The rate of return on power projects has been the subject of much debate over the years. Many have criticised the high returns awarded by the regulator as compared to similar projects in the region while there have also been reservations about the generous terms of contracts.
For example, the returns are also dollar indexed to offset the impact of any currency devaluation on power projects. So it came as a welcome move when the National Electric Power and Regulatory Authority (Nepra) decided to review the returns offered to power companies.
Initially, guidelines under the determination of tariff for independent power producers 2005 set the internal rate of return (IRR) for the power projects as the sum of the 10 year PIB auction rate and a premium determined by Nepra.
Subsequently, the Power Generation Policy 2015 indexed the return component of the tariff to the dollar. Nepra’s concept paper has proposed a capital asset pricing model (CAPM) which incorporates the asset beta of US utilities and the return on the S&P 500 index as market risk premium while the credit default swap (CDS) would be Pakistan specific.
Stakeholder comments have highlighted several important points to consider. They argue that the proposed changes should not be applicable to a project for which a Letter of Intent (LoI) has already been issued which seems to be a reasonable demand.
Another important issue according to KRAFAC Consulting is the double counting when it comes to exchange rate adjustments. The company argues that Nepra’s initial rates of return incorporated an implied compensation for adverse exchange rate movements but the government decided to provide a separate component for currency fluctuations resulting in double counting which should be removed. Firms undertaking hydropower projects also took issue with the proposed 14.25 percent IRR for small and 15-16 percent as compared to the 17 percent offered currently.
Arriving at an adequate rate of return is a balancing act at the end of the day. In order to encourage investment the return offered to investors should not be too low. But at the same time due care needs to be taken that undue benefits are not loaded into the return calculation costing the exchequer and ultimately the public to bear an unjustified premium. More on this in the coming weeks.