Bagasse-Based IPPs Agree to Revised Tariffs: Leading to Rs238 Billion Savings

December 20, 2024 Mahi Bukhari

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Introduction

In a significant move, the cabinet has granted approval for revised agreements with eight bagasse-based Independent Power Producers (IPPs), largely owned by influential political figures and corporate magnates. This new agreement is expected to generate substantial savings for the country, amounting to approximately Rs238 billion, with the adjustments coming into effect from October 31, 2024. The decision also involves changes in tariff structures, including reductions in working capital components and adjustments in return on equity (ROE) calculations. The development follows prolonged negotiations and aims to optimize the energy costs tied to these power plants.

Overview of the Revised Agreements

The government’s recent intervention into the energy sector through these revised agreements is poised to make significant changes in the way bagasse-based power plants operate. The eight IPPs, which primarily rely on bagasse, a byproduct of sugarcane processing, have agreed to reduce their working capital component of tariffs by 50%. This change, effective from October 31, 2024, aims to ease the financial burden on consumers while maintaining the operational stability of these power plants.

Key Provisions of the Revised Agreements

1. Working Capital and Tariff Reductions

One of the main objectives of the revised agreements is the reduction of the working capital component of tariffs. Under the new structure, this component will be slashed by 50%. The reduction in tariff components is expected to lead to a savings of Rs238 billion over the plants’ operational lifetimes, provided they run at full capacity.

2. Return on Equity (ROE) and Return on Equity During Construction (ROEDC)

As part of the agreement, the IPPs will now earn a fixed 17% return on equity (ROE), with the rate calculated based on the rupee-dollar exchange rate of 168, without any future dollar indexation. This adjustment aims to provide a more predictable financial environment for both the government and the power producers.

3. Adjustments to Debt Servicing

A major component of the revised terms involves the handling of debt servicing due to energy production shortfalls. If the actual plant capacity factor falls below 45%, the debt servicing component will be paid based on the surplus energy output if the capacity exceeds 45%. This measure is designed to encourage efficiency and greater energy production, benefiting both producers and consumers.

Impact on Energy Consumers and the Economy

The revised agreements are set to have a significant impact on both energy consumers and the broader economy. By reducing operational costs and addressing inefficiencies in energy production, the agreements promise lower electricity prices for consumers, which could have a ripple effect on industries reliant on power. The Rs238 billion savings figure represents a substantial reduction in costs over the long term, bolstering the government’s push for energy reforms.

However, critics have raised concerns about the political nature of these agreements, pointing to the involvement of powerful corporate and political figures in the ownership of the IPPs. The government’s close ties to these players could lead to questions about the transparency of the negotiations.

Legal Disputes and Regulatory Changes

Legal Challenges to the Pricing Mechanism

The tariff agreements have not been without controversy. In 2018, the National Electric Power Regulatory Authority (Nepra) took the initiative to revise the bagasse pricing and adjustment mechanism, linking it to domestic bagasse prices instead of the cost of imported coal. This decision was challenged by the bagasse-based IPPs, who filed writ petitions in the Islamabad High Court. As a result, the court suspended Nepra’s decision in 2019, directing that the matter be re-examined by the Nepra appellate tribunal.

Nepra’s Reevaluation of the Fuel Cost Component

On February 7, 2024, Nepra re-evaluated the fuel cost component of bagasse, linking it back to the price of imported coal. The new mechanism includes an annual indexation rate of 5%, which applies until 2022, when the linkage with imported coal will be delinked for the remainder of the plants’ contracts. This change had a direct impact on electricity consumers, leading to an additional burden of Rs22.97 billion for the period between FY 2019 to FY 2024.

Settlements and Discounts Offered by IPPs

As part of the ongoing negotiations with the bagasse-based IPPs, seven out of the eight plants have agreed to provide tariff discounts. These discounts primarily focus on reducing operation and maintenance costs, as well as insurance and return on equity components of the tariff. However, one of the plants, Chiniot Power, could not offer these discounts due to its underperformance, with its energy output falling below the agreed plant capacity factor.

The settlements reached during the 2020-21 negotiations resulted in tariff reductions and adjustments that were endorsed by the Economic Coordination Committee (ECC) in 2021.

Settling Historical Disputes and Future Adjustments

The recent cabinet approval also formalizes an agreement between Chiniot Power and the Central Power Purchasing Agency-Guarantee (CPPA-G), resolving longstanding disputes over tariff adjustments. The settlement agreement includes provisions for recalculating the fuel cost component of bagasse from Rs5,612 per ton to Rs4,500 per ton, with a 5% annual indexation.

These changes reflect ongoing efforts by the government to fine-tune tariff mechanisms and ensure the sustainability of the bagasse-based power plants. The revised tariff structure, effective from October 1, 2021, is expected to ease the burden on electricity consumers while also ensuring that the plants remain financially viable.

Conclusion

The signing of revised agreements with bagasse-based IPPs marks a significant development in Pakistan’s energy sector. The changes in tariff structures and the reductions in working capital are expected to lead to substantial savings for consumers while also ensuring that power plants remain operational. However, the involvement of politically influential figures in the ownership of these plants raises concerns about transparency and fairness in the decision-making process.

As the revised agreements are implemented, the government will need to carefully monitor the performance of these power plants to ensure that the anticipated savings are realized. If successful, the deal could serve as a model for future energy reforms in the country.

FAQs

1. What is the primary change in the revised agreements with IPPs?

The primary change is a 50% reduction in the working capital component of tariffs, effective from October 31, 2024. This is expected to result in savings of Rs238 billion over the operational lifetime of the plants.

2. How will the reduction in tariffs benefit consumers?

The reduction in tariffs is expected to lower electricity prices for consumers, making energy more affordable for both households and industries.

3. What was the legal dispute regarding bagasse pricing?

In 2018, Nepra’s attempt to link the fuel cost of bagasse to domestic prices was challenged by the IPPs, leading to a suspension of the decision by the Islamabad High Court. The matter was re-evaluated, and the tariff was re-linked to the price of imported coal.

4. Why couldn’t Chiniot Power offer tariff discounts?

Chiniot Power was unable to offer tariff discounts due to an energy shortfall, with its energy output falling below the agreed-upon plant capacity factor.

5. What does the future hold for bagasse-based IPPs?

The revised agreements aim to create a more stable and financially viable environment for bagasse-based IPPs, though ongoing monitoring will be necessary to ensure the full realization of savings and efficiency improvements.