Incentivising consumption

Pakistan has surplus power capacity, capacity costs of which are paid by all electricity consumers. Such capacity may be deemed as surplus due to successive years of low-growth, but it may not be considered surplus if the country starts growing at a rate which is a few percentage points higher than the population growth rate. Soon enough, any such surplus may turn into a deficit if planning remains reactive.

Surplus capacity is not a bad problem – it is a good problem. Electricity consumption has a strong direct correlation with overall industrial, and economic growth but it needs to be affordable, such that industries remain competitive, while its share of household budgets remains low. Despite surplus capacity, consumption remains low, mainly due to high prices, which are largely a function of debt repayments associated with long-tailed power projects and other inefficiencies, including commercial and line losses.

There is surplus generation capacity, but it remains unutilised. However, there will always be a price at which utilisation of such capacity can be increased. Such a price is one where the cost of producing one additional kilowatt-hour (kWh) of electricity matches with the price that the buyer is willing to pay for electricity. Important to note here that all fixed costs, which are referred to as capacity costs, are already being paid – thereby generating on additional kWh of electricity would only incur additional variable (mostly energy) cost.

The recently announced package by the government that incentivises electricity consumption is largely modeled on similar economic principles. During the first and last quarters of a calendar year, demand for electricity hovers in the range of 35-55 per cent of peak demand – effectively suggesting that there is 45-65 per cent of capacity (slightly lower after adjusting for hydel) that remains unutilised. Since capacity cost is already being covered, a strong case exists for incentivising consumption of more electricity at the variable cost, or effectively the marginal price.

Marginal price can be used as a policy intervention tool by policymakers to generate additional consumption (and thereby economic growth) through mid-to-long term price signaling regime. Since we have surplus capacity, there is no reason why such a tool can only be utilised in the first, and last quarters, of a calendar year. The marginal price for each month, and even for each hour is different – modeling out the same can provide necessary pricing signals that policymakers can send to the market, while enabling businesses and households alike to plan for more consumption in a more calculated manner.

A review of marginal cost data available through the CPPA suggests that the average marginal cost on a monthly basis over the last twelve months is Rs19.92 per kWh, reaching a high of Rs20.93 in June, considering its the hottest month. The sheer flux of distributed solar capacity in the system is a boon that can be fully leveraged, as marginal cost during the day can actually reduce, providing an incentive to businesses to consume more electricity through the grid.

The government can model out marginal cost curves on a twelve month basis, utilising historic data, expected energy mix during the next twelve months, and available surplus capacity. The same marginal cost curves can even be estimated on a weekly basis to provide more granularity. A policy intervention such that any incremental consumption is priced at marginal cost can then be rolled out throughout a calendar year. In such an intervention, the marginal cost may be higher during peak summer months, while decreasing as the heat settles.

The marginal cost can be used to charge for electricity on a monthly, weekly or even daily basis. Availability of such a long-term and granular pricing signal can provide necessary policy continuity, and guidance to businesses to plan their production activities accordingly. For example, a manufacturer can plan its production such that the same aligns with the period when marginal cost reduces. It can adjust the price it offers to its buyers accordingly, and be more competitive in the global marketplace.

Pricing an electron on the basis of economic merit remains crucial here. Given the availability of surplus capacity in the southern part of the country, the marginal cost is much lower than what it is on a national level. The arbitrage available can be leveraged, such that granularity in marginal costs can be location or region specific. This would enable pricing of electricity in a fair and competitive manner, while also all removing unintended consequences of pricing distortion in the process. Industrial users in the southern part of the country can ramp up production on the basis of expected marginal cost and be more competitive for the export market.

An electricity policy is a key tenet of an industrial policy. The country lacks any clear industrial policy, because industries have largely cross-subsidised households, becoming uncompetitive in the process. The deindustrialisation of the country is largely a consequence of an electricity policy that is anti-industry, and grounded in arbitrary prices, rather than a competitive market.

Surplus power generation capacity, particularly in the southern part of the country, provides an opportunity to price electrons in a manner that is grounded in economic principles. A policy intervention that provides a clear direction of marginal costs, and a benchmark against which incremental consumption will be measured provides the necessary framework for incentivising consumption and better planning for businesses. Having more granularity in terms of marginal costs in terms of weeks or even hours of the day can allow businesses to manage their resources, and planning in an effective manner.

The infrastructure to stimulate growth already exists. The policy to bring everything together to capture growth does not exist. An electricity policy that incentivises higher consumption remains a critical tenet for any industrial policy. If the country needs to grow, and unlock the prosperity of almost quarter billion people, it needs affordable energy, and that can be achieved through better planning, improving efficiency, and clear pricing signals.

The writer is an assistant professor of practice at the School of Business Studies, IBA, Karachi.