No Solution to Pakistan's Load Shedding Without Renegotiating IPP Contracts

[Riaz Haq]

Pakistan's installed generating capacity is about 20,000 MW. It exceeds current demand of 17,000 MW and actual supply of just 10,000 MW. The capacity utilization is only 50% mainly because the producers do not buy sufficient fuel and choose to operate at only 50% of capacity and still enjoy soaring profits. A third of the installed generating capacity is owned by the independent power producers (IPPs). The current IPP contracts guarantee payments and profits with no requirement for fuel efficiency.

Most private investors have built oil-powered inefficient plants because of their low construction costs and short lead times, and the oil price has skyrocketed since these plants were built in 1990s. The result is 18-20 hours of load shedding across most of Pakistan in the scorching summer heat in spite of the fact the taxpayers have shelled out billions of dollars in subsidies to the power sector since 2008.

According to an AP report, the Pakistan's government has assumed $3.6 billion of the power industry's debt. The government-owned power grid owes another $2.5 billion to private-sector generators, even as the government, according to Finance Ministry figures, spent at least $7.4 billion on electricity subsidies during the 2008-2010 period.

Here's Arif Habib Securities investment analysis of the IPPs sector:

All power companies from Arif Habib Limited research coverage witnessed surprising growth (36-58%) in net profitability. HUBC led the flock with 58% YoY jump in profit after tax, attributable to the growing indexation factors and ROE component. On the other hand, lower payables to fuel supplier and resultantly lower penal interest provided major support to KAPCO, pushing the net profitability up by 36% YoY. As far as Nishat group companies are concerned, rising fuel cost magnified the impact of fuel efficiency, which combined with O and M savings further improved the profitability. However, dividend from KAPCO and NPL disappointed the optimistic investors. Arif Habib Limited believes the dividends to rise in 2HFY13 for these companies, providing investor with greater value at the financial year end.

Source: IMF Pakistan

Pakistani government buys electricity from IPPs at a rate of Rs. 12.50 per KWhr while the consumers pay an average of Rs. 9.00, leaving a short-fall of Rs 3.50 per unit which is subsidized by the taxpayers. It adds up to hundreds of billions of rupees a year. Power subsidy target for FY 2012-13 was set at Rs 185 billion, 60 percent lower than the actual subsidy provided during FY12. The subsidy provided year-to-date (YTD) is Rs 311 billion, already having exceeded the target by 68 percent, according to PakTribune.

A significant part of the problem is the IPP contracts which guaranteed a 12 to 15 per cent annual return (indexed in dollars, not rupees), gave tax breaks and paid interest on private funding – more expensive for the government than providing the funding itself.  In addition, there are no incentives for the private power producers to produce power efficiently.

In a blog post published in Financial Times, Dr. Kamal Munir of Cambridge University's Judge Business School blames the IPP contracts signed as part of the power privatization in 1990s.

“The 1994 privatization of the energy sector offered investors generous returns and created pricey overcapacity,” he told Financial Times. “This created an expensive legacy which is the real problem of today’s energy crisis.” Unless that problem is dealt with, he sees no light at the end of the energy tunnel.

He says Pakistan’s government, helped by the World Bank, “sweetened” its energy privatisation with attractive conditions, fearing it wouldn’t be able to attract investors otherwise. It guaranteed a 12 to 15 per cent annual return (indexed in dollars, not rupees), gave tax breaks and paid interest on private funding – more expensive for the government than providing the funding itself. ”The deal was too good to be true for investors,” Munir says.

Munir says the model turned out to be badly constructed in terms of creating value for the government and people of Pakistan. Even in an environment of economic growth and efficient energy generation, it would have been hard for the government to finance the plan. But since both have been absent, it became nearly impossible to pay for privatised energy.

Since there were no incentives to be fuel-efficient, most private investors chose to build  plants using furnance oil as fuel because of their low construction costs and short lead times. This backfired as the oil price has trebled since the 1990s. Variable costs, and therefore prices to consumers, are at unsustainable levels. “No wonder many consumers can’t afford to pay their bills,” Munir says.

To make things worse, the government neglected to step on the brakes when its generous conditions attracted too many investors. Assuming economic growth would continue, it allowed too much capacity to be built and guaranteed the same return on that extra capacity, whether it was used or not.

Munir says the government should develop new power plants using cheaper fuels, and that this shouldn’t be a problem in a country with an abundance of coal, waterways and sun.

But Pakistan must first escape its vicious payment cycle.

“We need to get out of the the current deals,” says Munir. But at what cost, and does this imply default? “Your guess is as good as mine,” the academic admits.

Still, he felt it was time to make his point. “I’m not defending people who don’t pay bills and I’m not promoting government subsidies to keep prices low,” Munir says. “But why isn’t anyone talking about the policy that led to this situation to begin with?”

Fuel Cost per million BTU

The key to solving the problem is to renegotiate the old IPP contracts with new terms that reward lower fuel costs and higher efficiency. In addition to that, Pakistan's incoming government of Prime Minister Nawaz Sharif's has to explore multiple fuel options to meet the nation's growing energy needs. Some of the fuel options are as follows:

1. Developing its shale gas reserves estimated 51 trillion cubic feet near Karachi in southern Sindh province. The US experience has shown that investment in shale gas can increase production quite rapidly and prices brought down from about $12 per mmBTU in 2008 to under $2 per mmBTU recently. Pursuing this option requires US technical expertise and significant foreign investment on an accelerated schedule.

 2. Increasing production of gas from nearly 30 trillion cubic feet of remaining conventional gas reserves. This, too, requires significant investment on an accelerated schedule.

3. Converting some of the idle power generation capacity from oil and gas to imported coal to make electricity more available and affordable.

4. Utilizing Pakistan's vast coal reserves in Sindh's Thar desert.

5. Hydroelectric and other renewables including wind and solar. Several of these projects are funded and underway but it'll take a while to bring them online to make a difference.

In my view, the newly-elected government should pursue all of the above options with options 1, 2 and 3 as a priority for now. Its best interests will be served by developing its own cheap domestic shale gas on an accelerated schedule with Saudi investment and US tech know-how.

Related Links:

Haq's Musings

Comprehensive Energy Policy for Pakistan

IPP Contracts in Pakistan

Pakistan Needs Shale Gas Revolution

US Census Bureau's International Stats 

Pakistan's Vast Shale Gas Reserves

US AID Overview of Pakistan's Power Sector

US Can Help Pakistan Overcome Energy Crisis

Abundant and Cheap Coal Electricity

US Dept of Energy Report on Shale Gas

Pakistan's Twin Energy Crises

Pakistan's Electricity Crisis

Pakistan's Gas Pipeline and Distribution Network

Pakistan's Energy Statistics

US Department of Energy Data

Electrification Rates By Country

CO2 Emissions, Birth, Death Rates By Country

China Signs Power Plant Deals in Pakistan

Pakistan Pursues Hydroelectric Projects

Pakistan Energy Industry Overview

Water Scarcity in Pakistan

Energy from Thorium

Comparing US and Pakistani Tax Evasion

[Riaz Haq]

Pakistan to reform power distribution after IMF meetings, minister says
Owais Rawda explores what the most recent request for IMF climate funding means for power sector reform.

https://www.power-technology.com/comment/pakistan-to-reform-power-d...

At last week’s International Monetary Fund (IMF) Annual Meetings, Pakistan’s finance minister Muhammad Aurangzeb requested $1bn in funding from the IMF’s Resilience and Sustainability Trust (RST) to help mitigate the country’s climate risks and accelerate its energy transition. Established in 2022, the RST offers vulnerable low- and middle-income countries long-term concessional cash for climate-related spending.

Pakistan’s power sector circular debt, driven by inefficiencies in the power distribution network, crossed Rs2.66tn ($9.5bn) in May, according to a debt report released by the government’s power division. Meanwhile, citizens have suffered significant and frequent power outages in recent years, leaving millions without electricity.

The government’s faulty capacity payment contracts with independent power producers (IPPs) have come to light as the primary source of these challenges. Interest rates borne from private IPPs have not only worsened the debt crisis but spiked consumer tariffs, making electricity unaffordable.

In light of Aurangzeb’s request, coupled with multiple IPPs terminating their contracts with the government, the South Asian nation is now likely to announce significant reforms.

“These IPP payments had a detrimental effect on the overall quality of life for our citizens,” Awais Laghari, Pakistan’s minister for energy’s power division, tells Power Technology. “It is imperative that necessary steps are taken to resolve the issue.”

Without specifying the plans, he claims that the power division is currently evaluating options “through which the fiscal burden shared by the consumer, whether through taxes or debt repayments, can be optimised through various interventions that improves household economics and consumption at the same time”.

Laghari says that there are also plans to “unbundle electricity” and create a competitive market for energy, citing the recent introduction of an independent system and market operator (ISMO) as a step in this direction.

“This will ensure that a B2B [business-to-business] market for electricity can develop, which can eventually evolve into a B2B2C [business-to-business-to-consumer] market thereby providing greater options for consumers and lower prices through a competitive process,” he says.

The minister adds that the role of renewables in reforming the country’s power market will be imperative, “given their price advantage”. He believes that their ability to generate cheap electricity will “always put them ahead in any competitive market regime, making them critical to the success of the market.”

Following the IMF meetings, Laghari says that the government plans to “move forward actively” with the privatisation of electricity distribution companies and that “necessary improvements in governance are already underway”.

He believes that privatisation can enhance the efficiency of these companies, allowing them to remain a key player in the power market, which in turn will result in more affordable prices for consumers.

“Similarly, we continue to focus on investment in transmission to remove constraints so that lower cost electricity generated in the South can be moved across the country and overall consumer tariff can be reduced.”

About the author: Owais Rawda is a regulatory policy researcher that has written about the energy and technology industries.