Vicious Circle

By Amir Zia
Newsline, August 2010

For the top management of Pakistan State Oil (PSO), arranging monthly oil import payments is now an ordeal. The company, which holds almost 70% market share in the country’s downstream oil business, stands cash- strapped as the key public and private power generation entities fail to clear dues on time. PSO’s receivables hover, on average, in the range of 130 to 140 billion rupees every month, which explains its vulnerable situation not just in meeting its import payments but also with clearing dues of the oil refineries.

“We have been at the brink of default on oil import payments in recent months,” PSO’s Managing Director, Irfan Qureshi, told Newsline. “If PSO even once fails to meet import payment obligations on time, it means the country’s crucial oil supply would be suspended for at least four months.”

On June 14, the company sent a SOS message to the Petroleum Ministry through a “most urgent” letter underlining the gravity of the situation. “The default to international L/Cs (Letters of Credit) has also now become imminent as during the current month PSO has to retire Rs.36 billion against international L/Cs,” the letter said.

The situation prompted Prime Minister Yousuf Raza Gillani to order clearing of Rs 41.4 billion of PSO dues, of which the company received 34.2 billion. The timely payment of this sum helped the company to meet its June payments. However in July, PSO receivables again ballooned to more than 135 billion rupees, prompting the company to raise a red flag and request the top government officials to intervene. And this has been more or less the pattern since early 2010.

“It is survival on a day-to-day basis,” Qureshi said. “Most of our work hours are spent figuring out the company’s critical money matters. We have become sort of expert fund managers in the way we handle our fragile finances,” he said jokingly.

PSO, which once was considered one of the most financially strong state-run organisations, is a victim of inter-corporate circular debt that has held the country’s entire economy hostage. On one level it is hurting Pakistan’s overall energy supply chain, and on the other it is hitting the country’s already battered economy very hard. According to the latest Economic Survey of Pakistan, the cumulative effect of the energy crisis on the economy is estimated to be more than 2% of GDP in fiscal year 2009-10.

Independent experts put the figure of circular debt at around Rs 420 billion, which indeed would require a Herculean effort from the country’s economic managers to clear in the current difficult times.

Dr Ashfaque Hasan Khan, a former advisor to the Finance Ministry, said that circular debt has been rising every day. “And the irony is that the government does not seem focused on the issue. Its approach is ad hoc. If tough and bold measures are not taken, it will sink the economy.”

Dr Khan, who is now working as the Director General and Dean of the National University of Sciences and Technology’s business school in Islamabad, suggested that it was not just imperative to raise the power-tariff to meet its production cost, but checking power theft and line losses also remain a must.

“In Pakistan, only in big cities do people pay their electricity bills,” he said. “FATA is one chronic example where unpaid electricity bills soared to 85 billion rupees and the entire amount had to be picked up by the government. Half of Peshawar city’s electricity connections fall in the FATA jurisdiction.”

Then there is no tradition of paying electricity bills in the interior of Sindh, Balochistan and parts of Punjab, he said. “Whatever revenue is coming, it is from the select big cities.”

No wonder then that the power distribution and generation companies including Pakistan Electric Power Company (PEPCO), Karachi Electric Supply Corporation (KESC) and Hub Power Company (HUBCO), remain the top defaulters of PSO.

As of July 16, 2010, PEPCO owed PSO more than 32 billion rupees, HUBCO 49 billion, and Kot Adu Power Company 25 billion. Pakistan International Airlines, KESC and OGDCL also remain high on PSO’s list of defaulters. In turn, PSO owed 80 billion rupees to oil refinery companies and 36 billion to international fuel suppliers in July. A senior Finance Ministry official, who asked not to be named, said that PEPCO remains at the heart of the circular debt problem. PEPCO is a huge company and if it has about Rs 45 billion credit on a 45-day basis, it should not raise any eyebrows, he said. “But the matter of concern remains that it has liabilities worth more than Rs 130 billion.”

Saqib Sherani, principal economic advisor to the Finance Ministry, said there is a need to restructure PEPCO and other distribution companies that remain responsible for the crisis. “There has been a 60% rise in power tariffs during the last two years, but the cash flow of PEPCO has not improved. It has become part of the problem now,” he said. “This underlines the fact that along with tariff, power sector governance issue needs to be addressed on the war footing.” Sherani said that even after the increase in power tariffs, PEPCO has been selling electricity at around 2 – 2.5 rupees per unit lower than the actual generation cost. This kind of subsidy remains unsustainable for any country.”

The Economic Survey of Pakistan said that the country has been forced to depend more and more on the expensive thermal power generation because of a decline in hydroelectric (hydel) generation as well as unprecedented shortages of the natural gas. “Since this occurred at a time of a doubling of the international oil prices, the effect on the cost structure of the utilities was amplified greatly,” the Survey said. “With no change allowed in the electricity tariff between 2003 and 2007, the compounded effect on the viability of the energy sector has been devastating.”

The gap between average power generation cost and recovery hovers around 30 per cent. Ashfaque Hasan Khan, the former Finance Ministry advisor, said that the imbalance between cost of generation and distribution and the tariff remains the main cause of the circular debt.

The issue of circular debt existed even during 2000, but at that time it was not this acute because of low oil prices and also because of the fact that energy supply was higher than demand, he said. By 2003/04, Pakistan had surplus electricity. The crisis began when oil prices started surging, but due to political considerations the government continued to give subsidies to consumers. On the one hand, it did not pass on the production cost to consumers and on the other it failed to undertake any reforms that could stop or even reduce power theft and generation losses, which range between 30 – 35%.

“This is a huge amount,” confessed a Petroleum Ministry official, who spoke on the condition of anonymity. “But the government has not been able to move on this issue the way it is needed mainly because of political considerations. The increase in power tariffs has come too late while there has been no effort to stop the theft of electricity, which remains rampant both in rural and urban areas.” Mighty feudal politicians, tribal chiefs and industrialists are all involved in massive power theft, he said. Power theft also remains widespread among poor and low-income localities where legal connections are not available, he added. “Even where there are connections, people prefer to steal.”

A KESC official, who also asked not to be named, said that one reason for the lack of action on this front is the issue of law and order. “In Karachi, there are huge neighbourhoods running on stolen electricity, but we can’t take action because the administration, the police and paramilitary Rangers do not support us.”

Finance Ministry officials say that with circular debt piling up, heavy bank borrowing by the corporate sector has resulted. This has burdened them with high financial costs in terms of interest payments, erasing their profit. Take the case of PSO. From July 2009 to May 2010, PSO made interest payments worth 8.5 billion rupees, officials said. Had this amount not gone into interest payments, this would have been part of its profits, they added.

Ashfaque Hasan Khan said that the dilemma for the power generation companies remains their inability to recover money from consumers. “The IPPs (independent power producers) charge a fixed amount on their production, which enters the grid without any line or distribution losses. The problem starts at the end of distribution companies, which not only have to sell it lower than their production cost but also suffer theft and line losses.” He adds, “The irony is that when oil prices hit 140 dollars a barrel even then the cost of electricity was not increased.” Dr Khan says Pakistan missed a crucial chance to lower circular debt when oil prices slipped in 2008/09. “The government managed to get 130 billion rupees, but instead of clearing circular debt, it was taken as surplus revenue.”

Experts said that the issue of circular debt seems likely to stick for a long time to come as the country’s reliance on thermal power increases against the backdrop of rising international oil prices. And the negative consequences will continue to ripple through the country. Every downstream player is forced to delay payments for fuel supplies, which results in lower generation capacity as well as more pressure on the government, which subsidises this sector at the cost of social and infrastructure development.