Pakistani Energy Sector Essential Reforms

Essential Reforms for the Energy Sector

ISSUE: Structural Fragmentation of the Sector
There are four Ministries, Water and Power, Petroleum, Planning and Finance as well as three Regulators NEPRA, OGRA and DGPC involved in regulating and administering the Energy Sector leading to leading to a lack of a coordinated approach. The recent petrol shortage is one manifestation of this problem.
Potential investors in the energy sector have multiple policies, ministries, regulators and institutions to deal with leading to Pakistan being number 127 in the list of countries on Ease of Doing Business Survey as published by the World Bank. To complicate matters further the 18th amendment to the Constitution has created another layer of bureaucratic control and potential for lengthy delays both for policies and implementation of operational affairs.
There are numerous policies that relate to narrow sub-sectors. There is no entity responsible for the energy sector as a whole and there is no integrated energy policy or physical or financial planning. The overarching role of the Planning Commission in policy formulation and project coordination was lost over time and there was no institutional agency to fill the gap. Two regulators NEPRA and OGRA were created to oversee a market based energy sector whereas upstream regulation remained in the domain of DGPC ( a government department) but the sector did not move on to markets nor were the regulators given the autonomy, resources or legislative backing to oversee and fulfil the function of coordination. Similarly energy efficiency and conservation agencies/regulators are scattered throughout the Federal and Provincial governments.

Reforms Recommended
Creation of a Ministry of Energy- separating the regulation, administration/Ownership and Policy formulation and restricting the role of the Ministries to that of Policy formulation only.
Integrated Energy Planning and Execution allocation of resources to the sector by Planning Commission and Ministry of Finance should reflect the sectors importance.
Merger of the Regulators with expanded and more specific responsibilities
Streamlining the Energy Efficiency and conservation bodies between the Ministries and the Provinces

Conclusion:
Without far reaching institutional restructuring, piecemeal reforms are unlikely to form the basis of a sustainable and efficient energy sector. PML(N) had committed to a unified Ministry of Energy in its manifesto




ISSUE: Incomplete Unbundling/Lack of Market Development in the Power Sector
The unbundling of WAPDA was undertaken under a Strategic Plan separating companies to assume responsibility for generation, transmission, and distribution networks to create greater efficiency and accountability in the power system was started over 15 years ago. To date this has not been completed. The Plan was;
Government-owned corporatized entity responsible for owning and operating large multi-purpose hydel facilities.
Private generation companies to operate under free market conditions.
Transmission and dispatch arrangements involving a public sector "wires company" and privately traded electricity.
Private, regulated distribution companies
Market arrangements - final consumers to purchase power from generators/merchants; T&D entities providing transportation services.
National Electric Power Regulatory Authority (NEPRA) to oversee reorganized WAPDA, transmission/central dispatch entity, distribution and generation - until wholesale power market becomes competitive.
This Strategic Plan has obviously failed but failure is not because of the plan but because it was never allowed to become functional by successive governments, the power bureaucracy, and other beneficiaries of the sector such as equipment and fuel suppliers who have all continued to exploit the system for maximum undeserved benefits
Instead of the powers devolving to the Boards the Ministry of Water and Power has assumed direct policy and management control of all entities with the corporatized structure rendering the companies as ineffective paper entities.
The most serious of the issues in the power sector relates to the single buyer model. Under this model, no direct contractual links exist between Generators and DISCOs. Generators sell electricity at regulated prices, which is supplied to DISCOs at the pooled average power purchase prices. This arrangement lends itself to lack of regulation and abuse. In the light of non-cost recovery tariffs and multiple inefficiencies in the Discos and GENCOs circular debt i.e. non/under payment of dues to IPPs and fuel suppliers is but a natural consequence.

Reforms Recommended
Pending NEPRA restructuring empower NTDC to act as Central Co-ordination & Planning Agency to oversee coordination and the planning functions of Companies in the sector
Pending privatization separate the policy and ownership functions of the line ministries by assigning the responsibility for appointments to the Boards vesting with high powered inter-ministerial committee
Enforce mandatory listing of all SOEs on the stock market to ensure minimum operational and disclosure standards and corporate governance
Establish an electricity market for efficient market pricing, promoting fresh investment and promoting efficient utilization of installed capacities
Existing Power Purchase Agreements of IPPs may be modified allowing 25% of capacities to be traded on these exchanges. GENCOs may be allowed to trade independently as separate entities. Large consumers and cooperatives may also buy directly from these exchanges.
All new PPAs and coal conversion of existing IPPs to guarantee purchase of 50% of capacity, balance to be traded


Conclusion
The power sector-restructuring plan failed to reach the ultimate goal of creation of a power market because immediately after the crucial corporatization of the power sector, management of WAPDA was given to the army who in accordance with their training promptly proceeded to centralize all decision making under a unified command structure. The subsequent government of General Musharraf was too comfortable with the excess power created by the IPPs, the relatively lower oil prices, and the ample availability of cheaply priced gas, which kept power tariffs low. Pressure for continuing reform only built up with the whole scale diversion of the cheap gas to captive power and CNG and increasing oil prices. The failure to build any large-scale hydro facility during this time worsened matters. Without much thought parts of the plan such as Differential Tariffs were introduced at the NEPRA determination level but the political requirement of maintaining a Uniform Tariff across the country was too sacrosanct to change. As a result the Tariff Differential Subsidy and the rising power cost and tariffs assumed gigantic dimensions and precipitated the requirement for deep rooted and radical reforms.




ISSUE: Tackling the Power Sector Circular Debt

NEPRA determines distinct tariffs for each of the DISCOs, the system currently is:
Factors affecting Revenue requirements;
Major differences in the size and geographic conditions of their respective service area,
Socio-political settings,
Customer density, consumer-mix,
Infrastructure investment required per consumer,
Technical and administrative losses,
Operating and maintenance cost per customer,
Management performance.
The revenue requirement divided by the number and types of consumers in a DISCO is what determines the level of tariff in each DISCO's area.
In theory the government, notifies the lowest determined tariff amongst all Discos in each consumer category for uniform implementation across the country.
In actuality the government does not notify even the lowest determined tariff and the difference between Notified and NEPRA determined tariffs is classified as Tariff Differential Subsidy to be paid by the government which it seldom does in full or on time.
Other Factors which cause circular debt to accumulate are;
NEPRA does not give any allowance for interest on late payment to IPPs
GST is collected by FBR on billing whereas collection of DISCOs is only 85%
NEPRA does not recognize Agreement with AJK to provide fixed price electricity and fixes AJK tariff at much higher rates which are not paid
Ministry of Finance pays a fraction of the cost supplied to FATA as subsidy whereas there is no bill payment in FATA
Inefficiencies such as excessive line losses because of Power Theft and technical issues in the distribution companies
GENCOS do not produce power at efficiencies determined by NEPRA
Billing collection rates in some DISCOS are dismal because of disputes with the Provincial governments and uncovered subsidy to tube wells in Balochistan.
Cost of delayed notification of tariffs results in cash crunch and addition to circular debt.
Fuel price adjustment is retrograde rather than prospective and the formula needs reformulation to capture FPA lost to line losses.

A further complication is that the monthly fuel price adjustment mechanism which in theory passes on any change in fuel cost to the consumers but actually lags significantly and passes on only 80% of the change to consumers because the formula for Fuel Price adjustment uses units generated instead of units sold ignoring the line loss element.

This leads to a power sector deficit, which in FY 2013 exceeded Rs 700 Billion unpaid part of which emerges as the circular debt and is depicted in the following chart

Reforms Recommended
Empower NEPRA to directly notify Differential Tariffs comprising full cost recovery tariffs. Alternatively Government must cover all the costs not covered by NEPRA in its subsidy as the owner/operator of the power sector. In any case Differential vs Uniform tariffs must be debated and the issue settled with adjustment in the tariff determination methodology.
Ensuring transactions especially for purchase of power, in the Energy Sector are carried out through Letters of Credit or Escrow accounts.
Ministry of Finance to acknowledge and pay for under stated subsidy to FATA and AJK.
Provincial government offices to be provided power on prepayment basis.
Agricultural tube wells in Balochistan may be provided a structured subsidy through the provincial government.















ISSUE: Regulation is not effective
There is lack of uniform regulation in the energy sector that creates distortions between the gas and electricity sectors. Inconsistent regulation between the National Electric Power Regulatory Authority (NEPRA) responsible for the regulation of the power sector and the Oil and Gas Regulatory Authority (OGRA) responsible for the regulation of the oil and gas sectors sends confused signals to investors and creates disharmony in pricing strategies between gas and electricity. This also allows for arbitrage between gas and electricity sectors and the capture of the cheap gas by influential lobbies at the cost of the country maximizing economic benefit from the gas resources.
Both the energy sector regulators have an incomplete mandate on regulating the industry and a severely limited interpretation of the roles assigned to them by law. OGRAs mandate does not even cover the upstream, which is still regulated by DGPC a government department; staffing and other problems at DGPC are far more severe than at NEPRA or OGRA.
OGRA's regulation of the downstream gas sector centres on determining the revenue requirements of the two gas utilities SSGC and SNGPL on a return on assets formula which has been counterproductive in encouraging efficiency despite the limits sets on Unidentified for Gas, UFG which has kept on increasing with time and is at present over 12% which is many times more than the accepted international practice.
The government still allocates both gas and electricity based on political or other pressures
The Government issues policy guidelines; but other sub- government institutions such as PPIB and AEDB intervene in the tariff making process. There is no clarity of applicability of generation tariffs obtained through the tendering process.
Members are appointed at the nomination of the provinces and have no industry knowledge.
Operational directives from the GOP undermine the independence of Regulators
Regulator is not provided with sufficient legal capacity to effectively promote competition under their legislation.
NEPRA takes generally six months to determine tariffs; for some IPPs it has taken even up to ten months.
Regulator lacks capacity in terms of human resource and necessary tools and competencies to effectively monitor compliance of licensees with operational standards.
Gas transmission and distribution remains vertically integrated impeding development of a market for gas while concealing inefficiencies such as leakage and theft (UFG) costing the country over 2 Billion $ per annum.

REFORMS RECOMMENDED
Law must protect sanctity of tendered tariffs.
Ultimately merge the regulators to have uniform regulation across the energy chain
Redefine the role of the regulators focusing on operational rather than just tariff setting
The regulators must focus on creation of energy markets as defined in their acts
Until markets are operational the regulators must be responsible for allocations of energy and reporting on shortages and load shedding on a transparent basis preferably on their websites updated daily.
Revamp staffing of the regulators with competent professionals paid at par with Industry.
Strictly apply the criteria for selection of chairmen, revoke amendments allowing bureaucratic capture
Increase the number of members in NEPRA to 9 by appointing 4 professional members apart from the provincial members.
Downstream gas sector structure to be redefined through creation of as discos and separation of transmission.

Conclusion
The quality of Energy Sector Regulators has continuously been declining as a result of creeping bureaucratic capture of both NEPRA and OGRA whereas DGPC remains a government department. Instead of appointing technocrats as required by their respective acts, the government has amended the legislation to appoint bureaucratic favorites to these coveted tenure appointments. Independence of DGPC and separation of policy making and regulation can only be seen to be effective if DGPC is also made an independent regulator or this role also merged within OGRAs Mandate. The technical organization and manpower needed to regulate a vibrant market based energy sector were never hired. The regulators as a consequence have very narrowly interpreted their mandate and limited it to functions they were already performing i.e. tariff setting.




ISSUE: Sub-optimal exploration activities

Effective Petroleum exploration needs to be expanded in order for Pakistan to utilize its indigenous resources and contain requirement of imported fuels. Pakistan still has huge potential gas reserves, which have been estimated to be more than 400 TCF of recoverable reserves by various basin studies in the past. These are generally agreed to be:

29 TCF of conventional discovered but not produced gas.
Over 200 TCF of undiscovered conventional gas.
40-50 TCF of tight gas.
Over 50 TCF of Shale Gas in the lower Indus Basin (approx. 150 TCF in the whole the Indus Basin).

The success of the 19993/94 Petroleum policies lay in the fact that they were progressive, offered market based economic terms and promised equitable treatment to public and private firms. As a result on completion of the exploration cycle BHIT, SAWAN, ZAMZAMA and various other fair sized gas deposits were discovered. Ever since then the Ministry has slowly but surely retaken control and economic terms have been set on adhoc basis leading to many foreign companies leaving Pakistan and those present curtailing there exploration programs. This has resulted in gas production stalemating at 4 Bcfd despite potential to grow substantially.
Reasons for sub-optimal exploration activities:
OGDC, PPL and Mari, all state companies hold about 60% of all exploration acreage. In the 2012 concessions round over 90% of all the concessions were awarded to the SOE's. This increasingly over whelming role of the state companies is crowding out the private sector companies with the consequential impact of sub optimal induction of new technology and curtailed access to risk capital for exploration.
Policy formulation is ad-hoc with 6 different producer-pricing policies currently in vogue.
DGPC office lacks capacity to efficiently manage and process issues related to the E&P industry. This lack of capacity results in inordinate delays.
Data & Information requirements of Regulator and Policy makers are not met adequately
The amendments in the Petroleum Policy 2012 have taken away incentive for E&P Companies to invest in additional production.
Perceived security issues in Balochistan and the KPK frontier regions
About 60% of all exploration acreage is held by OGDC, PPL and Mari, all state companies. In the 2012 concessions round over 90% of all the concessions awarded were to the SOE's. This increasingly over whelming role of the state companies is crowding out private sector Companies both foreign and local with the consequential impact of sub optimal induction of new technical and severely curtailed access to risk capital for exploration






Recommended Reforms
Post 18thAmendment Clarification of:
i) The role of provincial set-ups to be clearly defined
ii) E&P industry need a one-window operation (at the Federal level)
iii) Approval process delays need to be eliminated.
Multiple policies need to be consolidated and the policy offered economic terms to be market linked.
DGPC office needs to be restructured as an Independent regulator.
Discretionary powers to be identified and replaced by clear-cut rules.

Worldwide petroleum activities have not been hampered by security concerns once the pricing, economic and administration hurdles have been removed. Security can be enhanced by the participation of the local population in benefits of activities in their region.
Transition to market based producer-pricing mechanism should be pursed.
Auction of non-performing concessions held by public sector companies.
Participation of state owned firms in exploration rounds to be restricted to sensitive areas only.






ISSUE: Pakistan remains one of the most inefficient countries in Energy Consumption and conversion rate to GDP

It has been estimated by National Energy Conservation Centre (ENERCON) that conservation has the potential to save up to 20% of all energy consumed in Pakistan. It can best be achieved by appropriate pricing policies, which force consumers to make appropriate changes in equipment and lifestyle changes. This has happened in industry, which has stayed energy efficient in order to stay competitive. However the residential sector that is the biggest consumer of electricity and substantial user of gas remains unmoved because of the low energy commodity rates. Government intervention through legislation enforcing minimum standards is required to make a serious impact on inefficient use of energy. Energy conservation measures are profitable investments compared to new energy supply capacity – also cheaper and quicker to implement.

Recommended Reforms
Legislation
Expedite promulgation of Pakistan Energy Efficiency and Conservation Bill - the Bill stands cleared by the respective Standing Committee of the National Assembly and is now on the floor of Parliament for enactment.
Energy Codes and Labeling
Implement Pakistan Building Code – the code has been prepared in consultation with all stakeholders and is now pending formal notification by the governing body of the Pakistan Engineering Council for quite some time.
Launch standards and labeling regime for energy guzzling inefficient electric and gas appliances.
Effective implementation of conservation measures by the Government requires outreach to consumers.
Encourage Conversion to solid state lighting. All Street lighting to be changed to LED/solar combinations over time all new installation to be mandatory.
Replace conventional gas geysers with solar and hybrid heaters (solar/power and solar/gas) and instant gas heaters (saving of upto 500 MMcfd of gas if implemented fully).
On a National Scale replace badly made /designed gas burners with properly designed burners for the small gas consumers…Estimated saving of gas is 200 MMcfd at an estimated one time cost of RS 2 Billion
Mandatory solar lighting for telecom towers and billboards.
Implement a mechanism for annual fitness testing and certification of motor vehicles to improve vehicle efficiencies.
Implementation of effective load management at national level (leveling peak demands).

Conclusion:
There is huge potential for gains in the energy sector in Pakistan. There is also a large scope for private energy conservation companies that can help realize these efficiencies. Policy advocacy has to plug the knowledge gap in this area and also reach and strengthen constituencies that currently get drowned out by stakeholders whose primary focus is to increase installed capacity.


Issue: Limited Private Sector Participation in the Energy Sector

Pakistan's investment needs in the energy sector cannot be met by the public sector. Private sector investment is crucial to address the energy gap. Private sector investment in energy is also critical to tap offshore capital resources, inject new technology and management expertise, develop domestic financial sector capabilities, and generate greater efficiencies in the delivery of energy and services.
The privatization process was considered a primary tool in the unbundling and divestment of energy sector assets as evidenced by the inclusion of major energy sector assets on the privatization list. The entities earmarked for privatization included two of the largest exploration and production companies in the oil and gas sector, the Oil and Gas Development Company Limited (OGDCL), Pakistan Petroleum Limited (PPL), and Pakistan State Oil (PSO). Two big gas transmission and distribution companies, SSGCL and SNGPL, along with key assets in the power sector that included selected electricity distribution companies and a power generation company are also targeted for privatization. Unfortunately because of the potential political fallout, the currently stalled privatization program has reduced options for Pakistan to divest its energy sector assets and there is an urgent need to develop an alternative strategy for induction of private sector capital, management expertise as well as new technologies. Such a plan could be based on management contracts of the existing entity or desegregation into smaller operating entities and community-based management/ownership.

Recommended Reforms
Make the payment mechanism for the entire energy sector robust thereby eliminating the risks of the circular debt and risk of delayed payment.
Consider Management Contracting of existing assets as an alternative to outright privatization
Restructure the Downstream Gas Sector into a transmission only and several smaller distribution companies which are small enough for local entrepreneurs to manage.
Establish market trading for power and gas.
Remove unnecessary regulations such as Generation licensing.
Simplify the institutional and policy framework by reducing the number of institutions, merging policies and eliminating discretionary policies and rules.
Consider limiting state owned exploration companies' participation in bid rounds to frontier areas only. At least provide a true level playing field for the private sector to compete.
States participation in new generation should be limited to large-scale hydro or strictly on a PPP basis in new thermal projects.
Encourage community based and much smaller power and gas distribution companies.
Conclusion:
The state owned and operated energy utility model has failed to deliver worldwide, however for the private sector to succeed, competent regulation and an energy market/ exchange are fundamental requirements. If all transactions in the energy exchange are between privately owned companies issues such as circular debt will not arise. In the case of Pakistan as outright privatization is so politically charged and market development deferred, management contracting is suggested as an interim measure.

Issue: Loss Reduction in Distribution Companies
Line Losses in the distribution companies exceed 22% whereas on the basis of a scientific assessment by USaid in 2012 the technical losses of the system do not exceed 11%.

Non-technical losses: Non-technical losses are a euphemism for theft and it has been estimated by USAID that these are more than half the reported line losses. Over-billing is one way the DISCOs try to conceal some of these line losses, which can also be minimized through smart metering, and establishment of metering trees.

Recommended Reforms
Install a modern smart metering, billing and collection (MBC) system to reduce non-technical losses. Appropriate metering and concomitant billing and collection are fundamental to reducing non-technical losses. These are also tools to reduce human intervention in the MBC chain. 
High Voltage Distribution System (HVDS) and eliminate low voltage distribution (400v and 220v) to the extent possible which is particularly effective to eliminate 'kunda' way of stealing electricity.
High Loss feeders may be contracted with communes of linesmen and meter readers for billing and collection on a sliding scale basis compensation for improvements.


Technical losses: Technical losses occur in the long lower voltage lines and substations, essentially transformers. Technology solutions are needed:

Accelerate the induction of Smart Meters and establishment of metering trees.
For each DISCO, enable them to hire a set of consultants/advisors to help with:
Overall management; Operational Management; Commercial Management; Capital Expenditure Management; and Financial Management.
The hired set of consultants/advisors should perform the role of mentors to senior management of each DISCO.

Recommended Reforms
List each company on the Stock Exchange. Listing companies on the Stock Exchange will bring significant transparency and reporting requirements compared to unlisted companies, which the DISCOs currently are.
All of the above should be made part of the Performance Contracts already signed by each of the DISCOs with MoWP. NEPRA should be the monitor of these Performance Contracts and certainly not MoWP.
Upgrade the power system load dispatch, control and management at the national and regional level. This is an urgent need, as the national load dispatch system is quite archaic (1980 vintage) and has not kept pace with the expansion of the system nor the modern technologies.
A complete transmission SCADA, a national Energy Management system, as well as automating transmission substations should be inducted. Installation of these will provide the basis for the Smart Grid in the near future.

Conclusion:
Short of outright privatization, efficiency in the power generation and distribution can quickly be achieved through management contracting. The management and workers of the utilities have opposed implementation of new technology, which solves many of the problems, this issue needs to be addressed by the newly inducted management as state employees would not be able to take the bold steps required.



ISSUE: Oil Purchases, Logistics and Refining Problems
Pakistan does not benefit from the opportunities offered by the volatile oil and spot based tanker markets:
Refineries rely on long term contracts tied to traditional suppliers and very few spot tenders.
There is no incentive to reduce import cost (passed to consumers).
As an example Pakistan bought Crude at an average price of $105/bbl from July to November 2014 (at a time when prices were tumbling like ninepins) while in the same period of 2013 the average purchase price was $104.
Major ports worldwide are initiating modifications to load/discharge larger vessels. Logistics capability is being improved to reduce costs and ensure uninterrupted fuel supplies. However, Pakistan continues to face logistics bottlenecks both at the ports and transportation across Pakistan through an inefficient and open to abuse tanker fleet.
There is a mix of regulated (HSD/SKO) and de-regulated products.
De-regulation has shifted calculations from OGRA to refineries – but same mechanism.
Refining losses are covered via deemed duty (hidden Subsidy) on HSD added to ex-refinery prices.
Refineries have been collecting funds for years through deemed duty at public expense with time bound agreements to upgrade and meet EU specs but have failed to do so. This is one of the biggest scams in the oil sector.
Inland Freight Equalization Margin (IFEM) is a freight pool to maintain uniform tariffs but is also used for various disbursements to the oil sector and is open to massive irregularities–As a consequence the transportation mafia manages to fudge consumption of petroleum products to show higher consumption in far flung areas.

Recommended Reforms
Oil procurement can be out sourced based on performance contracts to arbitrage firms. At present Pakistan's oil purchasing is consistently at least 10-12% more expensive than the market
There should be a single ownership for logistics development, strategic stocks and linkage with oil/energy plans:
A national oil logistics study should be conducted.
Port capabilities should be enhanced to berth larger vessels.
Projects for improving port logistics should be expedited e.g. a 52 km white oil pipeline linking KPT- PAPCO terminals ($ 26 Million).
A proactive downstream policy should be formulated with proper incentives at par with the intl. oil industry that stimulate efficient growth of the sector.
Local refineries should be upgraded/expanded to improve yield value and meet Euro-II specifications with a time frame to meet Euro-III and IV specs or face closure. Deemed duty should be discontinued forthwith.
Power plants should switch to FO 380 Cst from FO 180 CST (only used in Pakistan and consequently priced at a substantial premium). FO 380 CST is cheaper and readily available in international markets.
A new refinery (200 KBBL/day – complex configuration) should be initiated in the private sector in order for Pakistan to benefit from cheaper products and get out of the subsidy at the cost of consumers and the current stranglehold of the existing substandard refineries.