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Coronavirus
LOW Source: covid.gov.pk
Pakistan Deaths
28,328
1624hr
Pakistan Cases
1,266,826
62224hr
1.4% positivity
Sindh
466,750
Punjab
438,433
Balochistan
33,149
Islamabad
106,571
KPK
177,132

Decades long poor planning and flawed policies in the energy sector have finally brought matters to a head and until and unless some bold politically challenging measures are not immediately taken the situation would further exacerbate.

Decisions favouring independent power projects at the cost of the consumers and the treasury began in 1991 and continued till 2015: (i) on 1 August 1991 Hubco was incorporated as the first independent power producer (IPP) in the country with four projects listed under China Pakistan Economic Corridor, (Nawaz Sharif was the prime minister from 1990 to 93); (ii) 1994 power policy (Benazir Bhutto was the prime minister and Ghulam Mustafa Khar Minister for Water and Power); (iii) 2002 policy (Musharraf was President as well as Minister for Water and Power); and (iv) 2015 power policy (Nawaz Sharif Prime Minister, Khawaja Asif Minister for Water and Power). The overarching objective of these policies was to end load shedding that was not only compromising the growth rate and its consequent impact on unemployment but was also generating general public angst against the administration.

Setting up Hubco, and 1994, 2002 and 2015 power policies made three assumptions. First, that the rising energy shortfall must be met through higher generation, with all other associated infrastructure ignored including distribution and transmission networks which remain major lacunas in vacating the country's generation capacity today.

Second, even though hydel is the cheapest source of electricity, water flows fluctuate seasonally and additionally dams require annual maintenance during which electricity from this source is not available. In this context it is relevant to note that: (i) Pakistan is a lower riparian country and India has constructed dams on its side of the Line of Control which has compromised the water flow into Pakistan over time; and (ii) Pakistan was warned decades ago that it is a water-stressed country. Today the International Monetary Fund (IMF) ranks Pakistan third globally among countries facing acute water shortage.

And finally, the incentives offered to the private sector to invest in Pakistan's electricity system had to be more than on offer by other countries, and it is in this particular context that political opponents found ample room to denigrate their opponents' policies - a practice that continues to this day.

The basic policy framework was laid with Hubco and followed in 1994 by the Benazir Bhutto government which faced a 2000 MW shortage during peak hours, particularly during low river flows. Demand was acknowledged as being suppressed as electricity was available to only 40 percent of the population. Generation companies (Gencos) were government owned and came online at least two decades earlier and were rarely, if ever, upgraded. Thus to compare Gencos with projects installed under subsequent policies was grossly unfair.

Be that as it may, the incentives offered to IPPs were very generous and included: (i) cost-plus-return in US dollars with an internal rate of return of 15 to 18 percent over 20 to 30 years (indicating that many are near the end of their contracts today) after covering operational costs; (ii) debt to equity ratio of 80:20 (though most opted for 75:25) backed by sovereign guarantees (which raised the government's indebtedness) and the option to go for arbitration abroad, a reflection of the lack of faith in Pakistani administrations to keep to the terms of the contract as well as the judicial system; and (iii) IPPs were to be paid Energy Purchase Price (EPP) and Capacity Purchase Price (CPP) every month including fixed costs (irrespective of the type of fuel used), debt servicing and a return on the investor's equity irrespective of electricity purchased or not by the only buyer - the government. The tariff was set at 6.5 cents, considered too high at the time by international standards.

Sartaj Aziz, a PML-N stalwart, pointed out that this policy led to a reversal from 60:40 to 30:70 in favour of thermal capacity (based on imported fuel).

The 2002 policy adopted many of the premises of the 1994 policy though by that time a regulator was tasked to set the tariff based on EPP and CPP. To ensure sustained interest of the Sponsor during the entire life of the project, the sum of EPP and non-debt related CPP was to remain constant or increase over time while the debt-related CPP stream was to match the loan repayment stream. Separate components in the CPP and the EPP subject to adjustment for variations in the exchange rate between the Pakistan Rupee and US Dollar were allowed between the reference date and the date of payment. Adjustment for exchange rate fluctuations was to be effected quarterly.

These conditions as per a recent inquiry report, accounted for the following disturbing statistics: (i) 16 out of 17 projects invested a combined capital of 51.8 billion rupees and earned a profit of 415 billion rupees and dividends of 310 billion rupees as per financial statements available with the regulator; and (ii) during the past eight to nine-year operational period, these companies earned 203 billion rupee in profit against combined investment of 57.81 billion rupees; and after adjustment for debt, the companies earned 152 billion rupees and made dividend payments to the tune of 111 billion rupees.

The Khan administration has successfully renegotiated with IPPs established under the 1994 and 2002 policies, with invaluable assistance from intelligence agencies. However, agreed payment to those IPPs established under 2002 policy remains stalled due to the ongoing investigation by National Accountability Bureau (particularly against Chunian) though the option to subtract the amount agreed to be paid and the amount identified as being over paid can be easily adjusted. The gains from these negotiations have been estimated at around 800 billion rupees over 30 years with the consumers benefitting less than 37 paisa per unit.

Today the problem is with the rising circular debt - from 1.2 trillion rupees inherited by this administration to around 2.6 trillion rupees. The main cause is traceable to capacity payments which incidentally are not unique to Pakistan; and are payable in other countries but by the end consumers to secure supply (currently being debated in Germany after it decided not to rely on nuclear power plants). In some countries the option of selecting from multiple supply sources is available though in Pakistan the government remains the sole buyer of electricity and therefore capacity payments are subsidies paid for, from the taxpayers' rupees.

The narrow fiscal space that all our administrations have contended with and, needless to add for which they themselves are responsible for (the Khan administration has set a record by budgeting an unsustainable deficit in excess of 8 percent in the three years of its tenure) have been unable to disburse the subsidy required to fund the capacity payments. This year the government has budgeted 330 billion rupees against the requirement of 500 billion rupees - a shortfall that would be parked under circular debt.

And why have capacity charges risen from around one-third of total generation cost in 2018 to two-thirds today? New generation capacity due to the completion of the projects under CPEC and net hydel profits being paid to Punjab and KPK.

The donors (World Bank is the lead agency in this sector) legitimately argue that the rise in capacity charges (given the fact that a contract is binding with the option of project sponsors to seek arbitration abroad which has already cost the government millions of dollars) must be met either through: (i) renegotiating with the Chinese companies though to date this has not borne any fruit; or (ii) raise tariffs and reduce subsidies as they are not targeted (24.5 million domestic consumers - 99 percent are receiving a subsidy).

The public and the productive sectors are clamouring for: (i) affordable electricity and in this context building dams and renewables may theoretically be the way forward but one would hope that appropriate studies have been carried out to ensure that sufficient water would be available; and (ii) uninterrupted supply which remains a challenge in spite of generation capacity in excess of demand.

The government is renegotiating with the IMF as project sponsors under CPEC have refused to renegotiate the contracts and is resisting a tariff rise while doing little to check its budgeted expenditure. Something has to give and one would hope it is out of the box thinking with respect to expenditure and revenue generation.

Copyright Business Recorder, 2021

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