Trapped by capacity

August 26, 2019

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Khaild Mansoor, CEO of Hub Power Company
Khaild Mansoor, CEO of Hub Power Company

Robber barons, extortionists and rent-seekers are some of the colourful adjectives that analysts have used for Independent Power Producers (IPPs), a group of 39 private companies that generates electricity and sells it to the government.

IPPs view themselves as superheroes that swooped down and rescued the economy by contributing around 60 per cent of total electricity to the national grid.

But the anti-corruption watchdog and public representatives have been sounding the alarm about the rising cost of power owing to the ever-growing ‘capacity charges’ — one of the three components of the rate that IPPs charge their sole customer: the government-owned Central Power Purchasing Agency.

As opposed to the variable fuel charge and operation and maintenance cost, the capacity charge is based on an IPP’s guaranteed return on equity, debt financing charges and construction cost of power units. The government has to pay IPPs capacity charges even if they don’t produce a single megawatt of electricity. It goes without saying that all capacity charges are eventually incorporated in the retail tariff that the consumer pays at the end of the power supply chain.

“Capacity charges can’t just be wished away. We’re not a merchant market,” said Khaild Mansoor, CEO of Hub Power Company (Hubco), the country’s largest IPP, while speaking to Dawn in a recent interview.

‘Most furnace oil-based power plants are about to fully repay their debt. This means their capacity payments will go down soon’

He said a spinning reserve — which is the extra capacity available upon increasing the output of generators already connected to the grid — is necessary to ensure uninterrupted supply. “I’ll need capacity charges if I have set up a plant worth billions of dollars that has a 75pc debt component. Debt repayment is not going into the pocket of the sponsor,” he said.

According to a recent study published by the State Bank of Pakistan (SBP), the power purchase price that distribution companies pay to buy electricity in bulk constitutes on average 65pc of the end-user tariff. The biggest contribution to the power purchase price comes from capacity charges. They amounted to Rs664 billion in 2018-19, up 60pc from a year ago.

One of the reasons for the sharp rise in capacity charges was the addition of 729MW capacity into the power system during the year. After all, the overall revenue requirement for capacity charges goes up with the induction of every new power plant.

In addition, capacity charges surged in the last couple of years partly because they are indexed to the exchange rate, benchmark interest rate and inflation rate.

“Capacity payments will go up for a shorter period of time — maybe seven to 10 years — but the fuel cost component will also come down,” Mr Mansoor said.

His company has 47pc shares in the $2 billion 1,320MW coal-fired power plants set up by China Power Hub Generation Company under the China-Pakistan Economic Corridor that commenced operations last week.

The company’s old plants of 1,292MW — which are mostly idle these days in line with the government’s policy shift away from furnace oil-based electricity — produce power at the rate of Rs17-18 per unit, he said. In contrast, the newly minted power plants are running at full throttle and producing electricity at Rs4 per unit on imported coal.

“Most furnace oil plants are about to fully repay their debt. This means their capacity payments will go down soon. The cost of fuel is also coming down because furnace oil plants don’t run anymore. All coal plants are in the top merit order,” he said while referring to the efficiency-based list of IPPs that National Transmission and Despatch Company (NTDC) uses for electricity despatch.

But what’s the use of surplus electricity if it simply doesn’t reach the consumer? Installed capacity has grown 45.7pc to 34,282MW since June 2014. Even the ‘reliable’ capacity — as opposed to the ‘nameplate’ capacity that cannot entirely be counted on — is theoretically enough to meet the peak summer demand of 27,000MW. Yet the transmission system is capable of transferring only 25,339MW at best.

Significant parts of the country, particularly in Balochistan and Sindh, continue to suffer loadshedding of up to 12 hours a day despite the installed capacity outstripping demand.

For example, Quetta Electric Supply Company (Qesco), which covers whole Balochistan except Lasbella, is getting only 1,150MW from the transmission network against demand of 1,800MW. One of its reasons was that Qesco’s recovery was only 25pc in 2017-18, down from 37.84pc a year ago, because the federal government failed to pay the promised agricultural subsidy.

Some observers, especially from Balochistan, criticise Hubco for not providing electricity to the province where most of its plants are located.

“My contract is with NTDC. (Qesco) can take it from the grid and settle its issues with the federal government,” Mr Mansoor said. “There is no shortfall on the NTDC (network) in Balochistan. It supplies electricity according to demand,” he said, adding that Qesco should improve its governance.

Mr Mansoor believes there is no ‘capacity trap’ and the government should not shy away from letting power producers set up new plants. About 5,000MW is captive power, which has to shift to the national grid eventually, he said.

In contrast, the SBP study says the subdued growth environment and rising power tariffs will make it challenging to generate power demand sufficient to compensate for the expected rise in capacity payments.

“The government should decide whether it wants a 3pc GDP growth rate or 7pc. Is Pakistan always going to be below Sub-Saharan Africa in the electrification rate?”

Published in Dawn, The Business and Finance Weekly, August 26th, 2019