Pakistan’s energy policy ignores lessons of history

By Usman Naeem

At a recent workshop^[1] held in Kathmandu, Nepal on September 28, 2016, Punjab Secretary of Energy Asad Rehman Gilani said that 1,500 megawatts (MW) have been added to the province’s power supply within the past 24 months. This is an astounding 38 percent of the daily average shortfall (between peak demand and supply) of 4,000 MW in Pakistan’s energy sector. This figure excited regional policymakers and energy economists, who sat on the edge of their seats to learn more about the “Punjab speed”.

“Punjab speed” is actually based on “Shenzhen speed”, a term Secretary Gilani picked up during an official visit to China. “Shenzhen speed” refers to China’s rapid execution of large projects. Gilani used “Punjab speed” to describe a coal-based power plant (1,320 MW) and three LNG-based power plants (3,600 MW) in Punjab that are expected to become operational seven months and three months ahead of schedule, respectively.

While all of this sounds very impressive, has it addressed the underlying issues in the energy sector or have we simply chosen not to learn from past mistakes? This question is all the more important as the budget season approaches and energy expenditures loom large in the public debate.

Take the Benazir Bhutto administration’s response to the energy crisis of the 1990s. To draw private investment into the energy sector, investors were offered attractive upfront tariffs^[2] that guaranteed returns on equity of 15 to 18 percent and tax exemptions. This led to US $5 billion in investment and about 4,500 MW of private generation in record time.

However, investors had little incentive to spend on projects that maximized generation and minimized cost because they operated under a “cost-plus” model, in which returns were governed by expenditures on initial capital investments and not on how well the plant performed. This payment formula was fixed for the life of the power project. Even worse, the government decided to bear the costs of any increase in fuel prices and/or rupee devaluation to make investments more attractive. Consequently, expensive and poorly designed power plants which required both high government subsidies and higher electricity prices were constructed.

Unfortunately, the government’s current approach to expanding its coal, natural gas, and renewable power generation is also problematic.

For the coal-based power plants, indigenous coal exploitation in the Thar Desert region is still far from reality. At least in the medium-term, both coal as well as equipment for coal-based power plants would have to be imported. This would again expose the government to exchange rate risks (i.e., rupee devaluation) that translate into higher prices for the consumer. And even in the long-term, there is a lack of technical capacity and financing to exploit Thar’s coal reserves and insufficient infrastructure to transport coal across the country. As the world moves away from coal, power plants imported from China may be inefficient with high per unit costs, not to mention the high environmental costs.

LNG-based power plants are simply far too expensive to afford. The costs of LNG generation are double those of coal. Plus, even if we choose to import LNG to meet the current demand-supply shortfall, it will only be a short-term fix.

Renewable energy is costly because of a widely-held belief that private investors made huge fortunes under prior policies of the 1990s, while the people of Pakistan paid the price. Misguided by this belief, the national regulator has focused on limiting how much profit investors can make rather than fixing energy policy to promote low-cost generation. This misplaced priority has favored suboptimal technologies and resulted in expensive generation.

For example, in the draft 2013 upfront wind tariff, the regulator proposed that the government will only purchase energy generated up to 31 percent of the capacity factor^[3] at full tariff. Any excess generation will be purchased at a decreasing tariff. This took away any incentive from the power producers to maximize generation (i.e., to invest in better quality wind turbines that will produce more electricity from the same wind speed), and instead led them to invest in less efficient technology that translated into higher per unit price. The experience of the solar sector is similar.

Pakistan’s energy crisis is arguably rooted more in issues of weak governance that have produced a sub-optimal regulatory framework rather than shortage of supply. Over the years, we have succeeded in attracting private investment and setting up power projects, but with a poor understanding of how to respond to changing costs. This has resulted in expensive generation that is a burden on consumers and the government exchequer and has disrupted the energy supply chain.

To avoid past mistakes, we need to fully understand the costs associated with each project and carry out comprehensive contingent liability exercises to assess the potential risks and devise strategies to mitigate the risks.

The energy mix should be determined on the basis of technical and economic analysis given the evolving cost structure of different sources of energy as opposed to the ad-hoc and crisis-driven decision-making that has become the status quo.

Usman Naeem is a Pakistan Country Economist at the International Growth Centre (IGC). The opinions expressed here do not represent the views of the IGC.

[1] The workshop, funded by UK Aid and organized by Oxford Policy Management (OPM) and the Center for Effective Global Action (CEGA) at the University of California, Berkeley, focused on identifying energy challenges facing the South Asia region and developing policy-relevant research questions to overcome them.

[2] Under an upfront tariff regime the energy regulatory body fixes the per-kilowatt-hour price of electricity in advance and the project sponsor agrees to pay that tariff regardless of what the building cost of the project will be.

[3] Plant capacity factor is the ratio of a power plant’s actual output over time to its potential output over the same period of time.