The natural gas controversy

The natural gas controversy

There is a general gas shortage in the country for the past few years. Known reserves and deposits are on the way to exhaustion, while the exploration activity has been at a low level. Most of the gas these days is being produced these days. Gone are the days when most gas used to come from Sui in Balochistan. Thanks to exploration activities in Sindh, many new deposits have been discovered in Sindh and production started from those wells. More exploration activity is expected to yield new gas resources in Sindh. Due to the political and law and order problems in Balochistan ,no new deposits are being discovered as no exploration activity could be sustained there for the past many years. This is a very unfortunate situation , in which no body is benefitting, people or province of Balochistan who are deprived of income and employment and the other parts of the country and people as they are facing gas shortages.

Shortages create many economic and political problems. A number of controversies have developed. Industries have protested and some of which closed down in protest or due to gas shortage. Earlier Sindh assembly passed a resolution demanding priority in gas allocation and a number of prominent politicians issued statements in this respect. They have complained that Sindh's gas is being taken elsewhere in the central system and that Sindh’s demands should be met first, and then the residual should go elsewhere. The issue of distribution priorities! They have argued that there is a constitutional provision in support of this stance. Now KESC has joined the debate. In a message to the public and consumers in Karachi printed in this newspaper, CEO of KESC demanded more gas allocation and implied that the gas supplies were available and adequate gas supplies are unfairly denied to his company. And in a related case, LPG distributors are going on strike because of what they think is an arbitrary increase in prices by the LPG producers’ cartel. Let us examine the merits of the issue. To top it all, some multilateral agencies are proposing to enhance gas prices to the level of line which in their view would solve many problems including the ones in gas allocation. GOP is already under severe public pressure regarding the proposed increase in electricity tariff. This last issue would require exclusive discussion and we leave it to some future opportunity. We would examine here the other issues as described earlier in the above.

There is a general shortage of gas throughout the country. Power plants in Sindh are not getting enough gas and thus load shedding of electricity. Gas and electricity are distributed to user sectors and customers who pay for the service. It is not supplied to an abstract concept or entity as a province. Then gas is distributed and allocated as per priorities. For example, fertilizer sector is a priority and supposing all of the capacity is located in Sindh, allocating and distributing gas to Fertilizer sector does not mean that gas is allocated to Sindh.

If this logic of prior right of producing province is accepted, then many problems would have been created for Sindh itself. Gas exploration and abundance in Sindh is only a recent phenomenon. Previously all gas consumed by Sindh came from Balochistan and most hydro electricity came from Sarhad/KP. Very little was consumed or allocated in the producer provinces, as there was no demand or distribution investment was not justified for widely scattered insufficient demand. Similar demands and protestations were made by some circles in Balochistan, when natural gas was brought to Karachi and Sindh first leaving Balochistan towns unsupplied.

The issue is that Production, transmission and distribution facilities have to be invested in. Often the investment comes from private and foreign entities that have to be paid back. The revenue is generated through consumers and customers and not from provincial or federal government. Principles of economic efficiency, markets, sustainability and rate of return to investors are involved. If we do not learn to respect these principles, we are going to end up in more shortages due to lack of investment in supplies sector and higher production costs of utilities and services. The capacity of people to pay has already reached or even crossed their limits.

If there is a shortfall both equity and efficiency considerations are their in allocating priorities. Where there is no efficiency or criticality issue, equity principles of equal distress are to be applied and not a province based formula based on the ownership of resource.

As to the ownership issue of the resource , except for political ownership which does not mean much in practical sense ,bulk of the resource(88%) that has been extracted belongs to the producer who has spent money, effort ,resources and know-how in bringing out the resource from the earth and processing it and making it use-worthy. So the ownership of the extracted resource belongs to the producer, save the royalty portion of say 12%, and not to the province where the resource is located. What is in ground belongs to a people and provincial or federal government as per laws and constitution of the country, but when it comes out of ground it is a different issue.

Energy sector in Pakistan has been developed as one undivided market. It is still the case even after 18^th amendment. Electricity has become a federal only subject, while it used to be a concurrent subject earlier. In the past almost all investments in energy have come from federal or foreign equity or debt sources. All WAPDA investments and the ones in Oil and Gas have come from federal kitty. And even in future all investments in nuclear and hydro resources is to come from federal resources. After all these investments, would KP politicians be in their right to make similar demands of electricity ownership. Certainly, they can demand their royalties which issue should be resolved on a permanent basis. They cannot possibly demand that Tarbela should meet their demand first and then the electricity should flow to the rest of the country. KP has been suffering severe load-shedding despite Tarbela being right there. In future also when hydro power would come from Bhasha and Bunji etc dams, there would be no fundamental right of priority allocation to KP. In fact if Sindh’s argument and demand of priority allocation based on producer provinces right is accepted and established, it would be a sufferer in the long run .Temporary advantages and ups and downs do develop in various parts of the country at different times and these should not lead us to bring in constitutional issues unnecessarily.

Constitutional provisions are often desires and ideals. These have to be creatively and constructively interpreted and understood. It is well-nigh impossible for the framers of the constitution to understand the implication of every sentence they write into the constitution. American constitution explicitly allows only currency, defence and foreign policy in federal domain. American courts have interpreted the constitution so broadly and in totality, that there are sixteen federal ministries dealing with 16 or more subjects. Constitution may have to be amended if too literal interpretation of the quoted constitutional clause is attempted.

As for KESC, its issue is a bit complicated due to the tariff issue, which may not be intelligible to the non-specialist. KESC runs on what is called a constant tariff, with periodic adjustments for the fuel price inflation and general inflation as well. Gas is more thermally efficient fuel than oil in the sense that in combined cycle plants, an efficiency of 50% or more is possible to day than the traditional efficiency of steam turbine plants run on oil. KESC is expected to earn through increase in thermal efficiency and reduce other losses and leakages. There are many other issues with KESC tariff formula as it exists today. Normally such formulae are agreed to for relatively short periods. It has no answers or solutions for the long run. It may cause much more serious problems in future, details of which cannot be explained in this space. A review of this formula is required, along with a number of reforms and pro-active actions. For the time being GOP has allowed Oil sales and supply in lieu of non-supplied gas, at the price of gas. Perhaps this solves KESC’s working capital problem. A longer run solution would require the following steps; KESC should be a part of the central pool and eligible to draw from the central pool as per an agreed formula ; KESC to be treated as an IPP, and allowed to make investments in generation outside Karachi, for example utilizing cheaper gas resources elsewhere. KESC’s generation assets and activities be separated and treated at par with other IPPs .A new tariff formula based on cost-plus approach and central whole-sale pricing is introduced as it is there in other parts of Pakistan

Re-organisation Of electrical sector; the closure of PEPCO

Reorganization of Electrical sector: closure of PEPCO issue ?

Contradictory reports are coming in regarding the closure of PEPCO, which was created a few years ago in the wake of restructuring of WAPDA. Earlier WAPDA used to be the sole organization, responsible for the power sector, which was a continuation of an early power regime, where hydro power used to be a major component of the electricity supplies. Reorganization was done as under; WAPDA restricted to the dams, irrigation system and the hydro generation facilities like Tarbela etc. WAPDA happened to be the owner of these assets and facilities. PEPCO was given the ownership and management of Power distribution companies (DISCOs) and possibly the thermal generation plants. NTDC (National Transmission and Dispatch Company) was to own and manage the Transmission facilities and act as an integrated system operator (ISO) responsible for power dispatch management. There is a CPPA (Central Power Purchasing Authority) under NTDC with a low profile, which bought electricity from all the IPPs and GENCOs and sold it to the distribution companies (DISCO). The need for this arrangement was felt because of a uniform tariff regime system, under a huge subsidy. The whole system except for KESC and other IPPs was in public sector.

Under a Power Utopia, the entire power sector would be eventually privatized, there would be no subsidies and there would be separate regional or DISCO tariff and thus no WAPDA or PEPCO. Two developments have taken place recently. CPPA has been upgraded from a section under NTDC to a full-fledged company under GOP guarantee. Perhaps this was a step in the right direction. It had to be a guarantee company because, it would be entering into power purchase agreements, that had to have the benefit of GOP guarantee for the satisfaction of investors and IPPs. It is being wishfully contemplated by the Power theorists of multilateral agencies under which all reform is being engineered that the subsidies would go away along with the uniform electricity tariff in the country.

The whole electricity sector has been structured under a unified model of uniform tariff and central investment. All assets and fuel sources have been developed under it. Power sector, under 18^th amendment has become a Federal subject, rather than being on the concurrent list as it was earlier. Subsidies may go, but a regional tariff is impossibility due to the baggage of the past. In a decade, the sector configuration may change appreciably due to increased contribution of IPPs. Regional tariff may then be a possibility.

Nationalists of KP, rightly or wrongly, already allege that cheap hydro electricity is bought from Tarbela, and sold back to the province through PESCO at a rate many times higher. They, however, forget conveniently that, it is the federal investment through which cheaper hydro electricity is produced. KP contribution it is of its location, which is rewarded under a royalty system. Except in Punjab, the electricity losses are 30-40% which is largely taken care of by subsidies. These subsidies are assumed by GOP were never paid off timely resulting in circular debt which leads to shortage of liquidity in the system and low capacity utilization in a situation of power shortages. The theft in Punjab is at its lowest of 15%. If regional tariff is introduced, Punjab as a whole would benefit, which in effect subsidizes the more theft prone regions of the country. Under go alone system, it would probably have a lower tariff. The utopia may, however, have some chance if all resources are priced at their true value or market worth. Natural gas according to this theory is currently underpriced and thus its price /tariff should go up.

All of this can lead to a political disaster, threatening and risking not just the sustainability of democratic system, but the very foundation of a united federal Pakistan. Federalism is popular under which the political actors and the system is ready to get rights and not the responsibility. Let the people get the putative merits and advantages under the new system for a while, and then the requisite burdens and liabilities may be shifted. No wonder some rebalancing may be demanded later.

Coming back to PEPCO, its role and its rationale, in Pakistan an administrative model has worked satisfactorily in the past of sectoral corporation controlling and administering the sectoral companies. As in the manufacturing sector, the privatization took place these corporations went away, as has happened in the case of PACO, Ghee Corporation and others. The Corporation model is of a holding company that serves as a professional intermediary between the public sector companies and the bureaucracy of the ministry, obviating a direct role of the latter in the day to day affairs of the companies. These corporations are also supposed to take care of the sectoral issues and its development, suggested policies and advised government. However, the enterprise/company management has often complained of a rigid control by these corporations, hampering their management independence and flexibility. The notion is sometimes supported conveniently by the ministry bureaucracy who wants direct control without intermediaries of the corporation. Opposition to PEPCO is to be seen in this perspective, although there are genuine issues of reconciling the roles in face of a rejuvenated CPPA. The role of a sectoral corporation and a holding company would be there in the background of the aforementioned issues. There may be no role for it in a Utopia and a totally privatized regime, which time has not arrived yet.

We cannot possibly afford to be reckless theorists unmindful of the consequences of policies and new regimes. The foreign advisor and theorists do not buy the same medicine for themselves as they prescribe for us. Had they done so, there would have not been much of an inefficient manufacturing sector in their countries surviving on trade barriers .Even agriculture survives there on trade barriers and subsidies. Inefficient and labour intensive sectors would have been long shifted to this part of the world promoting mutual welfare and employment in labor surplus economies. This has not happened and would happen very gradually, minimizing dislocation on the part of adjusting people, labor and sector. Same gradualism would be advised here and not the abrupt actions under the knife of IMF and dagger of project loan giving agencies. PEPCO may be allowed to continue or merged with CPPA.

KESC Tariff difficulties;Shun constant Tariff formula

There seem to be difficulties again with the implementation of a rather unique tariff system given by foreign privatization consultants. I have not been closely following KESC tariff issues over the past many months.However my cursory following indicates to me that there are implementation issues involved in KESC tariff.There was earlier some kind of a divide on KESC issue at NEPRA board ,wherein two of the honorable members either wrote a note of dissent or withheld signature altogether.Now there are difficulties in awarding fuel price and O&M adjustments.NEPRA member Tariff,who reportedly presided over three member public hearing on KESC tariff,ordered physical verification of fuel expenditure invoices from the KESC. Let me give the reader some background on the tariff setting systems.

There are broadly two system:one of cost-plus,where all costs of the utilities are paid as these occur,and a fixed or variable Return on Investment(ROI) or Equity(ROE) is paid,generally related to the on-going interest rates.All IPPS are paid based on this cost-plus approach.There is a reference tariff determined through regulatory process,escalation above which is provided based on agreed formula and current fuel and other variable prices.It is relatively fair and simple.In case of distribution companies,with highly depreciated assets and often negative equity,Return on Asset(ROA) approach is used.OGRA is also doing the same with the gas distribution companies.

In case of KESC , a constant price tariff approach was adopted,however,with provision of escalations.The difficulty with KESC is that ,it is an integrated utility,with generation,transmission and distribution.Electricity is self generated by the KESC and is also supplied from WAPDA network.At the time of privatization, a certain mix of self generation,and purchase and an assumption of oil/gas mix was made.Depending on such assumption, a reference tariff was given with provision of escalation.At that reference price, there was an implicit loss to KESC, and the expectation was that the new KESC management would make the required investment and essentially earn through loss reduction.There were and still are Transmission and Distribution losses in the KESC system more than if compared with the

public owned companies like LESCO and IESCO etc.Also the thermal efficiency od most of its plants is very low,wasting a lot of expensive fuel oil.KESC has done some investments and is in the process of making more investments towards improving thermal efficiency and saving fuel cost.This saving ,however,will go towards reduction of losses,wiping out the accumulated losses and finally towards return on investment.These savings cannot be passed on to the public as some people seem to be demanding.

However the existing system of constant price with escalations has become very cumbersome and even lacking in terms of transparency due to its complexity.Traditionally,this constant price formula has been used in distribution companies only, and that also for up to three years,with no provision for escalation.

In most of the developed world, electricity generation is out of regulatory process.Whole sale electricity prices are set through demand and supply through an auction process through electricity exchanges on the lines of share bourses.Generation prices are relatively more stable in the OECD countries as most electricity generation is based on gas,coal and nuclear power,where price volatility has been lesser.Even in the neighboring India,the electricity prices are much more stable than here,due to the domestic and public controlled coal.In Pakistan,hydro and gas based electricity used to provide price and tariff stability,but due to increasing contribution of oil based generation.price volatility has increased.This oil dependence and the increasing trend on oil dependence is the single largest threat to Pakistan's economy and social stability.The earlier other sources such as hydel and coal are utilized the better.

Coming back to KESC,the very purpose of constant price system of offering simplicity and transparency seems to have been defeated due to so much variability and complexity.It is quite possible that the young men at NEPRA who do these calculations may sometime fail to appreciate the issues and commit mistakes.Even this writer often gets confused and finds himself at a loss as to how to separate permitted variabilities from the non permitted ones.The situation would get even more complex and complicated if and when KESC makes new investments in new generation capacity.Questions have already been raised by the stake-holders,casting doubt and feeling confused.

Our business community,which is not used to spending money on building institutional capacity in their representative organisation,has never managed to make a technically valid case and has relied more on delaying litigation to oppose tariff increases.If nothing else ,the KESC tariff system is becoming too cumbersome to be transparent.Recent load balancing practices and requirements ,and the consequent changes of oil and gas mix have further complicated the situation.

It would be only appropriate that the government and the regulatory bodies consider changing the KESC tariff system to a conventional simpler system of Cost-plus,which is being practiced with other IPPs ,and distribution companies.Even KESC management may feel at ease, if the stake-holder confidence in the system is improved.For this to happen,KESC tariff has to be a three part tariff, separately for generation ,transmission and distribution.In this case comparability with other similar companies would be available preventing abuse or error.This would be for regulatory body and the KESC: public would be having one tariff as usual and would not be burdened with such disaggregation.Foreign consultants as usual are to be appointed,as the requisite expertise and objectivity may not be available locally.

Targeting loss reduction and basing tariff on it is to make tariff contentious,controversial and fluid.KESC tariff system has this feature as well.It has been demonstrated now that the private sector has no special leverage in reducing T&D loss reduction.most of which is theft and pilferage.In fact private sector is susceptible to political and group pressure more than the government functionaries.As to the reduction of fuel cost and increasing thermal efficiency,it is a matter of attractiveness of investments in the sector and tariff stability.Third party investment for Karachi is being discouraged due to the existing system and KESC would itself be discouraged to make the requisite investments,if tariff issues remain fluid as these are at the moment.Lenders would also be hesitant as well.

And finally contemplating over these problems,one reaches a conclusion that after all,the idea of privatizing distribution utilities may not be a good one.Government would have to be around to take responsibility and to keep footing the bill,if there are losses,be it private or public sector.However,IPPs have been a successful innovation that must continue and in all probabilities would be sustaining into the long term future.

Load-shedding :why? when there is ample capacity

Current Installed capacity of Electrical power generation is 21000 MW.We seldom see in the summer,Maximum demand to be exceeding 17000 MW.And the load shedding is to the tune of 2-3000 MW. And still more astonishing to a lay person may be that there is load shedding in winters as well,when the demand is several thousand MW lesser. What is the problem then.Firstly the installed capacity is not always put to use for a vareity of reasons such as the following:

1)A considerable capacity is of outdated old plants,which run as and when these are not sick or broken down. At least 2-3000 MW of capacity is in that category. In most countries such plants would be replaced by new.It costs only 50-60% of green field project costs and is always the most advisable investment.

2)Hydro capacity goes down to 10% of the installed capacity in winters due to low discharges in the river and possibly lower water requirements as well.So although demand goes down, supply goes down as well in the winters.

3)There is a gas shortage as well.So some capacity is not utilized due to gas shortage.

4)Finally there is a shortage of liquidity in the power sector and oil sector.GOP is not able to pay the subsidy promised by it.Provincial governments do not pay the bills.KESC has been suffering from low liquidity due to its accumulated losses exceeding Rs 100 billion.Oil cannot be purchased and refined to be used in the power plants.In the last NEPRA meeting two of the members were so annoyed with KESC's inadequate capacity utilization,that they did not sign the KESC determination.PEPCO did the same.

5)Rental Power could not come on stream due to long debate and protestation in the media and the parliament with accusations of corruption.ADB was called in which more or less supported the government position and the go-ahead was give belatedly.Benefit of the rental power was partly washed away due to the inordinate delay.

What is to be done.Most of the required steps have already been taken by the government.I would be narrating and critically evaluating those and offer one or two of my own thoughts.

1)Drastic steps have been taken to manage the demand,which has caused a consuderable reduction of Peak Demand by 1000-1500 MW.Similarly steps have been taken to manage gas load to supply more gas to the power sector.

2)Tariffs have been raised already and additional increases would be gradually made to reduce the subsidy requirements and the consequent circular debt.GOP has taken steps to inject money into the system.Provincial governments have been asked to pay their dues.

3)Steps are under way to undertake BMR(balancing, modernization and replacement).Assistance of USAID has been sought in this respect as well.

Perhaps this is all that was required except that implementation of the decisions be made seriously and swiftly.The outdated plants should be maintained for peak loading purposes and should be run on oil rather than gas.Rental Power which has been discussed elsewhere should ha ve been acquired for peaking purposes which would have cost lesser in fixed costs.

Gas fired IC engines should be installed in IPP or Rental mode or by PEPCO itself on stranded gas fields and wells.Also there are a number of Low Btu gas fields that should be utilized for these purposes.Some adjustments and arrangements should be made with companies like UCH power whose expansion project has not moved as per expected schedule, and thus gas resources remain unutilised.A good inventory of stranded gas should be taken to identify possibility of extra gas and implement gas based I.C.engine power projects on fast track basis. Reorganize and rejuvenate PPIB.They also need a BMR.A closer liaison and coordination between Ministry of Petroleum and Ministry of Water and Power is required.