Special editorial feature

Private Investment in the Power Sector

a Different Route

By Dr. Shahid Rahim | August 2020

The IPP issue has taken center-stage in Pakistan yet again, with the government accusing them of fleecing the nation by minting billions by way of profits while the IPPs vehemently deny this. Experts on both sides of the fence must be left to wrangle out the extent to which these allegations are true, if at all, and who has actually been responsible for this alleged abuse — the IPPs, the sector managers, or both? Our focus is only on why the IPPs end up in such controversies every few years and how such conundrums can be avoided in the future. But, first a few words about the electric supply industry itself.

Most people expect electricity to be available to them on the flip of a switch. Few, however, realize that to provide this control and flexibility to its customers — day in and day out, under scorching heat and bitter cold, during heavy rains or choking dust storms — the electricity suppliers have to make tremendous investments in generation, transmission, distribution and allied facilities. Power systems are among the most complex and expensive of infrastructure facilities for any country, but are a lifeline for their economy and society. Electricity is also a unique product. It must be produced and delivered, the moment it is demanded, as its large-scale storage is very expensive, if not impossible.

Three features of the electric supply industry stand out: (i) it must maintain sufficient power generation “capacity” in the system to meet any reasonable demand on the system, regardless of its location, timing and duration; (ii) it must keep at hand adequate resource supplies (fuels, water, nuclear, solar radiation, wind, etc.) to serve the consumer’s’ “energy” demands (the electricity consumed by their machines and appliances); and (iii) it must design and deploy each component in the system carefully to deliver electricity to consumers “reliably” and within a tight band of “quality”.

The electric supply company is a capital-intensive enterprise, often involving billions in investment upfront and also during operation. Roughly, 60% goes to generation facilities, 15% to transmission systems, and 25% to distribution networks and services. A 1,000 MW power plant alone can easily involve over a billion dollars of investment upfront. The generation and other facilities in the plant are not independent of each other but are tightly interlinked. Any disruption in fuel supplies upstream or demand downstream can cause billions invested in the system to become stranded, leading to bankruptcy of the utility.

When power sectors of many countries around the world were opened to competition in the late 1980s, there were two key motives behind the move: (i) share the financial burden of the sector’s capital-intensive schemes with the private sector; and (ii) subject it to the discipline of private markets, to remove the rampant inefficiencies in the industry. However, when the generation part of the electric supply was opened for private investment, complex policy packages based on attractive return on investment, long-term commitments, guarantees (including the infamous “take-or-pay” contracts), and risk sharing had to be introduced, as without these, no commercial creditor would lend capital to sponsors of such projects.

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