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A Very Messy Hotchpotch

Published in Mar-Apr 2022

Pakistan’s power sector remains mired in entanglements driven by politics, writes Kazim Alam.

Pakistan’s power sector is as messy as its power politics. In fact, most problems within the energy sector are political in nature. From poor choices in terms of power generation to mounting line losses incurred by the distribution companies (DISCOs), political expediency dominates nearly every aspect of the power sector.

Take Circular Debt, the singular issue that manifests all that is wrong with Pakistan’s energy sector. Defined as the sum of unpaid government subsidies, it is the cost of energy that is either not budgeted in the form of a subsidy or not passed to the consumer as part of the tariff.

Since the PTI came to power in 2018, Circular Debt has more than doubled to approximately Rs 2.5 trillion. According to Tabish Gauhar, who served as Imran Khan’s Special Assistant on Power and Petroleum until 2021, one of the main reasons for this is the rupee’s depreciation against the dollar. “Up to 40% of the increase in Circular Debt can be directly attributed to the devaluation of the currency,” he stated in a recent webinar. So how is the depreciation – which saw the dollar rate rise from Rs 120 three years ago to Rs 186 as of now – central to the increase in the circular debt? The answer lies in the way the electricity tariff is determined.

All power producers sell their output to the government against a regulator-determined tariff, which has three components. The first are variable fuel charges, which partly depend on the exchange rate, given that our power mix has a fair share of imported fuels like furnace oil, diesel and LNG. The second and third components are operation/maintenance charges and capacity charges. The latter constitute the fee that the government must pay to private-sector independent power producers (IPPs) to ensure that their plants are on standby whenever the government needs them. These capacity charges are based on their dollar-denominated return on equity, debt financing charges and construction costs and they go up in line with the appreciation of the dollar rate, even when IPPs are not generating a single unit of electricity. The result is that the capacity charges constitute the biggest portion of the power purchase price.

The onset of Covid-19 exacerbated the build-up of Circular Debt. New power generation capacity, which was planned years ago, became available during the pandemic. Accordingly, its associated charges should have promptly been reflected in the consumer tariff, and as per one estimate, almost Rs 250 billion worth of increases came into the system on account of new capacity in FY 2019-20 alone. Yet, these increases were not passed on to consumers in order to shield them from rising electricity costs in the midst of nationwide lockdowns. The power tariff freeze lasted for over a year, leading to a sharp increase in the circular debt.

Analysts believe this ‘tsunami’ of new capacity has “overcommitted” Pakistan in terms of megawatts – which were contracted at rates of up to 30% more than the previously added capacity. The primary cause for this folly was that policymakers in the energy sector had expected demand to double between 2018 and 2023. This obviously didn’t happen for a multitude of reasons. By design, the upfront tariff for newly added power plants is higher compared to the older plants because the debt portion of the project costs is usually payable in the initial years. As a result, while capacity charges kept increasing, their pass-through impact on the consumer tariff remained minimal. Meanwhile, demand failed to grow as rapidly as policymakers had originally envisaged. In addition to this hotchpotch of policy failures are long ongoing structural issues, such as subsidised electricity for tube-wells in Balochistan and elsewhere as well as the supply of cheap electricity to Azad Jammu and Kashmir – where the receivables amount to more than Rs 500 billion.

It would, however, be unfair to say that the PTI did not try out a number of initiatives to fix the energy sector in its stint in power. A major step was to rein in the galloping cost of power by renegotiating the power purchase agreements with 35 IPPs; renegotiations that led to the ‘notional’ savings of Rs 700 billion over a period of 20 years. These ‘signed and sealed’ agreements with private investors were revised by ‘freezing’ the dollar rate at Rs 168 and making them agree to share the operations/maintenance costs with the government. Secondly, the government tried to fast-track its move to indigenous fuel from dollar-denominated imports of furnace oil and LNG. In the Indicative Generation Capacity Expansion Plan 2020, the PTI Government decided they wanted to achieve up to 90% indigenisation through coal, nuclear, hydro, wind, solar and bagasse sources. This is in contrast to the current power generation mix, which had a contribution of more than 27% from imported fuels, such as LNG, furnace oil and diesel, in the first eight months of FY 2021-22.

According to data released by the National Electric Power Regulatory Authority (NEPRA), the cost of fuel, which makes up one of the three components of the rate that power producers charge their government-backed buyers, went up by almost 90% in February 2022 – a rise reflective of what is happening with global energy prices.

To protect consumers from the vicissitudes of the international energy markets, the PTI Government had been pushing to increase coal mining in Thar – the price of Thar coal is not pegged to the international market and buyers pay only $61 per ton, which is substantially lower than the going rate of $295 per ton in the global market.

Since 2019, about 3.8 million tons of Thar coal are being mined from Block 2 and the entire output goes straight to Engro Powergen Thar, the country’s only indigenous coal-based 660 MW power plant. The output will double to 7.6 million tons per year by June 2022 and increase to 12.2 million per year by June 2023. Thanks to economies of scale, the price of Thar coal will drop to $28 per ton after the expansion of mining operations. The PTI Government also wanted the 5,500 MW power plants that are currently using imported coal to switch to local fuel sources in order to save foreign exchange.

Other than the push for the indigenisation of fuel sources, the PTI Government aggressively dealt with the thorny issue of the weighted average cost of gas (WACOG). This is a pricing mechanism that takes into account the blended costs of both indigenous and imported gas, as opposed to the current pricing method which ring-fences the use of imported fuel. However, there has been no definitive success regarding this, as the gas-producing smaller provinces remain opposed to WACOG on the basis that it will benefit Punjab disproportionately. The PTI Government had the move approved by the legislature, but its fate hangs in the balance as the smaller provinces have mounted a legal battle to stop it. Perhaps the most consequential policy decision the PTI government took was the Competitive Trading Bilateral Contract Market (CTBCM). The head of NEPRA, Tauseef H. Farooqi, speaking at an energy conference in April, said May 1, 2022 would be the first day when bulk consumers of electricity would have the option to buy power on a competitive basis from any producer. The switch from the multi-seller/single-buyer model to the multi-seller/multi-buyer model will allow wholesale power consumers (they cumulatively use up to 20% of total electricity supply) to access their choice of supplier. In other words, it is hoped that the merchant market model will increase efficiency, reduce losses and theft and ensure higher recovery against billed units.

Arundhati Roy once wrote that one should “never simplify what is complicated or complicate what is simple.” Her quote is relevant to Pakistan’s power sector. Its problems may be deep-rooted, but their solutions are well-documented. The only thing missing is the political will to tackle these issues head-on. 

Kazim Alam is a staff member at Dawn.