The power pandemic

The power sector, unfortunately, is often in the news for the wrong reasons -- whether it be the growing circular debt, the infamous IPPs, the controversial RLNG deals or the rising cost of electricity, everyone and their uncle has an opinion on how to solve the crisis. The decline has been accelerated by the addition of about 14,000 MW in the last 3-4 years with no demand to match. The nose-diving rupee and the COVID-19 pandemic further seems to have sealed a bleak fate.

Half-hearted attempts by the government to clear the circular debt in the past, are temporary measures at best which ‘flatten the curve’ without treating the ailment. Circular debt now exceeds Pkr 2 trillion -- a battery of relief measures, warranted by the current lockdown, will make it worse.

This pile-up has not only endangered the viability of 80 plus IPPs, but also the solvency of local banks – which will be crippled in case of defaults by the power sector. Foreign lenders will not go unscathed, either, ruining our international credit. This risk alone warrants serious government action.

The sector is complex, with many players and inter-linkages, but the government has the flexibility to start anytime, anywhere along the power train e.g., generation, distribution, administration, regulation even.

For a perspective of the complexity, let us look at the cost of electricity procured in Jan 20. The variable cost of RFO electricity ranged from Pkr 12.54 - 20.73/unit, gas/RLNG PKr 4.32 – 16.68/unit and coal Pkr 8.30 – 14.22/unit. In renewables, tariffs ranged for solar Pkr 19.59 – 26.60/unit and wind Pkr 16.66 – 26.85/unit.

If one looks at this data in isolation, the differences cannot be understood or explained. The differences are because of age of plants, choice of fuels, capacity utilization, duties on fuels and much more. The way forward is that this problem needs to be understood in terms of its parts and solutions are going to arise out of different sub-sectors of the power sector. Here are some ideas on how to proceed.

Firstly, put a temporary ban on new IPPs. Take stock of the energy requirements for the next five to ten years. This exercise should result in identified projects, specifying location, capacity and technology. NTDC and discos do the same for their grid stations. All fresh capacity should be procured through open bidding. No upfront tariff, no cost-plus regime.

Fix the merit order. Merit order, based on variable costs, is used by the power purchaser for deciding which IPP to dispatch. Determination of IPPs ranking on the merit order is an important and a dynamic phenomenon. Import taxes on coal and furnace oil create distortion in pricing which is eventually passed on to the consumer. Similarly, import of Furnace Oil is not allowed to support the local refineries, whereas today its 25% cheaper than local oil.

Gas tariff regime for IPPs is even more problematic – with multiple gas tariffs for power generation, some inefficient government plants end up higher on the merit order as they get cheaper gas, and efficient plants end up lower on account of allocation of expensive gas. A merited gas allocation can result in immediate cost reduction.

Situation with coal is more interesting. Variable cost for imported coal fired plant at Port Qasim for Jan 20 is Pkr 5.47/unit. Whereas plant using local Thar coal for the same period is Pkr 8.02/unit. We must use local resources; however, local coal price is also linked to Rs-USD rate and as such the advantage is gone.

Renewables, solar and wind IPPs, are not baseload supply. On availability basis, a 100 MW solar plant translates into an average of around 18 MW per annum only whereas a 100 MW thermal IPP is at around 90 MW. Such IPPs’ tariffs, no imported fuel here, are also indexed to US dollar. For Q1, 2020, Govt. of Punjab owned Quaid-e-Azam Solar, is selling power at Rs 26.27/unit!

The issue of “high” tariffs is thus more complex than is appreciated. On the other side of the equation, however, the government has options to raise cash to overcome liquidity crunch. It may convert its hydropower plants into IPPs, by refinancing at 20%-80% debt: equity with debt tenors at a minimum of 15-20 years. The government may use such proceeds, to pay off circular debt, invest in discos, buy off debts of the current IPPs, etc. All such actions shall help reduce current tariff which in turn could increase the demand for electricity and partly solve the capacity glut.

IPP debt reprofiling is another option. IPPs’ debts, at 75%-80% of the IPP cost, have generally been serviced in the first 10 or so years increasing tariff for those years. A very large recent capacity induction has caused tariff hikes because fresh IPPs’ debts are being serviced now. Solution lies in re-profiling the debts of IPPs with 60 percent or more of their debt outstanding. Local currency debt could be reprofiled through a swap. Foreign currency, debt a large portion being CPEC debt, will have to be reprofiled by negotiations between Pakistan and China. If the goal is to reduce the current cost of generation the biggest relief might come from this exercise.

On distribution side T&D losses for 2017-18 stood at 18.32% against allowed 16.15%. The disallowed loss, 2.17%, needs to be eliminated. Around 12.29% of electricity bills are not paid by consumers and the recovery ratio actually fell by 5% between FY 2017 and 2018. Lots of money here, but much remains to be done.

Larger Discos need to be unbundled into smaller units reflecting market realities. Near term, the government may try to improve discos’ management, but privatization is the only answer. Privatization through open bidding must bind investors over margins, improvement in line losses and bad debts recovery.

Administrative and governance related issues, as mundane as accounting practices at the relevant government entities, need immediate attention. It is not certain whether discos and CPPA-G consistently follow cash-based or accrual-based accounting or some hybrid. Electricity procured but not invoiced is one example. Neelum Jhelum started feeding the grid in July 18 and interim PPA was signed in Jan 20. In short, on a given date one may not be sure of the liabilities of these entities and, consequently, the circular debt.

What is to be done is known. Cosmetic window dressing and mudslinging is not the solution though -- a comprehensive master plan needs to be worked out.

The writer is Chairman Nishat Chunian Ltd.