Safeguard industrial efficiency

May 27, 2024

Safeguard industrial efficiency

May 27, 2024

By Shahid Sattar

The government’s recent contemplation of cutting off gas supply to industrial captive power plants (CPPs) while maintaining subsidized gas supply to so-called “industrial connections” is a move that defies all economic rationality.

It’s a policy decision that will not only undermine the principles of efficient resource utilisation but also threatens the competitiveness and survival of large industrial units, particularly in the textile industry.

A more prudent approach based on free-market principles and sound economic arguments is required.

At the heart of this is a fundamental misunderstanding of energy efficiency in industry.

In addition to captive power generation, natural gas is used extensively in industrial processes across various sectors in Pakistan, including for textiles, chemicals, glass, cardboard, and plastic manufacturing. These typically involve the use of gas for generating steam via boilers, heating thermal oil for dryers, directly hearting dryers, powering chillers, etc., (Table 1).

Table 1: Gas Consumption in Industrial Processes
Textile and Apparel Sector    Other Industries
Hot water/steam boilers       Hot water/steam boilers (*50-60% of total gas usage)
Printing                      Injection molding machines (plastic)
Stenters                      Pharmaceutical manufacturing
                              Industrial/molding furnaces (glass)
                              Packaging machines for corrugated materials
                              Oil Heaters, Power Chillers, Printing etc.

The gas tariff code separates industrial gas usage by process and captive, with the price of gas for the latter at Rs 2,750/MMBtu compared to only Rs. 2,150/MMBtu for the former.

Now, the government is exploring options to completely cut off gas supply to CPPs based on the argument that captive gas usage is inefficient, lowers demand for grid electricity, and that redirecting gas supplies to other uses could optimize resource allocation.

Conversely, various reports and consultations with industry experts highlight the extremely low efficiency of boilers at 45-50% as over 90% of operational boilers are low pressure and single burner based.

Furthermore, problems such as poor insulation, unaddressed leaks, outdated equipment, and improper operational settings are also prevalent.

However, no comprehensive surveys or audits have been conducted to benchmark the efficiency of gas usage in industrial processes. This lack of data and analysis hinders efforts to implement targeted improvements and achieve higher efficiency and sustainability in gas-based industrial processes.

The wastages not only drive-up operational costs but also undermine broader efforts to achieve energy efficiency and sustainability.

The government’s perspective overlooks the critical role of cogeneration units in CPPs, which are far more efficient than the available alternatives. Cogeneration units, or Combined Heat and Power (CHP) systems, operate at efficiencies exceeding 70%. These units not only generate electricity but also utilize the same gas to produce steam and hot water, essential byproducts for industrial manufacturing processes.

The dual output from a single energy source maximizes the utility derived from each unit of gas, making it the best possible use of our scarce energy resources.

Contrastingly, the alternatives are less efficient and more costly. Grid electricity tariffs are prohibitively high, currently around 15.4 cents/kWh and as high as 17.5 cents/kWh a few weeks ago and are expected to increase by another 2 cents/kWh following the tariff rebasing in July.

Moreover, the frequent outages, voltage fluctuations and overall poor reliability associated with grid electricity cause significant operational disruptions, leading to costly wastages and downtime.

Similarly, standalone industrial boilers used for steam and hot water generation typically operate at efficiencies of around 45-50%, substantially lower than cogeneration systems.

Thus, shifting away from high-efficiency CPPs to these less efficient methods would result in a greater overall energy consumption to achieve the same industrial output, undermining the very goal of resource optimization and energy efficiency.

Moreover, the distinction between gas used for industrial processes and that used for captive power generation is highly problematic. It is not only artificial but also opens the door to widespread corruption and system leakages. Many industries already use their process gas connections for both process use and power generation.

If the government decides to completely cut off gas supply for CPPs, more industries will inevitably find ways to circumvent these restrictions, leading to unauthorized use of process gas for power generation.

Overcoming this would necessitate stringent administrative measures and policing, incurring significant administrative costs and fostering corruption as industrialists seek to bribe inspectors to overlook violations. The implications of such a policy are far-reaching.

“Cutting off gas to CPPs would force industries to rely more heavily on grid electricity in the short-term while seeking cheaper sources of energy, increasing their operational costs and making them less competitive in international markets. This is particularly detrimental at a time when Pakistan’s industries are already struggling with high production costs and shrinking margins. Many of the most efficient and largest vertically integrated manufacturing units, which rely heavily on captive power for stable and cost-effective energy, would be hit the hardest. With energy prices constituting a significant portion of total production costs, any increase in energy expenses could lead to a decline in exports, loss of jobs, and further economic downturn.”

Just a few years ago, the government introduced policy measures to incentivize CPPs to transition from less efficient single cycle units to highly efficient combined cycle units. In response, several CPPs made substantial investments in CHP units and even had their efficiencies audited by NEECA.

According to SNGPL data, of the 383 CPPs on its network, 306—or 80 percent—are now CHP co-generation units. A blanket ban on captive generation would show a complete disregard for policy continuity and the commitments made by the government to private sector investors.

This move would sink the substantial investment that has been made in CHPs, further erode trust in Pakistan’s policies, increase investment uncertainty, and deter future investors from considering Pakistan as a viable investment option.

Moreover, the proposed policy overlooks the broader economic implications of inefficient energy allocation. Historically, the power sector has been the primary offtaker of imported RLNG, with its cost passed through to consumers.

However, as the power sector is transitioning to cheaper alternatives, this results in a surplus of RLNG in the system that then needs to be diverted to consumers who would otherwise be supplied with indigenous gas, at highly subsidized rates.

Cutting off gas supply to CPPs will further exacerbate the issue of surplus RLNG and diversion costs. The increased RLNG diversion to domestic and fertilizer sectors at highly subsidized rates is likely raise SNGPL’s Revenue Requirement (RR) to Rs 100 billion for 115 MMCFD. For instance, OGRA, in its Estimated RR decision dated May 20, 2024, has allowed Rs 184 billion for RLNG diversion in FY 25 at the rate of Rs 3400 ($12.19) per MMBtu, significantly lower than the Rs 298 billion requested by SNGPL for 209 MMCFD RLNG diversion, resulting in a Rs 114 billion annual shortfall for SNGPL.

In addition, the sale of indigenous gas of 59 MMCFD to public sector power plants at Rs 1,050/MMBtu instead of Rs 2,750/MMBtu for captive power plants will generate an additional Revenue Requirement of Rs 38.5 billion for SNGPL.

The cumulative increase will be a staggering Rs 138.5 billion, which will necessitate a price increase of Rs 310/MMBtu for all SNGPL consumers due to the shifting of Captive Power Plants in the SNGPL network to the Power Grid.

Reduced domestic demand during the summer could result in the diversion of cargoes at distressed prices, and SNGPL may also incur significant losses due to take-or-pay clauses and demurrages. If the take-or-pay clause is triggered after 96 hours of LNG cargo arrival, the penalty incurred will be passed through, leading to demand destruction among RLNG consumers.

This will expose SNGPL to take-or-pay contractual risks with RLNG suppliers or sovereign default, potentially causing the cascading collapse of several State-Owned Entities of the Petroleum Division, i.e., PSO, SNGPL, PLL, OGDCL, and PPL.

A more prudent approach in this regard would be to recognize the high efficiency of certified cogeneration units and classify them as industrial consumers, entitled to the same gas tariff rates as other industrial processes.

This would ensure a level playing field and encourage industries to maintain or improve their efficiency levels.

Additionally, introducing mechanisms for regular monitoring and public reporting of compliance would foster transparency and build public trust, ensuring that CPPs operate within stipulated efficiency parameters.

The government’s role should be to create an enabling environment that promotes efficiency, competitiveness, and sustainable growth.

By cutting off gas supplies to CPPs, it is doing the opposite—discouraging efficient energy use, increasing operational costs, and undermining the competitiveness of industrial sectors. It is crucial to adopt policies that align with free-market principles, where resource allocation is driven by efficiency, productivity, and economic rationality.

In conclusion, the proposal to cut off gas supply to industrial captive power plants is a regressive step that threatens to undo the progress made in industrial efficiency and competitiveness. It is a policy that fails to recognize the superior efficiency of cogeneration systems and the critical role they play in the industrial ecosystem.

Rather than penalizing these high-efficiency units, the government should support and incentivize their use, ensuring that industries can compete on a level playing field and continue to drive economic growth.

Only by embracing rational, efficiency-driven policies can we hope to secure a prosperous and sustainable future for Pakistan’s industrial sector.

Table 2: Benefits of Combined Heat and Power (CHP) Systems over Industrial Gas
Benefit Category for           Description
Combined Heat & Power
Primary Efficiency             CHP systems can achieve efficiencies over 70%, with some systems
                               even approaching 90%
Fuel Efficiency                CHP systems require less fuel to produce a given amount of energy
                               output, leading decreased fuel dependency
Avoid Transmission             Producing electricity on-site eliminates losses associated with
and Distribution Losses        transmitting electricity over long distances
Reduced Greenhouse Gas         CHP systems emit less CO2 SOx NOx and PM, reducing Scope 1
Emissions                      emissions aligning with the European Union's Carbon Border
                                Adjustment Mechanism (CBAM) standards
Improved Energy                CHP systems provide a stable supply of electricity and heat, ensuring
Resilience and Reliability     energy supply during power outages, interruptions, breakdowns,
                                voltage fluctuations, brownouts and blackouts.
Cost Savings and               High efficiency and reduced fuel consumption lead to lower energy
Enhanced Competitiveness       costs, lowers operational costs and improves energy efficiency with
                                additional savings from avoided steam generation, water heating and
                                T&D losses
Flexibility and Scalability    CHP systems can be tailored to various applications and utilize
Support for Renewable           different fuels, adapting to different operational contexts. It can
Energy Integration              complement renewable energy sources, providing tailor made
                                solutions to meet climate targets for exports to the West.

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