How to manage the power sector’s circular debt?

One of the biggest challenges to Pakistan’s economy remains its ever ballooning power sector circular debt. When the PTI government came to power in August 2018, it declared energy sector reforms, including addressing the issue of circular debt, as one of its top priorities. But almost half-way through its term, the government continues to struggle on this front.

Narratives asked Dr. Fiaz Ahmad Chaudhry, a former Managing Director of the National Transmission & Dispatch Company Ltd and Professor at LUMS, Mohammed Sohail, CEO of Topline Securities and Dr. Shahid Rahim, a freelance consultant specialising in sustainable energy system planning and development, to give their views on the subject.

Dr. Fiaz Ahmad Chaudhry

Professor and Werner-Von-Siemens Chair School of Science & Engineering LUMS

Circular debt is not unlike a virus that continues to plague Pakistan. It has infused itself in the blood vessels of the power sector, crippling the economy and creating misery for the people. While the treatment required structural reforms and a shift away from conventional practices, historically, little has been done, with governments focused on managing the symptoms and not remedying the underlying conditions. At present, though, there appears to be a stronger political will and long-term sustainable-thinking in vaccinating the power sector. This article discusses some of the ways the government is managing the challenge of circular debt.

The circular debt was born over a decade ago when the actual cost of providing electricity began to surge amidst lack of revenue realised by the DISCOs. Over time, the cash deficit widened due to a host of reasons: poor planning, meagre governance, ballooning capacity payments, grid deflection, un-budgeted, delayed and/or insufficient tariff differential subsidies by the government, delayed fuel price adjustment mechanism, high T&D losses, and low recovery and theft. While these are visible causes, there are also hidden elements of ‘out-of-merit’ system dispatch to cater for unwarranted power purchase obligations and flawed network infrastructure. The root problem has really been the inability to let go of control of un-bundled power institutions as typically enjoyed by the government apparatus in the previous vertically integrated utility. In the absence of sound, sustainable and evidence-based integrated system planning, the payables of the government increase and the corresponding debt has accumulated to a mammoth Rs. 2.5 trillion, as of November 2020.

Recently, the government entered into MOUs with IPPs that noticeably deal with lowering the fixed capacity costs, the main contributor to the rising cost of generation. Although the process was disjointed and there may be medium to long-term implications for future investments by the private sector, both sides needed to accept the reality that the existing financial eco-system of the power sector was simply not tenable. The intention of these MOUs is to smoothen the “front loaded” tariff profile of power projects and provide direct relief to rate-payers. Nevertheless, this step merely provides a breathing space, which must be complemented by structural reforms to make it meaningful. A competitive wholesale market model has been approved by the regulator for deployment by April 2022 and the process of integrated system planning has been initiated by NTDC through preparation of Indicative Generation Capacity Expansion Plan (IGCEP) and the corresponding Transmission System Expansion Plan (TSEP). Both developments are welcome, long over-due and will ensure optimal generation development and improve service in system operations but require an enabling institutional framework to be worthwhile.

The power sector risks are being re-organised through a competitive market regime that rewards efficiency and penalises rent-seeking culture

A roadmap is in the works by the government, which is promising, albeit belated. It focuses on corporatising the DISCOs through public-private arrangements to improve recovery and reduce losses and theft. A performance-based model is indeed apt in the current climate as the private sector can bring financial discipline and improved managerial competence. This will coincide with opening up the retail market, which will bring the power of choice to consumers. Simply put, the power sector risks are being re-organised through a competitive market regime that rewards efficiency and penalises rent-seeking culture. In addition, the government should formulate and implement ‘ease of doing business’ policies and strategies, especially for industrial consumers. The purpose would be to reduce electricity costs and increase base-load on the national grid. Some policy changes and initiatives may include, to bring back to grid the load being served by inefficient captive generation, electrification of rail roads (ML-1), induction of electric vehicles, and development of efficient electrical appliances for space heating, cooking, etc.

The reform roadmap must address other critically important issues such as myopic leadership, outdated administrative practices and lack of workforce agility. These must be addressed immediately to prevent institutions from falling into the same well that they are trying to climb out of in the first place.

Mohammed Sohail

Chief Executive Officer Topline Securities

One of the biggest issues currently faced by the Pakistan economy is Energy Sector mismanagement. Though load shedding has declined in Pakistan after huge expansion of capacity over the last few years, circular debt and other matters are affecting the whole energy chain of Pakistan along with the government’s own budget.

Circular debt in Pakistan is growing by Rs. 400-450bn a year, wherein DISCOs’ inefficiencies (T&D losses and recovery issues) contribute around 37 percent, followed by late tariff adjustments, 26 percent, and unbudgeted subsidies, 18 percent, to the annual circular debt in the country.

Populist socio-economic decisions by the government in the form of tariff subsidies for the residential and agriculture sectors and/or export oriented industries lead to accumulation of funds against the government (by DISCOs), which due to poor budget planning and fiscal space of the government remain uncollected in the system.

Unbuilt portion of T&D losses and recovery shortfall (together called aggregate technical and commercial losses) in the consumer tariff creates a gap of -12 percent in the system and every single percent costs the economy Rs. 10-12bn. As a result, this amount is cumulated under the DISCO inefficiencies head.

 Due to these losses, CPPA/NEPRA are unable to pay due amounts to IPPs, which in turn rely on bank borrowings to finance their working capital. The shareholders of IPPs are also affected, as their investments do not yield good returns in the form of dividends.

The total stock of circular debt in Pakistan has crossed Rs. 2tn, which is indirectly a liability of the government of Pakistan, although it is parked in the books of PHPL and DISCOs. If converted to government debt, it will increase interest expenses by Rs. 160bn a year.

Power sector subsidies should be targeted for the poor and specific sectors only and not for all

Historically, the government has not been able to address the root cause of this problem. A couple of times, the incumbent and previous governments have issued Sukuks to clear backlogs. But that is a short-term and temporary solution.

The government is exploring different options to resolve circular debt. Amongst the options are (i) increase in the energy tariff by Rs. 4-6/kwh, (ii) negotiation with IPPs to reduce future capacity payments, (iii) out-of-the-box solutions like divesting shareholding in one public company to repay debt of another public company and (iv) issuance of Sukuks and bonds to clear outstanding backlog.

Governments have spoken/negotiated with lenders to reduce this spread and extend loan tenor from 10 years to 20 years. In recent negotiations, these points are also under consideration by government committees, but success depends on Pakistan’s relationship with international lenders.

Better management of DISCOs and their privatisation should also be followed. Moreover, power sector subsidies should be targeted for the poor and specific sectors only and not for all. Plus, to address this issue, there should be a more cost efficient energy mix, including renewables, which are less than 5 percent of the total mix as of now. T&D losses in the system, which are at 18 percent vs. the regional average of 10 percent, must also be reduced.

The new team has done a few things like i) negotiating with IPPs, and ii) increasing the energy tariff. However, they are unable to address the root cause in the system, which is aggregate technical and commercial losses.

Reduction of T&D losses requires huge investment. The best way is to privatise DISCOs, which requires political will. A successful model in these reforms is K-Electric. At the time of acquisition, K-Electric’s T&D losses were above 30 percent and in a decade these losses have come below 20 percent.

Apart from this, in Gujrat India, the Gujrat Electricity Board, a public company, turned itself from loss to profit through political will and investment.

Dr. Shahid Rahim

The writer is a freelance consultant specialising in sustainable energy development

 The power sector’s circular debt, which now tops Rs. 2.3 trillion, is spiralling fast and it is feared to grow into a vicious monster in just a few years. It must be checked before it jeopardises our economic survival. Analysts often cite pervasive inefficiencies and poor management in this sector to be the main causes behind this menace. This sector’s problems are, however, acute, chronic, multi-dimensional, and have accumulated over decades. They are all feeding the monster. Improving efficiency and management will be necessary, of course, but will not be sufficient to heal this sector back to full health.

We cannot afford to continue running this sector on traditional lines — trying to serve all electricity demand through the central grid. Electricity consumers are no longer a helpless lot captive to this sector’s outdated systems and dysfunctional institutions. They now have choices to satisfy their needs independently of the grid. A new vision and a carefully-crafted programme stretched over 3 to 5 years along the lines below is required to save it from sinking, and to transform it into a viable contributor to the nation’s progress.

An old English saying offers a short-run (next 2 years) remedy: “If you find yourself in a hole, stop digging”. First, no more capital-intensive power projects through long-term contracts, since in the rapidly changing energy landscape, making any commitment beyond 3 to 5 years carries huge risks. Second, spread the fixed-costs of existing generation by incentivising existing consumers to stay with the grid and attract new ones. Third, shift from the present volumetric (kWh-based) rates to a two or three-part tariff — a fixed capacity charge, a variable energy charge, and a service charge — for all consumers. Fourth, put the “Net Metering” policy on pause until the monster is tamed. Fifth, grasp the industrial demand patterns, and make aggressive efforts to win back the demand that has switched to captive plants and encourage new demand for the grid.

In the medium-run (next 2 to 3 years), plan to serve any new demand by squeezing additional energy out of the existing facilities through grid modernisation, improving operational practices, and reshaping the system’s demand curve. Switch from traditional least-cost central planning to integrated and value-based planning. Bigger is no more better or cheaper as small-scale, distributed, and renewable energy technologies now offer more feasible alternatives to serve demand at or near its source. Therefore, shift the business-case evaluation from generation terminals to distribution substations.

A solid, robust, and resilient grid is critical for optimising generation and subsequently its reliable and economic operation.

Plan to recast the power sector over the long-run (from 3 to 5 years and beyond). NTDC’s present strategic plan contemplates adding 50 GW of new capacity by 2030 to serve peak demand of 44 GW and replace 6.5 GW of retiring capacity through USD 70 billion of new investment. As the cost of serving one MW of demand at source can avoid 1.5 to 2 MW upstream, use every opportunity to avoid future costs by serving demand closer to its source. A solid, robust, and resilient grid is critical for optimising generation and subsequently its reliable and economic operation. Therefore, focus future investment in modernising and strengthening the transmission. Also, 15 to 20 percent “reserve” in the system is normal but the 70 percent envisaged in the above plan, to cover the intermittency and variability of renewable plants (government’s 30 percent by 2030 target), is way too high. Though highly desirable, deployment of renewables via central grid may not be the best policy. Other distributed and off-grid options may be more feasible and must be explored.

The remedies prescribed for the short-run will only help to stop the patient’s bleeding while those for the medium-run will acclimatise it for the main surgery that can be performed best over the long-run. Collectively, these will take the sting out of the monster and gradually neuter it.