Energy Policy 55 (2013) 271285

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Energy Policy
journal homepage: www.elsevier.com/locate/enpol

Chaos in power: Pakistans electricity crisis$

Ioannis N. Kessides n
Development Research Group, The World Bank, 1818 H Street N.W., Washington, DC 20433-0002, USA

H I G H L I G H T S
c c c

We analyze the structure, conduct, and performance of Pakistans electricity sector. The causes and economic impacts of Pakistans electricity shortages are analyzed. We identify the potential policy response to the power crisis.

a r t i c l e i n f o
Article history: Received 25 June 2012 Accepted 2 December 2012 Available online 17 January 2013 Keywords: Power crisis in Pakistan Circular debt Loadshedding

abstract
Pakistan is facing a severe electricity crisis due to a persistent and widening gap between demand and available system generating capacity. The worsening of power shortages has become a major political issue, reecting the hardships for individuals and businesses. It threatens to undermine the credibility and legitimacy of government and to further stress the social fabric of the country. The power crisis did not emerge suddenly. It is the direct result of imprudent and reckless energy policies over the last three decades. These policies have impeded the development of cheap and abundant domestic energy sources. They have also resulted in very inefcient fuel-mix choices, compromising energy and economic security. Pakistans energy bankruptcy is ultimately due to massive institutional and governance failure. This paper analyzes the problems confronting Pakistans electricity sector and identies the key elements of a potential policy response to address the countrys severe power crisis. & 2012 Elsevier Ltd. All rights reserved.

1. Introduction Pakistans electricity sector is facing the worst crisis in its history. It is saddled with an overloaded infrastructure with sizeable capacity shortfall and is marred by unprecedented loadshedding, excessive transmission and distribution losses, and a massive circular debt. According to the Pakistan Electric Power Company, in April 2011, the shortfall in power generation across the country was in excess of 5000 MW, with demand standing at 14,475 MW and supply at 9465 MW. There are reports that some rural areas have been experiencing loadshedding and blackouts up to 20 h, while in cities loadshedding increased to 14 h a day. In May 2012, the shortfall increased to 6000 MWdemand was estimated at 15,000 MW and supply at just 9000 MW (Ebrahim, 2012; NEPRA (National Electric Power Regulatory Authority), 2011a, 2011b; The Express Tribune, 2011).

Tel.: 1 202 473 9345. E-mail address: ikessides@worldbank.org The ndings, interpretations, and conclusions are the authors own and should not be attributed to the World Bank, its Executive Board of Directors, or any of its member states. I would like to thank Christine Kessides, Raghuveer Sharma, Michael Toman, and two anonymous referees for their helpful comments.
$

The upsurge in power shortages represents one of the most serious adverse domestic developments in Pakistan. It has become a major political issue, undermining the credibility and legitimacy of government. According to some observers, the countrys power crisis threatens to further stress the social fabric of the country and may ultimately eclipse the terrorist threat. Electricity shortages have been causing substantial damage to Pakistans economy and constitute a binding and powerful constraint on the countrys growth. They constrain growth in terms of GDP foregone and have very signicant negative impacts on employment, international competitiveness and exports, and poverty alleviation. For the ordinary citizens, extensive loadshedding is causing signicant disruption of their daily life. For the industrial, commercial, and agricultural users, the costs of the upsurge in power shortages have been enormous. Pakistans industry has been effectively crippled. The textile sector source of over half of the countrys exports and about 40 percent of its manufacturing jobs has been hit hard. Especially small businesses have been paralyzed (Leiby, 2012; Siddiqui et al., 2011). Public protests against the blackouts have been widespread and riots sometimes have turned deadly. In some parts of the country, shopkeepers have threatened mass suicide to protest 18 to 20 h of blackouts every day. In response to the deepening

0301-4215/$ - see front matter & 2012 Elsevier Ltd. All rights reserved. http://dx.doi.org/10.1016/j.enpol.2012.12.005

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energy crisis, in 2010, the countrys political leadership held an energy summit in Islamabad. Thus, for the rst time since the commencement of power shortages, policymakers nally started giving the problem the attention it deserves. More recently, the government has been preoccupied with long debates over how to address the energy crisis. In April 2012, a two-day energy summit in Islamabad sought to come up with a viable strategy to end power shortages (APR (Associated Press of Pakistan), 2012; BNU (Beaconhouse National University), 2010). The electricity shortage did not emerge suddenly. It is the direct result of imprudent and reckless energy policies over the last three decades that impeded the development of cheap and abundant domestic energy sources. Pakistans energy bankruptcy is ultimately due to massive institutional and governance failure. The task of restructuring the electricity sector in Pakistan and of designing an appropriate policy framework for attracting largescale private investment and improving its performance is complex and daunting. There are certainly several important elements of sectoral reform in other countries that can provide useful benchmarks. However, the unique adverse conditions for better governance and performance confronting Pakistan generate signicant obstacles to restructuring efforts.

2. The structure of the electricity supply industry The electricity supply industry of Pakistan is characterized by a semi-public/semi-private market structure. The sector has been dominated by three entities: Water and Power Development Authority (WAPDA); Karachi Electricity Supply Company (KESC); and Pakistan Atomic Energy Commission (PAEC), the operator of the countrys two nuclear plants. Since 1994, a number of Independent Power Producers (IPPs) have also entered the market. WAPDA was created in 1958 as a semi-autonomous entity with the statutory authority to coordinate the development of the water and power sectors. In October 2007, WAPDA was split into two separate entities: WAPDA and Pakistan Electric Power Company (PEPCO). WAPDA is now responsible only for water and hydropower development. Its former monolithic Power Wing was vertically and horizontally restructured into four Generation Companies (GENCOs), the National Transmission Dispatch Company (NTDC), and nine Distribution Companies (DISCOs). PEPCOs stated mission was to oversee the reform and restructuring of the power sector and transform the above 14 corporate entities into autonomous and commercially viable enterprises.1 Due to the worsening power crisis, in April 2012, PEPCOs Board of Directors approved its dissolution. PEPCOs functions were transferred to the NTDC which will be subsequently handed over to the Central Power Purchase Agency (CPPA).2 KESC is the only vertically-integrated power utility in Pakistan. Its license covers the entire metropolitan area of Karachi. PAEC operates the countrys nuclear power plants. There are also several IPPs operating in the market on a Build-Own-Operate basis, and three Rental Power Plants (RPPs). During 20102011, seven new IPPs entered the market (NEPRA (National Electric Power Regulatory Authority), 2011a, 2011b). In June 2011, the total installed generation of the country was 23,412 MW out of which: 16,070 MW (68.6 percent) thermal, 6555 MW (28.0 percent) hydro, and 787 MW (3.4 percent) nuclear. The installed capacity by system was: PEPCO, 20,818 MW (88.9
1 Rather than overseeing this process of structural reorganization, PEPCO increasingly assumed a centralized role and made decisions about the unbundled entities. 2 The News, April 20, 2012 (http://www.thenews.com.pk/Todays-News-13 14050-Pepco-dissolved-670-employees-transferred#).

percent); KESC, 2594 MW (11.1 percent). In the PEPCO system, 4885 MW of installed capacity was accounted by GENCOS under PEPCO, 8325 MW by IPPs and 403 MW by RPPs. In the KESC system, 1821 MW of installed capacity belonged to KESC, 262 MW to IPPs, and 50 MW to RPPs. The bulk of the hydro capacity was accounted by WAPDAs stations: WAPDA, 6444 MW; IPPs, 111 MW (NEPRA (National Electric Power Regulatory Authority), 2011a, 2011b). The transmission segment of the industry includes two entities: NTDC, which is the national grid company of Pakistan with exclusive responsibility for the transmission, overall reliability, planning, and coordination of electricity in the entire country except for the area served by KESC; and the vertically integrated KESC, which is covering the Karachi metropolitan area. NTDC is also solely responsible for making all the necessary interconnection arrangements with new power stations. Given its role for system-wide planning, NTDC prepares the investment plan in the transmission network and grid stations. The distribution segment of the industry is comprised of eight public DISCOs that were established as a result of the unbundling of the vertically integrated power wing of WAPDA. These distribution companies serve end consumers in all Pakistan except Karachi and its suburbs. The latter are being served by KESC under a separate license granted by the National Electric Power Regulatory Authority (NEPRA). In addition, NEPRA has granted ten distribution licenses to small power producers for supplying electric power to designated bulk power consumers.

3. Insufcient installed capacitylack of adequate planning One key, long-term contributing factor to the increased power shortages has been the robust growth in demand for electricity during the past three decades. This growth averaged around 11 percent per annum during the 1980s, moderated to 4 percent per annum during the 1990s, and then increased to an average of over 6 percent during the following decade (Table 1). Industrialization, urbanization, growth in agriculture and service sectors, rising per capita income, and rural electrication led to this growth in demand. In particular, there has been extraordinary growth in domestic demand for electricity averaging over 21 percent per annum during the 1980s and 10 percent during this past decade. This rapid growth in domestic demand was fuelled by subsidized tariffs, which had declined by 24 percent in real terms during the 1980s (Pasha et al., 1989). The substantial increase in the use of electrical appliances played a major role. As a result the share of domestic consumers in total power consumption increased from 23 percent during 19801981 to almost 46.5 percent in 20102011 (Fig. 1). Growth in demand, especially during the current decade, was not fully anticipated and adequate provisions were clearly not made to meet it. Indeed, the last few years have been characterized by a totally inadequate and ill-proportionate response at the supply end. After impressive increases in installed generating capacity which were achieved with the construction of the Taberla and Mangla dams, policy action in the electricity sector has been short-sighted, inadequate and even reckless. The power sectors share of public sector expenditure, which averaged around 28 percent since the 1980s, fell to less than 3 percent during the previous decade (BNU (Beaconhouse National University), 2010). As Table 1 indicates, while demand grew at an average of 6.1 percent per annum between 2001 and 2008, growth in generating capacity was only 1.5 percent per annum during the same period. Consequently, after having surplus electricity from the late 1990s to 20042005, in recent years

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Table 1 Growth rates of electricity demand and supply (ACGR%). Source: IPP (Institute of Public Policy) (2010). Demand Supply Installed capacity 19721980 19811990 19912000 20012008 8.6 10.9 4.2 6.1 8.3 6.8 8.5 1.5 Generation 8.9 9.9 5.4 5.0

(CGD (Center for Global Development), 2010). Investor fears about quasi-expropriation were not unfounded. In May 2012, the governments failure to reimburse nearly $ 500 million to a group of nine IPPs that were supposed to be guaranteed payments led to Pakistans rst sovereign default. These developments could have signicant implications for the countrys credit rating and further undermine investor condence.

4. The circular debt

Other Govn't, 6.10% Commercial, 7.50%

Industrial, 27.50% Domestic, 46.50% Agricultural, 11.60% Street Lights, 0.80%

Fig. 1. Electricity consumption by sector, 20102011. Source: HDIP (Hydrocarbon Development Institute of Pakistan) (2011).

Pakistan has been facing severe electricity shortages.3 The present acute crisis started in 20052006 and since then electricity shortages increased and by 2010 they exceeded 5000 MW (Table 2). Under current policies, the supply gap is projected to persist into the future. By some estimates, electricity shortages will increase to 8000 MW by 2017 and rise to over 13,000 MW in 2020 (Shahbaz, 2011). The severe shortfall in electricity supply that the country is facing today is a direct result of the failure to forecast and plan for the future, upgrade existing plants, and set up new generating stations in the face of rapidly rising demand. An example of failure to design and implement an effective and coherent policy response to the countrys growing electricity needs is provided by the saga of the IPPs in the 1990s. As a result of the inadequate capacity expansion during the 1980s and early 1990s, the government decided to go for thermal generation through IPPs. It is generally acknowledged that the IPPs made a signicant contribution to the countrys energy balance, enhancing generating capacity by more than 5000 MW. Still, the terms under which the IPPs were negotiated, and especially their tariff structures, raised concerns and became a matter of signicant controversy. The protracted legal, political and economic battles that followed the introduction of the IPPs were partly due to inexperience on both sides of the fence and are suggestive of a move made in panic rather than deliberate planning.4 The environment became highly politicized, eroding investor condence and the perceived threat of political quasi-expropriation scared off foreign investment, especially in assets characterized by high degree of sunkeness
3 It should be noted that according to some studies, Pakistan faced an electricity demandsupply gap since 1980 (Alter and Syed, 2011). 4 In 1998 the Nawaz Sharif government accused the IPPs particularly HUBCO of hoodwinking the former government of Benazir Bhutto into signing fraudulent and unaffordable agreements with WAPDA. Despite intensive investigations, no charges of corruption have been proven. However, the Supreme Court in their June 2000 ruling drew attention to the fact that prolonged negotiations on tariffs between WAPDA and HUBCO suddenly ended after the installation of a new government in 1993 and supplementary amendments were suddenly executed (Bayliss and Hall, 2000).

In addition to insufcient installed capacity, Pakistans electricity shortages are closely interlinked with the growing circular debt problem. The circular debt arises when an operating entity facing problems with outstanding receivables holds back payments to its suppliers and creditors. More specically in Pakistans power sector, it refers to the debt prevailing among the various government departments, DISCOs, IPPs and the GENCOs under the control of PEPCO and KESC, domestic fuel suppliers, reneries and international fuel suppliers. Fig. 2 illustrates the prole of the energy sector in Pakistan. It is easy to see how problems in the cash ow of a given operating entity can cascade to other segments of the payment chain. For example PEPCO until recently the holding company of the GENCOs, NTDC and CPPA supplies power to and collects tariffs from the private sector, all government departments and KESC. PEPCO in turn has to pay for the power it receives from the IPPs and the fuel it purchases from oil marketing and gas companies. However, it can face delays and even non-payment in its receivablesi.e., there are delays in tariff payments, especially from the various government departments.5 The government also delays providing the tariff differential subsidies to DISCOs to make up for the shortfall between the customer tariff and the cost recovery tariff. Thus, PEPCO is facing an imbalance in its cash owsinows are uncertain and lag behind outows, most of which are contractual in nature. The buildup of receivables eventually leads PEPCO to delay or suspend payment to its suppliers. Consequently, the payment arrears facing PEPCO seep into the other segments of the supply chain: power generation companies (IPPs, GENCOs, WAPDA hydel), oil marketing companies, gas distribution companies, reneries, and oil and gas exploration companies. Thus, the main causes of circular debt are: failure of distribution companies to collect dues from consumers and nonpayment of dues by the public sector including provincial governments; subsequently, the distribution companies default on payment to generation companies; power producers in turn are unable to pay for fuel purchased from oil companies; in turn, oil companies delay settling their dues to reneries. Ineffective contractual arrangements between PEPCO and KESC are also a major contributor to the intercorporate debt problem (Ali and Badar, 2010).6 In July 2010, independent experts put the gure of circular debt at around Rs 420 billion. By September 2010 it was reported to have touched Rs 584 billion. In November 2011, the Special Parliamentary Committee on Energy Crisis was informed and the circular debt in the power sector had reached Rs 665 billion (Ahmad, 2010; Chaudhry, 2011). The circular debt problem is closely related to PEPCO, the sectors core entity. As of May 2012, the companys receivables
5 When private sector (domestic, commercial, or industrial) customers default on their bill payments, they normally get disconnected. However, big defaulters from the public sector are generally spared of such actions. 6 The electricity arrears of public sector commercial entities such as Pakistan Railways, Pakistan International Airlines (PIA), Pakistan Steel Mills (PSM), and provincial and federal government departments are running into billions of rupees.

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Table 2 Historic demand and corresponding generation capacity (MW). Source: USAID (United States Agency for International Development) (2010). Fiscal year 20012002 20022003 20032004 20042005 20052006 20062007 20072008 20082009 20092010 Computed peak demand 10,459 11,044 11,598 12,595 13,847 15,838 17,398 17,852 18,467 Supply 10,894 10,958 11,834 12,792 12,600 13,292 12,442 13,637 13,445 Surplus/shortfall 435 86 236 197 1247 2546 4956 4215 5022

amounted to Rs 360 billionapproximately Rs 40 billion from federal ministries and Rs 90 billion from the provinces and other federal institutions. PEPCO in turn has substantial arrears to IPPs, oil and gas companies. Indeed, due to the swelling circular debt, once well-performing state-owned entities such as the Pakistan State Oil, Sui Northern Gas Pipelines Limited, and Sui Southern Gas Company, are on the verge of nancial collapse. Oil reners in particular have been hit hard. As a result, they have been forced to operate at much lower capacities and are close to crossing their borrowing limits from banks. Thus, the oil reneries are not in a position to import crude oil for a long period. Default by these companies could lead to shutdown of generation plants, thus further exacerbating the countrys already severe power shortages (Javaid, 2012). Delays in the differential subsidy payments by government have undermined considerably the nancial condition of PEPCO and its afliated DISCOs, limiting their capacity to pay their own liabilities for the purchase of electricity. Delays also curbed the maintenance and expansion funding of the DISCOs, thus further exacerbating existing problems related to high distribution losses, continuity of supply, and low coverage. Because of signicant imbalances in their cash ows and their constrained ability to pay for their fuel inputs, the IPPs have been running at less than their generating capacity. As its cash ow became increasingly strained, beginning in 2006, PEPCO sought bank nancing supported by government guarantees. Running nance requirements from a few power companies increased because of the inter-corporate circular debt problem. As a result, the overall exposure of the banking industry to the power sector increased substantially.7 Furthermore, bankwide analysis indicates that the loans extended to the power sector (both public and private) during FY09 were concentrated in the top ve banks (Fig. 3). These banks have almost reached their exposure limits to the power sector and consequently are reluctant to nance any new power projects. This is especially serious because the top ve banks have traditionally accounted for a very large share of the credits extended to the power sector. Thus the circular debt has become a major hurdle to potential power investment (SBP (State Bank of Pakistan), 2011).

5. Revenue inadequacy Inefcient and below-cost recovery tariff structures have been one of the most important causes for the secular deterioration in the performance of Pakistans electricity sector. The failure of
7 To put this in perspective, at the end-December 2009, the banks outstanding credit to PEPCO, IPPs and Shell (oil marketing company) stood at just over Rs 485 billion while their outstanding credit to the textile sector the largest industrial sector of the country was Rs 535 billion (Ali and Badar, 2010).

government to prescribe adequate rate increases, especially during periods when the price of primary energy inputs (oil and natural gas) increased dramatically, subjected the sectors operating entities to considerable nancial distress and substantially impaired their ability to maintain and expand service. NEPRA determines tariffs for the three segments of the market generation, transmission and distribution on a cost-plus basis. However, there is a fundamental difference in the way tariff determinations are implemented for generation companies and nal consumers. Tariffs for generation companies are governed by long-term (25 to 30 years) power purchase agreements (PPAs), which include specic provisions for adjustments due to rising fuel costs, ination, exchange rate changes, etc. Thus, once NEPRA validates the cost claims of the power suppliers, the tariff revisions are automatically reected in the power purchase prices. In the case of nal consumers, on the other hand, NEPRAs tariff determinations become legally binding only after being notied by government. This enhances signicantly the scope for political intrusion in the process of tariff determination. The government effectively froze end-consumer tariffs from November 2003 to February 2007.8 No tariff adjustments were allowed by NEPRA despite requests from the DISCOs. During the same period, the price of imported furnace fuel, accounting for approximately one third of the fuel mix in power generation, increased by over 75 percent. And the price of natural gas increased by 78 percent. Thus the cost of electricity generation increased. In turn, the tariffs for power suppliers (IPPs and GENCOs), whose adjustment required no government approval, also increased. Consequently, the notied end-user tariffs were not able to cover these higher costs. After February 2007, NEPRA allowed some upward revision in tariffs in response to the increase in the power purchase price. However, the notied tariffs remained below those determined by NEPRA, reecting the governments unwillingness to pass the tariff increases to endusers (Fig. 4). The government provides a Tariff Differential Subsidy (TDS) to DISCOs to cover the gap between the notied tariff and the cost of service tariff as determined by NEPRA. In FY20092010 alone, the cost of electricity subsidies was estimated to be around Rs 226.6 billion, despite the fact that tariffs were raised by approximately 34 percent during the same year. Thus the TDS imposes a very heavy burden on the budget and is clearly unsustainable. Still, the governments subsidies have not been sufcient to ll the gap between the cost of electricity and the notied tariff. As Fig. 5 indicates, the wedge between end-user tariffs and unit costs has been rising consistently, especially after 2007 (ADB (Asian Development Bank), 2010) The governments decision to approve lower tariffs than those determined by NEPRA perhaps was due to socio-political considerations and legitimate affordability concerns. Moreover, the fact that the government did not pay the TDS to the DISCOs on time or in full perhaps reected genuine scal constraints. However, no matter how well-intentioned or understandable the policy, it had devastating impacts on the balance sheets of the operating entities and caused serious nancial instability in the power sector. PEPCOs receivables increased substantially from 2006 onwards. As a result of its deteriorating nancial condition, beginning in 2006, PEPCO started delaying its payments to its suppliersespecially the IPPs, but also the oil and gas supply companies. Thus, PEPCOs cash ow problems spilled over and contaminated the other segments of power supply chain. This is the point at which the circular debt problem emerged.

8 Electricity prices increased, on average, 12 percent per annum during 19932003 (Siddiqui, 2004).

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Exploration companies OGDCL/PPL

Oil refineries: Bossicar/NRL/ARL/ PRL/PARCO etc.

POL imports

Gas companies: SNGPL/SSGPL

OMCs: Shell, PSO, Caltex, APL, etc.

POL consumers: Individuals, industries

Pepco IPPs: HUBCO/KAPCO etc. Gencos WAPDA Hydel Fuel subsidy KESC: Vertically integrated company involved in generation and distribution

NTDC/CPPA (under PEPCO) Supplying power GoP notifies end-users prices and provides subsidy when these charges are not adjusted as required

Power distributors (under PEPCO): LESCO/HESCO/TESCO MEPCO/FESCO/PESCO QESCO/GEPC

Power consumers: Individual HH, industrial consumers, government (federal/provincial/local), FATA

Fig. 2. Key players in the energy sector. Source: Ali and Badar (2010).

Power subsidy

Tariff inadequacy, coupled with persistent operational inefciencies, has caused considerable nancial distress in Pakistans electricity system. It has resulted in the sectors weak selfnancing, debt service and liquidity capabilities. Thus it has substantially impaired the sectors ability to undertake the needed investment in capacity expansion and modernization, and to maintain service. In view of the key role that revenue inadequacy has played in the deterioration of the sectors performance and the circular debt problem, any policy to address the root causes of the sectors problems and prevent their catastrophic consequences, will have to include signicant tariff rebalancing. In addition to the level of prices there are signicant policy issues related to the structure of electricity prices and potential cross-subsidization from industrial and commercial to agricultural and domestic consumers. According to Figs. 6 and 7, current residential tariffs in Pakistan are the lowest among Asian oil-importing countries, while the industrial tariffs are somewhere in the middle of the range.9 Electricity service is regarded as essential both to the public and to the effective functioning of the economy. Like other infrastructural services, it tends to be extremely price and income inelastic. Thus, its pricing has important distributional implications. Raising the price of electricity appears like a lump-sum tax bearing heavily on the poor, elderly, and those with large families. Not surprisingly, the movement towards cost-reective electricity tariffs frequently encounters strong political obstacles. However, the tariff differential subsidy has imposed a very heavy scal burden on Pakistans economy. Therefore, it is important to ascertain whether it can be justied on social equity grounds.
9 These gures represent the scal year 20092010. During 20102011, the average residential and industrial tariffs in Pakistan were PKR 9.84/kW h and PKR 8/kW h, respectively (NEPRA (National Electric Power Regulatory Authority), 2011a, 2011b).

400 350 300 250 200 150 100 50 0 Jan-08

Fig. 3. Top ve banks loans in the power sector. Source: ADB (Asian Development Bank) (2010).

All banks Excluding top five

Casual empiricism suggests that, as in many other countries, electricity subsidies in Pakistan are very poorly targeted. One of the frequent limitations of subsidy schemes is that they suffer from leakage to untargeted groups. In Pakistan, poor people and other vulnerable groups capture only a small share of the subsidy. As Fig. 8 illustrates less than .5 percent of the TDS is allocated to customers who consume less than 50 kW h per month, and less than 10 percent to those consuming up to 100 kW h per month. Thus, poor rural customers who can experience loadshedding for up to 20 h a day, and low-income lifeline customers, capture a tiny portion of the subsidy. And those without access to electricity services most of them the rural poor clearly receive no subsidy at all. On the other hand, more than 60 percent of the subsidy is allocated to customers whose consumption exceeds 100 kW h per month.

6. Availability and efciency of existing power plants Revenue inadequacy and the lack of timely capacity additions to meet the growth in demand for electricity had profound

Payment

Energy

Jan-09

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12 10 8 6 4 2 0

Determined by NEPRA Approved by GOP

50% 45% 40% 35% 30% 25% 20% 15% 10% 9.45% 0.42% Up to 50 units per month 1100 units

45.13%

9.45% 5.53%

Nov-03

Feb-07

Mar-08

Sep-08

Feb-09

Oct-09

Dec-09

Jan-10

5% 0%

Fig. 4. Electricity tariffs for consumers. Source: Ali and Badar (2010).
9 8 7 6 5 4 3 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10 Average consumer end-tariff PKR/kWh Cost in PKR/kWh

101300 units

301700 units Above 700 units

Fig. 8. Allocation of TDS to residential customers. Source: ADB (Asian Development Bank) (2010).
Designed Thermal Efficiency (%) 45 40 35 30 25 20 15 10 5 0 Unit 1 (TPS Jamshoro) Units 24 (TPS Jamshoro) Units 12 (GTPS Kotri) Units 36 (GTPS Kotri) Units 37 (GTPS Kotri) 37.58 32.03 33.28 29.23 24.40 21.54 15.64 27.85 De-rated Thermal Efficiency (%) 40.10 32.29

Fig. 5. Gap between cost of service and retail price. Source: PEPCO data.

(PKR/kWh)
Philippines Japan Singapore Sri Lanka Hong Kong Korea India Malaysia Thailand Nepal Bangladesh Pakistan 0 5 16.32 15.05 12.85 11.81 10.33 9.94 9.16 7.46 7.39 7.29 6.62 5.62 10 15 20

Fig. 9. Designed vs. de-rated thermal efciency GENCOI. Source: NEPRA (National Electric Power Regulatory Authority) (2010).

Fig. 6. Residential tariffs. Source: ADB (Asian Development Bank) (2010).

(PKR/kWh)
Philippines Singapore Japan Thailand Vietnam Hong Kong Pakistan China Malaysia Korea Indonesia 0 7.40 7.36 7.12 5.96 5.58 5.38 4.20 5 10 15 9.51 9.32 8.93 13.89

Fig. 7. Industrial tariffs. Source: ADB (Asian Development Bank) (2010).

implications for the operating performance of Pakistans power plants. Both the efciency and availability of those plants have reached alarmingly low levels. The inability of the utilities to operate their generation plants due to the liquidity crunch has been the primary reason for the non-utilization of all available capacitythere has been a shortage of natural gas and government has been unable to nance the purchase of furnace oil. These developments are a direct consequence of the circular debt problem and the huge pressures it has been generating on the total supply management of the power sector. At the one end of the supply chain, oil marketing and gas supply companies are not receiving timely payments for their deliveries. At the other end, IPPs are not being paid for the electricity supplied to the national grid. Thus the circular debt has made it very difcult for fuel suppliers to deliver fuel on credit. The generating companies, in turn, have no other option but to curtail their outputs. Thus the net effect of the circular debt has been a signicant decline in the effective utilization of available generation capacity in the system. On July 1, 2011 total installed capacity stood at 23,412 MW, whereas the available capacity was 19,669 MW. During 20102011, capacity utilization was approximately 59 percent (NEPRA (National Electric Power Regulatory Authority), 2011a, 2011b). The chronic shortfall in electricity revenues has also severely undermined the ability of operating entities to modernize, maintain and rehabilitate existing power installations. Most PEPCO plants have been substantially de-rated because of low budget allocations for operation and maintenance. In the face of signicant loadshedding, there have been understandable pressures to minimize plant shutdowns for routine maintenance and inspection activities. This failure to adhere to recommended operations and maintenance practices has further exacerbated the operational performance problems of existing power plants. On installation, generation plants have rated (design) thermal efciencies which thereafter can only be maintained through

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Picture 1

stringent maintenance and rehabilitation processes. In case of negligence in the level and timing of their maintenance, plant thermal efciencies de-rate at a much faster rate. According to Fig. 9, in Pakistan, the efciencies of power plants, specically in the public sector, have been substantially reduced below their design values. This creates the need for greater amount of fuel to generate the same amount of power.

7. Transmission and distribution losses The safe and reliable transmission and distribution of electricity remains a major problem in Pakistan. In addition to the ever widening gap between demand and supply, the countrys electricity system has been marred by inefcient administration, poor maintenance, and a dilapidated transmission network. Due to weak grid infrastructure and signicant theft of electricity, technical and commercial losses from the transmission and distribution network are substantial. In 20092010, ofcial estimates put transmission and distribution (T&D) losses at around 22 percent, which are extremely high in comparison to other Asian countriesin Korea T&D losses are 3.6 percent, in China 8 percent, and in the OECD countries below 7 percent (Malik, 2012). In recent years the nature of load has changed drastically. Household and agricultural demand has experienced very robust growth and it now accounts for almost 60 percent of electricity consumed. This led to a dramatic increase in the use of electrical machinery (i.e., mercury lamps, transformers, motors, and switchgears) that are running inherently at low power factor. When a large number of dispersed residential customers and villages using low quality equipment (e.g., tubewells made from sub-standard materials) are supplied with power, technical losses are high due to the length of lines and the low power factor of the equipment used. Moreover, while projects in generation and transmission segments of the industry have benetted from technical assistance and funding from international lending agencies, for many years distribution was neglected. Thus, the development of the distribution network has been somewhat haphazard and lines have been extended, especially in rural and tubewell electrication, without any careful technical design criteria to minimize losses. Due to political pressures, 11 kV lines have been hurriedly extended over long distances to feed loads over large areas. Many of the 11 kV feeder lines are more than 150 km long. This results in high resistance losses. In many areas, the 11 kV line losses account for the bulk of total distribution losses. Moreover high distribution losses are caused by inadequate conductor sizes and undersized transformers in urban areas which have been experiencing very rapid growth in demand. Oversized transformers in rural areas, on the other hand, add to technical losses. Not surprisingly, distribution losses make a major contribution to system losses and

account for about 70 percent of the total (Qureshi and Mahmood, 2009; Beg, 1986). The poor physical condition of the transmission and distribution network is not the only or most important cause for the high T&D losses. Although the precise percentage breakdown of technical and non-technical losses in distribution is a matter of controversy, there is ample evidence of rampant electricity theft. For example, there is a strong variance in system losses across the different provinces, which cannot be explained by differences in the characteristics of their networks alone. Line losses in Punjab are much lower than those in Sindhin 20082009 these losses were 13.1 percent in Punjab and 34.7 percent in Sindh. Moreover, there has been a substantial increase in the losses reported in the North-West Frontier Province (NWFP) they increased from 13.2 percent in 20062007 to 35.3 percent in 20082009. If the condition of the transmission and distribution system was the main cause, it is unlikely that the losses in NWFP would have increased at that rate. Clearly, there are signicant nontechnical losses (Mushtaq, 2010). Non-technical losses of WAPDAs distribution system are extremely high. It is estimated that they account for over 33 percent of the total distribution system losses. Theft and pilferage are very extensive and are partly due to the lack of a rational pricing policy characterized by orderly price adjustments. Instead, in Pakistan, periods with very little or no adjustment in the level of tariffs have been followed by upward revisions that have been instituted extremely rapidly. These caused large and unnecessary adjustment costs to consumers and rms alike and have increased the temptation to steal electricity. However, the widespread theft of electricity also has an important cultural dimensionnonpayment of government dues has little stigma attached to it. In Baluchistan and the tribal areas of NWFP, the people are not convinced that stealing electricity is as immoral or illegal as any other form of theft and therefore that they need to pay for electricity services (Qureshi and Mahmood, 2009). Electricity theft has become a prevalent practice in many parts of the country. Surveys conducted during scal years 2009 and 2010 indicate that stealing of electricity was endemic in the provinces of Khyber Pakhtunkhwa, Balochistan, Sindh, and to a lesser extent Punjab. From March 2007 to March 2009, a total of 165,963 cases of pilferage were registered in Punjab alone. In 2009, KESC stated that thieves were costing it Rs 1 billion a month.10 Moreover, the act of electricity theft is not particular to the less advantaged. The actors in the theft game also include: agricultural and industrial units accounting for the biggest losses; middle, upper middle, and upper class households accounting for a big portion of the losses; and various local organizations (Picture 1). Even private schools have been caught

10 Daily Times, February 25, 2010; BBC News, July 13, 2009 (http://news.bbc. co.uk/2/hi/south_asia/8148328.stm); The DAWN Media Group, August 28, 2009.

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Installed Generation Capacity in the Country for the year 1985 (MW)
137 (2.44%) 2580 (45.96%) 2897 (51.60%)

Installed Generation Capacity in the Country for the year 2011 (MW)
787 (3.36%) 6555 (28.00%)

16070 (68.64%) Nuclear Hydel Thermal Nuclear Hydel Thermal

Fig. 10. Shift from hydro to thermal generation. Source: NEPRA (National Electric Power Regulatory Authority) (2011a, 2011b) and earlier years).

stealing electricity. In 2009, the National Assembly was informed that several politicians, bureaucrats, industrialists, and sensitive organizations were stealing electricity in Karachi (Cheema, 2010).

8000 7000 6000 5000 4000 3000

8. Shift from cheap hydro to expensive oil-red generation After the construction of the Mangla and Tarbela reservoirbased generation stations, with the exception of Ghazi Barotha (a peaking plant) no major hydropower project was undertaken. And this despite the fact that: (i) a very small portion (around 16 percent) of the countrys substantial hydro potential of over 41 GW has been exploited; and (ii) hydro is one of the cheapest options for power generation in Pakistan. In recent years, most of the generating capacity additions consisted of thermal plants. Thus there has been a marked shift from hydropower to thermal generation. In terms of installed capacity, between 1985 and 2011 the share of hydro declined from 52 percent to 28 percent while during the same period the share of thermal increased from 46 percent to 69 percent (Fig. 10; NEPRA (National Electric Power Regulatory Authority), 2011a, 2011b). The adverse economic consequences of shifting from cheap hydropower to more expensive thermal generation were compounded by the rapid depletion of the countrys natural gas reserves. Natural gas has been a key primary energy and power source in Pakistan. Against all forecasts the gas reserves have been depleting rapidly. By 2011, 49 percent of the original recoverable reserves [54 trillion cubic feet (TcF)] had been exhausted. The country now has sufcient reserves to last just over 20 yearsassuming that the current production rates are maintained. There are also 35 Tcf of additional reserves in tight/ difcult gas.11 However, due to the lack of a coherent development strategy and a facilitating policy framework, gas production is projected to rapidly decline in the medium term (2014 2015).12 Gas production is facing an even bigger decline in the long-term (20192020). Gas demand, on the other hand, will continue to increase during the same period. Thus, there will be a growing gap between gas demand and supply (Fig. 11). Under a business-as-usual scenario, Pakistans gas shortage is likely to get much worse in the next two decades and could ultimately cripple
11 This is gas whose surrounding sandstone, shale, or other sedimentary rock is very dense rather than porous or permeable as with conventional gas. The lack of permeability locks the gas underground and makes it more difcult and costly to drill. 12 The gas pricing system has caused signicant distortions in demand and supply.

Gross Demand Domestic Production

2000 1000 0 200809 200910

201011

201112

201314

201415

201920

Fig. 11. The increasing gap between gas production and demand under a donothing scenario (in million cubic feet per day). Source: ADB (Asian Development Bank) (2010).

the economy (SBP (State Bank of Pakistan), 2011; ADB (Asian Development Bank), 2010).13 Due to limitations in natural gas supply growth and the rapid depletion of natural gas reserves, within thermal generation there has been increased reliance on more expensive furnace oil. During the scal year 20052006, the respective shares of thermal electricity generated using furnace oil and natural gas were 31.2 percent and 68.6 percent; during 2010-2011, the corresponding shares were 55.1 percent for oil and 44.7 percent for natural gas (NEPRA (National Electric Power Regulatory Authority), 2011a, 2011b). The increased reliance on furnace oil for electricity generation has rendered power tariffs in Pakistan vulnerable to spikes in oil prices. Unfortunately, the shift from gas to furnace oil was concurrent with the sharp escalation in the international price of oil. Basically it occurred at a time when the price of oil and furnace oil more than doubled (Fig. 12a and b). This had profound negative implications for the cost structure of electricity generation in Pakistan.

9. The economic impacts of loadshedding In recent years there has been a signicant increase in the frequency and intensity of power outages generally in Pakistan and in the industrial sector in particular. A manifestation of this problem can be seen in the large number of reports in the popular press highlighting the incidence of outages. During 20102011, the problem was aggravated to such an extent that it led to protests and riots in several cities across the
13 The country experienced some of the worst gas shortages in its history in 2011. Supply to the industrial, compressed natural gas, and power sectors, was signicantly curtailed [Daily Times, December 28, 2011 (http://dailytimes.com.pk/ default.asp?page=2011%5C12%5C28%5Cstory_28-12-2011_pg5_10)].

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1200 80% 77% 1000 70% 60% 50% 600 40% 30% 20% 200 10% 0 0102 0203 0304 0405 0506 0607 0708 0809 0910 0% 0304 0405 0506 0607 Jul-Dec 0708 0809 0910* 24% 75% Gas 68% FO

57%

800

Gas

HSFO

55%

400

Fig. 12. (a) Price of gas and furnace oil delivered to the power sector. (b) Shift in fuelmix (proportion of thermal generation). Source: Saeed (2011).

country.14 There have been persistent complaints by various chambers of commerce and other industrial associations that the outages have forced a signicant reduction in the level of output across a large number of industries. The normal rhythm of production cycle has been especially disrupted in electricityintensive sectors like textiles, basic metals, rubber and plastic, paper, and leather products.15 Loadshedding is causing signicant dislocation of economic activity in the industrial sector. The costs of loadshedding consist of two components: (i) direct costs which include the net value of production permanently lost, spoilage costs, process restart costs, damage to machinery, etc.; and (ii) indirect costs arising from the adjustments made by rms in their operations to recover at least part of the output lost during and immediately after outages. Firms can make multiple types of adjustments in response to outages depending on their time of occurrence and duration, warning time, frequency, and coverage. Typically such adjustments may include: acquisition of self-generation capacity, more intensive utilization of existing capacity (machinery and other assets), overtime work, working additional shifts, and changing shift timings. There are also indirect costs that do not fall upon the sector impacted by the outages but on the rest of the economy. These may include: (a) consumer surplus losseswelfare losses incurred by consumers of various industries due to the contraction in the level of these industries production induced by the power outages; (b) multiplier and ripple effects of the outages in a given sector contraction in the level of activity in other sectors of the economy

Table 3 Types of adjustments to loadshedding. Source: IPP (Institute of Public Policy) (2009). % Of sample Self-generation of electricity Working overtime Working additional shifts More intensive utilization of machinery Changing shift timings Changing working days Firms making some adjustment to loadshedding 75 18 15 10 6 5 84 Extent of recovery (%) 85 30 33 28 30 6 60

14 Consumers have been facing extensive scheduled and unscheduled loadshedding across most of the countrys jurisdictions. The distribution companies have been complaining that PEPCO has kept them in the dark regarding the shortfall faced by the national grid and has not been providing them with proper loadshedding and management plans. There have also been persistent complaints about discriminatory loadshedding especially from ofcials of the Punjab province. In July 2012, the Chief Justice of the Lahore High Court (LHC) observed that discrimination was being meted out to Punjab by the federal government and directed the federal government and PEPCO to carry out equitable loadshedding across the country. LHC further ordered PEPCO to submit its loadshedding schedule to the court. Due to mounting public pressure, the federal cabinet decided that loadshedding would be conducted on an equal basis across the country (http://dawn.com/2012/07/31/lhc-orders-equitable-outages/ and http:// www.samaa.tv/newsdetail.aspx?ID=51873&CID=1). 15 In April 2012, the federal government instructed PEPCO to exempt the textile industry both prime users and those having self-generation from loadshedding (http://paktribune.com/business/news/Textile-industry-exemptedfrom-load-shedding-PEPCO-9734.html).

because of the fall in demand caused by the decline in income generated in the former sector (Pasha et al., 1989). Given the long history of outages, most rms in Pakistan have incorporated into their production planning the expectation that power outages will persist in the long run. As a consequence of those strong expectations about future outages, rms tend to undertake mitigation options that are either not feasible or economically justied when outages are a temporary phenomenon. Installation of stand-by self-generation facilities is the best example of such a mitigative response that is being increasingly observed in Pakistanespecially by industrial units that are facing large time losses due to outages.16 The extent to which a given rm substitutes conventional power with self-generation will clearly depend upon the energy-intensity of the rms operations, the terms and conditions governing its access to capital, the availability of alternative less-costly adjustments, and its ability to pass on the higher energy costs to nal consumers in the form of higher prices. In a survey conducted during 2008 on a stratied (by city and industry group)

16 In response to inefciencies (especially the unreliability) in public electricity supply, industrial rms typically adopt four strategies: self-sufciencythe rm provides its own electricity to the point where it no longer needs the supply from the public utility; standby private provisionthe rm switches to its own generators only when the reliability of public supply falls below a certain minimum level; public source as standbythe rm relies on its own generating facilities but switches to the public supply during those times of the day when the public utility is highly reliable; captivitythe rm relies entirely on the public utility despite the low reliability of service (Anwar, 1999).

21%

32%

43%

44%

46% 52%

51% 47%

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sample of 65 industrial units, 75 percent of the sample units indicated that they invested in self-generation capacity (Table 3). More intensive utilization of machinery and other assets to compensate for output lost during outages generally leads to higher repair and maintenance costs. Also, because of the xity of contractual arrangements with labor, overtime work, additional shifts and major changes in shift timings or working days are likely to result in additional labor costs. According to Table 3: 10 percent of the rms tried to recover some of the lost output through more intensive operation of their machinery; 18 percent by working overtime; 15 percent have worked additional shifts; 6 percent changed shift timing; and 5 percent changed working days. Although the gures for these mitigative options are low by comparison to self-generation, they still indicate a denite cost of adjustment in response to outages. The estimates from Table 3 indicate that 84 percent of the rms sampled made an effort through various adjustments in their operations to recover part of their lost output lost. For the sample as a whole, the extent of recovery was 60 percentalthough such a recovery was achieved at a higher cost. In 2008, for example, the average DISCO tariff was Rs 7.94 per kW h. The average cost of selfgeneration, on the other hand, was Rs 19.85 per kW h, implying that self-generation costs an extra Rs 11.91 per kW h (Sheikh, 2008). Therefore, the extra cost to the industrial sector due to selfgeneration was estimated at Rs 32 billion. The rms that acquired self-generation managed to recover 85 percent of the lost output. The cost of the remaining 15 percent which was permanently lost by the same rms was estimated at Rs 42 billion. Thus, for rms that acquired self-generation the total cost of loadshedding in 2008 was approximately Rs 74 billion. Firms that utilized mitigative mechanisms other than selfgeneration recovered on average approximately 29 percent of their lost output. In 2008, the estimated costs (overtime/shift/changing working days premia to labor, additional wear and tear of machinery due to more intensive utilization, etc) of these mechanisms were estimated at Rs 6 billion. For these rms the cost of permanently lost output was estimated at Rs 77 billion. Thus, the total cost of loadshedding to rms that did not engage in self-generation was approximately Rs 83 billion. Over all, in 2008, the cost of loadshedding to the industrial sector was estimated at Rs 157 billion or 9 percent of the total industrial value-added. This reduction in value-added led to a likely loss of industrial employment of around 300,000 workers (IPP (Institute of Public Policy), 2010). A proper valuation of the costs of power outages must also take into account the secondary or multiplier effects of the decline in industrial value that is caused by these outagesi.e., the secondary or multiplier effects in other sectors of the economy like wholesale and retail trade, transport and communications, banking and insurance, etc. In 2008, these indirect costs were estimated to be around Rs 53 billion. Thus the total cost to the economy due to loadshedding in the industrial sector was approximately Rs 210 billion or around 2 percent of GDP, approximately $ 1 billion in lost exports, and potential displacement of around 400,000 workers. The year 2009 witnessed a signicant increase in the frequency and intensity of loadshedding, especially in the industrial sectorthe incidence of outages increased in 2009 as compared to 2008 by around 30 percent. Given the upsurge of power outages, the damage to the economy in terms of adjustment costs, and foregone output and GDP, was higher in 2009. Overall the cost to the industrial sector (extra costs due to self-generation, adjustment costs, and the cost of output permanently lost) climbed from Rs 157 billion in 2008 to Rs 230 billion in 2009. Similarly, the spillover costs of industrial loadshedding to the rest of the economy rose from Rs 53 billion to Rs 95 billion. Thus the total cost of industrial loadshedding to the rest of the economy rose from Rs 210 billion (2 percent of GDP) in

Table 4 National costs of loadshedding. Source: IPP (Institute of Public Policy) (2009, 2010). 2008 Rs 157 billion Cost to the other sectors of industrial loss of value- Rs 53 added billion Total cost of industrial loadshedding to the Rs 210 economy billion Cost as % of GDP 2 Loss of employment in the economy 400,000 Loss of exports $ 1 billion Cost to the industrial sector 2009 Rs 230 billion Rs 95 billion Rs 325 billion 2.5 535,000 $1.3 billion

2008 to Rs 325 billion (2.5 percent of GDP) in 2009. Moreover, in 2009, loadshedding caused a loss of $ 1.3 billion in export earnings and led to the potential displacement of 535,000 workers (Table 4).

10. Key policy issues and options We summarize below the problems confronting Pakistans electricity sector and the key elements of a potential policy response to address the countrys severe power crisis. 10.1. Inefcient generation mix In recent years, the generation mix has deteriorated substantially with serious adverse consequences for the countrys energy and economic security. Today, Pakistans electricity mix is very heavily skewed in favor of thermal generationmostly oil- and gas-red with a tiny contribution from coal-red plants. Even more problematic is the countrys heavy dependence on oil-red generationat present almost 35 percent of total electricity generated compared to a global average of just 5 percent. Not surprisingly, the steep increase in furnace oil prices in the international market has played havoc with Pakistans power sector. In the face of escalating oil prices, rapidly depleting domestic gas reserves, and inadequate liqueed natural gas (LNG) terminal infrastructure, continued heavy reliance on fuel oil and natural gas could further undermine the countrys energy and economic security. There is an urgent need to rationalize the countrys generation mix in order to reduce its vulnerability to the oil price shockss in the global energy market (Malik, 2010). Pakistan is blessed with an abundance of renewable energy resourcesincluding hydropower, solar, wind, geothermal, and biomass. Renewable technologies could offer tremendous benets for meeting the countrys energy needs. They would reduce costly fuel imports and their attendant foreign trade impacts; diversify Pakistans energy mix, an important consideration in the face of signicant technological, market, and climate disruption risks and uncertainties; and match well to a variety of grid, off-grid, remote, and distributed applications, thus offering the least-cost option for the electrication of the countrys large number of remote villages without the need for costly grid expansion; and create local job and income opportunities. However, with the exception of a few large hydroelectric projects, the bulk of the countrys renewable energy potential has not been adequately explored and developed. Pakistan has a substantial hydro potential of over 41 GW. To date only 6.5 GW or around 16 percent of that potential has been developed.17 While the benets of utilizing
17 For an insightful analysis of the costs and benet of large dams see Ansar et al. (2012).

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World World powergeneration fuel mix 200910

Others, 3.30% Nuclear, 13.50% Others Nuclear Hydro Hydro, 16.20% Gas Oil Coal

Pakistan Pakistan power generation fuel mix 200910

Others, 0.30% Nuclear, 3.20%

Coal, 40.50%

Gas, 25.40%

Hydro, 32.30%

Coal, 0.20% Oil, 5.10% Gas, 21.40% Oil, 38.20%

Fig. 13. A comparison of fuel mix in electricity generation. Sources: IEA (International Energy Agency) (2011), NEPRA (National Electric Power Regulatory Authority) (2011a, 2011b).

the countrys renewable resources have been long recognized and gured prominently in most of the energy policy and plan documents since the early 1980s, little concrete and substantive action has been taken for their effective utilization. Indeed, the governments pronouncements on sourcing a signicant portion of electricity generation from renewables have been interpreted by skeptics as more symbolic rather than representing a strong and committed policy push (Mirza et al., 2009). Pakistan has the worlds fth largest coal reservesaround 185 billion tonnes. Yet, coal-red plants accounted for just 0.2 percent of the countrys electricity generated as contrasted to a global average of 41 percent (Fig. 13). Two units of the Lakhra power plant the only coal-red power plant in Pakistan have been out of order since 2006 due to a leasing dispute. It will be exceedingly difcult, if not outright impossible, to resolve the power crisis in Pakistan without a more aggressive rebalancing of the countrys energy mix and greater deployment of its immense coal resources. Indeed, coal might ultimately present itself as one of the key solutions to Pakistans current power crisis (Malik, 2010). However, there are strong international pressures for curtailing carbon dioxide emissions from coal-red electricity generation. Pakistan faces serious scal limits on its ability to nance generation through costlier lower-carbon alternatives. Given the enormous damage that the countrys economy has already suffered because of extensive loadshedding, the need to balance reductions in carbon emissions against developmental needs is very relevant. The resolution of Pakistans power crisis is likely to require an aggressive rebalancing of the countrys energy mix and greater deployment of its substantial hydropower and immense coal resources. In the face of escalating imported fuel oil prices and falling supplies of indigenous natural gas, in October 2012, the government announced that it plans to convert its oil- and gas-red power stations to coal-red plants. Initially, the Jamshoro and Guddu stations (with de-rated capacities of 675 MW and 580 MW, respectively) will be converted. The Muzaffargarh, Multan, and Faisalabad plants (with respective capacities of 1130 MW, 120 MW, and 100 MW) will be taken up in the second phase (Siddiqui, 2012). 10.2. Lack of an effective and credible regulatory regime has undermined incentives for private investment A major factor for the slow progress in addressing the performance problems of the power sector is the ineffectiveness of its governance structure and the low credibility of its

regulatory regime. The sectors policy and regulatory framework are designed, at least in principle, to encourage private investment and participation. However, the inefciency of implementation exhibited by NEPRA e.g., long lead times and delays in tariff agreements and its tendency for regulatory micromanagement, as well as the governments continuing interference in the regulatory process, have undercut investor condence (Malik, 2007). Moreover, the experience with the IPPs during the 1990s has entrenched in the minds of private investors strong fears of political quasi-expropriation. Thus, despite the very attractive terms and conditions of the 2002 Policy, very little foreign investment has owed into the power sector. Resolving Pakistans power crisis and reducing the severe shortfall between supply and demand will require substantial new investment, especially in generation but also in transmission and distribution. The governments Vision 2020 Program envisages adding around 20 GW of capacity into the system by 2020 at an estimated cost of around US$ 32 billionan average annual investment requirement of US$ 3.2 billion (IGI Securities, 2010). Given that the governments scal space is very limited, a signicant portion of the requisite investment will need to be raised by the private sector. 18 However, continuing perceptions of high country and sector risk are major stumbling block to private investment. Owners of private capital will be unwilling to invest in sunk electricity assets in Pakistan unless there is a convincing commitment that the government will not explicitly or implicitly expropriate the resulting private value. Foreign investors in particular that are vulnerable to administrative intervention will make disproportionately low investments in electricity activities characterized by large sunk costs and will demand high risk premia. Thus, there is an urgent need for a mechanism that provides appropriate limits on the discretionary exercise of governments regulatory powers. To adequately address the huge shortage of power capacity and improve the supply-side of the electricity market will require substantially enhancing the effectiveness of the sectors regulatory regime. This regime must include an institutional mechanism that imposes substantive and procedural restraints on arbitrary

18 The 20 GW capacity additions envisaged by the Vision 2020 Program include: 6 GW of hydro; 6 GW of coal; 5 GW of gas; 1 GW of naphtha; and 2 GW from alternative energy resources. The government foresees a 5545% publicprivate nancing mix (ESMAP (Energy Sector Management Assistance Program), 2010).

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administrative intervention and credibly commits against political quasi-expropriation of private investor value.

10.4. Inefcient, below-cost tariff structures have been one of the most important causes for the deterioration over time in the performance of Pakistans power sector Tariff policy is one of the most controversial issues in most countries power sectors. Nevertheless, the failure of past governments in Pakistan to realign prices with underlying costs and prescribe adequate rate increases, especially during periods when the price of furnace oil increased dramatically, has substantially undermined the nancial viability of the electricity sector. End-consumer tariffs were effectively frozen by government from November 2003 to February 2007. During the same period the price of furnace oil approximately a third of the fuel mix in power generation almost doubled, causing a signicant increase in the cost of electricity generation. The cost of service was further elevated because of the high commercial and technical losses and other operating inefciencies of DISCOs. As a result the gap between the cost of service and retail price increased over time. Due to scal constraints, the government has been unable to provide (on time or in full) to DISCOs the required tariff differentiated subsidy to cover the widening gap between the cost of service and retail price. This caused considerable nancial instability in the sector. The DISCOs were unable to meet their obligations to power producers, who in turn could not make payments to fuel suppliers. The problem of inter-corporate circular debt gravely affected the power generation capacity available in the country. Thus the tariff policy, circular debt and power crisis are closely interlinked. In addition to imposing an unsustainable scal burden, electricity subsidies have been very poorly targeted. Low-income lifeline customers and the rural poor capture a tiny portion of the subsidy. Moreover, the current structure of electricity tariffs contains signicant elements of cross-subsidization from industrial and commercial customers to domestic customers. These cross-subsidies conict with the efcient use of limited resources to support economic progress, and social equity. In view of the power sectors dire nancial condition and the inability of government to absorb the losses caused in large part by its intervention in the setting of tariffs, it is imperative to rationalize the pricing of electricity. The highest policy priority in the electricity sector should be to rebalance the structure of tariffs and realign prices with underlying costs, in part to restore revenue adequacy and generate internal funds for capital investment and in part to eliminate poorly-targeted and inequitable subsidies that have created an unsustainable scal burden. 10.5. A market structure dominated by a monolithic state entity no longer serves the public interest To address Pakistans crippling power shortages, investment decisions urgently need to be made with respect to new generating capacity. These decisions will entail critical choices among alternate electricity generation technologies. And they will have profound macroeconomic, energy cost, and environmental implications. The emerging international experience raises signicant doubt as to how a market structure heavily dominated by a vertically-integrated, state-owned utility can support economically efcient new generation and other investment decisionsboth with respect to size and the choice of technology. It is increasingly argued by electricity sector experts that with workable markets, private participants investing their own funds can better balance risks and rewards than central planners. Investment driven by market incentives rather than bureaucratic preference tends to serve the public interest better. How this international experience can be applied

10.3. Pakistans extensive loadshedding highlights the need for electricity governance reform The shortfall in electricity supply (Table 2) has been exacerbated by extremely high T&D losses due to poorly maintained and outdated generation plants and grid infrastructure, inaccurate metering and billing, and extensive theft from illegal connections. Below cost recovery tariffs that have encouraged inefcient consumption and local politicians populist free power campaigns have further aggravated the demandsupply gap. Almost 70 percent of T&D losses occur in the distribution segment of the supply chain and a signicant portion of these distribution losses are due to electricity theft (Malik, 2012). Thus Pakistans power sector is a leaking bucket with large holes. While a number of policy working groups have focused on these holes and proposed appropriate remedial measures, to date there has been very little progress in bringing down the huge system losses.19 Part of the problem is that the holes are deliberately created and the resulting leaks generate economic rents for vested interests that have successfully undermined the modest efforts by government to x the problem. All of the above factors that have contributed to the shortfall in electricity supply and consequently to loadshedding are fundamentally due to the electricity systems weak governance structure. Indeed, the blame game that has followed most recent blackouts is clearly symptomatic of such governance failurethe lack of accountability, coordination and communication.20 One of the fundamental weaknesses of the sectors governance structure is the fact that no single public institution or member of the industry has responsibility for system-wide planning and implementation. There are more than 20 organizations involved in the power sector, including WAPDA, PEPCO, GENCOs, DISCOs, NEPRA, the Private Power & Infrastructure Board, the Thar Coal and Energy Board, the Infrastructure Project and Development Facility, the Alternative Energy Development Board, the Pakistan Council of Renewable Energy Technologies, the National Engineering and Science Commission, the Solar Energy Center, and the provincial power and irrigation departments with responsibility for hydropower (under 50 MW) and off-grid renewable projects (Sheikh, 2010; Malik, 2012). This institutional fragmentation and the consequent splintering of planning and development responsibilities have inhibited the formulation of a coherent and comprehensive energy policy, and ultimately contributed to the sectors failure to meet the power needs of a modernized and growing economy. Reducing line and theft losses to levels comparable to other countries is an indispensable precondition for resolving the huge demand and supply imbalance. The rst step towards this goal is requiring accurate estimates of electricity losses and demanding greater accountability from all members of the industry and policymakers as well as public disclosure of the efforts being undertaken to close the demandsupply gap. Resolving the countrys power crisis will also require reforming the sectors highly fragmented governance structure.
19 One of the proposals of the governments April 19, 2010 Energy Summit was to reduce distribution losses by 2 percent within six months. During that period, rather than decreasing, distribution losses actually increased. 20 The DISCOs have been complaining that PEPCO has not provided them with proper loadshedding management plans. On the other hand, the DISCOs themselves have failed to control their inefciencies, minimize power theft, and overcome their technical constraints (e.g., overloading of transformers).

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to the unique circumstances of Pakistan needs to be assessed further. The long-term viability of the electricity supply industry calls for major structural reorganization and rebalancing of the roles of the public and private sectors. It is essential to radically shift away from a predominantly state controlled industry to one where the government maintains a strategic presence and exercises its regulatory function, while the private sector plays a leading role in operating the sector and managing its development. The role and centrality of WAPDA/PEPCO, as well as their structure of ownership, need to be reassessed also because the power sector is confronted with grave and potentially debilitating problems of operating performance. The long-term sustainability of the power sector is at stake.

11. Need for radical decentralized solutions Incremental reforms have been successfully implemented in countries with mature electricity systems supported by wellfunctioning institutional arrangements. However, an incremental approach to electricity reform may not be the right prescription for a country like Pakistan that is facing a severe power crisis: acute electricity shortages and very extensive loadshedding, poor operating efciency, high transmission and distribution losses, and a massive circular debt. In the face of such severe performance problems and the serious crisis of governance in the electricity sector, far-reaching reforms based on radical structural options may constitute a sensible, even conservative response to Pakistans electricity problem. The centralized electricity supply model where electricity is mainly produced at large generation facilities and shipped through a countrywide network of transmission and distribution grids to the end consumers has traditionally offered important economies of scale/scope and, by and large, high reliability. However, the performance of the centralized electricity system is very sensitive to the quality of the sectors institutional governance. Attempts at reforming large public utilities in the context of centralized electricity systems have largely failed. These efforts either did not bring the desired results or the improvements were not sustained. Very few governments, if indeed any, were able to introduce and maintain the large number of complex and demanding policy measures needed for efcient performance of large public electric utilities. It became evident to policymakers throughout the world that the long-term solution to the problems of poor service delivery, lackluster operating performance, and damaging political interference in the electricity sector may require bypassing the aws of the centralized electricity system and focusing instead on complementary decentralized generation techniques. Moreover, addressing the energy marginalization of rural areas may require an alternative to centralized energy delivery. In recent years the quest for energy efciency, concerns over fossil fuel depletion and uctuating prices, and climate change have caused a paradigm shift towards decentralized market structures. Indeed, there has been a resurgence of interest in distributed generation (DG)i.e., energy produced on or very near the site of use from relatively small and modular generating units. In several developing and transition countries, DG is already accounting for a signicant share of total electricity generated. Classic forms of DG include combined heat and power (CHP) and industrial gas turbines. More recently, the denition has expanded to include renewable technologiessolar, wind power, small hydro, biomass, landll gas to energy, and waste to energy DG technologies are especially well-suited for off-grid remote applications in rural areas where consumption is low and the

distance to the nearest distribution center is high. These technologies can be effectively deployed to improve reliability and thus protect households and industries against the risk of costly voltage uctuations and power outages. This is especially relevant in Pakistan, where power swings and blackouts can be very extreme. Moreover, it is becoming increasingly clear that in addition to reducing the losses incurred in transmitting centrallygenerated electricity to the point of use, community-based DG systems can lead to greater individual sensitivity to energy scarcity issues and might be more effective in dealing with Pakistans problem of extensive power theft. Thus, by driving a change in social attitudes and a more efcient use of energy resources, DG could make a valuable contribution to energy efciency and security, and carbon savings. A key part of responding to Pakistans enormous electricity challenge and reducing the countrys huge demandsupply gap is to investigate to what extent DG and other decentralized market arrangements could complement, and in the longer term potentially offer an alternative to, the countrys centralized electricity system. It is still too early to provide a denitive assessment of the experience with DG technologies in developing countries. India and China have aggressively promoted their deployment with relative success. In other countries, technical, regulatory, and nancial barriers continue to impede their development. Still, abundant evidence is emerging on the economic and social benets of distributed generation in a variety of countries. Biomass and solar DG have facilitated community-based development projects as well as income generating activities at the household level, and increased employment in a number of Indian and Nepalese villages (Hiremath et al., 2009). One of the important benets of the aggressive development of DG in Cuba by the end of 2007, over half of the countrys generating capacity was distributed has been the increased resistance of electricity generation to natural disasters (Lovins, 2010). 11.1. Privatizing distribution is an especially important step for rapid action The logical place to address revenue shortfalls is at the distribution end, which collects revenue from customers. The best way to start and sustain pricing and related reform is to separate the local/regional distribution monopolies from the rest of the industry, privatize them, and subject them to price or revenue cap regulationwith an explicit commitment from the government that it will refrain from interfering in the tariff determination process. The governments announced plan to privatize the electricity distribution companies should be accorded the highest policy priority and its timetable be accelerated. 11.2. An effective energy efciency policy Population growth, industrialization, and rising incomes in Pakistan are stimulating substantial energy demand. A number of energy sources and technological options exist for addressing this demand though with major environmental, social, and economic tradeoffs. Improvements in energy efciency represent an important option for restraining the increase in per-capita energy consumption that would bring substantial benets to the nations economy. The energy efciency option remains largely unexploited in Pakistan (Malik, 2008). A vigorous advocacy campaign could enhance the publics awareness of the importance and substantial social benets of energy efciency. There is a need for a strategy to launch a

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sustainable long-term national energy efciency program and most importantly, design effective incentive mechanisms. 11.3. Regional market integration In Pakistan and elsewhere in the South Asian region, limited investment resources and institutional deciencies have resulted in supply-constrained energy systems. Signicant differences and complementarities exist in the energy resource endowments and energy consumption needs of the region. Thus there is considerable scope for regional cooperation and trade in the power sector. In recent years, the governments of the region have become increasingly aware of this potential and the winwin opportunities it offers. The regionalization of electricity markets in South Asia is likely to yield signicant benets that go beyond exploiting important complementaries in primary energy resource endowments. Regional market integration could assist the governments of the region in overcoming institutional constraints and increase their capacity to make credible policy commitments; facilitate the introduction of competition into historically monopolized electricity markets; improve the efciency of electricity supply industries by allowing them to grow without respecting economically articial national boundaries; and ultimately increase sectoral investment. Once considered outlandish, the idea of a single, regionally unied electricity market in South Asia needs serious consideration.

credible regulatory and political commitment for the viability of IPP investments. This experience is highly relevant for other developing countries that have similar governance problems in the electricity sector.

References
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12. Limits of the standard template for reform The full implementation of the standard reform model21 especially the establishment of effective regulation, vertical and/ or horizontal unbundling, and the introduction of wholesale and retail competition has several commitment-to-reform, legal, nancial infrastructure, and other institutional pre-requisites that are not present in Pakistan and in most developing countries. Thus in recent years, increasing doubts have been expressed about the applicability of the standard template to the unique circumstances of many of these countries. A new hybrid model has emerged with IPPs playing an important role alongside the state-owned electric utilities. IPPs have been an important source of new investment in Pakistan. Their introduction has led to a major increase in generating capacity. Moreover, many of these IPPs have exhibited superior technical performance relative to the state-owned utilities. However, as the experience from Pakistan clearly indicates, the success of IPP schemes is contingent upon a coherent policy framework that pays explicit attention to planning, procurement, and contracting issuesi.e., effective governance. There is greater potential for successful outcomes, both for investors and the host countries, when effective regulatory governance (characterized by coherence, independence, accountability, transparency, predictability, and capacity) is put in place, preferably before the IPPs are negotiated. An effective regulatory oversight can lead to reduction in specic capital costs (capital costs per unit of installed IPP capacity) as well as to improved operating efciencies. Pakistans experience highlights the detrimental consequences of the lack of
21 This refers to the new paradigm that has emerged in recent years for the organizational restructuring of the electricity industry. The reform steps have included some of the following: corporatization and commercialization; creation of (independent) regulatory agencies; vertical and horizontal restructuring; establishment of regulatory rules to promote efcient access to the transmission network; privatization; independent power producers; designation of an independent system operator; unbundling of retail tariffs; and creation of markets and trading arrangements for voluntary energy and ancillary services.

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