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Fri, 24 October 2014 01:28:13
How political decision-making hurt Sri Lanka's power sector
18 Apr, 2005 00:00:00
By Fuss-Budget
April 18, 2005 (LBO) - Oil prices are on the rise again, and the weakest link in the 'Rata Perata' economic strategy is coming back to haunt the economy of Sri Lanka. The foundation of the 'Rata Perata' framework, largely based on backward-looking JVP thinking, was to remove the 'plug' from the international markets by subsidizing imported energy, fertilizer and wheat flour.
.But now, with the President re-asserting her authority over the Marxists, more practical policies that will not harm the poor as much as the Rata Perata inflation strategy is beginning to be talked about.

Talking the talk

Unlike the opposition leadership, which is crawling about the country getting advice from villagers on how to get their economic strategy right, the President is shouting from the rooftops to convince the people why a specific policy is needed.

Under UNP management, CPC turned around, and CEB losses fell to just Rs 3.7 bn. But last year CEB lost Rs 15.1 bn again. But of course very few people know this, because the UNP leadership not interested in making this known. It is quite evident who are the real enemies of these institutions. But the public thinks it is the UNP and now SEMA.

The burden of educating the public on good policies has now fallen on the President. So far she is doing a pretty good job, 'Boodale' and all.

Utility privatization

Nobody doubts that the CEB has to be taken off the clutches of the politicos. But restructuring is also not going to solve all its problems. The splitting is obviously a first step to privatization. Since Sri Lanka's governments have proved time and again that they are incompetent at running any kind of entity, may be privatization is a better option.

But utility privatization is tricky, and sometimes fails, probably because it is difficult to create genuine competition. Regulation is an even more difficult issue. Many western firms that invested in water distribution in South America for example found that those countries were simply not ready for private water.

But in power, Independent Power Producers or IPPs now make billions in profits. How this came about is interesting.

In the late eighties, multilateral lenders and OECD governments (except Japan) stopped funding hydro plants in the developing world, ostensibly on environmental considerations.

How Sri Lanka came to build, close to 1000 MW of expensive thermal plants, some of which burn heavy fuel oil, with hardly a squeak from environmentalists, is a telling monument to how the lobby could be manipulated.

The real reason, for the policy push to accommodate IPPs, critics argued, was to increase the cost of production in emerging markets (in addition to making a buck in energy and finance), whose cheap exports and cheap labour were hurting producers back home.

IPPs were easier than power distribution for private firms, because it did not involve dealing with hard-up third world consumers. IPPs dealt with corrupt politicians and corrupt utilities in third world countries.

Indirect funding was also (allegedly) made available to the environmental lobby, which was expected to put a monkey wrench on cheap state-owned plants in the developing world.

In 1995, the CEB had 272 MW of thermal capacity. By 2003 this had risen to 973 and there was a further 260MW of 'hired' power.

How Sri Lanka came to build, close to 1000 MW of expensive thermal plants, some of which burn heavy fuel oil, with hardly a squeak from environmentalists, is a telling monument to how the lobby could be manipulated.

But to build these plants, and ignore CEB's long-term generation plan, was ultimately a third world political decision.

Private Power

Private IPPs have watertight contracts. The host governments, which own the utilities, underwrite almost all the IPP's risks. The trick is to land the initial Power Purchase Agreement (PPA).

A PPA has two parts; a capacity charge, which is fixed, and a variable charge, which covers the cost of fuel and lubrication for each unit generated.

The capacity charge is basically the cost of maintaining plants on standby. The capacity charge is fixed so that the IPP will make profits even if the utility does not buy a single unit of power.

A PPA is therefore like a dollar denominated Treasury bill. Even otherwise, IPP contract terms tended to favor the private entity, because government owned utilities were, either poor negotiators or their officials and/or political masters could be bribed.

In any case, PPAs ran into hundreds of pages, which legal departments of some emerging market utilities barely understood.

Systematically, IPPs were pushed through in the 1990s throughout the developing world. The multilateral funding, which were not available for state-owned hydro plants were magically available to IPPs.

By the time the first IPP contracts were signed in Sri Lanka in the late nineties, Malaysia's Tenaga Nasional (state power firm) was having its profits halved because of payments to IPPs. Its share price plummeted, while newly listed IPP shares soared.

In Pakistan, the two distribution utilities KESC and WAPDA got into worse trouble and even defaulted payments. In the late nineties the Pakistan government forced IPPs to renegotiate contracts.

It was quite evident that a high proportion of IPPs in a system (like in Sri Lanka) would automatically destabilize the finances of the distribution utility. But this was cynically accepted as a first step to force privatization of the energy sector.

In Sri Lanka, both the World Bank and ADB were suspiciously mum on coal plants. It was just some CEB engineers shouting in the wilderness.

Mini conundrum

How political decision-making and skullduggery affects CEB is best showcased by the so-called mini-hydro issue.

Generation costs are dependant on the technology and fuel. Gas turbines (basically a jet engine) like the infamous GT-7, has a comparatively smaller capital cost, but uses up lots of fuel. A combined cycle plant (a gas turbine with a steam turbine run on its exhaust) is cheaper to run but is more capital intensive.

A piston engine generator would fall in between. Coal plants are cheaper and large hydros even cheaper. Say a gas turbine costs Rs 15-12 a unit and a large hydro Rs 3.00 or so. Now you have an idea. Coal would be about Rs 4.50 a unit (an IPP coal may cost higher, may be up to six rupees according to some estimates).

Games that boys play

A mini-hydro on the other hand would cost more than a large hydro because of economies of scale. The practice is to pay IPPs based on costs, plus a reasonable profit margin.

Yet a decision (political) was made to pay mini-hydros on the basis of what is grandly referred to as 'avoided cost'. This means, mini ? hydros would be paid based on a cost 'saved' by the CEB 'avoiding' thermal generation, with no regard to the actual costs incurred by mini-hydros.

This was supposedly to encourage new players, but the politicos defeated their own argument by making it applicable to existing ones as well. In other countries hydros are a hedge against rising fuel prices. Here, mini-hydros make the problem worse.

In a further twist there is a dry season and a wet season tariff. CEB has to pay a higher price on the dry season when it faces a severe cash crunch anyway!

In 2003, thermal generation costs fell, because Kukule, and two combined cycles, came on stream. The 'avoided cost' in the wet season came down from Rs 5.85 to 4.95. Then the mini-hydros screamed blue murder and managed to get a cabinet decision (no less!) to force the CEB to pay the higher tariff of the previous year.

This is yet another case of the politicos working to undermine the finances of the CEB.

Not cricket

But in defense of the mini boys, they have been complaining (and even gone to Court) that the naughty boys in CEB have been manipulating the avoided cost formula to pay them less cash and save money for the CEB.

The latest twist to this saga was the statement in the budget speech that CEB would pay mini-hydros 6 US cents a unit. This is higher than both the disputed prices. Ooh la la!

How the formula is exactly arrived at, is only known to the secretive boys at CEB. This is obviously not fair. There should be some independent oversight. In developed markets even household meters are installed and calibrated by independent firms. If a regulator was there the situation may have been different.

The latest twist to this saga was the statement in the budget speech that CEB would pay mini-hydros 6 US cents a unit. This is higher than both the disputed prices. Ooh la la!

But, fixing the price, even if it does give excessive profits to existing mini-hydros, is not a bad strategy in the long-term because thermal costs are set to rise further and it is better to fix the cost than expose CEB to further price risk.

But as can be clearly seen the whole exercise has a malodorous aura about it and it is definitely not cricket.

Coal plant

The LPG plant saga was another such story but let's get back to the coal plant. Coal plants, which the utility had wanted to build for nearly 20 years, were vetoed; by President Premadasa, President Chandrika, Opposition leader and later Prime Minister Ranil, egged on by the environmental and religious lobbies.

That the so-called 'diesel mafia' is a powerful political opinion making force no one can deny. In 2003 the CEB paid out Rs 14 bn to IPPs and a further 4.8 bn to emergency suppliers. Just three percent of that (standard broker commission) is more than half a billion rupees, which is enough to fund the election campaigns of a couple of political parties. See? Big money.

But how can a single 300MW coal plant make a big difference to a grid that has nearly 2483MW of capacity connected to it? It is just 12% of capacity.

For one thing coal plants can generate vast amounts of energy, because they have a high plant factor. Plant factor is the total time a plant can be run in a year.

At 80% plant factor, a 300MW coal plant could have generated about 25% of CEB's total energy last year or 2100GigaWatt hours (a 01 MegaWatt plant run for 1000 hours would generate 1GWh of energy, or one million units).

Most hydro plants can only be run at certain times of the day as peaking plants, so they have low plant factor (say 30%). So a single coal plant can make a huge impact on the finances of the CEB.

Another reason Coal helps is not just the total energy, but role it can play in supplying base load.

Loaded

To understand the concept of base load it is necessary to look at the load curve of a typical day in Sri Lanka.

Base load is the load that is found right round the clock. This is about 600 MW. Base load is generally supplied by the cheapest sources.

Sri Lanka used to have a mainly hydro base. But as demand rose, hydro was not able to deliver. Now we have a thermal base, made of expensive diesel IPPs and even more expensive gas turbines, which are only used as peaking plants elsewhere in the world!

In 2003, CEB paid an average of 8.45 a unit for IPPs and 12.32 a unit for emergency power.

Each 300MW coal plant that comes up can save the CEB about Rs 10-11 bn on current pricing, assuming the alternative displaced is diesel. Even one coal plant therefore can make a huge impact on CEB finances.

Devil and the deep blue sea

The latest story doing the rounds on the coal saga is that China offered a coal plant for just US $ 350 mn (read Rs 4.00-Rs 4.50 a unit) on a soft loan, but our government (in its infinite wisdom) wants an Indian IPP instead, giving Indian government firms control not only over of two thirds of the petroleum sector, but 50 per cent of CEB's base load as well! Achcha!

Because of these political decisions, CEB now has Rs 27 bn in short term loans whose interest is adding to the losses.

CEB engineers told the media recently that it now costs the utility Rs 10.50 on average to produce a unit of electricity but the selling price is Rs 7.68. This is the fundamental problem with the CEB. The selling price is also a third world political decision.

After UNP adjusted prices, and cut losses to Rs 3.7 bn, it got kicked out for its pains. No wonder the present government is scared to fix the problem, particularly as the constituent parties conditioned the public to demand subsidies.

Because of these political decisions, CEB now has Rs 27 bn in short term loans whose interest is adding to the losses. There are also other issues like system losses. It is quite plain that 'restructuring' is not a magic wand that will solve these problems.

That is why the engineers say the government claim that electricity would be Rs 2.50 cheaper if restructuring goes ahead is a damn statistic. Even if the entire short-term debt and even the long-term debt is taken off CEB's books, electricity prices cannot be brought down, or kept the same, without a coal plant.

No commercial risks, no competition

But there are other problems with the 'restructuring' model as well. New plants would be commissioned by TRANSCO, another CEB-like state owned monolith, which would own the high-tension transmission network.

DISCO companies would buy power from TRANSCO at an average price and sell at a regulated price. There is no commercial incentive for the distribution companies (DISCOs) to contract cheaper power. Just like the IPPs' treasury bill-like contracts there are built-in profits here. Anyway the tiny DISCOs would be too small to contract directly with a large plant anyway.

One advantage of the break up would be that future losses would be inside TRANSCO and the other firms' activities would not be crippled by losses. Like LECO (Lanka Electricty Co (Pvt) Ltd), they would be insulated.

Apparently the entire Sri Lankan market is too small for a competitive energy market, hence the present model. What is the bet that Sri Lanka would be big enough for a 'competitive market' just about the time most of the IPP contracts run out?

Nobody is really sure why there are five DISCOs. Why not three, like the petroleum sector? After they are made, hopefully some strategy would not have to be devised to consolidate them again because they are found to be too small.

In the restructuring process LECO, is going to be broken into little pieces as well. LECO already has a different management structure and even its distribution network is better. It has overhead bundled insulators (almost impossible to tap) and lots of pole mounted step-down transformers near the customers so that losses are minimized.

Now this is also to be broken into pieces. The DISCOs are cut up like nice wedges spreading out from Colombo. For the sake of comparison or benchmarking, the DISCO supplying the East would also have part of the Western Province. DISCO 2 would have Kelaniya, Ampara and Baticaloa. DISCO 4 would have Ratmalana and Hambantota. Boundary metering between the DISCOs alone is estimated to cost around Rs 2 bn. Also, lots of opportunities to appoint entire Boards of Directors. Nice!

In fact the LECO break-up is a major sticking point in the whole exercise. The retiring age for LECO employees is 65, at CEB 60. This worries the unions more than anything. To compensate LECO employees it may cost nearly a billion rupees. If this does not happen, unions are unlikely to agree to the unbundling anyway.

Having being given a political promise during the last election that restructuring would not go ahead, even the engineering unions who previously did not oppose it, now have an alternative plan. They also want independence and regulation, but not a break up.

Funnily enough the CEB restructuring law is already passed by the Parliament. The President does not even need cabinet approval to gazette the changes, though presumably she wants to be democratic and get everyone to agree.

In any case, the whole issue shows how dangerous it is to spread unsustainable empty promises on political platforms that take the country not only backwards, but also into crises, so that we can remain a high inflation, third world economy forever.

Post script

I haven't been taking up readers' e-mails lately because the column is too long. However I have answered most individually. I am featuring this e-mail from a reader, Mr. Samuel who responded to the last column on negative rates and the EPF (Thrift Column - Grand Larceny) and also made a comment about the CEB, which was partly responsible for fuss-budget writing this column. Just a point to note, there isn't a Rs 80 bn loss in the CEB. There are about Rs 53 bn long-term loans, which are normal for a utility to have, plus the Rs 27 bn short-term loans largely taken to finance political subsidies.

This e-mail also points out that some steps would have to be taken to protect the proposed coal plant from tsunamis;

"Your article is worrying to me as I am a retired public servant and live on my small pension plus interest from deposits in two finance companies.

The future appears bleak. Not only the opposition, but even majority of government are stupid - if all read and understand your article, something might happen - but will they - as they are all busy trying to survive!

How did buying and selling petroleum products at a profit to a 'captive' market over two decades result in Rs 80 Billion loss? This must be happening only in Sri Lanka. The Oil Lobby has successfully blocked coal power generation up to now - but even now there seems to be a lack of political will to get it going!

Mawella - the best site, had been sidelined - President Premadasa had been earlier misinformed that Mawella was the one near Galle - there are three Mawellas on the map - & not the one near Dickwella situated near a deepwater bay - and he vetoed it. But on hindsight, if it had been built there, the tsunami may have destroyed it!"

fuss-budget@vanguardlk.com

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