The chaos in the power sector: Part - I

There is a reason the power sector puzzle, which has drained the economy and harmed citizens, has stayed unsolved. It is because no one wants to fix it.

The issue is too complex and seized by too many interest groups to lend itself to resolution. The days of citizens’ misery will not be over soon. While many columnists and the social media are consumed by the problem, no one in position of authority has said anything meaningful.

What is the problem? There are enduring issues at the heart of the crisis. It began in the 1990s, when an international financial institution (IFI) recommended that we source private investment to fill the capacity gap in the sector. Power shortages and line losses had constrained the economy. The government also decided to ‘unbundle’ Wapda, an organization that had built two of the world’s largest storage dams. ‘Unbundling’ is fancy language for breaking up an organization into parts.

The government separated Wapda’s several power functions: production, transmission, distribution and purchase of power. Wapda was unable to get funds from the government for new investment, but it did not need major surgery. The IFI helped give birth to the 1994 private power policy. Since then, the sector has been in a tangle that each government has found hard to straighten. Power was short then for want of investment by the government. Today, we have surplus capacity that, because of the cost and transmission constraints, still does not reach the consumer. Yet, they pay for it. This was Washington Consensus economics at the expense of our businesses.

In the beginning, foreign private investors needed comfort to invest. They received power purchase and fuel supply guarantees and an implementation agreement from the sovereign. Through ‘take or pay’ capacity payment and indexation, the government of Pakistan took on interest, exchange and inflation rates risk.

Cost of fuel was a pass through item. And there was RoE guarantee. The FBR exempts power producers from income tax. Projects were allowed debt of up to 80 per cent, whose repayment was assured by the guarantees. Open ended indexation without any cap, made worse by the sharp fall in the rupee, has meant ever rising tariffs.

As the government took on all the risks, FDI poured in. Eager to get the investment quickly, the government did not call for competitive bidding. It did not lay requirements for plant efficiency or the type of source fuel. Nor was the project cost important. All this added to cost and consumer tariff.

The government may have assumed that the consumer had bottomless resources to pay for power. But, as consumers could not bear the cost and DISCO losses stayed high, the government had to pay a subsidy. And the government too does not have the means to pay the dues in time. So, circular debt has become the new constant.

Usually, economies adjust policy according to circumstance. After the power policy of 1994, power generation capacity grew, and within a few years was more than demand. Yet, the Pakistan government did not change the scheme to reduce its own liabilities by lowering the incentives for new IPPs. It continued to allow more IPPs with the same generous incentives, sticking to the scheme even when there was no need for more power. Now, as supply exceeds demand and transmission is short, the cost to the consumer and the subsidy amount has become astronomical.

At first, FDI came from firms with experience in the power sector. After several years, they sold their equity to Pakistani firms. No Pakistani firm had experience of the business. Yet, generous incentives assured high profits. PIDE says there is no example of such high returns on investment anywhere.

What is the government’s response? The consumer and the taxpayer pay for the follies of decision-makers and their inability or unwillingness to correct a wrong. Rather than fix the conundrum, government actions in the last ten years have multiplied the distortions.

Instead of protecting the consumer, the government got into the act of IPPs itself. In burlesque disregard of citizen and business needs, there are now government owned IPPs with 6,650MW thermal capacity. Even a GENCO owned by Wapda was converted to IPPs. In 2023 alone, the government of Pakistan owned IPPs yielded a net profit of Rs67 billion, not including the 1,263MW Punjab Thermal, which began operations in 2023.

The fascination with IPPs was such that the government chose to use the bulk of CPEC and Saudi aid to add IPP capacity. During 2014–2023, we added IPPs amounting to 16,318MW. While generation capacity grew to 45,000MW, our ability to transmit the power is less than 25,000MW. Yet, decision-makers binged on new IPPs.

Since 2021, when the finance ministry has shown subsidy as a separate head, the government has paid about a trillion rupees yearly. The travesty of the private power policy is shocking. Even at present rupee value, the amount needed in the 1990s by Wapda to increase capacity was perhaps less than the amount paid through high tariffs and subsidies.

PIDE estimates that in the last two decades consumers may have lost as much as Rs4 trillion from high tariffs. Taxpayers have paid trillions more. The loss to the economy from demand curbing high tariffs and taxes is in addition. Since its break up, Wapda has built no new storage. Like the rest of the economy, it too is busy making ends meet.

As the cost of power produced by IPPs varies greatly, from under Rs5/unit for Thar coal to over Rs40 for RLNG, there was a need for a market for power. Decades after Wapda’s unbundling, a market for power is still in the making. Government-owned CPPA is the sole buyer of power on rates determined by Nepra. And the merit order, i.e., the cost of power produced, does not matter much. Capacity payments reduce its relevance.

Let us recap the scenario of the power sector. Generous incentives for private power production increased the cost of power for consumers. Add to that ‘take or pay’ provision on capacity and the consumers pay for power they do not use. More so, consumers pay for DISCO losses estimated at several hundred billions. And allegedly, the cost of projects was 20 per cent more than comparable investment made elsewhere. The project cost too feeds into the tariff.

We also did not have the capacity to transmit the new power. Some of the new IPPs source equipment and fuel from companies within their own group. We cannot rule out transfer pricing. This scenario counseled caution, but the government was having an IPPs blast.

As per Nepra, in June 2023, the amount owed to IPPs was over Rs1.5 trillion (in addition to the Rs765 billion with Pakistan Holdings). Of the Rs1.5 trillion, Rs700 billion was for capacity payment, Rs560 billion was the price of energy and over Rs200 billion for interest on late payment. It is an object lesson in how not to run public policy.

To be continued

The writer is chair and CEO,

Institute for Policy Reforms. He has a long record of public service.