China Pakistan Economic Corridor brought with itself a huge opportunity to address the lacunas of the power sector: power shortages and affordability. Credit should be given where due; the previous government was able to increase the country's generation capacity significantly during its tenure, thank to China's exuberance in the country's power sector. Ideally, these increased megawatts should also have brought down the cost of electricity for the end consumer. But that's the reason it's called an ideal situation.

Power tariffs continue to remain high in Pakistan. State Bank of Pakistan in its quarterly report on the State of the Economy, published this week has devoted a special section on why power tariffs have remained persistently high in the country – maybe at the right time when tariffs are expected to go up further now that the country has successfully entered the IMF Program.

A one-liner: it is all because of the tariff structure – the mere existence of the capacity charge component of the tariff has been crushing any decline in the variable cost components of the tariff. And it is this capacity charge that has been ballooning the circular debt for long.

So how has it been contributing to consistently high power tariffs? SBP defines capacity payment or capacity charge as cost that pertains to the design and construction of power units, the guaranteed return on equity, debt financing charges, etc. that will still be paid for and added to the end-consumer tariff even if power producer does not sell a single unit into the national grid.

The crux of the section is that there are at least three factors that have kept the capacity charge high in recent times even after so many megawatts added to the national grid under CPEC. First is that despite the increase in generation capacity, the dispatch of electricity (commonly known as the power sold) has remained weaker in comparison due to transmission and distribution constraints – an area that remained largely ignored for long while the authorities were busy focusing on the power generation side. And hence, power sold by generation companies has been insufficient to keep the capacity cost unchanged. Also, the power companies dispatch levels have been weaker in FY19 particularly due to the mismatch between the supply (read generation) and demand highlighted by weak economic and industrial growth, which is a factor likely to prolong into FY20.

The second factor that has been pushing up capacity charge is the sharp rise in the controversial net hydel profit (NHP) that goes to the provinces for their bulk hydropower generation. The uncapping and hence the rise of NHP since FY16 has added to the capacity payment burden. And thirdly, indexation mechanism of capacity payments against macroeconomic amid rising interest rates, sharply depreciating currency and rising inflation continue to increase the sum.

The bad news is that tariffs are likely to remain high unless transformative actions and reforms are adopted across the board like changing the capacity payment structure. Not only has IMF stressed on the need to increase tariffs quarterly, but also (a) capacity payments will continue to rise if power plant do not operate at 100 percent capacity, (b) higher interest rates and weaker currency will continue to stress the capacity payments, (c) weaker demand against the more generation capacity coming online especially in coal and renewables will continue to widen the gas that adds to the capacity charge.

Copyright Business Recorder, 2019