Reforming CPEC

Energy crisis appears to be tapering off, thanks to the CPEC and non-CPEC projects which had been commissioned already or are to come on line by mid-2018, if not earlier. There has been criticism of CPEC in terms of transparency, its contractual terms and economics and the issue of public participation in programme design. Others have argued that much time had been wasted by the energy crisis, and there is no longer a crisis, and there may be opportunity for discussion and re-examination of certain aspects of the CPEC programme on which there has been criticism. Since a new phase has begun, in addition to energy and a road infrastructure, the industrial and agricultural sectors are being brought in.
In this article, I will be mainly focusing on the energy sector (it being my forte) which occupies the bulk of the monetary outlays. Also I would like to clarify that this is an attempt to explore options and approaches for working out a framework for a mutually beneficial and sustainable cooperation between the two countries. We will take a case study of the two coal power plants that have already been commissioned; Sahiwal completely and Port Qasim partly. It is widely argued that the terms of the CPEC should be fairer and competitive.
On the average, the coal power plants are cited to be 40 percent more expensive both in terms of CAPEX and tariff. The Port Qasim power plant has been installed at a cost of $2.08 billion, including a high CAPEX component for a coal jetty. The tariff of the two projects is 8.26 USc per kWh. And a unit CAPEX of $1.45 million per MW. There is a consensus in knowledgeable circles that this is a high cost and tariff.
I would like to distinguish myself from those less informed people who have been criticizing high returns on equity of 28 percent or so, which actually is equivalent to 15-16 percent IRR - on equity which may not be regarded as too high. A technical discussion on this may be space-consuming.
Normal tariff elsewhere in the world is under or around five cents. In India, it is still lower due to low-cost local coal and less stringent environmental control requirements in its old power plants.
Even new coal power plants in India are based on more expensive imported coal have a tariff of 3 to 4 cents. A contract has been signed recently for the installation of a 2400MW coal-fired power plant with state-of-the-art environmental controls and a coal jetty with a CAPEX of $2.47 billion. By comparison, the Port Qasim coal power plant of 1300MW with comparable situation and specifications, and lower efficiency (42 percent vs 50 percent current typical), has cost $2.08 billion).
The tariff is around 4.86 US cents per kWh. Alstom (now part of GE) is providing the hardware and China's Harbin is to be the main constructors. Financing consortiums involve Chinese, the Middle Eastern and western banks and agencies. Even in Pakistan, the ADB's Jamshoro project, where bids have been opened, the contract has yet to be awarded, and the contract prices are much lower than the two CPEC power plants.
Why did this happen? Haste (although justified), poor regulatory mechanism and lack of competition appear to have been the main reason. Without competition, it is well nigh impossible to get the right prices. In all of the afore-mentioned cases, it is the magic of competition that has worked. It is argued that competition is not possible under government-to-government contracts, which we will discuss later.
The next best approach is for the buyer to know the prices of the product he is buying and do some hard work to find that out, or seek the assistance of third parties who may have the required experience and knowledge. This could have been done by both the regulator and the government ministries and agencies. This was not done.
What has been done is that Chinese vendors and contractors asked or negotiated a price with the minister or the ministry which the latter communicated to the regulator, Nepra, which without a meaningful scrutiny and effort issued a high tariff. Nepra held public hearings inviting the locals who hardly had any knowledge of the prices (they may have had some knowledge about coal-power plants though), but certainly had no data on prices. This became even worse than a cost-plus tariff as in the latter, the responsibility of unrealistic or unfair cost claims lies on the supplier which can be questioned at almost any stage.
In this case, Nepra assumed the responsibility by issuing a high tariff based on the unverified demand of the vendors. Obviously, it is NEPRA's decision, although allegedly manoeuvred by the vendor. Thus, one of the possible solutions is for Nepra to be mandated to seek third-party input in making such determinations. Under the new law, the government has acquired more powers and skies have not opposed the dilution of the powers of the regulators.
A moratorium on new tariff determinations, except where competitive bidding is involved, should be imposed unless Nepra does not bring its house in order so that the mentioned inadequacies are removed.
Additionally, high returns of 16 percent (20 percent on Thar) and higher interest rates risk a margin of 4.5 percent are supposedly for general non-governmental projects where there are competitive situation and not a single-bid situation.
In CPEC, there are guarantees and other risk mitigation features not available for non-CPEC projects. In such single-bid government-to-government contracts, two percent interest rates are more common than the higher commercial rates in competitive situation. Had the latter been the case, the coal power tariff of these two plants (Sahiwal and Port Qasim) would have been close to the more reasonable 5 cents rather than 8.24 cents charged currently.
The least that could have been negotiated was a longer loan repayment period of 15 to 20 years, which could have reduced the debt component of capacity charge in the initial years.
One must also describe the projects where Nepra applied its mind and conducted project scrutiny diligently, collected international data and hired experts. This is the example of HVDC Matiari Lahore project where it managed to bring down the asking tariff from more than one rupee per unit to around 76 cents per kWh. It could have been even lower but for the poor reputation of the desi system which tends to award higher prices in most cases.
Another approach is to have an agreement with the Chinese government that it would provide correct and credible data and information on costs, prices and CAPEX of similar items or projects executed in China.
The reported cost of similar projects in China is 50 percent of the cost charged by Chinese companies on Pakistani projects. A classic example is of Senhua's Anqing project (one of the best and the cleanest power plants ever built in China) which has been completed at a cost of $478,000 per MW, as reported in an article published in PowerMag and authored by a GM of Senhua company itself. It is Senhua which had offered earlier to install a coal power plant at Thar at a tariff of around 5 cents.
An ideal solution is competitive bidding. This is only possible when the source of financing is not a tied one. Many countries such as Russia, Saudi Arabia, and the US have expressed interest in joining CPEC. The possibility of installing a multi-country fund may be investigated to enable competitive practices. Alternatively, the Chinese government and banks could be requested to allow and encourage genuine competition at least among its own companies, if not those of third countries.
I would like to make two short comments on the two other components of CPEC: road-building and industrial cooperation. It is believed that CPEC roads will shorten the distance of Chinese markets to the markets of the Middle East and Europe. If that is the case, why should Pakistan build the roads, pay their cost and carry the debt burden? What is the arrangement for such costs to be defrayed?
No agreement has been made public in this respect, except promotion of a vague hope that there will be some tolling with a hitherto undefined framework. It is either a transparency issue that the agreement has not been made public or a case of unfair negotiations and distribution of costs and benefits, and the risks attached.
In case of energy projects, we have at least some regulators, but in the case of roads we have no third party to adjudge and verify the costs. There could be at least third-party consultants.
It is to be hoped that the industrial and agricultural cooperation framework and terms are made public for seeking input and comments from a wider group of experts and knowledgeable people than those being restricted to inter-departmental cozy discussions among an ill-trained and equipped bureaucracy.
Transparency works both ways. It can benefit more often than not in favour of the forthright party. There were some positive aspects of the project which remain in the black box due to lack of openness. For example, there were doubts about installation of adequate environmental controls, which even this scribe was unaware and unsure of. It was only later that clarifications alleviated these doubts. Projects and IPPs should be encouraged to have their own websites.
There is a strong case of working out a fair and sustainable framework of cooperation involving costs, benefits, tariff, interest rates and other debt and commercial terms, which strengthen Pakistan's economy enabling it to grow and thus be able to pay the debt liabilities that Pakistan has incurred already and will do more so in the future.
(The writer is former member energy Planning Commission)