Circular Debt in Power Sector

Indepent Power Producers Earned a Profit of Rs. 415 Billion Since 1994: Report

A report that makes startling revelations prepared by a nine-member committee headed by ex-chairman of SECP Mohammad Ali was submitted to the Prime Minister.

The committee was previously constituted by Prime Minister Imran Khan on August 7, 2019, to identify and examine the causes of the high cost of electricity, including a review of private producers, ways to resolve circular debt and inefficiencies in the transmission and distribution sector and suggesting a future road map for the power sector.

Power sector policies during the last two decades have enabled exorbitant profits to a select group of investors and encouraged de-industrialization by incentivizing higher capital allocation to a guaranteed and less risky power business said a report that’s shared with Prime Minister of Pakistan and is available with ProPakistani as well.

During this time, inefficiencies in the public sector generation and distribution companies were unfortunately tolerated by the federal government and NEPRA. The reform towards the goal of the ultimate privatization of ex-WAPDA distribution companies has been pending for more than two decades.

These companies have been corporatized with independent boards of directors, yet operationally this entire distribution sector worth Rs. 1,400 billion is being managed by the federal government.

The report stated that during the 30 years between 1990 and 2019, the dynamics in the global financial markets, as well as opportunity cost of investments and returns offered to power sector investors around the world, went through many changes.

In Pakistan, we remained stagnant in our offering of unjustifiably high guaranteed returns indexed to the US Dollar to investors, presumably in the hope of attracting foreign investment, said the report.

This is despite the fact that during this period there has been an improvement in the expertise and learning of the local pool of potential investors in the power sector. The federal government has continued taking responsibility for payment obligations of all costs and investments because of resistance against transitioning to competitive power markets. This is a classic example of the damage caused to the economy because of partial reform, maintained the report.

The committee divided its review over three parts and proposed an overall action plan consolidating its recommendations in the last section. This is followed by individual IPP-wise reports.

Accordingly, the report is divided into five main sections:

  • Review of Private Power Producers;
  • Circular debt and distribution inefficiencies;
  • Future roadmap towards a competitive market structure;
  • Implementation Plan;
  • IPP wise reports.

Under the 1994 Power Policy, 16 out of 17 IPPs invested a combined capital of Rs. 51.80 billion and have so far earned a profit of over Rs. 415 billion, having taken out dividends of over Rs. 310 billion.

Both numbers are understated since they are based on the 275 financial statements available with NEPRA and SECP out of the total 312 statements required, said the report, whose copy is available with ProPakistani.

The report stated that most of these IPPs had an investment payback period of 2-4 years, profits generated were as high as 18.26 times the investment and dividends taken out 22 times higher than the investment. Six companies earned an average annual RoE between 60-79% and four companies earned RoE of around 40%.

These profits are probably unheard of in any other sector, especially with such low levels of risk and guaranteed payments by the government, maintained the report.

Around 13 Residual Fuel Oil (“RFO”) and gas-based plants with a combined capacity of 2,934 MW were established under the Power Policy of 2002. During the last 8-9 years of operations, these companies have earned profits of Rs. 203 billion against their combined investment of Rs. 57.81 billion noted the report.

Even after adjusting for the debt component to arrive at the true profitability, the companies still earned Rs. 152 billion in profit and made dividend payments to the tune of Rs. 111 billion.

The individual profitability among these companies also varies, with some showing a much higher profit to investment ratio than others, with the average annual RoE as high as 87%, profits of around 9 times and dividends up to around 7 times their investment, stated the report.

A review of the profitability of two imported coal-based plants established under the Power Policy of 2015 shows that one of them has already recovered 71% of investment in only two years of operations and the other plant has already recovered 32% of its investment in the first year.

These plants have been offered USD Internal Rate of Return (“IRR”) of 17% which works out to USD RoE of 27%. Due to rupee devaluation against USD in the last two years, their Rupee RoE today stands at 43%

Excess Profitability on Account of Misrepresentations

The report also points out:

  • A significant percentage of these profits have been earned on account of misreporting by the generation companies while seeking tariff from NEPRA.
  • Misreporting by the generation companies while seeking a tariff adjustment at the time of commercial operation date (CoD).
  • In the case of IPPs, established under the power policy 2002, it is found that a major component of excess payment to the IPPs was on account of the actual fuel consumed to generate the electricity being less than the payments made by the purchaser instead of the use of such electricity. Similarly, actual O&M expenses incurred by the producers were less than the payments received under this head.
  • Total excess payments made under these and other heads works out to Rs. 64.22 billion during the last nine years with expected future excess payables of Rs. 145.23 billion during the remaining years of operations bringing the total excess payments of Rs. 209.46 billion to these plants.
  • RFO based IPPs, NEPRA had approved their heart rate based on information provided by the respective IPPs. The actual heat rate was submitted by one of the IPPs which has consistently operated at a high-efficiency level than those submitted to Nepra.
  • The report also highlighted saying that the O&M component of the tariff was based on the estimates provided by the IPPs, which was consistently higher than the actual expenses incurred and this also holds in case of most of the IPPs.
  • Excess set-up cost of Rs. 32.46 billion was allowed to the two coal-based plants due to misrepresentation by sponsors regarding interest during construction (IDC) as well as non-consideration of earlier competition of plants by NEPRA. These plants were completed within 27 to 29 months.
  • IDC was allowed for 48 months as a result, one of the plants, Huaneng Shandong Rule (Pak) Energy HSR, commonly known as Sahiwal Coal power plants, was entitled to an excess RoE of USD 27.30 million in an annual payment of return which is indexed to USD and will be made every year over the entire project life of 30 years. If a 6 percent annual Rupee depreciation is assumed, the excess payment over the project life has been worked out to a total of Rs. 291.04 billion.
  • Under the 2013 framework for coal generation, eight bagasse-based power plants were set up with a total capacity of 254MW. At the time of tariff determination, the Pakistan sugar mills association reported a net annual plant capacity factor (NAPC) of 45 percent, which was used by NEPRA to recover the fixed cost in tariff determination. However, the bagasse power plants under review were operating at higher than 45 percent NAPC and were, therefore, being paid for a fixed cost, and debt payment which was higher than their actual expense and liability and this has led to excess payments of Rs. 6.33 billion to the four baggage power plants so far.

The report has also recommended to the government to shift the base tariff for IPPs from US dollars to Pakistani rupee and finish ‘take or pay’ contracts and start the move for taking and paying contracts. It also recommended the establishment of a Commission for Forensic Evaluation and Legal Audit of all IPPs.

The committee has recommended the government to consider the retirement of GENCOs, as well as IPPs that was established as per the 1994 and 2002 power policies. About the menace of circular debt in the power sector, it also asked for one-time absorption of circular debt stock to the public debt, ensuring it is linked with quantifiable and accountability mechanism whereby future savings due to reduced cost of generation and other measures outlined in this report are used to pay back this one-time payment.

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