Pakistan risks all in clash with IPPs

29 May 1998

For Senator Saif ur-Rehman, head of the Pakistan parliament's economic watchdog committee, the issues at stake in the independent power producers (IPPs) controversy are simple. 'It is a worldwide rip-off,' he says.

According to this view, Pakistan has been saddled with electricity bills it has no possibility of paying because of contracts signed by a corrupt administration. The contracts must therefore be amended. However, the picture is not so clear-cut for the IPPs and the banks, private investors and international agencies that stand behind them. Ill-considered action against legally binding contracts would cause long-term damage to Pakistan's reputation, and threaten to choke off much needed flows of aid and


Urging restraint

The IPP issue - like that of the Indian bomb crisis (see box) - has taken on a strong nationalist flavour, and the government of Prime Minister Nawaz Sharif is being urged by the business community to avoid getting carried away by his own rhetoric.

The origins of the crisis can be traced back to the former government of Benazir Bhutto. Nineteen IPPs were granted permission to set up operations under the administration's 1994 energy policy. The state-owned Water & Power Development Authority (WAPDA) is contracted to buy most of the output of the IPPs at prices regarded by the current government as unjustifiably high.

'Bhutto wanted to make political gains by increasing the power supply in the country. This is why she gave lucrative incentives to investors willing to set up IPPs,' says an Islamabad-based economist. 'She had forecast a substantial growth in demand over the next few years and had projected major developments in the industrial sector. But she failed to do her sums properly and consider the long-term impact of her policies.'

The 19 IPPs - four of which are already in operation while the rest are due to start generating electricity by early next year - were funded heavily by international donors such as the World Bank, the Asian Development Bank and the Export Import Bank of Japan. Facilities were also extended by commercial banks on the basis of guarantees provided by the World Bank. The Bhutto government in turn provided sovereign guarantees.

When the present government realised that WAPDA was unable to pay for the 60 per cent of the production it had contracted to buy from the IPPs, and also could not back out of the contracts, it cried foul. It has alleged that the former administration received substantial payments from the IPPs in return for favourable power purchase agreements and tax concessions. It also says that the Bhutto government signed far too many IPP agreements as it was motivated by the rewards it would receive - not by concern to meet Pakistan's power requirements.

'Analysts had forecast demand at 1,500 MW by 1998,' Sharif said in a 9 May address to the nation. 'The previous government approved 34 projects and signed agreements with them to buy 8,340 MW. We now have total installed capacity of 3,165 MW and have 1,800-1,900 MW of surplus power which the government is bound to pay for.'

Sharif has raised the stakes by threatening that legal action will be taken against the IPPs if they are found guilty of having paid bribes to win contracts. For their part, the IPPs have strenuously denied any impropriety.

The government has summoned nine IPPs for talks and demanded that they reduce their tariffs by 25-30 per cent. Sharif claims that all those involved in the talks have agreed to cut prices. 'We are giving a chance to others to tread with prudence. This is a matter of our survival,' he said. An indication of the government's seriousness came on 19 May, when a Lahore court ordered Hub Power Company (Hubco) to cut its tariffs by just over 50 per cent to $0.034 a kWh. The move has driven brokers on the local stock exchange to despair as Hubco is one of the leading stocks.

The other prong of the government's strategy is to try to do something about WAPDA. Assuming the original contracts are honoured, WAPDA faces a bill of $1,656 million from the IPPs in 1998, rising to $3,404 million in 2001, according to Sharif. 'With this money, Pakistan should be able to repay its loans, cut prices of utilities, increase expenditure on education and healthcare and uproot corruption and injustice,' he said in his address to the nation.

The government is now finalising plans to restructure WAPDA. It has set up the Pakistan Electric Power Company (Pepco), which will oversee the operations of the eight generation and three distribution firms that will be created out of WAPDA by 31 October. At the

same time it is also seeking to secure a loan of $500 million from the World Bank and the Asian Development Bank for restructuring WAPDA. Sources say that the two international donors have asked the government to first resolve its differences with the IPPs, in which they have invested heavily, before expecting a new loan.

Don't blame us, say IPPs

The IPPs contend that they are not in a position to cut tariffs on their own, given that the projects have been financed by the international community. However, they have argued that the tariff could be reduced if the government makes some concessions. For example, it should increase the amount of power to be bought by WAPDA from the IPPs to 85 per cent, as is the case in Bangladesh. It should also reduce the price of furnace oil in line with international prices and persuade international donors to increase their loan repayment terms.

The average period for the repayment of loans has been set at 10 years by the lenders. 'If they restructure it to 15-20 years then it will be possible for us to bring down the tariff,' says the chief operating officer of one IPP. The fuel costs now account for 45 per cent of the power tariff, a situation that gives IPPs little room to manoeuvre. 'When we signed the power purchase agreements, furnace oil was available for Rs 2,850 ($65) a tonne from Pakistan State Oil. Now they are selling it to us for Rs 6,850 ($155) a tonne while in the international market it is available for about $70 a tonne,' says the finance director of another IPP. 'If the government allows us to buy it directly from the international market or reduce prices we can cut our tariffs substantially.'

Some investors are adamant that there is no scope for changing agreements signed with the Bhutto government. 'We have contracts and those contracts must be fulfilled: the government has an obligation and WAPDA has an obligation - we see little room for renegotiation,' says Fritz Reuss, managing director of Siemens Project Ventures, which has a 26 per cent stake in the Rousch power project, due to come on stream later this year.

Investors argue that the terms of the agreements they signed with the Bhutto administration were not their own. They say that these terms were devised by the government, precisely to attract as much investment as possible into installing new power capacity. 'They made the tariffs, not the IPPs,' says Reuss. 'We did not set the charges, they did,' says a representative of another private power company.

The threat of legal action is not just coming from the government. 'If the government cancels agreements it would have to face the consequences,' says Reuss. 'We would take them to court.' He points out that the agreements are binding under international law. Siemens would not hesitate, it seems, from putting this to the test.

However, with the threat of cancellation being linked to allegations of corruption, Reuss emphasises that he does not foresee the cancellation of the power purchase agreements for the Rousch power project. 'We have no reason to think that the government wants to cancel our project,' he says.

While the debate rages on within the power generation sector, it could also have an impact on other sectors of the economy. International investors have shied away from the stock market and the idea of implementing further build-own-transfer (BOT) projects in the present climate appears distant. 'If they cancel agreements, who will invest a single dollar in this country for the next 10 years?' asks Reuss. Another developer says: 'This affair will make the lending banks think twice and unless we can persuade commercial banks and the World Bank to support projects, we cannot do them. It is the banks which will eventually decide.'

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