Why ‘loss making’ electricity firms hurt customers

Like Houston, we will have a problem. Results of a case when utilities are not encouraged to invest.

Earlier this year, millions of homes in Texas were without power for days in what is dubbed as one of the worst power crises in world history. Houston is really a case in point. The electric grid in Texas was built for efficiency, but not for climate resilience and resultant changes to operational requirements.

The past three decade’s policies in this sector do not reflect any adequate framework for future growth and it is all the more difficult for privatised entities like K Electric (KE).

The utility business is not like most other businesses. Utilities inhabit special accounting rules and pre-established investment returns, where ordinary business incentives often do not matter, and where changing the course is exceedingly hard.

Utilities’ performance and their sustainability are mainly driven by the investment in assets (pipes, substations, transmission lines, etc) that are used to provide the service and efficiency in managing existing systems.

As far as regulation is concerned, in the foreseeable future, it would not be possible for countries like Pakistan to deregulate the key utility like power to generate and supply electricity on market based prices in an open competition.

Losses are not only bad but suicidal for society if utility companies are not sustainable in their operational and investment functions.

Nevertheless here it is important to distinguish between ‘subsidy’ and ‘loss’. A subsidy is the price of electricity which is borne by the government as a public welfare activity for economic reasons. The size of a subsidy for any utility company is not to be seen as an indicator of the efficacy of that entity. Thus genuine tariff price differential which is actually a credit on the income side is to be totally divorced from a perception that this sum is a compensation of the losses if any made by the utility firm.

In the case of Pakistan, the consumer tariff is determined by National Electric Power and Regulatory Authority (Nepra) and notified by the Government of Pakistan, which is uniform across the country. A uniform tariff means that the same type or category of customers pay the same price per unit regardless of which province they are based in.

Under the current tariff regime in Pakistan, the customers are charged a price that is less than the actual cost of electricity and the differential is paid by the government.

The regulator is charged with reviewing and approving investments in tariff to make sure spending is prudent and reasonable to strike the right balance between sustainability of the business and consumer service levels. Therefore, one often sees former Water and Power Development Authority distribution companies and KE appearing before Nepra to lay out arguments for how much they need to invest.

Years of underinvestment in the transmission and distribution (T&D) segment of Pakistan power sector has been the primary reason for the lack of reliable power supply, which has cost billions to the economy. Investment certainty in tariffs is a prerequisite for private sector participation in the T&D segment.

To achieve this, utilities, especially in the private sector, must be sustainable and have sufficient motivation to re-invest into the system. Hence, instead of keeping investment plans rigid, the focus should be on providing an investment enabling tariff. This will automatically ensure that utilities are able to make investments sustainably. This in turn benefits consumers while also keeping a close check that investments are made as committed.

Are we prepared?

As publicly reported, KE has already invested over $3 billion across the power value chain including $450 million on the Transmission capacity enhancement project.

A $650m project is underway to install 900MW of RLNG-based generation. The utility has also invested to upgrade and strengthen the distribution network including a project of Rs9bn dedicated entirely to bolster infrastructure as part of the company’s plans for rain mitigation and monsoon season.

An additional Rs10bn is being invested across the city’s 12 most densely populated districts — home to two-thirds of the city’s population and a high prevalence of katchi abadis — to install Aerial Bundled Cables, bring low-cost meters to the residents so that they may avail regularised electricity supply.

However, is it worth contemplating if this investment trajectory is sustainable if the utility is not allowed to recover these costs in the tariff?

If not, this will be suicidal for the economy of the country. The rapid expansion of Karachi, boom in construction spurred by government policies and other infrastructural challenges due to unplanned settlements has exponentially increased the need for capital expenditure.

Currently, KE’s investment limits are capped by the tariff and they have no incentive to make any further investments in the system. Without adequate returns on investment, and the pending problems of outstanding payments from the government and associated entities, KE is borrowing from financial institutions to meet its working capital requirements as well, a figure reported exceeding Rs100bn.

This poses a threat to the utility’s operations as well. If the incentive is absent, utilities have two choices — continue to operate at current levels and let the customer service level deteriorate or petition the regulator for allowance of planned investments and wait for a nod to proceed.

In Pakistan, such deliberations typically take anywhere between one to two years to conclude. KE has already made a plea to allow for further investments in its “mid-term review.”

In KE’s case, if requested investments are not allowed, the utility may inadvertently be forced to suspend ongoing and planned investments. If the tariff adjustments for investments don’t come through, KE, and with it, Karachi will embark on a journey towards economic regression.

Ultimately the burden will still be borne by the government and the customer because we will have a problem. In fact, there is no choice. Investment has to be made. As soon as it is done it is better for all stakeholders.

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