IPPs: missing the forest for the trees

The 2024 Independent Power Producers (IPPs) negotiations are entering their second round. The authorities are employing game theory strategies, but this round is being conducted under different terms compared to the negotiations in 2020.

Back then, open rounds of discussions involved IPPs, technical teams, government officials, and establishment representatives all sitting together. The rules of the game have changed.

Now, the technical team is invisible, and the government is absent. IPPs are being approached individually or in small groups, and their interactions are only with powerful state actors.

IPPs are being asked to voluntarily sign revised agreements in the larger interest of the country.

The approach varies: some are met with harsher demands, while others are treated leniently. The game theory in play seeks to prevent the IPPs from uniting. It’s a complex and interesting scenario.

The 1994 IPPs are being asked to terminate their agreements, while revised terms are being proposed for the 2002 IPPs and those from subsequent policies.

Notably, there has been no mention of IPPs under the China-Pakistan Economic Corridor (CPEC) or those owned by the government itself.

In terms of tariff impact, even if all 1994 and 2002 IPPs were terminated today without compensation, the reduction in consumer tariffs would be minimal—just Rs1.2 per unit.

Of the Rs2,139 billion in capacity payments last year, 4.3% went to 1994 IPPs, and 3.4% to those from 2002.

The process is expected to resume this week, with the 1994 IPPs being the first to be called. The logical solution is to offer some compensation and terminate these agreements.

Most of the plants are barely in use, with just 1-5 years left on their contracts. This was the proposed solution in 2020, and all parties agreed to it at the time. However, the finance ministry lacked the funds for a one-time compensation payment.

Now, with less time remaining and lower compensation required, this solution seems more feasible. Terminating these contracts would result in a mere Re0.68 per unit reduction in power tariffs.

Regarding the 2002 policy IPPs, some plants operate on oil and others on gas. Oil usage is low, while gas plants run at 30-40% capacity. These contracts are relatively newer, with 12-15 years remaining.

The establishment wants these IPPs to transition to a ‘take and pay’ model, reduce their return on equity, fix payments in PKR, and cut operating and maintenance expenses.

However, the key issue is the shift to ‘take and pay,’ which conflicts with the government’s exclusive right to purchase electricity from them. It’s contradictory to have a ‘take and pay’ contract in a single-buyer market.

No IPP is willing to accept this shift. For them, terminating the contract with some compensation is more attractive than moving to ‘take and pay,’ where they would continue to incur losses of Rs1.5-2 billion annually in fixed costs.

The move to ‘take and pay’ was discussed in 2020, with the agreement that it would occur once the market opened—but that never happened.

The Central Power Purchasing Agency-Guaranteed (CPPA-G) wants to set the wheeling charge at Rs27 per unit by including all stranded costs, inefficiencies, and cross-subsidies, which is not viable for any party. If the wheeling charge is lowered to Rs10 per unit, both parties would find it workable.

Negotiators, along with an invisible technical team, are working on this issue. The true cost of wheeling is estimated at Rs5-6 per unit, and setting it around Rs10 would be fair.

If this doesn’t happen, and the negotiators push for ‘take and pay,’ the 2002 IPP owners may opt for contract termination and pursue legal action. This could reduce the tariff by Re0.55 per unit, but it would also result in load shedding in Punjab during the summer of 2025, as transmission constraints would prevent the country from meeting peak demand without the 2002 IPPs.

Additionally, if wheeling is set at Rs10 per unit, gas IPPs would demand LNG at market rates, opening another Pandora’s box. Expensive long-term LNG contracts with Qatar would force the government to sell gas at inflated rates.

The situation becomes more complex with plants established after the 2002 policy, particularly renewables like wind, solar, and bagasse, where wind dominates.

Capacity payments for these plants total Rs150-200 billion. In the case of wind energy, the government is obligated to purchase a certain amount of electricity, with the capacity payments factored into the energy price. However, due to grid constraints, the government has failed to meet its obligations, violating the contracts.

There are also outstanding loans for newer wind projects, with international lenders such as International Finance Corporation (IFC) and the Asian Development Bank (ADB) involved.

Some lenders have warned the project sponsors that they cannot unilaterally renegotiate with the government, as doing so would jeopardize their loans. Negotiations will need to include international lenders as well, making the process even more challenging.

If the authorities insist on renegotiating the wind and 2002 policy contracts through pressure, the disputes could end up in international courts, leading to a situation similar to the Reko Diq case. Ultimately, the savings from upfront tariff reductions could be minimal.

A more effective approach would involve the Ministry of Energy, engaging in negotiations in a more cordial manner.

Everyone understands that the current power pricing structure is unsustainable and needs to be revised. Simply negotiating on the premise that IPP owners have already made enough money is insufficient.

Consumers are unlikely to benefit significantly from such moves, and investor confidence would be further eroded. Already, some private energy sector deals are facing challenges, and future investments in renewables could be delayed.

Once negotiations with local IPPs are complete, the focus should shift to CPEC projects, where loan repayments need to be extended to create a meaningful impact. CPEC accounts for 35% of capacity payments. The largest share, however, comes from government-owned projects, which account for 50% of total capacity payments. The government should reduce its returns and negotiate with its lenders, including the Chinese, to extend loan repayments.

Simultaneously, the process of wheeling should begin, and distribution companies (DISCOs) should be unbundled and privatized.

Gains will not come overnight, but the example of K-Electric shows that privatization can work. Between 2008 and 2015, K-Electric reduced losses, benefiting consumers. The same should happen with other DISCOs.

There are no magic solutions, and coercive negotiations will not yield sustainable results. The negotiators need to approach the problem holistically.

Copyright Business Recorder, 2024