When General Zia died in 1988 plane crash and power came into the hands of Lt. General (Retd) Aslam Beg, Lt. Gen (Retd) Hameed Gul and of course Ghulam Ishaq Khan , the then Federal Finance Minister Dr. Mehboobul Haq [a toady of World Bank/IMF who served General Zia, IMF and World Bank very well] signed several accords with the IMF and World Bank and he signed these accords when there wasnot any representatvie elected government in the country, to be precise Dr Mehboobul Haq enslaved the people of the Pakistan through this accords. Comes Benazir Bhutto as the first elected Woman Prime Minister of Pakistan and she was told by the three above and Robert Oakley the then American Viceroy of Pakistan that she will have to accept and honour the Accords signed by Mehboobul Haq with the IMF, and many other things like accepting Sahibzada Yaqoob Khan as Foreign Minister and Ghulam Ishaq Khan as the President and the so-called Daughter of the East Ms. Bhutto accepted all the demands to be ousted from power from the same group in August 1990 and now General Beg and General Hamid Gul have the audacity to lecture all of us about Islam, Democracy, Pakistan and Loyalty.
Dr Mehboobul Haq [In the middle]
Lt General Retd. Sahibzada Yaquoob Khan
Robert Bigger Oakley
Lt General Retd. Hamid Gul [Former ISI and MI Chief]
Former Chief of the Army Staff General Mirza Aslam Beg
Former President of Pakistan Ghulam Ishaq Khan [Oath Taking Ceremony in 1988]
The most sad thing is this that those who served under General Musharraf from 1999 to 2005 are nowadays addressing letters to him to quit [in my humble opinion General Musharraf should remain in power for at least 25 years] e.g. Javed Jabbar [Musharraf's Former Infromation Minister] , Lt General Retd Moeenuddin Haider [Musharraf's Former Interior Minister], Lt. General Retd. Tanveer Naqvi [Musharraf's National Reconstruction Bureau's Planner (BBC's Tim Sebastian had ruined Tanveer Naqvi and his so-called Devolution Plan in one of his program Hard Talk], Lt. General Retd Mohammad Asad Durrani [Musharraf's Former Ambassador in Saudi Arabia]etc.etc I wonder why all of a sudden the former cabinet members are so worried that they started writing letters to General Sahab. They have got what they had always wanted the complete Militarization of Pakistani society. I wonder why havenot they joined yet the Polytheist and Innovative [Shirkiya and Bidaati] Islamic Religious Party "THE TABLEEGHI JAMAT OF RAIWIND PUNJAB" like the Lt. General Retd Javed Nasir, and Lt. General Retd. Mehmood Ahmed. Where the hell their pomp is gone.
The power companies e.g. HUBCO, KAPCO, and others have made shady deals involving, but not limited to, the companies themselves, the World Bank, other international lending agencies and our so-called signatories of the Charter of Democracy worthy 'democratic' prime ministers Benazir Bhutto and Nawaz Sharif aided by their team-mates. Instead of booking Benazir and Nawaz Sharif on Pseudo Fake Corruption cases the government should book them both in IPP MESS.
We have to be very thankful of MS. BENAZIR BHUTTO [signing MURKY IPP DEALS] , MR. NAWAZ SHARIF [RAISED ELECTRICITY CHARGES AND FORCED RETRENCHMENTS OF EMPLOYEES AND GENERAL MUSHARRAF [since 12 Oct 1999 till now the Electrictiy Charges have been raised by the Military Government more than 30 times]
KESC [Karachi Electric Supply Corporation]
INFLATED ELECTRICITY BILLS AND COSTLY ELECTRICITY
General Sales Tax
The bill comes regularly but the electricity doesnot particularly from June to September they resort to loadshedding because of the usage and load and during winter the authorities say due to less water in the Dams we do not able to supply but one wonder why the bills alwasy remain same. Why the hell the charge bill when they donot supply because the bill doesnot reflect any decrease, the charges remain the same whether you supply or not.
High electricity bills have become a national issue and seriously eroded the competitive performance of our industry and agriculture. Foreign investment has all but dried up, investor confidence is at an all time low and the country is bleeding through a prolonged recession which shows no signs of ending.
Did WAPDA sign expensive IPP contracts?
A Special Research Report and Economic Analysis of the IPP Tariff By Dr. Anjum Siddiqui Sep 20 - 27, 1999
Pakistan’s growth is dependent on direct foreign investment and one of the major hindrances to increased foreign investment has been the yet unresolved issue between the Independent Power Producers or IPPs and WAPDA.
There has been a lot of controversies in the media regarding the actual details of the contracts that were signed as well as studies of the actual long term benefits of using IPPs.
The fact of the matter is that the IPP issue has to be resolved and the quicker it is, the better for the country. To play our part in assisting and helping to clarify some of the confusions that have resulted in this sector of our economy, PAGE is creating an open forum and is inviting letters and articles from our readers whose input would help.
We have asked Dr. Anjum Siddiqui of HUBCO to open this forum with his views and he has presented us with a paper which we have decided to use as a cover story. I would like to express that the views stated in Dr. Siddiqui’s article are not necessarily shared by PAGE. We would like to think of them as an invitation to response from anyone involved in this industry.
High electricity bills have become a national issue and seriously eroded the competitive performance of our industry and agriculture. Foreign investment has all but dried up, investor confidence is at an all time low and the country is bleeding through a prolonged recession which shows no signs of ending. Even after deliberations of 12 IPP committees, the IPP crisis continues unabated and there is no immediate solution in sight.
The GoP contends that the IPPs are solely responsible for high electricity bills. The tariff row started in early 1998 when the present government of Mr. Nawaz Sharif decided that the Agreements signed under the Benazir Bhutto government were invalid, fraudulent and could not be afforded by WAPDA. Since then WAPDA, assisted by Ehtasab Bureau are on a witch hunt to prove that (a) IPPs including Hubco were involved in corruption and (b) IPPs including Hubco produce expensive power — more expensive than the state utility WAPDA.
The misperception that the IPPs are solely responsible for high electricity prices is based on the belief that IPPs hoodwinked WAPDA into signing expensive power purchase contracts with them. Such rhetoric draws attention and blame away from the parties who are actually responsible for high electricity prices in this country i.e. GoP and WAPDA. In the case of GoP, regressive taxes such as Petroleum tax, Octroi and Excise Duties etc. have significantly increased the price of fuel and overall cost of production of electricity. WAPDA’s production inefficiencies, distribution losses and overemployment have increased its costs of production and distribution, which it seeks to recoup through exorbitant surcharges. No wonder that the price of electricity has shot up for both industry and households.
It seems that the media and industry experts in our country have turned a blind eye to the contribution of GoP and WAPDA in high electricity prices. Instead the focus is on the much maligned IPPs against whom a number of "reasons" are being advanced as explanations of high tariffs.
"Causes" of High Tariffs: It is alleged that tariffs charged by IPPs are high because:
(i) IPP tariffs are front loaded - i.e. higher in the initial years and lower in the latter years
(ii) IPPs’ 18% real dollar rate of return is "excessive"
(iii) WAPDA has to pay a minimum 60% capacity charge even if it purchases less power
(iv) IPPs’ Fixed Costs are higher than WAPDA’s Fixed Costs
(v) WAPDA has to pay foreign exchange risk insurance (in the case of Hubco)
In other words it is being argued that the IPP contracts should have been structured differently. None of these so called "causes" actually supports the flawed proposition that IPP tariffs are high.
Essential Elements of an IPP Contract:
Looking purely at the project economics, and all the risks that are associated with greenfield (new) projects, and given the fact that Pakistan was facing immense difficulties in raising international capital through bonds or loans, one cannot but help conclude that irrespective of whether there was the alleged "over-invoicing" in capital costs and irrespective of the silly assertion that "WAPDA did not know what it was signing" and they were duped into signing "expensive contracts", the IPP contracts that have been signed are optimal. Any investor would have demanded some fundamental clauses in the IPP contracts, without which no investment would have taken place.
These are an 18-20% return on investment commensurate with the risk of the project in a low investment-grade country, a fixed capacity charge for captive IPP capacity purchased by WAPDA, provision of tariff escalation in the presence of inflation and rupee depreciation, economically viable compensation to the Operations and Maintenance Contractor for running the plant, some type of foreign exchange risk insurance unless WAPDA wishes to self insure, guarantees provided to lenders and investors by GoP about sovereign risk and fulfillment of obligations of key parties i.e. WAPDA (procurer of electricity), PSO (fuel supplier), State Bank (Foreign Exchange provider). These essential ingredients of the Power Purchase Agreement would remain the same even if WAPDA signed new contracts today. In fact, given the further deterioration in the economic environment, new IPPs would be extremely reluctant to sign contracts and if they do, they would demand even higher risk premiums than those agreed for current IPP contracts.
Front Loaded Tariffs:
It has been argued that WAPDA should have negotiated a differently structured tariff as the tariff profile shows that tariff is front loaded. The tariff profile of a project is determined by the amount of debt and by the structure of financing arrangements with lenders. As such it makes no difference whether Hubco, or another IPP or WAPDA are the loan recipients — the tariff profile would be the same for all. The average Base Tariff (or Reference Tariff) in the case of Hubco is Rs. 2.21/kWh (during year 1-5), Rs. 1.49/kWh (during year 6-15) and would fall to Rs. 1.19/kWh during the years 16-27 of project life (the last year being 2027). Upon payment of senior debt, after first 8 years in the year 2005, Hubco’s Base Tariff would fall by 15% and upon payment of subordinated debt in the year 2015, the tariff would fall by an additional 5%. There onwards the tariff would be just sufficient to cover the remaining dividend payments and other Fixed Costs.
The above statistics reveal that IPP’s tariffs are indeed front loaded because IPPs have to make huge payments for debt in the initial 8-15 years of project life. Top that off with a constantly depreciating rupee and the international debt payments become much larger, making the front loading appear more pronounced. The bottom line of the above arguments is that front loading was necessary and that WAPDA or anyone else could not have negotiated any better.
"Excessive" Return on Investment:
There is also the ‘charge’ that if IPPs had not got away with an 18% return, the tariffs could have been lower. Pakistan was, and still remains, a high risk country for investment purposes. Wars, nationalizations, prolonged military rule, civilian unrest, poor economic growth and very low foreign exchange reserves had made the investors reluctant to take exposure on Pakistan’s sovereign and project risks. The providers of capital demanded an adequate risk premium and an 18% dollar rate of return was the minimum return which could interest investors. The IPPs are paying the price today for taking on this risk, such as WAPDA’s inability to honour its signed contracts and the GoP’s reluctance to fund its sovereign guarantees for default of WAPDA’s contractual obligations towards IPPs. If the GoP guarantee is worthless, then what recourse do project equity sponsors and lenders have for compensation of political risks?
Minimum Capacity Charge:
Another common charge against the IPPs is that electricity is expensive because WAPDA has to pay the IPPs a fixed monthly capacity utilization charge (at 60% of installed capacity) even if it is utilizes lesser or even zero capacity. WAPDA’s Capacity Payments to Hubco alone were supposed to be approximately Rs. 1 billion per month (it pays much less — 730 million). Such capacity charges make economic sense and are entirely justified. If WAPDA is not going to allow the IPPs to sell power in the open market, then surely it must pay for the captive capacity that was installed at the cost of millions of dollars. One cannot have captive power and not pay for it. It is like booking a hotel room and not paying for it. Where would the hotel owner recover his lost revenues from, especially if he is not allowed to rent rooms to anyone else who is willing to pay.
WAPDA can reduce its per unit capacity payments and hence the per unit tariff payments to Hubco, if it purchases more hours of electricity. How? If WAPDA were to purchase more hours, its Total Fixed Cost would remain constant (in rupee terms), but its per kilowatt Fixed Costs would fall, thereby resulting in lower prices of electricity. This is so because the Fixed Costs are now spread over more units of purchased power.
In fact, WAPDA has not been buying enough power to reduce its average costs. In 1997-98, WAPDA utilized only 55% of the available plant capacity of Hubco, 42% of Kohinoor Electric and 45% of Kot Addu Power Company (KAPCO). Thus, approximately 50% of the capacity of these plants went to waste through non-utilization by WAPDA. The unutilized capacity could not be diverted for sale to other potential buyers, as under the PPA, IPPs are bound to sell to WAPDA only. The upshot of the argument is that if WAPDA had purchased more capacity say 85% (of Hubco’s capacity), it would have been able to reduce its per unit tariff actually paid to Hubco by 20%. WAPDA could have purchased more power saved on its per kilowatt capacity charges and passed on these savings to the consumer. Instead, it kept imposing exorbitant surcharges and electricity bills have become expensive by the day. If WAPDA purchases more power, the above fall in tariffs would be achieved even if all other costs remain the same i.e. the government does not remove or reduce the petroleum surcharge, inflation does not come down and the current rate of rupee depreciation persists.
IPPs’ High Fixed Costs:
WAPDA has reluctantly accepted that IPP’s variable costs are cheaper than WAPDA due to their fuel efficiency but they insist that the Fixed Costs of IPPs which are approximately 60% of the total costs are much higher than WAPDA.
Let us analyze the non-fuel fixed costs and consider the veracity of these claims. These costs pertain to Debt Servicing, Fixed Operations & Maintenance expenses, Company’s Administrative Overheads, Insurance Costs and Return to Equity Investors.
Debt servicing is a major component of fixed costs. The project was financed with a 75:25 debt-equity ratio and debt servicing amounts to 28% of the per unit (kWh) tariff of Hubco. Unfortunately, debt servicing costs cannot be directly compared between WAPDA & IPPs for a compelling reason. WAPDA’s older plants were set up with highly subsidized financing from international donor agencies such as World Bank and Asian Development Bank and such subsidized financing is no longer available to WAPDA. IPP plants on the other hand have been financed at internationally competitive interest rates. Therefore, comparing IPP debt costs with WAPDA’s is a futile exercise simply because the cost of loans has escalated in the post cold war financial markets.
What would be WAPDA’s cost of financing today if it embarked on a new project? To qualify for any World Bank/Asian Development Bank assistance WAPDA would have to first raise on its own 40% of the capital cost of the project. Such costs would most certainly be more than IPPs, as lending banks would demand a hefty premium keeping in view WAPDA’s financially unsound balance sheet and its poor track record of honouring its contractual payments to IPPs. To Hubco alone, WAPDA owes Rs. 9.3 billion in arrears for the capacity charges. One wonders which banks (if any) would give WAPDA better loan terms than IPPs who have been able to set up their multi million dollar projects at very competitive interest rates. WAPDA’s inability to raise finances through the failed WAPDA Bond Scheme is still fresh in the minds of many Pakistanis.
Operations & Maintenance Costs:
WAPDA has made a huge fuss over Hubco’s Operations & Maintenance (O&M) costs and alleges that O&M costs are very high. O&M costs constitute only 4.3 % of Hubco’s Total Costs and a mountain has been made of a molehill. On a comparable basis, WAPDA’s O&M costs may be cheaper than IPPs, simply because WAPDA’s maintenance record leaves much to be desired. Engineers estimate that due to poor maintenance and operations practices, WAPDA’s available generation capability has been reduced 20% below their installed plant capacities resulting in a capacity loss of approximately 1500 MW. So, while WAPDA’s Operations and Maintenance costs are perhaps lower than IPPs, this cost ‘saving’ has been achieved through permanently lost generation capability resulting in an approximate loss of Rs. 80 billion to the country.
WAPDA’s administrative overheads are surely much higher than IPP overheads. This becomes evident when we compare the relative employment of WAPDA & Hubco. Hubco and its plant operator employ 350 people to generate 1292 MW which means a ratio of 3.69 MW per person. WAPDA employs approximately 138,000 people to produce an installed capacity of 7795 MW (derated capacity is much lower) and if we make the generous assumption that 20% of this workforce is associated with power production the ratio of power produced per person still works out to be less than 1 MW per person which is much less than Hubco.
Return to Equity Investors:
This is another major fixed cost of Hubco which is allegedly high according to WAPDA. It has been charged that Hubco’s capital investors have already taken all their money out. This is most incorrect. Shareholders purchased Hubco shares in October 1994 at a price of Rs. 13.26 per share and received their first dividend of Rs. 7 per share in 1998 and a second return of Rs. 3.91 in 1999 (undistributed). With these dividends the annual return on investment for Hubco’s Rs. 10 face value shares is 10.3% (in rupee terms) which translates into a meagre return of 1.05% (in dollar terms). Contrast these earnings with the promised 18% real dollar rate of return that shareholders were promised and WAPDA’s allegations of excessive returns falls apart.
The above clarifications demonstrate that IPP’s have made a very strong economic case about being cheaper than WAPDA in fixed costs.
Role of GoP & WAPDA:
IPPs only produce electricity, they do not distribute it (WAPDA does) and neither do they determine the cost of their raw materials (the GoP does). Surely these two parties play a big role in determining the price of electricity in the country. The GoP affects the price of electricity through affecting furnace oil prices, inflation and exchange rates and taxes/octroi. WAPDA affects the price of electricity through surcharges levied in electricity bills and through inefficiency in distribution and general management.
It is correct that electricity bills paid by the consumer have increased significantly. Over the three year period 1996-99, the increase in Hubco’s average actual tariff over the average reference tariff has been a phenomenal 71%, almost exclusively due to factors outside the control of the Company. The following table illustrates the point.
Tariff Average for 1996-99
Reference tariff (unindexed or Base Tariff)- (I) Rs. 2.53/kWh
Actual tariff billed to WAPDA- (II) Rs. 4.31/kWh
Tariff Escalation = (II-I) and % increase Rs. 1.78/kWh (or 71% increase)
39% of the tariff increase is explained by fuel price hike, 25% by rupee devaluation, 20% by the high cost of foreign exchange risk premiums charged by the State Bank of Pakistan and which are quite high in the initial years of insurance coverage, 7% by inflation and 8% by other factors.
Note that almost 40% of the tariff increase is due to increase in fuel prices which have increased as the direct consequence of GoP’s furnace oil surcharges. During the 3 year period 1996-99, furnace oil prices increased by 34% from Rs. 4515 per tonne to Rs. 6070. This increase is associated with an escalation in furnace oil surcharges from 14% to 25% of the per tonne price of furnace oil.
The government’s most recent measure of increasing furnace oil prices by another 15% would further increase electricity prices. The GoP’s plea that this increase was necessary in the face of a rise in world furnace oil prices is not economically prudent. The prudent policy is to absorb the fluctuations in world oil prices in domestic prices and to simultaneously reduce the furnace oil surcharge. Obviously, government revenues would decline, but these should be made up through increasing the tax net for direct income tax collection and not through further petroleum surcharges which are highly inflationary in nature. The government continues to seek the easy way out to the detriment of the whole macroeconomy.
Over and above the fuel price impact, a constantly depreciating rupee and foreign exchange risk insurance costs account for another 45% tariff increase. Thus, fuel price hikes, rupee depreciation plus hedging measures and inflation explain 92% of the total increase in tariffs. These factors are totally outside the control of IPPs and are the direct consequence of the GoP’s macroeconomic policies.
It is most unfortunate that those who have jumped on the "Bad-IPPs" bandwagon have totally lost sight of three important facts, that:
(i) the GoP is mismanaging growth policies which has created a recession and consequently reduced electricity demand.
(ii) the GoP has failed to check the decline in the value of the rupee which along with inflation is responsible for a 53% increase in tariffs over the last three years.
(iii) the GoP has consistently failed over many decades to address the single most important issue facing Pakistan’s economy, that is, insufficient revenue collection from direct taxes. The failure to raise direct taxes has led the GoP to levy a plethora of indirect taxes of which the furnace oil and petrol taxes are the worst in terms of their inflationary consequences.
(iv) the GoP’s efforts to cleanse WAPDA through the army intervention has met with very limited success and all major ailments of WAPDA’s balance sheet remain uncured. The failure to check the rot in WAPDA has resulted in a vicious circle of ever escalating electricity surcharges which are the direct consequence of WAPDA’s 30% line losses, 109% increase in receivables and operational and administrative mismanagement. There is no alternative but to expeditiously privatize WAPDA on which the GoP does not seem keen, atleast for the foreseeable future.
By critically examining all the so called "causes" of high cost of electricity, this article establishes that it is the escalation in fuel costs due to GoP’s petroleum taxes, increase in debt costs due to depreciation and increase in all other costs due to inflation is the reason d’être for higher electricity prices in Pakistan. Top that off with WAPDA’s ever increasing surcharges levied to recoup losses from production inefficiencies and we have the reason for expensive electricity in Pakistan. None of these factors are caused by or are under the control of IPPs and consequently blaming them for high electricity prices is incorrect and results only in diverting blame from the real contributory forces, namely, GoP & WAPDA.
DR. ANJUM SIDDIQUI Senior Advisor
Financial & Risk Management
The Hub Power Company
Dr. Siddiqui is an Economist and currently working as Senior Advisor on Financial and Risk Management with the Hub Power Company. Before joining Hubco, he was employed with Engro Chemical Pakistan Ltd. (formerly Exxon) as Business Planning Advisor of New Projects. At Hubco, he is an important member of the team which is responsible for negotiating with the government and resolving the current controversies surrounding Hubco.
Previously, Dr. Siddiqui was an Associate Professor at the Graduate School of Business & Economics at the University of Auckland in New Zealand. Upon returning to Pakistan, he has taught at the Applied Economics Research Centre (AERC) at University of Karachi and is Visiting Professor at the Institute of Business Administration (IBA) at the University of Karachi.
Dr. Siddiqui specializes in Macroeconomics, International Trade & Finance and also in Project Management and Project Financing of large multi million dollar projects. He has published many articles in prestigious international journals of economics e.g. International Economic Journal, New Zealand Economics Papers, Pakistan Development Review, Indian Economic Journal etc. and in the daily newspapers "Dawn" and "The News" as well as in Zameen magazine.
Being an active researcher, he has presented many papers on economics in conferences of American Economic Association, Canadian Economic Association and New Zealand Economic Association. He recently presented a paper "IPPs: The Real Issues" at the annual conference of Pakistan Society of Development Economists in Islamabad. The paper was well received by the economists and the general audience.
Dr. Siddiqui is also an Associate Member of the Federal Reserve Bank of San Francisco and is on the Editorial Board of International Journal of Business Studies published from Australia. He has appeared many times as an expert commentator and analyst on the Pakistan television programs "Business Week", "Business Update" and the "Spectrum".
Dr. Siddiqui has been a consultant to the Reserve Bank of New Zealand, ABN-AMRO Bank, Leasing, Power and Gas Companies. He has also lectured senior staff of the State Bank of Pakistan and has recently worked as a member of the Prime Minister's Committee on "Monetary Policy and Balance of Payments" at the State Bank of Pakistan.