The power sector tariff dilemma

The biggest economic headache this government inherited in 2018 was energy circular debt, which has only exacerbated since. At Rs2.3 trillion, it has doubled since PTI came to power. If nothing is done to curb the malaise, it will likely cross Rs4.5 trillion by the end of PTI term, growing 5 times between 2018 and 2023. This alone can drag the economy into an abyss. Business as usual simply cannot continue.

The rate of growth is attributable both to currency adjustment (2018-20), and new capacity additions. Another Rs980 billion capacity payment shall be added during 2021-23. The government has developed a circular debt reduction plan with the support of the IMF and ADB, although it has not been made public so far. Here, the highlights of the plan (based on background discussions with the stakeholders) are presented and the viability is evaluated.

The primary challenge is to make electricity distribution companies (discos) efficient. This falls under the purview of Ministry for Power, whose performance has remained sub-par during the first half of PTI's term. That discos cannot be mended if they continue to remain under government control is a fact. The plan aims to reduce T&D losses from 18 percent to 15.5 percent, and to improve recovery from 90 percent to 95 percent by June 2023.

The idea is to develop public-private partnership models. Ten discos have been bifurcated into two segments - five of which are doing well (and operate in Punjab) while the remainder five operate in other parts of the country (excluding Karachi). For the good discos, the idea is to give 10-year concession with management rights to the private sector. The concessionaires will invest own resources and the weighted average cost of return shall be determined by Nepra - as in the case of K-Electric. For the other discos performing poorly, a five-year management contract is proposed with performance-based returns - the government will invest and share the benefit of reduction in losses with the respective private party.

Discos' management in private hands may not only improve revenue recovery from existing customers but may also help acquire new customers. Many industrial players rely on captive power generation. The government is persuading them with the use of stick to move to the grid. Private players can offer marketing carrots to lure them.

Five years ago, discos' inefficiency was the elephant in the room. Now, a much bigger monster is showing teeth. The cost of generation must be rationalized. Recently, the government renegotiated contracts with old IPPs. A similar treatment is warranted with the China Pakistan Economic Corridor (CPEC) and other new and upcoming IPPs. For the government to be seen credible, it is better to release old IPPs' due payment sooner than later. The National Accountability Bureau (NAB) must be taken out of the equation.

The Central Power Purchasing Agency (CPPA) supplies 650MW to K-Electric; but the deal has not been reached on commercial basis. This summer onwards, another 450MW will be supplied to KE. This should be on commercial basis - KE must sign a Power Purchase Agreement (PPA) to receive the incremental power.

With new plants coming up, there is surplus electricity. The government's plan is to retire old inefficient Gencos, which has been achieved partly. Combined with all the above-mentioned steps the government aims to curb the flow of Rs850 billion during 2021-23.

The second contour of the plan is directly subsidizing the partial gap. Right now, the amount of budgeted subsidy is Rs140 billion. The government's plan is to provide additional Rs740 billion in the next two years. This will invariably widen the fiscal deficit unless the government miraculously manages to increase the revenues.

Still, a one-third of the circular debt flow is to be dealt with. That is said to be met by raising power tariffs by Rs4.50 per unit - initially, the increase would be of Rs5.50 and then reduced to Rs4.50. Mind you, the government has already increased the tariffs by Rs1.95. The average tariff is at Rs16.5 and this will increase further to Rs21. This could well be counterproductive.

In the amended Nepra Act, this increase will be automatically passed on to consumers. The government will not have the option to delay it. The tariffs will be notified; and if consumer do not pay, the government ought to. The NEPRA Act eventually will undergo the required parliamentary process.

When this plan was presented to the PM, he declined the tariff increase. All IMF asks is to reduce the net flow to zero by 2023. If the government does it without increasing tariffs, the IMF should be on board. Power ministry is coining alternate options. One is to reduce or abolish the GST on electricity. Will FBR agree?

The second option is to restructure the debt of Chinese IPPs. In the next three years, the debt principal payment of CPEC IPPs is $2.8 billion (Rs435bn). This is in addition to the interest cost and return on equity (RoE). Pakistan has dry powder within the CPEC ambit. One option is to use this to pay Chinese banks in IPPs. The money will move within China and banks would be indifferent. This will give a three-year principal holiday to Pakistan and will have an impact of Rs1.5/unit. These debts are frontloaded - the projects are for 25 to 30 years while the debt is to be paid in the first ten. This is like pushing the can down the road but will help solve today's cash flow problems.

Another option is to end take and pay contracts with IPPs operating on furnace oil. 3,000MW is seldom used (4-5%), but the government pays Rs60 billion capacity charge on them. The government can buy them out by paying Rs150-200 billion as compared to Rs450 billion over the next seven years. The other option is to give these a further haircut (Rs75-100 billion) by letting them have the plants, but end take or pay contracts.

These steps would dilute the increase in tariffs. Even without, PM has the discretion of not increasing tariffs. The Nepra Act was promulgated through an ordinance. Eventually, it will pass through parliamentary process - just like amendments to the SBP Act. Parliament can change or altogether shelve it.

There is no plausible reason to further increase the power tariffs. The good domestic, commercial, and industrial users will move to renewables or captive plants - already industry and government are at loggerheads on converting from captive to grid. The better consumers cross-subsidize majority of the domestic consumers. Nearly 85 percent of domestic consumers are of 300 units or below consumptions. The tariffs for these are lower than those for similar consumers in India, Bangladesh, and Sri Lanka. On the flipside, industrial and commercial consumers pay higher tariff at home.

Pakistan is already less competitive with its peers insofar as energy cost is concerned. There is no way industry can grow and sustain at high rates. On pure economic principles, lower slab domestic consumers should pay their due cost. However, the practice of cross-subsidy is going for long. It is a kind of informal social contract. Breaking it has a huge political cost.

The PM is already under immense pressure to deal with inflation. It seems unlikely that tariffs will increase further. If at all, it would be a fraction of what is proposed. One school of thought argues that tariffs should decrease. That is to encourage consumption and to pick up the economic growth. Once the economy consistently starts growing over 5 percent, the electricity puzzle would solve by itself. Perhaps, it is the only way to control this circular debt monster.

Copyright Business Recorder, 2021