London. “The Ghanaian government has now decided to use the put-call option agreement as well.”
Another layer of protection negotiated in 2014 comes from a partial risk guarantee provided by the World Bank. Under this instrument, if Nigerian Bulk Electricity Trading defaults on payments to Azura-Edo, the plant’s owners can collect as much as $117 million through a letter of credit from a commercial bank. In that scenario the World Bank would then negotiate with the state to recover what is owed. The guarantee gives the Bank the authority to pause or cancel any of its other loans or projects in the country until the money is repaid — a forceful stick for ensuring payment by the Treasury. Azura-Edo’s backers obtained additional insurance from the Multilateral Investment Guarantee Agency (MIGA), a separate arm of the World Bank, that will cover as much as $420 million in losses from war, terrorism or civil disturbance; from breach of contract; or from restrictions on repatriating profits from the plant. OPIC chipped in an additional $20 million in political risk coverage.
With all of this coverage in place, a ground-breaking ceremony was held in October 2014, with president Jonathan attending. But it would take 14 more months to close the deal financially and begin construction in earnest. The problem: The partial risk guarantee required a legal opinion confirming that the state would honor its terms rather than invoking sovereign immunity. Attorney general Mohammed Adoke failed to provide the guarantee. The delay led to speculation about graft, with local media reporting that a bribe of $20 million had been requested. Adoke’s term in office ended with that of president Jonathan. Buhari learned about the problem soon after he took over and by late July had signed the necessary documentation himself.
That action was telling, says anticorruption campaigner Apampa. Buhari hasn’t announced a detailed plan to implement the campaign promises he made before the election, but the president does take action on an ad hoc basis, Apampa notes. “Anything that manages to reach his attention he will act on fast,” he says. The time it took to secure the president’s signature presented a problem for Azura-Edo, however, as some of its contracts had to be confirmed and re-signed because of the delay. With a deadline of midnight on December 31, 2015, most of the ingredients came together in the last week of the year. The final step — a payment to the contractor — was made at 9:30 p.m. on New Year’s Eve, Amaya Capital’s Ladipo recalls.
Construction is now well under way at the site, and the plant is due to begin generating power in two years’ time. The equity investors are eager for it to go live. They expect the project to produce an internal rate of return of just over 13 percent. For leveraged investors like Amaya Capital, the return is projected to be an even juicier 16.8 percent. Ladipo and his team are already considering sites for their next independent power project.
The other financial architects of the deal are on to their next project as well: The power plant that Black Rhino is in negotiations to acquire has already secured a partial risk guarantee and MIGA insurance, and some of the same development agencies are likely to lend money and risk instruments. Ladipo identifies two principal risks to leveraging the intellectual capital Azura-Edo has created: the short-term risk of continued vandalizing of the pipeline network by militants and the long-term risk presented by the transmission grid. The African Development Bank, which has a partial risk guarantee program similar to that of the World Bank, said it could consider using the structure to encourage investment in the grid, according to Alex Rugamba, the bank’s director for regional integration and trade. As of early May both the World Bank and the African Development Bank were expecting to receive from the government a list of other power projects that will be eligible for partial risk guarantees. The World Bank has thus far set aside $700 million for guarantees on Nigerian power projects, and the African Development Bank has allocated $180 million. Given a debt-to-GDP ratio of just 13 percent, Nigeria’s balance sheet has room for more sovereign guarantees, says Brett Rowley, an emerging-markets strategist for TCW Group in Los Angeles. “Investors would be more concerned if these investments ultimately did more to line someone’s pockets than provide meaningful relief to Nigeria’s power deficit,” he contends.
Other financiers are equally optimistic about the outlook for more investments in the power sector. “We believe there is financing available for power projects in Nigeria provided they are well structured,” says Standard Chartered’s Sankaran. “We’re working on the power projects coming after Azura-Edo, and we’re seeing that there is definitely interest from some of the same lenders. The support from local government is very promising.” •
