Why ‘loss making' power utilities are bad for customers

Like Houston, we will have a problem.

Syed Shabbar Zaidi June 19, 2021
The writer is former chairman of Federal Board of Revenue

Earlier this year, millions of homes in Texas were without power for days in what is dubbed as one of the worst power crises in world history. Houston is really a case in point. The electric grid in Texas was built for efficiency, but not for climate resilience and resultant changes to operational requirements. As Katherine Blunt and Russell Gold reported in the Wall Street Journal:

“A fundamental flaw in the freewheeling Texas electricity market left millions powerless and freezing in the dark (this week) during a historic cold snap…A severe storm paralyzed almost every energy source, from power plants to wind turbines, because their owners hadn’t made the investments needed to produce electricity in subfreezing temperatures. While power providers collectively failed, the companies themselves didn’t break any rules.”

Ed Hirs, a professor and energy fellow at the University of Houston, cited focus on cheap energy which resulted in the exclusion of reliability at the core of the Houston problem. In essence, the quest for efficiency and ‘low cost' led to ‘under-investment’ and energy facilities poorly prepared for extreme weather and operational dynamics – echoing the need for flexibility in investment plans for power utilities.

The real life case of Houston leads to the following two question of sustainable investment in the power sector and its two related dimensions:

● Is that investment to be financed by the private or public sector in Pakistan especially in transmission and distribution;

● Is the mantra of constant low tariff without providing adequate return to private sector investors for ‘capital investment’ a recipe for disaster.

These are the fundamental questions which are not being answered in many developing countries, including Pakistan. Past three decade’s policies in this sector do not reflect any adequate framework for future growth and it is all the more difficult for privatized entities like K Electric. The effects of this issue have been briefly touched upon in the following paragraphs.

Speciality of Utility Business

The utility business is not like most other businesses. Utilities inhabit special accounting rules and pre-established investment returns, where ordinary business incentives often do not matter, and where changing course is exceedingly hard.

Utilities’ performance and their sustainability, which is critical for consumers, is mainly driven from the ‘investment’ in the assets (the pipes, substations, transmission lines, etc.) that are used to provide the service and efficiency in managing the existing assets and systems.

The monopoly model of utilities is not unique to Pakistan. “Regulated monopolies” in which public officials or the regulator guarantee the private sector enterprises a return on their investments while also fixing prices for consumers is the predominant model across the globe.

In order to understand this matter in the correct perspective two terms very relevant in this sector which have a special meaning and significance would have to be fully deciphered. The first is ‘regulation’ and the second word is ‘loss’. In summary, as far as regulation is concerned, in the foreseeable future, it would not be possible for countries like Pakistan to deregulate the important utility like power in the manner that privately owned companies are allowed to generate and supply power on market based prices with open competition. This means that regulations will continue to exist and in these circumstances monopolistic latitude to the supplier, may be provided as that monopoly is effectively tabbed by way of government regulation on major ingredient being supply price and return on investment by the regulator being NEPRA in the case of Pakistan.

The second term is ‘loss’. As noted in the heading of the article losses are not only bad but suicidal for the society if utility companies are not sustainable in their operational and investment functions. Nevertheless here it is highly important to distinguish between ‘subsidy’ and ‘loss’. Subsidy, is the price differential, cost of producing/procuring the electricity and the regulated supply price as a national economic policy. This has been described in the following paragraph. In other words the right description for subsidy is the price of electricity which is borne by the government as a public welfare activity for economic reasons. The size of ‘subsidy’ for any utility company is not to be seen as any indicator on the efficacy of that entity. Thus genuine tariff price differential which is actually a credit on the income side is to be totally divorced from a perception that this sum is compensation of the losses if any made by the utility company.

In the case of Pakistan, the consumer tariff is determined by National Electric Power and Regulatory Authority (NEPRA) and notified by the Government of Pakistan, which is uniform across Pakistan. A uniform tariff means that the same type or category of customers pay the same price per unit regardless of which province they are based in. The categories, or slabs as they are more popularly known, are determined by the government as well and applied indiscriminately across Pakistan.

Under the current tariff regime in Pakistan, the customers are charged a price which is less than the actual cost of electricity and the differential is paid by the government.

The regulator, in Pakistan like elsewhere in the world, is charged with reviewing and approving investments in tariff to make sure spending is prudent and reasonable to strike the right balance between sustainability of the business and consumer service levels. Therefore, one often sees former WAPDA Distribution Companies and K-Electric appearing before the NEPRA to lay out arguments for how much they need to invest.

Investment enabling tariffs create future fit utilities Years of underinvestment in the Transmission & Distribution segment of Pakistan power sector has been the primary reason for lack of reliable power supply, which has cost billions to the economy.

Investment certainty in tariffs is a prerequisite for private sector participation in the T&D segment. Looking at the dire state we are in, there is a need to develop strategies that incentivize utilities to invest, build resilience in their systems and upgrade continuously.

To achieve this, utilities, especially in the private sector, must be sustainable and have sufficient motivation to re-invest into the system. Hence, instead of keeping investment plans rigid and construing that as efficient, focus should be on providing an investment enabling tariff. This will automatically ensure that utilities are able to make investments sustainably. This in turn benefits consumers while also keeping a close check that investments are made as committed.

Are we prepared?

As publicly reported, K-Electric (KE) which serves power to Karachi has already invested over USD 3 billion across the power value chain including USD 450 million Transmission Capacity enhancement Project. A USD 650 million project is underway to install 900 MW of RLNG-based generation. The utility has also invested to upgrade and strengthen the distribution network including a project of PKR 9 billion dedicated entirely to bolster infrastructure as part of the company’s plans for rain mitigation and monsoon season. Additional PKR 10 billion is being invested across the city’s 12 most densely populated districts – home to two-thirds of the city’s population and a high prevalence of katchi abadis– to install Aerial Bundled Cables, bring low-cost meters to the residents so that they may avail regularized electricity supply.

However, is it worth contemplating if this investment trajectory is sustainable if the utility is not allowed to recover these costs in the tariff? If not this will be suicidal for the economy of the country. The rapid expansion of Karachi, boom in construction spurred by government policies and other infrastructural challenges due to unplanned settlements has exponentially increased the need for capital expenditure. Currently.

KE’s investment limits are capped in the tariff and they have no incentive to make any further investments in the system. Without adequate returns on investment, and the pending problems of outstanding payments from the Government and associated entities, KE is borrowing from financial institutions to meet its working capital requirements as well, a figure reported to exceed PKR 100 billion. This poses a threat to the utility’s operations as well.

If the incentive is absent, utilities have two choices - continue to operate at current levels and let the customer service level deteriorate or petition to the regulator for allowance of planned investments and wait for a nod to proceed. In Pakistan, such deliberations typically take anywhere between one to two years to conclude. KE has already made a plea to allow for further investments in its “mid-term review.”

In KE’s case, if requested investments are not allowed, the utility may inadvertently be forced to suspend ongoing and planned investments. If the tariff adjustments for investments don’t come through, KE, and with it Karachi, will embark on a journey towards economic regression. Ultimately the burden will still be borne by the government and the customer because we will have a problem. In fact there is no choice. Investment has to be made. As soon as it is done it is better for all stakeholders.

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