A convenient scapegoat

The ongoing debate in the media is trying to pin all the current challenges on one sector: the IPPs. Arguments typically revolve around capacity charges paid to IPPs coupled with various extracts from the 2020 report by Mr Muhammad Ali on the power sector.

This is distracting from the real issues in the power sector without understanding the basics and context. It is always easy to criticize decisions retrospectively. The decisions made at the time, when the country was losing two per cent of its GDP due to power shortages, were probably the best possible based on country risk, investor appetite, available fuel/technology and power requirements.

The concept of IPPs was introduced by the government, in consultation with the World Bank and IFC in the early 1990s. This included a two-part tariff – capacity and energy charges, a global concept for developing countries. The goal was to cover the shortfall in electricity, trigger economic growth and remove government inefficiencies through the support of the private sector. This led to multiple private power policies and the establishment of several IPPs in Pakistan.

Capacity charges are now being blamed as the root cause of today’s high electricity prices without much understanding on composition or necessity. Capacity charges consist of fixed O&M (operations & maintenance), insurance, working capital, debt service, and return on equity (ROE). As can be seen, capacity charges cover the ongoing fixed charges for a plant that supplies electricity dedicated to the government. Capacity charges ensure IPPs remain available all the time. If an IPP is not able to provide electricity when demanded, capacity charges are not paid to IPPs and liquidated damages can apply.

Capacity charges apply to both government plants and IPPs. The current tirade against IPPs is misdirected as more than 80 per cent of current capacity charges are associated with government owned, CPEC and must-run plants. The reality is that Pakistan has surplus power available added over the last decade, doubling the installed capacity to 46,000MWs. New power plants have debt components frontloaded in capacity charges for the first 10-15 years of operations, adding to the high capacity charges challenge. The matter has further escalated due to rapid rupee devaluation and underutilization of plants.

The issue of surplus power has also been compounded by the fact that the country has not seen required growth to absorb installed capacity. This has resulted in considerable underutilisation of power plants. Capacity charges per unit to the consumer increases with underutilisation and vice versa, whereas the utilization of IPPs is controlled solely by government entities.

In FY24, the government estimated 40 per cent utilization of power plants, resulting in capacity charges of around Rs14/kWh. If utilization was 80 per cent, the capacity charges would have reduced to Rs8/kWh, translating to lower electricity costs to the consumer.

In addition to misunderstandings around capacity charges, snippets are being quoted from the aforementioned report on the power sector at various fora. There is a lack of acknowledgment that matters raised in the report were already addressed through contract renegotiations in 2021. Mr Muhammad Ali himself was part of such renegotiations which led to IPPs providing significant concessions in national interest. These concessions were estimated to bring around Rs800 billion savings to the national exchequer. The matter related to alleged excess past profits was agreed to be resolved through arbitration, which is currently under process. CPEC plants, however, were not part of the negotiations and should be considered to help further reduce the tariff to the consumer.

It is also confounding that termination of IPP contracts is being repeatedly suggested as a solution to reducing capacity charges. Premature termination will not result in material relief to the consumer; rather there are contractual and legal costs associated with this which would have to be funded by the government. Why not fully utilize infrastructure already installed and readily available? Terminating or revisiting signed contracts, backed by government sovereign guarantees, severely damages the investment climate in the country. This was demonstrated recently when a solar project was tendered twice by the government, but no bids were received.

I had the privilege to lead the process of establishing Attock Gen Limited (AGL) as the first IPP under the 2002 Power Policy, following a fair and transparent process. After scrutiny by PPIB and Nepra for almost 1.5 years, AGL’s groundbreaking was done by former president General Pervez Musharraf in May 2007 and it was inaugurated by former PM Yousuf Raza Gilani in April 2009. This was done with great fanfare as the country was in dire need to resolve the issue of non-availability of electricity – with no alternate solution to IPPs in sight.

I cannot vouch for other IPPs, but the allegations levelled against AGL, within the earlier mentioned report, were misleading. AGL’s capital cost was less than $1 million per MW which was internationally competitive. AGL’s declared 45 per cent efficiency was also much better than earlier IPPs’ efficiency with similar technology (up to 42 per cent), and significantly higher than government owned GENCOs (up to 30 per cent).

AGL is fuelled by indigenously sourced crude oil and low sulphur furnace oil without any transportation costs. Therefore, AGL not only helped plug the electricity demand gap, but did it at a competitive cost with local fuel and transparent pricing. Having first-hand experience in the process followed for AGL, I was open to any kind of audit or investigation during renegotiations. Nevertheless, we agreed to renegotiate in the larger national interest and voluntarily reduced ROE from 15 per cent to 12 per cent on foreign equity, gave up dollar indexation on local equity, and also agreed to share fuel and O&M savings.

Though the efficiency test is typically conducted for new plants, we also agreed to a one-time heat rate test. Since 2021, only the points related to IPPs seem to have been addressed through renegotiations while ignoring the other ‘bleeding’ segments which were also highlighted by Muhammad Ali in his report.

The transmission and distribution (T&D) sector has consistently been unable to invest in infrastructure and control losses, under recoveries and theft. In FY23, the cost to the power sector for transmission and distribution losses, under-recovery and theft amounted to approximately Rs400 billion which equates to almost 30 per cent lost units.

There are also bottlenecks, which seasonally hamper the system’s capability to transport cheaper electricity from south to north of the country, resulting in expensive fuels being used. Such incremental costs, in addition to other taxes and surcharges, may end up ballooning circular debt (Rs2.3 trillion at FY23 end) and doubling the per unit cost of electricity for the consumer.

There is no denying that capacity payments have escalated in recent years. However, they have primarily increased due to rupee devaluation, considerable capacity additions followed by underutilization of power plants. Therefore, there is a need to increase industrial growth, restructure international debt obligations for the power sector, and introduce T&D system reforms to minimize electricity costs for the end consumer.

Other aspects such as abolishing cross subsidies, introducing seasonal pricing, installing smart metering, enhancing competition through open access, and reducing reliance on imported fuels should also be considered to help mitigate the challenges discussed. We should refrain from trying to find ‘a convenient scapegoat’ and instead focus on the real issues that need addressing.

The writer heads Attock Refinery Ltd and Attock Gen Ltd. He can be reached at: adil@arl.com.pk