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Debunking myth surrounding capacity payment to IPPs.


One may remember a time when the nation was faced with endless hours of power outages, and the local industry had begun to wrap up operations and move overseas. Friends would exchange load shedding schedules first before planning visits. Everyone seemed to have an opinion then, as everyone does today. Seeing as we no longer face this problem to the same magnitude, people with or without understanding of the issues have now moved their focus onto Capacity Payment and Independent Power Producers (IPPs), again.

Everyone seems to know exactly, albeit mistakenly, what is wrong with Capacity Payment to IPPs this year. This is the new fad, IPPs are the new villain. Usually, there is nothing wrong about new fads, though. Let us entertain the concerns of the people with a reasoned discussion. First, we need to understand where the problem began and why these IPPs were set up to begin with.

At the time of independence in 1947, Pakistan started with a power generation capability of 60MW for a population of 31.5 million, yielding 4.5 units per capita. Whereas, with the creation of the Water and Power Development Authority (WAPDA) in 1959 this capacity increased to 119MW. In 1964-65, the electricity generation capability rose to 636MW.

Unfortunately by the 1970's, Pakistan was yet again faced with the acute shortage of power, which continued to worsen in the years to follow. In 1978, Karachi Electric Supply Company (KESC) was granted the license to generate and distribute power in their assigned areas. The government of the time then decided, with the help of multilateral financial institutions, to co-opt the private sector via a policy package with a marketable and enforceable contractual framework acceptable to leading international investors.

To achieve that goal, both local and international investors were invited to set up power generation plants in the IPP format, which was understood to be the most developed power project development and operations format. In order to convince these investors to empower an uncertain economy with no history of absorbing such a sizeable quantum of FDI, they were granted guarantees and de-risking initiatives under a two-part tariff regime i.e., energy payment and Capacity Payment. This was and is a standard IPP payment structure found in numerous other IPPs around the world. The Capacity Payment Mechanism is a fixed revenue stream for an IPP offering generation capacity and availability. At its core, the mechanism features a fixed 'pot' of money which is determined through the tariff table, and is calculated at the time of project agreement with the power purchaser after tariff determination by the regulator, NEPRA.

However, these payments, to cover capital, its costs, and some other fixed costs, are only available to the IPP if it is 'available' and ready for generation under pretty standard protocols. IPPs are, however, only eligible for payment if they are 'available' for generation. These payments are used to cover capital, costs, and other fixed costs. If an IPP is unable to abide by these conditions, it is subjected to liquidate damages payable to the power purchaser.

According to the Private Power and Infrastructure Board, Pakistan nearly has 30 or so active IPPs, with an overall installed capacity of about 7,410MW, largely thermal power projects. Other power plants also operating within the private sector include Kot Addu Power Company (1,638MW) and K-Electric power plants (2,341MW). There have been more than 80 IPPs in Pakistan, including wind and solar IPPs.

As per recent press reports, the Senate Standing Committee on Power was informed of Capacity Payment to the tune of Rs. 664 billion in 2017-2018 to the IPPs. These press reports also state that IPPs were guaranteed 17% rate of return. The senators were justifiably unhappy when informed that the return in some cases was '40%', as calculated from their accounts. But only if this was true.

Let us look at some basics:

Firstly, IPPs are only eligible for capacity payment if they are 'available' and ready to produce power. Moreover, IPPs can only sell electricity to government owned power purchaser and to no other entity. Therefore, a host of measures are put in place in an attempt to safeguard the investor and to ensure transparency over the life of the contract, 20 - 30 years.

Secondly, these calculations for return on capital are done over the life of a project agreement. For instance, the rate of return for a project that, in a 25 year contract, needs to be calculated based on those 25 years rather than on a per annum basis at a random point in time. These parameters are agreed to in writing at the time of the agreement and are binding on all. These terms and conditions can only be amended by mutual consent of the parties in writing. The Government of Pakistan signed the agreements when they were in dire need of assistance, but as the situation has now settled they cannot seem to strike a balance. Thirdly, like any other major investment into a country's infrastructure, there need to be safeguards against known risks. It is common practice around the world to use Capacity Payment, as an element of a two-part tariff structure, and investment security frameworks for key infrastructural projects like IPPs, ports, toll highways, transmission lines, etc.

Given the current domestic scenario and the series of statements and hearings, it would not be incorrect to say that IPPs are indeed being subject to a lot of scrutiny, again, if not outright political victimization. It is therefore imperative that we understand the fundamentals behind the mechanisms for Capacity Payment and IPP policy before we decide which side of the argument we stand.

Power shortage has been subdued quite a bit in comparison to the 1990's. It now takes a smaller toll on the country's productive capacity and infrastructure, and that is in large part to do with IPPs. The role of IPPs can certainly not be downplayed as their long term stake in the economy has been pivotal in realizing the country's economic potential, and has greatly improved its standing. If the country still suffers, it will not be on account of lack or shortage of power.

The fault, therefore, is not in IPPs. The fault is in the sinking rupee, in losses at Distribution Companies (DISCOs), and the piling payables of the Government of Pakistan and other government owned entities. We must focus on where the problem is and where the counterparty is keeping its end of the agreement.
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Publication:The Nation (Karachi, Pakistan)
Geographic Code:9PAKI
Date:Aug 7, 2019
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