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Cradle of power

October 10, 2013

IT’S a good thing that the government has been forced to change its stance on the recent power tariff increases.

The constant hikes in tariffs with no meaningful reforms have had a pernicious effect on the power sector. Allow me to explain, but first a little context.

Take the case of Hubco, the largest independent power producer, which began as an experiment in mobilising private-sector investment to meet the growing demand for power generation in Pakistan in the early 1990s. But building confidence amongst private investors to acquire stakes in the power sector in Pakistan was no small feat.

The power sector presented unique challenges for any private investor. In the case of Hubco, for instance, the new plant was going to feed something like a billion watts of electricity into the national grid every hour, give or take, and needed to do this for something like 300 days in a year for the proposition to be meaningful.

To accomplish this, the plant would need a continuous supply of fuel — furnace oil — totalling something like 5,000 tons every day. And in order to keep that fuel supply running, it needed to be paid promptly. An interruption in any one of these vital flows meant the whole system inside the plant could grind to a halt.

Since all three flows — fuel supply, power purchase, payment — were controlled by the government, the infant investment would be surrounded on all sides by the towering and imperious power of the state, with its political storms, unpredictable moods, unaccountable officialdom and constant thirst for revenue.

A formidable apparatus of protection was assembled to safeguard the infant investor from the vagaries of this rugged landscape. A large suite of binding agreements governed the relationship between the investor and his sole customer. Each of the vital flows involved in the operation of a plant had its own mortar: Fuel Supply Agreements and Power Purchase Agreements and Implementation Agreements, all underlain by a sovereign guarantee.

The price at which the electricity would be sold was similarly subjected to heavy legal control, with various segments such as a capacity payment, a tariff indexation and a fuel adjustment mechanism, and a regulator had to be created by special legislation and empowered as an autonomous entity to operate this pricing mechanism.

The strength of this framework is the reason why the power sector has attracted so much investment, and why after almost two decades of its operation, today more power generation capacity sits in private hands than in government.

But no sooner had the new policy framework been launched, with 19 investors who between them put down almost $5billion inside the protected space, that the first challenge came from the state. In 1998, Nawaz Sharif accused 11 members of the group of having used corrupt means to acquire favourable terms for themselves, and launched police actions and litigation against them all.

It took three years to unwind the resultant disputes from this impetuous and ill-advised action, but the framework survived and all players emerged from the episode slightly bruised but with their investments intact. From that time onwards, the state has worked within the framework established by the private power policy, issuing updated versions along the way but never trying to step outside of it.

Nevertheless, the initial attack of 1998 had a deeper impact on the power sector’s subsequent evolution: it focused all debate and scrutiny of the framework around questions of pricing and malpractice in the award of contracts. Either the tariffs were too high, or capacity charges were an unfair imposition, or project sponsors had engaged in underhanded deals to gain advantageous terms.

Behind this misplaced emphasis in the public debate, an important evolution went unnoticed: the broader power sector reforms, of which the private power policy was only a part, ground to a halt. All further additions to our power generation system came exclusively from privately contracted thermal power plants.

Thermal power plants are not meant to be the mainstay of a country’s power generation system. They are best seen only as a stopgap measure.

Take the example of Japan. After Fukushima, a furious debate over the growing use of nuclear power to generate electricity engulfed that country. The government decided to break the country’s growing dependence on nuclear power by moving towards more renewable sources of energy such as solar and wind. A new policy was announced to encourage investment in these fields, and in the last two years Japan has added more than 3,500 megawatts of generation capacity from solar and wind alone.

In the meanwhile they set up natural gas plants, and tendered so massively for LNG in global markets that they caused the international price to skyrocket. But their use of thermal power generation using liquefied natural gas is only temporary.

Similarly, the use of thermal power in the private power policy was only meant as a temporary measure. But in our case, as soon as the electricity materialised, we forgot all about the problem and set about bickering over its price and who got what out of the whole deal.

The net result was that we got stuck in a high-cost option, and today cannot afford the electricity in our own system. How did this happen? Part of the reason is the lack of attention to how we might use the interlude provided by the abundant thermal power of the late 1990s, to leapfrog into a more sustainable and affordable option.

But another — equally important — reason is that the protected space created by the policy framework gave birth to vested interests of its own. What was meant to be a protective cradle for infant investors back in the 1990s morphed into a fortress for exorbitant privilege.

Nothing illustrates this better than a close look at what happened to Hubco in the era of the circular debt. More on that next week.

The writer is a business journalist and 2013-2014 Pakistan Scholar at the Woodrow Wilson Centre, Washington D.C.

Twitter: @khurramhusain