Roland Berger Strategy Consultants. content Fresh thinking for decision makers

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1 Roland Berger Strategy Consultants content Fresh thinking for decision makers Nigeria's power sector open for business A newly liberalized market welcomes new players Fundamental challenges persist and must be addressed Long-term value to be created in this private sector-led growth October 2013

2 Percentage of population WITH 74% WORLD AVERAGE Access to electricity 99% OECD AVERAGE 61% GHANA 49% CAMEROON 51% NIGERIA KENYA 16% 66% INDIA 65% INDONESIA 98% BRAZIL SUB-SAHARAN AFRICA AVERAGE 32% 75% SOUTH AFRICA

3 content NIGERIA'S POWER INTRODUCTION A History of Power in Nigeria With a population of 160 million and real GDP growth of 8.9% over the past decade, Nigeria is undeniably a major emerging economy it is also one of the world's most energy deprived nations with yearly average per capita consumption of just 129 kwh (compared to 12,670 kwh in the US). The nation relies heavily on gas as a source of power generation (ca. 70%) but despite having the world's 8th largest proven natural gas reserves, its generating capacity has yet to exceed 4,000 MW. This pales by comparison to Brazil which generates 100,000 MW for its population of 200 million. Government estimate of annual economic cost by USD bn Tariff and other subsidies 15 USD bn Incremental cost of self-generation This scenario has been decades in the making and is the product of a turbulent history. The power sector was created in 1896 when a 20 MW generator was installed by British colonialists in Ijora, Lagos state. Thirty years later, NESCO (Nigerian Electricity Supply Company), the nation's first utility company came into being, supplying electricity to the growing tin mining industry of the Jos Plateau. The Electricity Corporation of Nigeria (ECN) was established in 1951 with a view to democratize electricity supply and make it available to all citizens. Over the next decade, the sector witnessed few large-scale investments, a result of low electricity demand and a lack of energy-intensive industries. A number of small generators (approx. 3 MW) were installed in different towns across the country but a substantial rural population remained without access to power. The Niger Dam Authority (NDA) was created in 1962 to develop the country's hydropower potential and its first dam was constructed two years later with an installed capacity of 760 MW. In 1972, the ECN and NDA merged to form the Nigeria Electric Power Authority (NEPA) a vertically integrated state power utility. In its early years, NEPA commissioned a number of studies to estimate electricity demand across the nation. The result of these studies were detailed reports that accurately captured and forecasted energy demand and provided comprehensive blueprints for long-term investment in the country's power infrastructure. However, from the mid-1970s the Nigerian government began to disregard the findings of NEPA's reports and depart from its carefully-laid plans. This was a pattern repeated by sucessive governments, military and civilian alike, severely weakening the fledgling power sector. The following twenty years were characterized by the neglect of energy infrastructure and negligible investment between 1979 and 2000, only one new power facility was commissioned and brought to completion (600 MW Shiroro hydroelectric power station in 1990). This, combined with a high population growth rate, set the stage for a crisis in the energy supply landscape in 1999, average daily generation fell to a historical low of 1,750 MW. No emerging economy can make the transition from third-world to developed status without robust economic growth and access to energy. In appreciation of this reality, the Obasanjo administration ( ) embarked on an agenda to liberalize the power sector. The NEPA (Amendment) Act, was enacted to liberalize the state monopoly and Lost GDP growth due to lack of electricity supply 129 USD bn Cost of unserved energy 146 USD bn Total cost Source: Presidential Task Force on Power

4 Roland Berger Strategy Consultants Key industry players Regulation & OverSIGHT > > NERC > > BPP > > BPE/NCP > > ICRC > > NELMCO > > Ministry of Energy Gas Supply > > Various players incl. IOCs for gas production > > State-owned monopoly company for gas transmission Power Generation > > 6 successor companies > > 6 "live" on grid independent power producer (IPPs) Transmission > > State-owned transmission company of Nigeria (TCN) Distribution & RETAIL > > 11 successor companies covering each distribution zone encourage private sector participation in the industry. This privatization initiative was reinforced in 2005 with the passing into law of the Electricity Power Sector Reform Act (EPSRA). This act transferred regulatory authority from the government to NERC (Nigerian Electricity Regulatory Commission) a federal institution with independent regulatory powers, and mandated the transformation of the state monopoly NEPA into the Power Holding Company of Nigeria (PHCN). PHCN assumed the assets, rights and liabilities of NEPA and was subsequently unbundled into eighteen successor companies (eleven distribution, six generation and one transmission). The sector at a crossroads High-Stakes Privatization is widely perceived as a panacea to Nigeria's energy sector woes the costs of maintaining the status quo are unsustainably high and the government is not in a position to offer a way out. The power deficit hinders the growth of the non-oil sector and hampers job creation and poverty reduction efforts. The World Bank estimates that 90% of industries and a significant proportion of residences provide their own backup power at great personal cost and at a prohibitive cost to the economy estimated at ca. 3.7% of GDP. If the situation were to persist, the Nigerian government approximates that USD 130 bn in GDP will be lost every year. On the other hand, a successful overhaul of the sector could bring about annual, double-digit GDP growth rates. To meet its stated goal of becoming a top 20 global economy by 2020, the Nigerian government aims to increase production to 40,000 MW of on-grid electricity. To do so would necessitate annual investments of USD 10 bn through to 2020, a level of investment that the government is unable to provide. The government also acknowledges that it lacks the managerial and technical know-how to run power sector enterprises effectively. Privatization Today A pivotal milestone in the privatization process was reached on August 21, 2013 with the successful sale of almost all of PHCN's outstanding assets to private consortia. Twelve preferred bidders paid up the balance of their bid values on ten distribution companies (DisCos) and five generation companies (GenCos) and were thus qualified to take full possession of the entities. The next important round of sales is the scheduled mid-2014 sale of the 10 gas-fired power plants under development by the Niger Delta Power Holding Company Limited (NDPHC). The plants are products of the National Integrated Power Project (NIPP), launched in 2004, ostensibly to capitalize on Nigeria's abundant natural gas reserves. An 80% ownership stake in each plant will be up for sale when construction is finalized across the board. Once the plants come on-stream, they will jointly contribute in excess of 5,000 MW of generating capacity to the grid. Source: BPE, Presidential Task Force on Power

5 content NIGERIA'S POWER Can Nigeria Power On? Challenges Lack of Cost-Reflective Tariffs Electricity prices in Nigeria are significantly lower than the West African average due to a long-standing history of subsidization. Subsidies have been applied by charging tariffs that are much lower than electricity production costs and by under-charging the industry for natural gas. The combined effect of this under-pricing is a yearly subsidy of ca. USD m. Depending on a residential customers' subcategory, the price of electricity currently hovers around NGN 10/kWh with the actual cost of production placed at NGN 22-24/kWh. Nevertheless, the power industry has been moving towards a more appropriate pricing regime since 2005, with efforts bolstered by NERC's introduction of the multi-year tariff order (MYTO) in This 15-year roadmap aims to maintain low end-user prices whilst facilitating gradual price increases to a cost-reflective level. Phase 2 ( ) of the MYTO also sets out a timeline to raise the price of natural gas to USD 2/mmbtu by year-end Nigeria Gas Production 31% DOMESTIC 13% DOMESTIC Political Constraints Unfortunately, tariff hike plans are facing vocal opposition from certain groups, and this is likely to gain momentum as the general public begins to feel the pinch. Nigeria's poor currently pay an effective rate of NGN 80/kwh to burn candles and kerosene and its industries spend more than NGN 60/kwh to power back-up diesel generators. Nevertheless, the public is loathe to comply with staggered tariff hikes without tangible improvements in power supply. If the events following the government's proposed removal of the nation's petroleum subsidy in January 2012 are anything to go by, stringent implementation of the MYTO carries significant political risk. Law and Order The current price regime is unsustainable because it repels investors and acts as a disincentive for players in the value chain to optimally operate and maintain infrastructure. For DisCos for example, infrastructure rehabilitation and expansion hinges largely on the ability to recover costs and raise funds through billing. As evidenced by PHCN, the government cannot guarantee the security of their assets, the safety of their staff or the payment of bills by consumers. NEPA and more recently PHCN have historically struggled with bill collection with estimates placing the unpaid rate at 50%. Disgruntled consumers have been known to assault staff or take out their grievances by vandalizing distribution facilities. If subsidization is ultimately to be scrapped, these issues will require an urgent resolution. 69% Export LNG 87% Export LNG Gaps in Gas Provisioning Despite having one of the world's largest natural gas reserves (estimated at 160 tn cubic ft.) the Nigerian power sector is plagued by persistent gas shortages. Domestic supply obligations are in theory imposed on oil companies to ensure that certain quantities of Source: Nigeria National Petroleum Corporation

6 Roland Berger Strategy Consultants Nigeria's ranking of natural resource proven reserves, 2011 their gas production are sold domestically. However, companies are discouraged from honouring these obligations by the higher international gas prices. Additionally, there is limited infrastructure in place for gas distribution and the facilities that exist are a frequent target for sabotage. PPAs (Power Purchase Agreements) may not be financeable if GenCos are not offered adequate protection to mitigate these risks. 9. Gas 10. Oil 1. Gas 2. Coal &Oil Multiple Layers of Bureaucracy The high number of regulatory bodies in the power sector creates a difficult business environment which acts as a barrier to entry for small-scale participants. As of mid-2013, there were six separate agencies providing oversight to the privatization process and carrying out other regulatory functions. As a collective, these agencies are criticized for crafting regulations that are tailored for a more sophisticated power industry and more developed economy than currently exists. Small players that can scale up capacity quickly are thus hindered from entering the market. Opportunities Generation Transmission is a weak link in the power sector value chain but with the government retaining ownership of the Transmission Co. of Nigeria (TCN), there is no room for private sector involvement. In contrast, opportunities abound on the generation side. Nigeria currently has 34 licensed Independent Power Producers (of which only 6 are feeding power into the grid), with the newest being Afam VI, which came on-stream in Despite the feverish pace of reform, no IPPs have emerged since that year. This has been due in part to the government's failure to enforce its domestic gas utilization policies and to work out PPAs that would enable IPPs to finance equipment procurement. Evolving conditions are now making the market more appealing to IPPs new players are expected to add 1,000 MW of generation capacity to the grid over the next two years with a "snowball effect" occurring post Long-term success in the generation space is dependent on the ironing out of gas supply volatility and the attainment of costreflective tariffs, amongst other things. If resolved, well-structured IPPs, with efficient, lean operations and strong technical partnerships will be able to carve out profitable ventures in this space. This is especially true if they can capitalize on captive generation opportunities and offer their services to heavily energy-reliant corporations and industries. GLOBAL 30. Coal AFRICA Distribution There is no direct avenue for new entrants on the distribution side as the country has been divided into eleven distribution zones wherein the DisCos operate as virtual monopolies. Companies can apply for independent electricity distribution licenses but they are restricted to serving small, well-demarcated regions that are not already covered by existing networks. The real opportunities lie in the area of investment there is significant demand for capital to upgrade and extend the life of existing assets, expand distribution networks and formalize grid connections to cater to previously underserved areas this is where the astute investor can step in. Source: Roland Berger, Petroleum Insights, EIU

7 content NIGERIA'S POWER Diversification of Energy Sources Given the nation's insufficient gas supply and the inability of hydro power sources to compensate for the shortfall, it is important for energy sources to be diversified. Approximately 25% of the country's current generation capacity comes from three large hydro plants with two more plants in the pipeline the balance is comprised of gas-fired power. In comparison, coal-fired plants contribute ca. 93% of South Africa's energy needs. Nigeria has unexploited coal deposits of 640 m tons spread across thirteen states deposits that can be harnessed to provide a much-needed boost to the national grid. It also has vast renewable energy resources such as solar and biomass that remain largely untapped. Conclusion If current affairs in Nigeria's power sector are an indicator of what is to come, the nation's sporadic and insufficient power supply is far from over. The transition from vertically integrated monopoly to a mature, liberalized market with multiple players is never smooth, and this is particularly true when fundamental challenges are kept under wraps and not addressed decisively. There is a high degree of optimism surrounding the industry's prospects. The government is often hailed in the press for crafting and implementing a prudent and transparent privatization process that is moving forward with great momentum. Key parties at the helm of privatization are credited with opening up opportunities for a host of enterprises, from private investors to equipment suppliers and technical service companies. Agency spokespersons release public statements from time to time, promising drastic increases in electricity generation and supply within a relatively short timeframe. This exuberance must be tempered with the reality that key issues impacting the long-term success of privatization are yet to be resolved. As demand continues on its upward trajectory, stiff bureaucracy, conflicting policies, infrastructure inadequacy and law and order problems remain the status quo. Without sweeping and effective changes in government policy and the creation of a business climate that attracts significant private sector investment the sector will not deliver the power required to secure the nation's future. IF YOU HAVE ANY QUESTIONS, PLEASE FEEL FREE TO CONTACT US: Jaap.Kalkman@rolandberger.com Senior Partner Sergio.Pereira@rolandberger.com Project Manager Zara.Ugbabe@rolandberger.com Consultant think:act CONTENT Editors: Jaap Kalkman, Sergio Pereira, Zara Ugbabe Project management: Katherine Noelling, Mia Mutic Design: Roland Berger Middle East Media Design Roland Berger Strategy Consultants Al Thuraya Tower No. 1, 12 th floor P.0. Box Dubai, UAE Mulliner Towers, Office 330, 3rd floor 39 Alfred Rewane Road Ikoyi, Lagos, Nigeria

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