Turning Energy Around

Pakistan’s energy sector is in crisis.

Power outages of up to 18 hours a day disrupt the lives of people and threaten the economy in an unprecedented way. Despite abundant installed capacity the power system is mired in critical operational issues including a pervasive circular debt.

Payment arrears between various entities has jammed the flow of funds through the power supply-chain, and deprived fuel suppliers and independent power producers of cash to the extent that their viability and therefore output is jeopardised.

Demand is outstripping supply at a time when the country’s security situation imposes obvious constraints. But if the energy deficit is not urgently tackled it contains the seeds of dangerous social unrest.

Equally disquieting is the fact that energy policy initiatives being promoted today are the same as those proposed some thirty years ago, indicating little implementation progress in the intervening years while the crisis deepened.

How can this situation be remedied? In light of overwhelming evidence that the absence of a coordinated energy policy remains a fundamental constraint, an integrated approach needs to be established together with an institutional structure that supports it.

This was partially implemented in Pakistan in the 1980s but faded away subsequently with the increasing fragmentation of policy institutions and functions. Without integration, decision-making remains inherently flawed and policy initiatives are reduced to shooting in the dark.

The country has the capacity to speedily revive the integrated approach together with the first steps of a supporting institutional structure. The rest of the institutional changes can be phased in gradually.

This will enable policy-makers to rapidly tackle, on an informed basis, the urgent and longer-term problems facing the sector, replacing the current ad hoc approach which reacts to, rather than averts, crises. It will help pave the way for the recovery of the energy sector that can then aid the economic rebound. It is not so much the availability of resources but how they are managed which makes the difference between success and failure.

State of the Energy Sector

Pakistan’s policy-makers have done a reasonably good job of articulating (repeatedly through several five-year planning cycles) policy objectives for the energy sector.’ The broad objective is to develop the sector to support an expanding economy. Developing indigenous resources, importing energy at competitive prices to meet deficits, expanding delivery infrastructure and improving energy efficiency and reliability, would enhance energy supplies.

Security of energy supply would be increased by greater reliance on national resources thus reducing import dependence, and by diversification of energy supplies to manage risks and external shocks. Long- term viability of the sector would be supported by a shift in the role of government from owner to that of policy-maker and regulator, encouraging the private sector to own and run the energy companies through appropriate incentives, including attracting foreign and local private capital and deploying competitive processes.

Also, the objectives contain consumer- oriented, eco-friendly and pro-poor elements, promoting service-provision, environmental protection and affordable energy for the underprivileged. Despite these laudable objectives the sector is in a dire state. The problem is not a lack of clarity on what needs to be done but how it is to be done.

Before considering solutions, it is essential to briefly review the state of the sector, the gravity of issues, and why the situation has become so serious. The official Pakistan Energy Yearbook 2009 lays out the supply and consumption picture. Total primary energy supply in Pakistan is 63 MTOE (Million Tons of Oil Equivalence) of which natural gas accounts for 48 per cent, oil 32 per cent, hydroelectricity 11 per cent and coal around 7 per 245cent. Nuclea1 LPG and imported electricity make up the remaining 2 per cent. Pakistan imports a third of its energy requirements mainly in the form of oil and coal, despite huge proven reserves of coal and a significant exploration potential of oil. Over 80 per cent (17 MTOE) of Pakistan’s oil requirements are imported at a prohibitive cost of $12 billion a year, and over 60 per cent (3 MTOE) of its coal supplies come from overseas.

The official figure for total energy consumption is 37 MTOE, the difference between supply and consumption being the losses in conversion, processing, transmission, distribution, as well as non-technical losses, which is a euphemism for theft. The industrial sector is the dominant consumer with over 40 per cent of the market. The transport sector consumes just over 30 per cent and households around 22 per cent. The remainder consists mainly of commercial and agricultural consumers.

The Hydrocarbon Development Institute of Pakistan (HDIP) in the Ministry of Petroleum and Natural Resources produces an impressive document, the Energy Yearbook, based on input from various energy­ related ministries and agencies. The quality of information and analysis is testament to the fact that, despite the serious brain drain from Pakistan, islands of excellence remain. This offers hope for the future and gives pause to those who maintain that the situation is beyond redemption. There is, however, a glaring omission, which reflects the preoccupation of policy-makers. The data pertains only to commercial energy, i.e., energy for consumers connected to national grids and billed for services.

Estimates of non-commercial or traditional forms of energy are missing. Data in this area is sporadic and much less reliable, mainly because of the conspicuous lack of attention accorded to it. If non- commercial energy is included, the supply picture changes dramatically. Traditional biofuels (fuelwood and other biomass) head the list, followed, in descending order, by natural gas, oil, hydro and coal. On the consumption end, again, a starkly different picture emerges. Households become the primary consumer using 50 per cent of the mix. Biofuels account for over 85 per cent of household energy use, of which fuelwood is the largest component followed by biomass, and crop residues.

The most egregious aspect of the omission is that non-commercial energy use accounts for nearly half of the overall demand for energy in Pakistan. By including non-commercial energy in the calculations, policy- 246makers will be forced to consider major shifts in emphasis. Supply and consumption patterns are presented in Table 1 below.

Table 1: Pakistan energy supply and consumption 2009 1.1: Primary commercial energy supply Energy sourceMTOEPercentage Share natural gas30.348% Oil20.132% Hydro6.611% Coal4.67% Nuclear, LPG, imported power1.02% Total62.6100% 1.2: Commercial energy consumption Consumption SectorMTOEPercentage share Industry14.840% Transport11.430% Household8:122% Commerce, agriculture, govt.3.08% Total37.3100% 1.3 : Total energy consumption: commercial plus non-commercial Consumption sectorPercentage share Household50% Industry26% Transport19% Commerce, agriculture, govt.5% Total100%

Note: Non-commercial primary energy supply not shown due to inadequate data. In one sense, the historical neglect of non-commercial energy seems understandable.

Commercial energy is a key ingredient for national growth and prima facie warrants the lion’s share of attention, particularly if growth has been stymied, as has often been the case in Pakistan, and there is pressure on policy-makers to jump-start the economy. There is an inherent fallacy in this approach. While commercial energy consumers contribute significantly to GDP growth, neglected non-commercial consumers drag down national output over the longer term by unregulated and unchecked practices and technologies, which waste energy and denude forestry resources by harvesting beyond the maximum allowable cut, i.e. beyond the level at which the forestry resource becomes unsustainable.

Although the economic, social and environmental implications of the neglect requires a separate detailed study, we only need to look around us to see the disastrous effects on the degradation of forests and eco-systems, and the poverty that this approach has engendered over the past sixty-four years.

In evaluating the state of the sector in relation to the economy, three other parameters are significant. First, data from the Energy Yearbook and the Economic Survey clearly show that growth in energy consumption and economic growth have followed almost identical patterns for the last decade and a half, reaffirming that energy fuels the economy and its shortage curbs growth.

The second is Pakistan’s per capita energy consumption, which at 0.49 TOE is significantly lower than the world average of 1.78. This reflects the country’s level of development. As energy availability is a key determinant in the standard of living, this parameter is also indicative of the high incidence of poverty.

The third is Pakistan’s energy consumption per dollar of GDP growth, which is around 0.82 against the world average of 0.32. This illustrates the relative inefficiency of energy use in Pakistan and highlights the pressing need to strengthen policy initiatives that encourage greater utilisation efficiency. In a constrained energy supply situation, any improvement in efficiency means adding to the supply.

The above figures are based on commercial energy but if non- commercial energy is included, the comparisons are likely to be even more pronounced. Moreover, the household sector, which is the largest consumer and where waste is greatest, would become the focus of improving energy efficiency.

By excluding non-commercial energy, the industrial sector appears as the largest consumer and therefore the focus of attention. This does not imply that the industrial sector should be overlooked. There are many low-cost and no-cost initiatives that can be implemented here. But it is important to strike the right balance between available financial resources and the concentration of effort.

Pakistan’s energy resource potential is substantial and remains largely unharnessed although not all of it is currently financially or technically exploitable. This potential is in the form of depleting fossil fuels (oil, gas, coal) as well as renewables (hydro, solar, wind, wood fuels and agricultural residues). Among fossil fuels, in the petroleum (oil and gas) sub-sector, Pakistan has a large prospective area (or, in geological language, sedimentary basin) covering 830,000 square kilometres. Probable reserves are estimated at twenty-seven billion barrels of oil and 282 trillion cubic feet (TCF) of gas.

Of this, 936 million barrels of oil had been confirmed and 609 million barrels produced till 2007, leaving 327 million barrels of proven reserves yet to be recovered. The reserves-to-production ratio stands at fourteen, critically low considering the high and growing level of oil imports, and compared with the worldwide ratio of forty. For natural gas, 53 TCF have been confirmed, of which 23 TCF were produced till 2007, leaving 30 TCF of proven reserves. The reserves-to-production ratio is twenty-one— uncomfortably low given Pakistan’s heavy dependence on natural gas as the primary commercial fuel, and in comparison with a worldwide ratio of 59.

Till early 2009, 725 exploratory wells had been drilled which resulted in over 219 oil and gas discoveries. This works out to a drilling density of 1.99 wells per 1,000 square kilometres—far lower than the world average of ten. However, the success rate of 1:3.3 is much better than the world average of 1:10. The success rate coupled with the large sedimentary basin implies that if the exploration level is increased, there are good chances of significantly raising the level of proven reserves and, consequently, production of oil and gas. This, however, is proving difficult since vast portions of the sedimentary basin lie in areas where security deters any significant exploration—more so as such activity is usually carried out by international oil companies with their own manpower and risk capital.

Pakistan’s indigenous coal reserves are huge, estimated at 186 billion tons, of which the Thar deposit of 175 billion tons is the fifth largest in the world. Proven reserves stand at 1,980 million tons and at the present 249production level the reserves-to-production ratio is well over 400. This signals the need to enhance production significantly. However, most of this coal is of low quality (high sulphur and ash content) and is located in remote areas. Its exploitation therefore requires expensive excavation, treatment and transport infrastructure, in areas where security is a concern. Renewable energy sources are also significant. Hydroelectric potential in Pakistan is an impressive 41,700 MW of which only 6,600 MW or 16 per cent has been harnessed till today. For mini-hydro (units up to 5 MW capacity), the potential is about 1500 MW of which only 60 MW (4 per cent) has been tapped. Pakistan’s almost entirely untapped wind energy potential, according to the USAID Renewable Energy Lab, is estimated at 41,000 MW of power generation based on areas of favourable wind regimes.

Solar energy is abundant and remains unharnessed except for a few isolated projects. If only 0.25 per cent of the land area of the province of Balochistan were covered by solar panels of 20 per cent efficiency, this would be enough to provide electricity to the entire country. However, the feasibility of generating large quantities of wind and solar power (while improving with continuing research) is highly questionable. Estimates for non-commercial sources, mainly wood fuels, are less reliable. These resources are considerable and constitute 45 per cent of the energy supply mix for the country. However, there is ample evidence that in several parts of the country, unregulated harvesting of this poorly managed resource is severely impairing its sustainability.

The current state of the energy deficit and its projected growth is even more worrisome for the future. Data from the Planning Commission, although ignoring non-commercial energy, illustrates the magnitude of the crisis ahead. It projects an annual energy demand increasing from the present level of around 60 MTOE to 198 MTOE by the year 2025. This is based on an annual economic growth of 6.5 per cent. While not consistent with recent trends, this could be envisioned over the longer term, with an abating global financial crisis and a cautiously optimistic view of Pakistan’s economic regeneration.

The total indigenous supply over the same period increases from around 40 MTOE to only 75 MTOE. Oil and gas supplies are assumed to increase only slightly in line with constraints on future exploration 250activities. In contrast, indigenous energy from coal, hydroelectricity, nuclear and non-traditional renewable sources, are assumed to increase significantly in an attempt to offset limitations in oil and gas. The resulting deficit grows from the already disquieting level of around 20 MTOE to a staggering 122 MTOE by 2025. These figures, perhaps more than any other, underscore the fragility of the energy sector, implying a long-term dependence on external sources. This is neither a viable nor affordable scenario.

Three characteristics of Pakistan’s energy sector take on special significance. First, the indigenous resource potential is substantial, not- withstanding some critical exploitation issues. Two, the energy deficit is prohibitively large and expanding. Three, nearly half the population, mainly the rural poor, is not connected to the commercial grids and relies on non-commercial energy. This combination often tempts policymakers to promote the harnessing of all forms of energy available. This is a common trap, particularly in a severely cash-strapped environment such as Pakistan. In this approach, for example, undue priority is given to renewable forms such as solar and wind, since they are considered free and able to reach poor, remote localities. Such forms of energy are indeed ‘free’ since they are constantly renewable, but they are not necessarily cheap. Moreover, they do little to close large deficits. Even compared with nuclear power generation, itself an expensive option, wind power is around 60 percent more expensive and solar about 30 per cent. Nevertheless, to support poverty alleviation objectives under severe budgetary constraints, all options should be on the table but a mechanism needs to be in place to strike an affordable balance. The degree of departure from the optimum can make the difference between success and failure of energy policy.

How did we get here? How this dire state of affairs came about is analysed in a noteworthy work, which traces the history of the downward spiral and milestones along the way. The path is characterised by ‘stop-go’ reforms, policy reversals, bureaucratic delays and missed opportunities and, over the last decade or so, a growing security crisis. Through all this, there were some sound and well-intentioned policy initiatives and concerted efforts towards implementation. However, these efforts could not yield the desired results in a policy environment, which lacked the necessary fundamentals.

251A few examples illustrate the dilemma. In the early 1980s, there were four international oil companies, which had been granted concessions for exploration in Pakistan. Such companies commonly deploy their own capital for exploration, relying on satisfactory profit sharing or production-sharing agreements with the government to recoup their expenditures once commercial production begins. Drilling conditions were difficult and expensive with deep wells in high-pressure areas but discovery prospects were good. However, a major oil company, on the verge of a significant discovery, decided to suspend drilling operations and leave the country. The net effect was to discourage further exploration at a time when at least ten companies were considering the possibility of exploring in Pakistan with their own capital for the first time—a possibility that could have turned around the country’s energy future.

A combination of factors led to the oil company’s departure. Among them was the inflexibility of the bureaucracy to address glaring anomalies in the tax structure, which severely eroded the cash flow of the company especially in areas with high exploration costs. The second, more significant reason was that, under the prevailing policy regime, oil and gas prices could only be negotiated after commercial discovery. This was a major disincentive for a company deploying its own capital in expensive operations. Rising expenditures in an uncertain post-discovery regime was enough to warrant a pull-out even on the verge of discovery, to the detriment of Pakistan’s economy. Pakistan’s policy­makers failed to understand that the country was competing with others across the world in attracting scarce exploration risk capital. For this, it needed to make its pricing regime as attractive as possible. If there had been a mechanism to rapidly assess the economic penalty of the policy, which traded immense long-term benefits for short-lived financial gains, the story would have been different. It is a credit to subsequent policy-makers that these retrogressive policies were amended. This is now reflected in the government’s exploration promotion and investment promotion documents. However by the time this was done conditions had changed. The security situation became a key deterrent to exploration. This underscores a lost opportunity, one of many policy actions offering too little, too late.

At around the same time, another petroleum company involved in a joint venture with the government had decided to sell to the government its shares in a natural gas field development operation, which provided valuable nitrogen-rich gas feedstock to the fertilizer industry. It took over a year to negotiate the sale price and government inter­locutors were able to reduce the 252purchase price by a significant amount. This could be considered a major gain but for one serious repercussion. Through the protracted negotiations, the field expansion program was put on hold, resulting in immense losses in revenue to the joint venture itself, as well as to the fertilizer industry, and in terms of lost agricultural productivity due to lack of fertilizer. Again, a mechanism to assess the penalty could well have prompted speedier negotiations with less immediate financial gains but with vastly greater financial and economic benefits in the longer term.

Perhaps the most significant example of lost opportunities relates to Central Asia in the early to mid-90s when all six of the newly independent republics, under immense internal economic pressures, were actively seeking avenues to export their surplus energy. Strong consideration was given to the southern corridor through Pakistan to tap the large energy- starved South Asian market as well as gain access to ports on the Arabian Sea for further extending export. This was well before the security situation in Afghanistan had begun to deteriorate. As expected, there were competitors promoting alternative routes. The Great Game was on again, being played with higher stakes and at electronic speed.

Central Asian authorities and international consortia made several attempts to pursue discussions with Pakistani authorities but progress was elusive. One thing was evident. The level of interest and effort of the competitors drowned out the lukewarm response of the Pakistani government and private sector. The rest is history.

One can only surmise how the trade corridors, had they been established, would have transformed the regional scenario. Revenue from trade and from transporting energy across the region would have brought immense benefits to Afghanistan and Pakistan. Both countries, as well as India, would have also benefited from greatly enhanced energy supplies. The resulting prosperity and trade links would certainly have strengthened interdependence among the three countries and helped mitigate the conflict which currently engulfs the region.