Power Sector - Quo Vadis?

Muqtadar Quraishi and Daud Khan

Power Sector - Quo Vadis?
The much-awaited report on the power sector which came out recently, while a comprehensive document, has nevertheless on the whole proposed a symptomatic treatment of problems without addressing the disease. The piecemeal approach has characterised government’s approach for the last several decades. They have been putting out fires but failing to focus on the causes of the fire.

The Report was commissioned by the Ministry of Energy (Power Division) in August 2019, under the directions of the prime minister. A committee was constituted to identify and examine the causes of the high cost of electricity in the country, including review of private Independent Power Producers (IPPs), ways to resolve circular debt and inefficiencies in the transmission and distribution sector, and suggest a future roadmap.

This report has delved into a myriad of causes and explanations for the quagmire which according to the report were the result of many “oversights,” as well as astonishing systemic and non-systemic errors. There are many important and loss-reducing areas of focus that the report has outlined. The rationale and associated workings appear to have been done in a diligent and logical manner. There are important actions suggested that, if implemented, would have a lasting positive effect in the future.

To understand what is at issue, a little background, starting with the power policy of 1994. As a consequence of the policy, the government moved to unbundle WAPDA, replacing it with three functionally separate sectors (generation, transmission and distribution) all under a newly formed Pakistan Electric Power Company Limited (PEPCO) owned by the government of Pakistan (GoP). This division of the power sector was in line with international best practices. The aim of above initiatives was purportedly to promote competition and improve financial, operational and management performance in all functional tiers of WAPDA. It was also intended to develop efficiencies, promote commercial viability and enhance assets values of each new corporate entity and develop a “corporate outlook and culture” to eventually offer affordable electricity to customers. National Electric Power Regulatory Authority (NEPRA) among other duties, became responsible for tariffs. KESC (now K-Electric) which supplies electricity to Karachi had been at times autonomous and at times under WAPDA. It was eventually privatised in 2005. It remains fully integrated.
Solutions have been attempted several times. Most of these tried to address root causes but ending up simply being window-dressing

In Pakistan, we have a single-buyer market where all power generating companies sell to a government purchasing agency – the Central Power Purchasing Agency (CPPA).

The 1994 Power Policy also encouraged foreign investment in power generation through Independent Power Producers (IPPs) as it had become clear that neither GoP nor WAPDA had the investment or management capacity to meet Pakistan’s rising electricity demand. These IPPs sell electricity into the national grid at a fixed price. However, if the national grid did not need the electricity the IPPs would nevertheless be eligible to “capacity payments” which would help recover investment costs even if the plant were to remain idle. It was these “capacity payments” and in particular how they were set and administered that has come back to haunt the power sector.

Even though the reforms were well-designed with good technical expertise and help from development partners, the entire implementation process was fraught with several missteps. The major consequences of this include power shortages coexisting with excess generating capacity and idle power plants; a staggering government liability of over Rs2 trillion (US $ 12.5 billion) mainly towards the IPPs; and a relatively inefficient transmission and distribution system which substantially raises costs and results heavy subsidies due to price ceilings on the final selling prices to consumers.

Solutions have been attempted several times. Most of these tried to address root causes but ending up simply being window-dressing. An example is that of passing liabilities from one government entity to another without addressing the inherent structural deficiencies.

If one were to focus on systemic issues, there are three areas which merit greater attention. These relate to demand forecasting on the basis of which the establishment of new IPPs is sanctioned and ultimately results in excessive capacity payments; the dismal condition of the transmission and distribution systems again leading to greater GoP liabilities; and the future challenges of renewable energy.

The first area that needs more attention relates to demand forecasting. Over the last decades forecasted demand has consistently been much higher than actual demand - it is expected that in 2021 the capacity to produce electricity will be over 36 GW whereas our demand will reach a peak level of 27 GW. This is a huge discrepancy – much more than in other countries. The bias to over-optimistic demand is one of the key causes of the overcapacity and as a consequence of the excessive payments being made by the government to the IPPs.

Are our demand forecasting models flawed? Presumably the Indicative Generation Capacity Expansion Plan, a fancy name for our demand forecast model, has all the tools and trappings available to determine demand accurately. In theory, it is a bottom-up model built up from estimates of potential demand provided by the different discos. In practice, it is more likely based on a simple heuristic model which extrapolates past trends using GDP as the pivot. In order to improve demand forecasting there is a need to drill down further to determine what makes our demand model process flawed and what can make it better. Questions that need to be asked include: do our discos have the capacity to provide appropriate input into the demand model; is electricity demand in Pakistan more volatile than other countries due to instability, whether macroeconomic or political; and is there an optimism bias in forecasting demand, driven by the political influences – after all given the history of power cuts in Pakistan, it would take a bold government to publically state that we wish to stop investment in electricity generation. Whatever the answers to these questions, it clear that we need to transition to more robust econometric models.

This is not just an academic exercise; it is sorely needed as the stakes are high.

The second key area meriting greater attention is the dismal performance of the public transmission and distribution companies. With regard to Discos, the Report has highlighted the main areas where change is necessary including ownership structure, reduction of distribution losses and theft, and the further breaking down of Discos into more manageable units. The focus on improvement of Discos in the Report is pertinent and directionally correct. It is expected that the Power Division will focus on this very important area for deeper review and more importantly, action. This will necessitate political and judicial will; significant policy and legislative changes; and strong implementation with focus on the devil which lies in the details. The government should also push ahead to fully privatise some Discos, several of which are inherently stable and sellable. About the transmission system, the Report quite rightly concludes that ownership and operation of the main transmission system should continue to rest with the government ensuring open access to all electricity suppliers and buyers. However, the Report does not set out any clear-cut strategy to enhance investments in the system.

The third area which needs further work is how to make a smooth transition of renewable energy into our fossil fuel dominated system. The report makes little mention of how this transition will be negotiated – perhaps not its mandate but crucial, nevertheless. The quickening pace and penetration of renewable energy, their intermittency and the resulting effects on our electricity system hardware will necessitate significant improvements and enhancements in our transmission/distribution systems and our electricity storage capabilities including a focus on making our grid smart, more reliable and resilient.  Advanced digitalization and an accompanying smart grid with demand response/management capabilities will be essential enablers. Demand response will reduce or postpone demand resulting in the reduction of investment in power plants. This focus is essential if we are to have renewables as a significant component of our energy mix. It will also be equally imperative to look at the planned competitive market structure and how renewables can adversely affect both the operations and profitability of conventional power plants which will still be needed to fill the gap when the sun isn’t shining and the wind isn’t blowing. Let us remember that energy storage for long durations is still not a viable option.

Lastly, it is of paramount importance that the momentum generated by this report is not lost and determined efforts made to implement the report findings and points of action. The IPPs have sent in a consolidated response to the Report a few days back. The responsibility for timely discussions, negotiations, a building of trust and final agreement rests on all stakeholders.

Muqtadar Quraishi has worked in the energy industry for over 30 years. He is currently a lecturer on Energy Economics and Energy Policy at Cornell University and University of California, Berkeley.

Daud Khan is a former senior United Nations official who now lives between Italy and Pakistan