Cost of power outages to the economy
By Shahid Javed Burki
Monday, May 11, 2009
THE second annual report of the Beaconhouse Institute of Public Policy offers a menu of options for the policymakers in Islamabad.
Joining me as the authors of the report titled ‘State of the Economy: Emerging from the Crises” are some of the more experienced policy analysts including Sartaj Aziz, Aisha Ghaus-Pasha, Parvez Hasan, Akmal Hussain, Shahid Kardar and Hafiz Pasha.
Here I will deal with one aspect of the analysis offered in the report.The year 2008 witnessed a major increase in the frequency and intensity of power load shedding or outages generally and in particular in the industrial sector. A manifestation of this problem can be seen in the large number of reports in the press of high incidence of outages and protests, by not only the domestic and commercial, but also industrial consumers.
During the course of the year, complaints by the various chambers of commerce and industry and other industrial associations that the level of production in a number of industries has been reduced due to the persistence of outages which apparently have fundamentally disturbed the normal rhythm of the production cycle in a large number of industrial units, especially in electricity-intensive sectors like textiles, non-metallic mineral products, basic metals, leather products, rubber and plastic products, paper and paper products, etc.
The economic costs of power outages in the industrial sector which ac counts for about 28 per cent of total power consumption is having a profoundly negative impact on the economy. The magnitude of cost is a basic indicator of the benefits that could be realised from investment and improved management of the power sector. Major factors contributing to increased power shortages include: growth in demand for electricity, particularly domestic demand fuelled in part by subsidised tariffs; inadequate policy response to the increased demand, reflected in the lack of expansion and upgradation of power plants and the low priority to public sector expenditure on the power sector; lack of improvement/upgradation by the IPPs, partly because of the uncertainty created by the ad hocism in the government’s privatisation policy earlier; overall mismanagement of the power sector, reflected both in the accumulation of over Rs370 billion of circular debt and the heavy line losses and large scale theft; and shortterm supply-demand imbalances due to the seasonality, in particular in hydro power generation.
Costs of outages consist of direct costs which primarily comprise the spoilage cost and net value of lost production and indirect costs incurred by firms to recover at least some of the output lost during and immediately after outages. The particular mechanisms chosen for recovering output lost, will, of course, be based on cost minimisation considerations. Typically, types of adjustments made by a firm include: acquiring self-generation capacity; more intensive utilisation of capacity; working overtime; working additional shifts, and; changing shift timings. A pattern of response by industrial units increasingly observed, is that of development of own sources of energy supply through investment in generators.
Some of the key parameters required to estimate the cost of loadshedding for this report have been collected through a survey of a predesigned and tested questionnaire on a purposive sample, stratified (by city and industry group) of 65 industrial units.
The survey reveals that the average annual hours of outages per unit was 1379 in 2008. The average duration per day was four hours and 36 minutes. The highest incidence of outages in 2008 was between the months of December and January and in June. Industries which have been affected more by outages are textiles, machinery and equipment, food, glass and allied products. Also, continuous-process industries appear to have been less exposed to outages than batch-making industries.
Time losses during the outage plus restart time account for were over 20 per cent of the total time of operation. About 84 per cent of the sample units did make an effort to recover part of the lost production time. The highest proportion, 75 per cent, have done so through self-generation of electricity. Wherever generators have been installed, the extent of substitution has been high, at 85 per cent of the normal power consumption.
Firms which do not have self-generation capacity, either because it is not economically feasible or affordable, have tried to recover some of the lost output through other adjustments identified earlier. However, their level of recovery of lost output is lower, at 29 per cent.
The recovery of lost output is at a higher cost. The average cost of selfgeneration is almost two and a half times more than the cost of acquiring electricity from power utilities. Therefore, the extra cost to the industrial sector due to self-generation of electricity is about Rs32 billion. This is also an indicator of the extent to which profitability of firms is lower because of load shedding. Also, since such firms recovered about 84 per cent of the output, the cost of output permanently lost is estimated at Rs42 billion.
Firms adjusting through other mechanisms also incur additional costs which include overtime/ shift/changing working days premia to labour, additional wear and tear of machinery and spoilage of raw material/inputs in process. These costs aggregated to Rs6 billion at the national level. For such firms, the cost of value added lost is Rs77 billion. Therefore, aggregate cost to the industrial sector of load-shedding is estimated at Rs157 billion. This is equivalent to nine per cent of the industrial value added. The loss of industrial output is estimated at seven per cent of potential production.
Over and above the direct costs on the industrial sector, a change in value added in the industrial sector has secondary or multiplier effects on the rest of the economy. Adjusting for these forward and backward linkages increases the overall costs of industrial load-shedding to the country by Rs53 billion. Overall, power loadshedding in the industrial sector has cost the country Rs210 billion or over two percent of the GDP, over $1 billion of export earnings and potential displacement of 400,000 workers. Costs could be even higher if impact on other sectors like agriculture and services are allowed for, which account for almost the same share in power consumption as industry.
Following are some of the recommendations we have made to deal with this situation. The high economic cost of unsupplied electricity justifies a case for expanding power generation capacity. In fact, there is a stronger case for upgrading existing power generation facilities, which can be accomplished at almost one-third the cost of new plants. This will require development and quick implementation of an accelerated generation investment programme, which includes the project to import 1000 MW electricity from Iran and a comprehensive programme to reduce technical losses and improve the reliability of the distribution system. Simultaneously, the enabling environment has to be improved so that IPPs investment plans can be encouraged and the problem of circular debt has to be resolved on a priority basis Such a strategy should focus on a loss-minimising policy. The load-shedding schedule should reflect clear and transparent priorities, in consultation with stakeholders, and be predictable. Sectors that deserve priority, in particular should include export industries. There is a strong case to develop and implement customer outreach programmes to encourage energy conservation measures, steps to improve the power factor, and methods of limiting peak demand. It is also important that alternative sources of energy, in particular solar energy be explored. Pakistan should enhance its capacity to follow international developments on alternative sources and promote greater use of renewable energy for light, heating, agriculture and smallscale enterprise.
Some of the policy recommendations enunciated above can be implemented immediately while others have a medium-term perspective, given the gestation period required for completion/execution of investments. But one thing is clear. This is a crisis that cannot wait for too long to be sorted. The cost to the economy and to the society are very high and their political consequences could be exceptionally grim.