Tackling the energy mess

Last week, Chief Justice of Pakistan took notice of excess payment made to a few independent power plants (IPPs) in relation to the circular debt. These IPPs have been accused of seeking rent and making money above the government contractual obligations, but that is a small fraction of energy mess the country is dealing with - the country is seemingly trapped in capacity, and the magnitude of problem is much higher than it was in the 1990s.
The problem of circular debt started in around 2006-07 when the oil price had started heading north and the build-up of debt has not stopped to-date - on average around Rs 200 billion per year of fresh circular debt is created since to push the fiscal space to its limits. The overall stock of circular debt is standing in the vicinity of Rs 2-2.5 trillion with some above the line while the rest hidden in public sector entities.
"We cannot kick the can down the road because we have run out of the road". In the past twelve years, the problem has not been resolved and the debt kept on piling on the government balance sheet; now there is no buffer to absorb it any further. The finance, energy and information ministers first have to create awareness of the gravity of the issue to generate political capital for tough decisions of energy prices upward revision, and on deregulating energy market and privatizing gas and electricity distribution companies. Subsequently, these steps have to be taken in chronological order.
There is no time to do politics on the issue any more, the electricity tariffs have to be increased in proportion to the gap. The government's recent tariff revision is simply not enough as even after doing it, the yearly subsidy, at current consumption mix, stands around Rs 250 billion. That is too high a number, given the tight fiscal space.
The problem is in government fixing the prices as it is politically tough to pass on the impact to the consumers. That is where the IMF comes in handy. In days of heightening oil prices, the government was not used to pass on the fuel impact to consumers till the IMF made this happen. The previous government kept on passing the fuel benefit to consumers as both energy mix and oil prices moved in favour of lowering the fuel cost component.
The power mix has moved from expensive furnace oil to cheaper gas and coal options with new plants, having better efficiencies. The benefit of variable cost was passed to the consumers - average fuel cost of NTDC system reduced from Rs 7.9/unit in 2013 to Rs 5.5/unit in 2017. On the flip, the base tariff (fixed cost) revision did not take place along with additional capacity charge.
Had both variable cost and base tariff moved in tandem, the base tariff revision required would have been much lower. The IMF may now ask to keep the final tariffs closer to the NEPRA determined tariffs. This will be much easier under an IMF programme than without one.
That is why it is imperative to deregulate the energy market and government should come out from fixing the energy prices. In early 2000s, telecom market was deregulated and today telecommunication is cheap in Pakistan. Prior to that, telecom prices were too high and access to services was too little. The sector is revolutionized in the past fifteen years and that can happen in energy sector too, if the government plays it right.
It was responsibility of distribution companies (discos) to forecast demand and the government should have allowed new IPPs on guaranteed returns (take or pay policy) in the vicinities where there was demand supply gap. Anyone else wanted to build power generation plant should have been on the basis of take and pay.
However, discos did not have the capacity and politically charged decisions were taken with less economic sense. The demand gap was calculated based on peak hour load shedding, without incorporating captive power generation and other avenues deployed by consumers themselves.
The industry has largely moved to the captive power plants (CPPs) and still prefers that over grid supply for various reasons. In Punjab, low reliability of grid is the main issue - the interruption cost is too high for industry which is a norm due to tripping issues and that is why industry prefers own supply despite the fact that grid supply is enough. In KP and Sindh, the price distortion is making captive generation on gas the preferred option as natural gas is much cheaper there.
The problem is of low magnitude in K-Electric domain where if any factory or plant is running on grid, it has to contractually buy the electricity from the grid. The KE invests in transmission to ensure no interruptions and it does not supply electricity at all to those industries which are running on CPPs.
In case of rest of the country, discos' grid is supplying to anyone who wants to buy anytime. Industrial costumers move to grid at their choice, and when they do, tripping starts. The discos should make long term contracts with the industrial players to remain on grid, if they chose it, and the discos should invest in grid to ensure uninterrupted supply.
However, it is hard without building requisite capacity in discos and without empowering them. That is one reason for discos to privatize, others are to reduce corruption and to stop supplying to those who do not pay. The government should involve local investors in it and let the discos become wholesalers with small to medium players to retail in pockets.
The discos should invest in transmission and distribution networks based on their own assessment and risk. The government should increase the tariff today and work on deregulating the energy supply system, and incentivize economization of energy use.