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Pakistan’s power sector way forward

Pakistan’s power sector way forward

Pakistan’s power sector remains in news for all the wrong reasons. Circular debt is continuously increasing where private power producers are primarily accused for the increase in high electricity prices in the country and mounting circular debt. Besides other measures, it is believed that if tariffs are awarded through competitive bidding process then tariffs of new power projects would be very low and circular debt would taper off.

Policy makers are considering various plans e.g. IGCEP, CTBCM, and DISCOs long-stop date for managing the current crisis of the power sector; but it seems that all are not well synchronized. It is evident from (1) there would be a competitive regime under CTBCM with multiple sellers and multiple buyers – then why we need IGCEP; (2) IGCEP will be effective as soon as it is approved by NEPRA and thereafter new projects will only be added in the system on the basis of the plan – then why private power companies are being included in the plan; (3) exclusivity of DISCOs will end in 2022 (20 years from date of issuance of license) and thereafter, private sector could also enter into the distribution sector after getting a distribution license – then what is the purpose of having CTBCM and IGCEP (4) wheeling arrangement but that is challenged by DISCOs in the courts – then first two are irrelevant.

It’s a myth that tariff bidding will yield in lower tariffs. A lot of references of Middle East bidding process are given in Pakistan, which are mostly out of context. Government agencies in the Middle East add additional power in their system on the basis of long term planning, which hardly change. In comparison, the economy of Pakistan is highly volatile, it moves like a pendulum where no one can even estimate the expected GDP rate of any fiscal year till that fiscal year is actually closed.

In order to make a competitive bid, three main aspects are carefully assessed i.e. capital cost, which is mainly the EPC Price and EPC Contractor, lending cost and the lenders, and return on equity of the sponsors.

For tariff bidding, one of the most important factors is forming a consortium, which includes equity partners, lenders, EPC companies, a bunch of consultants and legal counsels. Those who are obsessed with the bidding model, must have seen the list of participants along with the list of lenders, equipment suppliers etc. when the results are declared. In order to keep the bidding process competitive, no lender or equipment supplier or an EPC Company is engaged by more than one bidder.

Unlike in Pakistan; where effectively there is only one foreign EPC contractor for the wind projects. Local companies don’t have the capacity and attitude of doing international standard quality work. In this situation; that particular EPC contractor will offer same price to all the bidders. Thus the key to the lowest tariff is in the hands of that particular EPC contractor, if EPC contractor agrees to offer a discount to any particular bidder. Having multiple EPC Contractors can only help in getting better EPC prices thus lower tariffs. For that, government needs to offer some incentives to the international EPC Companies and do the capacity building of the local companies along with encouraging foreign companies to set up manufacturing units in Pakistan.

In addition; every bidder negotiates different debt structure and terms with banks, which is dependent on the financial strength of a bidder. Almost all the power projects in Pakistan have been financed by ~5 main local banks and ~4 international banks. Not all banks in Pakistan have the capacity or appetite to finance a power project, whereas large banks have the capacity to move fast thus those banks remain the preferred choice of the power companies. In this situation; all companies will get the same level of financing cost and terms.

If above two components remain the same, then the decisive factor will be the rate of return on equity (ROE). This will make foreign investors at a disadvantage where foreign investor will offer dollar linked ROE whereas a local investor will offer local currency ROE. Due to this, the offered tariff of a local investor will always be less than the foreign investor. Some say SO WHAT, when local investors can invest then why to bother about the foreign investors. In reality, this is the most bizarre argument because confidence of foreign investors on a country actually brings more investment in a country. Even China progressed because of western companies like General Electric, Apple, Boeing, all invested in China and set up their manufacturing units in China. Once, HSBC and AES Corporation like companies had investments in Pakistan but all have exited from Pakistan for one reason or the other. Ideally such companies should have been approached at the highest level and would have been requested to stay because through these international players, a country can showcase its international acceptability and can present it as a success story. King of Jordan himself approached an American power company not to exit from their power project and requested them to even expand their capacity – that American power company sold all other investments in the region except their Jordan investment. That’s how foreign investment is taken seriously.

The point is tariff bidding of utility scale projects will not yield in lower tariffs in Pakistan (as is being expected) because circumstances don’t support this. Instead cost plus tariff regime is far better and can give the desired results.

A 50MW wind project in Pakistan is considered a big project whereas in Middle East it is just nothing, where they solicit bids for one project of 500 or 1000 or 2000MW at least. Once Pakistan has multiple bankable EPC contractors, currency becomes stable and banks are willing to offer better terms, tariff bidding would become the preferred and only choice. Some say that bidding is the only way to cancel the LOIs of unsuccessful bidders, which can be challenged in any court. Therefore, it is safe to say that bidding would not yield the desired results.

Moreover, some proudly claim that they have done some remarkable work in making an IPP Investigation Report and signing of the MOUs with IPPs of local investors. Ironically, Chinese IPPs have refused to reduce their ROEs and very intelligently linked it with the reduction in the circular debt. Now IPP sector is badly stuck and is facing worst ever unprecedented crisis.

The clean and effective way to address the high cost of electricity rests in the wheeling arrangement and opening of the power market on a business-to-business basis. The clean way of getting tariff reduction is to terminate the existing power agreements with government’s CPPA and allowing IPPs to sell their power to anyone in the market through wheeling. IPPs would automatically reduce their tariffs by reducing their returns and delinking tariff from US dollar so as to get the long term contracts from the market.

By allowing wheeling, on one side electricity prices would slacken while on other, government would be out of their obligation of paying fixed capacity payments. However, the biggest stumbling block in wheeling is none other than the state owned distribution companies. Federal government provides DISCOs all sorts of support (financial, technical and regulatory) but these DISCOs are virtually bankrupt. It is not advisable to keep these DISCOs on the ventilator at the cost of the entire power generation sector.

Privatizing DISCOs is too late now, therefore, the best possible solution to ever increasing circular debt is to let the exclusivity of DISCOs be expired; allow wheeling arrangements; and let B-to-B happen. Sooner it is done, better it would be as everyone acknowledges the importance of wheeling then why to waste time and continue feeding the bankrupt DISCOs.

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