THE TRUE COST OF POWER
Header illustration by Samiah Bilal
China in the 1990s had about 80,000 state-owned enterprises (SOEs), spanning from cottage industries to commercial and industrial behemoths. Most incurred perpetual losses. Policymakers identified raging corruption as one of the key drivers of those SOEs’ terminal decline. While noting that many directors had enriched themselves at the expense of the loss-making firms and an impoverished labour force, Chinese officials quipped in their customary style: “the temple is poor, but the monks are rich.”
Nearly three decades later, this phrase aptly describes the state of Pakistan’s electric power sector.
Notwithstanding the virtual bankruptcy of the “temple” for several years, it’s not only the “monks” who have been taking advantage of it, but everyone who interacts with it — from the pilgrims to builders to its security guards, i.e. consumers, power producers and law enforcers, respectively.
Writing for this newspaper last autumn, I had noted that “Major stakeholder groups have been working in a regrettable harmony for the undoing of this crucial sector. […] As a mere reflection of its players’ deeds, the sector is plagued with voracious interests and rent-seeking ambitions.” It is painful to see that stance being vindicated.
In August 2019, Prime Minister Imran Khan directed the formation of a committee to examine the causes of the “high cost of electricity” and circular debt, and to propose a way forward to ensure “the future energy security of the country.” The Committee was given 12 weeks to complete the onerous set of tasks, which it concluded in April in the form of a 296-page report, titled “Report on the Power Sector: Committee for Power Sector Audit, Circular Debt Resolution & Future Roadmap”. And, predictably, the report was “leaked” before the federal cabinet gave the nod for its publication.
The report addressed a wide range of issues, but the subsequent media coverage focused almost exclusively on only one aspect: independent power producers (IPPs). It’s even being referred to as the “IPPs report”.
That is a poor choice of title, even in colloquial terms. Like many other state affairs, the government made little effort in informing the public of the Committee’s findings and how it would implement the recommended action plan, supposedly because it’s been engulfed in tackling the Covid-19 pandemic and its multifaceted fallouts.
Consequently, speculations and misinformation are rife. People cherry-pick numbers from the vast swathes of data the report, contains to serve their particular narrative. Commentators, regardless of being unaware of the sector’s subtle intricacies, think of the report’s findings as definitive. And the rudimentary nature of the ongoing discussion is depriving the general public of an informed policy debate that should have ensued, given the power sector’s pivotal role in the economy. However, for such a discussion, a comprehensive, critical review of the findings of the report is in order.
HOW ‘BAD’ ARE THE INDEPENDENT POWER PRODUCERS?
The Electricity Supply Chain (ESC) consists of three primary functions: generation, transmission and distribution. Due to the high interdependency of all segments, ESC is as robust as its weakest link. Inefficiency in one vertical flows across the value chain. Moreover, unlike the lately infamous sugar-wallas, IPPs are not the sole driver of the cost of electricity, nor does anyone have enough influence to distort the dynamics of the whole sector, which we’ll see later.
Against this backdrop, it becomes necessary to take a holistic view of the sector to make an informed opinion about its troubles and the potential way forward. Since the public debate remains fixated on the role of the IPPs, let’s examine the report’s methodology and conclusion in this regard first.
The timeframe of a few months is inadequate to analyse several years’ record of 78 IPPs objectively. The urgency seemingly led the Committee to find a quicker way to complete their job. It employed accounting techniques to analyse IPPs’ earnings, which can be placed in three broad categories: returns allowed through successive national policies and regulations; irregularities in day to day operations; and misreporting of cost during project construction.
Despite recognising the unavailability of necessary data, the report presents the “profitability” of projects established under the 1994 policy. In such cases, half the information is not half the truth. It could be misleading, which is why it should have been revealed only after the complete data was available. It’s, therefore, unnecessary to discuss these projects here.
The Electricity Supply Chain (ESC) consists of three primary functions: generation, transmission and distribution. Due to the high interdependency of all segments, ESC is as robust as its weakest link. Inefficiency in one vertical flows across the value chain.
The most complete picture the report presents is of the 3 gigawatts (GWs) of thermal power capacity built under the 2002 policy. As part of the Musharraf regime, Shaukat Aziz doled out USD-indexed profits through an ECC decision in 2007, although almost all developers were local businesses. It’s an astonishingly hostile arrangement towards the consumer because it increases IPPs’ profits and the cost of electricity whenever the rupee loses value against the dollar. Indeed, it’s among the most damaging policy decisions concerning the promotion of IPPs in the country.
But who is more culpable for this disastrous incentive — the opportunistic power barons or the state that continues hurting its citizens’ interests? Successive governments protracted this ill-advised incentive and all subsequent IPPs, foreign and local, were guaranteed massively lucrative returns. More strikingly, some government-funded power plants also have dollar-indexed profit rates. The Committee rightly observes that future depreciation in the rupee will render the ratepayer far worse off. However legitimate the concerns, they can be discussed more appropriately in the context of public policymaking rather than IPPs’ perceived plunder.
In terms of irregularities in routine operations, the report argues that IPPs’ accounts reveal profits more than what was permitted to them. It’s relatively easy to probe because the power sector is highly regulated. The National Electric Power Regulatory Authority (Nepra) determines how much a power producer can spend, down to rupees. The Committee compared the costs allowed by Nepra with IPPs’ financial statements and concluded that many are “saving” money in multiple ways. The misrepresentation of fuel cost and inventory shortfalls are the dirty little secret of many IPPs, which is argued to have cost 34.2 billion rupees to the consumer already. Other “irregularities” remain open for further examination though. For instance, IPPs usually spend less from their maintenance cost allowance during the earlier years of operations, which may level out when plants start ageing and need more frequent repairs.
Lastly, the report claims that some newly established IPPs “misrepresented” their set-up cost. If found correct, this allegation can have severe consequences for the relevant investors. However, this judgement is far from conclusive, since a slight variation in one’s assumptions and understanding leads to entirely different conclusions. A case in point is the Chinese-funded coal projects at Sahiwal and Port Qasim. The report suggests that Nepra allowed an excess set-up cost of 32.5 billion rupees to the sponsors, owing to the Committee’s interpretation of some clauses of tariff documents. It’s well known that Shahbaz Sharif, then Punjab’s Chief Minister, persuaded the Sahiwal IPP to take alternative measures to speed up the construction process, requiring a host of details to calculate the project cost accurately. Regardless of the envisaged precision, arguments will persist about the rightful beneficiary of the financial efficiency: Is it the IPP who took the risk and is subject to losses in case of cost overruns, or the ratepayer who will compensate for these costs for 30 years?
Then there are instances where the Committee pays insignificant regard to Nepra’s tariff determination mechanisms and remains indifferent to ground realities, leading it to form views that are fundamentally different from those of the regulator’s. For instance, the regulator allows a dollarised return on equity (ROE) of 27.2 percent — which is prohibitively high. The Committee, however, by invoking another measure of profitability, i.e. the internal rate of return (IRR), maintains that the ROE should be 20.8 percent for the Sahiwal plant. With this backdrop, one can compellingly say that the report is not definitive but can serve the purpose of preliminary findings to kickstart an exercise of evaluating earlier power policies and excessive regulation vis-à-vis the establishment of IPPs.
THE ‘DINOSAURS’ IN THE ROOM
Nature’s diversity dazzled the ‘Inquisitive Man’ of Russian fabulist Ivan Krylov upon his visit to the Museum of Natural History. He narrated his observation of the wondrous butterflies and beetles to a friend, who quizzed him about his thoughts on the mountainous elephant in the museum. Stunned, the Inquisitive Man responded, “Well, old man, don’t tell anybody — but the fact is that I didn’t notice the elephant!” If the Committee’s report were a museum, it presents anatomical details of several dinosaurs — the elephant metaphor doesn’t quite characterise the size and antiquity of the issues. But most media outlets and policy pundits didn’t bring these dinosaurs to light sufficiently.
For context, let’s revert to the power sector’s three verticals: generation, transmission and distribution. State-owned utilities, operating under the auspices of the Ministry of Energy Power Division (MOE-PD), are the most notable players of the ESC. They manage nearly half of the country’s power generation capacity and have monopolistic power in the transmission and distribution (T&D) sectors. About 5.6GWs of their generation capacity burns local gas as the primary fuel, with a cost of power production that is much higher than that of comparable IPPs. These plants, aka Gencos, are known for their wasteful utilisation of domestic gas due to chronic operational inefficiencies.
Instead of allocating invaluable indigenous gas for newer, more efficient plants, the Nawaz Sharif government contracted regasified liquified natural gas (RLNG) supply from Qatar — a decision that lost commercial appeal for Pakistan before the ink of the agreement had dried. Therefore, the role of Gencos — and of several other factors that require further inquiry — cannot be underplayed in the growing cost of power generation.
Once generated, electrons flow into the national electricity grid. From here onwards, government utilities become the sole custodians of T&D functions, excluding that for K-Electric customers. Notwithstanding their limited sectoral know-how, the MOE-PD babus micromanage those utilities whose widespread inefficiencies are illustrated in the graphs. Resultantly, their losses, known as the aggregate transmission and commercial losses (AT&C), are the highest among South Asian nations.
India’s power sector, for instance, had AT&C losses of 20 percent in 2019 despite its colossal outreach. Pakistan’s AT&C losses have an eye-watering financial burden, which, according to Nepra, plays “primary role in [the] creation of circular debt”. Discos’ AT&C losses amounted to a whopping 788 billion rupees from FY2014 to FY2019, bringing their cumulative receivables to 1,131 billion rupees as of December 2019.
Although the MOE-PD, under Federal Minister for Energy Omar Ayub Khan, has continued boasting about its “achievements”, Nepra’s flagship ‘State of Industry Report,’ published in May, laid bare that Discos’ receivables soared by 249 billion rupees in FY2019 compared to 166 billion rupees in FY2018. With the given state of affairs, it’s foolish to expect any improvement in the sector without fixing these bottomless pits, aka Discos.
The debate about such critical issues, which have stunted economic growth in the country, is avoided perhaps because it pins more responsibility on power consumers and demonstrates the failure of the MOE-PD.
THE LIMITATIONS OF INVESTIGATION
It’s a cinch to judge others’ decisions in hindsight. The convenience skyrockets if analysts set aside the circumstances under which a particular policy decision was taken, but that can fetch an imperfect analysis at best. In this case, the prime minister asked the Committee to find the reasons for the “high cost of electricity” — a suboptimal framework, for it’s immensely prone to the risk of confirmation bias.
That is how most Pakistani rulers tend to run government affairs. The practice of “inquiry commissions” is reaching new heights under the current administration, which appears less interested in reinforcing the existing regulatory frameworks. Consequently, the narrowly defined scope and the unnecessary haste resulted in apparent compromises on the part of the Committee, despite its tremendous effort. Ideally, this should have been an objectively defined, well-funded, and transparent policy evaluation exercise under the chairmanship of the prime minister.
The Committee delved deep to deconstruct the cost of power generation and called out two players: IPPs, for their alleged misconduct, and Nepra, for its officials’ dereliction of duties. But it sheds no light on the financial integrity of Discos and Gencos, whose annual expenses of tens of billions of rupees are borne by the ratepayer.
Desperate, successive governments caved into investors’ demands of usurious returns. Since the MOE-PD didn’t calibrate the optimal level of generation capacity buildout and a prudent fuel mix, every policy spawned a “capacity trap”, laden with imported fuels. That delinquency continues wreaking havoc on the country’s fragile balance of payments and hence its macroeconomic stability.
More surprisingly, it stopped far short of examining the role of other key players. And for that, we have a rule of thumb: Those who vie to take credit for any improvement in the sector, no matter how rare and marginal, will also bear responsibility for its failures. In that context, the report may have failed to unearth the hotbed of the mayhem, but Nepra’s 2019 State of Industry Report is spot on.
Let’s recall that it’s the MOE-PD that plays the most influential role, ranging from policy development that contains various incentives for IPPs to managing SOEs. Firstly, the MOE-PD never produced and executed a long-term development plan for the electricity sector to discourage a cyclical addition of power generation capacity. The policies of 1994, 2002 and 2015 aimed solely to overcome loadshedding, lacking any strategic consideration.
Desperate, successive governments caved into investors’ demands of usurious returns. Since the MOE-PD didn’t calibrate the optimal level of generation capacity buildout and a prudent fuel mix, every policy spawned a “capacity trap”, laden with imported fuels. That delinquency continues wreaking havoc on the country’s fragile balance of payments and hence its macroeconomic stability. Secondly, Nepra’s damning of the centralised, ineffective role of MOE-PD in public sector entities is on the mark which, it argues, has “led those [SOEs] to unacceptable levels of technical and financial performance.” Is there still any ambiguity about the order of responsibility?
Lastly, but not exhaustively, despite having many thoughtful suggestions, the report tends to push the envelope to wrap several silver bullets too. For instance, it proposes to strong-arm IPPs, under the pretext of their “wrongdoings”, and rewrite contractual terms unilaterally. No matter how befitting it may be for a populist narrative, our prior discussion demonstrates that the Committee’s findings are not definitive yet. Therefore, such recommendations must be carefully pondered, because any action in this regard will have ramifications. A considerate plan is also necessary because the government should allocate its limited resources to kickstart a virtuous cycle in the power sector that can yield far-reaching outcomes.
OUT, PARASITES, OUT
More than 20 years on, the Chinese ‘temples’ have grown rich, and the ‘monks’ richer. Admittedly, the monks were ‘disciplined’ to harness patience along with an overarching reform plan. There should remain no doubt that Pakistan’s power sector would achieve lasting improvements if all key stakeholders tamed their relentless swindling. But that doesn’t absolve the government of playing its part in taking necessary measures to set course for a robust electric power market and, consequently, fiscal and economic stability.
The Committee has detailed a comprehensive action plan with forceful suggestions, chiefly about fixing the systemic inefficiencies to stem the infamous circular debt. Like many past plans, however, it appears very ambitious against the backdrop of limited sectoral know-how across the ranks of the current administration and the urgency of the corrective measures.
Therefore, while the government ponders on the nuts and bolts of its way forward, it may jumpstart a few steps while considering the following guiding principles: plan strategically, act tactically and don’t be obsessed with the symptoms; target the illness.
Two broad categories of actions are suggested: tactical, firefighting measures and the promulgation of a long-term strategy. For the former, three policy interventions are proposed:
First, and foremost, the MOE-PD, with its obsolete bureaucratic structure, cannot pull off meaningful improvements. Its role in state utilities’ operations needs to be replaced with that of independent directors, and SOEs held accountable by the Cabinet Committee of Energy (CCoE). Nepra’s benchmarks can serve as performance indicators for the utilities during the 2020-2023 period.
On its part, the MOE-PD can serve as a coordination unit between the CCoE and independent utilities. This measure will stem one of the gravest structural bottlenecks in the effective and efficient functioning of state utilities.
Second, if consumers don’t pay their bills upwards of 100 billion rupees each year, how can we expect the sector to remain solvent? The government may consider engaging provincial authorities to help Discos improve bills recovery and overcome power theft. A coordinated approach will lay the groundwork for the provinces to play a more proactive role in the overall reform process for the future. Since the Pakistan Tehreek-i-Insaf (PTI) is governing Khyber Pakhtunkhwa and Punjab, it’s fair to assume that it can engage provincial authorities to curb AT&C losses. Only if Khyber Pakhtunkhwa, the party’s apparent stronghold, yields a 95 percent bills recovery ratio, it may cut losses by over 40 billion rupees through 2023.
Finally, let’s delve into the burning question of ballooning capacity payments and IPPs’ excess profits identified by the Committee. In terms of past payments, there’s unfortunately not much the government can expect from the IPPs. Moreover, the government is better advised to avoid being penny-wise and pound-stupid. Nonetheless, Nepra ought to thoroughly re-evaluate every rupee of fuel cost paid for by the consumer and hold IPPs accountable for any misreporting, enforce indemnity to the ratepayer for excess payments with interest, and slap applicable penalties.
On its part, the CCoE made an excellent suggestion to lower the profit rate for state-owned plants to reduce the overall cost of power generation. It has to ensure that the return on equity for these plants, including thermal (gas and LNG), nuclear and hydel, doesn’t exceed 10 percent and isn’t indexed to the US dollar. Ideally, the government may consider suspending its equity returns for its power plants until 2023 to steer the sector away from its financial troubles. There is also an urgent need for the federal government to persuade the Khyber Pakhtunkhwa government to rationalise its demand for excessive ‘net hydel profit’.
FLOGGING A DEAD HORSE OR...
IPPs must take note. Confrontation and legal wrangling will help no one in the long run. Local investors rightly plea that the USD-indexed returns are legally binding. But nothing dissipates this incentive’s unfairness to the ratepayer and its potential to worsen the systemic risk. The sponsors’ insistence on injudicious returns from a sector that’s in terminal decline and doomed to fail, unless revived, could be anything but rational. They may need to consider whether to utilise their energies in hastening the demise of the power sector — and their investments — or in partnering with the government to find ways to steer the sector away from the muddle. Surely, an amicable solution, where investors can draw competitive and fair returns on their investment, would be preferable.
There are ways to rationalise the cost of power projects developed under the CPEC umbrella. Most of these discussions can be carried forward with the Chinese government.
In a February 3 op-ed, I highlighted the need to reduce the 7 percent premium of Sinosure, which alone will help slash the burden of several hundred million dollars. Moreover, there’s a possibility to extend the repayment period of these loans and lower the interest rate. However, this solution can prove beneficial only in the immediate future and is most likely to inflate total interest payments, and thus demands careful deliberations.
The writing that ‘the future of power is distributed’ is written on the wall. IPPs ought to play their part in driving down the cost of electricity since a financially robust sector is in their best interest. IPPs’ short-sightedness, on the other hand, will hasten the adoption of inexpensive off-grid solutions and public officials won’t have the mettle nor the need to foot the bill of capacity payments to the tune of several billion dollars each year. IPPs’ long-term relevance hinges on their ability to produce very cheap and reliable electricity.
While the government ponders on the nuts and bolts of its way forward, it may jumpstart a few steps while considering the following guiding principles: plan strategically, act tactically and don’t be obsessed with the symptoms; target the illness.
While taking these firefighting measures, the government shouldn’t underplay the urgency of a rigorous, long-term strategy. The absence of integrated planning was the key driver of past torrents of power capacity addition. An Integrated Energy Plan (IEP) is a precondition to sustain any near-term gains and guide the sector towards a resilient future. But the question persists about government departments’ capacities for such a specialised task. In many countries, energy ministries are custodians of integrated plans. Pakistan can make it a joint effort of the planning and energy ministries. Nonetheless, it will require extensive expert knowledge, which, for once, should be funded by the country’s finances — not from aid dollars.
In the second stage, the IEP draft needs to be discussed in parliament and adopted as a joint strategy. That will garner much-needed ownership across the political spectrum and ensure continuity of the plan beyond a government’s term. The remaining tenure of the incumbent regime lends it an opportunity to hatch and notify an IEP for its lasting legacy. A few years from now, most people will not remember how, if at all, the PTI government dealt a blow to sugar barons. But the implementation of an IEP may pave the way for economic stability. Should the PTI fail in this endeavour, the power sector will remain in its death spiral before any short-term improvements take hold.
THE MILLION-DOLLAR QUESTION
The question now is whether the PTI government can deliver what is expected of it in the next three years. The short answer: it’s highly unlikely, owing principally to the absence of catalytic leadership in the energy sector. Omar Ayub Khan and Nadeem Babar are running the ministry as a federal minister and special assistant to the prime minister (SAPM), respectively. The former may have limited political firepower, being a novice amongst the PTI ranks. The latter’s credibility has arguably eroded because of his affiliation with a few IPPs that the report accuses of misreporting. Lately, Asad Umar, a cabinet heavyweight, took over the reins of the CCoE and is understood to be driving the reforms agenda with support from SAPM Shahzad Qasim.
Clearly, the disarray is far from ideal for the energy sector, whose operational, structural and strategic deficiencies call out for a capable leadership more than ever before. Having said that, the yearning of this analyst for a stellar performance by the PTI to prove this assessment wrong is strongest.
The writer would like to thank public and private sector officials who shared their invaluable views on the condition of anonymity.
The writer is an analyst. He tweets @sohaibrmalik and can be reached at email@example.com
Published in Dawn, EOS, June 7th, 2020