Legacy Power Contracts

Legacy power contracts

As reported by the press, NEPRA Chairman Tauseef H. Siddiqui stated last month that Pakistan is being held to an expensive electricity ‘ransom’ whereby the government “purchases electricity at Rs 24 per unit and sells it to consumers at Rs 15 -16 per unit in a basket price.”

Pakistan has some of the highest power tariffs in the region, which has adversely not only impacted competitiveness but has also raised pertinent questions about affordability. Tariffs are not commensurate with the income levels of the general population or regionally prevailing tariffs.

When household finances are taken into account, the high cost of power makes everyday living unaffordable. The average salary level in Pakistan is roughly 1/10th of that in Europe, while power tariffs exceed those in Europe. This results in a poor standard of living and difficulty in making ends meet for the average Pakistani. Exporters also face the brunt of the pressure from high energy tariffs, leaving Pakistan behind its regional competitors and results in a reduction in market share.

This is also one of the prime reasons for the stagnation of exports, a fact which was duly acknowledged by the government when it announced regionally competitive tariffs in 2018.

The NEPRA Chairman also said that alternative, viable energy options are available and “the price of electricity to be purchased from wind projects will be at Rs 6 per unit which is four times cheaper than the electricity available at present.”

The Finance Minister in a recent tweet acknowledged that there have been promising levels of export growth and positive impacts on industrial expansion and job creation over the last few months. In the five-month period from July to November 2019, the volume of exports picked up by 4.8% in comparison with the same period of last year, owing to a great degree of textile sector expansion. Value added exports, including readymade garments, knitwear and other major exports have been showing substantial increases in both quantity and value. The impact of this growth on Pakistan’s economic stability cannot be overemphasized.

However, the legacy contracts in the energy sector and inefficiencies of the system have resulted in outrageous levels of tariffs. Some of these are:

1) 2002 Policy Based IPPs with tariffs that yield over 70% returns on dollar terms whereas the policy restricted returns to 15-16%.

2) Wind Power Tariffs of 14-15 cents/kWh as opposed to tariffs of approximately half this amount at the time when these legacy plants were installed which are currently below 4/5 cents/kWh.

3) Coal Power Generation Tariffs, at 9.5 cents/kWh whereas the going rate at the time was less than 6 cents/kWh. The two Port Qasim and Sahiwal power plants will cost the country in excess of $400 million each year in overpayments as a consequence.

4) Solar Power Tariffs of 18 cents/kWh which are currently under 5 cents/kWh.

5) Distribution Losses beyond NEPRA.

6) Failure of DISCOS to collect the amounts billed.

7) A highly skewed generation mix with excessive dependence on imported fuels.

The combination of legacy contracts, erroneous mechanisms and tariffs have resulted in highly unsustainable energy costs for all sectors of the economy.

Inefficiencies of this manner cannot be exported, and neither can the legacy contract costs. The need to reduce the energy price basket is increasingly urgent, as reduced energy rates have proved invaluable in other countries.

A key principle of industrial competitiveness is that unjust taxes and inefficiencies are removed and efforts are made to facilitate exports by the provision of internationally competitive inputs. The consequences of failing to do so are most strongly felt by the country’s GDP. According to the latest report of the IMF, Pakistan’s GDP growth is the lowest in the region, below that of Sri Lanka’s, Bangladesh’s and India’s.

If we aim to understand why, we must look no further than the costs of certain inputs in our manufacturing and exporting sectors. Regional competitors easily capture market share with facilitation from their respective governments, while Pakistani industry flounders to get its voice heard.

Without the provision of a sufficient and continuous power supply at reasonable rates, it will be impossible to achieve sustainable long term growth rates. The matter can only be dealt with through the establishment of a competitive energy market, and until that happens, it is the government’s responsibility to keep rates at the internationally competitive level. There is a need to structurally reassess the conditions of the power sector in Pakistan, which has consistently struggled to make ends meet, to provide reasonable energy prices and to remain consistent with its policies. This will entail dealing with the “legacy” contracts, and the consequently redundant investments which will have to be written off.

In addition, CPPA is currently arguing for charging industrial consumers a capacity charge of Rs. 4.75/kWh on the basis of installed capacity, irrespective of whether it is being used or not. This would truly ensure that any move towards a free market would be stillborn. The cost of inefficiency would have to be borne by the consumers.

The opening up of the power sector to a competitive market is long overdue whereby the export oriented industries should be given room to generate their own electricity and to export to the other industries through wheeling at competitive rates, without any hindrance from public sector entities.

Apart from being contrary to the principles of a market, an unwarranted reversal in competitive energy pricing would mark the beginning of a downward spiral for Pakistan’s export industry, exports and ultimately the road to economic growth. One can picture the same problems recurring in a vicious cycle, from struggling before international donor agencies for additional loans, to struggling for the rollover of existing loans and deposits at the State Bank.

The conclusions of recent ADB study outline the most critical structural change required. According to this study, a basic structural reform which shifts the focus towards exports is a far more effective policy than those which have recently been tested. In spite of significant currency depreciation, merchandise exports declined by 2.2%, between FY2018 and FY2019. On average, over the last decade, Pakistan has lost global market share by 1.45% per annum, with foreign exchange reserves further declining from $9.8 billion at the end of FY2018 to $7.3 billion at the end of FY2019, only enough to finance about 1.4 months of imports. “Hence, improving Pakistan’s export performance remains the most relevant long-term structural challenge to alleviate the balance-of-payments constraint to sustained economic growth.”(Asian Development Bank)

The only path to sovereignty and independence for Pakistan is by a rapid increase in exports and the ability to compete in the international arena. It is high time those in power view the scenario from this perspective and reassess the broad consequences of the policies they propose.

Link: Legacy Power Contracts