Reforms can help improve operational inefficiencies in the power sector but green financing for energy transition is the way forward
he start of Modern Industrial Age was based on a big push for investment in fossil fuels. The countries with high per capita availability and consumption of total primary energy supply (TPES) have a high human development index (HDI). Realising that fossil fuels contribute to climate change, the world is moving towards renewable energy.
Compared to peer economies in Asia, Pakistan has a low per capita availability of TPES and a low HDI. The share of hydel power in the national generation mix that was once around 65 percent, is now 23.7 percent. The share of fossil fuel based thermal generation is 61 percent, that of nuclear energy 12.35 percent and that of renewables 3.02 percent (Economic Survey of Pakistan 2021-22).
Increased reliance on fossil fuels and fuel price fluctuations has been blamed for a large energy circular debt (ECD). The ECD arises when distribution companies’ (Discos) collection of revenue fails to cover the cost of generation. Due to the liquidity problems, the Discos withhold payments of generation companies’ (Gencos) dues. The Gencos cannot pay the oil marketing companies, who cannot pay refineries and withhold petroleum levy and other duties payable to the federal government. But the high cost of electricity generation is just one factor in ECD accumulation. The other causes are under collection of power bills, high transmission and distribution losses (T&D losses), capacity payment charges (CPC) to independent power producers, under-budgeted and delayed subsidies, delayed tariff determinations and notifications, under-recovery of the financial cost of circular debt and energy sector governance issues.
Until 2014, the power sector had inadequate generation capacity and a growing demand for electricity. From the early ’90s till the installation of new plants under the CPEC, successive governments preferred buying electricity from independent power producers/ rental power producers (IPPs/ RPPs) rather than further expanding the hydrogeneration capacity.
The 1994 Power Policy offered lucrative incentives to the IPPs, including capacity payment charges, guaranteed profit on equity, and lifetime exemption from corporate income tax.
The ECD problems started emerging in the late 1990s, but today’s ECD originated in 2007-08. During this period, the natural gas allocation for the power sector was reduced, and the use of furnace oil for power generation increased considerably. Meanwhile, crude oil prices doubled from $55 to $110/ barrel, increasing the cost of power generation. However, it was an election year, so the electricity prices for domestic consumers were raised by only 9 percent. The situation worsened between 2011 and 2014 when global prices of Brent crude ranged between $90 and $120 / barrel, but the price hike was not passed on to consumers, leading to a fiscal deficit and non-payment to IPPs/ RPPs.
Many IPPs/ RPPs stopped generating electricity due to a liquidity crunch. At the same time, remaining power producers were generating electricity at half their capacities because of the non-affordability of fuel. Most parts of Pakistan witnessed power outages of 10-16 hours per day. Violent protests over power cuts became a routine in some parts of the country. By 2013, the ECD had reached Rs 450 billion (more than 2 percent of GDP).
The Pakistan Muslim League-Nawaz won the elections in 2013, mainly on the promise of finishing power outages. It did honour its commitment. Power generation capacity was expanded to 29,573 megawatts (MW) by March 2018, with an addition of 7,096 MW (mainly under the CPEC). However, the primary fuel sources of the new plants were coal and LNG. Fuel costs remained modest during 2013-18. However, mainly due to T&D losses and CPC, the size of ECD reached Rs 1.14 trillion by the end of 2017-18.
Successive governments have strived hard to bring ECD down. Over the past three and half years, the ECD stock more than doubled to Rs 2.46 trillion (3.8 percent of GDP), despite the disbursement of more than Rs 700 billion in subsidies. During the same period, the circular debt in the gas sector nearly doubled to Rs 0.65 trillion from Rs 0.35 trillion in 2018.
By comparison, Pakistan’s defence budget for the year is Rs 1.50 trillion, and the cost of running the federal government (pays) for 2022-23 is Rs 0.55 trillion. Our cumulative ECD (including gas circular debt) equals two years of our defence budget and five years of federal salaries.
If it is allowed to grow at the current pace, the ECD is estimated to reach Rs 4 trillion by 2025. The consumer electricity prices so far are too low to stem the flow of circular debt as the cost of generation has increased hugely due to more than cent percent increases in the price of gas and more than fifty percent increase in the price of oil in the international market during last six months. Hence, the IMF has advised increasing the power tariff (to recover the total generation cost from consumers except for the lifeline consumers). However, this will result in high-paying domestic consumers reducing the offtake of grid electricity through solarisation. At the same time, the industries will look for ways to increase self-generation. This, in turn, will increase the CPC, which is projected to increase to Rs 1.4 trillion in FY 2023.
A multipronged approach is being pursued currently to pull the country out of the crisis. Major structural reforms in power sectors carried out during the last four years include the approval of energy policy 2021 and the renewable energy policy 2020. While the latter focuses on competitive tariffs through reverse auctions, the former focuses on the least cost principle. An energy plan for implementing energy policy is being developed through an extensive consultative process. Moreover, the regulator approved an Indicative Generation Capacity Expansion Plan after consensus among provinces in 2021 for the next ten years, based on the least-cost principle. Under the subsidy reform principles, full cost recovery, protection of most marginalised consumers, and gradual reduction of subsidy from other residential consumers have been approved by the Federal Cabinet and endorsed by the regulator. Regulatory functions have been strengthened by introducing automaticity to regulators’ determinations of tariffs and reducing the government’s authority in tariff determination. To reduce the tariffs, the return on equity for most IPPs and all government power plants has been reduced. Likewise, dollar linkage in most IPP’s capacity charges has been done away with, introducing a ceiling of Rs 168 to a dollar. On the gas side, similar automaticity has been introduced in law for the gas regulator and legislation has been approved to recover the cost of imported gas (Weighted Average Cost of Gas).
The abovementioned reforms may help improve power sector operational inefficiencies and reduce the ECD to some extent. However, these reforms will not provide solace to the masses who are finding energy beyond their economic access. Increasing the tariff is a first aid but not a cure. In the medium to long run, we have to reduce our dependence on fossil fuels and increase the share of renewables in our energy mix. The way forward is to explore green financing for energy transition, improve energy governance, and take care of the low and the lower-middle income earners through strengthened social safety nets.
The writer heads Sustainable Development Policy Institute. He tweets @abidsuleri