Time to negotiate IPP contracts

The report on Power Sector by M. Ali and team touched the IPPs where it hurts the most. The reaction of Independent Power Producer Association (IPPA) and a letter by the sitting Petroleum Advisor to PM (who is a shareholder in an IPP and ex-chairman IPPA) is depicting some panic in the IPPs' club. Where there's smoke there's fire. In power production, it is literal smoke and fire, metaphorically burning billions of rupees of government and public on a daily basis.

A pile up of Rs 1,000 million a day in circular debt is not possible with a few pocketing that money at the expense of masses (electricity consumers and tax payers). The report is talking about facts and figures, and is proposing a way forward. There is no mentioning of any malign intentions of IPPs. There is no recommendation of revisiting the contracts to lower the return formula.

One may wonder why IPPA in its letter to Energy Minster tries to portray that this report is aiming to defame the IPPs. There is no personal attack in the report. But IPPA is questioning the intentions of M. Ali by showing a TV clip (prior to him assuming Chairmanship of the committee) to prove his bias. This in essence is demonstrating IPPA bias towards the committee and its findings.

Those who are questioning the integrity of the committee and highlighting the legal challenges in renegotiating the contracts are at the same time in other forums underscoring the need for revisiting contracts with Qatar (on RLNG), renegotiating with the IMF on a tough programme, etc. How selective could they get in their patriotism priorities.

Some say these agreements are watertight and cannot be renegotiated or disputed. Well there is a precedence. HUBCO resettled with government and Wapda in Dec 2000. Some say that renegotiating with IPPs is bad for investment climate. But without resolving the energy mess, the investment climate will remain even worse due to high cost of power generation and build-up of circular debt.

It takes no genius to find out that why electricity is more expensive in Pakistan and why no major investment is made (other than IPPs) in the past decade or so in Pakistan. This explains why Pakistan is uncompetitive, why it is staying behind in exports and why reverse of imports substitution is happening.

It is widely argued that the returns these IPPs have made are unheard of. The IPPs formed in 1994 policy, have made over 8 times the profits and have drawn over 6 times the dividends on the capital they invested. The return on equity (ROE) 10 companies (out of 17) made is in range of 40-79 percent. The returns of IPPs under 2002 policy are even more mouthwatering. Average annualized ROEs amongst these companies is as high as 87 percent. They made 9 times profits and 7 times dividend on their investment.

The story did not end here. The magnitude becomes bigger for projects under 2015 power policy. For instance, one coal power plant has recovered 71 percent of investment in two years of operation and the second has recovered 32 percent in the first year. A significant chunk of these profits (for plants under all power policies) is earned due to misreporting by the generation companies (IPPs) in tariff determination process.

In the 2002 policy, tariff was based on cost plus. The energy purchase price (EPP) is a passed through item. The regulator (Nepra) approved heat rate based on what is submitted by IPPs. The actual heat rate is higher than what is submitted. Thus, the fuel expense billed was higher than the actual use. In last 9 years, these companies made Rs64 billion in excess due to misreporting (theft) of fuel. Expected future payment for this (till expiry of PPA) is Rs145 billion. Similarly, there are a number of other ways where excess payments are made to IPPs. The numbers are mind boggling.

A few say that persistent fiscal deficit is the biggest economy worry. The circular debt pile-up and its financing through budgetary resources is breaking the camel's back. Part of the gap between recovery and cost is funded by budget and rest is stocked in circular debt. During last 12 years (FY07-19), government paid Rs 3,202 billion in subsidies and the circular debt was Rs 1,600 billion. A total of Rs 4,802 billion is the cost to taxpayers and electricity consumers in 12 years. Continuation of this can render the country fiscally bankrupt.

There are two options proposed in the report to deal with the IPPs. One is to sit on table and renegotiate The other is to do forensic audit of IPPs on "over-invoicing", heat rate audit, "kickbacks" and on "misreporting". In my view, IPPs should opt for first, otherwise this will turn ugly. Many IPPs (barring a few in the 2002 policy) are ready to renegotiate.

The problem with old IPPs is higher in EPP and above mentioned way is to resolve it. The bigger problem is of Capacity Purchase Price (CPP) for new projects. The biggest portion of CPP is debt repayment. For old IPPs, that portion is done, so CPP is less of an issue. In the 2015 policy, CPP is a big headache. The CPP per annum increased from Rs 275 billion (Rs 2.7/unit) in FY16 to Rs 640 billion (Rs 5.2/unit) in FY19. The gains from fuel saving (due to efficient and low fuel cost plants - RLNG and coal) is outweighed by increase in CPP.

The CPP will be in excess of Rs 900 billion in FY20 and may reach Rs 1,500-1600 billion by FY24. This can be reduced by debt restructuring of plants (in addition to renegotiation on excess costs in EPP). For instance, two nuclear plants are coming online with PPA of 25-40 years while debt is to be repaid in 10-12 years. The useful life of these is stated at 60 years. The debt has to be elongated for the full PPA term. Similar treatment is required for other plants.

After negotiating with IPPs (mainly 2002 and 1994) on EPP, the government needs to sit down with its own debtors and other projects (including CPEC and Chinese funded) under the 2015 policy to restructure the debt payments. Once that is done, other leg of problem of transmission and distribution has to be dealt with by moving away from single buyer model through deregulation and privatization.