What is really going on in power sector?

GoP’s guarantee close to worthless piece of paper; bureaucrats disregard contractual commitments; govt unable to pay for power from current projects; how will it pay for costly power from CPEC projects?

There was a time when the guarantee of the Government of Pakistan meant something. Unfortunately, today it is close to a worthless piece of paper, mostly because of overzealous bureaucrats showing complete disregard for contractual commitments and flagrant disrespect for law. Whether this is so because of personal egos or express instructions from the elected parliamentarians remains a mystery, but in this process the long term damage to the credit of the sovereign has been done in exchange for deferring short term financial obligations. Let me first tell a story, to make this simple to understand.

AAA Airline issues a tender for a transport services for its crew. An investor ABC bids for it and wins the contract. He has to deploy ten vans, marked with AAA Airline logo and sign a five-year contract developed by AAA Airline, with pre-agreed per hour and per km rates. ABC can only bill monthly, and is supposed to be paid another month after that. Having won the tender, ABC leases ten vans, employs thirty drivers and keeps the vehicles in top condition to avoid any breakdowns while transporting crew. 

AAA Airline does not clear his bills in time and after repeated complaints, offers him a bank guarantee by B Bank.  As the delayed bills pile up his cash flow keeps getting tighter and tighter, since he has to pay his leases, his drivers, his insurance, fuel for running, and maintenance. He cannot use his vans for any other purpose. Eventually after numerous pleas that go unanswered, he decides to call on the bank guarantee. The bank manager calls his client AAA Airline since the guarantee is not cash collateralized, and asks for the money, only to be told that AAA Airline has other more pressing payments due. Rather than honoring the guarantee, the bank decides to find a way to get out of paying. So he tells Mr ABC that calling on a guarantee while wearing a blue shirt is against the rules and therefore the guarantee call is rejected. When Mr ABC asks, what color shirt he should wear if he is to present the guarantee again, the manager tells him that this is confidential information. By the time ABC gets home to change his shirt to another color, AAA Airline sends a letter saying that his old bills are invalid, because his drivers did not provide good service, without defining what deficiency in service was identified many months after it had been provided. The next day, ABC goes to the bank wearing a white shirt, only to be told by the bank that since the client has disputed his bills, the guarantee is invalid. 

AAA Airline then issues another tender for another ten vans. ABC is set up to be the lowest cost provider, but decides not to bid. ABC advises his friend XYZ, who is interested in the tender, against it given the payment risks. XYZ still decides to bid, but at a higher price, and still wins. The story of delayed payments and defaulted guarantee is repeated with XYZ. Eventually a third tender comes along and the whole story gets repeated once again with a third investor MNO at rates higher than even XYZ.

As a footnote, it should also be noted that AAA Airline threatened legal action against ABC for unspecified damages and B bank also threatened suit that if he ever claimed that his guarantee was not cashed.

If you have not found the parallels already, let us wind the clock back. The first IPP in Pakistan was HubCo, which preceded any policy and was financed by the World Bank. Then, the PPP government announced its 1994 Power Policy with a fixed tariff developed by WAPDA/GoP, under which over $3 billion of projects were put up, 90% of them being owned by foreign investors, and practically 100% of loans coming from outside Pakistan. Pakistan was the darling of investors. These projects had a GoP Guarantee since WAPDA’s financial position did not support them. After the plants came on line, and WAPDA was unable to pay the IPPs threatened that they will call the GoP Guarantee. At this point, Ehteshab Bureau was unleashed on them, and rather than dealing with issues commercially, they were threatened and fake cases were created against them. Eventually under pressure of various foreign governments, the GoP backed off and asked for a commercial renegotiation of the very rate that it had itself offered. Not left with much choice, most IPPs provided some rate reductions and continued to run the plant. The country that was lauded as having the best power policy in the developing world overnight became a pariah in the international energy investors community. It is instructive that when 2002 Policy was unveiled by the Musharraf government, not a single one of these foreign investors came back. Only Fauji Foundation, which had done a project in 1994 Policy took a project in 2002. So if the experience was so fantastic and the returns so great, what went wrong and why did investors not put up new projects when Pakistan needed them?

In 2002 Policy, almost all projects were done by local investors. This time all lenders were also local since no foreign lender was interested. The payment situation did not get any better. In 2011-12, the backlog of payments had ballooned to a point that most IPPs started shutting down intermittently. WAPDA (by now NTDC) first agreed in writing that it would not penalize the IPPs for these shut downs, but after a few months changed its mind and decided to impose penalties for shutdowns, even when these shutdowns were occurring because of its own payment defaults. At this point, the 2002 Policy IPPs called the GoP Guarantees and went to Supreme Court. The GoP went into default, acknowledged that it owed the money, but told the SC that it did not have the resources, and needed more time. Eventually the IPPs agreed to an installment plan. But this worked only for old payments, while new bills were being generated, and accumulated again. The PML-N Government cleared these past bills in June 2013, for power already consumed 1-2 years before that. The Auditor Generals’ report about this matter does not question that IPP payables per se, but rather questions the internal procedure followed by GoP in paying the subsidy to NTDC, but it does raise some issues that show either lack of understanding of the signed contracts or expresses desire to re-open the agreements a second time around.  In December 2014, many IPPs once again called on GoP Guarantees because of mounting receivables, and the GoP paid them some portion, and promised to clear all amounts in a few months. The IPPs withdrew their Guarantee calls but this GoP promise was once again breached. 

Approximately one month ago, 13 IPPs once again called on GoP Guarantees. The IPPs claimed that the total outstanding amount for the sector was Rs 414 billion in mid-February 2017, and the IPP share of it was Rs 254 billion. The MoWP claimed in the Senate that the number was PKR 393 billion. It appears that the IPP number includes some smaller payables like renewables/purchases from Iran while GoP number does not, but even if the GoP number is taken to be correct, it really makes no difference to the core issue and the instructive thing is that GoP is making no effort to clear it. Informed sources tell us that rather than addressing the issue, GoP stated that the Guarantee call by IPPs is “not in conformance” without identifying these “non-conformances”. Similarly, NTDC has, facetiously enough, disputed all prior bills without giving the specifics as to what is against the contract, even the ones that it has verified and paid, to avoid the possibility of any GoP Guarantee call being made.

So with this history, who is the third generation investor, since in the current round of thermal and hydel projects under 2015 Power Policy, with the exception of one, no prior investor of 2002 Policy or 1994 Power Policy is doing a project. It is our Chinese friends, who have been good allies of Pakistan, but this friendship is not blind when it comes to commercial matters. In addition to GoP Guarantees, this new round of projects had to be given many more protections than even the 2002 Policy projects. Two of them are telling: (i) there is a funded cash escrow amount of PKR [50] billion from GoP since GoP Guarantee does not seem to be sufficient, and (ii) what was previously a protection in law with NTDC chose to violate it, has now been converted to a contractual commitment: if a Chinese owned plant shuts down because of non-payment, NTDC cannot impose LDs and still has to pay fixed charges. Putting aside the discrimination angle this creates amongst different types of investors, these two changes demanded by Chinese investors in the contracts clearly point to the sordid history of disregard for sanctity of contracts.

Since almost 7000 MW of new generation capacity is under construction through GoP funded LNG projects, or under CPEC, it will get completed soon, whether it is before election or not. The question to ponder, therefore, is not whether power capacity will be there to end load shedding but whether GoP will have money to pay for it, given that it cannot pay for power from current projects. The rates for the coal and the LNG projects, based on the NEPRA determinations, are around PKR 8.5/kwh at current prices. Add the 25% claimed loss/theft/non-recovery to it, and the true cost to the system is about PKR 11/kwh. Compare that to the last determination of NEPRA for the DISCOs for December 2016, which is less than half of it, and it is glaring obvious as to what we are headed for.  

The GoP claims that IPPs make a huge profit. That may be so, but until the GoP comes clean, the public will never know. It is natural that in any industry some companies make more profit than others. But in an industry which has tariff rates fixed by NEPRA for 25-30 years, the issue to discuss is not the level of profit being made by the IPP, but rather are they charging more than what their contracts with NTDC, incorporating the NEPRA approved tariff, allow them to do? If the answer is yes, IPPs should be taken to task. If no, the GoP needs to be taken to task. As we go through the history, we realize that the answer is likely to be the latter, since the Babus in Islamabad decide to ignore the contracts, and consider their word to be law, and in their zeal, they keep increasing the risk perceptions for the investors. 

If only someone could make the Babus understand that rather than finding dubious ways to defer current obligations, if they maintain the sanctity of the contracts they sign, over time the returns that investors demand will start dropping, and the protections they seek through contracts will start falling away. That is what has happened in most other developing nations including our neighbor Bangladesh. But perhaps that it too much to ask from the current lot.

The writer is Patron in Chief, Pakistan Bedwear Exporters Association