Multi-Year Tariff of KE: Nepra to hear reconsideration request on December 5

The National Electric Power Regulatory Authority (Nepra) has fixed December 5, 2017 to hear reconsideration request filed by Government of Pakistan for Multi-Year Tariff (MYT) of K-Electric determined by Nepra for period effective from July 2016 to June 2023. Section Officer (Tariff) Ministry of Energy (Power Division) in his covering letter has asserted that the Power Division has reviewed the contents of KE''s letter and feels that it is important that the Authority reconsiders its earlier determination to ensure that consumer interest, in terms of continuous and efficient service of delivery, is maintained.
Nepra has also framed certain issues for hearing regarding GoP reconsideration requests in the matter of K-Electric which are as follows; (i) in the matter of K-Electric as well as Discos, the Authority has determined the tariff based on recovery targets with actual write-offs duly allowed. And whether this request of the GoP to consider recovery loss of KE based on recoveries of 87.6 per cent is justified in the interest of consumers; (ii) considering spirit of privatisation of KE (KESC) and earlier correspondence of January 27, 2017 from Secretary Water and Power whether this reconsideration request for a performance based tariff structure similar initial MYT( 2002) is justified wherein efficiency gains in power generation as well as in Transmission and Distribution are to be retained by KE. iii - in the matter of all Discos, Wapda hydel and NTDC, the Authority allowed RAB based on the written down value of fixed assets. Whether this request of the Government to work out the RAB of KE based on capital employed (sum of equity plus debt) is justified; (iv) the tariff of IPPs, Gencos, Discos and NTDC: are all based on debt: equity ration wherein in any equity over 30 per cent is considered as debt. Whether this request of government to calculate KE''s tariff based on actual debt: equity considered over the allowed threshold is justified; (v) Nepra has already allowed KE a comparable return for its generation, transmission and distribution business. Whether this request of government to consider higher return to KE with US$ indexation also allowed on transmission and distribution business is justified; (vi) whether the determined MYT have any significant adverse implications on KEs'' consumers and; (vii) whether the determined MYT will turn KE into loss making?
KE in its letter to Power Division maintains that Ministry of Energy (MoE), Power Division is a key stakeholder in KE as the Government of Pakistan has a 24.36% shareholding in KE and is also responsible for the overall situation of electricity and energy in Pakistan.
Raising its concerns, KE management said that the determined MYT will have significant adverse implications on KE and consequently on the consumers of Karachi. The determined MYT will turn KE into a loss-making entity with significant cash shortfall over the next seven years. This will make the company''s operations unviable, un-bankable, unsustainable, and impair KE''s ability to undertake much-needed investments in generation, transmission and distribution which would lead to significant increase in load shedding and technical power outages.
As shareholders in KE and key stakeholders of the energy sector, this should be a matter of serious concern for MoE as KE''s inability to invest and improve Karachi''s power infrastructure will have material implications with significant consequences on the public and economy of Karachi and Pakistan, including but not limited to: (i) inability to bridge the growing gap between electricity demand and generation in Karachi;(ii) escalation of load-shedding throughout Karachi.
This would include industrial areas, which have been exempted from load-shedding since 2010. This will adversely affect the Industrial and commercial activities in the economic hub of Pakistan; (iii) drastic reduction in the quality, reliability and availability of electricity in Karachi over the next decade, along with de dining levels of customer service; (iv) jeopardize, a much needed, Shanghai Electric Power''s (a subsidiary of State Power Investment Corporation of China) acquisition of a controlling stake in KE. Negative precedent in relation to private investment in Pakistan''s power sector and potentially hampers the planned privatization of DISCOs.
This acquisition would go a long way in privatization of DISCO''s that will help government to reduce the burden of unaccounted inefficiencies in the operations. The termination of this transaction will not be in the public Interest and will mean that Karachi will not benefit from SEP''s investment plan and technical expertise;(v) on a national level, economic and social agenda of Government of Pakistan ("GoP") could be severely set back.
It is a known fact that electricity provision has a direct positive correlation with economic development and growth. Consequently, the load shedding will impact Karachi''s GOP through lost productivity, lost exports, lost FDI and funds inefficiently diverted to captive generation. This will slow Pakistan''s growth and would lower employment in Karachi. Finally, the shortage of electricity would also set back human development metrics in Karachi.
KE further stated significant essential costs such as Recovery loss have not been appropriately accounted for in the Determined MYT. Completely ignoring recovery loss while determining the tariff is not only contrary to ground realities but will also result in severe liquidity issues for KE, thus putting the Company''s planned Investments for the infrastructure of Karachi at risk.
The power utility argued that Nepra, by allowing bad debt allowance of just 1.69%, with impractical conditions and not recognizing the KE''s actual recovery of 87.6% as a performance measure in tariff, means a severe gap in cash flows for KE over the next seven years. As a result, the tariff determined is not cost-reflective and will continue to result in solvency issues for KE. This will directly impact KE''s investments planned to improve the available and reliability of supply to its consumers.
According to KE management, this will create massive liquidity issues and due to that a significant increase in load shedding across the city including industry. Therefore, it is imperative for NEPRA to recognize Recovery as a performance measure in the Base tariff and allow realistic improvement trajectory that the tariff remain cost reflective and does not lead to insolvency Issues for the distribution segment which is against the public interest and NEPRA tariff Rules.
Performance based Tariff Structure: The determined MYT is a fixed rate based structure which significantly curtails KE''s ability to invest and is not practical for a vertically integrated utility (VIU) which requires the flexibility to make additional investments in order to ensure affordable and reliable supply of power. Further, under the determined tariff structure, there is no incentive for KE to improve generation efficiency thereby reducing costs or to accelerate T&D investments.
Significant portion of KE''s infrastructure and distribution network are many decades old and must be replaced or rehabilitated at short notice to meet field conditions. A rigid investment plan does not provide KE with any flexibility to address these needs or to invest to meet these challenges as a result, consumers will suffer. Hence the rigid structure curtails KE''s ability to meet its public obligations which are to ensure smooth and reliable supply at all times.
In this regard, it is important to highlight that the performance based tariff regime during the last control period offered flexibility for the utility to invest and improve efficiencies while ensuring that the returns are capped through the built-in claw back mechanism. This resulted in KE investing Rs 130 billion across the value chain which were higher than the committed investment in the 2009 tariff petition.
This clearly suggests that the previous efficiency based tariff structure was effective in attracting the much needed investments and improved its operational performance which benefited the public at large while KE''s return was restricted through claw-back. This has resulted in exemption from load shedding in more than 60% of the city including all industrial zones.
Hence the performance base tariff given to KE since 2002, designed through advice from World Bank and PwC International, was the very basis of the privatization and in the greater public interest. Going back to a cost based/ fixed rate based tariff regime at this stage would be a regression and would be unfair and against the public interest.
The performance based mechanism allowed KE to improve generation fleet efficiency levels from 30% to 37.4% and T&D loss from 36% to 22.2%. The benefits of these improvements have been passed on to the consumers by using the current generation efficiency (37.4%) and T&D (22.2%) levels in the base tariff which demonstrate that the performance structure worked well in reducing costs over time.
Therefore, going forward if the generation efficiency improves eg from 37% to 42%, then KE should be allowed to retain that increment from 37% while ensuring the benefits are shared with consumers in the form of an agreed claw back mechanism. This will incentivise KE to invest in bringing efficiency as opposed to current tariff which provides a disincentive to do so.
Therefore, a performance based tariff structure as done in the previous MYTs be allowed to KE where the onus to invest and make return is on KE and consumers are not required to pay in advance. Nepra should set minimum investment requirements and ensure that KE adheres to these targets. Also, Nepra should provide a transparent mechanism for the claw-back to ensure that excess profits are not made and the benefits of the efficiency improvements (beyond the thresholds) should be shared with the consumers.
The performance based structure has proven to achieve most of the regulatory and power sector objectives, including protection of public interest due to improved service and reduced load shedding: i) attracting investment and setting minimum investment amounts; ii) improving customer service and quality; iii) reducing costs over time; and iv) providing investors with adequate incentives and returns to invest while consumer are protected through claw back mechanism
Regulatory Asset Base (RAB) and Debt to Equity Profile: The definition of RAB has been revised from capital employed (ie sum of equity and debt) to written down value of fixed assets (on cost basis). Moreover, the base tariff has been determined on the basis of a notional debt equity structure of 70:30 instead of actual, whereas under the Previous MYTs, no such restriction was applicable to the Company.
KE, being a 100 year old company, as opposed to a Greenfield project which has a 70:30 debt/equity locked at time of financial close, cannot be expected to have such debt/equity ratio and that too overnight. Also, KE only became profitable (for the first time in 17 years) in 2012. Prior to that, raising debt was difficult and most of the investments were in the form of equity. KE''s debt capacity is not akin to that of an IPP given IPPs have 25-30 year tenure of tariff and debt is pass-through over the term of the loan.
Furthermore, as KE has a different tariff structure to other power sector companies, therefore, instead of a notional debt equity assumption of 70:30, tariff should be based on actual debt to equity for the purpose of determining the base tariff with a targeted Debt to Equity in the future. Otherwise, investments would not be made being unviable, which would lead to drastic consequences for KE''s consumers.
KE further argued that due to unrealistic and impractical tariff set, the cash deficit over 7 years would be in excess of PKR 400 billion. This shortfall will result in breach of minimum thresholds required by lenders for financing the existing and future projects of the Company. This will have severe consequences. Therefore, it is important that KE''s tariff should be cost reflective with the incentive to invest through performance based mechanism along with the claw back mechanism to ensure investment is made in the infrastructure to provide smooth and reliable power to citizens of Karachi and adjoining areas of interior Sindh and Balochistan.
Further, SEP''s acquisition, which is a significant breakthrough in having a strategic Chinese State-owned enterprise operating power distribution business in Pakistan, will be terminated. The termination of this transaction will not be in the public interest and will mean that Karachi will not benefit from SEP''s investment plan and technical expertise.