Power at the margin

Published December 30, 2024

A power policy is effectively an industrial policy. To unlock growth, it remains critical that an export-oriented industrial policy that is adequately supported by an efficient, market-oriented power regime is shaped.

Over the next 12 months, to stimulate sustainable growth, the current power infrastructure must be operated efficiently and with market-oriented pricing rather than arbitrary cost-plus mechanisms. It is important that competition provides an opportunity to buyers and sellers rather than creating walled gardens and espousing more inefficiency in the process.

The current electricity pricing structure has stifled industrial expansion, with high tariffs pushing businesses toward on-grid and off-grid solar. However, the impact is restricted at best, with a transition of roughly 300MW of industrial use from the grid, to behind-the-meter solar.

Industrial growth cannot be supported solely by solar energy, and an efficient grid is required to power it. This requires that the tariff is rationalised by trimming excess costs that have been loaded onto it and by pricing the same at the margin rather than through arbitrary cost-plus mechanisms.

Simply tweaking existing pricing frameworks to a dynamic market-oriented pricing mechanism can enable higher utilisation of existing capacity

Capacity costs make up roughly 51 per cent of the base price. However, half the capacity cost is long-term debt raised to finance power projects. The debt is primarily denominated in foreign currency, which is settled by the sovereign. Effectively, such debt is already deemed as part of the country’s total external debt. However, the same is serviced by the consumer through tariffs and any rupee depreciation results in a significant increase.

There exists a case where such debt repayments are swapped out to the government, which already has the responsibility of repaying the same in foreign currency. Moreover, extending its maturities while moving the benchmark rate from the Secured Overnight Financing Rate to the Shanghai Interbank Offered Rate through a refinancing manoeuvre at the sovereign level can provide necessary breathing space.

Moving debt to the sovereign can free up more than Rs5.1 per kWh of space in electricity tariff — which can then be passed onto consumers. However, it remains critical that any benefit passed on must take into consideration the economic value-addition that can be generated by using an incremental electron.

Similarly, another Rs3.23 per kWh is charged in electricity bills as markup on circular debt, which increases to Rs3.78 per kWh, on a post-tax basis. There exists a possibility that the same can be refinanced, benefiting from surplus liquidity in the system. The stock of circular debt can be refinanced, and the reduced burden shifted to the sovereign. Even though the same is a sovereign risk, the markup being charged on that risk remains higher than what the sovereign actually pays — reducing the spread can generate consumer welfare in the process.

More than 4,000MW of imported-coal fired power plants remain underutilised in the South

There exists surplus power capacity in the country, which, according to some, is a big problem, but it is a good problem to have. It is estimated that more than 4,000MW of imported-coal fired power plants remain underutilised in the southern part of the country. To harness the underutilised capacity, a reverse-dutch auction model is proposed, such that any unutilised capacity for a period of five years can be auctioned off to prospective bulk power consumers.

Effectively, such consumers can lock in their prices for the next five years, which is linked with a fuel index, and can plan future expansion accordingly. To stimulate industrial growth, such auctions can only allow consumers to add greenfield or brownfield capacity so that incremental consumption can materialise. With eligibility restricted to new consumption, this initiative can potentially drive incremental GDP growth.

The prevailing Time-of-Use (TOU) tariff structure is designed for peak hours in the 7pm to 10pm range, and the same has not been updated for more than a decade. Actual peak usage is now between 11pm and 2am. We are suggesting a move of Peak TOU so that consumption behaviour can be adjusted through price.

Similarly, the surge in solar installations has led to a scenario where demand for electricity from the grid drops significantly during peak daylight hours — between 7am and 2pm — such that the drop in demand relative to peak during the same day is in the range of 1,500-3,000MW.

Effectively, the capacity that already exists is being used during the day, but because it is not priced appropriately, its usage remains low. There exists a strong case to create an Incremental Daylight TOU tariff — proposed for 7am to 2pm — such that electricity during this time period can be priced at the margin.

Incentivising incremental consumption at marginal cost during peak daylight hours would lead to efficient utilisation of all on-grid and off-grid solar capacity while also enabling industries to reduce their average cost.

Such pricing can be announced in advance and can only be restricted to industries initially, given a 99pc recovery rate from the same. It is estimated that if industries start operating at close to optimal levels, an additional 600MW of industrial demand can enter into the system (excluding any captive power) without additional infrastructure investment and would lower average costs for all users.

The writer is the CEO of National Credit Guarantee Company Ltd and assistant professor of practice at IBA, Karachi

Published in Dawn, The Business and Finance Weekly, December 30th, 2024

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