Monday, November 21, 2011

Upfront Wind Tariff-the issues

NEPRA has recently announced an upfront wind power tariff .In this space, we would attempt an evaluation of the scheme as announced, and apprise the readers of its pros and cons. First of all, let me explain some technical terms, which may not be readily intelligible to the lay reader. There are many types of tariff schemes; for the purpose of generation tariff, the following two types are relevant for our discussion. One is cost-plus, which means, the producer/seller IPP is paid its actual cost plus an agreed profit by the power purchasing company. Practically, it is almost risk-free to the seller, as all seen and unforeseen costs are paid for in this scheme of things including escalations of all kind, interest rates, foreign exchange and inflation. Determination of this tariff poses great responsibility on the shoulders of regulatory authorities, as the true costs have to be determined, in the face of the seller having a natural tendency to overcharge. In developed economies, cost-plus is mostly outmoded, as energy/electricity price is determined through market forces as these operate on energy exchanges, where electricity price is determined in an auction manner of a typical stock exchange. In Pakistan, this disease of booking unfounded cost has acquired unmitigated dimensions. The other tariff type is what we call an upfront tariff. This is also called a feed-in-tariff these days and is also being practiced in the West, for the purpose of promoting investment in the renewable sector. Under this scheme of things, regulators do their own investigations into the costs and competitive tariffs, and announce a tariff which aims at enabling the investor to recoup its investment and get an attractive return. In many developing countries (Brazil, Turkey and India and many others in Asia), this type of tariff has been determined through auction. This indeed is an ideal market based arrangement, which could also have been adopted by our decision makers. More on this is to come later.

NEPRA has approved a wind power tariff of 14.66 cents (Pk. Rs. 12.61) per unit levellised at 10% discount rate(We have seen tendency at NEPRA to compute levellised cost at a fixed 10% irrespective of the average cost of capital at which rate discounting ought to be made; more on this later).In actual terms, in the first ten years the tariff has been fixed at Rs 14.81 per unit and Rs.6.8977 for the next 11-20 years. Bad news for those who think, wind is free or cheap. It is elsewhere, but not in this land of pure. Today, in the US, Wind electricity is the cheapest at 5-6 cents, cheaper than any other alternative, fossil or renewable. In nearby India, it is IRs 3.50 per unit (1 Indian Re equals to Pakistani on the average).In Brazil and Turkey, it is has been auctioned recently at 7 cents per unit. In Germany, it is 10.61cents and lower and in Spain at 7.85 cents. NEPRA has itself in the past awarded tariff ranging between 9.5 and 10.50 cents, since 2006. Wind Turbine costs had increased in the intervening period with the hike in commodity price 0f 2008. However, in recent years Wind Turbine costs have come down by more than 20%.In Europe, Wind Projects (all costs including Turbine) cost around 1800 USD per kW and In India and USA, the same are at 1200 USD per kW, as opposed to USD 3000 per kW implicit in the upfront tariff of Pakistan and in other cost-plus tariffs awarded by NEPRA.


In some respects, there is an improvement, as the Wind Risk clause has been practically eliminated. This was a relic from the past, when bankable wind data was not available in Pakistan. Now the data is abundant, reliable and bankable. Operational problems would have been there in implementing the wind risk, as underperformance of turbines, it was likely, could have been booked under wind risk. At times, it becomes difficult to distinguish. The new scheme under demand of stakeholders, does maintain an element of Wind risk issue in a guarded and circumscribed manner. Also, there is a provision of escalation on the lines of cost-plus schemes where in exchange and interest rate variations, and other inflationary formulae have been built in, making it almost as bulky as cost-plus regime. In India, there is no escalation and the tariff is denominated in Indian Rupees 3.5 per unit, not a lot of money to play around and to build in escalations. In Pakistan, Inflation is generally high and currency depreciates faster than it does in India. I wonder, if Wind tariff is denominated in US dollars at 12-14 cents(with out escalation ,which is taken care of by the average 5% currency devaluation per year in the long run)would have been more handy and simple. One has to study the option for its implication on both the sides. On the issue of Green Credits, there is confusion; at one place, it awards the same to the power purchaser, while at other reference is made to GOP policies. Under other schemes, Green credit is to be shared among buyers and seller equally.4) this very attractive tariff is to remain valid for the first 1500 MW and for projects that achieve financial closing before the end of 2012.

Most of the times, I have been expounding the public perspective and vantage. An affordable and payable tariff, in my view, is the only guarantee that investments would be paid back with a fair return. Excessively high tariff may not be able to attract investors, as some hope that they may queue up for this kind of return as permitted by the announcement of 15 cents , perhaps the highest ever in the world. I do sincerely hope that investment does come in and we do not become a victim of double jeopardy, low investment that would have come any way and high tariff.

We have to think about reducing the energy costs and tariffs. The earning power of our people is low and there is 30% populace living under extreme poverty line. At least, it should be competitive with other countries of the world and the regions, and not 50-100 % higher than elsewhere, as the data provided earlier indicates. Overbooking the capital costs and its institutionalization in the upfront tariff is part of the problem, although a major one. Most power projects are foreign funded in debt, if not in equity. Large projects may have majority or 100% foreign equity. Foreign debt is priced at LIBOR+3% usually. After the law and order conditions improve, this mark-up may be halved in line with other countries of the region. More crucial may be the local debt, which is unaffordably high, either for industries or power sector. One wind project has asked for KIBOR+6%, which jacks the interest rate to 17-18%.In India, Power Finance Corporation charges 12% on the average, elsewhere interest rates for power sector are even lower. Except for working capital and local construction costs, it is arguable whether permitting local currency financing is the right policy. Keeping in view the enormous investment requirements of the power sector in the coming two to three decades exceeding one hundred billion USD, consideration may be given to set up a specialized financing institution on the lines of Power Finance Corporation India. Already, it is emerging on a small scale as can be seen by the initiatives of some institutional financial companies like EOBI. Renewable energy, which is the future of energy and not a very distant one in that, poses special problems; fuel costs are zero, but the capital cost may be higher. Viability of these projects is very sensitive to the capital costs, interest rates and rates of return to equity investments. RoRs of 17-18% are simply not feasible and affordable, as the impact of these rates on unit production cost is almost twice as high as it is in the conventional energy sources.

Another important aspect that should not escape the attention decision makers is the promotion and support of local content in the imported turbines. It may be unrealistic to expect 100% local manufacture. A deletion Plan on the lines of automotive sector may be developed, building incentives for the local content. Eventually, the cost of incentives would be eventually paid off by the ultimate cost reduction and employment generation effect. There is a lot of unutilized capacity in Pakistan which could be put to use through partial local manufacture. Turkey is a recent example where local content based wind tariff has been introduced. One would be able to support such a high upfront tariff of 15 cents (levellised/average), had it been based on a local content basis.

NEPRA determination appears lacking in transparency. The determination, as posted on the website, talks of all other issues but the main issues. All that has been disclosed is a table providing O&M costs, Return on equity and debt servicing component. There is no discussion or revelation on the bases on which the determination has been made. Is it market based or cost based. It cannot be market based, as it is 50% higher or even more than any other tariff, either in the region or internationally. If it is cost based, the main issues of Capital Cost and cost of capital should have been discussed and dealt with. It has been clearly avoided, which is unfortunate. One notices a trend in NEPRA proceedings and recent determinations of curtailing and avoiding the main issues, at least from consumers’ perspective. Sellers’ perspective, concerns and queries are addressed only. There are hardly any interventions representing the contra point of view. Is it general apathy or a deliberate policy on the part of NEPRA to discourage diversity of views and opinions expressed? NEPRA should make every effort that its proceedings do not appear one sided and that there is adequate representation. Clearly, all points of view cannot be accepted and adopted. However, there has to be an adequate acknowledgement and the reasons for rejection and acceptance of those. For example, why does one think that a capital cost rate of 3.1 Million USD per MW (a figure that appears to have been used in arriving at the 15 cent’s tariff) is justified which is almost twice the prevailing cost for the similar equipment in the region and elsewhere?

Concluding, it is hoped that some projects would come on stream under this excessive tariff .Reportedly the government has given a target of 500 MW in this respect, which may not be an impossibility. After this immediate period, hopefully the country may adopt an auction based competitive system which may result in a better deal for the country. Finally, there are many lose knots that have to be tightened in the energy sector. The symbiosis between fuel and electricity is to be recognized through integration of policies and institutions, be it through mergers or through other policy and administrative instruments.

The writer is the author of “Issues in Energy Policy” (in the press).


  1. Good article. Many important points have been highlighted. I agree to many of these.

    Do someone has information that how many wind power producers have used upfront tariff till to date??

  2. Any one on new upfront tariff for wind, issued on 24th April.