Closing The Power Sector Cashflow Gap In Nigeria: Structuring Payment Security and credit enhancement mechanisms

Nigeria’s power sector continues to face a persistent liquidity crisis driven less by capacity constraints and more by structural weaknesses in cashflow collection tariff design and counterparty creditworthiness. The Nigerian Electricity Supply Industry historically operated on a sequential payment chain from customers to Distribution Companies (DisCos), Nigeria Bulk Electricity Trader (NBET), Generation Companies (GenCos), and gas suppliers. However, this structure consistently broke down at the distribution level due to high losses and weak collections. Although NBET previously served as the central bulk trader and intermediary within the market, recent reforms under the Electricity Act 2023 and Nigerian Electricity Regulatory Commission (NERC)’s Order on Bilateral Trading are gradually reducing NBET’s role in favour of direct bilateral contracting between market participants.. As noted by the NERC, DisCos have historically remitted well below market invoices, resulting in a sector wide shortfall estimated at over four trillion naira. Interventions such as the Central Bank of Nigeria Payment Assurance Facility and tariff adjustments have provided temporary support but have not resolved the underlying imbalance.

Recent developments point to a more commercially driven direction. Government-backed bond issuances to settle GenCo arrears and broader debt restructuring efforts have helped stabilise the market while structured gas payment arrangements have eased upstream pressure. At the same time, the Electricity Act 2023 is accelerating a shift toward bilateral contracting between GenCos and DisCos and eligible customers, reducing reliance on a centralised buyer model and strengthening contractual discipline across the value chain.

The focus is therefore shifting from capacity to bankability. Capital is increasingly directed toward transactions that demonstrate predictable cashflows, credible counterparties, and enforceable payment structures. In practical terms, projects will not attract investment on the strength of output alone but on how effectively they mitigate collection risk secure revenues and ensure payment certainty. The trajectory of the sector will ultimately be determined by the quality of structuring underpinning each transaction.

1. THE COMMERCIAL ANATOMY OF THE CASHFLOW GAP

The Nigerian Electricity Supply Industry (“NESI”) operates as a sequential revenue chain, flowing from customers to DisCos, NBET, GenCos, and ultimately, gas suppliers.. The breakdown occurs at the distribution level, where high Aggregate Technical, Commercial and Collection (“ATC&C”) losses, comprising network inefficiencies, energy theft, and poor revenue collection weak metering infrastructure, and historically non-cost-reflective tariffs significantly constrain collections. As reflected in the quarterly market performance reports published by NERC, these inefficiencies continue to undermine the ability of DisCos to meet their market remittance obligations..

The commercial impact is immediate and systemic. DisCos are often unable to remit full invoices to NBET which in turn constrains NBET’s ability to settle GenCos, leading to a buildup of receivables across the generation segment. This pressure cascades upstream as GenCos struggle to meet gas payment obligations resulting in reduced gas supply lower generation output and further revenue compression across the value chain.

The result is a self reinforcing liquidity cycle rather than a short term funding gap. Cashflow deficiencies at the distribution level propagate across the entire market creating a structure where each participant’s ability to perform is dependent on a weakened upstream counterparty. Addressing this dynamic therefore requires more than liquidity support, it requires deliberate restructuring of how revenues are collected, secured and distributed across the chain.

2. CURRENT MARKET REALITY: VERIFIED INTERVENTIONS

Nigeria’s response to the power sector liquidity crisis has evolved through a combination of direct liquidity injections, debt restructuring, tariff reforms and targeted upstream interventions. While these measures have stabilised the sector in the short term, they also reveal a gradual shift toward more structured and market-oriented solutions.

• CBN Payment Assurance Facility (PAF)

The Central Bank of Nigeria introduced the Payment Assurance Facility in 2017, with an initial ₦701 billion tranche, to address the immediate shortfall in payments to generation companies. The facility was designed as a stabilisation mechanism, ensuring that GenCos received a guaranteed portion of their invoices despite weak remittances from DisCos. Structurally, the intervention functioned as a loan to DisCos, to be repaid over time, thereby preserving liquidity across the value chain and preventing a collapse in generation capacity.

However, while the PAF succeeded in restoring short-term confidence and maintaining minimum generation levels, it did not resolve the underlying inefficiencies within the distribution segment. Collection losses, tariff constraints and governance challenges persisted, meaning that the facility effectively deferred rather than eliminated the liquidity gap. This underscores a key lesson in the Nigerian context: liquidity support without structural reform cannot deliver long-term sector sustainability.

• Power Sector Debt Refinancing and Bond Issuances

More recent interventions reflect a transition from temporary liquidity support to structured refinancing. The Federal Government has backed the issuance of over ₦500 billion in bonds to settle outstanding obligations to GenCos, alongside broader plans to restructure an estimated ₦4 trillion in sector debt. These instruments are typically sovereign-backed and structured with defined amortisation profiles, providing GenCos with predictable recovery of outstanding receivables while improving balance sheet stability.

From a commercial standpoint, this represents a significant shift. Rather than relying on continuous short-term interventions, the sector is increasingly utilising capital markets instruments to refinance legacy obligations. In effect, this approach reallocates credit risk from weaker market participants, particularly DisCos, to the sovereign, thereby restoring a degree of bankability and enabling renewed investor engagement in generation assets.

• Tariff Reforms under the Service-Based Framework

The Nigerian Electricity Regulatory Commission introduced the service-based tariff regime, segmenting customers into Bands A to E based on supply reliability. Recent tariff adjustments, particularly for Band A customers, have resulted in a measurable increase in revenue for DisCos, with industry estimates indicating significant uplift in collections within premium service segments.

Despite this progress, tariff reforms remain constrained by political and social considerations. The inability to fully implement cost-reflective tariffs across all customer classes means that revenue improvements are uneven and insufficient to close the overall liquidity gap. As a result, while tariffs are gradually moving toward commercial viability, they have yet to fully align with the cost structure of the sector.

• Gas Payment Interventions and Structured Settlements

Upstream liquidity has also been addressed through targeted interventions in gas supply payments. The Federal Government approved the settlement of approximately $128 million in outstanding gas debts through structured arrangements rather than immediate cash disbursements. These arrangements have included offset mechanisms and phased payments designed to ease pressure on public finances while maintaining gas supply to power plants.

This approach reflects a broader shift toward hybrid settlement mechanisms within the sector. Instead of relying solely on direct fiscal outflows, the government is increasingly deploying structured solutions that balance liquidity support with fiscal sustainability. While effective in the short term, these mechanisms further highlight the need for a more durable solution centred on predictable cashflows and enforceable payment structures across the value chain.

3. WHY THE GAP PERSISTS

The liquidity gap in Nigeria’s power sector is driven by a set of structural risks that collectively weaken cashflow across the value chain. At the core is revenue risk, where weak collections high losses and metering gaps mean that a significant portion of energy supplied is not converted into cash inflows, immediately constraining DisCo remittances and triggering upstream payment shortfalls.

This is compounded by tariff risk, as pricing remains only partially cost reflective, creating a structural mismatch between sector revenues and actual operating costs. Even where collections improve the system continues to operate below full cost recovery.

In addition credit risk remains a central concern as DisCos are not investment grade counterparties, limiting confidence in their ability to meet payment obligations. This is further pressured by currency risk, with foreign currency linked costs against predominantly naira revenues, and enforcement risk, where inconsistent application of contractual obligations weakens payment discipline.

Taken together these factors create a system where liquidity constraints are embedded rather than incidental requiring structural solutions rather than temporary interventions.

4. PAYMENT SECURITY AND CREDIT ENHANCEMENT MECHANISMS

This is the point at which power sector reform moves from policy to transaction design. Nigeria’s liquidity gap is not cured simply by increasing generation or adjusting tariffs. It is addressed when transactions are structured so that revenues are visible, payment obligations are backed by credible support, and cashflows are protected against diversion or delay. In practical terms, payment security and credit enhancement mechanisms are the tools that convert a technically viable power asset into a financeable transaction. Their function is to reduce the risk that a weak counterparty, a market shortfall, or a regulatory disruption will interrupt the flow of payments needed to service debt, pay operating costs, and sustain the project.

• Sovereign guarantees and partial risk guarantees

The most established form of credit enhancement in the Nigerian market has been the use of sovereign support layered with multilateral guarantees. In the Azura Edo IPP structure, the World Bank approved a Partial Risk Guarantee(PRG) arrangement that included an NBET credit enhancement guarantee, while the project structure also incorporated termination and liquidity support elements. Azura’s own published financial statements confirm the role of the World Bank PRG and additional termination support in underpinning the transaction. This matters commercially because it changes the risk profile of the payment chain. Instead of lenders and sponsors relying solely on the credit of NBET or the wider market, the project benefits from obligations that are effectively supported by the sovereign and multilateral institutions, which materially improves bankability and tenor.

In substance, sovereign guarantees and PRGs do not eliminate sector risk, but they reallocate it. They are particularly important in a market such as Nigeria where the offtaker’s standalone credit profile may be insufficient to support long term project finance. By backing payment obligations or specified termination payments, these instruments give lenders comfort that debt service will not depend entirely on the immediate financial strength of the DisCo or bulk trader. For sponsors, that support can mean the difference between a project that reaches financial close and one that remains commercially attractive but unfinanceable.

• Put Call Option Agreements

A Put Call Option Agreement, or PCOA, is one of the most important political and termination risk mitigants used in Nigerian independent power project structures. Although often discussed alongside the Power Purchase Agreement (PPA) and guarantee package, its importance is distinct. The core commercial purpose of the PCOA is to provide a defined exit route if the project is terminated following specified default or political force majeure scenarios. Azura’s published financial statements specifically identify the PCOA as part of its transaction suite, which reflects how central this instrument is in the Nigerian IPP model.

Its value lies in providing investors and lenders with termination certainty. In markets where project revenues are exposed to state linked counterparties and regulatory intervention, the risk is not only delayed payment but also the possibility that a project becomes stranded without a credible recovery mechanism. The PCOA helps address this by defining how the project company or investors may require the relevant government counterparty to purchase the project or compensate the investors upon certain trigger events. From a structuring perspective, it reduces political risk, offtaker risk, and tail risk. It also supports the financing package by giving debt providers greater visibility on recovery in downside scenarios, which can improve appetite for longer tenor funding.

• Escrow accounts and cashflow waterfalls

Where the problem in the sector is weak payment discipline, one of the most practical solutions is to control the movement of revenues after they are collected. That is the commercial logic behind escrow arrangements and cashflow waterfalls. In a well structured power transaction, revenues are paid into designated controlled accounts and then distributed according to an agreed order of priority. Typically, that order begins with taxes and essential operating expenses, then debt service, then fuel or gas supply obligations, with residual amounts released afterward. The goal is to prevent available cash from being diverted to less critical uses while more senior obligations remain unpaid. This kind of discipline becomes particularly important in a market where remittances are uneven and counterparties may be under financial stress.

The commercial strength of the waterfall is that it converts a general promise to pay into a managed payment process. Lenders are more comfortable where collections are visible and trapped in transaction accounts rather than left to the unrestricted discretion of an operating counterparty. For gas suppliers and other critical service providers, a properly designed waterfall can also improve confidence that their invoices will rank ahead of less essential disbursements. In a distressed or thin liquidity environment, this kind of structural protection can be more valuable than a general covenant package because it addresses not only willingness to pay but also the mechanics of how cash is applied once received.

Take or pay structures are particularly important in a sector where demand volatility, curtailment risk, and payment delays can undermine project economics. Under this arrangement, the offtaker commits to pay for an agreed quantity or capacity even if it does not ultimately take delivery of the full volume. In the Nigerian context, this type of obligation is valuable because it shifts the transaction away from uncertain spot style revenue exposure and toward predictable contracted cashflows. It is one of the clearest ways to support revenue security, especially where the project is being financed on the strength of future receivables.

The relevance to the cashflow gap is straightforward. If a generator can only earn when every operational and market variable aligns perfectly, the project remains highly exposed to system weaknesses. A take or pay structure reduces that exposure by ensuring that at least part of the project’s revenue base is contracted and less dependent on actual dispatch or short term market fluctuations. That contractual predictability is exactly what lenders and investors look for in fragile markets. It enhances debt service certainty, improves financial modelling, and strengthens the argument that the project can survive periods of market stress.

• Payment assurance facilities and other short term liquidity tools

Short term liquidity support remains relevant even where deeper structural reform is underway. The World Bank’s Nigeria Power Sector Recovery Operation records that from 2017 the Federal Government borrowed from the Central Bank of Nigeria to fund market shortfalls through the Payment Assurance Facility and related support, with total CBN loans to the power sector reaching about ₦2 trillion. The immediate value of such facilities is that they prevent arrears from cascading into operational disruption. They allow GenCos to receive at least partial settlement, help preserve gas supply, and buy time for broader reform measures to take effect.

However, these facilities are best understood as bridge mechanisms rather than permanent solutions. They improve settlement cycles in the short term, but they do not on their own cure weak collections, non cost reflective tariffs, or poor remittance discipline. Their real usefulness in structuring terms is to smooth timing mismatches and avoid acute payment shocks while more durable contractual and market based protections are put in place. In other words, they can stabilise the system, but they cannot by themselves make it bankable.

• Capital markets instruments

One of the most significant developments in the current market is the increasing use of refinancing and capital markets solutions to address legacy shortfalls. Rather than relying solely on recurring direct intervention, the market has moved toward using bonds and debt restructuring mechanisms to convert accumulated arrears into longer dated obligations that can be serviced over time. This is commercially important because it changes the nature of the problem from immediate unpaid invoices to structured financial liabilities with clearer repayment profiles. It also signals that the market is beginning to treat sector liquidity stress as a balance sheet and financing issue rather than only an operational one.

Power sector bonds are particularly useful where the objective is to refinance legacy debts and restore confidence among upstream participants. Commercial papers can provide shorter term working capital support, although they are more suitable where there is clear visibility on repayment sources. Securitisation, where feasible, offers another route by monetising receivables and turning future payment streams into present liquidity. The broader trend is a shift from ad hoc government funding toward structured market financing, with repayment tied to defined revenue streams or sovereign support rather than periodic discretionary intervention.

• Embedded generation and captive power

Embedded generation and captive power structures are commercially significant because they allow projects to bypass some of the weakest parts of the traditional payment chain. Instead of selling into a broad market where collections depend on financially stressed DisCos and pooled settlements, the project supplies power directly to a defined customer base, often industrial or commercial users with stronger payment capacity. These models are particularly attractive in sectors such as manufacturing and industrial clusters where the offtaker has a clear need for reliable power and is willing to pay for certainty of supply.

The relevance to the cashflow gap is immediate. Direct supply to creditworthy users improves collection efficiency, reduces leakage in the payment chain, and creates a more transparent revenue profile. In structuring terms, this can materially improve bankability because the transaction is no longer wholly dependent on the broader weaknesses of the sector. While this model does not solve the liquidity crisis across the entire NESI, it demonstrates how targeted structures can isolate viable revenue streams and attract capital even within a stressed market.

5. STRUCTURING A BANKABLE NIGERIAN POWER TRANSACTION

A viable Nigerian power transaction today usually requires a layered structure rather than a single protection tool. The first layer is revenue security. Without a credible offtake arrangement, the entire financing case is weakened from the outset. That revenue security may come from a strong take or pay PPA, a direct bilateral contract with an eligible customer, or a supply arrangement with an industrial user whose payment profile is materially stronger than that of the average distribution company. The objective at this layer is simple: to ensure that projected revenues are not merely theoretical but contractually supported and reasonably predictable.

The second layer is credit enhancement. Even where the underlying revenue contract is robust, financiers will usually require additional support if the offtaker is exposed to market wide weakness or policy risk. This is where sovereign guarantees, partial risk guarantees, political risk insurance, or other multilateral support become critical. Their purpose is not to replace the project’s commercial fundamentals but to strengthen them sufficiently for lenders and equity investors to commit capital on acceptable terms. In the Nigerian market, Azura remains the clearest demonstration that this layer can be decisive.

The third layer is cashflow protection. Once revenue is earned, the structure must ensure that it is captured and applied in a disciplined manner. Controlled accounts, escrow arrangements, waterfall mechanisms, reserve accounts, and debt service retention all sit within this layer. These features are particularly important where the operating environment is volatile because they reduce the risk that available funds will be misapplied before senior obligations are settled. For lenders, this layer often carries as much weight as the headline guarantee package because it determines how money actually moves through the structure after receipt.

The fourth layer is liquidity support. Even strong projects may face timing mismatches between invoicing, receipt, and payment obligations. Standby facilities, working capital lines, reserve accounts, and other short term liquidity tools help manage that mismatch. In the Nigerian context, the logic is particularly compelling because a project may be commercially sound but still suffer from temporary delays in settlement. A properly structured liquidity backstop prevents those delays from becoming defaults and gives the transaction resilience during periods of short term stress.

The fifth layer is exit and downside protection. Long term capital will be cautious in a market where there is no credible path to recovery if things go wrong. Instruments such as PCOAs, termination payment provisions, and refinancing options therefore, matter not only in distress but at the point of initial credit approval. They show that the transaction has been structured with both performance and failure scenarios in mind. In practical terms, this layer assures investors that they are not trapped in a politically sensitive or payment-stressed asset without a defined contractual remedy.

Taken together, these layers show why bankability in Nigeria’s power sector is fundamentally a structuring question. A technically viable plant is not enough. What attracts capital is a transaction in which revenues are contracted, counterparties are de-risked, collections are controlled, short-term shocks are buffered, and downside outcomes are contractually managed. The more effectively those elements are assembled, the more likely the transaction is to move from being merely operational to genuinely financeable

6. CONCLUSION

Closing the liquidity gap in Nigeria’s power sector will ultimately depend on the consistent deployment of robust payment security and credit enhancement mechanisms capable of unlocking private capital at scale. Experience in the market shows that bankability is achieved not by capacity alone but by the strength of the structures underpinning each transaction. Proven approaches such as sovereign guarantees and World Bank backed Partial Risk Guarantees as demonstrated in the Azura Edo IPP alongside Put Call Option Agreements escrow backed cashflow waterfalls and take or pay arrangements have shown that risk can be effectively managed where it is deliberately structured.

At the same time capital markets instruments including government backed power sector bonds commercial papers and receivables based financing are increasingly playing a central role in addressing legacy obligations and providing a pathway for more sustainable funding. These tools reflect a broader shift in how the sector is being financed moving away from ad hoc liquidity support toward structured refinancing solutions with clearer repayment profiles.

The direction of travel is therefore clear. Sustainable reform will not be driven by continued intervention but by the development of bankable contract driven frameworks that allocate risk efficiently protect cashflows and restore confidence across the value chain. In practical terms the future of the sector will be determined by how effectively transactions are structured to ensure that power generated is not only delivered but reliably paid for.

Ozioma Agu is a Partner at Stren & Blan Partners and supervises the Firm’s Energy, Finance and Infrastructure Sector. Anjoreoluwa Boluwajoko, David Olajide and Olaore Akinyemi are Associates in the Firm’s Energy, Finance and Infrastructure Sector.

Stren & Blan Partners is a full-service commercial Law Firm that provides legal services to diverse local and international Clientele. The Business Counsel is a weekly column by Stren & Blan Partners that provides thought leadership insight on business and legal matters.

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