Disconnecting captive power: balancing between costs and efficiency

The more one writes about Pakistan’s energy sector mess, the less it seems to cover. The latest issue involves the government’s commitment to the IMF to end captive power generation by January 2025.

This decision was made hastily, without thorough consideration, and now there are conflicting views within the energy ministry, with the power and petroleum divisions working at cross-purposes.

These two branches operate in silos, focusing on their own interests, while national priorities are compromised in a tug of war. This is precisely why a unified energy ministry is essential to ensure a single, cohesive national energy policy.

The power division wants industrial captive users to shift to the national grid to increase demand, which is currently declining. This would help dilute the capacity charge per unit.

On the other hand, gas utility companies prefer to retain high-paying customers who use expensive RLNG (Re-gasified Liquefied Natural Gas), as this cross-subsidizes domestic consumers. If captive power ends, excess RLNG usage will become an even bigger issue, potentially raising costs for domestic consumers and worsening the gas circular debt.

Industries, meanwhile, prefer to retain captive power since some use combined heat and power (CHP) plants, which are more efficient than even the best power plants in the country. Many have made substantial investments in energy infrastructure and have servicing contracts with generator suppliers. Transitioning to the grid would require further costs for grid installations and machine conversions to meet compliance requirements.

One textile company, for example, has around 25 percent of its assets invested in energy—a significant commitment. A similar company would face additional costs of about Rs9 billion and a three-year wait to connect to the electricity grid in the south.

Shifting captive power to the grid is not a simple switch; it is a complex, resource-intensive process. While meeting the IMF condition by January 2025 is urgent, it’s unrealistic. The government should seek a waiver, perhaps to discuss with the IMF mission currently in Pakistan.

However, inaction is also not a viable solution. Talks about transitioning captive power to the grid have been ongoing since 2021, when the previous government proposed the conversion. However, industrial players used their lobbying influence to delay it, even obtaining court orders to prevent audits that would determine which factories use combined cycle plants and which do not.

There are also instances of gas usage inefficiencies. For example, one major mall in Karachi runs on gas through an industrial connection, and a candy manufacturer serving mainly the domestic market uses cheap gas. Concurrently, some chemical processes using gas are highly efficient, and fertilizer companies rely on captive power for operations.

The core issue here is governance and misallocation. However, some companies genuinely use gas efficiently. The government’s tool to address this is pricing. It should increase gas prices as per the IMF commitment to reach full RLNG pricing by January 2025, possibly with a premium for inefficient users. This would pressure inefficient users to shift to the grid, while efficient, cost-effective users could continue using gas.

Industrial activity is concentrated in the South, which relies heavily on captive power, particularly in KE and HESCO networks. No testing has been done to determine whether the grid can handle the additional load, so investment and time are required in some cases. However, many industries are already transitioning.

One solution could be differential variable pricing. Why does Pakistan have uniform energy pricing across the country? This doesn’t align with practices in other countries. For example, in the US, energy costs in Texas are much lower than in California; and India also uses variable pricing.

There is a strong case for adopting this in Pakistan. Over the past few years, more low-cost variable energy projects, including nuclear and coal plants, have been built in the South. However, transmission constraints prevent much of this power from reaching the North, and the government has to invest heavily in transmission networks, which drives up costs.

Power is effectively trapped in the South, and it must be utilized. This can be encouraged by lowering variable prices to match production costs, incentivizing captive users to switch to the grid, and encouraging more industries to shift to the South. This would benefit export-oriented industries, which should ideally be closer to the port, and it would help lower the capacity charge per unit by increasing power consumption, thereby reducing the effective costs for northern consumers as well.

However, political challenges remain, as most policies tend to be Punjab-centric. There is a need to take a holistic view and address the issue of high energy costs through the most efficient and cost-effective use of energy resources, regardless of the type or location of the consumer.

Copyright Business Recorder, 2024