A multi-legged monster

KARACHI: The energy sector’s circular debt has ballooned to Rs2.47 trillion threatening to slash the country’s gross domestic product (GDP) growth potential despite a number of policy stimulus provided by the government.

With the latest increase in the rates of petroleum products and the expected hike in the electricity tariff, the crippling power sector debt is all set to shoot up further, having a devastating impact on the country’s overall economy. The Power Division has estimated that the average consumer tariff would increase from around Rs16/unit to Rs20.50 by July 2022.

Asif Qureshi, CEO of Optimus Capital, said that the increase in fuel prices has a direct impact on the circular debt. “The recovery against electricity bills is around 90 per cent, and this unrecovered 10 per cent increases in the rupee terms with every tariff hike.”

The build-up of the circular debt has led the banks to accumulate alarmingly high exposures on the energy sector, as the outstanding credit to the energy sector stood at Rs590 billion at the end of December 2021, compared with Rs558 billion in June 2021.

Although the government is willing to implement further tariff adjustments along with other steps to bring these liabilities to Rs1.88 trillion by the end of June this year, the stiff political resistance remains a challenge.

Besides, Prime Minister Imran Khan would not want a dent on his popularity, since the opposition parties are all set to launch a drive in an attempt to oust him from power.

The circular debt is a cascade of unpaid government subsidies, which results in accumulation of debt on the power distribution companies. When this happens, these companies can’t pay power producers who in turn, are unable to pay to the fuel suppliers; thus creating the debt effect as prevalent in the country.

“Billing under collection, excess T&D (transmission and distribution) losses, and unrecovered cost of the circular debt, unpaid tariff subsidies and delays in the tariff notifications directly contributed to the accumulation of the circular debt,” Qureshi added.

The National Electric Power Regulatory Authority (Nepra) noted in its last report that the inefficiencies in the power generation, transmission and distribution and non-payment of subsidies in a timely manner are the main causes of an increase in the circular debt.

“The increasing circular debt is not only a big financial stress for the power sector and the national exchequer, it is impairing the economic outlook of the country, sending negative signals for foreign investment. The permanent solution to the problem of the circular debt lies in developing the efficiency driven and financially viable power sector,” it noted.

The performance of the distribution sector has been of concern for a long time and the distribution companies could not show visible progress during FY20/21. The health of the whole power sector depends on the efficiency of the distribution sector being responsible to provide electricity to the end consumers and recovering bills thereof to pay for the transmission and generation services.

High T&D losses and low recoveries of the distribution companies hamper payments to the transmission and generation companies, which is a major cause for accumulation of the circular debt.

Historically, the five key contributors to the circular debt flow have been high cost of power generation, eventually contributing to the distribution companies collection and operational inefficiencies, pitfalls and delays in the tariff determination, high transmission and distribution losses and poor revenue collection by these companies, partial (and often delayed) tariff differential subsidies (TDS) payment by the government to the distribution companies and K-Electric, and high financial costs on borrowings by the Power Holdings Private Limited (PHPL) and expensive late-payment penalty surcharges on the CPPA-G payables.

Qureshi said that the circular debt could be contained through increasing operational efficiencies, improving collection and reducing T&D.

“Consumers are burdened with debt servicing, which is part of the electricity tariff. The government needs to re-profile and restructure the debt on power plants. They should start with the government’s own projects such as Neelum-Jhelum, as well as regasified liquefied natural gas (RLNG) plants and nuclear generation facilities.”

To arrest the pace of circular debt accumulation, necessary measures, including but not limited to, increase in electricity sales, ensuring optimum utilisation of efficient electric power generation plants, converting the tariff from “take or pay” to “take and pay” wherever possible, retiring the old generation companies plants with very low efficiency and utilisation, converting the tariff of old power plants of Wapda Hydroelectric from “take or pay” to “take and pay” basis, retiring the independent power producers (IPPs) having completed term of their licences, improving governance of the distribution companies to curb T&D losses, enhanced recovery of the billed amount and timely payment of subsidies, etc, need to be taken immediately.

On its part, Nepra has decided to convert the tariff of all old blocks of generation companies from “take or pay” to “take and pay” basis to reduce the capacity payment obligations.

Accordingly, during FY20/21, the tariff of old blocks of Genco-III has been converted from “take or pay” to “take and pay”. Further, the power regulator has also engaged Wapda Hydroelectric to convert the tariff of their old power stations from “take or pay” to “take and pay” basis.

A take or pay provision, in broad terms, entails an arrangement; whereby, a buyer agrees to either take and pay the contract price of the commodity goods or pay the contract price for this quantity even if it is not taken during a specific period.

In the take and pay arrangement, the buyer’s obligation to pay is not unconditional, but is contingent either upon the delivery of purchased goods or services or upon the buyer’s consent to take the delivery.

The Covid-19 pandemic has adversely affected the overall economic conditions, activity, and the paying capacity of the consumers. The CPPA-G estimates that the Covid-19-related issues contributed Rs235 billion to the circular debt during FY19/20.

Deterioration in the collection efficiency and the T&D losses are likely to further dent the financial performance of the distribution companies during FY20/21 and over the medium-term.

The government subsidies assumed in the tariff determination remain partially unfunded. The unfunded government tariff differential subsidies contributed Rs135 billion to the circular debt during FY19/20. The budget allocation for the government subsidy decreased from an earlier level of Rs240 billion to Rs120 billion for FY20/21.

Under the plan committed with the International Monetary Fund (IMF), the power sector was to get an additional financial injection of Rs2.650 trillion in two years. This plan included Rs1.060 trillion revenue generation through various tariff adjustments and rebasing by the government (40 per cent contribution); followed by Rs850 billion worth of governance, efficiency and recovery efforts of the Power Division (32 per cent) and Rs740 billion by the Finance Division (28 per cent) through realistic allocation and timely payment of subsidies.

Similarly, the Power Division was responsible to put together Rs850 billion through 5.73 per cent improvement in the overall recovery of billing (Rs205 billion), for 2.12 per cent reduction in the system losses (Rs130 billion), reduction in the IPPs markup on stock payments (Rs67 billion), impact of reduction in return on equity secured from IPPs (Rs146 billion) and the payment by the KE worth Rs303 billion, including Rs127 billion starting with July 2021 and Rs175 billion in FY23.

China-Pakistan Economic Corridor

The China-Pakistan Economic Corridor (CPEC) is a collection of infrastructure projects that are under construction across Pakistan beginning in 2013. Originally valued at $47 billion, the value of CPEC projects is worth $62 billion as of 2020.

However, now the Chinese investors are uncertain, as the commitments on the part of the Pakistan government are not being fulfilled to the letter. The payments are being delayed.

Besides, China has refused to re-profile the debt to rupee-based returns instead of dollar-based returns. The government had been able to convince the local IPPs to re-profile their returns, which is a good template. But, it didn’t have much impact, as these plants are years old and the capacity payments are nominal.

However, the debt on the CPEC projects, having high rate of return and even higher capacity payments, could not be restructured into the rupee-based return during Prime Minister Imran Khan’s recent visit to China.

Zafar Iqbal Subhani, an energy sector expert and former CEO of Hub Power Company (Hubco), said that the Chinese investors were uncertain because of delayed payments.

“The government is unable to retire debts on time because they have no money. The delayed payments to the power projects developed under the China-Pakistan Economic Corridor, which is taking a toll on the new projects.”

Subhani said that the capacity payments to these power projects were increasing, “And with the rising circular debt, it would be difficult to attract new investment.”

Asif Qureshi said that the circular debt impacts the industry across the board, including CPEC, as the payments to the Chinese investors are being delayed.

“Some projects under CPEC, including the Sino Sindh Resources project in Thar Block-I and Shanghai Power’s plant were delayed because of the Covid-19 pandemic. However, there has been no delay in the under-construction projects, as this would only result in increased costs,” he said.

Tabish Gauhar’s Model

Tabish Gauhar, former special assistant to prime minister on power and petroleum, had proposed a few specific work streams that can put the energy sector on a sustainable path to recovery.

Gauhar proposed privatisation of the distribution companies and upgradation of transmission and distribution (T&D) infrastructure.

“The Privatisation Commission and the Power Division need to complete the process by June-December 2022 alongside a more equitable financial and risk sharing arrangement with the provinces,” he said.

According to Gauhar, the recent supply-side challenges exposed the fragility of the energy ecosystem during peak times, notwithstanding the excess capacity syndrome.

“We need to fast-track privatisation of the public sector power plants, eg, RLNG and/or introducing a similar mindset to others, such as Guddu and Nandipur; set up a centralised power-cum-petroleum Planning Cell for more accurate demand-supply forecasts based on a data-driven and econometric modelling exercise.”

He also proposed to commission an independent audit of those thermal IPPs that were not available when needed the most and yet charged take or pay capacity payments throughout the year.

As an integral part of a revised Circular Debt Management Plan, the government needs to restructure and re-profile the next five-year debt service payments.

For Gauhar, the government needs to complete all steps to the wholesale power commodity exchange (CBTCM) launch by the first quarter of 2022, alongside allowing wheeling across the country at a tolling charge that reasonably addresses the issues of stranded costs and undue windfall gain/arbitrage opportunity for the private sellers.

K-Electric Limited

K-Electric is an intractable problem crying for a sustainable solution for too long. The government needs to sign a commercial-based Power Purchase Agreement (up to 2,000MW supply; Rs140 billion/annum) and facilitate handover of the management control of this regulated entity to another private operator with the capacity to fund its growth needs.

As a prior action, Nepra must also unbundle KE into separate generation, transmission and distribution businesses to avoid a single point of management failure (or success), going forward.