The monster named capacity charge

In 10 years, payments of $50b has been made, equal to 40% of foreign debt

KARACHI:

The ever-increasing power supply bills have lately assumed the status of a major existential threat to Pakistan. Some apologists still try justifying them with various pretexts.

This is despite the fact that our cost is the highest in the region with price for commercial use standing at $0.166 per kilowatt-hour (kWh), while Bangladesh, India and China are, respectively, at $0.087, $0.121 and $0.089.

Some analysts propose privatisation of distribution companies (DISCOs) as a solution, although the private sector is also barely surviving. Some experts propose nationalisation of independent power producers (IPPs) as a viable course.

This also seems impractical because of the incompetence pervading the public sector. Even if attempted, ensuing litigations would block it. This article is an attempt to share my thoughts on the issue.

Primarily, the tariff paid to the power producers, ie IPPs, comprises two parts – variable charge and capacity charge. The capacity charge is the payment contractually guaranteed to the IPPs whether they produce any electricity or not.

Pakistan's electricity consumption has barely increased since FY18 when it was 106,928 gigawatt hours (GWh). In fact, it declined by 10% in FY23 vis-a-vis the preceding year followed by a further decline during FY24.

However, to absorb the increasing capacity payments, either tariffs could be increased or subsidy payments by the government. When the government fails to pay subsidies, circular debt increases.

Similarly, in case of increase in tariffs, the consumers start avoiding the use of power, as we observed during FY23 and FY24. As a result, the capacity charge starts rising further.

Even after the bitter experience of oil-based plants established in lieu of the policies of 1994 and 2002 and continuous increase in the energy import bill, we further expanded our menu of expensive imported fuels in the form of liquefied natural gas (LNG) and imported coal. That made the nation further hostage to capacity charges as well as power shortages.

Since 2018 we also started following the goal of achieving 60% renewables' based power generation along with a policy of off-grid solarisation. The dire situation, instead, required a moratorium.

Resultantly, the capacity payments kept on piling up due to the continual increment in the idle generation capacity. Only in the past 10 years, we have paid more than $50 billion in this respect; which is equivalent to 40% of our foreign debt.

Circular debt

The annual capacity payments are expected to cross $10 billion by 2024-25. They increase the unit cost of power and also the circular debt, if the said cost is not immediately shifted to consumers.

While formulating the power policy of 1994, the oil prices had historically remained below $20 a barrel since long. However, since 1999 they started rising. The first spike was from $18 to $28 per barrel, but we attempted no course correction even vide policy of 2002.

We observed a price hike from $18 to $54 per barrel since 1999 till 2005 with a 40% increase from 2004 to 2005 alone. However, to avoid public backlash, the government started absorbing the additional cost by subsidising the tariffs. As a result, the circular debt made its first appearance in 2006 with a figure of Rs111 billion.

While earlier the oil-based plants were primarily deployed as peaker plants; however, by early 2000s, burning the candle at both ends, we started using some as base-load plants.

This ramped up the share of oil in power generation to 33%, when oil prices were continually rising. They reached $97 per barrel in 2008 and the crisis deteriorated thereafter.

The government attempted to absorb it through subsidies, however, it failed, causing the piling up of more circular debt. Resultantly, we observed extended load-shedding till 2013 when the circular debt had exceeded Rs500 billion. It now stands at Rs2.6 trillion.

PM's task force on energy

No performance analysis of the subject can be completed without mentioning the report of January 1994 of the PM's task force on energy from which the power policy of 1994 emanated.

In my view, the task force lacked professional capacity vis-a-vis complexity of its task and the due diligence it required, including the projection of multiple economic growth scenarios, global energy pricing sensitivities and local energy dynamics for the forthcoming few decades.

The deployment of a team of required credentials and a wider consultative process may have saved us from assuming an aggressive economic growth and associated additional power generation capacity, projected by the report to reach 54,000 megawatts by 2018, over and above the then available capacity of 10,800MW. It is at present only two-thirds of the same.

Similarly, the associated cost-plus model could prove challenging in any country let alone in a regulatory environment having negligible capacity to keep costs in check.

The model itself provided no incentive to the IPPs for the same. No wonder that by 2001-02, Pakistan was paying $1 billion in lieu of capacity charge alone.

Muhammad Ali report

Another crucial document in this respect is the subject report of March 2020. It is a world-class professional report comprising 288 pages and providing not only an in-depth analysis, but also practical solutions.

The report identified innumerable cases of excess payments to the IPPs in terms of fuel costs, set-up costs and costs which they were not entitled to or they claimed by misreporting data.

Based on the same, the report recommended a forensic audit of all companies to verify over-invoicing in project cost, fuel usage, misreporting in financial statements, etc; and heat rate audit of fuel-based IPPs.

Leaving aside the so-called sovereign guarantees, which are brandished to defend the continuation of the above farce, four years have elapsed, but we never heard about the above audits and nor about the accountability of individuals and institutions for turning a blind eye to the issue for decades.

As to guarantees, they remain valid only if both the parties fulfill their associated contractual responsibilities. Thus, a comprehensive third-party technical, commercial, contractual and legal audit of all the contracts is imperative.

For instance, it needs to be determined as to how the required capacity in terms of operational readiness, regulatory compliance, etc was established before making the corresponding capacity payment.

The avoidance of independent audits is quite a norm in our country. I recently came across some records littered with telltale signs of a PSE board terminating an energy project's contract to avoid a similar audit.

What is to be done

No country can afford to remain hostage to sheer and blatant incompetence whose ravages are detailed above. Therefore, it is high time that the concerned board rooms are liberated from the stranglehold of the so-called generalists and handed over to professionals and business leaders of proven track records. The sector would then start getting on track in a short time.

Also, the services of the team which compiled the Muhammad Ali report deserve to be recognised and rewarded at the state level followed by empowering them and then entrusting them with implementing the report's recommendations.

The writer is a petroleum engineer and an oil and gas management professional