Challenges of ‘Mainstreaming’ Renewable Energy in Pakistan’s Generation Mix
This article does not claim to be academic work which follows the same rigorous and uncompromising standards of accuracy, analysis and reasoning of research scholarship, but an article addressed to the public at large who wish to learn more about Pakistan’s experience with clean energy to date. The contents of this article, particularly the ‘Recommendations’, are intended to spark debate amongst readers in accordance with the objectives of ‘Green Energy’. Feedback and constructive comments are welcome.
What is the urgency in developing environmentally friendly energy generation?
Although Pakistan has added more than 7,000 MW installed capacity to the grid since 2013, the growing population and the demands of rapid economic development including urbanisation mean that Pakistan will need an additional 40,000 MW by 2035. Studies have estimated that such additional capacity would require capital investment of approximately US$6 billion per year until 2035.
How does Pakistan compare with other nations in developing its renewable energy sector?
Pakistan has a mixed history when it comes to the development of its renewable energy (RE) sector. Currently, renewable technologies (solar, wind, bagasse, but excluding hydroelectric plants) account for only 4.5% of the total electricity generation capacity in Pakistan. When this is contrasted with other countries, Pakistan lags far behind. California, USA has recently pledged to make its electricity generation carbon-free by 2045, and its current renewable capacity aggregates 40% of total electricity generation. Denmark, Finland and Netherlands generate more than 40% of their electricity from renewable sources. Even India has pledged as part of its climate change commitments under the Paris Agreement on Climate Change in April 2016 to deploy an additional solar power of 100 gigawatts by 2022, which is equal to more than half of all solar capacity installed worldwide in 2014.
So is Pakistan stalling in developing its RE industry?
Politically, Pakistan has always claimed to champion environmental protection initiatives. According to local news reports, Pakistan played a leading role in the climate change negotiations culminating in the Paris Agreement and last year the legislature passed the Pakistan Climate Change Act, 2017 to implement its obligations thereunder. The 2017 Act requires the formulation of climate change mitigation and adaptation measures as well as policy initiatives to limit carbon emissions. The 2017 Act provides for the establishment of a high-level political decision-making body, the Climate Change Council, to be chaired by the Prime Minister and comprising of the Chief Ministers of all provinces to supervise the implementation of the 2017 Act, and a technical Climate Change Authority, to establish policy measures and strategies to implement Pakistan’s obligations under international agreements and formulate energy efficiency, conservation and renewable energy plans. Despite such vocal pronouncements on fighting climate change, the Climate Change Authority has yet to be established.
Within the energy sector proper, Pakistan lacks an integrated long term plan to reform power sector organisations, hampering steps to develop a renewable energy sector. State-run institutions particularly distribution companies (DISCOs) require extensive management and governance reform. This state of affairs has led to malais and ad hocism in energy generation, resulting in energy planners meeting urgent power demand through plants run on imported fossil fuels such as furnace oil, coal and liquefied natural gas (LNG). Thermal plants, having relatively shorter construction periods, are tried and tested technologies in Pakistan and involve fewer risks for investors, therefore they are easier to develop and finance than ‘first of a kind’ technologies in Pakistan like solar and wind plants.
What is “circular debt” and how has it affected development of the RE sector?
Poor governance of state-run institutions and lack of political will to diversify the fuel mix for energy generation has contributed to a phenomenon known as ‘circular debt’, a term which is used almost as frequently these days as ‘load-shedding’ was in the dark decade from 2003 to 2013. Circular debt is a serious problem affecting the reliability of electricity supply to consumers and industry, and putting in jeopardy the financial sustainability of the electricity sector. According to the Senate Report of the Special Committee on Circular Debt authored by Senator Shibli Faraz in August 2018, circular debt first emerged in the distribution sector in 2007 following the shift from low-cost hydel generation to high-cost thermal generation based on imported furnace oil.
The use of imported fuel made DISCOs vulnerable to fluctuations in the international petroleum prices and depreciation of the Pakistan rupee, as the increase in the fuel cost paid by independent power producers (IPPs) was passed on in the supply chain to DISCOs. Due to political reasons, the higher generation tariff was not passed on to end-consumers, leaving DISCOs unable to recover fully the cost of electricity paid to IPPs, which in turn caused DISCOs liquidity problems when paying for the electricity supplied by IPPs, resulting in the emergence of “circular debt”.
As touched upon above, the main risk of circular debt for developers and financiers is that they may not get paid on time or at all by cash-strapped DISCOs. The latter is represented by Central Power Purchasing Agency Guarantee Limited (CPPA-G), a company owned by the federal government which procures power on behalf of DISCOs from IPPs. When CPPA-G on behalf of DISCOs fails to pay for the electricity supplied by the due date prescribed in the purchase agreement, or at all, IPPs face difficulties in making onward payments to their fuel suppliers and lenders. This negatively affects the risk profile of new generation projects for prospective investors, and even where developers and financiers are willing to participate in a project, they are likely to demand higher tariffs from CPPA-G than similar plants in other countries to compensate for the higher risks of non-payment.
This has had a devastating effect on investments in ‘first-of-a-kind’ technologies such as renewables, even though RE plants based on wind and solar do not contribute to the problem of circular debt because there is no imported fuel cost.
Many potential investors have been discouraged from investing in RE plants due to circular debt. Therefore until the root causes of circular debt are resolved, the country will find it difficult to attract sufficient levels of private investment to scale up RE generation capacity to levels at par with other countries and at tariffs which are cost-effective for distribution companies and consumers in Pakistan.
What specific steps has the government taken in promoting RE generation ?
There is no doubt the fossil fuel industry has benefited from successive government policy incentives. Under the latest 2015 Power Policy, coal plants including those under process will provide a total installed capacity of 12,163 MW. Plants fuelled by gas/regasified LNG will total 12,626 MW, when all those currently under development are completed. Of this almost 5,000 MW will be derived from RLNG plants developed between 2016 to 2019. By way of contrast, during the same period, total electricity from RE plants will only total 5,153 MW (of which wind constitutes 2,457 MW, solar constitutes 1,612 MW, and bagasse constitutes 1,084 MW). 20,676 MW is expected from hydro plants, however, not all of this may come to the grid in view of the extensive technical and financial prerequisites required for commercial operations.
Having said this, it would be untrue to state that good faith efforts to promote RE generation have not been made by successive governments. As early as 2006, the federal government introduced a detailed policy framework dedicated to increasing RE generation capacity in the country’s electricity mix. The 2006 Policy for Development of Renewable Energy is a very comprehensive document which ticks all the boxes when it comes to setting out a long-term integrated policy framework for development of a robust and sustainable renewable energy industry. Progress is divided into three phases:
- Medium-Term, and
These phases set out timelines for investors to begin construction of RE plants to avail the benefits offered or to be offered in the relevant phase.
The 2006 RE Policy is administered by a federal body, the Alternative Energy Development Board (AEDB), to provide a dedicated one-window-facility to facilitate private sector developers and financiers in accordance with the conditions set out in the 2006 RE Policy.
The 2006 RE Policy sets out a generous package of incentives for the Short-Term phase including attractive power purchaser tariffs, tax breaks and liberal risk cover for development of RE plants to “enable a reasonable generation capacity to be installed as ‘first-of-a-kind’ RE projects in the private sector that can serve as successful business and technology-assimilation demonstrators”.
For the Medium and Long-Term phases, the 2006 RE Policy envisages a gradual shift from the lenient policy measures and hand-holding of projects into commercial operations of the Short-Term phase to more competitive prices for sale of RE power (ie. lower generation tariffs), reduced tax benefits and risk cover. It also foresees the development of a local manufacturing industry and service base for RE technology, equipment and infrastructure (e.g. wind hubs and rotors for wind and solar panels). Detailed policy guidelines for the Medium-Term and Long-term phases including the incentives and benefits for investors are, however, left to be formulated by the government at a later stage. The policy guidelines were never formulated and the 2016 RE Policy expired in 2017 without being extended by the then government.
Until 2017, progress in implementing the 2006 RE Policy had been slow. Projects of total installed capacity of only 5153 MW had been completed or were under development. In fact, investor interest in solar and wind projects only picked up in 2014, over 8 years after the 2006 RE Policy was introduced following the introduction of an ‘upfront tariff’ (or feed-in tariff as the term is recognised globally) by the power sector regulator, National Electric Power Regulatory Authority (NEPRA).
What is an upfront tariff and why did this attract investor interest?
Tariffs charged for the sale of electricity by IPPs to DISCOS, as well as DISCOS to end consumers are determined through the issuance of a tariff determination by NEPRA and notified to the public by the federal government. The tariff only becomes effective on such publication. The 2006 RE Policy allows for three methods of determining tariffs:
- Direct negotiations between CPPA-G on behalf of DISCOs and the IPP for a cost-plus tariff. The tariff is based on the cost incurred by the IPP in constructing the plant and producing electricity sold (including the servicing of loans) plus a rate of return to its equity investors. The negotiation cost-plus method only applies to direct or unsolicited proposals submitted by proposed IPPs to AEDB. The IPP will submit a proposed tariff in a prescribed format (referred to as a Tariff Petition) together with its calculations and evidence, amongst other matters, for its estimated project cost (including details of construction and supply contract(s)) for approval by NEPRA. After reviewing this and a public hearing attended by the IPP and other interested parties, NEPRA will issue a tariff determination. During the course of the project, the determined tariff rate will be adjusted and subject to allowed indexations to take into account inflation, changes in fuel price (if any) and the foreign currency exchange rate (if loan repayments or payments to contractors are required to be made in foreign currency) so that during the long-term electricity supply agreement with CPPA-G (typically 20-25 years) the tariff will remain financially viable for the IPP.
- Upfront Tariffs set by NEPRA. The Upfront Tariff is an indicative rate at which electricity can be sold by the IPP to DISCOs based on the technical and financial parameters for the generation plant such as total installed capacity, technology, fuel source, cost of servicing its loans and return on shareholders’ equity, subject to certain allowed adjustments and indexation similar to those available under the cost plus tariff regime. The Upfront Tariff is open to acceptance by an IPP within a prescribed time frame after being issued by NEPRA.
- Competitive bidding after solicitation of proposals by AEDB for a power generation facility at a specific location and prescribed generation capacity, fuel source and technology after a feasibility study is approved for the project.
The first Upfront Tariffs for wind and solar determined by NEPRA in 2014 were set at high rates compared with tariffs in other countries for similar plants as contemplated for the Short-Term phase in the 2006 RE Policy, and accordingly attracted strong investor interest from both local and foreign entities. Successive Upfront Tariffs, however, gradually reduced the tariff rates. For example, the first Upfront Tariff determination issued in January 2014 for solar plants was set at approximately 17 US cents per kWh of electricity when the international norm was 10 cents per kWh. By the issuance of the third Upfront Tariff in 2016, the rate had gone down to approximately 11 US cents per kWh. NEPRA’s justification for the drop was that the cost of RE technology had rapidly decreased in the international market and so the project costs had fallen.
Investor interest further nosedived a year later when NEPRA issued Tariff Determinations in 2017, dated 27 January 2017 and 3 March 2017, determining that it would not henceforth issue any further Upfront Tariffs for wind and solar respectively, and all projects which had not accepted earlier Upfront Tariffs could only be implemented through competitive bidding. AEDB was directed to initiate a reverse bidding process by preparing the relevant bidding documents for approval of NEPRA within an unusually long timeframe of 12 months. In the case of wind projects, NEPRA even set a benchmark tariff of approximately 7 cents per kWh (meaning that a bid must be less than 7 cents per kWh to be considered) which was nearly half the rate set in the last Upfront Tariff, and 3 US cents less than the global average for wind plants.
Developers as well as provincial governments in which the RE projects were proposed to be located, claimed the sudden change in policy would render further investment in ongoing projects without an approved tariff uneconomic. Whilst investors were still entitled under the NEPRA Rules to apply for tariffs on cost-plus basis (the tariff regime described at (i) above), they argued this regime was cumbersome and exposed project development to uncertain and lengthy delay, making it difficult to lock-in favourable prices with contractors for construction of plants.
Based on the above course of events, it is clear that a sound policy framework promoting renewables is not worth much to potential developers unless implemented by proactive and responsive regulator and government agencies. It is a challenge for developers to finance RE projects in view of the economic, political and governance challenges affecting Pakistan’s power sector, however, without clear, predictable and efficient government and regulatory decisions and actions which implement the declared policy framework, it will be impossible to attract the required levels of investment to scale up the RE sector in the future.
To be fair NEPRA and AEDB are well resourced institutions in the energy sector in terms of their capacity, expertise, and institutional memory. Until the 2017 Tariff Determinations they had been widely applauded for efficiently promoting the RE sector. So what were the reasons for the U-turn?
The federal government, until 2018, had frequently expressed its displeasure at NEPRA tariff determinations and at times the delayed official publication rendering the tariff ineffective. In hearings held prior to the issue of the 2017 Tariff Determinations, the Ministry of Water and Power (MOWP) and CPPA-G (on behalf of DISCOs and the federal government) strenuously argued that the Upfront Tariff regime was no longer economically feasible for DISCOs, implying it would contribute to the circular debt problem. In 2017, the federal government initiated steps to amend the NEPRA Act reducing NEPRA’s autonomy by requiring NEPRA to determine rates in accordance with a national electricity plan and guidelines formulated by the federal government. The amendments to the NEPRA Act were subsequently passed in 2018.
These actions undermined NEPRA’s independence and autonomy, ultimately pressurising it to issue the 2017 Tariff Determinations ending the Upfront Tariff regime for solar and wind.
As mentioned earlier, since there is no fuel cost for renewable energy, CPPA-G and MOWP’s argument was disingenuous at best. Most observers believe the real reason the government halted the growth of the RE sector mid-stream in disregard of the 2006 RE Policy objectives was related to the then elected government’s pledge in 2013 to end within its 5-year term the back-breaking load-shedding inherited from its political predecessor. It had also entered into certain long-term LNG supply contracts with Qatar (through Pakistan State Oil Limited of which it was majority shareholder) in 2016. Since RE plants (other than hydro) were ‘first of a kind’ technologies in Pakistan and required huge levels of financing to scale up, the government pursued the development of imported LNG and imported coal-based power plants because they could be commissioned on a fast-track basis to meet the supply shortfalls (estimated at 3000 to 6,000 MW in peak hours) projected in the summer months of 2018.
From the perspective of a proponent of RE generation, what lessons can be drawn from recent events in Pakistan?
Pakistan is blessed with abundant renewable energy potential in the form of solar, wind and hydro power. For example, according to an International Finance Corporation (IFC) Report on solar development potential, solar irradiance levels in Pakistan, particularly in the southwest (southern Balochistan and Punjab and western Sind), are at par with the best in the world.
Political decisions have, in the past, proved to be obstacles in promoting an environmentally sustainable power policy. Future governments need to take bold policy decisions how ever politically unpopular to address economic problems in the power sector value chain. A new policy roadmap to boost RE development will need to consider the following solutions:
- Steps to permanently eliminate circular debt by addressing its multiple and disparate root causes rather than short-term measures such as setting artificially low tariff rates for IPPs.
One of the root causes is the use of imported fossil fuel plants which exposes DISCOs to fluctuations in international oil prices and depreciation of the Pakistan rupee. An obvious solution is to gradually shift to renewable and alternative sources which do not have a fuel cost. The gradual shift will require the government to proactively introduce innovative measures to attract private and multilateral financing in RE plants, a few of which are discussed below.
Steps which can be taken immediately to tackle circular debt include improving technical and commercial performance of DISCOs through increased recoveries, cutting off supplies to defaulters, criminalising power theft (including illegal hook connections) and curtailing line losses by upgrading and modernising the distribution system. Time-bound targets should be fixed with the DISCO’s board of directors being held accountable for meeting performance targets and making progress publicly available.
- Governance reform of public sector institutions in the energy sector including regulators (such as NEPRA and the Oil and Gas Regulatory Authority (OGRA) which regulates the oil and gas sector and, inter alia, sets petroleum prices), and DISCOs.
Professional board members who have international exposure should be inducted in DISCOs who can bring ‘out of the box’ solutions based on international best practices to resolve operational, management and human resource deficiencies in DISCOs.
The roles and powers of energy regulators like NEPRA and OGRA should be more clearly defined and government interference should be confined to policy formation.
Decisions such as setting of generation and distribution tariffs and consumer petroleum prices are best left to institutions with technical depth and those having direct interface with industry stakeholders and industry data. This will also avoid the risk of politicising institutions to favour special interests which could destroy stakeholder confidence and trust in the industry. For these reasons, the 2017 amendments to the NEPRA Act allowing the federal government to influence tariff determination process should be revisited.
- Promote development of a local manufacturing industry for renewable energy technologies through setting up special tax free economic zones and other fiscal and financial inducements. This will also foster technology transfer through joint ventures with international companies.
Since China is the world’s largest manufacturer of solar and wind technologies in terms of volume, the second phase of the China-Pakistan Economic Corridor Project (CPEC) presents an opportunity to develop a domestic RE manufacturing base producing solar panels and wind hubs, rotors and even turbines with Chinese partners. This will reduce the project cost of new RE plants.
- Take steps to attract huge investment flows for scaling up RE generation.
In addition to resolving problems such as circular debt which have held back financing flows, innovative government-backed financing schemes should be introduced to attract local, foreign and multilateral investment in the RE sector.
In 2009 the State Bank of Pakistan (SBP) introduced a Scheme for financing RE plants (which was updated in 2016). Investors availing the Scheme would be entitled to obtain loans to construct RE plants at concessional rates of interest below the levels offered by commercial banks (local and foreign). Although this was a welcome initiative, the relatively small number of RE plants that were financed and developed since the Scheme came into effect suggests that more needs to be done to increase investment. As a first step, evidence of how the Scheme operated in practice, including feedback from investors, should be collated and analysed, so that further changes to the Scheme can be proposed to build on its successes and strengths.
Another option includes establishing an infrastructure development finance institution backstopped by the government to catalyse energy investments. Funds can be invited from domestic and international subscribers including overseas Pakistanis. Subscribers funds will be pooled by the institution who will decide which RE projects are eligible to receive financing. Such institutions have shown to be effective in mobilising funds in countries where government resources are limited. Since subscriber’s risks are spread out between a portfolio of funded projects, failure of a single project is unlikely to materially dampen deposits by future subscribers.
- Impose targets on provincial governments to ensure that a minimum level of RE generation capacity (either directly or through the private sector) is situated in their territory, based on the province’s renewable energy potential.
To incentivise provinces to meet targets, the federal government may consider offering ‘carrots’ such as increasing the amount to be allocated under the National Finance Commission (NFC) award or offering federal government guarantees and fiscal incentives to the provinces and/or private sector project proponents.
- Tax carbon emissions from fossil fuel power plants which use imported fuels so as to make them uncompetitive when compared with RE plants.
Tax breaks and other fiscal incentives available to RE Plants (such as low rates of customs duties on imported plants and no corporate income tax on profits) may also be denied to such plants.
‘Policy for Development of Renewable Energy Development for Power Generation 2006’, Government of Pakistan
‘Circular Debt Issues and Solutions’, Senator Shibli Faraz, August 2018
‘State of Industry Report 2017’, National Electric Power Regulatory Authority (NEPRA)
‘Decision of Authority in Matter of Solar PV Power Generation Tariff’ dated March 3, 2017, NEPRA
‘Determination of New Tariff for Wind Power Generation Projects’ dated January 27, 2017, NEPRA
‘Decision of National Electric Power Regulatory Authority in the matter of Review Motion filed by the Government of Sindh against the Determination of New Tariff for Wind Power Generation Projects’ dated May 30, 2017, NEPRA
‘Reach for the Sun: How India’s Audacious Solar Ambitions Could Make or Break its Climate Commitments’, Varun Sivaram, Gireesh Shrimali, and Dan Reicher, Stanford Taylor Centre for Energy Policy and Finance, dated December 8, 2015
‘A Solar Developer’s Guide to Pakistan’, IFC in Partnership with Australian Aid, Japan and the Netherlands
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