EDITORIAL: It increasingly appears that the government is again in the process of renegotiating the already negotiated deal with Independent Power Producers (IPPs). Any negotiations with investors on sovereign contracts can hurt the investor sentiment and add risk premium to future projects. The IPPs structure in Pakistan began to acquire a visible shape in the 1990s. Two projects were born under the pre-1994 policy and then numerous projects were installed under the 1994 policy. At that time, the majority of investors were foreigners. The rates of return offered for those projects were quite high and the idea was that once investor confidence will be built and Water and Power Development Authority (Wapda) unbundled in letter and spirit, future projects’ risk and return structure would improve in Pakistan’s favour. But in 1998, the then government of the day, carried out a renegotiation exercise when representatives of foreign shareholders of IPPs were summoned to the Prime Minister’s office in the wee hours and forced to renegotiate. Thereafter, virtually, no Western investor participated in subsequent policies. In the 2002 policy, the government could only attract domestic investors. But the dollar-based returns and quasi-equity structure (take or pay policy) were maintained, although the return on equity (ROE) was reduced from 17 percent to 15 percent. It, however, took a number of years before the projects could start and meanwhile power load-shedding became a norm. Once the new projects came on stream, the infamous circular debt began to swell, and cash flow problems of IPPs started building up. In 2013, there was a settlement on the circular debt to solve the cash flow problems of the energy sector. The government had to spend over Rs400 billion. Future investors were witnessing a boost to their perceived risks.
In 2013, power load-shedding was at its peak. The oil prices remained high in the past few years. There was immense pressure on the government to set up new power plants. But it was hard to find investors. The 2002 policy investors were not interested in further investments. The government wanted coal projects but Western lenders (and multilaterals) were not interested. Then came the China Pakistan Economic Corridor (CPEC) and new power projects came under it. Apart from the CPEC, the government itself installed a few projects. The IPPs’ structure continued – be it a project by government, under the CPEC or fully private. In IPPs, the debt-equity structure is usually 80:20. No debtor was willing to finance without ‘take or pay’ structure. One reason was that the unbundling of Wapda couldn’t take place. Since the government was the single buyer, it became the price setter and sole seller; inefficiencies continued on a large scale.
Investors wanted higher return for compensating the growing risks of potential renegotiations and cash flow problems. The ROE became as high as 17 percent for some projects. The financing of the CPEC was too high and on top of that, there was expensive insurance against it. Every element of cost was to be passed on to consumer – if not the end-consumer, then to be absorbed by the intermediary – the federal government. Since it is politically tough to pass on the cost to the end consumers, the government continued to absorb the difference, and the circular debt continued to mount. Prior to the 2013 circular debt clearance, the problem was high oil prices and transmission and distribution losses (including non-recoveries) of Discos. After the addition of numerous and expensive new plants under the 2015 policy, the growing capacity payments – mainly to debtors of the 2015 policy projects – became the elephant in the room. This major problem exacerbated with currency depreciation. There was no noticeable improvement in the transmission and distribution (T&D) losses; it is, however, becoming a secondary problem. The government-IPPs deal is aimed at changing the contract structure, as agreed, for prospective payments. A Memorandum of Understanding (MoU) was signed between government and IPPs a few months ago. It was based on the findings of a report on IPPs. The agreement was supposed to be signed based on clearance of accumulated circular debt. It was written in the MoU that payments are to be made before the agreement is signed. Now the government is changing it into a schedule of three tranches; in other words, it is negotiating an already negotiated and agreed item. The foreign and local investors are watching this. The government has to do a similar round with the 2015 investors and lenders. They, too, are observing the situation. One may apprehend if things continue to move the way they have since 1994, future projects in the power sector may ask for even higher premiums. The government moving out from buying and selling of power is the solution to power sector problem. Then there will be no sovereign contracts in future and there will be no ‘take or pay’ contracts. Investor confidence stands eroded in the power sector. Repeated exercises of renegotiating a contract militate against the sanctity of contracts and hurt investor confidence in general even if these are aimed at adding a layer of security to a document already signed and agreed to by all parties.
Copyright Business Recorder, 2021