An Historical View of the Electricity Crisis in Pakistan

Much has been written about the omnipresent power crisis in Pakistan. Analysts have blamed it on various factors including lack of reforms, excessive subsidies, lack of planning and investment, etc. Whereas all these factors may be important contributors to the current crisis, they remain superficial to the extent that they fail to explain the nature of crisis in its entirety. The nature of the crisis is structural, which implies that addressing these epiphenomenal concerns may provide temporary relief but the crisis will return (with a vengeance) in the long run. This article looks at the issue in its entirety by exploring the power sector’s history and political economy. The crux of my argument is that the crisis is here to stay despite measures that may provide temporary relief and that nothing short of major policy changes will help us address this crisis.

            The roots of the present day crisis lay in the 1994 power policy. Before I elaborate on this let us revisit the current situation. We know that we have massive power shortages because of the circular debt, which is why power generation companies have been unable to obtain fuel from Pakistan State Oil. They, therefore, cannot operate or operate at less than usual capacity, which in turn results in power shortages. How did this circular debt come to exist at unmanageable levels? There are two aspects of this that I think can be explained in simple flow terms – flow of fuel and flow of revenue.

 Let us try to understand this as the movement of two flows along the power sector supply chain. There is a forward flow of the fuel along the supply chain and a backward flow of money/revenue. A simplified version of the power sector supply chain would comprise Pakistan State Oil (PSO), Private Power Generation Companies (PGenCos), National Transmission and Dispatch Companies (NTDC), and distribution companies (DisCos). PSO supplies furnace oil to PGenCos, which produce electricity and then sell it to NTDC after accounting for other costs and profits. NTDC then supplies it to various DisCos that supply to their many different end consumers. This, in its simple form, is the forward flow or movement along the supply chain. One can always conceive of this first flow in monetary terms as well by converting the quantum of fuel supplied into its monetary value. The backward flow is the flow of revenues that move from consumers to DisCos to NTDC to PGenCos and then finally to PSO. In simple terms a debt would arise when there is a mismatch between these flows. It becomes circular when the above described movement happens repeatedly.  This circular debt has existed in Pakistan’s power sector for a very long time but reached unmanageable levels only a few years ago. One of the most oft-mentioned solutions is to improve the revenue collection and make prices “rational” so that the debt can ultimately be removed. There is no doubt that revenue collection needs considerable improvement and will help in mitigating this crisis to some extent. However, that alone cannot solve it and rationalizing prices is not a viable solution either politically or socially. This is where history becomes important--specifically the 1994 power policy that needs some revisiting.

Some readers may recall that Pakistan suffered from power shortages in the early ‘90s as well and power outages and ‘loadshedding’ had become quite the norm. Although, they were not this horrendous, in that context power outages had become a problem. Pakistan Peoples’ Party’s (PPP) second government under late Benazir Bhutto launched the 1994 power policy to attract private investment in the sector and deal with power outages. The policy was successful in attracting a lot of private investment and a number of projects were approved and commissioned within a few years after the policy was launched. However, the policy also attracted a great deal of controversy, mostly related to widespread allegations of corruption, too many lucrative incentives, and the agreed upon tariff rate. I shall not go into the details of these and for the purposes of this article, I shall only focus on two aspects of the policy that I believe have contributed towards the present day crisis.

The first aspect deals with the nature of incentives offered by the government at that time. The tariff rate that was agreed upon between the government and private investors had two components. There was a capacity charge/payment and an energy charge/payment. The contracts signed assured the investors that the government would buy 60 percent of the installed capacity of the plants--no matter what. Technically speaking this meant that even if the plant is not running (for reasons other than repair and/or maintenance outages) the government still has to pay 60 percent capacity payments to the investor since it had promised to do so in the contracts signed with the investors. The energy payments dealt with production of electricity by the plant above its 60 percent capacity. The capacity payments included several other guarantees as well. For example, it included a guaranteed return on equity (investors’ own part of total investment), included components that covered the interest payments of the investor(s), protection from fluctuations in exchange rate and domestic and international inflationary pressures. The second aspect of the policy that has contributed towards the circular debt crisis was making furnace oil the fuel of choice for the private power generators. Fuel costs were also made a pass through items i.e. any changes would be passed on from one company to the next along the supply chain described above. How have these possibly contributed to our circular debt issue?

The significance of the guarantees mentioned above is important to understand. The contracts ensured that the investors get a return on equity and will also be able to pay their debts even in a scenario where it produces nothing at all! In reality things have not quite panned out this way and most of the plants were working over 60 percent of their capacity since they were commissioned till before the start of the current crisis in 2008-09. For all the days, weeks, or months the plant is running under 60 percent capacity the government still has to pay the 60 percent capacity charges. The capacity charges component of the tariff rate is also indexed to various other variables. For example, if the investor had taken any loans in foreign currency then the interest payments were indexed to guarantee changes in exchange rate since all the payments to the power companies were made in Pakistan Rupee. Between 1993 and 1996 the average exchange rate was around 32 PKR to one USD. It currently stands at around 94 PKR to one USD. This possibly means that the part of the capacity payments that deals with interest payments to be  made on foreign loans have gone up by almost 3 times for the government of Pakistan. This is so because all payments are made in Rupee terms but they must match the dollar equivalent of what is agreed in the contract. Capacity payments were also indexed to Pakistan’s and the US’s inflation rates, both of which have seen an upward trend in the past 16 years. The capacity payments have therefore been made to adjust to reflect this upward trend. The other big contributor is the furnace oil price. When the policy was launched its import prices was around 3000 PKR per tonne. Its price has now gone up to 70,000 PKR per tonne. This means that there has been an over 2200 percent increase in the cost of production for these plants since the introduction of the 1994 power policy. And since this is a pass through item a firm/organization in the supply chain would shift it to the next firm/consumer along the chain. But the final burden of this falls on the government since end user prices can never be rationalized enough to reflect a possible 2200 percent increase in cost of production. This discussion clearly identifies the major contributors of the circular debt. As mentioned above, circular debt in the power sector existed from the very beginning. But its size was manageable and these dues were cleared with time. The size of the debt become unmanageable after the price of imported furnace oil started to rise steadily and reached its peak in the third quarter of 2008 at 65,000 PKR per tonne. The price fell afterwards till the third quarter of 2010 but has gone up again since to arrive at the present level of around 70,000 PKR per tonne. Government subsidization of all end consumers due to the increase in the price of furnace oil has clearly played a major role in making the circular debt unmanageable. Other factors discussed earlier are exchange rate depreciation and hikes in domestic and foreign inflation rates.

A natural question at this point would be to ask if we are stuck forever in this vicious circle of circular debt and should all the blame be rest with the PPP’s 1994 government? I would say no; the answer is not quite this simple

Let’s start with the PPP government in 1994. One cannot absolve it from all the blame yet we have to understand that the lucrative guarantees and incentives that it offered to the investors were not entirely of its own making. The World Bank was heavily involved in the policy making process and ensuring that investors bring their capital to Pakistan. The incentives and guarantees in the 1994 power policy were modeled after the HUBCO agreement that was first signed in the mid-1980s by the then military government of General Zia-ul-Haq and then renegotiated in 1995. Again, the Bank was closely involved with the whole project. Third world countries have been largely unable to resist the pressure of international donor agencies – particularly so in the 1980s and the 1990s. Pakistan, therefore, is hardly an exception in that regard. The idea of a third world or developing country resisting the onslaught of international financial institutions is of more recent history and largely spearheaded by Latin American countries (Bolivia, Venezuela, Ecuador in particular). Small economies like Pakistan are particularly vulnerable to the pressures (or ‘advice’) of various international financial institutions (IFI). Also, accessing cheap foreign credit is important for Pakistan to finance its imports if exports and foreign remittances are not enough to foot the bill. Hence, Pakistan, like many other developing or third world countries, faces these structural impediments that make it difficult to make entirely independent or ‘sovereign’ policies.

Yet this still does not mean that nothing could have been done to avoid this present day crisis. And here it is not just the PPP but all governments that followed it that must be blamed. For example, one policy change that could have been made was to diversify our fuel mix for the power generation sector. By the early 2000s the fuel price had increase four times and had been steadily rising for a few years. There was pressure from the World Bank to revise electricity rates to account for these changes so that government subsidies to the consumers could be weeded out. A sound policy measure would have been to encourage private power plants to gradually move toward coal fired power plants. We would have still needed to import coal but the difference in the import price of coal and furnace oil is significant. In any case it would have allowed us to manage the cost of production in the power sector considerably. But both the PML-N government from 1997-99 and the Musharraf government after that hardly took any concrete measures to address these concerns. The PML-N government spent a lot of time investigating corruption allegations and harassing officials of different companies but never really took any concrete steps to address the structural problems introduced by the 1994 policy. But what about the Musharraf government ? Were they just as bad? 

In a way, yes, because they ended up doing nothing to address the developing crisis. Third world governments generally don’t like to think long term but Mushraff’s government suffered particularly from what Moeed Yousaf calls ‘vision capability deficit’. In another way the Musharraf government – or some parts of it – did show considerable understanding of the future needs of Pakistan energy sector in general and power sector in in particular. For example the Planning Commission developed an Energy Security Action Plan in 2005, which was a 25 year vision of Pakistan’s energy needs. It discussed in detail the looming power and gas shortages and how they can be met. Diversifying Pakistan’s fuel was a particularly important policy recommendation in it. Similarly, the Water and Power Development Authroity (WAPDA) prepared its Vision 2020 document (and then later Vision 2025) around the same time period. Both these documents highlighted the rapid growth in demand, the need to diversify the fuel mix, and increasing installed capacity. Why these documents were not taken seriously remains a mystery. Perhaps policy paralysis in Pakistan has never been this tragic or stark before. Another possible reason for the failure to address these concerns is the entrenched interests in Pakistan’s oil and gas sector. PSO currently holds a monopoly in the import of furnace oil and Bloomberg reports that 56 percent of PSO’s gross profits come from imports of furnace oil. But it is not just PSO that benefits from this. All other businesses that are involved in supplying furnace oil to some end consumer (power plants, other industrial units) would then benefit from rising prices if there are no other alternatives.

The present government again could have done many things but chose to bog itself down in other matters. What is remarkable is how little understanding it showed of the implications of the 1994 power policy. The rental power policy was hardly any different from what was offered in 1994 and allowed plants that would run on diesel, which is even more expensive than furnace oil. Perhaps one of the reasons for this is that one of the main characters (or architects) of the 1994 policy – Salman Farooqi, a top bureaucrat at that time – was back in business after the 2008 election.

Is there a way out of this? Yes. But not any time soon. The earliest this crisis can abate is by the end of 2013 if some of the coal fired plants that are supposed to become operational by then actually do so. At the same time we need to start encouraging some of the plants to shift towards coal fired power technology so that we can spread our generation costs over a larger fuel mix. The other drastic step that we could take is to nationalize all private power plants without compensation. It will hit us in the short term but in the long run we can avoid several other costs and actually run the plants on desired capacity levels. But then this PPP government (or the one coming after it) is not tempted by leftist radicalism anymore.