Here’s How Reduction in Circular Debt Will Impact IPPs, E&Ps, and OMCs

In a positive development, the government is inching closer towards a settlement with Independent Power Producers (IPPs) concerning the downward revision in their returns against the release of power sector circular debt.

The brokerage house, Topline Securities, released a report on the partial payment of the circular debt, explaining how it will impact IPPs, exploration and production companies (E&Ps), oil marketing companies (OMCs), and others.

The brokerage house also believes that the recent tariff hike is likely to work positively, but other long term measures are also required.


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The government is contemplating increasing the power tariff by 30 percent over a period of time, which can improve the liquidity of the sector by Rs. 400-550 billion (equal to annual shortfall), assuming annual power demand of 110 billion Kwh, the report noted.

The shortfall should expand if international oil prices trend up from here. Therefore, a more sustainable option would be to address issues concerning transmission and distribution (T&D) losses, recoveries, unbudgeted subsidies, and delayed tariff adjustments, the report recommends.

These T&D losses and recovery shortfall, together named as Aggregate Technical and Commercial losses (AT&C), is a figure which contributes approximately 40 percent to total circular debt. Delayed tariff adjustments and unbudgeted subsidies make most of the remaining part of this ever-accumulating debt.

Topline research says, “Ensuring 100 percent recovery (current 90-92 percent) requires political will and it is also doable in the short-term, however reduction in T&D losses would require a heavy investment which will also take time.”


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The privatization process of distribution companies (DISCOs) will also be pivotal, as seen in the case of K-Electric, which has reduced its T&D losses from 36 percent in FY09 to 20 percent in FY20.

Another important factor highlighted by this report is that the inefficient IPPs or those close to the expiry of their power purchase agreements are likely to benefit from the measures taken recently towards this circular debt.

“From shareholders perspective, we believe this settlement cycle will be relatively more beneficial for those IPPs which are least efficient or whose Power Purchase Agreement (PPA) is set to expire in the near future,” stated the report. The report further pointed out the IPPs, Lalpir (LPL) and Pakgen (PKGP), fall on lower merit order (relatively inefficient) of National Transmission and Dispatch Company (NTDC), while the PPA of the Kot Addu Power (KAPCO) is expiring soon.

The report recommends the government follows a merit order in deciding which plant to run. The report further states that future working capital requirements of inefficient plants would be lower, and thus, their payouts may remain higher.

Topline also predicts that the cash flows of the Pakistan State Oil (PSO) and other holding companies will improve due to the reduction in circular debt.


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PSO received around Rs. 60 billion and Rs. 22-23 billion from Energy Sukuk I and Sukuk II, which were of Rs. 200 billion each. PSO receives amounts from generation companies (GENCOs), Hub Power Company Limited (HUBC), Kot Addu Power Company (KAPCO), and Sui Northern Gas Pipelines Limited (SNGP).

“We believe that PSO based on previous settlement ratio can receive [an] amount in the range of Rs. 20-30 billion from the first installment,” Topline said.

Holding companies of listed IPPs are largely Nishat Chunian Limited (NCL) and Nishat Mills (NML). Regarding these, the brokerage house expects that NCL and NML can witness higher cash flows due to higher net balances of Nishat Chunian Power Limited (NCPL), Nishat Power Limited (NPL), Lalpir Power Limited (LPL), and Pakgen Power Limited (PKGP).

NML holds a 51 percent stake in NPL, a 29 percent stake in LPL, and a 28 percent stake in PKGP. NCL holds a 51 percent stake in NCPL.

Another major issue in the energy chain is the gas sector circular debt, which arises due to recoveries below cost in both natural gas and RLNG segments, stated the report.

The annual pileup of circular debt in the gas sector is around Rs. 100-120 billion, while the total has crossed Rs. 300 billion. During 9MFY20, SNGP’s differential amidst RLNG has increased by Rs. 27 billion (full-year estimated at Rs. 40-50 billion). In FY21, it is also expected that due to the diversion of RLNG to residential consumers, the shortfall will increase by Rs. 60 billion alone in winters.

On the natural gas side, the overall cost of gas procurement largely equals the price of natural gas. However, OGRA did not allow a Rs. 85.5/mmbtu hike in natural gas in FY21 petition after turning down/postponing treatment of late payment surcharge (LPS).

Topline believes, going forward LPS will be accounted into tariff (given the past practice) and natural gas may also contribute to circular debt. As a result, gas (RLNG plus Natural gas) circular debt may also prevail unless a hike in gas price is announced or the weighted average cost of gas (WACOG) is announced.

The report further added that OGDC and PPL are affected by the gas sector circular debt and their receivables on account of circular debt have touched Rs. 286 billion and Rs. 90 billoon respectively.

In the last Energy Sukuk (II), both companies received Rs. 6.5-7.0 billion each, indirectly through IPPs.

“We expect a release of the amount in the same run rate during the current settlement cycle, which may not provide significant upside to cash flows,” stated Topline Securities.

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