Overview

Today the world is seeing another source of necessity for everyday life known as Electricity. Where there are many in the world taking electricity for granted, still availability of electricity is not the same in the entire world. The Islamic Republic of Pakistan, a country born on 14th August 1947 and in a 73 years journey had a constant struggle with the Electricity sector. Still many of the country inhabitants are deprived of this basic necessity of Electricity. So where did it all went wrong for a country of 220 million people? 

It has been a thought process that the decline of any sector in a country is linked to the bad decisions by people in power, in principle it is a half-truth as the private sector is equally responsible for the misery of people in Pakistan. In this article, we will bring the facts behind the decline of the electricity sector in Pakistan. In order to understand the flaws of the overall sector, we have analyzed the recent investigation report on the electricity sector by Federal Investigation Agency (FIA) and all the data is analyzed in view of the data provided by the report. One of the highlights of the investigation is the increase of Independent Power Producers (IPPs) in the country. We will try to bring the key facts on the contribution of these IPPs locking the electricity sector in complete chaos for years and why it contributes immensely to average citizen life. 

Independent Power Producers

Independent Power Producers (IPPs) have been set up in Pakistan under various power policies issued by the Federal Government, each addressing or tapping into certain aspects of the power sector. IPPs are usually referred to as Private Investors investing in the establishment of a power production unit based on the rules of agreement decided among regulatory authorities and Govt.

As per 2019, 78 IPPs exist in Pakistan with a gross capacity of 19,418 MW, and dominating the country’s power generation capacity with a share of approximately 54%.

Let us take you through the story of the Power sector in Pakistan, giving the complete picture of how the power sector marched towards the disaster of today. In the wake of acute power shortage in the country, the Federal issued a first-ever Policy Framework and Package of Incentives for Private Sector Power Generation Projects (“1994 Policy“) based on oil, coal, and gas in 1994. Considering a conservative 8% demand growth over the next 25 years, the 1994 policy aimed to attract overseas and local investment in the power generation sector in Pakistan. The policy offered a bulk power tariff of US cents 6.5/kWh for the first 10 years, with the levelised tariff of US cents 5.9/kWh over the life of projects (typically ranging between 25-30 years). The policy was later supplemented by a 1995 Policy for hydro based IPPs.  

The 1994 policy was followed by the issuance of Power Generation Policy 2002 (“2002 Policy“), owing to the unbundling of WAPDA (sole power generation company at that time) and creation of independent power regulator, NEPRA (National Electric Power Regulatory Authority). The policy enclosed a comprehensive security package where the Federal Government guaranteed all payments to IPPs (which power purchaser is obliged to do so). Moreover, exclusive tax exemptions for oil-fired power generation projects, along with USD indexation for Return on Equity (RoE) were allowed. I put money in Rupees and you give me all in US dollars, Why not? 

For the development of renewable energy in the country, Pakistan introduced its first RE based policy named Policy for Development of Renewable Energy (RE) for Power Generation (” RE 2006 Policy“) in 2006, wind, solar, thermal, and small hydro (50 MW) technologies. Policy set a target of a minimum of 9700 MW of renewable energy in the energy mix by 2030. Incentives offered in the policy included exemption from income tax, repatriation of equity and dividends and provision to raise local and foreign financing. RE projects developed under this policy were allowed to follow Build, Own, and Operate (“BOO”) or Build, Own, Operate and Transfer (“BOOT”) models with a validity of up to 20 years. Additionally, benchmark payments (considering wind speed variability and water flow) were guaranteed to IPPs by the purchaser.

In 2013, the scope of RE2006 Policy was expanded with the inclusion of bagasse, biomass, waste-to-energy, and bioenergy technologies through a Framework for Power Co-generation 2013 (“Framework 2013”). The framework allowed for co-generation of power facility as part of an existing sugar mill or as a completely separate entity.

Govt. of Pakistan envisioning to end energy crisis by 2018, introduced a comprehensive Power Generation Policy (“2015 Policy”) in 2015. The policy allowed for public-private partnerships for energy projects along with backup securities for payment obligations to IPPs from the purchaser. The policy introduced a two-part, USD indexed tariff comprising of CPP (Capacity Purchase Price: PKR/kW) and EPP (Energy Purchase Price: PKR/kWh). Meaning, if a power is not bought from the IPP the Govt. will pay and combination of CPP and EPP converted to USD to each IPP part of the 2015 policy. Lastly, the Internal Rate of Return (IRR) of up to 20% was allowed on USD equity in the tariff by the regulator (NEPRA).

Key Issues

• Exorbitant Profitability

First IPPs were established in Pakistan under the 1994 Power Policy. Under this policy, 16 out of 17 IPPs invested a combined capital of PKR.51.80B and earned a profit of PKR 415B.  

Similarly, 13 Residual Furnace Oil (RFO) based plants established under Power Policy of 2002, have earned PKR 152B in profit, against a combined investment of PKR 57.81B during the last 8-9 years of operation. This translates to the dividend payments to the tune of PKR 111B, earning profits around 9 times against the investment.  A profit that makes gold look cheaper? 

Imported coal-plants set up under the Power Policy of 2015 also depict the same story. One plant recovered 71% of the investment in only two years and another plant recovered 32% of the investment in the first year of commercial operation.  Take my money and give me a Power Plant. 

• USD Indexation 

PKR based return of 15% (based on 10-year Pakistan Investment Bonds (PIB) yield of 10.2%) was converted to 15% USD-based return without considering much lower USD bond yield (in comparison of PIB). PKR based PIB which already incorporates future depreciation between PKR and USD, along with USD indexation has in effect resulted in duplication of PKR depreciation. This has resulted in excessive payments to the tone of PKR 16.48B. 

Similarly, due to the provision of USD based return (USD IRR), a continuous appreciation of USD against the PKR has led to increasing consumer tariffs. The amount of difference between offering returns in PKR and USD varies across various projects.  

• Payments on account of Fuel, O&M, Heat Rate

Excessive payments made to IPPs include a significant portion for Fuel along with Operation and Maintenance expense. However, it was determined that payments for higher fuel consumption and O&M were expenses made to IPPs, in contrast, the actual fuel consumed for electricity generation, along with O&M expenses incurred were less. These excessive payments account for PKR 209.46B (including expected future payments). 

Similarly, heat-rate (an efficiency measure for electrical generators that convert Energy in fuel into heat and electricity) provided to NEPRA for tariff calculations were significantly lower in comparison to the actual operation of RFO plants. 

• Internal Rate of Return (IRR) Payment Miscalculation

NEPRA had allowed a return to IPPs based on 15% USD Equity IRR, assuming payment of a return on an annual basis. In reality, CPPA-G paid IPPs (including return on equity) through CPPA (Central Power Purchasing Agency, primary procurer of power on behalf of distribution companies in Pakistan) on a monthly basis. This mismatch between IRR calculation on annual basis and actual monthly payments results in an IRR earned by IPPs to be 16% (for 2002 Policy IPPs) and 18.39% (for 2006 and 2015 Policy IPPs). Extra earnings made by 11 IPPs due to payment mismatch are around PKR 6.46B in the last 5-9 years of operation. 

• Debt Repayment Mismatch

NEPRA allowed debt repayment on a quarterly basis, whereas CPPA-G made payments on a monthly basis, resulting in additional working capital availability for the IPPs. This is in addition to the working capital cost included as part of the tariff awarded to the IPPs by NEPRA.  

• Short Payback Periods 

Most IPPs had an investment payback period between 2-4 years. Six IPP companies have earned annual RoE between 60-79% and four IPPs have earned RoE of around 40%. 

“In some cases, profits generated were 18.26 times and dividends taken out were as high as 22 times the investment.” 

• Fuel Inventory Shortfalls

RFO based IPPs were required to maintain sufficient fuel inventories to operate the plant for 30 days at 100% load at all times. This was included in the tariff through the cost of working capital component. Actual inventories are not maintained at their required levels, despite payments being made by CPPA-G. The financial impact of this shortfall accounts for PKR 3.63B. 

• Capacity Payments 

With the current structure of “Take or Pay” tariff regimes offered to IPPs, regardless of consumption, the power producers are to be paid. This becomes prevalent in times of low economic growth which consequently affects the electricity demand. The projection for next year’s Capacity Payments stands at PKR 900B, as there will be an excess capacity of 30%. 

“An extra 900B to be paid just because IPPs, NEPRA and the Govt. at the time signed the agreement to make each citizen out of 220 million population in debt to every IPP.” 

In view of the aforementioned issues, the way forward for Gov. of Pakistan requires a comprehensive engagement with all the stakeholders within the power sector including the IPPs. IPPs lured by successive governments’ incentives and exorbitant returns, have established a dominating role in the country’s power sector. Negotiations between IPPs and Government needs to be done to ensure Pakistan’s power sector is sustainable in terms of finances and operations. This is also in the best interest of IPPs as collection of timely payments for the existing projects remains beyond the capacity of the Government.  

Written by: Muhammad Fahad Faizan (Founder, PakESDA)

Co-Author: Farhan Farrukh (Energy Professional, Norway)