How to fix the power sector

Hafiz Ahsaan Ahmad Khokhar
Wednesday, Jun 12, 2024

Power purchase agreements (PPAs) with Independent Power Producers (IPPs), made under various regimes without careful consideration of the potential consequences, are the primary cause of Pakistan’s power crises.

These contracts stipulate that you must purchase a minimum and fixed quantity of power from the IPPs. The tariff structure indicates that fuel charges, under the ‘take or pay’ contracts that Pakistan has embraced, account for one-third of the total expenses of a typical thermal IPP, while fixed charges make up two thirds of the total costs of these IPPs. The main drawback of these charges is that most of them were awarded without first seeking competitive bids and due diligence.

Because of the IPP agreements, energy users already receive the worst form of invoices in the world, taxes and capacity fees accounting for 70 per cent of their bills. In the past 15 years, the country has lost approximately Rs5,082 billion due to the governments’ inability to control the circular debt, amounting to an annual loss of Rs370 billion. Since July 2018, the power purchase price has climbed by 95.82 per cent. The spanning period of these IPPS will end around 2050.

Pakistan has to make investments in renewable energy sources like hydroelectric, solar, and wind power in order to diversify its energy mix. Reducing energy waste and transmission losses, governance, cost and infrastructure can also be achieved by putting energy-efficient technologies, including smart grids and metering systems, into use.

As of January 31, 2024 Pakistan possessed an installed power generation capacity of 46,035MW, comprising 28,811MW of thermal power, 10,635MW of hydroelectric power, 1,838MW of wind, 882MW of solar power, 249MW of bagasse, and 3,620MW of nuclear power. While the transmission and distribution capacity is stopped at about 22,000MW, the greatest total demand from residential and industrial estates is close to 31,000MW. This results in a roughly 9,000MW shortfall at the height of demand. The nation’s peak demand is significantly less than its installed capacity of 46,035 MW; hence the additional 9,000MW that is needed cannot be transmitted because of poor transmission.

Pakistan has been blessed by hydropower potential exceeding 60,000 megawatts. But only a small portion – 10-15 per cent – of this potential has been realized. Pakistan is expected to have wind power potential of about 346,000MW by the World Bank.

Pakistan attempted to attract private investment in the power industry during the severe energy shortages of the late 1980s and early 1990s, which is when IPPs first appeared in the country. Pakistan launched its Power Policy in 1994 with the goal of luring private capital into the electricity industry by means of competitive IPP project bidding.

The federal government issued 70 MOUs and Letters of Intent (LOIs) to IPPs in 1994, marking the beginning of the nation’s greatest energy conservation programme with the goal of producing 13,000MW. There are currently 49 IPPs in Pakistan, of which eight are hydroelectric and 41 are thermal. Pakistan started experiencing serious problems in the power sector after that.

Several reports state that IPPs had a fixed tariff of seven cents in dollar terms, without considering the country’s currency depreciation in the future. The investment payback period was of 2-4 years. Interestingly, under the 1994 Power Policy, 16 out of 17 IPPs invested a total of Rs52 billion in capital and made profits exceeding Rs417 billion.

There is no doubt that take-or-pay IPPs are reportedly placing a heavy financial strain on residential, commercial, and industrial customers. These reports are grounded in actual facts. While an additional 17,000MW of generation capacity is being planned, the industrial sector’s electricity use has decreased by 25 per cent as a result of exorbitant power prices.

Six IPPs had a remaining life of six to ten years under the 1994 generation policy, while the Kot Addu Power Company had a one-year lifespan. Similarly, 12 IPPs had 14–21 years left on their lives under the 2002 policy. There are 12–19 years left on the renewable energy (solar and wind) programme from 2006. This applies to 19 IPPs. Under the 2006 policy, the eight bagasse-based projects from 2013 had a remaining life of four to twenty-eight years. But it was a bad idea to prolong the terms of the contracts for IPPs established under the 1994 and 2002 programmes.

Notwithstanding the foregoing, Pakistan has nonetheless seen overcapacity in the electricity generation sector as a result of the construction of IPPs without sufficient demand forecasts. Consequently, even in cases where the generated electricity isn’t fully utilized, the government is required to provide capacity payments to IPPs. The nation’s finances are strained by these excess capacity payments, which also add to circular debt. Over the past five years, capacity costs have gone from one-third to two-thirds due to increasing generation capacity.

Without a doubt, the exorbitant cost of electricity under IPP contracts, along with the spiraling capacity payments and finance costs associated with cyclical debt, have rendered the country’s electrical supply unviable for customers and the economy.

Conversely, as per different reports during the first half of 2023–24, the electricity distribution businesses experienced losses and inefficiencies of Rs77 billion, compared to Rs62 billion during the same time in 2022–23. DISCOs’ under-recoveries increased to Rs149 billion in the first half of 2023–24 from Rs62 billion in the same period of 2022–23; as of June 30, however, their cumulative under-recoveries were Rs236 billion.

As early as possible, the federal government must begin conducting forensic audits of these IPPs, including investment forensic audits, in order to look into any abnormalities in their financial transactions. There needs to be a technical audit to evaluate the output and efficiency of power plants owned by IPPs; a financial audit to carefully examine the financial transactions and records; a fuel audit to confirm that IPPs’ reported fuel usage and expenses are accurate; and performance audits to assess how well IPPs are carrying out their allocated duties. They also include investment, tax, generation capacity, heat rate, and performance benchmarking audits.

The first step should be taken by the federal government to stop using capacity payment fees based on a ‘take or pay’ option if these audits show any substantial legal or technical discrepancies. Parallel to this, the federal government ought to renegotiate contracts with IPPs in order to resolve matters like tariff changes, payment conditions, or contractual obligations, as the issue of circular debt and capacity payment costs is becoming worse. Of course, there are provisions in IPP contracts that allow verdicts from international arbitrations to be implemented; nonetheless, taking action now is just as crucial as waiting until it is too late.

With the help of these audits, Pakistan can improve the power sector’s overall efficacy and transparency by finding and fixing any irregularities or inefficiencies in IPP operations; negotiating more fair terms and prices with IPPs; recovering any overpayments or excess profits made by IPPs; and transparency of the power sector.

A variety of further measures could be taken, including converting the fundamental tariff of IPPs from dollars to rupees and launching the country’s alternate energy resources by enhancing the current energy mixtures towards hydroelectric and alternate energy. Similarly, IPP owners should be paid their profits in Pakistani rupees instead of US dollars. Instead of using a take-or-pay contract, the country might save Rs5,500 billion by just exchanging currencies.

Given the alarming situation, it is imperative to review or renegotiate the IPPs Power Purchase Agreements immediately in order to prevent Pakistan’s economy from collapsing.

The writer is a practising advocate of the Supreme Court of Pakistan with 25 years of legal standing.

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