PAKISTAN has faced perennial loadshedding and frequent power outages over the past three decades. A high demand growth rate has seen supply lag far behind. And the state utilities suffer immensely from non-payment of dues, transmission losses, under-investment, circular debt crisis, and inefficiencies of manpower and plants.

The government initiated reforms in the early 1990s by opening up of private investment in thermal power generation. This was followed by reforms of the two state utilities: KESC privatisation and unbundling of Wapda.

This article attempts to establish how the Independent Power Producers (IPP) thrived in this environment and what pitfalls could have been avoided.

In the late 1980’s and early 1990’s, Pakistan’s total installed capacity (consisting only of Wapda and the KESC) hovered around 10,800MW. A burgeoning population coupled with robust economic growth reflected by an average GDP annual growth rate of seven per cent in the 1980’s (see Figure 1) brought about a sharp increase in overall electricity demand. It proved to be a severe strain on the existing power capacity with an estimated 2,000MW peak load shortfall. Widespread and unannounced loadshedding became common in most cities and villages. Electricity was effectively available to only 40 per cent of the population.

To meet the shortfall, the late Prime Minister Benazir Bhutto launched the 1994 Power Policy to attract IPPs. A number of incentives were offered to investors including long-term Power Purchase Agreements (PPA) containing GOP (government of Pakistan) sovereign guarantees for the payment obligations of the buyers (Wapda and the KESC). This comprised guarantees for the fuel supply obligations of the state fuel companies, a reference levelised bulk tariff of 5.6c/kWh (based on 60 per cent capacity) allowing pass-through of fuel and capacity costs, an 18 per cent real return on equity, indexations of variable cost elements (fuel price, foreign exchange rates, inflation), exemption from corporate income tax and other duties, and uninhibited repatriation of dividends.

In addition, the Private Power Infrastructure Board (PPIB) was created to act as a one-window face of the GoP to facilitate potential investors and IPPs. An overwhelming response was received from reputed international and domestic investors.

The 16 IPPs that were commissioned from 1997 to 2001 had a total installed capacity of almost 6,000MW (see Table 2). A total of $5.3 billion was invested, with the World Bank Group having part-financed 11 of the IPPs.

In the adverse perception of Pakistan’s politico-economic climate, this achievement indicates the attractiveness of the terms of the offer. The 1994 Power Policy was widely acclaimed, and even described as “the best power policy in the whole world” by the US Secretary of Energy while visiting Pakistan in 1994.

Most of these thermal IPP power plants were based on Residual Fuel Oil (RFO) while only a few on the cheaper and more efficient gas due to domestic gas reserves being insufficient. International Power of UK (formerly National Power) had controlling stakes in the two biggest IPPs: Kapco (1,638MW, 36 per cent shareholding) and Hubco (1,292MW, 20 per cent shareholding). Kapco was created through the divestment of Wapda’s shares to National Power of UK in 1996, with Wapda retaining a 44 per cent shareholding. The shares of both IPPs are also publicly listed and traded.

The timing of the commissioning of this new wave of IPPs did not prove to be the most ideal. The 1997 Asian economic crisis hit the economy hard, with a detrimental effect on industrial electricity demand in particular. The first ever nuclear tests in 1998 led to stringent economic sanctions by the West, mainly driven by the United States.

The multiple setbacks to the economy greatly affected the power demand, coming on top of the excess capacity being generated after several IPPs had started to get commissioned in the late 1990’s. The obligations of Wapda and the KESC to pay for a minimum 60 per cent capacity to the IPPs under the PPA contractual terms, irrespective of the actual utilised capacity, severely affected the state utilities’ cash flows. Indexation of tariff had allowed the tariff to rise 87 per cent over the reference bulk tariff between 1994 and 1998, due to inflation, significant rupee devaluation, and rising prices of the predominantly imported furnace oil. Pakistan found itself in the unusual situation of having to pay for expensive electricity that it did not need.

The state utilities, facing severe liquidity crunch, defaulted on their payment obligations to IPPs. While allegations of kickbacks and corruption surfaced against the previous government for signing with the IPPs without having solicited competitive bids, subsequent government’s mismanagement of macroeconomic policies and Wapda’s inefficiencies also had a detrimental effect on electricity tariffs.

With the low confidence in the economy and the government having frozen foreign currency accounts after the nuclear tests, the rupee rapidly depreciated and foreign currency reserves nose-dived. An inability to raise direct taxes induced indirect taxes via surcharges on various petroleum products, causing furnace oil prices to escalate.

Wapda continued to offtake lesser electricity from the more efficient IPPs (on average less than 50 per cent of their capacity), preferring its own older and less efficient plants under the debatable assumption that they were less expensive.

This is also a classic example of how integrated monopolies can utilise the system to their advantage, using leverage in transmission and distribution to quell competition upstream.

A major critique of the 1994 Power Policy involved the non-competitive nature of the bids that had led to perception of favouritism towards the selection of certain projects. The PML government created a revised Power Policy in 1998, with international competitive bidding as an integral part of private power development and a focus on indigenous coal and hydroelectric resources for power generation.

The government then set out to aggressively renegotiate the existing tariffs, and issued Notices of Intent to Terminate to nine IPPs on corruption and technical grounds. Strong-arm tactics were used and criminal and civil cases were lodged and pursued with intent.

Wapda used delaying tactics to push ahead the commissioning date of the new IPPs, which would have triggered its payment obligations. Finally, after over two years of protracted negotiations between Wapda /GoP and the IPPs, the tariffs of 12 IPPs were renegotiated downwards to a level ranging from 7-16 per cent. The legal cases were withdrawn and the much-delayed IPPs finally started to get commissioned.

During all this time, Pakistan’s perception as a safe investment destination took a hammering. The fact that the 1998 Power Policy had virtually no success in attracting private investment was hardly a surprise.

The government in its eagerness to go after the IPPs may have forgotten that a perennially capacity-short country like Pakistan can ill afford to attract private power investment without the help of an investment philosophy that protects the financial risks of the investor. This is especially true if the market is not liberalised, and the existence of vertical monopolies requires assurances from an investor’s point of view.