Friday July 19, 2024

A coherent energy plan

Detractors will say that the existing legal and governance framework makes it difficult to move towards a more competitive market

By Ammar Habib Khan
November 26, 2023
Two employees work on a gas pipeline. — AFP/File
Two employees work on a gas pipeline. — AFP/File

The government recently increased prices – across the board – of gas that is supplied through the country’s distribution network. The increase in prices, although justified and which may bode well for gradual reduction in gas circular deficit, may lead to other unintended consequences, since the increase will affect how energy will be consumed in the country.

The change in the formula through which pricing for supply of gas to industrial units is done will effectively lead to an increase in electricity prices across the country, further burdening households and small businesses that cannot transition towards gas-fired power generation.

Looking at gas prices in isolation from electricity prices is a fallacy. The country needs a coherent energy policy which should focus on how much more efficiently, and with how much value-addition, a molecule of gas or any other source of energy can generate. Policy decisions should be driven by such evaluation, rather than be arbitrary and at the behest of interest groups. However, there does not seem to be any coherent system at play to consider unintended consequences of policy decisions.

The recent change in price of gas for industrial units will incentivize industries to shift towards captive power and install more gas-fired captive power generation capacity. The price at which gas will be supplied to industry will result in the generation of cheaper electricity for such industrial units, relative to the electricity grid. As it will be cheaper to produce electricity through captive power generation, rather than buy from the grid, this will result in further reduction in demand for electricity from the grid.

It is essential to note here that the price of electricity being supplied through the grid continues to increase and has almost doubled in the last five years. Such a massive increase in the price of electricity without any corresponding increase in incomes has led to a reduction in demand of electricity across the country, as households and businesses alike are sensitive to increase in price of electricity.

A reduction in consumption of electricity inadvertently leads to reduction in economic output, eventually translating into lower economic growth. In such a scenario, it is imperative that electricity prices are either stabilized, or rationalized to catalyze economic growth. The inability to make electricity more affordable will result in a drag on economic growth.

Electricity prices in Pakistan are determined on a cost-plus basis, where the cost of generating electricity is a function of the cost of energy being used, and of fixed costs incurred in generating that electricity, the latter being commonly referred to as capacity payments. Such capacity payments are fixed, and as electricity consumption is reduced, they are spread over a small number of electricity units (kWH) generated, eventually translating into higher cost for every unit of electricity generation.

A reduction in demand means higher costs of electricity for everyone. As industries shift towards gas, and disregard the grid, consumption of electricity through the grid would reduce further, resulting in higher cost of electricity for consumers that stay on the grid.

Effectively as households and small businesses do not have any alternate options for generation of electricity, they will continue to rely on the grid and pay for government inefficiency embedded in the power transmission and distribution governance, as well as infrastructure. As more industries transition away from the grid, the price of electricity will increase for households and small businesses that do not have any other option than the grid.

The current power generation, transmission and distribution infrastructure and governance is not just inefficient, but also a major drag on economic growth. The recent gas policy further exacerbates the problem. Currently, the state is effectively the only buyer of electricity, thereby resulting in inefficiency and welfare loss. A radical approach needs to be taken wherein we move away from a single-buyer model to a multi-buyer and multi-seller model, wherein households and businesses alike can opt for a cheaper source of electricity, while suppliers make their generation and distribution more efficient to reduce overall cost of electricity. Currently, the system is rigged in a manner that suppliers and distributors do not have any incentive to be more efficient, and hence there exists no incentive to reduce the price of electricity and compete for consumers.

Detractors will say that the existing legal and governance framework makes it difficult to move towards a more competitive market. The same framework can be amended and renegotiated and restructured such that it serves all stakeholders. Continuing with the existing structure does not serve any stakeholders. The consumers will continue to pay an ever-increasing price for electricity, while suppliers will continue to struggle to generate financial liquidity as circular debt increases and continues to stress the fiscal deficit.

The country needs an integrated energy policy. Energy is the country's biggest import and is the core ingredient required for enabling sustainable growth. An integrated energy policy ought to cover everything from transportation to power generation, heating, industrial usage, and so on. Such a policy should double down on utilization of indigenous resources to ensure energy security, while also focusing on optimal usage of energy, whether that is through maximizing utilization of public transport, or reallocating gas to industries that generate maximum value-add.

The inability to create such an integrated energy policy will inadvertently lead to inefficient allocation, and utilization of resources, benefiting a few thousand rent-seekers while restricting access to affordable energy for millions of households and small businesses.

The writer is an independent macroeconomist.