Policy confusions in gas business

October 14, 2019

The plans for unbundling of gas utilities and their privatisation are back in business, this time as part of the International Monetary Fund (IMF) programme. Even before this unbundling, the government’s top priority is the sale of two LNG-based Government Power Plants (GPPs) to meet the Fund’s targets.

The unbundling of gas companies was originally proposed by the World Bank to the previous government but could not go through due to provincial opposition. The Bank had suggested a Water and Power Development Authority like unbundling of the gas companies into one transmission company (Transco) and four province wise distribution and sales companies (Discos).

An independent consultant KPMG was hired to evaluate the proposal. The consultant concluded that the unbundling of Sui companies will not improve efficiencies or profitability of the sector. It was noted that unbundled Discos could go into further losses as the coordination and cooperation among the transmission and distribution companies under separate ownership would be a tough job.

KPMG concluded that the unbundling of Sui companies will not improve efficiency or profitability; instead Discos could end up making steeper losses

The World Bank and government had made the financial sustainability group come up with a pricing framework that is viable for Transco and Discos. The group could not come up with a viable solution. The option of the Transco continuously subsidising Discos on a long-term basis was considered counterproductive. In that scenario, the commitment to disintegrate companies by June 2020 could lead to the bankruptcy of a number of Discos and put the energy sector on a steeper downhill path.

Interestingly, five directorates of the petroleum division are currently being kept aloof from this process and instead employees of the Mari Gas Company are leading the exercise and making commitments with the IMF on behalf of the government.

Amid this process, the government has put on the fast track the privatisation of two LNG-based power plants. The privatisation commission is suggesting the discontinuation of the minimum 66 per cent guaranteed LNG off-take to make them attractive to prospective investors. That would shift the power purchaser liability of capacity payments to the Sui Northern Gas Pipelines Limited (SNGPL) because downstream agreements with the GPPs reflect corresponding terms and conditions of upstream agreements on a back-to-back basis.

That would mean the SNGPL may not willingly agree for a reduction in minimum off-take of 66 per cent unless proportionate revision in upstream agreements, signed on a government to government basis with foreign entities.

Unfortunately, the LNG supply chain is built on an inherent shortcoming. The LNG import was targeted on the premise that it would cater for the gas shortage in the power sector. But average RLNG consumption by the power sector has always remained considerably lower than estimates and targets. Any fluctuation in RLNG consumption by the power sector adversely impacts the whole RLNG supply chain. Pakistan’s energy mix is quickly changing and is already resulting in underutilisation of RLNG based plants particularly in off-peak periods.

The worst part is that the federal government has spent around $7 billion in setting up of four RLNG projects, $1bn on pipeline besides two terminals and the necessary port structure to cater for RLNG being the primary fuel for the power sector.

The Power Division has now moved away from the committed 66pc dispatch to RLNG plants and wants the GPP agreements to be changed with no take-or-pay commitment within one year of signing the agreements. The change in mind is because of cheaper coal power plants. So, wrong estimates and poor planning are exposed.

On top of that, the government is going for major investment in renewables to make it over 25pc of power generation by 2025 while the existing $5bn investment is at risk.

But that is not all. There are key mismatches between upstream and downstream supplier agreements. The SNGPL has RLNG supply agreement on 100pc take-or-pay basis against significantly lower downstream firm commitments. The recent pipeline-packs pressure touching dangerous levels is just one example. On the other hand, the 66pc guaranteed off-take by GPPs are being relaxed to minimise liabilities and make them attractive.

That leaves the long-term power sector LNG demand in limbo. It has already been making short-term demands that are again subject to change every month. The higher imports have, therefore, been allowed to flow into the highly subsidised residential sector with a price differential of Rs1,580 versus Rs300 per Million British Thermal Unit (MMBTU). The estimate to cover only four months of the current year LNG diversion to the residential sector is put at Rs55bn.

This also results in underutilisation of LNG terminals most of the year except peak summer months that also involve capacity payments and resultant higher LNG price. That means the recent cabinet decision to allow five more terminals was unrealistic given the underutilisation of existing terminals and economic conditions insufficient to create space for five terminals even in 10 years. The commensurate pipeline capacity would also require substantial investments.

One of the major stumbling blocks in the sale of RLNG to downstream consumers is its higher selling price due to which existing RLNG terminals are underutilised during the period of lean demand by the power sector. Other sectors only consume meagre volumes of RLNG due to its high price, which adds to their production costs.

The recent government decision to provide gas mix at a fixed price of $6.5 per MMBTU further increases the price delta between the cost of domestic and imported gas. RLNG can only be absorbed in different sectors to the optimum level of existing availability if the RLNG price is made part of the weighted average cost of gas as part of major gas pricing reforms.

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