Report on Private Sector Hydel Development

This report was done by me in 2002 for a consultancy project. I don’t think much has changed since then.

Introduction:

It is universally acknowledged that the development of hydropower resources in Pakistan would make eminent sense.[1] As compared to thermal power, hydropower is not only cheaper but ecologically preferable. Furthermore, while thermal units run on imported fuel whose cost adds substantially to Pakistan’s balance of payments problems, hydropower units utilise natural resources without depleting them in any manner.  If one adds to these factors, the happy coincidence that the northern areas of Pakistan and Azad Jammu Kashmir are awash in sites offering hydropower potential,[2] the result would appear to be a perfect match of needs and resources.

Despite all the reasons favouring hydropower, the development of hydropower has lagged considerably in Pakistan. The mix between thermal and hydel power in Pakistan today stands at 28:72[3] and it has been acknowledged by Wapda in its recently released Vision 2025 document that ideally, the percentages should be reversed. It is in light of these realities that Wapda has pledged to pursue hydel power more seriously in the future.

Several problems inherent to the hydel sector have affected the development of hydel power in Pakistan. The basic issue though is that hydel projects are extremely capital intensive and that the economic advantages of hydel power only become apparent over a long term period.  Raising capital for large capital intensive projects with a payback period measured in decades is difficult for a cash strapped poor country like Pakistan, particularly so since the nuclear explosions of May 1998 resulted in the enforcement of sanctions and a freeze in economic aid from those sources most likely to finance such projects, such as the Japanese and the US governments. In any event, Pakistan is a heavily indebted country whose debt profile has not traditionally inspired Western countries and banks to give it more money.

Given that the availability of energy and the pace of economic development are considered to go hand in hand, that Pakistan has congenitally faced shortages of electricity, and that Pakistan lacks the resources to exploit its own hydel resources, the desirability of involving the private sector in developing hydropower in Pakistan would appear to be self-evident.

However, despite these very promising conditions, the involvement of the private sector in hydropower remains minimal.  At the current time, there is only one private hydel project which has reached agreement with Wapda on tariff rates. If that project achieves financial close, which is not thought likely, it will still be another four years or so before it comes on line. All other privately initiated hydel projects in Pakistan have yet to reach agreement with Wapda over tariff rates, despite years of negotiation. Furthermore, certain hydel projects were advertised for open bidding on a Build-Own-Operate-Transfer basis but the bidding was ultimately cancelled when no acceptable parties showed interest.

The basic issue then is to determine why private parties are not interested in investing in the hydel power sector in Pakistan. This question in turn breaks down into two sets of issues, one set comprises reasons unique to the hydel sector and the second set comprises general reasons as to why one might not want to invest in Pakistan. However, prior to examing these reasons, a brief history of private sector involvement in hydropower in Pakistan has also been provided for reasons of background.

1. History of hydel power policies in Pakistan

i)      1995 Policy Framework

Pakistan’s first hydel policy was announced in 1995 (the “1995 Policy”), hot on the heels of the thermal power policy announced in 1994 (the “1994 Policy”).

The 1994 Policy and the 1995 Policy shared many features. In both cases, a target tariff was declared (6.1c/kwh for thermal and 4.7 c/kwh for hydel) and effectively any company which could match that target price was allowed to work towards setting up its project.

As with the 1994 policy, the 1995 policy proved to be immensely popular with investors.  Five letters of support were signed under the 1995 policy[4] while letters of intent were signed for another 10 projects.

ii)     The fall of the Benazir government and its consequences

The 1994 Policy was controversial even during Benazir Bhutto’s tenure but the undesirability of the policy and the alleged corruption involved in the various independent power projects became a cause celebre following her removal on charges of corruption by the then president, Farooq Leghari.

In 1997, the Nawaz Sharif government took power following elections and embarked on a full scale assault on the IPPs in which they were bluntly told that the government was not willing to meet its commitments under the various power purchase agreements and that it was necessary for the IPPs to agree to lower tariffs than those which they had originally been promised.

The merits and demerits of the IPP issue are beyond our scope, but the short fact was that the Government of Pakistan did not have the money to meet its commitments under the various agreements.  There was also a great deal of evidence to suggest that the negotiations surrounding the IPP deals had not been entirely free from corruption. However, the way in which the Government of Pakistan extricated itself from its commitments was also not quite according to Marquis of Queensberry rules.

In the middle of this hullabaloo, unfortunately no distinction was made by the Government off Pakistan between thermal projects and hydel projects: all independent power projects were deemed to be tarred with the same brush and as such, equally undesirable. Thus, all the five hydel projects which had been granted Letters of Support were stopped from continuing through to financial close through various means,[5] while the Letters of Intent granted to various parties were simply cancelled outright.  Once the validity period of the Letters of Support had expired, the Government even attempted to encash the performance bonds submitted by the developers, resulting in litigation which is pending till date.

So far as the thermal IPPs were concerned, the Government eventually reached agreement with all of them on marginally reduced tariffs. The most prolonged negotiations came in the case of Hubco, a 1292 MW IPP which had actually preceded the 1994 policy, and which was eventually only settled by the military government which removed Nawaz Sharif in October 1999.

At a policy level (with respect to hydropower), two important decisions were taken by the government of Nawaz Sharif. Firstly, in February 1997, the Economic Co-ordination Committee (“ECC”) of the Cabinet decided that all decisions regarding tariffs would be decided by the Chairman WAPDA on a case by case basis. Subsequently, the 1994 Policy and the 1995 Policy were both formally replaced by a joint hydel and thermal policy announced in 1998, the details of which are discussed below.

Following the decision by the ECC to grant plenipotentiary negotiating powers to Wapda, the developers who had earlier obtained letters of support or letters of intent under the 1995 Policy approached the Chairman so as to reach agreement on tariff rates, which issue was understood by all concerned to be the main stumbling block.  With one exception, no developer has been able to reach agreement with Wapda on a tariff for hydel power, nor does it appear likely that any agreement will be reached in the  near future, given the gap in the two parties’ position. It may also be noted that the developers who had received letters of support had all sunk millions of dollars into preparing detailed feasibility studies, which cost so far has been completely wasted.  Moreover, some of the projects for which letters of support were granted are now being developed by the Federal and the NWFP governments themselves.[6]

 

iii)   The 1998 Policy

In 1998, the Nawaz Sharif government announced a new policy which was to govern both the thermal and the hydel sectors (the “1998 Policy.”)  The 1998 policy remains in effect till date but a revised policy has been circulating for many months now and it is widely expected to be replaced at any moment.

The biggest departure from the 1995 policy in the 1998 policy is the refusal to set a tariff target: instead, all projects were to be submitted to competitive bidding through which a tariff was to be established.  More specifically, with respect to hydel power, the 1998 policy sets up two different channels of consideration: one for “solicited bids” and the other for “unsolicited” bids.

The procedure with respect to “solicited bids” is meant to be applicable to a number of projects identified by the government with the assistance of a development agency of the German government.  The policy states that there are detailed feasibility studies available for these projects and that these studies are available for examination by developers, the idea being that the right to develop a site would be auctioned to the lowest bidder.  Till date, only one auction has been announced under the 1998 policy.  When no party showed interest in pre-qualifying, the date for pre-qualification was extended but to no avail. With the exception of one Turkish and one Chinese party, neither of them hydel developers of repute, no party showed any interest.

With respect to unsolicited bids, the policy states that only such parties as are not engaged in litigation with the government are entitled to submit “unsolicited bids.” This provision is clearly intended to exclude all those developers already in litigation with the government, which is to say all those developers who had received letters of support under the 1995 policy.

The procedure with respect to unsolicited bids is that developers who think that a site is economically viable are to submit this site for the consideration of the government, which would then conduct an auction for the right to develop the site. The original developer, however, has the right to match the lowest price and if he chooses not to match the lowest price, has the right to be compensated the “reasonable, audited cost” of the feasibility studies carried out by him.  Till date, no private developer has submitted a site for bidding under this provision of the 1998 policy.

While the 1998 policy remains the policy in effect, it is common knowledge amongst members of the hydel sector that there is a new draft policy on the anvil. However, this new policy has yet to be formally announced.

 

iv)   Current status of hydel power in Pakistan

In 2001, the government issued a Vision 2025 for Wapda which declares that it is in Wapda’s interest to forswear dependence on thermal projects and instead to concentrate on hydel projects as well as indigenously fueled thermal projects (i.e. coal-powered plants).

In keeping with the emphasis on hydel power in the Vision 2025 plan, the Wapda is proceeding with the construction of three hydel projects, namely those located at Allai Khwar (163 MW), Duber Khwar (130 MW) and Khan Khwar (72 MW).  All three of these projects are being constructed with the help of low interest loans from the Abu Dhabi government.  In addition to these projects, memorandums of understanding regarding the construction of three other projects – Jinnah Barrage (96 MW), Kheyal Khwar (51 MW) and Golen Gol (106 MW) – have been signed with the Chinese government.

Apart from these projects, the government of the NWFP has also been attempting to embark on the construction of the Malakand III project but is apparently hampered by the lack of funds. That project, it may be noted, is the subject of litigation currently pending in the Supreme Court which if successful would restrain the NWFP Government from proceeding.

The only “private” project currently on track is the New Bong Escape project, an 84 MW project whose sponsors, M/s Laraibe Ltd., signed an MoU with Wapda on December 15, 2001 whereby Wapda agreed to purchase electricity from the New Bong project at a levelised tariff of Rs. 3.1 c/kwh.

2. Specific Problems with Hydropower sector in Pakistan

i)                Existing hydel problems need to be resolved    

One point which has been repeatedly stressed by members of the hydel sector is that the world of parties involved in developing hydel power projects is fairly small. In other words, there are a limited number of companies involved in financing hydel projects, constructing hydel projects, examining hydel projects and preparing feasibility reports with respect to hydel projects.  Many, if not most, of those companies had become involved with private sector hydel projects in Pakistan as a consequence of the 1995 Policy, which is to say that they are unlikely to want to become involved again with hydel projects in Pakistan.

In any event, to the extent that there is any chance whatsoever of attracting any international investment in the hydel sector, no such investment is likely so long as the travails of the previous entrants in this sector remain unresolved. As one embittered developer put it, “Pakistan asking for fresh private investment in the hydel sector is like Count Dracula sticking a ‘rooms available’ sign outside his castle and expecting local villagers to drop by. It’s just not going to happen.”

It may also be noted that Pakistan’s problems in the hydel sector are not unique. Indeed, the situation is exactly equivalent to the situation three years ago when Pakistan was at loggerheads with the thermal IPPs. That situation was ultimately resolved but only after several years of bitter feuding, during which Pakistan became notorious as an investment hell.

In comparison with the row over the thermal IPPs, the disputes between Wapda and the hydel IPPs seems to have stayed under the radar of the international community.  This may be due partly to the fact that the sums involved – at least at this stage – are minuscule compared to the amounts involved with the thermal IPPs. For example, the largest loss being claimed by any hydel IPP is US$ 6 million, which while not exactly pennies, is still minor compared to the billions of dollars at stake in the thermal IPPs dispute.

Nevertheless, it is necessary that these pending disputes be resolved so that they stop “poisoning the well” because even though the actual losses may be minor, the investment being affected is greater by several orders of magnitude. For example, the same developer who claims to have sunk US$ 6 million into feasibility studies has repeatedly offered to invest upwards of US$ 1 billion if the tariff dispute with Wapda is resolved.[7]

To take another perspective, the 98 Policy states that by 2008, the shortfall in generation capacity “is expected to range between 5,000 and 8,500 MW.”  If that gap is to be bridged with the help of hydel power, then even at conservative estimates, one is looking at well over US$5 billion of fresh investment. One may also note that on average 50-60% of the cost of a hydel project is civil works, which expenditure occurs largely in local currency. This is in direct comparison to thermal IPPs where a large proportion of the cost (both initial and recurring) is spent on foreign currency inputs, i.e. fuel and machinery.

ii)               The resolvability of the tariff disputes

As noted above, the Economic Coordination Committee of the Cabinet decided in 1997 that all tariff decisions were to be made by Wapda itself. From published reports as well as from interviews and other sources, it is evident that Wapda has taken the position that any proposed tariff not in the vicinity of 3c/kwh is not acceptable to Wapda. The hydel developers, however, are adamant that it is simply not feasible for them to accept such a low tariff.

It is not feasible for this report to include an independent technical analysis of the merits of the competing positions adopted by Wapda and the hydel IPPs. Nevertheless, an number of points can be made in this regard: –

a)     Wapda has been a favourite target of multilateral institutions for much of the past decade, probably for good reason.  Under the privatisation and corporatisation program developed for Wapda, it will be unbundled into distribution companies, generation companies and a transmission company. All that will remain of the current Wapda is the water sector, which is to say, hydel power.  Not surprisingly, it is the candid opinion of a number of informed people that Wapda is simply not sincere in dealing with private hydel developers because that would dilute its control of the hydel sector. That opinion is obviously not verifiable but it would appear to be reasonable.

b)     The point that Wapda may not be the appropriate party to be making tariff decisions also seems to have occurred to the Federal Government. In this context, one may note that the various draft policies which have been circulated empower Nepra to make decisions regarding tariffs, not Wapda. Coincidentally or otherwise, the draft policy has yet to be formally enacted notwithstanding several false alarms to the contrary.

c)     Apart from the question of who should be deciding the tariff issue, the other problem complicating the resolution of the tariff debate is the perspective from which the “reasonability” of the tariff is being examined.

d)     To elaborate, Wapda is taking a “cost plus” approach to deciding hydel tariffs. In other words, Wapda examines the project details, decides what the reasonable cost of the project should be, determines what a reasonable rate of return should be, and then works backwards to come up with a tariff.

e)     The problem inherent in this approach is that Wapda’s conception of “reasonable” is – and will always remain – very different from that of the developers.[8] That divergence in perception is further exacerbated by the thermal IPP debacle as a result of which the Wapda hierarchy is convinced that all businessmen are over-invoicing thieves and the international business community is convinced that Pakistan’s state sector is economically illiterate.

f)      This gap in perceptions has also been exacerbated by the fact that one project, namely New Bong Escape, has managed to reach an agreement with Wapda at a levelised tariff of 3.103 c/kwh.  From Wapda’s perspective, the agreement with New Bong at 3.1 c/kwh (as opposed to the 4.7c/kwh under the 1995 Policy) substantiates its contention that hydel developers were being offered extortionate terms. On the other hand, the private sector parties are convinced that the project is not feasible at the agreed upon tariff, which opinion is affirmed by impartial experts.[9]  While this issue will be conclusively resolved only with the passage of time, for now the signing of the New Bong deal has only hardened attitudes on both sides of the divide.

iii)             Problems with the 1998 Policy

As noted above, the 1998 Policy divides projects into two categories, those stemming from solicited bids and those stemming from unsolicited bids.

a)     Unsolicited bids

 With respect to unsolicited bids, the procedure envisioned by the 1998 Policy is that private parties will identify promising sites, do the feasibility study themselves and then submit the site for competitive bidding on tariff rates. The developer of the site has the right to match the lowest bid price, and if he refuses to exercise that option, he is to be refunded the “audited, reasonable” costs of his feasibility study by the winning party.

The problem in this approach is that feasibility studies are expensive, often running into several millions of dollars.  Such an amount represents a major commitment of time and personnel, even for major international investors.  However, developers are unlikely to make such major investments “if the fruit thereof is uncertain.” The 1998 Policy may cheerfully say that the “audited, reasonable” costs of the developer will be refunded but such an assurance is grossly inadequate in terms of reassuring investors.

(1)  Given that only the “audited” and “reasonable” costs of the developer are to be refunded, that provision is an invitation to litigation, both as to the quantum of the alleged costs and their reasonability. However, the judicial process in Pakistan is both arbitrary and extremely lengthy.  The provision regarding the refund of “audited, reasonable” costs is not particularly reassuring therefore from the perspective of hydel developers.

(2)  Even if the developer’s entire cost was to be instantly refunded, that refund would not compensate the developer for the opportunity cost of the amounts spent on doing a particular study.

(3)  The biggest issue in an hydel project is always the identification and examination of the risk factors. Once those factors have been identified, quantified and examined, what is left is effectively only a construction problem. In this respect, what Western developers fear is they will be underbid by Chinese or other East Asian construction companies since their personnel costs would be significantly lower.

b)     Solicited bids

 With respect to solicited bids, the procedure envisioned by the 1998 Policy is that the Government of Pakistan will first identify the most attractive sites for hydel development, produce detailed “bankable” feasibility studies with respect to these sites, and then have the tariff determined through competitive bidding.

In contrast to the procedure with respect to unsolicited bids, the procedure with respect to solicited bids certainly appears to be somewhat workable.  However, the linchpin of this approach is the presence of a detailed, international quality, “bankable” and generally accepted feasibility study.  According to several sources, the feasibility studies produced by the Government of Pakistan are not international quality and certainly not “bankable.” One may also note that the Government of Pakistan has only once tried to solicit bids under the 1998 Policy, which effort failed miserably when not a single international developer sought pre-qualification.

c)     Non binding tariff determination procedures

As noted above, the prime focus in the 1998 Policy is on competitive bidding through which a tariff is to be determined. One obvious problem with the 98 Policy though is that the Government of Pakistan is not required to accept the lowest bid. Instead, the 98 Policy explicitly states “The Government will reserve the right to reject any bid without assigning any reason and assuming any liabilities.”

While there are understandable policy reasons for reserving such a power, this clause effectively conditions the value and credibility of the bidding process on the sole whim and desire of the Government of Pakistan, which currently means Wapda. As discussed above, Wapda is not seen as either sincere or realistic by private sector hydel developers at this moment.

Finally, one may note that even after a particular bid has been accepted by the Government, the tariff level is subject to approval by Nepra. Once again, this additional stage robs the bidding process of credibility and adds an additional level of negotiation and delay to the system.

3. General Reasons obstructing investment in Pakistan

A comprehensive analysis regarding the problems facing private investment in Pakistan is beyond the scope of this paper. However, there are certain fairly obvious and basic points which are discussed briefly below.

i)                Lack of credibility and creditworthiness

If Pakistan today is a pariah in the world of international investors, that is a status which has been hard won by various Pakistani regimes. Simply put, Pakistan’s economic history (particularly recent history) is replete with instances in which various regimes have abused the confidence of investors, both local and foreign.  That history is reflected many ways, but more specifically, in the political risk rankings by economic analysts, which place Pakistan below countries like Vietnam, Nigeria and Bulgaria.

 ii)               Lack of independent dispute resolution mechanisms

The lack of institutional credibility is a problem which affects not only Pakistan’s executive branch, but which also affects the judiciary. This is particularly important because foreign and domestic investors obviously rely upon the judiciary to enforce the terms of contracts with respect to the government. The performance of Pakistan’s judiciary in protecting economic and contractual rights, however, has been as dismal as its performance in protecting other rights. One may, in particular, note the way in which the IPP disputes (particularly the cases relating to Hubco and Kapco) were adjudicated by Pakistan’s judiciary and the manner in which soveriegn guarantees were stayed.

 iii)             Lack of a proper arbitration law

The lack of an independent judiciary in Pakistan is further compounded by the fact that the arbitration law in Pakistan has been gutted of much of its value, at least from an international investor’s perspective.

To begin with, Pakistan’s Arbitration Act of 1940 is an anachronism, preceding as it does the New York Convention of 1958. Secondly, the 1940 Arbitration Act allows far too much scope for judicial interference. Thirdly, there are several Supreme Court cases which have rendered arbitration clauses of questionable value and enforcement. For example, the Uzin Export case allowed a Pakistani party to avoid international arbitration on the grounds of “convenience.” Similarly, in the Rupali case it was held that a civil court judge in Pakistan could have some degree of control over arbitration proceedings in London, merely because the law of the contract was Pakistani law. Finally, in the Hubco case, the Supreme Court stayed ICC arbitration proceedings in London on the basis that allegations of fraud are not arbitrable.

It should also be noted that a draft Arbitration Act was being examined by the Senate in 1996 but that with the dismissal of the Benazir government, that measure disappeared and has not surfaced ever since.

 iv)             The value of customs and tax exemptions

The 1998 Policy does not grant any tax exemptions for the import of machinery. That policy is reversed in the Draft Policy which, as per the 1995 Policy, grants extensive exemptions, inter alia, from customs duties.

Under Pakistani law, if a customs exemption is withdrawn, an importer will have to pay the duty due on the day that the bill of lading is filed for the goods in question, even if the customs exemption was withdrawn after the purchaser of the goods opened an irrevocable letter of credit for those goods. The same holds true for sales tax exemptions.

It may be noted that under the Supreme Court’s decision in Al-Samrez, parties who had opened an irrevocable letter of credit were protected from any subsequent changes in tariff or withdrawals of exemption. However, the Al Samrez case was overruled through the induction of Section 31-A into the Customs Act, 1969 which remains the law till today.

Specific Recommendations

i)      Resolve existing hydel disputes

As long as the existing disputes with hydel developers linger on, the chances of new private investment in Pakistan’s hydel sector will remain remote. The first priority therefore must be to resolve these disputes.

One possible way to resolve the dispute is for the Government to examine the dispute from a different perspective than that currently being utilised by Wapda. Wapda’s current focus is on ensuring that it is not being ripped off by the hydel developers, hence the debate over rates of returns and project costs. However, the real issue from a societal perspective is not what rate of profit hydel developers should receive. Instead, the point here is that society has certain electrical demands – if those demands are not fulfilled through hydel generation then those demands will be filled through thermal generation.  The real choice therefore is between buying electricity from a hydel developer and buying electricity from a thermal IPP. So long as the hydel generation is cheaper than the thermally generated electricity, the government and Wapda should buy hydel: the rate of profit accruing to the hydel developer is immaterial.

In a perfect world, Wapda would be able to produce electricity itself in the most economically efficient manner. However, Wapda does not have the capital to invest in hydel generation and therefore it does not have the option of producing electricity in the optimally efficient manner. Instead, its only economic choices are to either purchase additional electricity from a thermal IPP or a hydel IPP.[10] Assuming that the hydel electricity is cheaper than the marginal cost of buying more thermal energy, Wapda has no other economically rational choice than to purchase hydel electricity.  Any other choice is the equivalent of cutting off one’s nose to spite one’s face.

In defense of Wapda, it may be noted that we are dealing with very large quantities of money. For example, over a thirty year period, every .1 cent increase in tariff means an additional payment of $40 million, for every 100 MW of generation. Clearly, Wapda and the government have a very large incentive to make sure that the tariff for hydel power is reduced as much as possible.  However, at the same time, basic economic facts do not change no matter how large the amounts involved. And the fact remains that Wapda is preferring to purchase more expensive energy than that available simply because it is convinced that the people selling cheaper energy are making too much money.

The other point to be made here is that there is a cycle at work, which works both in a vicious as well as in a virtuous manner. The more Pakistan delays the resolution of these cases, the greater the perception of risk, the higher the cost of capital, and the higher the resulting tariff. On the other hand, if the disputes were resolved, if Pakistan was in a position to show some private sector success stories to hydel developers, the perception of risk would come down, the cost of capital would come down and the end tariff would come down as well.

 ii)     Update and Review feasibility studies for high priority projects

The 98 Policy itself acknowledges “without a proper feasibility study for a particular site specific hydel or indigenous coal based project, it will not be possible to invite competitive bids and receive firm offers.” Despite this fact, private developers do not appear to have any faith in the quality of the feasibility studies being offered by Wapda. It is therefore necessary to have the feasibility studies for priority hydel projects reviewed by internationally respected consultants so that the international investing community is satisfied with the “bankability” of these studies.

 iii)   Authorise Nepra to determine tariffs on a marginal cost basis

The realisation that Wapda is not the appropriate entity to be making tariff decisions with regard to private sector hydel bids also seems to have dawned upon the Federal Government as shown by the amendments to the 98 Policy proposed in the Draft Policy.  It is the consensus of private parties that Wapda is simply not sincere in dealing with private hydel developers because it has a vested interested in retaining its monopoly over hydel power.

The perception of the private developers may or may not be accurate but that fact is not relevant. In marketing terms, perception is reality and Pakistan does not have the time to convince developers of Wapda’s bona fides. A simpler solution therefore is to authorise Nepra to make determinations regarding hydel tariffs, which in any event is what Nepra is meant to be doing. Nepra’s track record – particularly its decision to issue licenses to small and captive power producers – has been well received by the business community and it is therefore much more likely to be accepted as a neutral authority.

Merely authorising Nepra to decide tariffs will, however, not resolve anything if the basis for deciding tariffs is not specified. In other words, if Nepra adopts the same “cost plus” approach adopted by Wapda then disputes will continue to flourish. It is therefore necessary to work out an alternate methodology which is predictable from a developer’s perspective so that private sector parties have a target in mind when deciding whether or not to examine the possibility of investment.

It is not being suggested here that Nepra should override the results of competitive bidding. Instead, what is being suggest is that Nepra should examine the tariff resulting from a competitive bidding process and examine that tariff only to see if its is economically rational, for example by seeing if the quoted cost of a particular project is less than the equivalent cost of thermal power or the long run marginal cost. In this context, it will be necessary to update the 1994-95 study done by Coopers & Lybrand with respect to Wapda’s Long Run Marginal Cost.  Such an approach preserves not only the benefit of competitive bidding but also provides developers with a stable target tariff which would serve as a ceiling for all bids.

 iv)   Allow customs/tax exemptions on import of machinery for power projects

Under the 98 policy, imports of machinery are not exempted from import/customs duties. This change from the 95 Policy is justified in the 98 Policy on the grounds that the previous exemption had rendered uncompetitive Pakistan’s “fledgling engineering industry.”

The Draft Policy proposes reinstituting the tax exemptions for IPPs which is economically correct. The benefit to the state exchequer from the imposition of tax duties is more than made up for by the fact that the state itself will pay for those benefits, and probably several times over.  In any event, tax exemptions should certainly be allowed for such inputs as are not produced locally, e.g. turbines.

 v)     General measures to improve the investment climate

1)     Repeal Section 31-A of the Customs Act, 1969

2)     Introduce an updated and modern arbitration act

3)     Take comprehensive steps to strengthen the independence of the judiciary

4)     Set up commercial benches in all high courts, having original jurisdiction in high value disputes

Conclusion

Pakistan today enjoys a surplus of electrical generating capacity. However, even as per conservative projections, that surplus will disappear by 2005 and by 2008, Pakistan will require an additional 5,000 to 8,500 MW of electrical energy. Pakistan does not have the resources to fund that increase in generation capacity. It is equally evident that Pakistan cannot afford not to have that additional generation capacity.  The development of hydel power takes time. If Pakistan does not take appropriate steps now to develop hydel power, then within a few years it will have no option but to turn to thermal power once again. That fact, combined with Pakistan’s recent experience with thermal IPPs, makes it all the more imperative that the currently dismal state of private investment in the hydel sector be rectified speedily.

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[1] As succinctly stated in the Policy Framework and Package of Incentives for Private Sector Hydel Power Generation Projects” released in May 1995 (hereinafter, the “1995 Policy”), “Hydel power being cheaper will provide tariff relief to the consumers, utilize indigenous resources, involve Pakistani entrepreneurs and provide benefits of economic growth to the relatively backward parts of Pakistan.”

[2] Pakistan’s untapped hydropower potential is regularly estimated at 40-50,000 MW by newspaper columnists. GTZ, a technical development agency associated with the German government which is assisting Wapda, however estimates untapped potential at approximately 30,000 MW.

[3] Pakistan’s current power generation capacity of 17710 megawatts includes 5067 MW of hydropower, 150 MW coal, 9676 MW thermal (steam), 2380 MW thermal (combined cycle) and 462 MW (nuclear).

[4] The projects which received letters of support under the 1995 Policy were Matiltan (85 MW), Malakand III ( 81 MW), Ranolia (11 MW), New Bong Escape (79 MW) and Neelum Jhelum (969 MW). Rajdhani (132 MW); Jinnah Barrage (96 MW)

[5] In one case, for example, the Government of the NWFP refused to grant a water use license to a hydel developer.

[6] Malakand III, an 81 MW project originally proposed by a consortium including BC Hydro and SNC Lavalin, both of Canada, is now supposedly being developed by the NWFP Government, while Wapda has signed an MoU with Chinese companies regarding the Jinnah Barrage project.

[7] Dawn, Dec. 8, 2001 “Synergics’ terms for feasibility: Kohala project”.

[8] To take one example, the 98 Policy states that the Government of Pakistan will provide guarantees against “political risk.” However, experience has shown that the Government of Pakistan itself is the “political risk” and the Government cannot obviously guarantee its own good behaviour when it has already demonstrated an aptitude for rewriting the rules in its favor. Thus, while Wapda may discount political risk, that risk is probably the pre-eminent factor in the minds of potential investors.

[9] Lt. Gen. (Retd.) Zahid Ali Akbar, former Chairman of Wapda, stated bluntly with respect to the developers of the New Bong Project that “they will never achieve financial close.”  Similarly, Mr. Javed Rashid, the Chief Economist at GTZ, a German government technical agency assisting Wapda in the hydel field agreed that the New Bong Project was “not doable” at the agreed upon tariff. One may also note that the public announcement on 15.12.01 of the agreement between Laraibe and Wapda on tariff rates had been preceded by a newspaper report on 6.12.01 in New International (“Musharraf to sign MoUs during China visit”) that Wapda had taken the New Bong project away from Laraibe and given it to a Chinese company. In addition, as per a news report in the Nation on 11.10.01, Laraibe had offered a tariff of 3.66 c/kwh as a “last ditch effort.” The determination of the final tariff therefore would seem to have taken place in a somewhat coercive environment.

[10] It has been assumed for the purposes of this study that the government of Pakistan does not have access to the capital necessary to construct hydel projects. The question as to whether Wapda is actually capable of constructing and operating hydel projects more cheaply than private developers has not been examined but there is certainly evidence to suggest that Wapda’s calculations as to the cost of hydel power produced by it are not accurate. For example, the summary produced for ECNEC with respect to the Neelum Jhelum Project calculates the average cost of energy production as 3.03 c/kwh. The same project costs when analysed by an independent economist familiar with the power sector returned an average cost of 5.9c/kwh. One may note that over a thirty year period, the total difference in cost will be approximately US$ 11 billion.