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THE JOURNAL OF ENERGY

AND DEVELOPMENT

W. A. Isola,

“Market Structure in the Restructuring of the


Nigerian Electricity Industry,”

Volume 34, Number 2

Copyright 2011
MARKET STRUCTURE IN THE RESTRUCTURING OF
THE NIGERIAN ELECTRICITY INDUSTRY

W. A. Isola*

Introduction

T he market for electricity throughout much of the world used to be a monolithic


structure until the end of the 1980s. The Electricity Pool of England and
Wales, together with the North Pool of the Scandinavian countries, were the first
attempts to organize a market for electricity and to introduce competition into the
electricity industry. These attempts succeeded largely because of the advancement
in technology and changes in economic perceptions. Other nations, including
developing countries such as Chile, Argentina, and Peru, followed the England
and Wales examples; recently, Nigeria also joined the trend, having deregulated its
electricity industry through the enactment of the Electric Power Reform Act of
2005. Consequently, Nigeria’s defunct National Electric Power Authority (NEPA)
is now known as the Power Holding Company of Nigeria (PHCN). The law paved
the way for the unbundling of NEPA into 18 companies: six generating compa-
nies, one transmission company, and 11 distribution companies. The incorporation
of these enterprises has been concluded. The National Electricity Regulatory

*W. A. Isola, Senior Lecturer at the Department of Economics, University of Lagos, Akoka
Yaba, Nigeria, holds a Ph.D. degree in economics from the University of Lagos. His areas of
specialization are energy and industrial economics. The author has participated in and contributed
to a number of international training and workshops such as the Practical General Equilibrium
Modeling under the auspices of the Global Economic Modeling Network School—Europe
(Brussels, Belgium) and the African Economic Research Consortium (AERC) Technical
Workshop on Game Theory. Aside from contributions to edited volumes, his publications have
appeared in ICFAI Journal of Industrial Economics and The Journal of Economics and Business,
as a sampling. The author wishes to acknowledge the support of the University of Lagos and
AERC.

The Journal of Energy and Development, Vol. 34, Nos. 1 and 2


Copyright Ó 2011 by the International Research Center for Energy and Economic Development
(ICEED). All rights reserved.
209
210 THE JOURNAL OF ENERGY AND DEVELOPMENT

Commissions, which is the top regulatory body in the country, has been formally
constituted.
In view of this deregulation and unbundling, certain relevant questions relating
to the relationship among electricity generation, efficient supply, and quantities of
output cannot be ignored. In other words, what is the appropriate number of firms
that need to generate the required supply of electricity and what should be their
output capacities? These questions derive from the fact that too many firms could
lead to the creation of excess capacity and, if too few, there is a risk of abuse of
market power that can develop under such scenarios. However, it has been found
that duopoly is prone to the development of a high-degree of market power
concentration. Recent empirical studies also have provided some evidence that
electricity suppliers have exercised considerable market power concentration in
both California in the United States and the United Kingdom.1 This has been
attributed partly to poor market structure design. This study is germane because of
the need to ensure production efficiency and allocation efficiency in the genera-
tion segment of the Nigerian electricity industry. Indeed, many other countries are
undergoing similar economic and public-policy decision making as that of
Nigeria. Furthermore, this paper derives from the experiences of energy crises in
leading reforming countries such as Italy in 2003, California in 2001, New Zea-
land (Auckland) in 1998, and Chile from 1998 to 1999.2 As P. C. Watts noted in
his conclusions:

Deregulation is a high risk choice. Those jurisdictions that have not yet deregulated electricity
generation need to think long and hard before they go ahead. Those that have done so need to
figure out how to minimize the downside potential of the journey on which they have
3
embarked.

Again, it must be noted that the U.K. experience with restructuring of elec-
tricity generation and mitigating possible market power dominance has demon-
strated the complexity and challenges involved in introducing competition into the
sector. J. R. Green and M. D. Newbery have demonstrated, for instance, that the
initial structure based on only two unequal competing electricity generators was
inefficient as both firms abused their market power; two equal competing firms
could have been more effective.4 It is against such a backdrop that this paper seeks
to examine the market structure in the restructuring of the Nigerian electricity
industry using partial equilibrium analysis.
In the next section of this paper, we shall discuss some theoretical and em-
pirical considerations. Thereafter, a review of extant literature is presented from
which Nigeria can learn best practices. Following the literature review section is
the methodology, while the result of the model and the broader implications of the
study are presented next. The final section, which is the conclusion, is a pre-
sentation of the way forward.
RESTRUCTURING NIGERIA’S ELECTRICITY INDUSTRY 211

Some Theoretical and Empirical Considerations

A market in the economist’s technical usage is concerned with the inter-


relationship—something of a web—between the buyers and the sellers of a par-
ticular product that are involved in the exchange and distribution of wealth and
income. It has been argued in this context that the appropriate definition of
a market depends upon which aspects of this web are of interest to buyers and
sellers at a point in time; for different problems, there are different appropriate
definitions.5 The focus in this paper is on the different market structure paradigms
under which buyers and sellers of electricity interact. The term ‘‘market struc-
ture,’’ therefore, refers to a selected number of organizational characteristics of
interrelationships between the buyers and sellers of a particular product, including
perfect competition markets, monopoly, monopolistic competition, and oligopoly.
Thus, market structure analysis is a study of the organizational features of a market
that are believed to have significance for the conduct and performance of firms
constituting the market. P. R. Ferguson and G. J. Ferguson have suggested that
market structure is important because the structure determines the behavior of
firms and that behavior, in turn, influences the quality of the industry perfor-
mance.6 Based on this argument, if it is possible to demonstrate that particular
types of market structure consistently are associated with particular types of
performance; public policies may be framed to achieve predetermined per-
formance targets through the manipulation of market structures. The plausibility
of this argument lies in knowing that the move toward competition world-wide in
the public utility sector reflects developments in the literature on industrial
organization.
In the context of this paper, market structure refers to the wider framework
within which the interaction of supply of and demand for electricity takes place.
The motivation for the study of market structure largely derives from the need to
avoid the exercise of excessive market power and concentration, that is, the ability
of a firm to affect market price in excess of a competitive outcome of its product. It
has been observed that the presence of market power in a certain market relies on
the market structure. Market structure study is equally relevant to determine the
optimum number of firms and quantities of output in the electricity industry in
order to strike a balance between having too few firms (with the attendant problem
of collusion) and too many (that can lead to excess capacity). Consequently, the
need to ensure allocative, productive, and dynamic efficiency accounts for the
uniqueness of market analysis.
The central thesis of industrial organization is that the structure of the
organization determines the performance, which is normally measured in terms of
operational efficiency. However, one possible point in explaining the structure-
conduct-performance of an enterprise is the theories of perfect competition and
monopoly. The structural features of both markets have been discussed elsewhere;
212 THE JOURNAL OF ENERGY AND DEVELOPMENT

however, they provide a description of the extremes (an infinite number of firms
versus one firm and free entry versus blocked entry) and all industries in practice can
be seen as falling somewhere between them.7 The position of any particular industry
can be located along this continuum by looking at the structure of that industry in
terms of the number of firms, ease of entry, etc., and from that position predict the
performance of the industry, particularly in respect to profitability. Thus, as we
move through the continuum from industries with a large number of firms to in-
dustries with only few enterprises, it is postulated that profitability will rise from
a normal level towards the super-normal level of a monopoly. However, the long-
run economic implications of both competition and monopoly are well documented
in the literature.8 The rest of this section, therefore, presents the partial equilibrium
models for generating electricity under various market structures.
Basically, electricity demand q is a function of price, p
q = q( p): ð1Þ

The total amount of individual demand is the market demand Q, while the
market price is given as P. For convenience sake, let the inverse demand be linear,
that is, price is a function of quantity as
p = p(q): ð2Þ

This inverse demand function is downward sloping and concave.


Generation capacity in megawatts is labeled Q. In each period, aggregate
output cannot exceed available generation capacity denoted by hQ with h the
length of period time in hours. Therefore, t which stands for time, should be
written in full
Q = Sq £ hQ: ð3Þ

Alternatively, aggregate output is limited by national demand. Firm i has a cost


function given as
C(qi ) = ci qi ð4Þ
where qi is the output of the ith firm.
The following paragraphs describe the basic structure of the model. It is as-
sumed that all market players act in their own interest, that is, all firms maximize
profits while consumers maximize utility.

Monopoly: An attempt to mimic the current position in the generating segment


of the Nigerian electricity industry makes the modeling of a monopoly model
relevant at this point. In this case, the Power Holding Company of Nigeria is the
major firm generating electricity in the country. Production in the various plants is
equal to the production of the firm, Q = q. Since the market demand schedule is
RESTRUCTURING NIGERIA’S ELECTRICITY INDUSTRY 213

downward sloping, the firm must make a trade-off between price and quantity. In
other words, the firm’s marginal revenue is below the market price; if one more
unit is sold, the price of all the other units it sells must fall. Marginal revenue is
thus the price of an extra unit minus the revenue lost due to a decrease in the price
of all other units.
Profit maximization of the monopolist is given as
Y
Max ðqÞ = pq  Cq
subject to

Q £ hQ
The first-order conditions for firm i, the sole generator, is
@L @p @c dL
=p+q  £0 q =0 ð5Þ
@q @q @q dq
@L dL
= hQ  Q ³ 0 l = 0: ð6Þ
@l dl
Equation (5) shows that marginal revenue is equal to marginal cost, whereas
equation (6) indicates the marginal analysis of the constraints. Equation (5) can be
rewritten to render explicit the gap between price and marginal cost as

pðqÞ  MC 1
= ð7Þ
pðqÞ j
where h i
@x p
j is the price elasticity of demand, j = @p x

Equation (7), is often called the Lerner equation, it results directly from profit
optimization by the firm. This is the starting point of the simulation carried out
under the methodology of the study. To model the behavior of the agents under the
restructuring scenario, it is necessary to consider the Cournot game.
The Cournot Game: The problem facing the firm under Cournot oligopoly can
be laid out as follows. The pay-off function is given as the profit function, P, stated
as
Yi   X hX  i X
qi = pqi  C i Qi with Q j = qi ð8Þ

In equation (8), the first two terms in the square brackets are revenues from
electricity sales to the unregulated market segments. By assumption, production
costs are convex.
214 THE JOURNAL OF ENERGY AND DEVELOPMENT

Each firm has to predict the behavior of other firms in making its output de-
cision, if all coincide simultaneously with what the rivals will do, the supply by
each firm to maximize profit P can be set up as a nonlinear programming as
Y   X hX  i
j
Max qj = pq j  c j Q j ð9Þ

Subject to:

Qij £ hi Q j
X
Qj = qj

This results in the following first-order conditions for firm q j:

@Lj X @p @C j @Lj
= p + qj j   lj £ 0 qj =0 ð10Þ
@q j @q @q j @q j
@Lj @Lj
= hQ j  Q j ³ 0 lj =0 ð11Þ
@lj @lj

These are the traditional first-order conditions for profit maximization, i.e.,
marginal revenue equals marginal cost. Equation (10) is the reaction function of
the firm j. Equation (10) can be rewritten as

pðqÞ  MC 1
= ð12Þ
pðqÞ nj

where the price elasticity faced by the firm (ni) is equal to n j. As a benchmark to
compare the outcome of the Cournot and monopoly models, a presentation of
a perfect market model becomes relevant.
Perfect Competition Benchmark: The purpose of this model is to determine the
resulting price for energy and output for a perfectly competitive market. For the
competitive solution, P will equal MC; in addition, price P will be uniform
throughout the system. This derives from the fact that a competitive firm takes the
market price of output as being given and outside of its control. In a competitive
market for electricity, it is assumed that each firm takes the price as being in-
dependent of its own actions, although it is the actions of all firms taken together
that determine the market price. If a competitive firm wants to sell any output at
all, it must sell it at the market price. Since the competitive firm must take the
market price as given, its profit maximization problem boils down to choosing
output q to solve.
RESTRUCTURING NIGERIA’S ELECTRICITY INDUSTRY 215

Y   X hX  j i
j j j j
Max q = pq  C Q ð13Þ

subject to

Qij £ hi Q j
X
Qi = q j:
This results in the following first-order conditions for firm qj:
@Lj @c j dLj
= p  £0 qj =0 ð14Þ
@qj @q j dqj
@Lj j j @Lj
j = hQ  Q ³ 0 lj =0 ð15Þ
@l @lj
This implies that the selling price of energy must be equal to the marginal cost. As
shown in equation (14), in the long run it is presumed that all firms earn normal
profit. Therefore, the achievement of this long-run perfectly competitive solution
is the essence of electricity reform. Essentially, a restructured electricity market is
usually an oligopolistic one, and the modern theory of oligopoly is grounded al-
most entirely in game theory.9 This underscores the relevance of the Cournot game
methodology that is employed in this paper.

Literature Review

Game theory models of oligopoly, including Cournot, Bertrand, and Supply


Function Equilibria among others, have been employed variously in literature for
analyzing the deregulation process in electricity markets. This study assumes the
Cournot paradigm for a number of reasons. Computational convenience is cer-
tainly a first concern; specifically, Cournot equilibria are simpler to compute than
Bertrand or Supply Function Equilibria. Second, the computation of Cournot
equilibria also can be seen as a first step toward the treatment of other types of
Nash equilibria. S. Borenstein et al. also have argued that, at the initial stage of
restructuring, the Cournot model provides the appropriate model to gain an insight
into the behavior of players in the industry.10 Many of the new electricity models,
according to B. F. Hobbs, are developed as spatial models.11
In a related study, S. Borenstein and J. Bushnell examined the potential for
market power concentration occurring in California after deregulation of the
electricity industry.12 The authors employed a Cournot model to simulate the
potential for congestion of the transmission lines linking northern and southern
California. Peak demand in the south was more than double peak demand in the
216 THE JOURNAL OF ENERGY AND DEVELOPMENT

north. The impact of increased transmission capacity on the market was simulated.
It was revealed that the ratio of additional output to additional line capacity for this
marginal change was more than double. In addition, market-clearing prices
dropped considerably in both markets. The implication of this for Nigeria is that,
in order to ensure the adequate supply of electricity at the minimum tariff under
the deregulation regime, it is necessary to pay attention to the development of
transmission capacity.
Like S. Borenstein and J. Bushnell, W. Yuan and Y. Smeers carried out a study
of an oligopoly with spatially dispersed generators and consumers.13 The pro-
ducers were assumed to behave in a Cournot manner with regulated transmission
prices. A variational inequality approach was used for computing the equilibria of
the model, where the equations representing the electricity generators were treated
as a nonlinear programming model, while the transmission equation was assumed
as a linear programming problem. Using this approach, two variants of the model,
respectively based on average-cost and marginal-cost pricing for transmission
services also were formulated. The model was applied to simulate a long-run
electricity market where transmission prices were regulated.
In a related development, L. B. Cunningham et al. equally analyzed a simula-
tion study in a transmission-constrained network using the Cournot model.14 The
study investigated whether or not a pure strategy equilibrium existed in a simple
transmission-constrained Cournot model without explicitly indicating the meth-
odology of research. Two models were presented: Perfect Competition, which
served as the benchmark, and the Cournot solution. In addition, three hypothetical
utilities were used that were interconnected with three transmission lines. Finally,
it was assumed the utilities competed in a power pool type of arrangement that
required each utility to bid into a central operator that determined the market-
dealing price for energy. The behavior of the participants was analyzed under the
transmission-constrained scenario and the transmission-unconstrained scenario in
both models. Under the transmission-unconstrained competitive solution, a uni-
form price across the region was obtained. This was a reflection of the fact that
the players bid their true marginal cost to the central pool. In the transmission-
constrained competitive outcome, there was a location price differential across the
regions. A relative reduction in prices and profits was noticeable compared to the
transmission-unconstrained scenario. In our own case, the equilibrium conditions
under different production technologies will be analyzed without factoring in
transmission constraints.
Building on an earlier work by C. Kemfert and R. Tol15, C. Kemfert and V.
Kalashnikav examined the economic effects of the liberalization of the German
electricity market using game theoretical modeling based on the Cournot style.16
The paper investigated strategic behavior of electricity agents. The authors
developed a computational analysis (LEMI or liberalized energy markets in-
vestigation), which included strategic behavior of firms. Two cases were
RESTRUCTURING NIGERIA’S ELECTRICITY INDUSTRY 217

considered: (a) Perfect Competition, where firm profits were calculated upon
marginal production costs and price dependent demand, and (b) a Cournot model,
where firms maximize their profits given the strategic behavior of the other agents.
Under this case, profits were computed on the bases of variable production costs,
maximum net power, net access costs, and transmission costs. In terms of meth-
odology, the authors transformed the optimization problem into a mixed com-
plementarity problem, which they solved by the general algebraic modeling
system (GAMS). The results showed that the Perfect Competition scenario led to
implausibly high market shares, whereas in the Cournot model, mutual profit
maximization and strategic behavior led to reasonable market shares. Following
Kemfert and Kalashnikav (noted earlier), this study will rely on the Cournot
model, but the problem will be solved as a nonlinear programming model.
J. Yan et al. presented a comparative study of market behaviors in a future
South African Electricity Market in order to evaluate different market structures
and competition models.17 The results showed that the market structure affects the
market outcome, such as market-clearing price and power production. The more
concentrated the market, the higher the price increase and the lower the power
production. In contrast to the study by Kemfert and Kalashnikav, however, the
authors employed two market simulators to simulate the gaming behavior of
supply-side players in the Eskom Power Pool (South Africa). For instance, the
comparison of Perfect Competition and Nash-Cournot (quantity game) was con-
ducted using Plexos (a commercially available power market simulator) while
SiMEC (a game theory market simulator developed by the research and de-
velopment team of the Power Systems Unit at Instituto Superior de Engenharia de
Lisbon) was used to compare different market models, such as Perfect Competi-
tion and Monopoly.
In conclusion, research into modeling electricity markets is continuing and is
the subject of many debates. It is well recognized that models cannot address all
questions of interest. However, they appear to be a powerful tool for understanding
whether electricity markets are delivering the expected benefits of liberalization or
not. From the literature review, a number of lessons emerged for Nigeria in its
restructuring endeavors. First, there is the need to design optimum market
structure from the onset, taking into consideration the various production tech-
nologies. Second, there is the need to pay attention to the strategic interactions
among the electricity generators to avoid the abuse of market power by the
dominant players.

Methodology

The restructuring of a network utility, such as an electricity industry, requires


a fundamental rethinking on the way in which the sector is operated and regulated.
218 THE JOURNAL OF ENERGY AND DEVELOPMENT

The basic idea is to introduce competition in those market segments where it is


viable, that is, generation, and to introduce (better) regulation in the branches,
especially the transmission and distribution segments, where competition is not
viable. Accordingly, our model in this section recognizes the competitive/
deregulated market. In the deregulated market, a partial equilibrium model is
employed in the style of a Cournot game to explain the strategic behavior among
the generators.
Basically, the partial equilibrium model is a simulation model. The first step in
a simulation analysis is to replicate the initial base solution, i.e., this is called the
benchmark equilibrium. It assumes implicitly that the sector is at equilibrium in the
base year. The second step involves a change in a policy variable of interest. The
vector of equilibrium values for the endogenous variable resulting from a change in
the value of an exogenous variable or parameters is then compared with their
corresponding benchmark levels. The percentage deviations from the benchmark
equilibrium represent the sector’s reactions to the policy change. This is the basis
of the so-called counter factual policy analysis enumerated by Ali Bayar.18
The numerical solution of this model requires a nonlinear equation solution
algorithm. The study makes use of the solution algorithm GAMS, which is capable
of solving both linear and nonlinear programming optimization problems.

Model Specification: The following partial equilibrium model is specified to


describe the existing production and consumption activities in the electricity in-
dustry in Nigeria. The main functions/equations that constitute the model relate to
price, average cost (which incorporates increasing returns to scale), constant
elasticity of substitution production function, total cost function, demand function,
and factor demand/supply.

Price Function/Equation: The price specified here is derived from the Lerner
equation. It symbolizes the relation between the price of a commodity, its marginal
cost, and price elasticity of demand. The equation is specified below.

MCi
PQi =   ð1Þ
1  1j

where
i = technology (hydro /thermal);
PQi = electricity price;
MC = marginal cost;
x = price elasticity of demand.
The price elasticity of demand is calibrated within the model based on the data
on marginal cost and average cost while assuming that average cost is equal to
RESTRUCTURING NIGERIA’S ELECTRICITY INDUSTRY 219

price. In the model simulation, price (PQ) is an endogenous variable while price
elasticity of demand is a parameter.
Average Cost Function: Average cost of electricity production using either
hydro or thermal technology is specified such that it incorporates elements of
increasing returns to scale. It can be seen in the expression below; that as output
increases, the average cost of electricity falls given the assumption with respect to
marginal cost.

FC
AC = MC + ð2Þ
Q
where
i = technology (hydro or thermal);
AC = average cost of producing electricity using technology i;
MC = marginal cost of producing electricity using technology i;
FC = fixed cost of producing electricity using technology i; and
Q = output (electricity) of technology i.
The bar on FC implies that it is fixed. The value of the fixed cost is first
calibrated from the available information on production data (marginal cost,
output, and average cost) before it is introduced in the average cost equation.
Production Function: The underlying production function under each technol-
ogy is constant elasticity of substitution (CES). This is more appropriate than the
Cobb-Douglas production function with its restrictive elasticity of substitution.
The CES production function is specified below.
1
e e
Qi = Ai ðaLe
i + ð1  aÞKi Þ ð3Þ
where
Qi = output in megawatt of electricity produced using technology i;
Ai = shift parameter in technology i;
Li = labor input in technology i;
Ki = capital input in technology i;
a = CES share parameter in technology i; and
e = CES exponent or elasticity of substitution parameter in technology i.

Factor Demand Function: It is assumed that only labor and capital are the main
inputs needed in the production of electricity whether under hydro or thermal
technology. Capital input is composed of those inputs besides labor. The factor
demand problem facing the firm can be stated as
1
Max Q = AðaLe + ð1  aÞK e Þe
220 THE JOURNAL OF ENERGY AND DEVELOPMENT

subject to

PL L + PK K = TC: ð4Þ

We set up a Lagragian function for the problem as


1
‘ = AðaLe + ð1  aÞK e Þe lðPL L + PK K  TCÞ:

Taking the first partial derivative and equating to zero, we have

@‘
= Q1 aLð1 + eÞ  lPL = 0 ð5Þ
@L
@‘
= Q1 ð1  aÞK ðe + 1Þ  lPK = lPK = 0: ð6Þ
@K

Dividing equation (6) by equation (5), leads to

ð1  aÞK ðe + 1Þ PK
= : ð7Þ
aLðe + 1Þ PL

By rewriting the expression in equation (7), we have


  ðe + 1Þ
ð1  aÞ L PK
= : ð8Þ
a K PL:

Eliminating the share parameters from the left-hand side, we have


 ðe + 1Þ
L PK a
= : ð9Þ
K PL ð1  aÞ

Eliminating the power in the left-hand side, leads to


 1 +1 e 
L PK a 1 +1 e
= ð10Þ
K PL 1a
or
 ð1 1+ eÞ
L PK a
= : : ð11Þ
K PL 1  a
RESTRUCTURING NIGERIA’S ELECTRICITY INDUSTRY 221

Equation (10) or (11) implies that factor demand, say, for labor or capital, under
each technology will depend on the relative price of factors. In addition, it will
depend on elasticity of substitution and the relative shares of the factors in the
production of electricity.
Total Cost Function: This function is expressed as the product of average cost
and the quantity (megawatts) of electricity produced.
TC = AC * Q ð12Þ
where
TC = total cost of production under hydro, thermal, or a combination of both
technologies.
Household/Industrial Demand Function: It is assumed that whatever is produced
is sold to both household and industrial users of electricity. The equation describing
this relationship between production and consumption of electricity is presented
below. The demand function closes the model.
  ðjÞ
1 PF
Q= ð13Þ
D PQ

where
Q = electricity produced either by hydro or thermal or a combination of both;
D = reference demand for electricity, which is obtained through calibration
based on the data of Q, PQ, PF, and x;
PF = reference price for electricity, which in this study is assumed to be gov-
ernment mandated price per kilowatt of electricity; and
PQ = price that clears the electricity market.

Factor Requirements in the Electricity Sector and the Aggregate Supply of Fac-
tors: It is assumed that as output increases in the electricity sector, the factor
requirements/demand will still be lower than the national supply of the factors.
Since the prices of labor and capital are given, the following equations describe the
closure of the model with respect to the factor market.
X
n
Ki  KS ð14Þ
i=1

X
n
Li  LS ð15Þ
i=1

where
222 THE JOURNAL OF ENERGY AND DEVELOPMENT

i = technology of producing electricity, which, in this study, ranges from 1 to 2


(hydro and thermal);
KS = national supply of capital inputs; and
LS = national supply of labor inputs.

Data Sources: This study makes use of secondary data as well as official data.
The year 2002 is used as the benchmark year. The choice of the base year is
informed by the relative availability of data and the most reliable period for
generating some data before the 2005 Power Sector Act. That year in particular
was the last time there was a major upward review of tariffs in Nigeria. The
situation remained until the adoption of the Multi Year Tariff Order (MYTO) in
2008. However, MYTO made provision for subsidy in the first three years ending
in 2010. The sources of data are the Corporate Annual Report and Accounts of the
National Electric Power Authority (2002), the National Electric Power Authority’s
Generation Report (2002), publications of the Nigerian Ministry of Power and
Steel, the Annual Reports and Accounts of the Central Bank of Nigeria (CBN)
from1970 to 2002, the Statistical Bulletin of the Federal Office of Statistics (FOS)
from 1970 to 2002, and Annual Abstract of Statistics of the FOS from 1970 to
2002. However, data gaps are filled with other sources such as the World Bank’s
World Development Indicators (2005) and discussion papers. 19

Result of the Model

We considered a single technology reflecting the present disposition of the


Electric Power Sector Reform Act 2005. Under this case, there are six generating
companies using either hydro or gas. The base year solution and the various
scenarios were obtained using GAMS. The model was initially run as a one-person
game. The GAMS solution replicated the base-line data for the year 2002, thus
confirming the validity of our model for simulation. The result showed that, as
a monopoly, the price that cleared the market was Nigerian naira (N)11.60 per
kilowatt hour (kWh) compared to N7 per kWh, which was the ceiling price set by
the government. This is an obvious signal of inappropriate pricing.
It was equally found that, as the number of players increased, the market-
clearing price declined continuously up to the seventh firm. For instance, as a two-
person game, the price that cleared the market for a firm using hydro was N3.69
per kWh, while for a firm employing thermal (gas-based) it was N6.22 per kWh.
By the time the number of firms increased to seven, the prices fell to N2.66 per
kWH and N4.45 per kWH, respectively, for hydro and thermal (gas-based) firms.
This picture is vividly captured in Table 1.
Beyond seven firms, the model becomes infeasible as the difference between
marginal cost and price becomes too small to permit entry of an additional firm.
Table 1
PARTIAL GENERAL EQUILIBRIUM ANALYSIS OF ELECTRIC GENERATION IN NIGERIA

Number of Firms 1 2 3 4 5 6 7

Price of hydro in Nigerian nairi per kilowatt hour (NkWh) 11.60 3.692 3.130 2.909 2.791 2.717 2.667
Price of gas NkWh 11.60 6.222 5.250 4.870 4.667 4.541 4.455
Percent change in price of hydro 0.152 0.07 0.040 0.026 0.018
Percent change in price of gas 0.155 0.07 0.041 0.025 0.018
Composite output in total megawatts (MW) 2,500 11,083 19,666 28,250 36,833 45,416 54,000
Percent change in output 343.32 0.774 0.436 0.309 0.233 0.189
MW output of hydro 1,000 4,333 7,666 11,000 14,333 17,666 21,000
MW output of gas 1,500 6,750 12,000 17,250 22,500 27,750 33,000

Source: Computations from model simulations.


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224 THE JOURNAL OF ENERGY AND DEVELOPMENT

By the same token, as the number of operators increased, the composite output
correspondingly increased. From the production output of 2,500 megawatts (MW)
as a monopoly, the composite output steadily increased to 54,000 MW following
the entry of the seventh firm, using either hydro or gas. In other words, this study
has shown that 14 firms (seven hydro-based and seven gas-based) are feasible with
an output of 54,000 MW.
The relevance of this result can be evaluated against the backdrop of the
expected level of electricity generation within the sub-Saharan Africa group.
According to the World Bank’s World Development Indicators, given its pop-
ulation Nigeria needs about 60,000 MW of electricity generation to meet the
expected standard for the sub-Saharan Africa group. Although the government
tentatively has assumed six companies in the generation sector of the Nigerian
electricity industry (Egbin, Afam, Delta, and Sapele, which are thermal-based
stations, and Kainji/Jebba and Shirroro, which are hydro-based stations), this study
has shown that to operate optimally by using single technology there should be at
least 14 firms of equal size, seven operating on gas and another seven employing
hydro. It is even more worrisome to observe that almost all the generation ex-
pansion program of Nigeria’s federal government is thermal-gas based, with the
exception of the Mambilla hydro station. According to W. A. Isola and F.
Kupolokun, the federal government has promised to complete 22 gas-fired plants
by 2010 to improve the nation’s electricity generating capacity.20

Conclusion

The central focus of this paper is on the determination of an appropriate market


arrangement for the supply of electricity in Nigeria following the enactment of the
Electric Power Sector Reform Act of 2005. A partial equilibrium model in the style
of Cournot game is employed to explain the strategic behavior among the genera-
tors. Although the Electric Power Sector Reform Act of 2005 has proposed six
generating companies together with an unspecified number of independent power
producers, this study has shown that 14 firms of equal size, seven hydro-based and
seven gas-based are feasible. This study also has shown that a considerable market
potential exists in the generation segment of the electricity industry in Nigeria,
which foreign and local entrepreneurs can fill. Presently, the country generates
below 3,000 MW, whereas this study points to the country’s potential to generate up
to 54,000 MW. The results demonstrate that as a monopoly, the price that cleared
the market was N11.60 per kWh versus the N7 per kWh ceiling price set by the
government. It was equally found that as the number of players increased, the
market-clearing price declined continuously up to the seventh firm. For instance, as
a two-person game, the price that cleared the market for a firm using hydro was
N3.69 per kWh, while for a firm employing thermal (gas-based) it was N6.22 per
RESTRUCTURING NIGERIA’S ELECTRICITY INDUSTRY 225

kWh. By the time the number of firms increased to seven, the prices fell to N2.66
per kWh and N4.45 per kWh, respectively, for hydro and thermal (gas-based) firms.
As a way forward, there is the need for a massive expansion of the electricity
generation capacity in Nigeria. The expansion should not be overwhelmingly gas-
based, as is currently the case, but other means of generating electricity such as
hydro, solar, wind, and biomass should be utilized. In order to encourage genuine
foreign investors to participate in the power sector, there is a need for an in-
vestment environment free of policy reversal.

NOTES
1
C. Wolfram, ‘‘Measuring Duopoly Power in the British Electricity Sport Market,’’ The
American Economic Review, September 2000, pp. 805-26.
2
T. Jamash et al., ‘‘Electricity Sector Reform In Developing Countries: A Survey of Empirical
Evidence on Determinants and Performance,’’ Policy and Research Working Papers no. 3549, The
World Bank, Washington, D.C., 2005.
3
P. C. Watts, ‘‘Heresy: The Case against Regulation of Electricity Generation,’’ The Electricity
Journal, May 2001, pp. 19-24.
4
J. R. Green and M. D. Newbery, ‘‘Competition in the British Spot Market,’’ The Journal of
Political Economy, October 1992, pp. 929-53.
5
P. L. Sill, ‘‘Market and Industry,’’ International Encyclopedia of the Social Sciences, vol. 9
(New York: Free Press, 1972), pp. 575–80.
6
P. R. Ferguson and G. J. Ferguson, Industrial Economics Issues and Perspectives (New York:
New York Press, 1994), p. 14.
7
See G. F. Jehle and P. J. Reny, Advanced Microeconomic Theory (New York: Addison Wesley,
2000), pp. 153-80.
8
See E. Penrose, Theory of the Growth of The Firm (Oxford: Basil Blackwell, 1963), p. 229.
9
A. Schotter and G. Schwodlauer, ‘‘Economics and the Theory of Games: A Survey,’’ Journal of
Economic Literature, June 1980, pp. 470-527.
10
S. Borenstein et al., ‘‘The Competitive Effects of Transmission Capacity in a Deregulated
Electricity Industry,’’ Rand Journal of Economics, summer 2000, pp. 294–325.
11
B. F. Hobbs, ‘‘Network Models of Spatial Oligopoly with an Application to Deregulation of
Electricity Generation,’’ Operations Research, May-June, 1986, pp. 395–409.
12
S. Bornstein and J. Bushnell, ‘‘An Empirical Analysis of the Potential for Market Power in
Californian Electricity Industry,’’ Journal of Industrial Economics, September 1999, pp. 285-323.
13
W. Yuan and Y. Smeers, ‘‘Spatial Oligopolistic Electricity Models with Cournot Generators
and Regulated Transmission Prices,’’ Operations Research, January-February 1999, pp. 102-12.
226 THE JOURNAL OF ENERGY AND DEVELOPMENT
14
L. B. Cunningham et al., ‘‘An Empirical Study of Applied Game Theory: Transmission Constrained
Cournot Behavior,’’ The IEEE Transactions on Power Systems, vol. 17, no. 1 (2002), pp. 166-72.
15
C. Kemfert and R. Tol, ‘‘Economic Effects of the Liberalisation of the German Electricity
Market—Simulation Results by a Game Theoretic Modeling Tool,’’ Working paper no. 89, Carl
von Ossietzky University of Oldenburg, Oldenburg, Germany, 2000.
16
C. Kemfert and V. Kalashnikov, ‘‘Simulation of Electricity System by Oligopolistic Models,’’
Proceedings of the International Applied Business and Research Conference (ABERC 2002),
Mexico, March 2002, pp 14-19.
17
J. Yan et al., ‘‘A Comparative Study of Market Behaviours in a Future South African Elec-
tricity Market,’’ Power Tech, 2007 IEEE Lausanne Conference Proceeding, Lausanne, South
Africa, July 1-5, 2007, pp. 977-81.
18
See the Opening Remarks of Professor Ali Bayar of the Department of Applied Economic,
Free University of Brussels, at the training workshop on ‘‘Practical General Equilibrium Modeling
with GAMS,’’ Brussels, Belgium, July 10–15, 2006.
19
All data relating to the National Electric Power Authority (NEPA), which is now the Power
Holding Company of Nigeria (PHCN); Corporate Annual Report and Accounts of the National Electric
Power Authority, 2002 and National Electric Power Authority Generation Report, 2002; Power
Holding Company of Nigeria (PHCN), Corporate Annual Report and Accounts, various issues; the
Central Bank of Nigeria (CBN), Statistical Bulletin, various issues; the Nigerian Federal Office of
Statistics (FOS), Statistical Bulletin, various issues 1970-2002 and Annual Abstract of Statistics, var-
ious issues 1970-2002. Secondary sources include The World Bank, ‘‘Structure and Performance of
Manufacturing Enterprises in Nigeria,’’ Discussion paper no. 118, The World Bank, Washington, D.C.,
2002, and ‘‘World Development Indicators,’’ CD-ROM, The World Bank, Washington, D.C., 2005.
20
W. A. Isola, ‘‘Market Structure Paradigms and Institutional Setting in the Nigerian Electricity
Industry,’’ (Ph.D. dissertation, University of Lagos, Nigeria, 2007), and F. Kupolokun, ‘‘FG to
Complete 22 Gas-Fired Power Plants by 2010,’’ Financial Standard, vol. 22, no. 8 (2006).

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