The High Cost of Electricity: Breaking Down Pakistan's Energy and IPP Crisis

Power shortages have always been a critical issue in Pakistan, but the gap between demand and supply has recently widened significantly. To discuss this and the recent IPPs crisis in Pakistan, I sat down with Samiullah Tariq, Head of Research & Development at Pak Kuwait Investment, for a detailed conversation on the topic. Here's everything you need to know about IPPs, power shortages, circular debt, and much more.

You can listen to the complete discussion on my Podcast Channel at https://podcast.kahloon.com

First Reforms in Pakistan’s Power Sector

The energy crisis has been a longstanding issue in Pakistan. To address this problem, multilateral institutions and the World Bank recommended reforms to the country's power sector. As a result, NEPRA, OGRA, WAPDA, NTTC, and other organizations were separated from WAPDA. KE has always been a separate entity. The Power Policy of 1994 introduced Independent Power Producers (IPPs), with companies such as Hubco, Gul Ahmed, and Tapal participating in these projects.

The second Power Policy, introduced in 2022, established a capacity component for capacity payments to investors. These payments, determined by estimating the risk-free rate and offered in US dollars, cover fixed and variable costs related to the IPP plant's operation.

The capacity payment also includes the project's debt during the grace period, typically payable within two to ten years. As the project is funded by 75% debt and 25% equity, this debt component is substantial. To accommodate this, the debt grace period has been extended to ten years, while the equity component is spread over 25 to 30 years with a dollar-denominated internal rate of return (IRR).

These factors have been structured to achieve an energy utilization factor of 92% for a typical LNG power plant. However, Pakistani power plants are operating below their intended capacity. With power generation at a four-year low, fixed costs outweigh variable costs, increasing the per-unit cost for consumers.?

This contributes to high-capacity payments, with Rs. 2.2 trillion allocated for capacity payments and an additional Rs. 3.8 trillion to be recovered from customers. The interest rate, linked to the KIBOR rate, further exacerbates the problem, ultimately burdening electricity consumers as the government relies on borrowing and focuses on revenue requirements.

Cost Recovery Mechanism in Pakistan

Let's consider the example of China Power Hub Generation, a coal-fired power plant operating at only 4% capacity, significantly lower than its designed capacity of 80%. This vast difference has led to a 70% increase in energy tariffs for consumers.

As a result, consumers are turning to renewable energy sources to avoid high energy costs. However, this shift also disadvantages industries and other large consumers, making locally-produced goods less competitive. In some cases, imported yarn can even be cheaper than locally produced yarn.

Renewable Energy as a Solution

India and Bangladesh have successfully transformed their industries by using renewable energy. They combine clean and fossil fuels to boost production and reduce energy consumption costs.

In contrast, Pakistan relies on outdated hydropower plants like the Tarbela and Mangla dams, built in the 1960s. Thermal power plants have driven up electricity costs, hindering economic and industrial growth. The balance of payments crisis has further worsened Pakistan's power generation capabilities.

How does Renewable Energy Adds Fuel to the Circular Debt Fire

Ironically, renewable energy in Pakistan can exacerbate circular debt due to grid constraints. The south has an overcapacity of low-cost power plants near the port, including imported coal plants that include Port Qasim Electric, China Power Hub, and Lucky Electric Power Company.

Other power plants in this category include those in the Thar region such as Engro, Thal Nova, Thal Energy and two nuclear power plants - Kanup 2 and Kanup 3. The south has insufficient demand for the electricity they generate, but they supply the north region in Punjab.?

The Matiari-to-Lahore ±660 kV HVDC transmission line is supposed to transmit electricity from the south to the north. However, all these plants and the transmission line are underutilized, resulting in significant losses and expensive energy. The North plants that rely on furnace oil bear the burden of the high energy demand.

There's a substantial wind corridor in Gharo, near the Nooriabad industrial area outside Karachi. A 1,000-megawatt wind power plant operates there under a single-buyer model, with the government as the sole purchaser. Consequently, the power lines are underutilized, hindering their potential to transport electricity from Sindh to Lahore efficiently.?

The reason behind the 5.50 trillion is that the power plants are allocated to distribution companies based on their capacity needs. These companies collect payments from consumers to cover their costs. However, many of these payments still need to be paid, creating a shortfall. As a result, both power plants and distribution companies incur losses. This cyclical problem, where one government entity owes another, is the core of Pakistan's circular debt crisis.

Capacity Payment Problems and The Government of Pakistan’s Role

The annual capacity payments, currently at a substantial Rs. 2.2 trillion, fluctuates yearly due to new power plants entering the system. For instance, the upcoming 884 MW Suki Kinari Hydropower Project and another 1,100 MW plant will impact next year's payments.

Since both are hydropower plants, they'll likely receive consistent payments once connected to the grid. However, overall generation will vary seasonally. Adding new power plants can help stabilize the system and improve efficiency. The government needs to introduce productive ways to reduce capacity payments and reduce the burden on end users.?

How Do High Capacity Payments Affect Consumers and Industries

To grasp the impact of capacity payments, it's crucial to analyze the cost of electricity generation. Currently, the actual cost to produce electricity in Pakistan, considering the fuel mix, is approximately Rs. 7-8 per unit. However, the capacity payment alone is a hefty Rs. 22-25 per unit. When taxes, surcharges, and other charges are added, electricity bills have soared. To compensate for the sluggish economy and decreased energy demand, consumers are ultimately bearing the brunt of these costs.

Solar Panels Duty and Net Metering Policy in Pakistan

The government of Pakistan is never consistent in its policies related to solar panels and net metering. The ever-changing policies lead to confusion among the masses. Solar panels are used by the elite and upper middle class. The middle class is still reliant on the grid energy. Currently, the load on the grid is reduced due to solar panels at home. The excess electricity is consumed by other users. So far, there is a status quo regarding the net metering policy.?

Loadshedding Woes in Pakistan?

Load shedding in Pakistan is mainly due to payment constraints and energy theft. There is also a significant difference between demand and supply. Utilisation has increased, but several areas across the country are using an age-old structure that collapses occasionally.?

With high costs, frequent power cuts, and outdated systems, solving Pakistan’s energy crisis is difficult. However, finding ways to use more renewable energy, improve the power grid, and ensure people pay their bills is key to fixing the problem. It won't be easy, but it's essential for the country's future.

Public Listed IPPs for Investment

As per my conversation with Samiullah Tariq, Hubco is the most preferred option by investors. It's listed on the Pakistan Stock Exchange. KAPCO's contract has expired, and Nishat Chunniya, which runs on furnace oil, may face efficiency challenges. After thorough research, other options could also be considered.?

Note: This is not financial advice. Samiullah Tariq, I, and related parties are not liable for any losses incurred.?