Successive official reports on Pakistan’s power sector indicate that the country suffers from a shortage of power generation, transmission losses, lack of planning and inappropriate policies leading to an escalating energy crisis. This power crisis in Pakistan is the direct result of massive institutional and governance failure in the form of reckless energy policies over the last three decades.
This begs an answer to the question: what has been the impact of the investments from the China-Pakistan Economic Corridor (CPEC), with its much-touted power projects, on the energy crisis?
Circular debt, higher transmission losses and inefficiency of power firms afflict Pakistan’s power sector, according to the leaked government-mandated report of Pakistan’s National Electric Power Regulatory Authority (NEPRA).
In December 2019, Pakistan’s NEPRA determined tariff hike of Rs 2.44 per unit on account of fuel cost adjustment. Barely a month later in January 2020, it decided on another hike of Rs 1.76 per unit. By March 2020, the price of electricity per unit was further increased by Rs 1.61, taking electricity tariff to Rs 24.47 per unit. These are just a few highlights. NEPRA has revised power tariff 17 times since last year citing monthly fuel and quarterly adjustments. To a large extent, tariff was increased due to capacity payments worth billions of rupees that were made to independent power producers (IPP).
Pakistan’s ‘circular debt’ now exceeds PRs two trillion. This pile-up has not only endangered the viability of IPPs, but also the solvency of local banks – which will be crippled in case of defaults by the power sector.
And if that’s not enough, an inquiry report into suspected contract violations by independent power producers which have cost the Pakistani exchequer billions of dollars, reveals that IPPs have been earning 50% to 70% annual profits, as against the 15% limit set by the NEPRA. Most IPPs had an investment payback period of 2-4 years, profits generated were as high as 18.26 times the investment and dividends 22 times the investment and under the 1994 Power Policy, 16 out of 17 IPPs invested a combined capital of PRs 51.80 billion and earned profits in excess of PRs 415 billion. The governments’ failure to contain the circular debt had cost the country over PRs 4,082 billion in the past 13 years, with an annual loss of PRs370 billion.
These revelations were made by the ‘Committee for Power Sector Audit, Circular Debt Reservation, and Future Roadmap’, which was constituted last August in its report, which it submitted in March 2020 on the state of the power sector in Pakistan.
The report also alleges financial transgressions amounting to nearly $625 million in the independent power generating sector, with at least a third of it relating to Chinese projects under the umbrella of the China-Pakistan Economic Corridor (CPEC).
Power generation under CPEC approved by NEPRA had assured projects in energy and infrastructure worth $62 billion, with investment in energy projects of $35 billion and expected to bridge the capacity shortfall. For instance, the report reveals that in March 2015, the Huaneng Shandong Ruyi (Pak) Energy Ltd. (HSR) for 2X660 MW coal-based thermal plants submitted a cost assumption of $145.59 million against Interest During Construction (IDC).
After the ‘commercial operation date’, HSR submitted revised tariff rates of IDC in January 2019 amounting to $197.33 million. HSR had claimed IDC based on markup or long-term London Interbank Offer Rate (LIBOR) plus 4.5% during the entire construction period, whereas the financial statements of the company revealed that the company did not borrow any funds in the first year of construction and obtained short term loans at subsequently lower interest rates during the second year of construction.
Similarly, the Port Qasim Electric Power Company (Pvt.) Ltd. (PQE) inflated its set-up costs, requesting an IDC of $221.9 million at COD in April 2019, as against the IDC of $157.7 million cost assumption it has submitted in 2015. “Only equity was injected to finance the project and there was no borrowing. Therefore, there is no interest cost during this period.”
Initially Prime Minister Imran Khan’s government ordered an investigation into the alleged transgressions of IPPs’ contracts. But earlier this month, Khan’s government decided to defer the probe, citing preoccupation with COVID-19.
Similarly, power sector regulator NEPRA in its State of the Industry Report for 2019, has raised the issue of validity of power purchase agreements executed with private producers, as well as ‘excess’ payments made to them and the accumulation of massive circular debt. NEPRA’s report observes that centralised governance models for distribution companies have failed to bring any noticeable improvement over a period of more than 15 years. Even as the report raises questions on governance, excessive generation, transmission, and distribution costs, it squarely places the blame for distress in the power sector on the agreements executed with the independent power producers.
Pakistan’s energy policymaking credentials are well known for being half-baked and myopic. The country’s first formal energy policy and plan was adopted in 1994, 47 years after the country’s independence. In 2002, another power policy was approved, which provided generous agreements including dollar indexation and guaranteed capacity payments, to attract investors, at a time when the country was going through a power crisis and no one was willing to invest.
The 2009 power policy also failed as the ‘rental power plants’ adopted by the government provided expensive electricity. In fact, the Asian Development termed the agreements made for such plants to be the most expensive in the world at the time. Thereafter massive subsidies to appease the public led to government defaulting on its payments to the rental power companies eventually adding to the hefty circular debt within the supply chain and resulting in planned and unplanned power cuts worth 18 hours.
Over the years, power shortages have severely impacted Pakistan’s annual output, exports, and employment. The country faces a persistent and widening gap between demand and available system generating capacity. Electricity shortages and its price escalation have become endemic to Pakistan so much so that it was a primary election issue and is often attributed as the cause for the electoral setback suffered by the Pakistan People’s Party (PPP) in the 2013 national elections. Until the accumulated liabilities of the power sector dangerously threatening the country’s fiscal stability are addressed, Pakistan’s economic reforms cannot even begin to commence.
Earlier this year, NEPRA had urged PM Imran Khan to declare a national power emergency and take drastic steps for scaling down about PRs1.93 trillion circular debt. This circular debt accumulates through perennial defaults in payments by some of the power consumers (connected to various distribution companies (DISCOs), which default extends to the suppliers/producers of electricity (independent power producers – IPPs, Water and Power Development Authority ( WAPDA), nuclear power plants and generation companies – GENCOS) and the fuel suppliers (PSO and gas companies) for those power producers. It also includes theft and operational and technical inefficiencies of the system. NEPRA reported that circular debt had increased by about PRs 492bn during the fiscal year 2018-19 at a monthly average of about PRs 41-42bn.
The electric power crisis approximately trims 2% of Pakistan’s economic growth annually. Consequentially, for the successful realization of CPEC, the major share of the investments is allocated toward revitalizing Pakistan’s electric power sector. Since nearly 60% of the CPEC funds are directed at the energy sector, they should be carefully scrutinized by Pakistan’s government. Various assumptions were made postulating ease in the energy crisis in Pakistan with Chinese energy infrastructure investments resulting in the reduction of transmission losses and augmentation of a sustainable electric power generation mix.
But how viable are these CPEC energy investments? Theoretically, foreign direct investment under the umbrella of CPEC is a major opportunity for Pakistan. but once again most of CPEC’s investments in the power sector are targeted toward the power generation side and less focus is given to the distribution and demand side. Even after the Chinese-funded energy projects become operational, they will utilize a bulk of the current dilapidated infrastructure prone to annual losses of 25%.
Electricity transmission and distribution losses have been high in Pakistan. Until Pakistan’s power distribution networks are upgraded the energy crisis is unlikely to ease. Under CPEC energy projects, scant attention has been given toward the upgradation of the electric supply networks. No projects have been agreed upon toward the instalment of smart grids and smart meters. The new power projects being developed under the CPEC will utilise the same distribution and transmission networks plagued with issues of pilferage and losses. Even from an environmental point of view, CPEC energy sector investments have not lowered Pakistan’s power generation dependence on oil or increased dependence on other more sustainable sources.
Pakistan’s power sector circular debt has swelled to almost PRs 1.9 trillion as the payables stand at PRs 990 billion. Pakistan should try negotiating a decrease in the mark up on debt from the existing average of LIBOR+4.5% to Libor+2 and seek an extension in debt repayment period in the tariff to 20 years from the existing repayment period of 10 years. Unless Pakistan re-profiles a large portion being CPEC debt, it is in danger of getting into the debt trap and further ruining its international credit.
It remains to be seen if Pakistan’s closest ally China will ease payment obligations of over $30 billion worth of about 12,000-megawatt power projects under the CPEC to minimise Pakistan’s financial and economic difficulties.
Vaishali Basu has worked as a consultant with the National Security Council Secretariat (NSCS) for several years. She is, at present, associated with the think tank Policy Perspectives Foundation.