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.

Source: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).

Thar Coal: potential for Indo-Pakistan Collaboration

Thar Coal: potential for Indo-Pakistan Collaboration

There has been a long held desire in India and Pakistan to exploit the geographical advantage and expand trade and investment among the two countries. Most of such hopes have been sacrificed at the altar of political tensions, which have existed due to the Kashmir issue, which has been further complicated by the alleged terrorism episodes India appears to be more enthusiastic in broadening trade ties, however Pakistan links it to the settlement of the political issues. Many people in both the countries argue that strong trade links may create vested interest and stakes in peace and may create the requires rationale and pressure to solve political problems. The debate can be endless, among the unwilling partners.

Lack of availability of suitable projects has also been one of the reasons inhibiting economic cooperation among the two countries. Efforts have been made, in the past and continue to be so, towards building a project portfolio for possible collaboration, if and when political environment improves. SAARC project fund has been commissioning such studies. Reportedly, there is a SAARC energy initiative as well, headquartered in Islamabad for promoting cooperation in Energy sector. Let us explore what can be done in this direction.

Thar Coal and its vast deposits , apart from meeting Pakistan’s energy requirements, may have a potential for building and expanding regional economic cooperation .There are a number of possibilities such as; a)export of Thar coal to coal deficit adjoining states of Rajhastan and Gujrat ;b) India assisting Pakistan in developing and exploiting Thar coal resource; c) India installing coal –fired power plants in its border towns ,and exporting electricity to Pakistan produced by Pakistan exported Thar coal. Let me explain and analyze these propositions a bit.

First on India assisting Pakistan in developing Thar coal resources; India has one of the largest coal industries of the world. It has a coal fired Power Plant capacity of 50,000 MW. India has one of the most efficient coal power plant construction sectors, building coal plants at a capital cost rate of 1100 USD per KW, perhaps even cheaper than or competing with Chinese prices. It can supply consulting, training and even complete plant construction services and equipment supplies. They have experience and exposure in both types of coal; hard coal and our brown coal lignite, although most of their coal is hard coal with high ash content, considered inferior by many international end-users.

Reluctance of western countries with coal is increasing. International financing agencies are under pressure from environmental lobbies not to fund and assist such projects. Chinese appear to be reluctant as well, as reportedly; numerous attempts to revive their interest in Thar have failed. They still appear to have bitter memories from their past involvement in it and the uncooperative conduct of WAPDA that was manifested by the later. India may not be able to provide the full scope of services and may not be ultimately entrusted with a major role. However, it can be suitably involved and usefully inducted in a number of ways.

Secondly, exports of Thar coal to India’s adjoining states of Gujrat, Rajhastan and Punjab. It is a misnomer in Pakistan, that Lignite can be only utilized at mine-mouth. It is true that there is limitation in long-haul and international sea transport. However, in India Lignite is being frequently transferred in large volumes up to a distance of 400 kms. Exports to adjoining states should be very feasible, if the production and transport costs are competitive. One can only be sure of it after having done a feasibility study on the subject. This is an idea worth exploring. India is falling short of coal and has started importing it due to heavy demand. The adjoining states have a deficit of fuel/coal supplies. Exports from Pakistan may reduce traffic congestion caused due to interstate transportation of coal, which is expensive as well in terms of transportation costs.

The third proposition is rather unique, ambitious and extremely profitable, all at the same time. The detail is, that Pakistan exports/barters Thar coal to Indian border towns like Munabao and Bakhsar, the latter may not be more than 50 kms from Thar coal mines. Dedicated coal train can make several trips in a day, carrying 10,000 tons of coal in one trip. India installs Coal power plant(s) in its border town, which would remain a domestic investment in India. India burns Pakistan lignite and transmits the electricity so generated to Pakistan. India is only paid for the capital cost component, as the fuel would remain Pakistan supplied. It can become a total Barter trade, if more lignite is sent/ exported to cover the capital costs afforded by India in supplying electricity to Pakistan. There is a scope for several thousand MW of such projects.

Similar ideas have been put forward earlier as well. There were proposals for exporting electricity to India due to temporary Power excess situation created in the immediate aftermath of HUBCO installation. The proposition in this form may be unique that it offers an energy exchange opportunity. Besides, it is not a temporary surplus. Thar coal deposits are of 200 billion tons and are expected to last for centuries ahead.

Easier said than done, but it can be feasible. As for the security concerns, of large volume of goods transport and human traffic, Thar is a far-off town. Indian nationals may be allowed to come to Thar only through land route or a future direct flight from to and fro Thar. It may remain as good as domestic travel for them. Special immigration rules and status can be created for Thar coal projects. There is no major security installation or threat nearby. So security issues can be managed.

So many people and nations in the world want India and Pakistan to collaborate and work together, that the above propositions may receive instant support, if presented properly. Quite some funding could be garnered under this head. The relevant departments in the two countries and the business groups may like to examine these propositions. It pays to be optimistic, however, naïve it may sound in the beginning.

The role and performance of regulatory bodies like OGRA

The role and performance of regulating agencies like OGRA

OGRA is in news these days. Its parent ministry MPNR is criticizing it in public and other senior parliamentary leaders from the ruling party have led onslaught on it. Earlier OGRA chairman came into limelight when public heard of its board members being fired by the latter. Is it a personality syndrome or conflict and infighting or there is something more germane into it. ? What is the role of OGRA and for that matter any regulatory agency of this kind. What role it has been given and what role it could have carved out itself by creative maneuvering and internal negotiations with its main stake-holder which is the Ministry of Petroleum and Natural Resources itself. Its counterpart NEPRA has been more successful in having a working relationship with its parent ministry.

First of all, a regulatory agency may be associated administratively with a ministry, but for all practical purposes it is independent. However, its independence may be circumscribed by the statutes and the rules that are usually made by the Ministry itself. Sometimes the issues are multi sectoral and multi-ministerial and are thus to be handled by the PM himself and his Cabinet Division. It is through the statutes that ministries can control or dictate their way and policies and not through administrative orders. Regulatory agencies can strengthen themselves by bringing in public discussions and hearings and oversight and making it more effective and integrated with their processes. Public consultation process may at times be overbearing and impeding speed and convenience in decision-making , but it is worthy enough to be welcome and built into the decision making process. It is perhaps the only defence and support the regulators have to fall back upon in performing their function.

As to the regulatory agency’s independence, it can vary greatly from country to country and its relevant legislation and from sector to sector. The most powerful regulatory agency in a country is normally the Central Bank or State Bank as we call it here in this country. Obviously, it is much less independent than its US counterpart, in theory and as well as practice. Energy regulatory agencies are more powerful in India than these are in Pakistan. Perhaps size and multi-polarity matters, and makes central organizations more powerful and effective. Even after 18^th amendment, all regulatory agencies and functions have been given under federal domain. Conflicts are going to arise, when the implementation begins .It would be highly debatable, if except for Punjab, any smaller province can have the resources to run these agencies, technical and financial both.

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It has been alleged that OGRA has not been able to perform its function. The latest case that is cited of is the unduly rising prices of LPG. A broader criticism, and perhaps legitimate, is that it has not been able to carve out space for itself. Space is granted by the legislation and statute but the statutes themselves are influenced by the lobbying and input of the regulatory agency itself. In Pakistan, perhaps it would be too much to expect from the retired bureaucrats for whom these positions are lucrative parking places. The salaries are too high to be risked? Ministries generally would like to maximize their power for legitimate and not very legitimate purposes and commercial interests would also not like to be constrained. The maximum support should therefore come from the legislature and the public.

Now coming to the two specific charges on OGRA; LPG prices and the charge that OCAC performed better. LPG is a fuel for the poor. Its prices have been going higher and higher, whether it is justified on some grounds, is a separate discussion. The real policy issue is that LPG has been kept out of the regulatory process and thus it is beyond OGRA’s purview. The culprit is the classical phony and naïve argument of freeing the pricing and the misconception that opening up prices leads to market efficiency and would ultimately lower the price. There are several reasons that these ideologies do not work in societies like ours, for the following reasons:

1) We are always supply scarce countries. Only population and demand is abundant .Supply is usually restricted by a germane shortage of capital. Price signals are not strong enough to attract foreign and local capital. There are other factors such as political instability and the law and order whish over-ride economic factors and signals.

2) The regulatory and legislative processes are weak. Consumer is poorly represented in the power structure. Producer is powerful and integrated into the power structure.

3) Anti-competition and price collusion behavior is rampant and generally well entrenched. Competition protection legislation is weak, ineffective and perpetually sabotaged as we have been observing in the case of Competition Commission of Pakistan.

4) We can not wait for the ultimate rationalization and resource allocative process to show its promised results. It may never happen or may be too little too late. Our consumer is poor. One-third of our people lives in abject poverty and cannot get the minimum nutritional requirement. And others are only marginally and slightly better off except for a very thin minority.

Thus the price unfreezing and letting it to be decided by the market and in fact by the producers does not seem to be working and resulting into lower prices. Price decontrol of such things as energy and LPG is a fools’ paradise. It should be shun at the first opportunity indeed immediately. Only when price decontrol is lifted by the ministry of petroleum, OGRA cannot do any thing in this respect. People can do it in the long run, but they rise only occasionally and randomly and such processes are only disruptive, as there is ample history to suggest.

Now coming to the case of oil pricing, it is alleged that OCAC (Oil Companies Advisory Committees) has performed and could perform better than OGRA. I have no mandate or axe to grind with OGRA to defend its performance. As for OCAC, there could not have been a more shameless and disgusting name for an entity that is to set prices; a producers club setting prices for consumers with the support of the ministry. This may have been valid in military oligarchies of the past but it is very disturbing to find support for this coming from the ministry of petroleum .Oil prices used to be set on a cost-plus basis earlier and supported an essential but basically inefficient oil industry which made huge profits in the past. Now that the more saner policy of oil pricing based on landed price parity with imports , the oil industry is crumbling .It would need support like many other inefficient but essential entities. OGRA’s’ job today is implementing a formula, calculate the price and publish it. There are many ifs and buts in it, which OGRA should have made a practice of discussing in broad day light in public hearings than adjudicating on these quietly and slipping into the pricing system. No wonder it has not managed to attract a lot of respect from the stake-holders and the public.