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August 18, 2019

Restructuring gas

Opinion

August 18, 2019

The Pakistan-IMF agreement includes restructuring of the gas sector, involving integration of gas transmission and bringing about a number of gas distribution companies. The issue has been on the table for the last ten years but has acquired more importance and urgency recently. Bad performance of gas companies, leakages and losses have given a new rationale to reforms and restructuring.

Essentially, the gas sector is proposed to be reorganized ala the restructuring of the power sector, which has come along a long way from a monolith Wapda to many companies and DISCOs. The central idea is that smaller companies may be better managed than larger companies and ultimate privatization may become easier to the local investors. A distribution company should not be spread beyond, say, 200 kms in diameter.

Also, in terms of the number of customers, there is a reasonable upper limit which can be efficiently managed; there is a lower limit as well below which a company may suffer from lack of economy. From this point of view, MEPCO, PESCO and LESCO are ready candidates for sub-division into smaller companies; similar is the case with gas companies. Small gas distribution companies are common in Europe. In India, there is a district/city based gas distribution companies system.

In the gas sector in Pakistan, there are two integrated transmission and distribution companies, SSGC and SNGPL; the two companies own both transmission and distribution assets. Both companies handle a large number of customers spread across very wide and rather unmanageable geographical areas. There are several other differences between the power and gas sectors. Gas companies buy gas directly from producers and LNG importers. Gas companies pay directly to gas suppliers without the intervention of an intermediary single buyer like CPPAG in the power sector. Income and expense are balanced through a system of cross subsidies (somebody pays more to take care of others who pay less). The role of direct GoP subsidies is much less than it is in case of the power sector.

Simply speaking, the proposed restructuring for thee gas sector aims at bringing it almost at par with the power sector. There are some variants among various threads in this respect. Basically, the common theme is to have one gas transmission company and many distribution companies. It could be one provincial company each or could be like the power sector's many (10-12) DISCOs. However, a single buyer agency like CPPAG may have to be established which would buy gas from various producers and LNG importers and sell it to gas DISCOs at a weighted average (price) cost of gas (WACOG). Various gas-DISCOs would receive varying subsidies to cover their shortfalls or surpluses. It is feared that transmission companies may earn more profit due to their heavy capital assets and DISCOs may be in loss due to smaller capital investments. This may not be the case, as the single buyer may be able to balance the surpluses and deficits or different tariff approach may be adopted. The power sector is handling this problem in an adequate manner.

In the proposed restructuring, organizational issues are relatively simpler, although unions may oppose the status-quo. More difficult are political and legal issues. Punjab’s share in consumption is very high and it is not a gas producer. All three provinces produce gas and their consumption is lower than their production. However, the supply scene has been changing; Balochistan was replaced by Sindh as the largest gas producer and now Khyber Pakhtunkhwa is emerging as a new challenger. And LNG is increasingly acquiring a larger market share, as local gas production dwindles.

There are constitutional issues which specify that the demand of the producer provinces be met first before exporting it to other provinces. That is easier said than done; gas is required for cooking needs and is almost a human rights issue; gas is used by the power sector which in turn is supplied to the whole country; gas is supplied to the fertilizer sector which is a common agricultural input. Political cleavages would make resolution of constitutional issues very difficult, although in three provinces, one party has formed the provincial governments.

Existing separate prices for locally produced gas and LNG are creating many problems including price disparities among the provinces. Pakistan’s economy is based on a uniform pricing system in most areas which conflicts with the dictates of provincial priorities. With the advent of LNG and its increasing market share, the idea of WACOG (weighted average uniform price) is acquiring more legitimacy.

The two gas companies are not 100 percent owned by the federal government; their shares are floated in the stock exchanges. Corporate processes to merge the transmission assets of the two companies and split the distribution may be time-consuming and complicated. A long-standing proposal has been to follow a step by step approach -- forming virtual gas-DISCOs. Legally, these may be part of the parent gas companies, SSGC and SNGPL, but several gas-DISCOs may be organized like an independent company. This may give an opportunity to study and learn the issues of a decentralized operation. Earlier administrations wanted to implement this virtual concept, but reportedly the companies' managements dragged their feet.

There are people who argue that, in the utilities sector, there is no competition and thus there wouldn’t be much advantage in privatization. New market structures have been created to solve these problems like retail competition wherein electricity and gas producers directly sell to retail customers, small or large. Alternatively, marketing companies buy from producers and retail electricity and gas. In this scheme of things, DISCOs are reduced to providing distribution services companies.

There are other changes that have to be brought about; change from cost-plus to a fixed charge rate cum incentive based system ala KE. Currently, except for UFG reduction, there is no incentive to reduce costs on the part of the gas companies.

After the initial bout of privatization in the 1990s, practically no significant privatization has happened. However, the pressure is great this time from IFIs, including the formidable IMF. High UFG losses and the falling capital base of the companies have created more incentives and pressures to implement reforms. It might be difficult to postpone it this time.

The writer is a former member of the Energy Planning Commission and author of ‘Pakistan’s Energy Issues: Success and Challenges’.

Email: [email protected]

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