The 1994 Power Policy’s ‘door-crashing’ offer, designed to attract private investment in Pakistan’s power generation sector, hinged on the inclusion of capacity charges.
The 1994 Power Policy’s ‘door-crashing’ offer, designed to attract private investment in Pakistan’s power generation sector, hinged on the inclusion of capacity charges.
This provision, added just before the policy’s enactment and absent from the original recommendations made by the Prime Minister’s Task Force on Energy, served as a pivotal element in reshaping the sector’s landscape. Capacity charges, covering returns on equity, debt repayment, interest, and fixed operation and maintenance (O&M) costs, were all indexed to future cost increases. This provision, often viewed as the root of the sector’s issues, transferred almost all risk to consumers while insulating Independent Power Producers (IPPs) under sovereign guarantees.
The policy essentially stated that “non-purchase of electricity will not affect the smooth operations and investor’s profits as envisaged in the base tariff profile.” As a result, consumers were forced to pay capacity charges whether a plant produced electricity or not -- an inclusion that has continued to burden consumers to this day.
The policy received overwhelming interest from investors, with the US energy secretary even calling it “the best energy policy in the world” that year. Sponsorship of IPPs soon became a political status symbol, much like owning textile mills or sugar factories in earlier decades. Initially, 15 IPPs were commissioned, growing to 100 today, with 52 per cent government-owned and 28 per cent privately-owned. Over the last decade alone, IPPs received Rs8.344 trillion, with an additional Rs2.1 trillion expected by FY2024-25. Despite an installed capacity of 45,885MW in FY2022-23, Pakistan generated only 15,756MW, leaving 30,128MW of excess capacity that consumers still paid for through capacity charges. This is economic oppression in one of its starkest forms.
The fallout from the 1994 policy, as foreseen by many national and international observers, was inevitable. The World Bank, a key player in reforming Pakistan’s power sector, later acknowledged these flaws in a 2001 report, calling it a “learning experience”. The report outlined several core issues within the power sector: tariffs that were lower than production costs, lack of a regulatory framework, widespread theft, poor recovery rates, and significant line losses. It also noted that utility companies’ operational capabilities fell far below acceptable standards.
Most importantly, IPP selection criteria did not follow a least-cost expansion approach, lacked transparency, and were riddled with financial instability. These and other delays in reform implementation, coupled with irrational tariffs, exacerbated the sector’s challenges. The report further highlighted that the transaction design between IPPs and utilities exposed Pakistan’s power sector to multiple risks. Regrettably, little has changed in the decades since.
By the mid-1990s, public perception began to view IPPs as a costly burden and tariffs as prohibitively high. This perception was cemented in 1998 when a dispute arose between Wapda and Hubco, with both parties trading corruption allegations -- a controversy that even ensnared the World Bank.
Ultimately, the case was settled out of court through World Bank intervention, discouraging further litigation, a stance reinforced by subsequent cases like Reko Diq. Notably, Hubco was not covered by the 1994 Power Policy and was thus not subject to the same capacity charge clauses, making it an inaccurate comparison that has only muddied policy discourse.
The Pakistani government’s initial attempt to manage the 1994 policy’s fallout came in 1997, but it avoided addressing the core issues. Efforts included pressuring IPPs to reduce tariffs and even issuing contract termination notices in 1998 -- an action that damaged Pakistan’s global image. These measures resulted in slight tariff reductions in exchange for contract extensions.
To rectify past errors, the government introduced the 1998 Power Policy, which included competitive tariff bidding, foreign exchange conversion restrictions, fuel limitations, and reduced tax exemptions. However, it failed to attract new IPPs. Over the years, ten additional power policies have been issued, each retaining capacity charges as a core component. The transition from the 1994 policy to regulatory oversight has been, at best, a descent from bad to worse, culminating in the present-day power crisis.
Nepra should replace its merit order system with competitive e-bidding among IPPs. This could involve periodic electricity purchases at current input costs, with final adjustments upon contract expiration. Such a system would also reduce opportunities for collusion and corruption
Nepra’s establishment in 1997 was intended to enable regulatory oversight across the power sector but has largely failed to deliver. A special report from the Senate Standing Committee in 2020 expressed grave concerns about NEPRA’s competence and ethical standards. The report highlighted serious malpractices, noting that “the committee expressed reservation on the credential and appointment of chairman and members; there were serious malpractices carried out by IPPs to earn huge illegal profits and the authority had not paid due attention to prevent it. The accrual of IPPs’ profit not being very sensitive to allowed returns, which was 7 per cent part of the tariff, rather heavily dependent upon the O&M cost, fuel cost, and financial charges, which was 90% part of the tariff.” The committee further discovered that certain IPPs had misreported data, extracting an additional Rs39.020 billion from consumers.
For decades, these issues have persisted. Capacity charges continue to burden consumers, upheld by sovereign guarantees and a regulator hindered by nepotism and corruption. While experts have proposed various solutions, such as cost assessments and tariff reductions, the Capacity Charges dilemma requires a comprehensive approach:
1. Government-Owned IPPs’ Capacity Charges: The government did not intend to utilise the 1994 Power Policy, which was solely meant to attract private investment. Government-owned IPPs should immediately cease collecting capacity charges as per the original policy. Instead, consumers could be charged ‘alternate capacity charges’ that cover only decreasing debt repayments. Interest payments would be tax-deductible, and no return on equity would apply. ‘Alternate Variable Energy Charges’ would be indexed to actual costs and payable in rupees, covering fuel, fixed, and variable O&M costs, with all tax-deduction benefits directly benefiting consumers.
2. Privately-Owned IPPs’ Capacity Charges: The foundational principle of an ‘Arm’s Length Contract’ -- where both parties operate in their own interest -- was disregarded, with sovereign guarantees unfairly benefiting IPPs. Under an ‘Alternate Capacity Charges Regime’, IPPs could maintain a return on equity to encourage operational investment while being paid only for decreasing debt repayments.
Interest repayments would be covered by tax-deductible interest, while Fixed O&M charges would be covered by the owner’s equity return. ‘Alternate Variable Charges’ would be indexed to actual costs, payable in rupees, covering fuel and variable O&M costs, with all tax-deduction benefits passed directly to consumers.
3. Litigation: Legal precedents from other countries demonstrate the feasibility of renegotiating contracts under financial hardship. For example, Kenya’s government negotiated tariff reductions due to financial hardship, while Ghana and Mexico both renegotiated unsustainable energy contracts. A similar approach in Pakistan would require the government to engage with IPPs to negotiate public interest terms, especially after dissolving its own IPPs.
4. The Doctrine of Hardship: Belgium’s ‘Doctrine of Hardship’ has been applied to inflexible long-term agreements, enabling renegotiation when economic changes render the original terms unsustainable. Italy’s Supreme Court used this doctrine to amend long-term gas contracts. In Pakistan, adopting this doctrine could provide legal grounds for renegotiating IPP agreements based on the altered economic landscape.
5. Competitive Electricity Procurement: Nepra should replace its merit order system with competitive e-bidding among IPPs. This could involve periodic electricity purchases at current input costs, with final adjustments upon contract expiration. Such a system would also reduce opportunities for collusion and corruption between IPPs and regulators over reimbursable costs.
Real change requires decisive action, but who will cast the first stone? A former energy minister recently proposed initiating legal proceedings against IPPs but has since withdrawn from the scene.
Some issues in Pakistan, especially those in its power sector, seem immovable, persisting in one form or another for over fifty years. Those invested in the status quo will undoubtedly resist these proposals. As the saying goes, “The Almighty will not change the condition of a people until they change what is in themselves.” Are we prepared to make this change, in this arena or any other?
The writer is a chemical engineer.
