Restructuring IPPs debt

Pandemic are days of force majeure. Countries, multilaterals and organizations are taking decisions which were commercially/politically incorrect in usual times. PM IK has requested restructuring of Pakistan external loans. It is time to hit on to the energy sector IPPs mess when the iron is hot. The growing capacity payments and build-up of energy circular debt is by far the biggest economic worry the country has in the medium to long term.

The capacity payment per annum was around Rs280 billion in 2016, and it is around Rs900 billion in 2020 and would reach Rs1,500-1,600 billion by 2024 in today’s PKR/USD value. There are two ways to dilute capacity charge per unit – one is to increase consumption of units and other is to lower the capacity payment by sitting with IPPs’ debtors on the negotiation table. Now with COVID, the consumption will fall further. The only way to sustain is to revisit the contracts.

The resolve to revisit unrealistic contracts and payment structures of IPPs was already there prior to the COVID-19. Now it is becoming a do or die situation. A committee formed under Muhammad Ali has submitted its report to the PM office. PPIB has summoned 30 IPPs CEO today to discuss heat rate test, foreign currency indexation, rescheduling the debt, O&M costs and other factors.

These all are important; but major chunk of capacity payments charge in coming few years is emanating from government’s owned IPPs, followed by those under CPEC and then the quantum of private IPPs come in order. Charity begins at home. By some estimates, 45-50 percent of projected Rs1,500-1,600 billion capacity payment per year by 2024 will be to government owned projects. If the government is able to redo the numbers, and then renegotiate on CPEC projects, private sector would automatically fall in place.

Restructuring the repayments and other anomalies is the only way out. Otherwise, sooner or later the country will default on its sovereign commitments to these IPPs. These contracts are quasi debt ensuring handsome equity return in dollar terms. The contract structures are less lucrative in other emerging economies. Higher returns are guaranteed to private IPPs because of the high risk. In high risk environment, there are days when you make high returns and in others, you make losses. Some have minted for years.  It is time for returns to be normalized.

In order to do so, government has to be smart and come up with setting up an example of herself. There are issues of old power plants (government and private) which are inefficient and these are over with the equity and debt repayments cycle. These should be shelved. In percentage terms, the capacity payments are higher in their respective total payment. This argument was presented by Younus Dhaga in an article yesterday; but the savings from these would be Rs58 billion.

This is peanuts relative to what is coming in next few years. For instance, K2 and K3 nuclear plants would have capacity payment each of Rs100-125 billion per year. These will be online in next 6-18 months. These are government projects funded by Chinese (not part of CPEC). The useful life of these plants is 60 years. PPAs are of 40 years. The debt repayment is in 12 years. Just by rescheduling debt of these two plants to its PPA terms, can save more from shelving all the old plants.

Then big hydel projects are coming up again owned by government (WAPDA). In 2019, the capacity payment was Rs160 billions and is projected to grow to Rs250-300 billion once Nelam Jhelum, Tarbela 4 and others are online. Some argue on the chunk is going in transfer of hydel profits to KP and Punjab. Yes, that is an addition since 2017. But it is mostly in arears and the bigger issue is of new expansions coming online.

Then there are RLNG plants. One plant’s capacity payment for March 2020 was Rs2.3 billion. That makes annualized payment at Rs27.6 billion. Three plants are operational and one is coming online. The total sum of these four would be around Rs100-110 billion per year. Some say government would lose on privatization of two plants. The net gains of restructuring are far higher than one-time payment of privatization. These have to be negotiated along with talks with Qatar on supply of RLNG.

Once these government plants are done and dealt with. The next stop is to reevaluate the CPEC coal projects. One project’s capacity payment is of $380 million and there are three of similar capacity. The payments would be in excess of Rs180 billion in today’s currency rate. The coal plants were costlier in terms of capex and fixed O&M relative to RLNGs’; but these were supposed to be cheaper. These coal projects are not only expensive but have a higher tax on environment.

Once these all are restructured, private sector negotiation could be much easier. And the bigger quantum is in government and CPEC projects. In any project in its first 10-year cycle, about three fourth of capacity charge is of paying debt (mainly) and return on equity. Hence, bigger savings are in debt restructuring. That will increase the interest payments over the cycle of project, but Pakistan’s bigger problem is of cash flow. That is generating circular debt and its servicing has a huge cost. Plus, in the longer term (after 10 years), the consumption will grow and per unit charge of capacity will dilute. Restructuring IPPs’ debt should be a priority.