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July 3, 2019

Why is power so pricey?


July 3, 2019

Electricity rates have been increased significantly, mostly due to the rupee devaluation. Even before this increase, there has always been the question: why is electricity expensive in Pakistan?

Pakistan’s domestic sector tariff for high-end consumers is comparable to the corresponding tariff in Europe. In quite a few cases, high-end consumers in Pakistan have higher disposable incomes than an average European consumer. However, industrial power tariff is lower in most European countries. We will trace the reasons for the high cost and tariff and offer some humble suggestions to deal with it. There are some obvious reasons for high electricity costs: T& D losses (20 percent or more), legitimate and illegitimate tariff issues, lower capacity utilization, liberal and unreasonable Nepra tariff parameters, high capital cost (elite capture and cost padding) etc. Some of the issues are well known and some not that well known.

The burden of high cost has been borne by successive governments as is indicated by the ever mounting circular debt. The government had to pass this on under the present difficult circumstances. We will deal with only the generation cost and tariff issue in the following.

Generation costs in Pakistan are high by 40 to 100 percent, some for legitimate and some for not so legitimate reasons. Older hydro plants like Tarbela and Mangla and cheaper local gas have somehow neutralized the high generation cost effect. Expensive furnace oil has been eliminated to quite some extent, although oil refinery issues continue to militate against its total elimination. Some of the newer power plants (RLNGCC) are efficient and cost effective and will contribute to control the cost down, while others will contribute to increasing the average cost to an almost unbearable level.

We invested in coal power, both local and imported ones, despite knowing its environmental consequences and general world-wide opposition to it, thinking that it would be cheap or cheaper. We thought that local Thar coal would be cheaper – and its electricity also. Nothing of the sort has happened. And there is no sign of significant relief in the future; a whole bunch of small (330 MW) and inefficient coal power plants are being set up – which obviously cannot result in cost reduction.

Both local and imported coal electricity is priced the same, where coal is brought from thousands of miles away and Thar coal power plants are at the mine mouth. Lignite electricity generation cost in the US is 3 USc per unit and in Germany somewhat higher. Lignite electricity tariff in Gujarat is 4 USc and Nyveli is 6 USc per kWh. It is a double jeopardy in Thar – high mining cost and electricity generation (loaded of course). It may be noted that both the UAE and Egypt engaged international consultants who enabled them to get such low costs. In our case, both Nepra and PPIB and others did not bother to engage similar assistance and thus ended up with 100 percent higher tariff.

Coming to the local Thar coal and the comparative cost elsewhere, in India, for comparable mines (in terms of coal depth and stripping ratio) lignite is being produced and sold at $20 a ton. In Germany and the US, lignite price of similar mines are at the same rate. Pakistan’s Thar coal price is $47 per ton levellised, and 25 percent more in the initial years of debt servicing. This is despite a lower interest debt at 3.5 percent, because there is sovereign guarantee. This interest rate should have been lower.

Mining methods and technology are also primitive as compared to the norm of continuous mining of today. Under the garb of scale economy, existing players are trying to monopolize this precious resource. Across the border in Gujarat, small mines are producing at lower cost than us.

Imported coal power plants have been built at a cost of $1.4 million per MW and an exorbitant tariff. In the UAE, recently, a PPA (Power Purchase Agreement) has been signed for a coal power plant which is actually under construction, at 4.5 USc per kWh, almost half the Pakistan tariff, both local and imported. Egypt has entered into an EPC contract (with almost the same Chinese builders and financers) at less. The builders and financers are almost the same; only the buyers are different.

One of the main factors causing higher generation costs is the faulty upfront tariff system of Nepra. Nepra worked out a highly unreasonable tariff and awarded it in a wholesale manner in 2014. We have mentioned some cases of coal earlier. High interest rates of LIBOR plus 4.5 percent were awarded at a time of low LIBOR rates of 0.5 percent without thinking that LIBOR may go higher. It had gone as much as 8 percent in the past; it is 2.5 to 3 percent now. Thus, an effective interest rate would be 7 to 7.5 percent which would further the generation costs. And a still higher and unreasonable Return on Equity (15-18 percent) was introduced. There were other cost add-ons in the owners’ costs as well.

It is argued by many that special tariff parameters should have been negotiated for as large an investment package as CPEC’s $40 billion. Asad Umar petitioned against the coal tariff. His petition was rejected but he managed to raise the high cost issue and raised public consciousness about it too. After becoming finance minister, he went away too early. Had he survived, he might have taken some of the corrective steps that are still possible.

How do we reduce electricity costs and tariffs? The existing and in-pipeline capacity is under legal contracts. Contracts have to be honoured otherwise there will be litigation and loss of credibility. We are already at risk of Karkey and Reko Diq claims and penalties. However, quiet negotiations may be possible around accepted norms and financial traditions. Firstly, the Nepra tariff system is based on cash-flow and debt schedules. The life of the power plants and their depreciation is 25-30 years and the capital costs could be spread over the life period of 25-30 years instead of 10-12 years currently. It may be possible for CPEC projects where lenders and borrowers are under one command system. Even in other countries, refinancing is not uncommon; under it loan terms like interest rates and repayment can be renegotiated with change of new financiers and project risk reduction.

Also, it may not be too much to expect from Chinese investors keeping in view the profit margins earned under high priced electricity projects as mentioned earlier. Such a cooperative arrangement may be more attractive and feasible for the government of China than other potential bailout packages that may be ultimately needed, should Pakistan’s balance of payments and budgetary situation further deteriorate.

Nepra has been revising and lowering its tariff parameters and has to do more along with solving its capacity issues. The government, particularly the Ministry for Energy and DISCOs, are required to continue with their recent campaign for reducing theft and collecting receivable with even more vigour and steadfastness .Unfair and immoral practices related with capital padding and heat rate and fuel price manipulations are to be controlled and dealt with sternly. Circular debt and the associated financial costs are to be brought down. Capacity utilization and load factor have to be improved through tariff incentives, industrial development and other technology inductions like EV.

The task may be difficult but is possible to handle. Some of the approved projects may be delayed. And some are already being delayed under circumstances – for example, Basha. Old and inefficient power plants should be retired except for IC engines and gas turbines which may be retained for peak demand purposes. Competition has to be introduced under EPC and tariff bidding and solicited projects. And a good quantity of cheaper solar and wind power without giving opportunity to vested interests and elite capture. Competition is a great remedy.

The writer is a former member of the Energy Planning Commission and author of ‘Pakistan’s Energy

Issues: Success and Challenges’.

Email: [email protected]