Power tariff relief: Right step but one of many

Energy puzzle is necessary to be resolved for the economy to grow on a sustainable path. A crisis was already in the making when this government came to power. Circular debt has more than doubled in the last two years – but majority of the increase was bound to happen due to incremental capacity charge of new plants and currency adjustment. Having said that, there is no improvement in energy distribution management (governance) whatsoever in this regime.

The IMF programme is hanging in the balance primarily due to pending energy circular debt resolution plan. One argument presented is to increase tariffs to reduce the gap between energy cost and revenues. But with higher tariffs, there are more chances of industrial consumers moving away from the grid and others to ration consumption. This potentially can do more damage than good. Electricity tariffs in Pakistan are already at a steep premium to global average and regional competitors. There are both numerator (energy cost) and denominator (energy consumption) problems in the equation.

In the last regime, a number of new power projects were initiated. A few came online before the 2018 elections, some became operational in this regime and others are still to come online. In most of the new projects, relative to older ones, the marginal cost of production is less; while the fixed cost component is higher. In order to attain the benefit of low marginal cost, the consumption of electricity has to match (or come closer) to the production capacity. Otherwise, the fixed cost component would widen the gap between revenue and cost.

Before delving into the details, one distinction needs to be understood. While it’s true that projects under the 2015 policy have low levelized tariffs than older ones, this does not mean that tariffs are low today. Around 80 percent of project cost is debt and that has to be paid in initial 10-12 years while the equity (remaining 20%) return is paid in 25-30 years. Levelized tariff is the average tariff for the whole life – but the tariff in first 10-12 years is much higher. Hence the cost of new projects is not low today.This is creating a cash flow problem aka circular debt.

The government dealt with a small part of the numerator by signings MoUs with the 2002, 1994 and a few other policies. But in most cases the debt is already paid off. The real gain is against any future currency depreciation. The bigger part of numerator is newer projects. In 2016, the annual capacity payment was Rs292 billion. It’s now north of Rs900 billion. This would increase in today’s currency parity to Rs1,600 billion by 2023. If the currency depreciates, this amount grows further. According to SAPM on Power Tabish Gauhar, “The elephant in the room is not discos mismanagement, rather it is the growing capacity payment”.

The government has in principle decided on alteration of equity returns of its own projects on the lines of what has been negotiated with the IPPs. The catch is in debt elongation. Here financiers are domestic and international banks and other lending institutions. Negotiations with these are required. And a similar treatment of equity and debt is warranted for CPEC projects.

The bigger challenge is to work on the denominator. The fixed cost can only be diluted by increasing the consumption of electricity. Plus, what is the fun in installing new capacity when the consumers cannot afford it. Since energy management has largely remained in hands of the government, the base load has been added to gain votes. The reliance is on the residential consumers. Usually in the world, base load is built for industrial consumers. In Pakistan, a mere one-sixth of NTDC grid consumption is industrial. That is too low a number.

The electricity consumption is almost half in winter (7-8 billion kWh during Nov-Mar) versus peak summer time (over 14 billion kWh in Jul-Aug). Half of the summer load is mainly due to air conditioning for residential and commercial segments, as industrial consumption is largely uniform across the year. The government has finally taken a step in the right direction by encouraging industrial incremental consumption on the grid by offering lower tariffs.

The industrial average tariff is around Rs16/kWh off-peak and Rs21/kWh in peak hours. For big industrial connection, incremental consumption relative to same period last year is to be chargedat Rs13/kWh. For SME consumer (B1, B2 and B3), incremental consumption is priced at Rs8/kWh. Plus, there will be no peak-hour tariff for SMEs.The marginal cost (production plus T&D) is computed at Rs13/kWh. This incentive is effective till June 2021 and likely to continue till June 2023.

Industry experts are of the view that this will increase the industrial consumption on grid by 20-25 percent. Currently, around 20 billion kWh are being consumed annually by industry on the NTDC system. The total annual consumption is 120 billion kWh – residential is the biggest consumer, followed by commercial and agriculture. The energy processing and production capacity of grid is somewhere between 150-180 billion kWh. A likely 25 percent industrial increment will add around 5 billion kWh. Much more is required to impact the denominator.

The residential heating is mainly on gas. Pipeline gas pricing is much cheaper and heating methods are highly inefficient. This has environmental consequences in terms of wastage of primary energy source. If the pricing is right, this could shift to electricity. If the government cannot move up the gas prices due to political economic considerations, it can take a bold step this winter to lower the electricity tariff for incremental consumption of residential clients. The overall impact on electricity consumption could be higher than estimated incremental industrial use.

The estimated 5,000 MW of industrial energy consumption is relying on captive power generation. The government can get part of it into the system through direct wheeling. The government is providing gas at $6.5/mmbtu for exporting industrial consumers for their own captive generation. Why would these be moved to the grid when they can produce cheap energy using gas? All these pricing signals have to be right and the whole energy equation has to be seen as one.

Some of the industrial consumers are not on the grid because they don’t have a connection. Discos are not keen on issuing new connections as their incentives are not aligned with incremental consumption. That has to be fixed. Discos and energy market deregulation and privatization constitute a separate subject (more on this later). Without fixing this, the denominator cannot be solved.

Copyright Business Recorder, 2020