The energy value chain cannot be fixed without reforming electricity distribution companies. The inability to fix the chain and make electricity more affordable will continue to keep Pakistan stuck in a low-growth trap while accelerating de-industrialisation. The electricity distribution companies (Discos) are plagued with multiple problems, from governance and pricing to operations.

For any reforms to be successful, the first step needs to be the elimination of a national uniform tariff — which basically penalises efficiency and high repayment propensity while incentivising inefficient processes and low recoveries.

Through a national uniform tariff, well-managed Discos foot the bill for distribution companies with high losses. Disaggregating prices and, consequently, losses will remain critical for any reform. In such a scenario, incentives need to be aligned so that the Discos and respective provinces are motivated or forced to improve efficiencies and recoveries.

The same can only be done by linking financial losses with the National Finance Commission (NFC) award for provinces. As prices are disaggregated, any losses borne by Discos can be borne by the respective province rather than through a collective purse.

Eliminating a national uniform tariff while allowing well-managed Discos to move towards privatisation can minimise T&D losses, making electricity more affordable

Lower collections and recoveries are largely an administrative problem. As the subsidy is covered by the federation, provincial governments have no incentive to control theft because they do not pay for it directly, but the federation does. Once such subsidies are cascaded down to provinces, which may encroach on the NFC award, necessary incentives will be created to reduce theft and other operational inefficiencies.

Incentives can be structured so that transmission and distribution (T&D) losses exceeding the benchmark stipulated by the National Electric Power Regulatory Authority are split between the federal government and respective provincial governments in a 75 per cent to 25pc split, with the federal government share eventually moving to zero over a five-year horizon.

This does not add any upfront burden on the province while also providing sufficient time for reformation and restructuring of the Discos. The provinces can continue to provide subsidies to respective distributors through their respective budgets if required.

It is pertinent to note that the most efficient distribution companies that are located in Punjab and Karachi account for 17pc of electricity units lost, accumulating to Rs26.7 billion for 2022-23. On the flipside, the remaining Discos account for 83pc of electricity units lost, accumulating to Rs133bn for 2022-23.

The same Discos make up 81pc of the total billed amount that could not be recovered, while those located in Punjab and Karachi make up only 19pc of the amount that could not be recovered.

The elimination of a national uniform tariff needs to be accompanied by enabling each distribution company to enter into bilateral agreements with various Independent Power Producers (IPP). This would allow them to slowly move partially away from central power purchasing, thereby relieving the burden of capacity payments.

It is to be noted that there is excess capacity available in the system, which is pooled and priced on a cost-plus basis rather than on the basis of demand and supply. Due to this, even those consumers who are efficient and can increase consumption at an optimal price level are penalised, resulting in lower electricity consumption and higher capacity charges on a per-unit basis.

Allowing Discos to enter into bilateral contracts can lead to better management of available supply and demand. Such structuring will also reduce the capacity available for central purchasing, consequently reducing the liability of capacity payments.

On the governance front, there is a dire need to mix long-term concessions contracts with the private sector and privatisation. Long-term concession contracts make more sense with Discos, which have higher losses and operational inefficiencies. Through these contracts, the provincial government can provide necessary backstops for collecting receivables and reducing theft.

On the other end of the long-term concession, the private party can undertake necessary reforms of the entity while having the provincial government support the collection of receivables. A direct privatisation in such a scenario may not be successful, given the enormous nature of losses and governance problems that lead to those losses.

A privatisation model can be opted for Discos with high recovery levels, which can also be further improved through smart metering and better processes. The government can strive to sell the majority shareholding to a private party, based on whichever party can inject the most capital to catalyse necessary restructuring.

The primary objective at this stage ought to be to reduce T&D losses and make electricity more affordable — the same should drive the decision to privatise or make long-term concessions, depending on governance and administrative constraints.

A path to sustainable economic growth necessitates the availability of affordable electricity, and the same cannot be achieved without the reformation and restructuring of Discos and how electricity is priced in the country. Reforming the market structure by moving towards marginal disaggregated pricing rather than cost-plus pricing remains a core tenet.

If the same market structure and a national uniform price continue, losses will only continue to increase, and so will electricity prices.

Published in Dawn, The Business and Finance Weekly, April 8th, 2024