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Industry Profile: Circular debt cycle

Updated March 06, 2017

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‘Circular debt’, or the unpaid bills of the country’s power sector, is back with a vengeance to haunt the Nawaz Sharif government less than four years after it had paid off previously accumulated bills — of Rs480bn — of private and public power producers and their fuel supplier.

The current unpaid power sector bills had piled up to Rs414bn by the middle of last month in spite of a substantial decline of around 50pc in global oil prices over the last three years.

Even the government strategy to heftily raise electricity prices and enforce blackouts for up to eight hours a day — to keep power generation at the lowest possible level despite availability of capacity — to “minimise system losses and theft to slow down accumulation of the debt”, appears to have failed to work.


With the power purchaser showing no sign of making the overdue payments, at least 13 IPPs were said to have started the process of invoking sovereign guarantees for their bills recovery


With the power purchaser showing no sign of making the overdue payments, at least 13 independent power producers (IPPs) were said to have started the process of invoking sovereign guarantees for their bills recovery by the end of last week.

The last time private producers had called sovereign guarantees was in June 2014. They withdrew the notice later on the assurance of the government and payment of part of their overdue bills.

According to the Central Power Purchasing Agency’s own record, the government owed Rs253.60bn to IPPs, including Hubco and Kapco, and Rs160.80bn to public sector Gencos by February 17. These numbers do not include payments owed to Wapda for hydel generation and power producers’ billing of around Rs20bn for January.

The power sector debt mainly consists of unpaid capacity payments and late payment on interest (LPI) owed to producers in addition to the cost of the fuel used by them to produce electricity.

“The size of the power sector’s unpaid bills would have exceeded Rs500bn if global oil prices had remained at the May 2013 level,” argued the CEO of a private power company. Speaking on condition of anonymity, he blamed the water and power ministry’s utter failure to bring down system losses and arrest rampant power theft for the fresh build-up of the debt.

“For every 10 units billed, the distribution companies are able to recover the cost of only seven units. The remaining three units are lost in the system during transmission, or stolen. If new generation of 7,000 megawatts is inducted to the system in the next 24 months — with the completion of new power plants — without controlling system losses and theft or again raising electricity prices, the circular debt will balloon to an unmanageable level, leading to the total collapse of the power sector like Pakistan steel Mills,” he cautioned.

Consequent to the government’s failure to check losses and theft, three profitable distribution companies — Lesco, Fesco and Mepco — have also started incurring losses, delaying their privatisation.

The government’s failure to pay their bills on time and its strategy of enforcing blackouts has significantly affected the financial performance of listed private power companies.

Mehwish Zafar, a financial analyst at J.S. Global, told Dawn that the power sector had underperformed the benchmark KSE-100 index by 23pc during 2016 versus KSE-100 return of 42pc.

The unaudited half-yearly results of several IPPs show that their profits before tax had decreased substantially, mainly because of reduction in load factor — mostly on account of enforced blackouts but also because of addition of new generation to the grid, shifting of large-scale industry on captive power after induction of LNG into the system and increase in their running costs.

In case of Nishat Power Limited, for example, the power producer saw its turnover declining by almost a fifth from Rs8.49bn to Rs6.89bn, pre-tax profit by 17.5pc from Rs1.66bn to Rs1.37bn and earning per share from Rs4.70 to Rs3.89 during the half year ended on December 31, 2016 compared with the same period in 2015.

On the other hand, its trade debts — unpaid bills owed by government — rose by over 18pc from Rs6.38bn in June 2016 to Rs7.55bn in December 2016. Its overdue trade debt stood at 6.19bn at the end of December, up by almost a third from Rs4.73bn in June.

The same story goes for almost every IPP listed on the stock exchange.

That is not all, though. The power purchaser is also deducting millions from capacity charges bills of generation companies on account of ‘non-availability of the plants’.

The IPPs claim that the deductions are illegal because their plants were not available for generation owing to fuel shortages caused by non-payment of electricity they had sold to the power purchaser.

In case of NPL, the amount deducted stood at a whopping Rs816m at the end of the half year in December.

The reduced profitability and growing trade debts have caused a liquidity crunch for most power producers and forced them to borrow from banks to make payments to fuel suppliers.

The chief financial officer of an IPP set up under the 1994 power policy said that circular debt has remained a major concern for power producers, creating working capital issues for them and forcing them to shift reliance towards short-term borrowings to pay for fuel and dividends.

Ali Asghar Poonawal, a senior analyst at A.K. Securities, said: “It is not just that they have to borrow for fuel. They also borrow money to pay dividends to their shareholders.”

He went on: “The power companies have always been big on payouts to shareholders even if they have to resort to short-term borrowing to pay the dividends.”

But no more. Now they are reducing the size of their payouts. “If you see the half-yearly reports of the IPPs, you’d notice that they have significantly reduced the size of their payouts this year and a few may not be paying dividends at all. It is because they have exhausted their bank credit limits owing to non-payment of their trade debts and are now saving on cash to pay their fuel bills to keep their plants operational,” the CFO said.

He said the IPPs were also apprehensive of the government’s intention for the future.

“So far the government is dependent on us for the bulk of its generation supply. But once new, more efficient plants come online and create an electricity surplus, the authorities may not only stop purchasing power from us but also completely halt our capacity payments. Who will make it implement its legal obligations under the power purchase agreements?

“We (IPPs) have already spent more than Rs20bn on court cases for recovery of our dues from the government in the past. Does it seem proper for a government to be dragged to court for arbitration on account of sovereign default? What message would the world draw out of it?”

The government is hardly in a position to pay back the power producers their entire trade debt stock owing to its weak financial position.

Thus, it seems, the government — which had offloaded the debt accumulated by its predecessor in one go because it wanted to start its third term with a clean slate — will leave an even bigger mess for its successor.

Published in Dawn, Business & Finance weekly, March 6th, 2017