Restructuring the power sector!!!

Silent Spectator · #1 Sunday, November 08, 2009

RESTRUCTURING THE POWER SECTOR
By Shahid Kardar

[The writer is a former finance minister of Punjab. This article first appeared in The News International on October 6 & 7, 2009, in two parts.]

A common refrain in Pakistan today is that the role of the middle class and industry has been reduced to earning enough to pay WAPDA bills regularly so that it can stay afloat. The cost of doing business in Pakistan has been rising, affecting the competitiveness of the much-maligned domestic industry. In a highly liberalised import tariff regime industry continues to be under stress simply because of the high cost of energy provided by publicly controlled corporations.

Without trying to defend inefficient manufacturers one must ask that if prices of all major inputs of the manufacturing sector are administered by government-managed enterprises, how can private industry be expected to neutralise, entirely through its own efforts, the higher cost burden of the operational inefficiencies of these corporations? In this article I propose to take up the issue of the cost of one such input, electricity, the unit price of which for industry is one of the highest in the world. That it is the government's skewed resource mobilisation policy that further loads the electricity tariff structure with surcharges and withholding taxes and the distorted tariff structure whereby the bulk consumer, industry, pays a much higher tariff than domestic consumers (whereas it should be the other way around) are other matters that should be the subject of another discussion.

In Pakistan electricity is presently being priced well below the cost of service to less affluent domestic consumers (those consuming up to 300kwh) and farmers – at two-thirds of the average cost per unit (and whose consumption through tube-wells can also be overstated because of lack of metering). The other, more perennial issue is the increase in WAPDA's woes on not being able to pass on the rapidly rising international price of oil and our collective failure to exploit lower- cost alternatives like hydel and coal. With 60 to 65 per cent of the generation being oil-based, the cost of electricity in our homes works out to almost Rs16 per unit, the price of oil alone being Rs8 per unit today!

These factors, combined with overstaffing in WAPDA and the distribution companies which are unable to hold their staff accountable for electricity theft, the failure to get FATA and thousands of electricity consumers in Karachi to pay their dues, its misuse by the subsidised consumers (for example, farmers have changed cropping patterns and started cultivating water-intensive crops) and poor collections have resulted in commercial consumers, industry and domestic consumers in other parts of the country paying higher tariffs--to make up for the losses on these accounts.

The transmission and distribution losses on account of outdated equipment, technological backwardness, poor maintenance, theft and weak collection effort are being classified as "technical losses"; which, at more than 18 per cent for the Multan area, 21 per cent for Quetta, Peshawar 33 per cent and 35 per cent in case of KESC and Hyderabad, are among the highest in the world. This much publicised theft of electricity is, of course, carried out in collusion with staff of the distribution companies (DISCOs), especially in urban areas, by both the well-off and inhabitants of low income settlements and katchi abadis and by both large and small industrial units. All these issues are well known. But no one has the courage to tackle them, except to look towards the honest prosperous consumers to help these utilities cross-subsidise inefficiencies, theft and politicised populist tariffs chargeable to farmers and low-consumption households. The theft simply gets underwritten by a tariff increase: i.e., there is the privatisation of public theft! This is why WAPDA and KESC oppose consumers buying from others or from establishing facilities to meet their own electricity consumption requirements. To prevent this from happening these agencies either charge penal tariffs for using their transmission lines or levy a charge even when their transmission lines are not used.

Power-sector reforms involving foreign investors in power generation have been a costly outcome, largely because of the poor country image and a flawed policy framework. Not only has it been characterised by rent-seeking behaviour, investments have a huge debt component. The lenders want to reduce their risk and require assurance that the money being lent will be fully serviced and on a timely basis. For that they have sought the structuring of the power purchase agreements to guarantee a minimum level of sale of power units and payments of fixed charges (called capacity charge), even if the guaranteed quantities are not purchased, resulting in the transfer of both financial and market risks to the government. Seventy per cent of the tariff is a capacity payment (to be made whether WAPDA buys the power produced or not). This is presently being made to at least two companies which were, in one of the most stupid decisions ever made, committed provision of gas when there is little or no surplus of such a resource available, and which are literally lying idle and getting paid for not supplying any electricity, raising all kinds of doubts about the underlying motives for committing gas to them!

Even a cursory examination shows that, based on the guarantees announced by the government, investors will earn rates of return much higher than those being earned in other sectors, without them having to bear any risk. The returns built into the tariff structure have been truly excessive, especially in the case of the rental power projects--without, for the moment, entering into a discussion on the government's failure to manage and utilise existing capacities better by tackling the issues of the circular debt and the regular maintenance and upgrading of WAPDA's generation capacity prior to exercising the option for rental power.

The government has committed the tariff in dollar terms (although the billing will be in local currency). It has also guaranteed the power producers against upward revisions in the price of fuel and any additional costs that may have to be borne by them as a result of changes in any laws--almost akin to a constitutional amendment in their favour! In other words, all financial and attendant risks, including those pertaining to market demand, are being underwritten by the government. If producers are to be compensated for all changes in input costs, then where is the legendary efficiency of the private sector? This is in sharp contrast to the market conditions faced by other private investments. For example, there are no guaranteed off-takes in the case of consumer goods or durables.

Isn't it unnatural that while the rest of the economy is barely afloat--with a growth rate just ahead of population growth, foreign investment, which is generally shy of investing in other sectors, is relatively keen to sign up IPPs or rental-power agreements, concerns about the government's ability to make timely payments (the experience of the circular debt) notwithstanding. Could it be that the incentive/reward structure is far too attractive and unrelated to market principles?

In this writer's opinion the incentives are distorting market signals, inducing a switching of investments from other sectors into the power sector, especially with the commitment that the IPPs can borrow at KIBOR plus 3 per cent, almost creating a floor for the price of long-term private-sector credit!

It has also been a mistake to invite foreign investment in generation, when the problem lies with the distribution side of things (the bad experience with the KESC privatisation notwithstanding). In the opinion of this writer, the efficiency of the DISCOs with their massive theft simply cannot be improved: you cannot change a mule into a zebra by painting stripes on it. The only solution is the introduction of the private sector in the distribution system by inviting competitive bids on tariff ceilings, efficiency improvements and reduction in distribution losses. It should also be obvious that as long as distribution systems are rickety and not financially viable, foreign investors will demand a variety of measures to mitigate their risks, which automatically gives primacy to their looking at generation rather than distribution.

The government's defends its decision to invite RPPs based on shortfalls in supply and projections of demand for electricity. This writer, for one, would argue that the growth rate in demand for electricity is likely to be lower than envisaged by the government following the phased 31 per cent revision in its price over the next six months or so. The capability of the end-consumer and the slowly growing economy to absorb such costs remain to be seen. And if exports are not robust, will we be able to earn the foreign exchange required by WAPDA to meet its foreign-currency obligations? One of the key imponderables of the energy policy concerns the materialisation of such hopes.

However, the most disturbing feature of the power-purchase agreements signed between the government and the private power producers is the secrecy in which they are shrouded. That the terms of the agreements were revised from those set out in the tender documents is being hidden, unnecessarily raising questions about the potentially "sinister nature" of the underlying motive and doubts about the transparency of the process of the award of contracts. We therefore demand that all such agreements should be open to public scrutiny. To illustrate this point take the case of the tariff ranging from 2.5 cents to 3.6 cents negotiated for rental power plants a handful of weeks before the installation into office of this government, compared with the tariff ranging from 4.18 cents to 5.98 cents agreed in recent days for 1,500 MWs, which for the supply of roughly 10 billion units a year translates to an additional payment of at least $200 million a year--to say nothing of the grant of a 14 per cent mobilisation advance that was not mentioned in the bidding documents. Information on the "real sponsors" of the RPPs with which agreements have been signed will go a long way in explaining these revisions, especially in the tariff structure, and the commitments made to supply a scarce resource, such as gas!

Therefore, in the short term, the government should a) eliminate the circular debt immediately, even if it means cutting down the development programme drastically; b) revise the electricity tariff structure so that the issue of circular debt does not re-emerge; and c) help WAPDA collect its dues from government departments and agencies so that it can carry out urgent repairs of its plants and machinery and upgrade the generation capacities of some of its stations as a much cheaper option.

In the medium to long term, we should exploit our resources of coal and water. The latter through small hydel projects, by putting Kashmir on the backburner and initiating discussions with the Indians on a joint strategy for the efficient utilisation of this scarce resource: water. Next, we should privatise the DISCOs and stop cross-subsidising the more inefficiently organised distribution companies, a policy that unnecessarily penalises consumers meeting their obligations regularly.

Finally, the best way to help poor households using up to, say, 100-150 units would be to install solar panels for katchi abadis. The initial capital cost could be high, but the running cost of such an arrangement would be nominal, the tariff structure would not have to be distorted to cross-subsidise these lifeline consumers and WAPDA would be spared the agony of installing meters, hiring meter-readers and printing bills, thereby substantially reducing its transaction and operational costs. [Courtesy The News International]

Regards

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