Pakistan’s flawed energy policies lie at the core of the recent economic crises and rising circular debt.
Former finance minister Miftah Ismail said on Sunday that the incumbent government’s decision to raise the per unit electricity price by Rs1.95 came in light of the circular debt being at its highest in the country’s history, saying the masses will be deprived of another Rs200bn because of the decision. “We had left the circular debt at Rs1,036bn, which included power losses and bank’s loan both, and now it has crossed the mark of Rs2,400 billion.” Ismail said.
According to an earlier report, the total circular debt increased by Rs538bn during the fiscal year 2019-20 at a rate of about Rs45 per month. During the July-November 2019-20 period, circular debt increased by Rs179bn at a rate of Rs36bn per month, while it slightly reduced to Rs156bn during July-November 2020-21 at a rate of Rs31.2bn per month.It should be recalled that it was in July 2013 that the then PMLN government had cleared the circular debt of Rs480bn. By the time, the PMLN government completed its tenure, it had again crossed Rs1 trillion.
Why does the circular debt keep rising despite periodic settlements? A major reason for the chronic and growing circular debt problem is the size of the guaranteed capacity payments or fixed costs paid to the Independent Power Plans (IPPs). To understand this issue, it is important to understand the historic context of what led Pakistan to outsource power generation to the IPPs.
Until the mid-1980s, Pakistan’s energy needs were met by the Water and Power Development Authority (WAPDA) and Karachi Electric Supply Company (KESC), the two public sector organizations responsible for the generation, transmission, anddistribution of electricity. Both were faring quite well. Electricity was produced primarily through hydropower projects, keeping the production cost minimal. Since the cost of production and demand were low, so inevitably were the subsidies in absolute terms.
By the mid-1980s, increasing demand for electricity and WAPDA’s inability to keep pace with it began to result in energy shortages and load shedding, apparently because the government failed to invest in power generation. Entering the 1990s, Pakistan was planning to increase its existing generation capacity for power production. However, instead of increasing public investments in energy, the World Bank encouraged the Pakistani government to privatize the sector before increasing capacity. In 1994, Pakistan announced its privatization policy, and since then, many private sector power projects have been installed. Despite this, however, the country faces chronic shortages and increasing tariffs.
The power policy viz-a-viz the independent power plants (IPP) was against the very spirit of free market economics as the IPPs were guaranteed a rate of return for putting in a rather small portion of its own equity while major risks were assumed by the government and 70-75 per cent of the investments were actually financed by the bank loans. The first big step in this direction was the Hub Power Project (or Hubco), a 1,292MW, $1.6-billion thermal project that was actively supported by the World Bank. It was the beginning of a strategic blunder that was to haunt Pakistan for decades and continues to do so. This policy was continued by the successive governments and though adding thousands of megawatts to the electricity generation capacity, also made Pakistan hugely dependent on the costly sources, that is, thermal power, especially on imported oil and coal.
The terms on which investors were invited to set up generation capacity (under the 1994 Power Policy) in the country were some of the most generous in the world, according to a study done by two Pakistani economists and published by the London School of Economics (LSE). The paper entitled, Privatization in the land of believers: the political economy of privatization in Pakistan, was authored by Dr Kamal Munir and Dr Natalya Naqvi of the University of Cambridge and the London School of Economics, respectively. They contended that the policy was built on a cost-plus-return basis in US dollar terms. Investors were to be provided a US dollar-based internal rate of return of 15 to 18 per cent per year over the 25 to 30-year-period of the power purchase agreement after covering for operational costs. This was further backed by sovereign guarantees from the Government of Pakistan. The Independent Power Producers (IPPs) were to be paid every month in two parts, i.e., a ‘capacity payment’ and an ‘energy payment’. The ‘capacity payment’ reimbursed the IPP for all the fixed costs of the power plant, including debt servicing (which at an allowance of 80:20 debt-equity ratio proved to be very high) and provided the investor’s equity return on top. These payments were to be made irrespective of whether or not the IPP was asked to produce electricity. The ‘energy payment’ reimbursed the IPPs for all variable costs of production, e.g., fuel costs, regardless of the type of fuel employed and its market price. All payments were indexed (if relevant) to the USD/PKR exchange rate and inflation (local or foreign) changes.
The highly generous deals that the government offered (in the 1990s) to investors meant that for every hypothetical but typical 100 MW thermal (oil-fired) power plant in the private sector, the government would end up spending US $21.42 million more than it would in the public sector over the life of the power project, according to the LSE study.
The bulk of this investment was in power plants that ran on imported fuel oil, in part because the low oil prices of the 1990s made fuel oil an inexpensive option. These projects contributed to a substantial transformation of Pakistan’s power generation mix. Hydropower’s share of installed generation capacity fell from around 67 percent in 1985 to 27 percent in 2017, while oil’s share was 26 percent in 2017. The dramatic increase in oil prices in the 2000s (reaching a high of $147 per barrel in 2008) caused Pakistan’s power generation costs to skyrocket. Pakistan’s reliance on fuel oil for power generation contributed to the liquidity crisis in the country’s power sector known as circular debt, which in turn contributed to the country’s frequent power outages.
(To be continued tomorrow)
Copyright Business Recorder, 2021
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