Background: on August 16, 2022, President Joe Biden signed the Inflation Reduction Act into law. This has shaped the growth of renewable energy in the United States through the manufacturing of solar panels, wind turbine blades, battery storage, and other renewable energy investments that qualify for the investment tax credit. With this in mind, other countries worldwide, especially Nigeria, which faces the big challenge of lack of access to electricity for a substantial part of its population, can adopt the energy investment tax credit to attract power infrastructure investment.
Nigeria’s Economic Outlook and Energy Consumption per Capita
It is no news that Nigeria, the most populous black nation on earth and one of the largest economies in Africa, with a GDP of $252 billion, still lacks an adequate power supply to drive its economic growth and activities (Figure 1).
Figure 1
It is no serendipity that developed countries around the world with the highest GDP per capita are also the countries with the highest electricity consumption Figure 2.
Figure 2
Source: Energy for Growth Hub
The USA, for example, with a population of ~320 million people and 1.3x Nigeria’s population, has an energy use per person of 30x that of Nigeria (Figure 3).
Figure 3
Therefore, we can conclude that, for Nigeria to reach its full economic potential, and for the private sector to thrive, Nigeria needs to attract investments in power infrastructure, which includes generation, transmission, and distribution. One may argue that the major impediment to Nigeria attracting investments in the power sector is regulation of the sector, or, simply, the power subsidy provided by the government for low-income consumers known as band B to E. Private investors are skeptical that they will be unable to recoup their investments if they invest in Nigeria’s power infrastructure as the current electricity tariff may not be palatable for the desired IRR for most infrastructure investment funds.
Power generation economics and Levelized Cost of Electricity
Power generation is expensive everywhere around the world, and for someone unfamiliar with the sector, let’s run a quick calculation on what goes through the mind of an investor willing to invest in a 100 MW combined cycle gas turbine power plant. A combined cycle gas power plant can cost between $800K – $1.8 million per megawatt, depending on the technology, location, and infrastructure the country already has. For simplicity, we can assume that it will cost $1 million per megawatt in Nigeria, which gives us $100 million for 100MW. With the current exchange rate of N1665/$, we are looking at a capital cost of approximately N170 billion. Also, the initial capital cost is not the only variable an investor considers when investing in a power plant. The investor also needs to consider the levelized cost of electricity. The levelized cost of electricity is a metric for measuring the average cost of electricity generation over the useful life of a power-generating asset. Power infrastructure investors use LCOE as a business case to determine the financial viability of an energy infrastructure investment and its pricing to customers. For a 100 MW combined cycle gas power plant, I calculated the LCOE to be ~$0.06/KWh or N102.43 using the current exchange rate of N1665 to 1 USD. Let’s look at the current electricity tariffs in Nigeria, which range from N32-N64 for Band B-E[Figure 4], and the levelized cost of electricity without the cost of distribution and transmission. We can conclude that investing in power generation in Nigeria is not profitable for private investors without any form of subsidy from the government Table 1.
Table 1
However, there is still a way the government can attract private capital to the Nigerian power sector through a power infrastructure investment tax credit. In collaboration with state governments, the federal government of Nigeria can appropriate about $1 billion of power infrastructure tax credits for qualifying power generation, transmission, and distribution projects.
The Investment Tax Credit
The investment “tax credit” can be defined as the dollar-for-dollar amount an investor can subtract from the taxes they owe because they have invested in a qualifying asset or investment stated by the government. These tax credits are intended to encourage investment in certain areas that are of national importance to the country, state, or region that initiates the tax credit. The energy investment tax credit (ITC) can be structured to allow investors to deduct 30% – 40% of the total capital cost from their tax liability. For example, in a 30% ITC, if an independent power producer (IPP) invests N170 billion in a 100 MW power project, the IPP can get back N51 billion of the capital costs from the government in the form of tax credits, which means the investor can deduct it from their tax liability.
Figure 4
Source: ekedp.com
To understand the impact of a 30% ITC, if an Independent power company gets a 30% tax credit for a 100 MW combined cycle power plant, the levelized cost of electricity LCOE will reduce to N92.43/KWh Table 2. Also, if the $1 billion is fully leveraged with the 30% tax credits for power generation alone, it can add up to 3.3GW to Nigeria’s national grid.
Table 2
As good as the investment tax credit looks and sounds, it comes with its challenges. The challenge is that most power generation developers and independent power producers would not have sufficient tax liability to absorb these tax credits to recoup these power infrastructure investments. The government can make this possible by allowing tax equity financing for these investments.
Tax Equity Partnerships Investments structure
In a tax equity partnership, the tax equity investor, usually a large corporation with a high tax liability, will partner with the developer to build the power plant by providing cash for the transaction in exchange for a large chunk of the tax credits and a small percentage of the cash flow from the project Figure 5. Tax equity partnerships also come with different partnership types. The most common type of tax equity partnership is the partnership flip.
Figure 5
In a partnership flip, a joint venture partnership is formed between a developer and a tax-equity investor. During the partnership’s duration, the distribution of cash flow and tax benefits “flips” between the parties at least once. Through these flip(s), the majority (usually 99%) of the tax benefits can be transferred to the tax equity investor, and the developer can invest alongside the tax equity investor to maintain a residual interest in the project once it starts operation. After the tax investor has utilized all of the tax benefits, the developer can reclaim 100% ownership of the assets at a fair price. The potential impact of the investment tax credit in power generation for Nigeria can not be underestimated. The USA, for instance, has seen companies announcing $133 billion investments in clean energy technology and electric vehicle manufacturing since the IRA was signed into law by President Joe Biden.
Conclusion
In closing, if some of the fuel subsidy gains are channeled into the power generation investment tax credit and properly executed and monitored, it can propel Nigeria to achieve the pipe dream of reliable and sustainable electricity to drive economic growth. This is not to say it’s all-in-all or totally exhaustive, but it can lay the foundation for the country to attract private investors in the power sector.
Appendix
https://www.power-eng.com/gas/combined-cycle/capacity-factors-of-combined-cycle-power-plants-rising-as-efficiency-improves-eia-finds/
Innovators choose Wonder. (n.d.). https://start.askwonder.com/insights/average-natural-gas-power-plant-o-and-m-costs-us-6ed6estyi
Most combined-cycle power plants employ two combustion turbines with one steam turbine – U.S. Energy Information Administration (EIA). (n.d.). https://www.eia.gov/todayinenergy/detail.php
Tax Equity Financing: An Introduction and Policy Considerations. (2019). In CRS Reports. https://www.everycrsreport.com/reports/R45693.html
