Sell energy or pay capacity

Pay for what you use. Even though this is the common modus operandi in most commercial contracts, Pakistan’s IPPs get paid even when the government does not buy electricity from them. This is thanks to how take-or-pay contracts became the norm to woo investors in setting up power plants while mitigating their risk.

Even though it did manage to attract investments, the take-or-pay policy also brought a huge quantum of capacity payments as liabilities, also known as the “capacity trap.” The government has repeatedly been the victim of rising capacity payments which have in turn fuelled a vicious cycle of never ending circular debt.

According to Nepra’s latest State of Industry 2017 report, capacity payments for power plants were around Rs280 billion in the FY16 and reached more than Rs350 billion in the FY17. The regulator expects them to be roughly Rs490 billion in the FY18.

Now the only way to decrease the burden of these capacity payments is to increase the number of units sold. But the way things stand currently, distribution companies and the transmission system have severe supply side constraints. The capacity cost per unit of energy sold was almost Rs3.4 in FY16 and Rs4.1 in FY17. This translates into an increase of Rs0.7/unit or 20 percent compared to a 6.2 percent growth in energy sold in the FY17.

What is worrying is that in order to keep the capacity cost at this same level, the energy sold would be required to be increased by at least 30 percent from FY18 to FY19, according to Nepra. Failure to do so would increase the capacity cost per unit to Rs5 which will be another 22 percent increase over the FY17 cost.

Also, if the capacity payments are to be kept at the same level of FY16 i.e. Rs3.4, it would entail increasing the amount of energy sold by 57 percent in FY19 over FY18. But this is next to impossible and the regulator thinks the same. This is due to the bottlenecks in both distribution and transmission including high loss feeders and low recoveries.

Inefficient plants automatically benefit from committed capacity payments. Government run power plants which have low utilisation factors and rank extremely low in the merit order received Rs39 billion in FY17 and should be phased out at the earliest.
Granted the system now has additional power generation capacity. But energy affordability is of paramount importance too. In order to balance out the effects of these exorbitant capacity payments, the fuel cost has to come down. But this is hardly the case.

The average fuel cost has gone up by 14 percent from last year, and the total fuel component bill for August 2018 was 35 percent higher year-on-year, with 10 percent more generation. Gas prices have increased and gas based power plants will now pay 40 percent more. Given that share of gas is 15 percent, it will increase the fuel price component by 5 percent. Brent crude crossed the $80/barrel mark recently and that will drive the overall fuel component higher.

So an increase of almost 20 percent in capacity payments by next year coupled with a rising fuel cost component is sure to drive tariffs higher. It is imperative then, to make an active effort to push Discos to plug the leakages in their system and increase the number of units sold. The recovery ratios need to be increased to 100 percent and the use of technology to track electricity flows needs to become a reality. Failure to do so would result in the circular debt getting even uglier.