'PTI to go to court if Nepra rejects petition on coal power tariffs,' Asad Umar

Coal has long been termed the next big thing in Pakistan's power sector. It sadly has had one obstacle too many to turn into reality. Pakistan faces another round of disagreements as the government has gotten the revised tariff for coal power, challenged by PTI's Asad Umar.
BR Research sat with Engro's former boss, and got into details of the issue. Asad shared in details his viewpoints on technical and economic aspects. Below are the key takeaways from the meeting.
BR Research: Why are you against the review of Nepra's upfront coal tariff?
Asad Umar: The simplest argument is that while Nepra has the option to review, there has to be a basis of review, which in this case they don't have. There hasn't been any change in technology, or any other new scientific, technical or financial evidence.
So you have to ask whether the technology has changed during this period due to which costs have increased, or whether global economic environment has changed? No. Actually, costs have gone in reverse.
The world energy chain operates in tandem. When oil prices increase, the plant and machinery costs also go up, because the vendor knows that you can afford it. Between the time of last determination of coal tariffs, oil prices have declined 20 percent, whereas coal prices have also crashed. Merely saying that the investor demands it, is not a basis for the review.
BRR: What are your technical arguments against the 12-13 percent increase in headline tariffs?
AU: There are three main points from the technical aspects. But first, let's clarify something. To say that the headline tariff has risen by 12-13 percent is a false comparison.
There are infinite possibilities of what the tariff might turn out to be, and some of the variables that are going to affect that are: the exchange rate, fuel costs, and capacity utilisation or the plant factor. So just for the consistency of communication, the plant factor is assumed to be at 60 percent. Whether you run the plant at 60 percent, or 40 or 80 percent, as long as there is availability of plant, there is a fix charge. Base load plants are at 90-95 percent. Engro's Qadirpur used to run almost at 95 percent; coal fired plant will also run at 85 percent because it is a base load plant.
The headline tariff announced last year was communicated at 60 percent plant factor or capacity utilisation, whereas the tariff announced now is communicated at 85 percent.
If you divide the fix charge with 60 percent, it will give you a small number, whereas if you divide it by 85 percent it will give you a smaller number - everything else remaining the same.
So the 12-13 percent increase in tariffs is not 12-13 percent because the denominator to the fix charge has been increased to 85 percent from 60 percent last year. So the actual increase in tariff is far more; it's more than 40 percent, which is effectively camouflaged due to the increase in plant factor.
BRR: Let's come to the three sources of increase.
AU: The first aspect relates to the capital cost. They have allowed higher capital costs, which has been increased from $1.16 to $1.45 million per mega watt. They have done this on the premise that technical experts suggest that there should be European boilers instead of Chinese boilers.
So the first question that I ask is that a front end tariff is not made on the exact breakdown of your project. Either you go for actual determination; you tell Nepra that we have a European boiler and this and that, and Nepra might allow the costs for it. But how can you go for specifics in a front end tariff.
BRR: How do capital costs relate to the increase in tariffs?
AU: There are different components to the tariff. There is variable O&M costs, which includes the operating costs based on capacity utlisation. Then you have fixed O&M costs, which includes the monthly charge.
The third component is the big component, which is energy charge. Energy charge is determined by efficiency level plus whatever the formula for pricing that may be. Then the fourth part is debt servicing cost; whatever actual that may be is passed through. And the last component is the return of investment of your shareholder.
There is a trade off between variable costs and fixed costs. More efficient the machines, higher the capital costs, and lower the variable costs. Based on this information, you decide which one is good on NPV basis.
Nepra had initially allowed the efficiency level of 42 percent, but now they have allowed 39 percent. Everything else remaining the same, the capital costs should have come down, because you are putting in less efficient machines. But Nepra has instead lowered the efficiency and increased the capital costs.
So the drop in efficiency and the change in international energy environment should mean that capital costs should be going down, which is why we are questioning the basis for allowing higher costs.
BRR: Is a 300 basis point drop in efficiency really that bad?
AU: By dropping efficiency levels in its revised tariffs, Nepra has increased the environmental debit. The assumption here is that there is no cost to environmental pollution.
Keep in mind that around the world coal plants are being put into place, and at the same time they are also being decommissioned. The world has realised the environmental debit of coal, and it is moving towards higher efficiency, lower environmental damaging plants and decommissioning the old plants.
When the world realised the environmental damage of coal fired power plants, the banking industry started facing immense pressure in financing the coal plants.
The financial industry then devised a set of rules. These were called the Equator Principles, which was essentially a risk management framework for determining, assessing and managing environmental and social risk in projects, intended to provide a minimum standard for due diligence to support responsible risk decision-making. All the financial institutions agreed that if a project meets the Equator Principles, only then it will get the financing, not otherwise.
I asked all the potential investors whether the plants under Nepra's revised allowed efficiency level will meet the equator principle. And their point blank answer was 'no'. So there is a cost to the environmental degradation.
BRR: Shouldn't lower efficiency lead to lower tariffs?
AU: That is the beauty. We should now be getting cheaper energy as a result of compromising the efficiency levels. But look at Nepra's own tariff reconciliation. Of the total tariff increase that they are showing, one-fourth of the tariff increase is coming from the drop in efficiency. So lower efficiency is making electricity more expensive, not cheaper.
In effect, you are getting hit environmentally and economically both.
BRR: Let's talk about your reservations against the ROE.
AU: Ever since IPPs began, the project IRR has been the dominant force. Why is it that for the first time the need is being felt to express an ROE. Nepra's tariff determination last year says it in black and white that that was based on ROE. Now they are saying that, the new one is ROE, whereas the previous tariff was based on IRR.
But I am not even raising fingers on that.
BRR: So what is your criticism; because if it's about how high the rate of return is, then we also have to consider Pakistan's fragile economic, political and security condition.
AU: That's a misplaced argument. The last time huge power sector investments were made, this country was in a severe crisis. Those investments were initiated in 2006-2007 and were completed between 2009-2011. Those were the times of post 9/11, with soaring suicide bombings, Lal Masjid and what not. Or take the case of 1990s, when we were constantly running merely 3-5 weeks of reserves.
So it wasn't as if everything was hunky dory in Pakistan's yester years. Yet, at 15 percent dollar-based IRR, billions of dollars of investment came into the sector and thousands of mega watts were put into place. Suddenly these guys now say that this is an insufficient rate of return.
So I would like to raise two questions. One, why that 15 percent IRR dollar based return, that has successfully brought in investments, is being enhanced. And second, why this change to ROE from which we will back calculate the IRR, when in fact for the longest time we have had simple IRR based formula.
BRR: Well, they had announced lower tariffs last year, but nobody came to invest. Surely, something is wrong with the tariffs.
AU: Let me tell you that there are only four Pakistani investors who are willing to invest seriously into it right now; Tabba group, Mansha group, Engro, and Hubco. And tell me at what rate did Hubco make all its investments? It was at 15 percent IRR. Has Engro ever done a project of any size in its entire history, regardless of whether they had guaranteed return or risk-based return, that has had a dollar based IRR of more than 15 percent.
So it's not about the tariff alone. Engro was given a 20 percent IRR for Thar coal project, just to open up the indigenous resource. But tell me, why hasn't the project been put into place; clearly not because the rate of return was low.........because if you don't give me water for the project, then you can give me 100 percent IRR, the project would never be put into place.
My argument is that they had allowed 17 percent last year, but they didn't ensure good governance. Throwing money will not solve the problem if you do not solve the root cause.
BRR: But here is the thing; ten years ago circular debt didn't exist. Clearly, today's investors also have to worry about the circular debt.
AU: Well, should we solve the circular debt problem, which is relatively much easier to solve, or should we end up paying higher rate of return for the next 25 years?
We borrowed $2 billion in one day through sovereign bonds at 7.25 percent. In equity terms it means $8 billion power projects. So you demonstrated your ability to finance these projects at 7.25 percent. Why are you giving 17 percent dollar returns now? Keep in mind that is the same party that had claimed that 'the PPP government has bankrupted the country' when the IPPs were given 15 percent return in the second tenure of the PPP.
BRR: What is going to be your strategy if your petition is rejected by Nepra?
AU: This is exactly what we have been talking about, that regulators are rendered absolutely meaningless with no real power and a clear conflict of interest. Khawaja Asif's press conference is a perfect example of that.
When Nepra's hearing was completed, participants were given seven working days to give written comments.
And here I have not even submitted the comments, the minister comes out and says that Nepra has rejected the petition. This means that there is no segregation between the two.
If Nepra doesn't agree with us, we will go to court.