The conundrum of electricity surcharges
It is time to rethink our electricity sector policy and try and emerge from the surcharges loop
The writer is a Fulbright scholar and currently serves as a consultant to the Asian Development Bank
Ever wondered how much we pay in electricity surcharges? Here is a simple calculation.
The electricity regulator, National Electric Power Regulatory Authority (Nepra), has determined an average electricity tariff of Rs10.49/Kwh for the last fiscal year. To make consumers pay extra, the federal government has levied a few surcharges. First, there is a debt servicing surcharge which is Rs0.43/Kwh. Then, there is a tariff rationalisation surcharge of Rs0.96/Kwh and a Neelum-Jhelum surcharge of Rs0.10/Kwh. Combine these surcharges and they become a total of Rs1.49/Kwh. Consumers then pay an additional sales tax on these surcharges at 17%, which is an extra Rs0.25/Kwh. All in all, consumers pay over and above Rs1.74/Kwh in surcharges alone, which is equivalent to 17% more of what Nepra has determined as the price of electricity. With roughly 74 billion units of electricity sold every year in Pakistan, the federal government generates more than Rs129 billion through levying of surcharges alone.
But why does the government feel the need to levy surcharges? According to the government’s position, surcharges are levied to recover costs of the system, which if not recovered, adversely affect sector revenues. Revenue shortfalls leave the government with two choices: either pick the additional costs as subsidies or offset some of the costs through surcharges.
Under the last IMF programme, the government was restrained to provide free-flowing subsidies and hence, surcharges were used to close revenue gaps. The revenue gaps primarily ascend because our sector has inherent inefficiencies, such as low recoveries and high transmission and distribution (T&D) losses. For instance, average recoveries are 94%, which reflects a 6% loss on all the bills collected. In some areas, such as Hesco and Sepco, recoveries are only 40% which leaves a sizable gap in revenue collections. Similarly, there are T&D losses. On average, the system T&D losses are 17% with some distribution companies registering T&D losses as high as 40%. This means that with every hundred rupees of electricity generated, the companies get to bill only Rs83 worth of supplies, again creating revenue shortfalls. Someone will have to necessarily pay the costs or it will accumulate in the form of a circular debt. In the past, some of the debt buildup was paid by a commercial borrowing vehicle, Power Holding Private Ltd (PHPL), which borrowed at a commercial rate and accumulated interest. While the government has chosen not to pay the principal amount of debt stock, it continues to service interest through debt servicing surcharge, making sure that the debt stock remains constant while interest is serviced on a regular basis.
The government has also persisted with tariff rationalisation surcharge. The basic rationale is to build a cross subsidy mechanism whereby the government could protect the vulnerable segments, which are mostly residential and agricultural consumers. Logically, someone will have to bear the extra costs if certain segments are to be additionally subsidised. One way is to impose surcharges on commercial and industrial sectors, making them pay more than what is due on them and passing on the benefit to residential and agricultural consumers. We all know the impact of this surcharge. Industry which was competitive at an electricity price of Rs9/Kwh finds it difficult to be competitive when electricity is priced at Rs12/Kwh. Similarly, commercial segments, small business owners and medium-sized manufacturing outlets are priced the range of Rs14/Kwh, hitting their profitability unfavourably.
There is some sense to the Neelum-Jhelum surcharge. It is an important dam built primarily for long-term energy security. The idea is that every Pakistani should contribute to make the project a success. There is quid pro quo also. Consumers pay a little extra today merely to benefit more in the future through lower tariffs and improved water and energy security. However, there are questions that need to be answered for even a project which is of national importance. For instance, what is the timeline of this project? How long should consumers pay in the form of surcharges? Is there a sunset clause? Should consumers pay for costs escalations too? In this regard, the recent official statement from Wapda’s chairman was astonishing: the costs of the Neelum-Jhelum project have risen from Rs4 billion originally to over Rs500 billion today, registering a 125 time increase and further questioning the legitimacy of the surcharge.
The surcharges also come with a moral dilemma. The payment gaps exist primarily because there are consumers who do not pay. There are areas where recoveries are 40% and where illegal hook connections are a norm. To mitigate those payment gaps, surcharges are levied, but they are levied to those who have been paying fairly through all these years. In a sense, consumers who pay are penalised more with additional surcharges and consumers who do not pay at all escape rather easily.
Financially, the surcharges have helped the government generate additional cash flows, but their results have been a very predictive stalemate. A typical electricity sector like Pakistan, which is reliant on imported fuel combined with sector inefficiencies, will always have higher costs then revenues which will result in payment gaps and shortfalls. Higher payment gaps will result in either greater accumulation of circular debt or higher imposition of surcharges, rate increases or additional borrowings. Additional borrowings will result in greater interest accruals, whereas surcharges will be discriminatory towards industrial and commercial users, making them uncompetitive, while also raising legal and moral questions. The impact of surcharges, alongside other factors, is visible in our current export numbers, which hovers only at around $18 billion today, from a high of $25 billion just a few years ago.
One of the ways to move away from this surcharge loop is a consistent, lasting push away from fossil fuels and towards renewable energy. People tend to point out renewable’s intermittency and high costs, but consider what we have achieved from our fossil fuel reliance so far: sector inefficiencies, glut of surcharges, expensive tariffs, reduced export competitiveness, far and again bailouts, high capacity payments, high sovereign guarantees and above all, no end to the menace of load shedding. It is time to rethink our electricity sector policy and try and emerge from the surcharges loop, which continues to be the least effective long-term reform solution available.
Published in The Express Tribune, July 22nd, 2017.
The electricity regulator, National Electric Power Regulatory Authority (Nepra), has determined an average electricity tariff of Rs10.49/Kwh for the last fiscal year. To make consumers pay extra, the federal government has levied a few surcharges. First, there is a debt servicing surcharge which is Rs0.43/Kwh. Then, there is a tariff rationalisation surcharge of Rs0.96/Kwh and a Neelum-Jhelum surcharge of Rs0.10/Kwh. Combine these surcharges and they become a total of Rs1.49/Kwh. Consumers then pay an additional sales tax on these surcharges at 17%, which is an extra Rs0.25/Kwh. All in all, consumers pay over and above Rs1.74/Kwh in surcharges alone, which is equivalent to 17% more of what Nepra has determined as the price of electricity. With roughly 74 billion units of electricity sold every year in Pakistan, the federal government generates more than Rs129 billion through levying of surcharges alone.
But why does the government feel the need to levy surcharges? According to the government’s position, surcharges are levied to recover costs of the system, which if not recovered, adversely affect sector revenues. Revenue shortfalls leave the government with two choices: either pick the additional costs as subsidies or offset some of the costs through surcharges.
Under the last IMF programme, the government was restrained to provide free-flowing subsidies and hence, surcharges were used to close revenue gaps. The revenue gaps primarily ascend because our sector has inherent inefficiencies, such as low recoveries and high transmission and distribution (T&D) losses. For instance, average recoveries are 94%, which reflects a 6% loss on all the bills collected. In some areas, such as Hesco and Sepco, recoveries are only 40% which leaves a sizable gap in revenue collections. Similarly, there are T&D losses. On average, the system T&D losses are 17% with some distribution companies registering T&D losses as high as 40%. This means that with every hundred rupees of electricity generated, the companies get to bill only Rs83 worth of supplies, again creating revenue shortfalls. Someone will have to necessarily pay the costs or it will accumulate in the form of a circular debt. In the past, some of the debt buildup was paid by a commercial borrowing vehicle, Power Holding Private Ltd (PHPL), which borrowed at a commercial rate and accumulated interest. While the government has chosen not to pay the principal amount of debt stock, it continues to service interest through debt servicing surcharge, making sure that the debt stock remains constant while interest is serviced on a regular basis.
The government has also persisted with tariff rationalisation surcharge. The basic rationale is to build a cross subsidy mechanism whereby the government could protect the vulnerable segments, which are mostly residential and agricultural consumers. Logically, someone will have to bear the extra costs if certain segments are to be additionally subsidised. One way is to impose surcharges on commercial and industrial sectors, making them pay more than what is due on them and passing on the benefit to residential and agricultural consumers. We all know the impact of this surcharge. Industry which was competitive at an electricity price of Rs9/Kwh finds it difficult to be competitive when electricity is priced at Rs12/Kwh. Similarly, commercial segments, small business owners and medium-sized manufacturing outlets are priced the range of Rs14/Kwh, hitting their profitability unfavourably.
There is some sense to the Neelum-Jhelum surcharge. It is an important dam built primarily for long-term energy security. The idea is that every Pakistani should contribute to make the project a success. There is quid pro quo also. Consumers pay a little extra today merely to benefit more in the future through lower tariffs and improved water and energy security. However, there are questions that need to be answered for even a project which is of national importance. For instance, what is the timeline of this project? How long should consumers pay in the form of surcharges? Is there a sunset clause? Should consumers pay for costs escalations too? In this regard, the recent official statement from Wapda’s chairman was astonishing: the costs of the Neelum-Jhelum project have risen from Rs4 billion originally to over Rs500 billion today, registering a 125 time increase and further questioning the legitimacy of the surcharge.
The surcharges also come with a moral dilemma. The payment gaps exist primarily because there are consumers who do not pay. There are areas where recoveries are 40% and where illegal hook connections are a norm. To mitigate those payment gaps, surcharges are levied, but they are levied to those who have been paying fairly through all these years. In a sense, consumers who pay are penalised more with additional surcharges and consumers who do not pay at all escape rather easily.
Financially, the surcharges have helped the government generate additional cash flows, but their results have been a very predictive stalemate. A typical electricity sector like Pakistan, which is reliant on imported fuel combined with sector inefficiencies, will always have higher costs then revenues which will result in payment gaps and shortfalls. Higher payment gaps will result in either greater accumulation of circular debt or higher imposition of surcharges, rate increases or additional borrowings. Additional borrowings will result in greater interest accruals, whereas surcharges will be discriminatory towards industrial and commercial users, making them uncompetitive, while also raising legal and moral questions. The impact of surcharges, alongside other factors, is visible in our current export numbers, which hovers only at around $18 billion today, from a high of $25 billion just a few years ago.
One of the ways to move away from this surcharge loop is a consistent, lasting push away from fossil fuels and towards renewable energy. People tend to point out renewable’s intermittency and high costs, but consider what we have achieved from our fossil fuel reliance so far: sector inefficiencies, glut of surcharges, expensive tariffs, reduced export competitiveness, far and again bailouts, high capacity payments, high sovereign guarantees and above all, no end to the menace of load shedding. It is time to rethink our electricity sector policy and try and emerge from the surcharges loop, which continues to be the least effective long-term reform solution available.
Published in The Express Tribune, July 22nd, 2017.