IPP imbroglio - the role of regulator

Controversies can be avoided by introducing competitive tariff-based bidding

SYED AKHTAR ALI May 04, 2020

ISLAMABAD: The regulatory framework has a focal role in allowing sustainable and fair tariff acceptable to all parties and to later see that things go along with its determinations and rules.

Nothing can happen without its approval. Independent power producers (IPPs) have done what has been allowed by the National Electric Power Regulatory Authority (Nepra). We will present here the role of the regulator – Nepra – in what we are facing today.

The idea is not to defame any organisation but to offer corrective measures, as no time is more appropriate than now to speak out the truth. In the area of regulation, there are six issues – high generation tariff, excess capacity, transmission and distribution (T&D) losses and under-recoveries, inefficient Gencos, consumer tariff, and institutional matters.

Within the high generation tariff are the following issues – capital expenditure (Capex) and financial cost, fuel and operation and maintenance (O&M) cost. We shall quote here some examples of high Capex.

A ready example is the 40% difference in the engineering, procurement and construction (EPC) cost of Jamshoro coal power plant and the three other coal power plants.

A report points out very high Capex difference between the high-voltage direct-current (HVDC) Matiari-Lahore transmission line project and similar projects installed in India.

Current tariff of one of the wind power plants and several others of its genre is Rs23 per unit. Perhaps, nowhere in the world, a working wind power plant would have this tariff.

The tariff for the coal power plant is 8.45 US cents as opposed to 5-6 cents almost everywhere in the world. Why is this so? It is partly because of Nepra’s tariff framework and the associated practices.

Capex anomalies

There is laxity on the part of Nepra in assessing Capex correctly. Whatever little options are there to monitor and control EPC costs are not utilised. In case of hydel projects especially, almost phoney EPC bidding takes place. There are issues of capacity building and NEPRA does not seek expert external advice to get right assessments.

They try to save consultant fee of $20,000 to $30,000 and in the process lose hundreds of millions of dollars. They tinker with the data provided by investors and award the tariff. It is difficult to trace who influenced in such cases as we are seeing in the recent sugar and wheat crisis.

Upfront tariffs are so high that it is a common knowledge in the power sector that no equity is required to finance power projects. When there is so much cream, it is natural that the powerful would demand some share in it. The participation of third parties in public hearings is highly limited. Appellate tribunal has been provided in the legislation but it has not been implemented.

Advisory committees consisting of experts and representatives of think tanks and trade associations are usually there to assist regulators in many countries. It has become obvious that some third-party oversight over Nepra ought to be there.

High financial cost

A high rate of return of 15-20% in foreign currency and indexed with inflation and currency depreciation takes it to 30-40%. High interest rates awarding 4.5% margin over Libor is a major cause. It used to be 3% earlier and is a usual norm in other countries.

This margin doesn’t vary with the level of risk, or weak or strong parties. A small local party investing in a 25-50-megawatt project gets the same margin and an international company with a strong balance sheet and experience also gets the same margin.

A government-to-government project like CPEC or Saudi investment, often enjoying higher protection and safeguards, would also get the same margin. A differentiated approach with the three types may be called for. There was complacency on the issue earlier as when most of the tariffs were awarded, Libor was under 0.5%. It went as high as 3% and has only recently come down to 2%. Interest cost, therefore, increased by 30%.

Then, there is currency issue as Nepra tariff is dollarised. Due to rupee depreciation, the tariff has automatically increased by another 30%. Many countries calculate tariff in national currencies and the same ought to be here as well.

There are some other important issues as well of loan tenure. On large projects costing more than $500 million, the loan tenure ought to be 20-25 years.

Nepra’s generation tariff is cash flow based and not cost based, exacerbating the projects’ cash flow problem and front loads the tariff in early years. Some reform is urgently required and Nepra would be urged to initiate studies and considerations in this direction.

Fuel cost issues

Fuel theft has been alleged in government-owned Gencos and illegal fuel booking is blamed on private-sector IPPs.

Nepra has failed to follow standards in case of fuel costs and controls thereof. Thar coal costs more than twice what it costs in India and elsewhere. There is controversy over imported coal prices that are charged by the coal IPPs.

The difference in fuel cost of Sahiwal and Port Qasim coal power plants is Rs2.7738 per kilowatt-hour (kWh), which is 49.5% higher for Sahiwal over Port Qasim plant.

If the difference is genuine, it should be the inland coal transportation component. This is the cost of installing coal power plants in Punjab. The former Punjab chief minister wanted to install four coal power plants. He was persuaded to be content with one plant in Sahiwal.

In the meantime, he got four re-gasified liquefied natural gas (RLNG) combined-cycle power plants installed. As a result, there is excess capacity. Another 7,000MW will be commissioned in the next two years.

One 1,000MW plant costs at least Rs50 billion in fixed costs (capacity payment). A moratorium on new projects is called for earnestly. Also, inefficient and old Gencos should be retired at the earliest.

There are other issues such as high Qatar LNG prices and the merit order allowing inefficient power plants to come ahead, wasting valuable gas.

A weighted average cost of gas has been suggested by the report and has been on the negotiating table with provinces. Gas-producing provinces do not agree to mixing gas with higher prices. Until the issue is resolved, one would suggest using virtual weighted average cost for preparing the merit order.

O&M expenses

There has been laxity in awarding O&M expenses. Certain IPPs got more than four times O&M tariff components. With indexing, some power plants are enjoying more than Rs3 per kWh.

Most of the IPPs, which are alleged to be earning 40-80% return on equity (ROE), seem to have got this largesse through excessive O&M earnings.

Alternative system

All these controversies can be avoided, that is by introducing competitive tariff-based bidding.

It has been provided currently under the rules of solicited projects. Also, in the proposed CTBM framework, Private Power and Infrastructure Board (PPIB) has been provided with the role of capacity auctioneering competition and market, which is the solution of all ills.

Nepra itself was quite enthusiastic about competitive bidding, but continues to neglect it. Electricity market exchange/CTBCM is under process but may take a long time. Let us first start with tariff-based bidding.

However, competition cannot be organised under G-to-G contracts, which should carry concessional financial rates, say, of 2%, as its Capex is usually inflated.

Also, one can possibly develop a formula based on international electricity prices. In India, domestic gas prices are linked with a weighted average of five gas market prices? It can be tried in case of G-to-G contracts where competitive bidding is not possible?

One keeps wondering as to why the oil and gas sector is working on international prices and how they are able to get investment at affordable rates so as to become competitive. They get a small subsidy of 5-10%. Electricity generation tariff in Pakistan, on the other hand, is 40-100% higher.

The writer is former member energy of the Planning Commission


Published in The Express Tribune, May 4th, 2020.

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