COMMENTARY

june 23, 2012 vol xlviI no 25 EPW Economic & Political Weekly
24
Kamal Munir (k.munir@jbs.cam.ac.uk)
teaches at the University of Cambridge,
United Kingdom. Salman Khalid is an
emerging markets investments professional
with experience in power projects in several
countries.
Pakistan’s Power Politics
Kamal Munir, Salman Khalid
There is hardly any government
meeting in Islamabad these days
in which the debilitating energy
crisis in which the country is
engulfed is not discussed. Almost
invariably, however, the problem
is treated as one of governance –
the government failing to meet
its obligations to investors who
are left with no choice but to stop
producing electricity. This article
shows how the actual problem
lies in the privatisation policy
under which the energy sector
now operates.
I
n recent months, the Pakistan govern-
ment has come under tremendous
pressure to fix the dire energy situa-
tion. Entire cities plummet into darkness
for up to 12 hours a day, and industry has
come to a grinding halt. The government
responds with making false promises
and holding “energy summits” that in-
variably come to nothing. The blame is
always put on the people who are
deemed to have gotten used to “subsi-
dies” and the non-bill-payers. What no
one seems to question is the policy shift
that has led to a situation where people
are deprived of energy despite excess
capacity in the system, and yet this is
where the problem lies. This article
attempts to explain how this situation
has arisen.
Private Power
It was in the midst of much hype that
Pakistan launched the privatisation of
its power sector. The initiative was
based on the 1994 private power policy,
whose main contours were almost en-
tirely defined by the World Bank which
had long been pushing for opening the
sector to private investment through
generous incentives. The policy and the
deals that were struck under it were
lauded universally by private financiers
as well as by most development institu-
tions. The policy was even lauded by the
then United States secretary of energy,
Hazel O’Leary, who described it as “the
best energy policy in the whole world”.
1

O’Leary’s mission to Pakistan was lauded
in the US Congress in these terms:
“Energy Secretary Hazel O’Leary has
just returned from a highly successful
mission to Pakistan, which has opened
new doors to American business leaders
and may represent as well an important
turning point in our diplomatic relation-
ship with Pakistan”. O’Leary was accom-
panied by 80 American business execu-
tives, primarily from the energy sector.
The O’Leary trip resulted in the signing
of 16 contracts worth nearly $4 billion.
2
The 1994 power policy was essentially
based on the structure evolved for
the Hub Power Project (or Hubco), a
1,292 MW, $1.6 billion project that was
celebrated widely amongst global inves-
tors. Euro money Institutional Investor
first hailed the deal as “Deal of the
Year”,
3
and later as “Deal of the Decade”.
The acclaim that this deal received
meant that Pakistan had unprecedented
COMMENTARY
Economic & Political Weekly EPW june 23, 2012 vol xlviI no 25
25
interest from investors and had before
long contracted another 19 independent
power producers (IPPs) to contribute an-
other 3,400 MW. Pakistan was adver-
tised by the World Bank and global
investors as the gold standard for priva-
tisation of the energy sector.
The Deal
The policy separated generation of elec-
tricity from its transmission and distribu-
tion. Going forward, a vast majority of the
new generation capacity was to be the do-
main of private investors who were of-
fered a bulk tariff of US cents 6.5/kWh for
sale of electricity to the still state-owned
transmission and distribution companies.
Investors were to be provided a $-based
internal rate of return of 15%-18% over
the 25-30 years period of the power pur-
chase agreement (however, in HUBCO’s
case 18%
4
was initially agreed) after cov-
ering for operational costs, backed by sov-
ereign guarantees of the Government of
Pakistan. The IPPs could be built using up
to 80:20 debt-equity ratios, although most
opted for a 75:25 debt-equity ratio.
The IPPs were to be paid every month
in two parts, i e, capacity payment and
energy payment. The capacity payment
reimbursed the IPP for all fixed costs of
the power plant including debt servicing
(remember the 80:20 debt-equity ratio)
and provided the investor’s equity return
on top. These payments were to be
made irrespective of whether the IPP
was asked to produce electricity or not.
Second, this stipulation made sure that
the off-taker Water and Power Deve-
lopment Authority (WAPDA)/Pakistan
Electric Power Company (PEPCO)/Kara-
chi Electric Supply Company (KESC)
became contractually liable for repay-
ing the debt (and its interest payments)
taken to finance 80% of the project cost
anyway.
The energy payment reimbursed the
IPP for all variable costs of production
(e g, fuel costs) regardless of the type of
fuel employed and its market price. All
payments were indexed (if relevant)
with US$/Pakistan Rs exchange rate and
inflation (local or foreign) changes.
Thus, if the fixed foreign Operational
and Maintenance (O&M) cost of $1/kWh
is to be paid in year 1 and $1 is equiva-
lent to Rs 60, then the IPP was paid
Rs 60/kWh for that fixed foreign O&M
component in year 1. However, if in year
2, the rupee devalued to Rs 80 and US
inflation was 2% then the IPP was paid
Rs 81.6/kWh ($1.02 multiplied by Rs 80).
Finally, private producers were given
an exemption from corporate income
tax, customs duties, sales tax and other
surcharges on imported equipment.
Among other incentives was permission
for power generation companies to
issue corporate bonds and shares at
discounted prices.
The Gold Rush
Not surprisingly, investors rushed to invest
in Pakistan’s power sector and over-
whelmingly set up oil-based, inefficient
single cycle power plants. Twenty IPPs
(including HUBCO) reached financial clos-
ure with a combined capacity of 4,500 MW
(four projects with a combined capacity
of 435 MW were later terminated) and
brought in a total investment of $5.3 bil-
lion, of which 25% was financed by for-
eign equity. It should be noted that the
total predicted shortfall for which all
this private investment was being brought
in was only 1,500 MW! The World Bank
however claims that it had advised the
COMMENTARY
june 23, 2012 vol xlviI no 25 EPW Economic & Political Weekly
26
Government of Pakistan to contract only
2,000 MW. In any case, WAPDA was stuck
with massive overcapacity for which it
was contractually obligated to pay irre-
spective of whether it needed those IPPs
to produce electricity or not.
Many thought that it would be much
cheaper to follow the traditional approach
of getting soft loans as a sovereign and
building the power plant with WAPDA’s
expertise as much of the country’s power
infrastructure had been built that way
since 1947. However, sources close to the
HubCo deal reveal that by the mid-1980s,
the World Bank had indicated that soft
loans would no longer be extended and
the Bank would only support interna-
tional investment in Pakistan’s power
sector if private investment was brought
in through the IPP model.
The keenness of the Bank to usher in
privatisation can also be gauged by the
fact that it was involved in almost 88%
of the total IPP capacity contracted
(3,400 MW) through equity, loans, or
other guarantees.
When the Lights Came Back On
The privatisation juggernaut rolled on
through the 1990s. Capacity in the system
increased to first meet whatever the
forecast shortfall had been (this kept
moving upward), and kept increasing. It
took a few years for the true extent of
this policy’s fallout to become apparent.
When lights came back on, the power
sector and everything else that depend-
ed on it lay in ruins. All the promises of
great service vanished. Since 1990, tariffs
in rupee terms have climbed up approxi-
mately 530% for the median domestic
consumer (while doubling in dollar
terms) as the energy mix of the country
shifted away from much cheaper hydro
to thermal (read oil) based power,
exposing the average consumer to the
vagaries of the international oil price
fluctuations. As a result, the government
and the consumers found it increasingly
difficult, almost impossible, to pay for
this electricity. By 2011, it became usual
for large parts of the country to plunge
into darkness on a daily basis – all this in
the presence of substantial excess, un-
used capacity!
In the lead up to privatisation, the
World Bank had provided at least three
justifications for this move from public to
private provision of energy. First, it
claimed that the current level of service
that was being provided to consumers
was below par. Line losses were high and
disruptions were frequent. Second, by
subsidising power production, govern-
ments were coming under increased fin-
ancial strain. Facts and figures were pro-
vided to show how current expenditure on
health and education were insufficient
and how privatisation of the energy sector
would improve the government’s fiscal
position and free up public funds for these
important causes. Finally, it was suggest-
ed that the existing subsidies were not
helping the poor in any case since most of
them were not connected to the grids.
Thus taking away the subsidies would ac-
tually hurt the rich more than the poor.
A decade later, none of those “savings”
have been allocated to healthcare and
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COMMENTARY
Economic & Political Weekly EPW june 23, 2012 vol xlviI no 25
27
education as promised. In fact, in those
sectors too, privatisation has been con-
stantly encouraged. As a result of power
shortages, industry, commerce and agri-
culture have been taking serious hits
with the country’s growth prospects
dimming significantly. At the same time,
residential consumers have had to
endure over 8-12 hour blackouts in ma-
jor cities of the country with the situa-
tion even worse in rural Pakistan.
As for improving the government’s fis-
cal position and easing financial strain,
the power policy led to a crippling of
government finances through the “circu-
lar debt” – a debt that accumulated in
the system because of increasing oil
prices (nearly 70% of the total capacity
was now based on oil-fuelled thermal
units generally of low efficiency), and the
consequent inability of the government
to continue compensating the IPPs for
fixed and variable contracted amounts.
Meanwhile, the total energy produced
in the country actually decreased nearly
10% between 2007 and 2010.
When the country started out on the
road to privatisation, its electricity gen-
eration relied on a fuel mix heavily in
favour of hydro as opposed to thermal.
This has now changed dramatically over
the following decade with the fuel mix
changing to 30% hydro and almost 70%
thermal by the end of 2010. Given that
Pakistan imports all of its oil and has
scarce gas reserves, that the oil prices
climbed to $140/barrel in this period,
and combined with the fact that the
much-lauded 1994 policy did not dis-
criminate on the fuel source being em-
ployed, the consequences for Pakistan’s
“fiscal position” are there for all to see.
Paying the Cost
The cost of this strategic policy level folly
can be understood with the following
comparison. As per the National Power
System Expansion Plan 2010-2030 of
the National Transmission and Dispatch
Company (NTDC), as of 2010, WAPDA
(employing hydro production) generated
electricity at Rs 1.03/kWh (1.2 cents/
kWh) while public sector thermal power
plants provided the same at Rs 8.5/kWh
(10 cents/kWh). However, the IPPs (pri-
marily thermal) provided the same at
Rs 9.58/kWh (11.2 cents/kWh). As a result,
the average blended cost of generation
was Rs 6.6/kWh (7.7 cents/kWh) in 2010
which further increased to Rs 9.81/kWh
(11.5 cents/kWh) for the end consumer
due to line losses and theft in the trans-
mission and distribution systems.
Even after adjusting for debt repay-
ment, power production through indige-
nous hydro resources comes out much
better. The estimated cost of energy
from a majority of potential new hydro
projects is expected to come under 4.5
cents/kWh according to a recent NTDC
report. Moreover, the country has so far
completely failed to develop its coal re-
serves (only 30 MW comes from coal)
which are estimated at 175 billion tonnes
(the second largest in the world). Engro
Corporation, which owns a block of coal
in Thar, estimates a tariff of 10-12 cents/
kWh for Thar coal-based power produc-
tion based on the current policy. The
world average for coal-based power pro-
duction in the energy mix is 40% while it
is only 0.1% in Pakistan.
Incredibly, most policymakers continue
to blame non-bill-payers, line losses (which
are adjusted in the cost of production!)
and subsidies for this situation. The solu-
tion they propose is to switch off lights
in a country which already boasts one of
the lowest per capita electricity con-
sumption in the world. Similarly, they
keep increasing prices to supposedly
meet the “true” cost of production, when
the problem lies with the cost, not the
price! Because of the 1994 and later
2002 power policy, the cost is several
times higher than it would have been
otherwise. By choosing to buy power at
exorbitant rates from IPPs the government
is burdening the people, not subsidising
them! As for foreign investment, be-
cause of this policy, for the sake of the
25% equity (say $25 million for a 100 MW
plant) which the IPP investors typically
bring in, the government ends up spend-
ing approximately $83 million (in equity
returns and debt financing costs) more
through the life of a 100 MW thermal IPP!
The blackout in Pakistan is a policy
failure, a result of the disastrous privati-
sation undertaken by the government at
the behest of the World Bank. Blaming
petty theft, line losses or subsidies is
only going to create a bigger hole for the
government. The only way to reverse
this dire situation, which is crippling in-
dustry and plunging homes into dark-
ness, is to reverse the 1994 policy. But for
that to happen someone will first need to
admit failure. Unfortunately, that possi-
bility looks remote for the time being.
Notes
1 C Hill, “Power Failure”, Institutional Investor,
1 November 1999.
2 Congressional Record, Volume 140, Number 144
(Thursday, 6 October 1994).
3 J Fraser, “Lessons from the Independent
Private Power Experience in Pakistan”, Energy
and Mining Sector Board Discussion Paper
No 14, The World Bank Group, May 2005.
4 Later to be decreased to 12.06% in 2000 under
pressure from corruption investigation and
litigation in the courts.
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