Why Pakistan's power woes will get worse

March 23, 2015

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Circular debt and unaffordable electricity evolved in 1994. The current govt is doing all the wrong things to fix it.—AFP/File
Circular debt and unaffordable electricity evolved in 1994. The current govt is doing all the wrong things to fix it.—AFP/File

Notwithstanding the claims of the present government before and after coming into power, there remains little doubt that almost two years on, the PML-N government still struggles to articulate a coherent prescriptive strategy for solving prolonged loadshedding.

This government's missteps have exacerbated the situation, resulting in prolonged loadshedding and a deep power crisis, which has become irresolvable for decades to come.

Problems that need to be addressed

There are three main issues that need to be addressed if the power disaster is to be resolved:

1. Affordability: The energy source mix and tariff resultant from average production cost should be affordable to the consumer.

2. Reduction of losses: Bills collection must be improved as must the reduction of line losses, which are currently running at over 15 and 30 per cent respectively.

3. Lesser reliance on imported fuel: This is vital to prevent potential foreign exchange losses due to depreciation of the Pakistani Rupee.

According to NEPRA, an SDPI study mentions a figure of Rs 8 / unit as the maximum price the average Pakistani would be willing to pay for power, and that they are willing to tolerate prolonged loadshedding if the power cost went above that; thus an elastic demand.

In terms of energy source mix, Pakistan has one of the most expensive power generation costs in the world, with over-reliance on expensive furnace oil.

See the table below for global sources of power generation (all figures as a percentage of total generation capacity):


Blame the Power Policy 1994 for unaffordable power


The genesis of Pakistan's heavy reliance on expensive imported furnace oil lies in the Private Power Policy of 1994, chalked up during Benazir Bhutto's second term in government.

This policy was probably the most crippling economic decision taken in the last 30 years by any government. To date, this decision is estimated to have cost the country over $2 billion per year since 2006.

According the the policy:

  • Private investors were allowed to set up power generation projects under long term take-or-pay Power Purchase Agreements at extremely attractive rates.
  • There were few restrictions on technology, fuel source or efficiency.
  • Any increase in the cost of fuel was a pass-through item with the risk borne entirely by the buyer, and a sovereign risk guarantee was required in case of default.

In other words, it was an irresistible deal for the investors, and leading local and foreign companies all flocked to apply for potential projects like bees to honey.

Pakistan currently uses only 5 per cent of its total hydropower potential. —Reuters/File
Pakistan currently uses only 5 per cent of its total hydropower potential. —Reuters/File

As expected, the policy was a roaring success and a generation capacity of over 7,000 MW was installed (out of a total generation capacity of 22,000MW in the country). Launched with much fanfare, it provided photo-ops to all stakeholders, with the then US Energy Secretary Hazel O’Leary flying in to sign MOUs with major US corporations, and the mighty World Bank through the IFC and MIGA ended up lending oodles of money.

Almost a decade later in 2005, the IFC issued a rather contrite paper stating that they had ‘advised’ the government to limit the thermal generation to 2,000 MW. How forcefully this was conveyed in the face of its own deregulation and privatisation mantra of the time, will remain opaque.

But this much is beyond doubt: the IPP policy has resulted in Pakistan producing unaffordable power.

Based on flawed assumptions...

The underlying assumptions of the policy were also flawed. For example:

  • It assumed a capital cost of $1million / MW when the actual cost of setting up a furnace oil power plant at the time was at least 20 per cent less.
  • It also assumed a thermal efficiency of 38 per cent when plants of a higher level of efficiency were available.
  • Moreover, the cost of furnace oil was set at Rs 5,000 per tonne, giving a levelised tariff of $65 / MWh or Rs1.76 / unit (at then exchange rate of Rs27 / US$ 1) and a guaranteed Return on Equity of 15 per cent in US dollar terms.

It gave birth to circular debt (and the recent fuel crisis)

These generous terms resulted in a large number of inefficient furnace oil-fired thermal power plants. What was clearly not envisaged at the time was that the cost of furnace oil would increase to Rs 75,000 / tonne and the rupee would depreciate to Rs 105 / US$1, resulting in the cost of power increasing from Rs 1.8 per unit to Rs 20 per unit or US$200 / MWh.

Yet, the maximum average tariff that could be charged to consumers was only Rs 8.0 per unit (now Rs10), which led to a major budgetary shortfall. The government ended up picking the tab for the shortfall in the form of energy subsidies as it was committed to pay the IPPs a 45 per cent Return on Equity in Rupee terms. And when the government ran out of money, it promptly refused to pay the IPPs, who in turn could not pay the fuel suppliers.

This ended in billions of dollars of ‘circular debt’, which insidiously also crept into the vehicular fuel space, resulting in a shortage of petrol in Punjab recently – ironically just as one saw some of the lowest historic prices of world oil.


How the Nawaz government is trying to resolve the issue


Essentially, by throwing money at the problem in the hope that it will resolve itself.

Instead of analysing the situation and coming up with a cogent strategy to tackle the issue, this is how the government has chosen to act:

  • The withheld payments to the IPPs were released without reviewing the actual efficiency of the units. Thus, an IPP operating at 25 per cent efficiency was treated at par with one operating at the requisite 38 per cent efficiency, as escalation was a pass-through item.
  • Investment in additional generating capacity has been flawed. For instance the 400MW Chinese Nandipur unit completed at a cost of US$840million can only run on high speed diesel. At the time of commissioning, the power cost more than Rs 30 per unit to operate.
  • The initiative to set up a series of imported coal-fired power stations near cities, with Chinese collaboration is a highly undesirable measure considering the extreme pollution it will cause.
  • The latest measure to have been announced is the setting up of imported gas-fired power plants with the price of gas yet to be announced.

The current cost of power for each type of power plant is given in the table below (energy cost in US$ / MWh):

The cost of gas has been assumed at the current spot rate of US$6.5 / MMbtu plus transport and re-gasification. As per the newspapers, the cost of LNG imported from Qatar might be $12 / MMBTU, which would be equivalent to a unit rate of approximately Rs 10.5 per unit. The cost of nuclear is based on the agreed strike cost of the privately-owned UK Hinkley Point C nuclear power station at UK£92.5 / MWh.

The shift toward coal-powered stations is mind-boggling

The most curious and alarming decision to date has to be that of introducing imported coal-fired power stations to Pakistan, just as the entire world is moving away from coal technology – with the US alone in the process of decommissioning a proposed 30,000MW in the short term.

Also read: Ecnec approves 15 projects of Rs333bn

The question that begs asking is why are we embracing coal-fired stations next to major cities?

In particular, locating proposed units of up to 6,600MW capacity at Gadani, west of Karachi, does not make any sense at all.

Not only is it economically unfeasible, as explained above (besides the additional cost of a coal jetty), but given the West to East wind direction in Karachi for 10 months of the year (in the monsoon period this direction is reversed), it would cause the severest pollution.

Why condemn a metropolis of 15 million citizens to respiratory diseases by exposing them to deadly carbon emissions for all times to come?

Trees being removed from land purchased by the Punjab government for setting up the coal-fired power plant. —Photo by Dawn
Trees being removed from land purchased by the Punjab government for setting up the coal-fired power plant. —Photo by Dawn

A visit to any major city in China today provides sufficient warning against the tremendous perils of coal power plant proliferation. The great Chinese Admiral Zeng-He mastered trade wind directions to circumnavigate the globe around six centuries ago, yet our modern day coal-power admirals are oblivious to these very basic geographic facts.

While based on recent reports, this project is financially unviable and may now not proceed, but the time and energy spent on it amply demonstrates this government’s incoherent approach.

Another critical issue to consider is the cost of these units. The PML-N government has a penchant for spending substantially more than the average international cost of a project, as demonstrated in the Pindi Metro bus.

The much heralded panacea Nandipur power plant cost US$2m / MW for a Chinese unit whereas a similar capacity combined cycle gas turbine using Siemens – leading provider of German technology – with 60 per cent thermal efficiency SGT6-8000H Gas Turbine and SST6-5000 steam unit or GE-9FB turbine unit would cost US$1.2m/MW. Typically a Chinese power plant costs 60-70 per cent less than GE or Siemens.

The Nandipur unit's cost in China should therefore be in the neighbourhood of US$0.8-0.9m / MW, but quite enigmatically, the same unit in Pakistan costs $2m/MW ($1.5m/MW if financial charges are excluded).

With the bulk of the coal being imported as raw material, the government would once again be assuming all the exchange risk so that if the value of the Rupee depreciates, the cost would be passed on to the consumer.

Similarly, the capital cost of coal-fired steam turbines as per the Fang and Victor paper, the Capex for a typical coal-fired Chinese unit is US$0.8m / MW, yet the MOU signed by the Government of Pakistan for the 6,600MW was for $14 billion or $1.4m / MW (power plant only) – or an extra difference of a whopping US$3.5 billion.

Indigenous coal from Thar might have been an option to consider, as economically it makes sense, but to date we have not investigated it to ascertain if this is a commercially viable proposition. There is a large underlying layer of water, and to date nobody has paid any attention to establish how this may be addressed.

Also read: Thar Coal: A gateway to energy for Pakistan - I and II

Hence, at this stage, to enter into any binding agreement falls under what risk managers refer to as ‘uncapped liability’, meaning that you are guaranteeing purchase, without fully assessing the viability and cost of the fuel source. It may also be worth learning a lesson from the 150MW coal-fired power station at Lakhra that lies useless due to the poor quality of coal.

Thar coal is a major future energy source, no doubt, but we may be at least three years away from it becoming viable.

A far better option would be for the government to establish a pilot 300MW power station funded by its own resources and enter into an IPP-style agreements with credible private entities on suitable terms, only once it is up and running, and the associated risks have been clearly identified. Environmental safeguards and use of IGCC technology to reduce emissions are essential.


Alternative sources of energy


Global warming is a leading issue in our lives today, and it is nothing less than tragic that the thirst for coal is overblown in a country that only utilises less than 5 per cent of its naturally endowed Hydropower potential. There have been numerous private sector initiatives in the hydropower sector, particularly on the Swat River and other areas in northern Pakistan that were deemed viable but have yet to be investigated further.

Solar power is another feasible renewable energy source for a country with an abundance of sunshine, particularly in remote areas. The other advantage of solar is that it can be installed directly on-site, obviating the need for transmission lines and related line losses. Due to recent improvements in technology current prices are approximately US$100 / MWh but according to US-Energy Information Administration EIA forecasts, by 2020 due to improvements in technology solar energy prices will be down to as low as US$60 / MWh.

Also read: Solar energy to be brought into national power grid

Currently, solar panels with up to 44 per cent efficiency are available at research institutions and NASA. Should these become available commercially, in 15 years’ time solar power may well be the most economical and viable energy option for Pakistan.

Solar panels installed at a park in Peshawar to meet lighting needs.—File
Solar panels installed at a park in Peshawar to meet lighting needs.—File

Nuclear energy is a much touted option, but given the disaster at Fukoshima the Japanese have decided that it is far too risky to build nuclear power plants in seismically active areas. No one has more advanced and precise technical knowledge about earthquake engineering than the Japanese.

Also read: Let’s go nuclear — safely

Even without accounting for the costs of decommissioning these behemoths in case of a disaster, or at the end of their lifecycle, there are far safer and economically attractive energy options available appropriate for Pakistan.


Affordability of tariff and the way forward


Looking once again at the maximum affordable domestic tariff of Rs 8 per unit mentioned above and working back if we add the industry load (which can afford to pay more and use Rs 9 per unit as the maximum cut-off rate) and given that there will be at least 25 per cent line losses (currently running at 30-32 per cent, which could be much lower by the way) and a bill delinquency rate of 10 per cent (currently 15 per cent), it would mean that the maximum average generation cost that this country can afford to pay is Rs 9.0 x 0.75 x 0.9 or Rs 6 per unit.

So we can safely conclude that furnace oil, imported coal and new nuclear plants are not viable options in the long term. The question then is: Why is the government pursuing them and why is NEPRA approving them?

Egypt, with half the population of Pakistan, has an installed generation capacity of 30,000MW. So the latent demand for power in Pakistan is probably in the region of 50-60,000MW.

Though the immediate-term option of setting up power plants fueled by imported gas turbine units is a step in the right direction, it is only good for the next 10 years, and needs to be imminently followed up by cheaper medium term and long term solutions under a transparent and technically sound policy framework.

It is obvious that instead of a strategy, this government like the ones before it, is relying on a series of disconnected projects without examining any effect this would have on the country or whether the average person can indeed afford to pay for this power.

The present approach is fraught with danger, and as was the case with the IPPs in 1995-96, it could tie the country once again into long-term watertight agreements which are unaffordable.

We may not have a perfect solution, and there may not be one perfect solution; however a simple exercise is given in the following table that could potentially save two billion dollars a year:

By articulating a strategy and an accessible transparent cost structure for fuel and power costs at least we can start identifying the issues and debating them.

Unfortunately, our political leaders are unable to think beyond their current mandate, forsaking long term benefits for our future generations.

The laws for heat transfer have not changed, and it is straightforward to calculate the lead-time, capital costs and operating expenses for producing electricity, anywhere in the world. Being over smart or taking shortcuts, like previous ones will end up causing more harm than good.

In the words of the legendary risk expert Nassim Nicholas Talib, 'the definition of imbecility is to argue against proven mathematical formulae'.

We can only hope that our rulers are aware of these realities and will encourage transparency to prove they are different.


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