Govt should take more steps to reduce cost of power production
High rates of return increase generation cost, hurt consumers and economy
PHOTO: REUTERS
ISLAMABAD:
In the last two weeks, two important developments have taken place in the power sector – reduction in the rate of return for new electricity generation projects and announcement of a new retail tariff.
High rates of return (RoR) for power projects have been a source of major contention and controversy among the stakeholders. The previous government induced Nepra to increase the RoR to an unreasonably high level, which many knowledgeable persons opposed.
Present Finance Minister Asad Umar, then in the opposition, even filed a review petition with Nepra opposing the high rates. The impact of high rates had devastating effects on the cost of generation which were pushed to unaffordably high levels, contributing to circular debt, reduced exports and consumer misery.
The high rates will continue to have their harmful effect for quite some time as many projects have already been awarded at high RoR and the new reduced RoR will be applicable to new projects.
The new rate is to be appreciated by all. The utility and impact of the decision, however, would be limited as there is a consensus now among policy-making circles that competitive bidding would be adopted as much as possible.
CPPA-G has announced this in its presentation in a public hearing. Tariff-based competition has been followed in the case of RLNG combined-cycle projects and has yielded good results. It appears that hydroelectric power projects may only remain in the domain of cost-plus regulatory tariff.
This is a misplaced argument that high RoR necessarily attracts investment and is the sole way to attract investments. More important is the ability of consumers and governments to pay and send profits to investor countries.
High rates, especially the unreasonably high rates, increase the cost of generation, hurt consumers and economy and thus increase payment risks. RoR of 10-12% is common in western countries and 14% in India.
Before 2013, the average RoR was around 15%. In 2014, with the advent of CPEC and possibly under the developer’s pressure, the RoR was increased. For Thar coal projects, it was high at 20% and for other projects it was increased to 17%.
As a result, the obtaining cost of generation became too high, although not only due to the high RoR alone. Other factors were high capital expenditure (capex) and high interest rates.
Thar coal electricity which should have been produced at a cheaper price has a generation tariff almost 60% higher than comparable projects elsewhere - 8.4 US cents as opposed to 5 US cents per kilowatt-hour (kWh) elsewhere.
Similarly, imported coal projects have higher tariffs. People used to think that hydroelectric power is cheap, but with such policies, it also became at least 20% more expensive than would have been possible otherwise.
In order to correct the phenomenon of high cost of generation, other steps may have to be taken as well. Nepra itself has promised in its State of Industry Yearbook 2017 to correct and adjust other factors as well.
Following factors have been indicated; banking spread; debt and equity ratios; financing fee, insurance, etc.
There are also varied opinions on a single non-differentiated banking spread/risk margin over Libor of 4.5%. It is argued that this spread should be lower for bilateral G2G contracts and for other situations. There should be a differentiated approach in keeping with the risk situation.
One would expect that Nepra would pay attention to streamlining the engineering, procurement and construction (EPC) bidding process which happens to suffer from grave transparency issues. Capex comes out to be unusually high due to these issues.
In hydroelectric power projects, turbine prices vary among various projects by a factor of three in terms of USD/MW, while it should not vary more than 20%. There are other glaring instances as well.
It may also be appropriate that Nepra reviews the current practice of cost-plus/revenue requirement approach and substitute it with a performance tariff. This type of tariff is a widely used approach these days for the distribution companies (DISCOs).
An example is the K-Electric tariff developed by ADB consultants, which is working satisfactorily and comparatively much lesser regulatory effort is required in its application and maintenance.
The performance-based tariff may also create an incentive for the DISCO management to improve performance. Also as a first step towards freeing the sector, the generation licensing or certification requirements may have to be reviewed and done away with for small power generation, transmission and distribution. Specific cases are net-metering, small and micro-grids and even wheeling.
New electricity tariff
Let’s now come to the new notified tariff. Nepra works out the consumer tariff for each DISCO area which is different for every DISCO due to the differing transmission and distribution (T&D) losses and other factors.
Based on Nepra’s cost calculations, the government does its own working with two objectives – firstly, to have a uniform tariff throughout Pakistan and secondly to reduce the tariff through subsidies.
Earlier, the government used to notify a uniform tariff on the Ministry of Water and Power’s website, however, this time Nepra has been involved, possibly to give a semblance to the authority of Nepra. Frankly, when the government provides the subsidy, it has the right to determine prices.
Average selling rate has been increased by Rs1.27 per unit, from Rs11.71 to Rs12.98 per unit. For small domestic consumers of up to 200 units, there is no increase.
For large domestic consumers, there is an increase of 15%; for commercial consumers, the increase is at its highest at 20-25%; industrial tariff has been increased by 5-6%; bulk supply rates have been increased by 20-25%; agricultural tariff has been reduced to almost half of the 2014 rates to Rs5.35 per unit.
The average cost of supplies is Rs15.53 per kWh while the average of notified tariff is Rs11.95, giving a deficit of Rs3.58. Total deficit, depending on eventual sales, say of 100,000 GWh, would amount to Rs372 billion.
The government expects that some of the deficit will be reduced due to efficiency improvements such as reducing the T&D losses. Pessimists may not take efficiency improvement seriously. If the government does not have the required cash to finance the deficit, this would amount to an increase of Rs372 billion to the circular debt.
Unfortunately, more than 90% of the cost of supplies is in US dollar terms. If we convert the notified tariff into US dollar terms, the retail tariff, in fact, has been reduced. However, people do not get salaries and incomes in US dollars, hence comparison is to be made in rupee terms.
In cost terms to the government, the comparison is to be made in US dollars. However, the notified tariff is not the final one. It is increased or decreased monthly as the fuel cost increases or decreases. People may, thus, be happy. But IMF is not happy, for obvious reasons.
Although there does not appear to be much scope for improvement in the proposed tariff, there are some innovations that may be possible. Capacity (fixed) charge has been projected to increase to Rs5 per kWh, an increase of more than 25% over the current rate, which indicates the need for more sales to reduce the unit cost.
Electricity consumption during midnight to 6 in the morning is the least. It may be feasible to incentivise electricity consumption in this time slot for industrial sector. It may be reciprocally beneficial. Possibly, a surcharge can be levied on consumption by house dwellers of 500 square yards living in posh areas, should there be need for more revenue, which evidently is there.
The writer is former member energy at Planning Commission
Published in The Express Tribune, December 3rd, 2018.
In the last two weeks, two important developments have taken place in the power sector – reduction in the rate of return for new electricity generation projects and announcement of a new retail tariff.
High rates of return (RoR) for power projects have been a source of major contention and controversy among the stakeholders. The previous government induced Nepra to increase the RoR to an unreasonably high level, which many knowledgeable persons opposed.
Present Finance Minister Asad Umar, then in the opposition, even filed a review petition with Nepra opposing the high rates. The impact of high rates had devastating effects on the cost of generation which were pushed to unaffordably high levels, contributing to circular debt, reduced exports and consumer misery.
The high rates will continue to have their harmful effect for quite some time as many projects have already been awarded at high RoR and the new reduced RoR will be applicable to new projects.
The new rate is to be appreciated by all. The utility and impact of the decision, however, would be limited as there is a consensus now among policy-making circles that competitive bidding would be adopted as much as possible.
CPPA-G has announced this in its presentation in a public hearing. Tariff-based competition has been followed in the case of RLNG combined-cycle projects and has yielded good results. It appears that hydroelectric power projects may only remain in the domain of cost-plus regulatory tariff.
This is a misplaced argument that high RoR necessarily attracts investment and is the sole way to attract investments. More important is the ability of consumers and governments to pay and send profits to investor countries.
High rates, especially the unreasonably high rates, increase the cost of generation, hurt consumers and economy and thus increase payment risks. RoR of 10-12% is common in western countries and 14% in India.
Before 2013, the average RoR was around 15%. In 2014, with the advent of CPEC and possibly under the developer’s pressure, the RoR was increased. For Thar coal projects, it was high at 20% and for other projects it was increased to 17%.
As a result, the obtaining cost of generation became too high, although not only due to the high RoR alone. Other factors were high capital expenditure (capex) and high interest rates.
Thar coal electricity which should have been produced at a cheaper price has a generation tariff almost 60% higher than comparable projects elsewhere - 8.4 US cents as opposed to 5 US cents per kilowatt-hour (kWh) elsewhere.
Similarly, imported coal projects have higher tariffs. People used to think that hydroelectric power is cheap, but with such policies, it also became at least 20% more expensive than would have been possible otherwise.
In order to correct the phenomenon of high cost of generation, other steps may have to be taken as well. Nepra itself has promised in its State of Industry Yearbook 2017 to correct and adjust other factors as well.
Following factors have been indicated; banking spread; debt and equity ratios; financing fee, insurance, etc.
There are also varied opinions on a single non-differentiated banking spread/risk margin over Libor of 4.5%. It is argued that this spread should be lower for bilateral G2G contracts and for other situations. There should be a differentiated approach in keeping with the risk situation.
One would expect that Nepra would pay attention to streamlining the engineering, procurement and construction (EPC) bidding process which happens to suffer from grave transparency issues. Capex comes out to be unusually high due to these issues.
In hydroelectric power projects, turbine prices vary among various projects by a factor of three in terms of USD/MW, while it should not vary more than 20%. There are other glaring instances as well.
It may also be appropriate that Nepra reviews the current practice of cost-plus/revenue requirement approach and substitute it with a performance tariff. This type of tariff is a widely used approach these days for the distribution companies (DISCOs).
An example is the K-Electric tariff developed by ADB consultants, which is working satisfactorily and comparatively much lesser regulatory effort is required in its application and maintenance.
The performance-based tariff may also create an incentive for the DISCO management to improve performance. Also as a first step towards freeing the sector, the generation licensing or certification requirements may have to be reviewed and done away with for small power generation, transmission and distribution. Specific cases are net-metering, small and micro-grids and even wheeling.
New electricity tariff
Let’s now come to the new notified tariff. Nepra works out the consumer tariff for each DISCO area which is different for every DISCO due to the differing transmission and distribution (T&D) losses and other factors.
Based on Nepra’s cost calculations, the government does its own working with two objectives – firstly, to have a uniform tariff throughout Pakistan and secondly to reduce the tariff through subsidies.
Earlier, the government used to notify a uniform tariff on the Ministry of Water and Power’s website, however, this time Nepra has been involved, possibly to give a semblance to the authority of Nepra. Frankly, when the government provides the subsidy, it has the right to determine prices.
Average selling rate has been increased by Rs1.27 per unit, from Rs11.71 to Rs12.98 per unit. For small domestic consumers of up to 200 units, there is no increase.
For large domestic consumers, there is an increase of 15%; for commercial consumers, the increase is at its highest at 20-25%; industrial tariff has been increased by 5-6%; bulk supply rates have been increased by 20-25%; agricultural tariff has been reduced to almost half of the 2014 rates to Rs5.35 per unit.
The average cost of supplies is Rs15.53 per kWh while the average of notified tariff is Rs11.95, giving a deficit of Rs3.58. Total deficit, depending on eventual sales, say of 100,000 GWh, would amount to Rs372 billion.
The government expects that some of the deficit will be reduced due to efficiency improvements such as reducing the T&D losses. Pessimists may not take efficiency improvement seriously. If the government does not have the required cash to finance the deficit, this would amount to an increase of Rs372 billion to the circular debt.
Unfortunately, more than 90% of the cost of supplies is in US dollar terms. If we convert the notified tariff into US dollar terms, the retail tariff, in fact, has been reduced. However, people do not get salaries and incomes in US dollars, hence comparison is to be made in rupee terms.
In cost terms to the government, the comparison is to be made in US dollars. However, the notified tariff is not the final one. It is increased or decreased monthly as the fuel cost increases or decreases. People may, thus, be happy. But IMF is not happy, for obvious reasons.
Although there does not appear to be much scope for improvement in the proposed tariff, there are some innovations that may be possible. Capacity (fixed) charge has been projected to increase to Rs5 per kWh, an increase of more than 25% over the current rate, which indicates the need for more sales to reduce the unit cost.
Electricity consumption during midnight to 6 in the morning is the least. It may be feasible to incentivise electricity consumption in this time slot for industrial sector. It may be reciprocally beneficial. Possibly, a surcharge can be levied on consumption by house dwellers of 500 square yards living in posh areas, should there be need for more revenue, which evidently is there.
The writer is former member energy at Planning Commission
Published in The Express Tribune, December 3rd, 2018.