Pakistan's installed generating capacity is about 20,000 MW. It exceeds current demand of 17,000 MW and actual supply of just 10,000 MW. The capacity utilization is only 50% mainly because the producers do not buy sufficient fuel and choose operate at only 50% of capacity and still enjoy soaring profits. The current IPP contracts guarantee payments and profits with no requirement for fuel efficiency.
Most private investors have built oil-powered inefficient plants because of their low construction costs and short lead times, and the oil price has skyrocketed since these plants were built in 1990s. The result is 18-20 hours of load shedding across most of Pakistan in the scorching summer heat in spite of the fact the taxpayers have shelled out billions of dollars in subsidies to the power sector since 2008.
According to an AP report, the Pakistan's government has assumed $3.6 billion of the power industry's debt. The government-owned power grid owes another $2.5 billion to private-sector generators, even as the government, according to Finance Ministry figures, spent at least $7.4 billion on electricity subsidies during the 2008-2010 period.
Here's Arif Habib Securities investment analysis of the IPPs sector:
All power companies from Arif Habib Limited research coverage witnessed surprising growth (36-58%) in net profitability. HUBC led the flock with 58% YoY jump in profit after tax, attributable to the growing indexation factors and ROE component. On the other hand, lower payables to fuel supplier and resultantly lower penal interest provided major support to KAPCO, pushing the net profitability up by 36% YoY. As far as Nishat group companies are concerned, rising fuel cost magnified the impact of fuel efficiency, which combined with O and M savings further improved the profitability. However, dividend from KAPCO and NPL disappointed the optimistic investors. Arif Habib Limited believes the dividends to rise in 2HFY13 for these companies, providing investor with greater value at the financial year end.
Pakistani government buys electricity from IPPs at a rate of Rs. 12.50 per KWhr while the consumers pay an average of Rs. 9.00, leaving a short-fall of Rs 3.50 per unit which is subsidized by the taxpayers. It adds up to hundreds of billions of rupees a year. Power subsidy target for FY 2012-13 was set at Rs 185 billion, 60 percent lower than the actual subsidy provided during FY12. The subsidy provided year-to-date (YTD) is Rs 311 billion, already having exceeded the target by 68 percent, according to PakTribune.
A significant part of the problem is the IPP contracts which guaranteed a 12 to 15 per cent annual return (indexed in dollars, not rupees), gave tax breaks and paid interest on private funding more expensive for the government than providing the funding itself. In addition, there are no incentives for the private power producers to produce power efficiently.
In a blog post published in Financial Times, Dr. Kamal Munir of Cambridge University's Judge Business School blames the IPP contracts signed as part of the power privatization in 1990s.
The 1994 privatization of the energy sector offered investors generous returns and created pricey overcapacity, he told Financial Times. This created an expensive legacy which is the real problem of todays energy crisis. Unless that problem is dealt with, he sees no light at the end of the energy tunnel.
He says Pakistans government, helped by the World Bank, sweetened its energy privatisation with attractive conditions, fearing it wouldnt be able to attract investors otherwise. It guaranteed a 12 to 15 per cent annual return (indexed in dollars, not rupees), gave tax breaks and paid interest on private funding more expensive for the government than providing the funding itself. The deal was too good to be true for investors, Munir says.
Munir says the model turned out to be badly constructed in terms of creating value for the government and people of Pakistan. Even in an environment of economic growth and efficient energy generation, it would have been hard for the government to finance the plan. But since both have been absent, it became nearly impossible to pay for privatised energy.
Since there were no incentives to be fuel-efficient, most private investors chose to build plants using furnance oil as fuel because of their low construction costs and short lead times. This backfired as the oil price has trebled since the 1990s. Variable costs, and therefore prices to consumers, are at unsustainable levels. No wonder many consumers cant afford to pay their bills, Munir says.
To make things worse, the government neglected to step on the brakes when its generous conditions attracted too many investors. Assuming economic growth would continue, it allowed too much capacity to be built and guaranteed the same return on that extra capacity, whether it was used or not.
Munir says the government should develop new power plants using cheaper fuels, and that this shouldnt be a problem in a country with an abundance of coal, waterways and sun.
But Pakistan must first escape its vicious payment cycle.
We need to get out of the the current deals, says Munir. But at what cost, and does this imply default? Your guess is as good as mine, the academic admits.
Still, he felt it was time to make his point. Im not defending people who dont pay bills and Im not promoting government subsidies to keep prices low, Munir says. But why isnt anyone talking about the policy that led to this situation to begin with?
The key to solving the problem is to renegotiate the old IPP contracts with new terms that reward lower fuel costs and higher efficiency. In addition to that, Pakistan's incoming government of Prime Minister Nawaz Sharif's has to explore multiple fuel options to meet the nation's growing energy needs. Some of the fuel options are as follows:
1. Developing its shale gas reserves estimated 51 trillion cubic feet near Karachi in southern Sindh province. The US experience has shown that investment in shale gas can increase production quite rapidly and prices brought down from about $12 per mmBTU in 2008 to under $2 per mmBTU recently. Pursuing this option requires US technical expertise and significant foreign investment on an accelerated schedule.
2. Increasing production of gas from nearly 30 trillion cubic feet of remaining conventional gas reserves. This, too, requires significant investment on an accelerated schedule.
3. Converting some of the idle power generation capacity from oil and gas to imported coal to make electricity more available and affordable.
4. Utilizing Pakistan's vast coal reserves in Sindh's Thar desert.
5. Hydroelectric and other renewables including wind and solar. Several of these projects are funded and underway but it'll take a while to bring them online to make a difference.
In my view, the newly-elected government should pursue all of the above options with options 1, 2 and 3 as a priority for now. Its best interests will be served by developing its own cheap domestic shale gas on an accelerated schedule with Saudi investment and US tech know-how.
Haq's Musings: Pakistanis Suffer Load-shedding While Power Companies' Profits Surge
Most private investors have built oil-powered inefficient plants because of their low construction costs and short lead times, and the oil price has skyrocketed since these plants were built in 1990s. The result is 18-20 hours of load shedding across most of Pakistan in the scorching summer heat in spite of the fact the taxpayers have shelled out billions of dollars in subsidies to the power sector since 2008.
According to an AP report, the Pakistan's government has assumed $3.6 billion of the power industry's debt. The government-owned power grid owes another $2.5 billion to private-sector generators, even as the government, according to Finance Ministry figures, spent at least $7.4 billion on electricity subsidies during the 2008-2010 period.
Here's Arif Habib Securities investment analysis of the IPPs sector:
All power companies from Arif Habib Limited research coverage witnessed surprising growth (36-58%) in net profitability. HUBC led the flock with 58% YoY jump in profit after tax, attributable to the growing indexation factors and ROE component. On the other hand, lower payables to fuel supplier and resultantly lower penal interest provided major support to KAPCO, pushing the net profitability up by 36% YoY. As far as Nishat group companies are concerned, rising fuel cost magnified the impact of fuel efficiency, which combined with O and M savings further improved the profitability. However, dividend from KAPCO and NPL disappointed the optimistic investors. Arif Habib Limited believes the dividends to rise in 2HFY13 for these companies, providing investor with greater value at the financial year end.
Pakistani government buys electricity from IPPs at a rate of Rs. 12.50 per KWhr while the consumers pay an average of Rs. 9.00, leaving a short-fall of Rs 3.50 per unit which is subsidized by the taxpayers. It adds up to hundreds of billions of rupees a year. Power subsidy target for FY 2012-13 was set at Rs 185 billion, 60 percent lower than the actual subsidy provided during FY12. The subsidy provided year-to-date (YTD) is Rs 311 billion, already having exceeded the target by 68 percent, according to PakTribune.
A significant part of the problem is the IPP contracts which guaranteed a 12 to 15 per cent annual return (indexed in dollars, not rupees), gave tax breaks and paid interest on private funding more expensive for the government than providing the funding itself. In addition, there are no incentives for the private power producers to produce power efficiently.
In a blog post published in Financial Times, Dr. Kamal Munir of Cambridge University's Judge Business School blames the IPP contracts signed as part of the power privatization in 1990s.
The 1994 privatization of the energy sector offered investors generous returns and created pricey overcapacity, he told Financial Times. This created an expensive legacy which is the real problem of todays energy crisis. Unless that problem is dealt with, he sees no light at the end of the energy tunnel.
He says Pakistans government, helped by the World Bank, sweetened its energy privatisation with attractive conditions, fearing it wouldnt be able to attract investors otherwise. It guaranteed a 12 to 15 per cent annual return (indexed in dollars, not rupees), gave tax breaks and paid interest on private funding more expensive for the government than providing the funding itself. The deal was too good to be true for investors, Munir says.
Munir says the model turned out to be badly constructed in terms of creating value for the government and people of Pakistan. Even in an environment of economic growth and efficient energy generation, it would have been hard for the government to finance the plan. But since both have been absent, it became nearly impossible to pay for privatised energy.
Since there were no incentives to be fuel-efficient, most private investors chose to build plants using furnance oil as fuel because of their low construction costs and short lead times. This backfired as the oil price has trebled since the 1990s. Variable costs, and therefore prices to consumers, are at unsustainable levels. No wonder many consumers cant afford to pay their bills, Munir says.
To make things worse, the government neglected to step on the brakes when its generous conditions attracted too many investors. Assuming economic growth would continue, it allowed too much capacity to be built and guaranteed the same return on that extra capacity, whether it was used or not.
Munir says the government should develop new power plants using cheaper fuels, and that this shouldnt be a problem in a country with an abundance of coal, waterways and sun.
But Pakistan must first escape its vicious payment cycle.
We need to get out of the the current deals, says Munir. But at what cost, and does this imply default? Your guess is as good as mine, the academic admits.
Still, he felt it was time to make his point. Im not defending people who dont pay bills and Im not promoting government subsidies to keep prices low, Munir says. But why isnt anyone talking about the policy that led to this situation to begin with?
The key to solving the problem is to renegotiate the old IPP contracts with new terms that reward lower fuel costs and higher efficiency. In addition to that, Pakistan's incoming government of Prime Minister Nawaz Sharif's has to explore multiple fuel options to meet the nation's growing energy needs. Some of the fuel options are as follows:
1. Developing its shale gas reserves estimated 51 trillion cubic feet near Karachi in southern Sindh province. The US experience has shown that investment in shale gas can increase production quite rapidly and prices brought down from about $12 per mmBTU in 2008 to under $2 per mmBTU recently. Pursuing this option requires US technical expertise and significant foreign investment on an accelerated schedule.
2. Increasing production of gas from nearly 30 trillion cubic feet of remaining conventional gas reserves. This, too, requires significant investment on an accelerated schedule.
3. Converting some of the idle power generation capacity from oil and gas to imported coal to make electricity more available and affordable.
4. Utilizing Pakistan's vast coal reserves in Sindh's Thar desert.
5. Hydroelectric and other renewables including wind and solar. Several of these projects are funded and underway but it'll take a while to bring them online to make a difference.
In my view, the newly-elected government should pursue all of the above options with options 1, 2 and 3 as a priority for now. Its best interests will be served by developing its own cheap domestic shale gas on an accelerated schedule with Saudi investment and US tech know-how.
Haq's Musings: Pakistanis Suffer Load-shedding While Power Companies' Profits Surge
