Circular debt – a vicious cycle of unpaid bills

A recent report of the central bank said the problems in the energy system have worsened as reflected in the persistence of load management and the re-emergence of inter-corporate circular debt. Circular debt, - a vicious cycle of unpaid bills running through the entire power-generation chain, swollen to nearly 2.0 percent of GDP and has threaten the functioning of the energy sector.
The government, to limit the accumulation of circular debt, imposed a surcharge of Rs 0.30/unit from October 2014 following soft crude prices. The adjustment implied an effective increase of 2.5 percent in electricity tariffs and the government is planned to make more adjustments in January and February 2015 to reduce electricity subsidies to 0.7 percent of GDP in the current fiscal year.
The current fiscal year started on a positive note, when the government settled circular debt of Rs 500 billion in June 2013. Furthermore, the Pakistan Muslim League’s government was also showed its committed to resolve the root causes for the power crisis.
The government then vowed to implement a time-bound plan to tackle price distortions; inadequate collections; costly and poorly targeted subsidies; governance and regulatory deficiencies; and low efficiency in the supply and distribution of energy.
Unfortunately, most of the needed reforms including privatization of distribution companies; increase in household tariffs; price rationalization of CNG; and lower priority to households in gas allocations, either could not be initiated, or made very slow progress. The demand-supply gap hovered around 4,000 megawatt during the year showed a marked deterioration.
Qasim Niaz, Chairman IPPs Advisory Committee (IPPAC), said the government has made some payments to the power producers to run their plants on maximum capacity as hydroelectricity fell in winters. However, the initiative is not a sustainable solution.
“The government should avoid delay in payments, which would curtail accumulation of circular debt and enable IPPs to run on maximum capacity,” Niaz said.
Analysts said the vicious cycle of debt once again bogged down energy supply chain as power distributors delay payments to generators who, in turn, face difficulty in clearing dues of fuel suppliers like Pakistan State Oil.
An expansive fuel mix is partly blamed for the country’s energy woes. The average fuel component of generation cost on furnace oil has increased to Rs19/kilowatt hour in 2013 from Rs12 in 2011, while generation cost on coal is around Rs3/unit.
Still there has been no significant progress made on the coal side. Although, a number of power producers announced to convert on coal, none has been able to achieve the financial close so far primarily because of the lethargic attitude of National Electric Power Regulatory Authority (NEPRA).
“Vested interest groups mainly the infamous oil mafia in the country, keep bringing up frivolous points against coal, which is costing $700,000/day to consumers of Karachi,” an official of an IPP intending to convert on coal said. “Running 420 megawatts plant on furnace oil costs $500 million a year and it would cost less than $250 million on coal.”
“The addiction to oil is set to be replaced by addiction to natural gas/LNG. LNG is better than oil but still more expensive than coal,” he said.
The central bank report said energy conservation must be promoted to manage the demand-supply gap in the short-run along with supply initiatives to find a long-term solution of the issue. On the demand side, no policy initiative was implemented to rationalize power consumption.
The government though increased tariffs in October; it was more focused on commercial and industries users, compared to household users who are less productive from an economic point of view. Given the need to rebalance power consumption between productive and non-productive users, these tariff revisions could have been better targeted, the central bank said.
The bank believes that without bringing the consumption mix to a more optimum level, the likelihood of exiting the ongoing power crisis is not promising.
“Both natural gas and electricity tariffs for households need to be rationalized to encourage households to invest in more efficient appliances and reduce wastage. Ultimately, sustainable economic development will depend on changing the mindset that cheap energy is a right, with a culture that encourages conservation and productive usage,” the bank said in its report.
The IMF, in its December review, notes that the supply shortages stem from a lack of sufficient installed capacity to cover peak demand but also from the inability to keep installed plants running at peak output due to shortages of gas and of money to provide sufficient fuel oil in expensive oil-fired plants.
“There are also significant line losses in the distribution system due to inefficiencies and theft,” IMF said.
The efficiency testing of fuel-based electricity generation companies and three rehabilitations are expected to recover around 700 megawatts of capacity and increase efficiency by 1–1.5 percent. In the medium-term, the government will complete construction of an LNG terminal to ease gas shortages to increase electricity production, while also encouraging higher domestic gas production.
The government aims to promote policies for private investment in power generation through both the entry of new players as well as expanding existing capacity of those IPPs systematically adhering to energy mix targets and least-cost generation plans. These expansions are expected to generate additional 2,000 megawatts by 2016. Finally, in the longer-run they are launching the development of several major hydropower projects.