The IPP conundrum

Recent days have seen consumers, including households, trade, and industry, demanding -- amid massive protests across the country -- that the government take practical steps in response to the ever-increasing electricity tariff, which is crippling citizens, industry, and exports.

The government is being asked to renegotiate agreements with Independent Power Producers (IPPs) to reduce capacity payments and align tariffs with market conditions. A renewed focus on reviewing these agreements and implementing structural reforms will be key to ensuring a stable, affordable, and sustainable power supply for the future.

There is no denying that IPP policies have been instrumental in addressing the country's energy needs, attracting private investment, enhancing the overall capacity of the power sector, and ensuring energy security. IPPs have added thousands of megawatts to the national grid, helping alleviate power shortages and introducing modern technologies and efficient management practices. While addressing challenges such as circular debt, regulatory inefficiencies, and high tariffs remains crucial for sustaining and furthering the benefits of these policies, there is a clear lack of political will and seriousness on the part of the government to address the issue of high-energy costs.

A review of IPP policies shows that the Power Policy of 1994 offered attractive incentives to private investors, including guaranteed returns on equity and long-term Power Purchase Agreements (PPAs) signed with the IPPs, primarily aimed at increasing electricity generation through thermal power plants using furnace oil, diesel, and/or gas. This policy attracted significant foreign investment and led to the establishment of numerous IPPs. The Hydropower Policy of 1995, however, failed to attract investors in hydropower.

The Power Policy of 2002 aimed at diversifying the energy mix by encouraging investment in gas-based, coal-fired, hydropower, and renewable energy. It introduced competitive bidding for new projects and encouraged efficiency improvements, further expanding the IPP sector and promoting private sector participation. The power policies of 2015 and 2021 emphasized renewable energy development, particularly wind and solar power. They strengthened the regulatory framework to ensure transparency and accountability, leading to the development of numerous renewable energy projects and contributing to a more sustainable energy mix.

Currently, there are 100 IPPs, with a cumulative capacity of 24,958MW, using various technologies and fuels such as thermal, hydel, wind-power, solar PV, and bagasse-based units. There are 42 thermal power plants using gas/RLNG with a cumulative installed capacity of 9,867MW, imported coal of 3,960MW, and indigenous Thar coal of 3,300MW. These IPPs are major contributors to the high electricity tariff, having a multiplier effect on inflation and the national economy. Key elements of IPP policies include various incentives and guarantees to private sector power plants. IPPs are offered cost-plus tariffs, ensuring a reasonable rate of return on investment.

The government provides sovereign guarantees mitigating investment risks. Various tax exemptions and concessions are given to reduce the financial burden on investors. Long-term Power Purchase Agreements (PPAs), typically spanning 15-30 years, provide revenue stability for IPPs. Take-or-pay clauses ensure that IPPs are compensated even if the power is not dispatched. However, various challenges and criticisms faced by IPPs include the accumulation of circular debt due to inefficiencies, payment delays, and tariff imbalances, resulting in financial strain on the power sector and affecting the liquidity and sustainability of IPPs. There are concerns over transparency and accountability in tariff-setting and contract enforcement.

The cost-plus tariff model has led to relatively high electricity tariffs, impacting affordability for consumers. Hubco, with 1,292MW installed capacity, is the pioneering IPP incorporated in 1991, which was later covered under the Power Policy of 1994, extending all the benefits, guarantees, and concessions, which led to an increase in bulk power tariff from agreed some paisa to 6.1 US cents per kWh when a dollar was equal to Rs30. Hubco achieved commercial operations in 1997. The development of this project was funded by the US, UK, and Saudi Arabia, supported by the World Bank, and co-financed by France, Italy, and Japan.

Subsequent investors were also allowed the same or similar tariff and concessions, ignoring the larger size of the Hubco power station compared to smaller Pakistani IPPs developed later under different technologies, with capacities ranging from 117 MW to 225 MW, and the fact that its total financing was from foreign sources. Ironically the same conditions and concessions, including capacity payments and payments in dollars, were agreed to by the government later even in the case of using indigenous fuels, such as Thar coal, wind, solar and hydel.

Renegotiating the PPAs of IPPs developed under various power policies aiming to reduce capacity payments and lower overall tariffs is not practical. This was tried in the past but failed, and a unilateral decision by the government is not likely to achieve any result this time either unless the IPPs volunteer. Twelve IPPs developed under the 1994 Power Policy have completed 15-20 years of power generation operations, and the validity of their respective PPAs expired long ago. Somehow, the respective PPAs were revalidated by the government in 2017. Revisiting PPAs, which are governed by British law, will amount to a violation of contract provisions. Major IPPs have been established using foreign financing from the US, European countries, and China -- and the government is committed to ensuring a return on investment in foreign currency.

In the case of rental power plants, Pakistan lost its case in 2019 against Karkey Karadeniz, a Turkish company, when the World Bank’s International Centre for Settlement of Investment Disputes imposed on Pakistan a penalty of $1.2 billion. Pakistan had taken up a case with the London Court of International Arbitration in October 2018 against several IPPs for being unable to meet capacity obligations and other issues, but after long litigation, both the government and IPPs decided in April 2023 to withdraw their respective suits. Any adverse action now will cause colossal damage to Pakistan’s credibility and its investment environment, which it can ill-afford at this juncture.

Admittedly, there are weaknesses in the government, besides flawed power policies and a lack of transparency in their implementation. There is no check, control, or audit of the IPPs. Like any other industry in Pakistan, such as sugar and cement, the power sector is a cartel influencing the government in policymaking and gaining undue advantages. An atypical example is that of capacity payments to some IPPs without generating a single unit of electricity during the year. For instance, Habibullah Coastal and Reshma Power did not produce any electricity in 2021 or 2022 or 2023, whereas Altern Energy remained inoperative in 2022 and 2023. Interestingly, total thermal IPPs generated 62,644 GWh by the year ending June 30, 2023 compared to 82,630 GWh in the corresponding period of 2022, registering about 25 per cent decrease.

The critical issue is non-payments and inordinate delays in payments to IPPs, as the power sector circular debt has now swelled to over Rs2.6 trillion. Given the conditions, the practical approach for the government to provide relief to the masses and industry is to withdraw multiple taxes on electricity bills levied effective July 1, 2024. These unjustifiable and illogical taxes amount to about 37 per cent of electricity consumed and shall thus provide significant relief to the consumers.

The writer is a retired chairman of the State Engineering Corporation, and former member (PT) of the Pakistan Nuclear Regulatory Authority.