On November 11, 2024, Rousch (Pakistan) Power Limited (RPPL), an Independent Power Producer (IPP), made a pivotal decision to terminate its long-term agreements with the government of Pakistan. This includes the Power Purchase Agreement (PPA) and the Implementation Agreement (IA) with the Central Power Purchasing Agency (CPPA). The termination, effective from October 1, 2024, was agreed upon in a shareholders’ meeting and authorized a negotiated settlement with the government, furthering the ongoing trend of IPP contract renegotiations in the country.
The termination of these contracts is a clear indicator of the profound issues Pakistan’s energy sector faces, particularly with its reliance on IPPs. These private entities, set up during the 1990s to alleviate fiscal constraints, now sit at the heart of a financial quagmire that threatens to undermine the entire power sector. The current standoff between the government and IPPs has its roots in decades of policy missteps, which continue to haunt Pakistan’s energy landscape.
The Genesis of the IPP Issue
The story of IPPs in Pakistan dates back to the early 1990s when the Benazir Bhutto government sought to address the growing power shortages through private sector involvement. Faced with an overstretched fiscal budget, the government decided that private investment was the solution to rapidly expand electricity generation capacity. This decision was made at a time when the state-owned sector was failing to meet the country’s energy demands. Consequently, the 1994 Power Policy laid the groundwork for setting up IPPs, offering generous incentives and guarantees, including sovereign-backed agreements, to attract international investors.
Under these agreements, the government promised fixed returns and guaranteed payments to IPPs, even if they were not generating electricity. These commitments were seen as essential to incentivizing investment in the energy sector, but they also sowed the seeds for long-term financial issues. While these agreements did bring in much-needed generation capacity, the rapid growth in electricity supply did not coincide with corresponding industrial growth or an efficient transmission and distribution network. As a result, the country was saddled with overcapacity, rising electricity costs, and financial strain.
Soaring Capacity Payments and Financial Burdens
The financial burden created by IPPs has become a defining issue in Pakistan’s energy sector. Under the Cost-Plus tariff system, the government agreed to compensate IPPs based on their operational and capital costs, with a guaranteed return on investment. This system was supposed to ensure the financial viability of IPPs but led to escalating electricity costs that the government, and by extension, consumers, could not afford.
In the early years, these high capacity payments were manageable due to relatively lower electricity consumption. However, as the economy struggled to grow at a pace that would match the rising power generation capacity, the government found itself unable to meet its financial commitments. By 2024, the cost of these capacity payments had reached unsustainable levels. With the IPPs continuing to receive payments even during periods of low power demand, public outcry grew, accusing them of profiteering at the expense of the public. In response, the government began renegotiating these agreements, citing the need to reduce the burden on consumers and the national exchequer.
The Renegotiation and Termination Dilemma: A Policy Paradox
The termination of contracts with RPPL is part of a broader renegotiation trend involving other IPPs, including Pakistan’s largest IPP, Hubco. However, the underlying issue remains: the government cannot simply renegotiate these agreements without facing significant legal, financial, and diplomatic repercussions. Sovereign guarantees offered to IPPs are enshrined in international law, and the terms of these contracts were designed to ensure investor confidence. However, with each renegotiation or termination, Pakistan’s credibility as a reliable investment destination suffers, potentially leading to higher costs for future power projects.
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Renegotiating these contracts, while politically appealing, exacerbates Pakistan’s financial challenges. It undermines investor trust and makes it harder for the government to secure favorable terms for future energy projects. In addition, the increasing cost of IPP agreements has led to unsustainable tariff structures, with capacity payments pushing the per-unit electricity cost higher than what the country can afford. For instance, capacity payments in FY25 increased from Rs16.22 per kWh to Rs17.31 per kWh, further straining Pakistan’s already fragile energy economy.
The Policy Failures and Missteps: From Hasty Decisions to Costly Consequences
The roots of the current IPP crisis lie in a series of flawed policy decisions that prioritized rapid power sector expansion without addressing underlying structural issues. In the 1990s, the government rushed to establish IPPs, offering overly generous terms to attract investment without carefully considering the long-term economic implications. The “Cost-Plus” tariff mechanism, used to calculate IPP payments, was particularly problematic. This system incentivized inefficiency and failed to account for market dynamics, ensuring that IPPs received high returns even in periods of low power demand.
The situation was exacerbated by further policy missteps, including the government’s failure to introduce competitive bidding processes for future energy projects. Instead, IPPs continued to be awarded contracts under negotiated tariffs, which further inflated electricity costs. The government’s short-term focus, driven by electoral cycles, meant that energy policies were made without a long-term vision, leading to further inefficiencies in the energy sector.
The Road Ahead: Restructuring the Energy Sector
To address the crisis, Pakistan must undertake comprehensive energy sector reforms. The focus should shift from renegotiating IPP contracts to creating a more transparent and competitive market for electricity generation. Competitive bidding, which has been successful in other countries, should replace the Cost-Plus tariff system. Additionally, the government needs to prioritize demand-side management and improvements in transmission and distribution infrastructure to ensure that the country’s energy supply meets the needs of its growing population.
Pakistan must also address the broader institutional failures that have plagued the power sector. The National Electric Power Regulatory Authority (NEPRA) should take a more proactive role in overseeing the sector, ensuring that tariffs reflect market realities and incentivize efficiency. Additionally, strengthening the regulatory framework to prevent over-invoicing, tax evasion, and other forms of corporate malfeasance within the IPP sector is critical to building a sustainable energy future.
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The issue of IPPs in Pakistan is not a simple case of profiteering by private investors; it is the result of decades of policy mismanagement, regulatory failures, and a lack of long-term planning. While the government’s attempts to renegotiate contracts may seem like a necessary short-term fix, the real solution lies in structural reforms that focus on efficiency, transparency, and market-driven solutions. Only by addressing these deep-rooted issues can Pakistan hope to build a sustainable energy sector that supports economic growth and meets the needs of its people without burdening future generations with the mistakes of the past.