In 1995, the 1,292 megawatt (MW), $1.6 billion Hub Power Project was hailed as an important precedent for the viability of private finance for a major infrastructure project in a developing country. No other low-income country had made private investments a cornerstone of its energy policy at that point in time.

This strategy was a reflection of hard economic realities: an unsustainable fiscal deficit, a serious balance of payment situation, and the inability of the public sector to finance investments needed to keep pace with power demand. The experience led Pakistan to adopt its first private power policy, under which the government contracted 3,400MW capacity with 19 independent private power projects (IPPs).

However, by 1998, the second Nawaz Sharif government had issued notices of intent to terminate 11 IPPs, representing two-thirds of private power capacity contracted, on alleged corruption and/or technical grounds.

The project sponsors accused the authorities of initiating excessive coercion, harassment and heavy-handed legal actions to renegotiate tariffs or cancel contracts, which “contributed to Pakistan’s fall from grace in the eyes of the international private sector community”, according to a 2005 World Bank Study, “Lessons from IPP experience in Pakistan”.

IPP sponsors claim that coercive tactics and threats of project cancellation are used in contract renegotiations to obtain tariff reductions

Most contracts were ultimately renegotiated, with an average decrease of 10pc in their levelised tariff. In exchange for these concessions, the term of their power purchase agreements was extended from 20 years to 30 years.

A similar exercise was repeated in 2021, which helped the government extract concessions worth Rs836bn over a period of 20 years from the IPPs set up between 1990 and 2013 in exchange for payment of Rs403bn it owed to them. Background interviews with senior executives of private power companies at that time suggested that the IPPs might have been coerced into agreeing to new power purchasing agreements.

They were unanimous in alleging that the government had used the Mohammad Ali Inquiry Committee report on the IPPs to build a case against the power producers and force them into signing new contracts. “This isn’t a deal. We were told to ‘voluntarily’ give these concessions,” one of them had said at that time.

The agreements covered 53 IPPs with a total capacity of around 8,000MW or nearly 23 per cent of the installed generation capacity. According to Tabish Gauhar, the then prime minister’s advisor on the power sector, the agreements with the IPPs would help reduce the circular debt stock, which stood at Rs2.3 trillion at that time, down to Rs1.9tr.

History didn’t stop repeating itself after 2021. Recently, similar coercive actions have reportedly been initiated against private power producers after a lot of noise was raised by a textile lobby against the IPPs. They have been calling for contract termination of IPPs or conversion to a take-and-pay mode without realising its legal and financial ramifications. The so-called “negotiations”, according to a Business Recorder report, are being conducted discreetly in Rawalpindi.

At least five IPPs — four developed under the 1994 power policy and one under the 2002 policy — have been asked by a task force backed by the powers that be to “voluntarily” terminate their power purchase agreements (PPAs) without any compensation.

A report in The News quoted one of the government negotiators as saying that if any of these IPPs don’t terminate their contracts, a forensic audit will begin immediately against them on allegations of wrongdoings. He contends that it will save the government Rs300bn in capacity payments to be made to them in the next three to 10 years, and consumers would get relief of Rs0.60 per unit or equal to Rs60bn in one year.

He further stated that another 17 IPPs installed under 1994 and 2002 policies have been asked to switch over to take-and-pay mode from the present take-or-pay mechanism. The same conditions will be applied to the government-owned power companies representing 52pc generation capacity, and their capacity payments will be reduced to the minimum level.

Another Business Recorder report suggested that the government is set to announce revised agreements with the IPPs featuring significant tariff reductions, implying that the project sponsor has given in to the pressure tactics of the task force. Background conversations corroborate this assumption.

“We have our families here; our other businesses are also in Pakistan. How can we resist coercion and pressure? The threat of corruption inquiries and public humiliation is enough for investors to give in to the pressure,” a 1994 IPP executive told Dawn.

The China-financed IPPs set up under the CPEC initiative do not constitute part of these tariff reduction negotiations as the government is separately trying to convince Beijing to restructure the $15bn energy sector Chinese loan.

The recent years of volatile political economy — large currency devaluation, high inflation, soaring interest rates and rising system losses throughout the value chain — have led to substantial spikes in generation costs, capacity payments and circular debt, driving up retail prices. On top of that, the massive reduction in electricity offtake due to the economic slowdown is rapidly driving up retail prices and capacity payments.

In the last fiscal year, for example, the total units of 0.13tr produced were almost half of the available capacity of 0.23tr units. This means that the capacity payment per unit would have plunged to Rs8.32 from Rs16.22, where the entire generation capacity of 28,286MW was utilised. In other words, the government could have obtained a tariff reduction of Rs7.9 per unit.

According to the industry estimates, even if the capacity payments of all 1994 IPPs are reduced to zero, the savings would be just 0.54 per unit based on the reference price and Rs0.85 per unit for the 2002 IPPs. The cumulative tariff reduction would be Rs1.39 per unit.

Moreover, the way the current negotiations are being done has created confusion and distrust. Sponsors claim that coercive tactics and threats of project cancellation are being used in attempts to obtain tariff reductions.

IPPs and sector analysts agree that the way the government is forcing power producers to agree to revise their contracts will have a long-term impact on investments in the power sector and other areas of the economy. If the past experience is anything to go by, the risk premium on investment in Pakistan will increase manifold.

The recent failure of the government to sell the 600MW solar IPP in Punjab is a reflection of a lack of investor interest in the sector. Only a consistent policy could guarantee future investments in the power sector and tariff reduction.

Published in Dawn, The Business and Finance Weekly, September 30th, 2024