Professional Services

Nigeria’s electric power sector reforms: a good exception to the concept of the obsolescing bargain (Part 1)

by Editor

August 15, 2013 | 12:00 am
  |     |     |   Start Conversation

The concept of the obsolescing bargain was coined by Harvard economist, Raymond Vernon, in the year 1971 and essentially connotes a shift in the bargaining power from an investor, in favour of a host government. According to Vernon, the theory of the obsolescing bargain forecasts that the passage of time will lead to the loss of an investor’s (especially the multinational’s) bargaining power viz-a-viz, a host nation.

In international (energy) investment law, the situation is usually such that, an investor, at the start of an investment, faces high risk and uncertainty of success and is awarded a premium such as a fabulous rate-of-return to reflect the risk factor and to incentivise investments. Such incentives could include fiscal and tax incentives such as tax holidays and such other similar sweeteners.

The Obsolescing Bargain:

In practical reality, and as Vernon suggested, once the investor (particularly a multinational) has sunk its costs, risk capital and assets in a developing or less developed country, its susceptibility instantly increases. In fact, where the investor’s operations are now very profitable, the passage of time then reduces the government’s appreciation of the up-front risks assumed by such an investor at inception. The government now places little or no value on entry risks and the risk capital already sunk by the investor. As a result, the multinational investor, in particular, may be perceived as earning unduly high returns.

Besides, with time, the host government’s buoyancy improves, and with improved local infrastructure, its dependence on multinationals decreases. This then occasions a reduction in the perception of value generated by the investor. Finally, the government may be prompted by political and other considerations into reducing the investor’s (particularly where it is a multinational) gains, in a bid to assert or demonstrate its independence from foreign influence.

The Obsolescing Bargain in Practice

What typically happens is that a host country requires huge capital investments in a particular sector of its economy (the electric power sector for example) and would require foreign (or indeed private sector) investments; typically in the energy sector. To attract such investors with deep pockets and technological capabilities, the government enacts legislation, issues letters of comfort and enters into contracts with provisions which incentivize would-be investors. Upon negotiating very attractive terms, an investor, particularly the typical transnational corporation begins sinking costs by either providing or upgrading available infrastructure or facilities. It also begins to incur huge costs with the hope of generating returns after some years, considering the long lead time of energy projects.

With time, in countries that practice the dominial system of ownership of resources and utilities, the government begins to feel that the premium on the return on investment originally offered to induce investment is inherently unreasonable and will seek the renegotiation or forceful change (through legislation and such other similar means) of the terms of the original contract which significantly reduces the return on investment available to the operator.

In essence, the bargain between the State and private sector obsolesces with time.

The Obsolescing Bargain and the Nigerian Power Sector

The government of Nigeria, for example, has stated that, to meet the country’s vision of becoming one of the World’s leading economies by the year 2020, the country must have an available generation capacity of 40,000MW. To achieve this target, the country is estimated, according to the government, to require investments in power generating capacity alone of at least US$3.5 billion per annum for the next 10 years.

Correspondingly large investments will also have to be made in other parts of the supply chain (i.e. the fuel-to-power infrastructure and power transmission and distribution networks). Considering the various issues government is contending with, the government, cannot fund this very important sector and has, therefore, invited the private sector both locally and internationally, to participate in the sector. Similar to our opening paragraph, the government, has incentivized the private sector to invest risk capital in the electric power sector.

We believe the risks of the obsolescing bargain does exist, but are convinced that Nigeria and the electric power sector in particular will be exceptions to that rule. This piece continues in the next edition.

To learn more about the power sector in Nigeria and internationally, read the text, the Nigerian Electric Power Sector: Policy. Law. Negotiation Strategy. Business by Ayodele Oni.

 Ayodele Oni (ayodeleoni@outlook.com), a solicitor, specializes in international energy (oil, gas & power) investment law.

 By: Ayodele Oni


by Editor

August 15, 2013 | 12:00 am
12893  |   93   |   0  |   Start Conversation

Big Read |  

Analysis

Making the case for sustainability

The debate about the role of business in society has been ongoing since the 1960s. Over the years,literature and research...