Pakistan's Energy Sector Crippled By Circular Debt

Pakistan's Energy Sector Crippled By Circular Debt
In response to a news report that the Oil and Gas Regulatory Authority (OGRA) has recommended an increase of up to 74% in the price of natural gas, Shahid Mehmood, Research Fellow at the Pakistan Institute of Development Economics, tweeted that the real problem in Pakistan’s energy sector is the volume of circular debt, which is a political issue and largely unrelated to pricing.

“Pricing is a small component of circular debt, there are other issues like transmission and distribution losses, a lack of timely adjustments in the face of price changes, theft, leakages and an endemic lack of investment in infrastructure,” tweeted Mehmood.

Mehmood suggests that what we routinely refer to as ‘circular debt’ is “basically a cash flow problem within the power generation and distribution” system.” The energy system as it is currently set up does not have the capacity to run as intended without taking on massive debt, and the Rs 2.5 trillion in debt on the books “can be traced to the last years of General Musharraf’s rule.”

Mehmood claims that as oil prices rose globally, Musharraf was also losing popularity at home owing to the Lawyers’ Movement. Pakistan’s electricity production was heavily dependent at the time on furnace oil, particularly during the winters when hydroelectric generation capacity is significantly diminished. To improve the PML-Q’s chances of electoral victory, Musharraf refused to pass on the increases in energy costs on to end consumers, and instead levied a subsidy to keep prices artificially deflated.

This meant that electricity was being sold to consumers at prices much lower than the costs that were being accrued in production. This untenable state of affairs was being sustained through suppliers and producers taking on massive debt from commercial banks, which the government promised to shoulder the burden of. This debt has accumulated over the years, and governments have struggled to pay it back since. This is the vicious cycle in Pakistan’s energy markets.

While OGRA had recommended adjustments in the price of natural gas to the gas distribution companies last year in July 2022, the PDM – already losing popular support - did not approve. Now however, the politicians have no choice left: the IMF is forcing the government to pass on price increases to consumers, without which the next tranche of the program will not be released.

Mehmood argues that had price increases been passed on to consumers last year, consumers would have been incentivized to conserve gas and use it sparingly during the winters. The unintended repercussion of this untimely adjustment is that billions of rupees of additional circular debt have built up within the natural gas market, which have to be “paid through taxpayer money.”

The energy system in Pakistan is also plagued by some of the highest transmission and distribution (T&D) losses in the world, close to almost 18%. The infrastructure for energy transmission and distribution requires diligent maintenance and constant upgrades, which in turn require investments from the distribution companies. The gas and electricity distribution network in the country is owned largely by the federal government, with the exception of K-Electric, which has ultimately meant that there has been little to no investment in the maintenance of the power distribution infrastructure.

With 18% of the country’s electricity being wasted through transmission losses, “it is counterintuitive and absurd to believe that merely raising prices will solve the issue,” suggests Mehmood. Transmission and distribution losses are measured in nominal terms, so raising the unit price of power will cause a simultaneous increase in the monetary value of losses.

Theft and the non-payment of bills are an endemic problem in the power sector. Mehmood attributes the failures of the system to the federal and provincial governments, where he claims that the entire organizational structure of power generation and distribution companies – from the “SDO to the lineman to the meter reader is corrupt to the core.” Mehmood suggests that it is a common practice in areas with high losses for consumers to “pay meter readers a fixed amount per month to report lower readings.”

He adds that numerous government organizations do not pay their bills, and government owned power sector companies, and their regulators NEPRA and OGRA, are “dumping grounds for retired bureaucrats, generals and politically favored appointees.” This system of patronage and nepotism is supplemented by the myriad complications involved in the perennial expansion of power grids under the guise of “development schemes.”

Mehmood concluded by arguing that the government needs to remove itself from the energy sector, suggesting that privatization and market incentives might be part of the solution to Pakistan’s energy related circular debt woes.