Transitioning Pakistan’s CFPPs to renewable energy: what’s the hold up?

By: Syeda Masooma

Pakistan is grappling with an at-home energy debt crisis and severe external debt issues. One of Griffith University’s recent papers offers a potential solution to address both problems simultaneously. While the journey is fraught with financial and diplomatic challenges, it is a viable path forward nevertheless. In this feature, we will explore the proposed financial and infrastructural transitions, and hear from experts about the opportunities and obstacles that lie ahead.

First a brief recap of the energy sector crisis and external debt crises.

Latest data from the Power Division of the Ministry of Energy shows that the circular debt in Pakistan’s power sector increased by Rs 84 billion in January 2024, reaching Rs 2.636 trillion as compared to Rs 2.551 trillion by the end of December 2023. A major factor in this ever-soaring debt is underutilization of the generation capacity – more pronounced by Pakistan’s “Take or Pay” agreements. The State of Industry Report (SIR) 2023 says, “Under ‘Take or Pay’ agreements, power utilities are obliged to pay for contracted capacity, regardless of whether it is consumed or not. The unutilized capacity places a financial burden on electricity consumers, who end up paying for unused power. During FY 2022-23, the utilization factor of de-rated thermal electric power generation capacity remained 34.68 per cent”.

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The rupee devaluation coupled with under-utilization of ‘Take or Pay’ capacity significantly contributed to the higher cost of electricity exacerbating the financial liquidity and instability within the power sector. Non-payment to the power generation companies in timely manner hampers their ability to make timely payments to fuel suppliers and other stakeholders, triggering a ripple effect throughout the industry.

This precarious financial situation of power companies, compounded by the challenges of rupee devaluation and ‘Take or Pay’ obligations, may dissuade potential investors from participating in the power sector which could negative impact the power sector modernisation and expansion, the report added.

Now let’s move to the national debt crisis. As of 2024, Pakistan’s total external debt stands at around $126 billion. One significant factor of this debt are the import payments of coal used for fuel in Pakistan’s coal fired power plants (CFPPs). Pakistan had coal power generation of 0.15 GW in 2015. By 2023, it has exceeded 7.2 GW. According to Economic Survey 2023-24, Thar Coal projects have the installed capacity of 3,300 MW while imported coal capacity is 3,960 MW. The Private Power and Infrastructure Board (PPIB) is in the process of completing 300 ongoing IPPs as well.

In consequence of Pakistan’s economic situation, Chinese companies invested in coal projects are facing a backlog of payments with outstanding amounts at around USD 1.5 billion (by March 2023), resulting in serious financial problems on debt repayment and operational barriers for the Chinese-funded Independent Power Producers (IPPs). This situation, on the one hand, has led to political pressure on the Chinese government to ensure the viability and profitability of its overseas investments while also drawing international attention to its responsibility in addressing bad debt.

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This is where the “Managed transition vehicle: Financing mechanism for early phase-down of Chinese-sponsored coal plants” paper comes in. It suggests establishment of a special purpose vehicle (SPV) or in this case “managed transition vehicles (MTV)” that finances coal buy-out and renewables.

The paper outlines a financial as well as infrastructural transition of the currently operational coal power plants into renewable energy power plants. The mechanism given offers a way out for current investors to reduce their receivables as well as debt exposure, while transferring their ownership to renewable energy projects. It also presents a theoretical model for Pakistan’s public sector to reduce external debt burden by refinancing and grants, and the private sector to fulfil sustainability targets while still running profitable energy generation projects.

The proposed MTV model would include the establishment of an independent entity with the goal of accelerating phase-down of the CFPP, for instance five to ten years ahead of schedule. It will be financed by equity of original investors along with new investors, as well as concessional financing and/or guarantees by development finance institutions and potentially grants by donors. This allows for lower cost financing than was possible for the previous assets due to the green nature of the MTV.

The MTV will then buy out the identified asset (CFFP) at the market value, instead of the book-value. This will, possibly, increase the cost with respect to the value of the infrastructure e-g land, but, possibly, reduce the value of the equipment and the machinery. Put together, it might require debt and equity write-downs with the original investors and creditors. However, at the same time, the payout can be used to reduce the overall debt burden through a debt-for-climate swap, the paper proposes.

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Finally, the payments to the original investors can be utilized as equity for renewable energy projects along with concessional loans and possibly grants.

Not only will this allow Pakistan to obtain renewable energy financing at better rates, it will also reduce the operational cost of the coal power plants, potentially turning them into profitable ventures for the remaining amount of time until they are completely closed.

From the perspective of the lenders and investors, the delayed payments in the current structure should serve as a motivation to move towards a financial model that offers quicker repayment of loans as well as reduced debt burden. For Pakistan, the possibility of green financing as well as mobilizing new investors should also serve as a motivation to move towards an early phase down of coal power plants towards renewable energy power generation.

Experts in Pakistan’s energy sector seem to concur albeit with a note of caution. Dr Khalid Waleed of the Sustainable Development Policy Institute (SDPI) said that instead of establishing new renewable energy power plants from ground up, repurposing an existing power plant offers multiple advantages.

First of all there is already a transmission and distribution network present at the power plant, so the renewable energy generated through solar or wind can be readily made available to the consumers of the coal powered energy. Secondly, the existing building can be repurposed for administrative purposes, as is the existing workforce.

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Dr Waleed also lent credibility to the option of concessional refinancing, through means such as the Coal to Clean Credit Initiative (CCCI). CCCI is a consortium of global experts, which on December 4 2023 launched “transition credits” draft methodology. It will enable funding from carbon markets to accelerate a just coal-to-clean energy transition in emerging economies, operationalizing the Paris Agreement. In layman’s terms, under this initiative, countries aiming to reduce carbon emissions may apply for carbon credits, which in turn can allow for lower costs on financing for renewable energy products.

However, he said that the financial measures as proposed by the Griffith University paper, including refinancing and debt-for-climate swaps are still in nascent stages of development across the world. To move towards repurposing existing coal power plants into renewable energy plants will not be as easy as the financial model solely dictates.

Then there is also the issue of declining energy demand in the country. Private Power & Infrastructure Board (PPIB) Director Aqeel Jafri said that even though increasing the share of renewable energy in the total power generation mix is on the cards of the government, the process is not that simple.

Even if the model is to be considered, the transition from one source of energy to another will require a license of the respective power production from the National Electric Power Regulatory Authority (NEPRA). Furthermore, such a transition will come with likely altered generation capacity which also needs to be aligned with the total power production and consumption targets of the government.

He said that while Pakistan’s generation capacity has increased over the past few years, the demand has reduced, adding that since the primary driver of energy demand is residential, there is significant seasonal fluctuation.

A report by SDPI shows that nearly half of Pakistan’s energy demand comes from the residential sector (48 per cent) as compared to one-fourth of the demand from the industry sector (25 per cent). This means that during the summer season, the demand for electricity peaks at nearly 24,000 MW while in winters the recorded demand is at 8,000 MW.

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According to the World Bank, Pakistan has a solar power potential of 40GW and aims to source 20 per cent of its electricity from renewables by 2025. However, Aqeel Jafri says that with the industry players and a notable proportion of the households moving towards solar power generation, the government estimates of energy demand have become less certain.

He added that the proposed move of transitioning CFPPs to renewable energy will also come with possibility of expanded generation capacity, as well the requirement of specific licenses of the respective energy generation from NEPRA. With the demand already going down, he believes that any move impacting the generation capacity will have to be in line with the broader government strategy of production and transmission of energy, making the process all that more complicated.

Additionally, renewable energy is supply based, which means that the availability of sunshine, wind or water (hydel) is not consistent and with demand side already fluctuating, adding uncertainty to the supply side makes the transitions of existing infrastructure towards renewable energy even more difficult.

However, there is a silver lining despite all of it.

Aqeel Jafri said that under the Competitive Trading Bilateral Contract Market (CTBCM) model, a wholesale electricity market is on the cards for Pakistan, which includes both sellers and buyers. DISCOs will be given the additional responsibility of fulfilling excess demand that cannot be fulfilled through this market. That power generation, he said, will be focused on renewable energy resources.

In response to Aqeel Jafri’s argument that the transition of CFPPs to renewable energy generation plants can cause capacity expansion issues, Energy Finance Specialist Haneea Isaad said that the capacity and transmission issues are not specific to transitioning towards renewable energy. “There are many projects, hydro and coal, that are already in progress and will be coming online in the upcoming few years. Those projects will also bring similar issues of capacity and transmission.” She added, “When we talk about transitioning to renewable energy or phasing-down currently operational CFPPs, we have to remember that we are talking about five to 15 years down the line.” Even if we start the transitioning procedures now, it will be years before they retire; well in time for the planned capacity expansion to have already taken place.

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It is notable here that the Independent Evaluation Department (IED) of the Asian Development Bank (ADB) has already rated technical assistance (TA) for “Pakistan: Developing an Electricity Market” as successful and relevant. In its validation report, the IED said that the objective of TA of $1.2 million was to provide capacity building and policy advice on the introduction of market mechanisms for electricity sales and purchases in Pakistan based on a competitive trading bilateral contract model (CTBCM), which was developed under a preceding ADB TA.

All in all, it might be prudent for Pakistan to start weighing financial options to move towards phasing-down of CFPPs, with collaboration from the Chinese investors as well as from international donors and financing organizations through concessional financing and debt-swaps.