Karachi power needs investment

Earlier this year, millions of homes in Texas were without power for days in what is dubbed as one of the worst power crises in world history. Houston is really a case in point. The electric grid in Texas was built for efficiency, but not for climate resilience and resultant changes to operational requirements.

Katherine Blunt and Russell Gold reported in the Wall Street Journal: “A fundamental flaw in the freewheeling Texas electricity market left millions powerless and freezing in the dark (this week) during a historic cold snap…A severe storm paralyzed almost every energy source, from power plants to wind turbines, because their owners hadn’t made the investments needed to produce electricity in subfreezing temperatures. While power providers collectively failed, the companies themselves didn’t break any rules.”

Ed Hirs, a professor and energy fellow at the University of Houston, cited focus on cheap energy which resulted in the exclusion of reliability at the core of the Houston problem. In essence, the quest for efficiency and ‘low cost' led to ‘under-investment’ and energy facilities poorly prepared for extreme weather and operational dynamics – echoing the need for flexibility in investment plans for power utilities.

The real life case of Houston leads to the following two questions of sustainable investment in the power sector and its two related dimensions:

1. Is that investment to be financed by the private or public sector in Pakistan especially in transmission and distribution, and 2, is the mantra of constant low tariff without providing adequate return to private sector investors for ‘capital investment’ a recipe for disaster?

These are the fundamental questions which are not being answered in many developing countries, including Pakistan. Past three decade’s policies in this sector do not reflect any adequate framework for future growth and it is all the more difficult for privatized entities like K Electric. The effects of this issue have been briefly touched upon in the following paragraphs.

Speciality of Utility Business

The utility business is not like most other businesses. Utilities inhabit special accounting rules and pre-established investment returns, where ordinary business incentives often do not matter, and where changing course is exceedingly hard.

Utilities’ performance and their sustainability, which is critical for consumers, is mainly driven from the ‘investment’ in the assets (the pipes, substations, transmission lines, etc.) that are used to provide the service and efficiency in managing the existing assets and systems.

The monopoly model of utilities is not unique to Pakistan. “Regulated monopolies” in which public officials or the regulator guarantee the private sector enterprises a return on their investments while also fixing prices for consumers is the predominant model across the globe.

To understand this matter in the correct perspective, two quite relevant terms having a special meaning and significance in this sector would have to be fully deciphered. The first is ‘regulation’ and the second word is ‘loss’.

In summary, as far as regulation is concerned in the foreseeable future, it would not be possible for countries like Pakistan to deregulate the important utility like power in the manner that privately owned companies are allowed to generate and supply power on market based prices with open competition. This means that regulations will continue to exist, and in these circumstances, monopolistic latitude to the supplier may be provided as that monopoly is effectively tabbed by way of government regulation on major ingredient being supply price and return on investment by the regulator being NEPRA in the case of Pakistan.

The second term is ‘loss’. Losses are not only bad, but also suicidal for the society if utility companies are not sustainable in their operational and investment functions.

Nevertheless, here it is very important to distinguish between ‘subsidy’ and ‘loss’. Subsidy is the price differential, cost of producing/procuring the electricity and the regulated supply price as a national economic policy. In other words, the right description for subsidy is the price of electricity borne by the government as a public welfare activity for economic reasons. The size of ‘subsidy’ for any utility company is not to be seen as an indicator on the efficacy of that entity. Thus genuine tariff price differential — actually a credit on the income side — is to be totally divorced from a perception that this sum is compensation of the losses if any made by the utility company.

In the case of Pakistan, the consumer tariff is determined by National Electric Power and Regulatory Authority (NEPRA), and notified by the government. It is uniform across Pakistan. A uniform tariff means that the same type or category of customers pay the same price per unit regardless of which province they are based in. The categories, or slabs as they are more popularly known, are determined by the government and applied indiscriminately across Pakistan. Under the current tariff regime in Pakistan, the customers are charged a price less than the actual cost of electricity, and the differential is paid by the government.

The regulator, in Pakistan like elsewhere in the world, is charged with reviewing and approving investments in tariff to ensure spending is prudent and reasonable to strike the right balance between sustainability of the business and consumer service levels. Therefore, one often sees former WAPDA Distribution Companies and K-Electric appearing before the NEPRA to lay out arguments for how much they need to invest.

Investment enabling tariffs create future fit utilities. Years of underinvestment in the Transmission & Distribution segment of Pakistan power sector has been the primary reason for lack of reliable power supply, costing the economy billions. Investment certainty in tariffs is a prerequisite for private sector participation in the T&D segment.

Looking at the dire state we are in, there is a need to develop strategies that incentivize utilities to invest, build resilience in their systems and upgrade continuously.

To achieve this, utilities, especially in the private sector, must be sustainable and have sufficient motivation to re-invest in the system. Hence, instead of keeping investment plans rigid and construing that as efficient, an investment enabling tariff should be focused. This will automatically ensure that utilities are able to make investments sustainably. This in turn benefits consumers while also keeping a close check that investments are made as committed.

Are we prepared?

As publicly reported, K-Electric (KE) which serves power to Karachi has already invested over US$3 billion across the power value chain, including US$ 450 million Transmission Capacity Enhancement Project. A US$650 million project is underway to install 900 MW of RLNG-based generation. The utility has also invested in upgrading and strengthening the distribution network including a project of Rs9 billion dedicated entirely to bolster infrastructure as part of the company’s plans for rain mitigation and monsoon season.

Additional Rs10 billion is being invested across the city’s 12 most densely populated districts — home to two-thirds of the city’s population and a high prevalence of katchi abadis — to install Aerial Bundled Cables, bring low-cost meters to the residents so that they may avail regularized electricity supply.

However, is it worth contemplating if this investment trajectory is sustainable if the utility is not allowed to recover these costs in the tariff? If not, this will be suicidal for the economy of the country. The rapid expansion of Karachi, boom in construction spurred by government policies and other infrastructural challenges due to unplanned settlements has exponentially increased the need for capital expenditure.

Currently, KE’s investment limits are capped in the tariff and they have no incentive to make any further investments in the system. Without adequate returns on investment, and the pending problems of outstanding payments from the government and associated entities, KE is borrowing from financial institutions to meet its working capital requirements, a figure reported to exceed PKR100 billion. This poses a threat to the utility’s operations.

If the incentive is absent, utilities have two choices — continue to operate at current levels and let the customer service level deteriorate or petition to the regulator for allowance of planned investments and wait for a nod to proceed. In Pakistan, such deliberations typically take anywhere between one to two years to conclude. KE has already made a plea for further investments in its “mid-term review.”

In KE’s case, if requested investments are not allowed, the utility may inadvertently be forced to suspend ongoing and planned investments. If the tariff adjustments for investments don’t come through, KE, and with it Karachi, will go into economic regression. Ultimately, the burden will still be borne by the government and the customers because we will have a problem. In fact, there is no choice. Investment has to be made — the sooner the better for all stakeholders.