CASE NUMBER: 366
CASE MNEMONIC: PAKPOWER
CASE NAME: Pakistan's Power Project Hubco
CASE NUMBER: 366
CASE MNEMONIC: PAKPOWER
CASE NAME: Pakistan's Power Project Hubco
I. Identification1. The Issue
Environmental costs are increasing as demand for electrical power in Pakistan spirals due to rapid population and economic growth. Despite the Pakistani government's emphasis on providing electricity to a larger share of the population, the US Energy Department of Energy reports that only 37 percent of the population was hooked up to the electrical grid as of 1990. Both the domestic and industrial sectors suffer from frequent loadshedding and power outages due partly to demand far outpacing supply. Energy consumption demands are expected to exceed domestic production increases for the foreseeable future.1 The environmental costs generated in the power industry are on the rise as more plants are built. The Hub power project is oil-fired and contributes to air and water pollution. Due to these problems, conservation and more efficient transmission lines would go a long way to minimizing the environmental impact of the power project. I will examine the power situation in Pakistan in this case study and highlight the environmental costs of the trade of power investment in the country.
2. Description
Background on the Power Sector in Pakistan: A Dismal Picture of Supply to Demand
Until its recent private investment initiatives in 1995, Pakistan faced a dreary supply future in its power production sector. Pakistan has worked hard to expand its power generation capacity of only 119 megawatts (MW) at the time of partition from India in 1947 to almost 11,000 MW annually. However, the demand estimate for the year 1994-5 was 12,800; which leaves a demand and supply gap of around 2,000 MW annually.2 Moreover, with current demand growth at 8% annually, Pakistan will need to add 50,000 MW to its existing capacity by 2018. Currently the government is considering over 34 companies for power projects totaling 9,045 MW for up to the year 2,000.3 The power sector in Pakistan is a mixed industry of hydro, thermal, and nuclear power plants. As of December 1994, the power sector included 7,588 MW of thermal plants, 4,825 MW of hydroelectricity, and 137 MW from a nuclear power plant for a total installed capacity of 12,550 MW, according to the World Bank. The power system serves about 10 million consumers, in the following categories: about 7.9 million residential, 1.4 million commercial, 200 thousand industrial, and about 160 thousand agricultural consumers.4 The government has created a power sector plagued with production inefficiencies at every level. Officials estimate that $1 billion of production is lost every year in Pakistan due to loadshedding.5 On-line transmission losses are estimated to be as high as 30%, which skews the government's official production figures. This means that as much as 3,000 MW of electricity is lost annually due to the dilapidated distribution system and theft of power.6 One prominent example of such waste is that the majority of transmission wires in the Karachi area are made of steel, and not the more conductive copper, mainly due to a steel plant's proximity to the power plant and relatively cheaper purchasing price of steel. This led to a proliferation of steel transmission lines. However, the steel wires are not only substandard to international norms, but are responsible for the higher losses. In addition, it is common for thieves to cut and steal most of the neutral lines and sell these to the steel scrap dealers.7
Another aspect of the Pakistani power production sector is that the majority of plants are thermal. Pakistan is heavily dependent on imported oil for its domestic energy requirements due to the large amount of oil-fired thermal power plants. Because of larger start-up and initial production costs--as well as resettlement and water diversion controversies--oil-fired thermal power production far outnumber hydroelectric power plants. Currently, Pakistan depends on oil imports for about 30 percent of its domestic energy requirements, costing $1.6 billion in 1993!8 The World Bank estimates that Pakistan has a power production capacity of about 27,000 MW under average hydrological conditions. Pakistan's major oil fields have largely been exploited, according to the World Bank, with a reserves production ratio of only about nine years. In the gas arena, the World Bank notes that Pakistan has substantial gas reserves, but gas exploration has proceeded at a slower rate of development due generally to limited interest by the oil industry in gas exploration. Domestic proven reserves of recoverable coal and lignite are 432 million tons, and prospects for development of this domestic resource are promising.9
Finally, government neglect of power infrastructure has left many cities in Pakistan still using antiquated energy infrastructure. This state of affairs is complicating privatization efforts as investors are faced with a foundation that has crumbled from years of neglect. Ironically, this has in turn required the state to spend large amounts of money to update the infrastructure--so that it is attractive for investors--before being able to "save money" by privatizing.10 For example, a common complaint in Karachi concerns power fluctuations--which often irreparably damage electrical appliances--which are generally due to malfunctions in the city's dilapidated power transmission lines.
Moving to Develop Power Sector Development
The responsibility of power provision in Pakistan is shared between the Water Power Development Authority (WAPDA) and the Karachi Electric Supply Corporation (KESC.) WAPDA is responsible for developing Pakistan's water resources and for construction, operation, maintenance of power generation, and transmission and distribution facilities throughout the country, except the Karachi area.11 WAPDA accounts for over 90% of the total installed hydro and thermal power generation capacity of about 10,000 MW, while supplying approximately 88% of Pakistan's electric consumption.12 KESC supplies the remainder of the power demanded in the Karachi area and is responsible for that area's construction, operation, maintenance of power generation, and transmission and distribution facilities. The World Bank, as part of its Power Sector Development Project in Pakistan, is helping the Pakistani government to privatize the majority of its power sector. According to the World Bank Power Sector Development Project Loan and Project Summary in mid-1994, the project goals include restructuring and privatization, investment, and technical assistance components designed to improve the operations and managerial efficiency of the power system, increasing power supply and quality of service as well as decreasing the amount of unserved energy and environmental damage. WAPDA, in particular, has been under close World Bank scrutiny and is slated this summer to begin reorganizing into corporations--a holding company with decentralized power generating, transmission and distribution subsidiaries--which will operate as discrete autonomous profit centers.13 KESC is scheduled to begin privatization following WAPDA's reforms. Prior to the World Bank's help to Pakistan in liberalizing its economy, investor interest in Pakistan's power sector was minimal. The tedious and time-consuming process of entering into the private energy sector in Pakistan elicited few offers from investors in 1992 when the government first allowed the establishment of private power generation projects in the private sector.14 In addition, investors were discouraged by the prohibitive costs of importing the power plant materials (there was at that time little industry to support the construction of power plants.) In reaction to the tepid response of foreign investors to liberalization of the energy sector, the government convened a high-level task force on the power sector in 1994 which formulated the "Policy Framework and Package of Incentives for Private Sector Power Generation Projects in Pakistan." According to the World Bank, the incentives included:
1) "Bulk tariff of US cents 6.5/kWh (to be paid in Pakistan Rupees) for the sale of electricity to WAPDA/KESC with indexation mechanism for fuel prices, US and Pakistani inflation, exchange rate fluctuations, O&M costs, etc.
2) Fiscal incentives consisting of exemption from corporate income tax, customs duties, sales tax, Iqra, and other surcharges on imported equipment.
3) Standardized security package which includes a model Implementation Agreement, Power Purchase Agreement and Fuel Supply Agreement.
4) Creation of a Private Power and Infrastructure Board, so as to facilitate a one-window operation.
5) Fiscal incentive to facilitate the creation of a corporate securities market in the country, including permission for power generation companies to issue corporate bonds and shares at discounted prices, and establishment of an independent rating agency." The government subsequently added further incentives in March 1995 which led to a flurry of foreign investment petitions.
The new guaranteed revenue return rate was extremely attractive to investors; as well as the "one-window" operation. Investors were reassured that WAPDA and KESC would purchase electricity for a very reasonable 6.5 cents/kwh. This guaranteed the foreign producer that regardless of a potential drop in demand for electricity, the government would purchase the supply of electricity at a favorable prices. Moreover, the "one-window" interface with the government helps to minimize the time spent in the Pakistani bureaucracy, thereby reducing the cost of submitting a proposal.
While these incentives generated an avalanche of applications for power production--over 116 in 1995--the liberalization process by the Pakistani government is still encountering some major problems. The government has been slow to break down WAPDA for privatization and to move towards a more market-orientated and transparent pricing regimes. Consumer price hikes are running into opposition and the government still subsidizes tariffs for certain consumers. The consumer sector is heavily subsidized at almost 50 percent, while the commercial and industrial sector pays the highest rates. What is not included in this table, however, is the cost inflicted by waste and theft of electricity that these tariffs must make up for. In addition, the overall tariff increases have been made not only to bring the prices up to par with the marketplace, but to also generate enough cash flow in WAPDA and KESC to enable the organizations to qualify for additional debt for privatization. These factors will impede the restructuring of the tariff system, and therefore privatization.
The Hub Deal
Hubco, Pakistan's largest finished power project to date, began operation this summer. The landmark private sector power project began producing power from the first of its 4 x 323 MW oil-fired units on 4 July, with its second unit expected to be on-line by the end of August.15 The entire unit is expected to be fully operational by March 1997. The oil-fired plant is being built near the Hub River about 40 km northwest of Karachi, in the province of Baluchistan.
This was the first time in Pakistan that a private power project had been backed by multilateral (World Bank) and bi-lateral (French, Japanese, US, and Italy) funds in association with commercial banks.16 The project cost $1.8 billion and was financed as a build, own, operate (BOO) arrangement, under a term of 30 years which will be up for assessment at the end of 23 years.17 Citibank was the lead arranger for over $686 in commercial loans raised to push the project to financial closure in January 1996. The principal contractors are Mitsui of Japan, Ansaldo Energia of Italy, Campenon Bernard SGE of France, and Ishikawajima-Harima Heavy Industries of Japan.18 The breakdown of the construction responsibilities include: Saudi Arabia's Xenel is supported by France's Campenon Bernard for the civil works, Japan's Mitsui an IHI for the boilers, and Italy's Ansaldo for the turbine and generator.19 The talks for the Hub River project began in 1985 when the Pakistani government invited offers for IPP proposals. Following the initial letter of intent, sponsors formed a construction consortium to accelerate negotiations, even though financial closure not been reached. The project finally reached financial closure in January 1995 when consortium-leader British National Power company agreed to raise its stake in Hubco to $100 million equity from $40 million (the second largest member is Saudi Arabia's Xenel with $90 million); which finally persuaded bankers to fund the project.20
The project is not only unique in its size but the way in which the international consortium was able to combine equity, debt and guarantees. The breakdown in finances includes: $175 million from international and local equity investors and $689 million from international banks--the majority of the balance came via a $589 million subordinated loan provided by the World Bank.21 Although the World Bank traditionally only lends to government, the consortium was able to circumvent this convention by channeling the World Bank contribution through the government's private sector development fund. In addition, the consortium was also able to incorporate some financing from traditional Islamic banks.
The state-owned Water and Power Development Authority (WAPDA) will purchase power from Hubco and the power purchase agreement assures a guaranteed revenue equivalent to 60% of gross capacity utilization, irrespective of the actual takeoff from the power station.22 For the first ten years, Hubco will supply power to WAPDA at 5.9 cents/kwh if the authority uses up to 64.4% of total production; in the case of higher usage then the tariff falls to 5 cents/kwh.23 The national government's commitment to energy production--the project was able to enjoy continuing support from the several successive governments in Pakistan--played a large role in bringing the project to closure. Prime Minister Bhutto described Hubco this July as the "cornerstone of her government's energy policy aimed at attracting foreign investment."24 By establishing a standard agreement for power investment--especially in implementation, fuel supply, and power purchase agreements--the national government ensured that all investors are treated equally in the negotiation process. In addition, the investors utilized the government's "one-stop" shop, which guides investors through a simplified approval process; according to one project sponsor, "they are the people on the inside that are on our side."25 Moreover, the Pakistani government's willingness to underwrite the political risks in its energy policy kept investors interested. For example, one major incentive was the government agreement to provide foreign exchange risk cover for the principal and interest payments under the debt facilities.26 The government's open-door policy will pay off in the long run, according to the World Bank, which estimates that the Hub project and eight other private-sector exploration and generation efforts planned will help redress both the shortage of energy and the revenue drain on the government from pouring money into inefficient public sector power utilities.27 Hubco's Environmental Costs The downside, however, is that while much effort has been expended on bringing the project to fruition, the foundation for environmental protections has not been created. In fact, it seems that the enforcement will be left to the current national efforts. Hubco will generate at least two forms of pollution: air and water pollution. The air pollution derives from its oil-fired method of production and the water pollution from its proximity to a major river.
The government is having limited success in efforts to stem pollution in the power sector. This is due in part to its current policy to encourage foreign investment in order to meet demand. The environmental costs are not being compiled in the investment equation. The reason for this disconnect stems from the national government's troubles in merging the environment and economics in the decisionmaking process. Moreover, it does not appear they will be negotiated into further deals unless domestic pressure increases for such amendments. The 1991 Pakistan National Environmental Plan estimates that three main coastal industries located near the Karachi Port with the largest volumes of effluents are the steel mill, power plants, and refineries, and notes that many smaller industrial units are having more significant polluting effects on the marine environment. In 1992, a United Nations study noted that the "concept of wastes recycling, treatment, and disposal does not exist in the industrial sector [in Pakistan.] Even the highly polluted wastes are being discharged irrationally into water bodies, on soil and in the air...industrial waste treatment systems are virtually non-existent in the country and those existing in a few industries, either technically doe not meet the requirement standards or they are out of use or are nonoperational."28 With little national government policies on environmental controls, the industries are able to dispose of the waste the cheapest way for the company (which often translates into dumping.)
3. Related Cases
Key Words
(1): Environmental Problem Pollution Air [POLA], Pollution Sea [POLS]
(2): Industrial Category Power [POWER]
(3): Nation Pakistan
4. Draft Author: Theresa Augustus
B LEGAL Clusters
5. Discourse and Status
The Pakistani state, while at the same time needing to promote power sector investment, is the only entity that can formulate the strict environmental protection laws and ensure effective implementation at the local level. These responsibilities can be delegated to the Water Power Development Authority (WAPDA) and the Karachi Electric Supply Corporation (KESC.)
6. Forum and Scope: Pakistan and UNIlateral
7. Decision Breadth: N/A
8. Legal Standing: [Law], [Sublaw]
C. GEOGRAPHIC Clusters
9. Geographic Locations
a. Continental Domain: Asia
b. Geographic Site: South Asia
c. Geographic Impact: Pakistan
10. Sub-National Factors: NO
11. Type of Habitat: [TEMP]
D Trade Filters
12. Type of Measure: Regulatory Standard [REGSTD]
13. Direct v. Indirect Impacts: INDirect
14. Relation of Measure to Impact:
a. Directly Related to Product: YES Power [POWER]
b. Indirectly Related to Product: NO
c. Not Related to Product: NO
d. Related to Process: YES Pollution Air [POLA], [POLS]
15. Trade Product Identification: Power
16. Economic Data See Description section.
17. Degree of Competitive Impact: LOW
18. Industry Sector: POWER
19. Exporter and Importer: Domestic
E ENVIRONMENT Cluster
20 Environment Problem Type: POLA, POLS
21 Species Information: N/A
22 Impact and Effect: [HIGH] and [REGUL]
23 Urgency and Lifetime: N/A
24 Substitutes: CONSV
F OTHER Factors
25 Culture: NO
26 Human Rights HUMAN RIGHTS: [YES]
Air and water pollution impinges on the health and quality of life of Pakistanis. The increase in air pollution has repercussions to health problems, specifically leading to lung illness. Water pollution poisons the marine life in the sea, and the tainted fish can harm the unwary domestic consumer who purchases it. The marine life consumed domestically--such as fish, shrimp, and oysters--are directly contaminated.
27 Trans-Boundary Issues TRANS-BORDER: [NO]
28. Relevant Literature
See Endnotes
ENDNOTES
1 Energy Information Administration. "Country Energy Profile: Pakistan." US Department of Energy. September 1994.
2 Habib, Aba Ali. "Sector Watch: Power Sector." Pakistan and Gulf Economist. 25-31 March 1995. Pg. 29.
3 Ikram, Tahir. "Pakistan caps private power generation at 3,000 MW." Reuters Newswire. 6 March 1996.
4 Energy and Infrastructure Operations Division. "Pakistan: Ghazi-Barotha Hydropower Project" Staff Appraisal Report, World Bank. 27 November 1995.
5 "HubCo first dividend by '98" Power in Asia. 27 May 1996.
6 Zuberi, Khalique. "Power is a sacred trust." Pakistan and Gulf Economist. 7-13 January 1995. Pg. 3.
7 Kazm, Shabbir. "Privatization of WAPDA, KESC: Why Not!" Pakistan and Gulf Economist. 13-19 August 1994. Pg. 6-9.
8 Energy Information Administration. "Country Energy Profile: Pakistan." US Department of Energy. September 1994.
9 Energy and Infrastructure Operations Division. "Pakistan: Power Sector Development Report." Staff Appraisal Report, World Bank. 3 June 1994.
10 Menendez, Aurelio. "Access to Basic Infrastructure by the Urban Poor." Economic Development Institute of the World Bank. 1991.
11 Energy and Infrastructure Operations Division. "Pakistan: Power Sector Development Report." Staff Appraisal Report, World Bank. 3 June 1994.
12 Energy and Infrastructure Operations Division. "Pakistan: Private Sector Energy Development Project II" Staff Appraisal Report, World Bank. 28 October 1994.
13 Energy and Infrastructure Operations Division. "Pakistan: Power Sector Development Report." Staff Appraisal Report. 3 June 1994.
14 "Pakistan power sector." Journal of Commerce. 27 April 1996.
15 "Hab River festivities" Power in Asia. 8 July 1996.
16 "Campenon Bernard SGE and Hub River Project" Les Echos. 9 July 1996.
17 "Hab River festivities" Power in Asia. 8 July 1996.
18 "Pakistan's HUBCO" Reuters Trade Report. 2 July 1996.
19 "Hub wins over the skeptics" Project & Trade Finance. September 1994. Pg. 19.
20 "Hub capped" AsiaMoney. March 1995. Pp. 71-72.
21 "Hubco primes pumps for project finance" Euromoney. December 1994.
22 "HubCo first dividend by '98" Power in Asia. 11 June 1996.
23 "First Electricity from Hab River" Power in Asia 29 April 1996.
24 "Pakistan's Bhutto inaugurates Hub generator" Reuters Trade Report. 4 July 1996.
25 "Country Briefing" Project and Trade Finance. March 1995
26 "Project Finance: Power behind the loan" The Banker. January 1995. Pp. 55-57.
27 Friedland, Jonathan. "The nub of the Hub" Far Eastern Economic Review. 10 May 1990. Pg. 43-44. 28 "Pakistan National Environment Action Plan." Pakistan National Conservation Strategy, Volume 1. 1991. Pg. 86.