IPPs: Investor's perspective

Pakistan, a semi-industrialized economy, has relied primarily on agriculture for the most part of its existence. Despite a history of expropriation through nationalization, political strife, chokehold of bureaucracy and many other loose ends, foreign investors and some locals as well, did see tremendous potential when the GOP announced its first Power Policy in 1994.
That was an opportunity for Pakistan to develop as an economically attractive hub of investment which would not only tackle the power crisis but also provide employment opportunities and deliver economic growth. Well, it clearly did. We managed to dive out of the 'standstill'!
The electricity crisis in the country had resulted in shutdown of hundreds of factories, putting at halt the local production and costing billions of rupees to the economy in lost output, lost tax revenues etc. Pakistan, in the 1990s was short of at least 30% of the peak demand.
The government then decided to approve Water and Power Development Authority's (Wapda's) strategic plan for reorganization of the power sector, including incorporation of private capital and if then possible, privatization of at least parts of the power sector. The plan sought to meet three critical goals, firstly capital formation, secondly improving efficiency and rationalizing prices, and moving towards full competition over time.
Power Policy 1994 The idea of the Power Policy 1994 was to provide a policy framework to introduce private capital and consequentially reorganize the power sector through induction of Independent Power Projects (IPPs) which would be responsible for generation and transmission to meet the required demand.
Capacity purchase and indexation The policy ensured a two-part tariff structure guaranteeing minimum capacity purchase through a capacity purchase price part of the tariff, in addition to energy price, directly proportional to the amount of electricity sold by the IPPs, and offered a bulk power purchase rate to IPPs. The typical two-part tariff, fixed at the start for the entire tenure of the relationship between the IPPs and the Power Purchaser, has the fixed capacity purchase price, a fixed monthly cost to cover the costs and risks involved for the investors - which could be massive in an economy like Pakistan. This agreement entailed that the IPPs will maintain a capacity to supply electricity and the power purchaser will pay the IPPs a capacity charge directly commensurate with the capacity maintained by the IPPs.
It guaranteed that regardless of a change in future demand, the government would continue to purchase capacity at the agreed price with indexation mechanism for inflation, read PKR /USD indexation, exchange rate and interest rate fluctuations where applicable, etc. for the tenor. So, if inflation rates or currency devaluation takes a lead in future, the investors will still be protected. The fuel costs and maintenance costs etc., on the other hand, change with the volume of production and are as such pass-through.
The fundamental principle underlying such a contractual framework where investors are insulated from underlying economic risks through clearly stated terms and conditions are to limit as many risks as possible borne by the investors. In addition the GoP provided guarantees in the form of an Implementation Agreement to underwrite the performance of the power purchaser, and earlier on the fuel supplier as well, as all were and are GoP controlled entities. Most of these entities cannot stand without the GoP provided crutches; hence the need for GoP guarantees.
An important aspect of all of these contracts, more than 80 or so, is the indexation of PKR/ USD to equity related payments as well. It's also pertinent to note that IPPs are neither the first nor the only entities to have secured indexed contracts. A basic assumption in this case is that all parties abide by the terms of these contracts. And that is what the IPPs expected or at least hoped.
Current issue at hand Currently, IPPs are facing three major issues. Firstly, paucity of short-term liquidity because of the huge amount of receivables from the Power Purchaser. These receivables lead to the shortage of working capital resulting in hindrances to purchase furnace oil, diesel, and coal to keep the units running. Then there is the unpalatable business environment, a result of unwarranted investigations, unfair actions and a climate of fear targeting IPP owners, their employees and certain down-on-luck public officials as well. Power Purchaser's defaults, let alone overdues, on its contractual payments, capacity and energy, have furthered weakened the already vulnerable IPPs, and have been used unabashedly to force them to renegotiate, figuratively at gun point, and reconsider tariffs instead of honoring the contractual terms underwritten by their own sovereign guarantees.
Misconceptions The run-up to circular debt and the current economic slowdown is a subject of heated debate across multiple fora. Pakistan's circular debt stands at a whopping 1.4 trillion rupees, the highest so far. Where did this money go? Some was lost in T & D losses, some in theft, some was not recovered from defaulters, some is receivable from the GoP itself and some is receivable from the FBR itself. Some is on account of bad economic policies of the GoP, PKR devaluation. Period.
One can blame the IPPs as the devil, a number of other culprits are the major contributors to the current crisis. The solution lies in addressing these very crucial issues and taking action to treat the causes not the symptoms. This requires a clear understanding of responsibility and accountability that starts from an individual level and ends with the State, if only there is a realization.
Risk with future investments The current 'mess' does not only complicate the investment scenario at hand but also carries the risk of hampering any future investments, questioning the credibility of commitments, the value of the sovereign guarantees. Contractual enforcement pertaining to the current projects which have so far avoided NAB's attention by some twist of fate, is also on shaky grounds. They may be next visitors to the "KasuriChakki" equivalent at NAB regional offices.
The total value of CPEC projects is currently estimated at $62 billion. A major chunk of the CPEC investment, $34 billion, is going into electricity production and distribution in IPP/TIPP mode. These power projects are again under the umbrella of sovereign guarantees, with same tariff structure and conditions. Where on the one hand, CPEC power projects and CPEC in general are being seen as the game changer and a poster boy to attract future investments, signed agreements, many years into operations are not being honored.
(The views expressed in this article are not necessarily those of the newspaper)