Country’s energy woes

Energy sector issues risk further deepening Pakistan’s socio-economic divides as recent years have witnessed an unprecedented surge in energy prices, stretching consumer pockets beyond capacity.

Energy prices in Pakistan have surged to unsustainable levels, affecting every segment of society. Households are being forced to make difficult choices, cutting down on essentials like health and education just to afford their utility bills. Despite the burdensome tariffs, the government has failed to contain the energy sector’s circular debt, now exceeding Rs. 5 trillion.

The entire economy is feeling the strain, with industries losing competitiveness and households facing a sharp decline in living standards.

In a country where public services like education, healthcare, and social safety nets are already inadequate, higher energy expenditures further impoverish households. There are numerous reports of families selling household appliances or taking children—especially girls—out of school only to keep up with electricity bills. As the share of income spent on energy rises, the financial strain becomes unbearable, with significant social implications.

Figure 1: The gap between residential time of use and protected power tariffs has grown dramatically over the past two years.

Figure 2: Residential gas tariffs have increased drastically for high end consumers with little change for protected categories.

To understand how energy prices have affected living standards, we look at the evolution of the share of household expenditure on electricity and gas.

Table 1: Share of household income spent on energy has risen for all quintiles, but the lower middle class is most impacted.

Notes: Assumed electricity tariff category (increase in tariffs, July 2019-July 2024): Q1 = 0-200 units (protected) (88.7%); Q2 = 0-300 units (unprotected) (288.7%); Q3 = 300-500 units (130.9%); Q4 = Above 500 units (143.5%); Q5 = ToU (166.3%); Assumed gas tariff category (increase in tariffs, July 2019-July 2024): Q1 = up to 0.90 hm3 (protected) (47.1%); Q2 = up to 0.6 hm3 (unprotected) (125%); Q3 = up to 1.5 hm3 (239.4%); Q4 = up to 3.0 hm3 (295.4%); Q5 = Above 3.0 hm3 (215.5%); calculations based on average energy tariffs within assumed range of consumption for each quintile. Source: HIES, authors’ calculations.

Expenditure on energy as a share of household income has increased significantly across all income levels, with the highest income quintiles nearly doubling their share. But the second quintile—those struggling but not considered “poor enough” to receive government support—has seen the steepest increase, from 4.2% in 2019 to 9.7% in 2024.

Almost all households have been forced to make trade-offs that significantly lower their welfare, leaving them trapped between falling living standards and rising prices.

On average, households in Pakistan are spending greater parts of their incomes in the way of energy than most advanced economies (Figure 3, below) and, consequently, are maintaining much lower standards of living. This disparity is attributable not only to higher energy tariffs but also to lower levels of income compared to other economies.

Figure 3: Pakistani households spend a significantly higher share of their income on energy expenditure than those in advanced and emerging market economies.

The government uses a cross-subsidy model to protect lower-income households. Electricity and gas consumption up to a certain threshold is subsidized, with higher tariffs imposed on high-end consumers to cover the costs.

However, high tariffs discourage consumption, reducing overall demand and increasing per-unit capacity costs due to underutilized generation. All those who can afford it, tired of bearing the brunt of cross-subsidies, are turning to solar energy to escape the grid altogether.

Nepra’s 2023 State of Industry Report shows a 49% increase in net-metering consumers, from 37,769 in June 2022 to 56,427 in June 2023, with electricity exports from these connections growing by a whopping 220% during the same period. The incidence of off-grid solar is likely many times larger, but not captured in the data.

As more households switch to solar, the per unit burden of stranded capacity payments increases and those still reliant on the national grid face even higher prices. This dynamic threatens the financial stability of the energy sector as the government’s and cross-subsidizing consumers’ subsidy burden grows beyond what they can afford. Of the 29 million residential power consumers, around 17 million fall under the “protected” categories, accounting for ~30% of power sector demand but only contributing 12.6% of revenue. Residential ToU consumers, on the other hand, contribute 8.3% to power revenue with only of 5.5% in demand.

The persistent cycle of rising subsidy costs stems from a misalignment between the tariff structure and market dynamics. Designed to curb electricity consumption through higher rates for higher consumption, it made sense when demand for electricity exceeded its supply. However, with significant expansions in generation capacity, Pakistan has moved well beyond its supply-side constraints.

As a result, maintaining an incremental slab-wise tariff system focused on limiting usage is economically outdated and ill-suited to the present energy landscape. Constraining electricity demand despite ample supply leads to unsustainable stranded capacity costs and insufficient revenue to cover these payments, accumulating circular debt. The glaring disconnect between current policies and the evolving needs of the power sector raises a critical question: why is the government failing to recognize and apply basic economic principles?

The gas sector tells a similar story of mismanagement. Once abundant, Pakistan’s domestic gas supplies are near depletion due to economic distortions discouraging investment in domestic exploration and production (E&P). The government prioritizes payments for expensive LNG imports over domestic producers, depriving them of working and investment capital and building Rs. 2.7 tr of circular debt in the gas sector. The depletion of domestic gas has far-reaching socio-economic consequences, not least because local exploration creates jobs and helps support marginalized communities in remote areas.

Figure 4: Rural areas primarily rely on firewood while urban areas consume more natural gas.

As in the power sector, the government attempts to mitigate the impact of the gas sector inefficiencies through an incremental slab-wise tariff that cross-subsidizes tariffs for supposedly lower-income consumers with lower levels of consumption through higher rates charged to high consumption consumers.

The fundamental flaw here is that most low-income households are not connected to the gas pipeline network—according to a PIDE survey 78% of households do not even have access to natural gas, making the notion that “cheap” domestic gas is to support the poor highly questionable. Low-income households, in fact, rely on more expensive LPG and fuels like firewood (Figure 4, above).

The high consumption of natural gas in urban areas is the result of the politicization of the commodity that is in part responsible for the demise of the sector.

While domestic gas prices were once linked to crude, in 2006 the government established a ceiling price, effectively delinking them from oil and causing producers to lose out on significant revenue when oil prices rose sharply in 2008. When gas was made a tool for exerting political influence, the ensuing distortions left no incentives to invest in domestic E&P and no significant gas discoveries were made as a result, causing the country to rely increasingly on imported LNG (Figure 5).

Figure 5: Gas supply stagnated as consumer price delinking from oil took effect from 2006, sparking a growing reliance on RLNG imports.

Heavy subsidies for residential gas have encouraged inefficiencies and unsustainable use, leading to rapid reserve depletion, seasonal shortages, and financial strain on the sector.

Given Pakistan’s low per capita electricity consumption and current power generation capacity surpluses, shifting residential gas load, especially for winter heating requirements, to the grid is a highly viable option for increasing grid demand, thereby reducing the quantum stranded capacity payments and eliminating the need for subsidized residential gas.

Rising energy tariffs also disproportionately impact vulnerable segments, particularly women, who bear the brunt of household chores. Many households have been forced to sell off essential electrical appliances to pay their electricity bills, increasing manual labour for women and worsening their standard of living. There is also a growing risk of domestic violence as economic frustrations are linked to domestic tensions, leading to abusive situations, exacerbating both economic and social instability.

Decades of poor planning and mismanagement have brought Pakistan’s energy sector to the brink of collapse, yet policymakers are failing to implement effective reforms. Pakistan’s energy strategy is devoid of sound economic rationale and fails to achieve the primary objective of improving economic conditions.

The current policy to cut gas supply to captive power plants is the latest in a series of missteps and conflicts with the government’s goal of economic stability. By forcing industries to depend on a prohibitively expensive national electricity grid, the policy will cause them to either shut down or drive them towards other sources of energy, lowering their cost-efficiency, profitability, and capacity for innovation.

As rising energy costs continue to undermine the competitiveness of exports, this will have lasting adverse effects on the country’s already declining investment and manufacturing portfolios.

The only viable solution lies in allocating resources productively towards activities that create future revenue streams for the economy and the government, rather than using them consumptively in a way that depletes resources and leaves nothing for tomorrow.

By transitioning residential consumers to electricity and LPG, natural gas can be redirected to industrial sectors that contribute to long-term productive capacity, ensuring sustainable growth and resource efficiency for future generations.

Realizing this demands nothing less than a radical shift in policy—one that redefines priorities, focusing on the economy’s productive capabilities, and placing productivity and sustainability at the heart of decision-making instead of relying on short-term pacifying measures.

Copyright Business Recorder, 2024