Tough road ahead for energy sector amid fragile economy

Prime Minister Shehbaz Sharif on 29 April stated that Pakistan’s energy sector faced significant challenges stemming from widespread electricity theft and persistent circular debt – projected to reach PKR 2,310bn (USD 8.2bn) by June 2024. We explore the outlook for the sector under the new government installed following the February polls.  

Crux of the issue

During the winter months between November 2023 and March 2024, Pakistan witnessed frequent power and gas shortages. Although such outages often occur during the winter, these were slightly less severe than those seen in recent memory. From late 2022 to early 2023, Pakistan was unable to secure liquefied natural gas (LNG) cargoes amid a relatively more fragile economy and international suppliers’ failure to deliver supplies under long-term contracts. Pakistan’s USD 3bn Standby Arrangement (SBA) with  the International Monetary Fund (IMF), which ended on 29 April 2024, provided some relief to its foreign reserves. This allowed state-owned entity Pakistan State Oil to secure two LNG cargoes – in December 2023 and February 2024 – under a framework agreement with Azerbaijan.  

The summer months (June to September) will likely see a rise in power generated from hydropower. After being used for agricultural purposes in the winter months, dams predominantly generate power during the summer while water resources are replenished during the monsoon season in late summer. Meanwhile, high domestic energy prices will weigh on electricity demand. However, although demand will therefore be lower than usual, it will still peak with the rise in air conditioning use.  

More broadly, Pakistan’s energy crisis will continue to be closely tied to its financial difficulties. With nearly two-thirds of Pakistan’s power generated from hydrocarbons largely secured through imports, it will remain reliant on energy imports.  Consequently, with a weak currency and limited foreign reserves, its import bill remains high relative to levels of exports and remittances, sustaining its current account deficit.  

No quick fixes  

The PML-N government is seeking to secure another long-term Extended Fund Facility (EFF) programme with the IMF over the coming months. Doing so will require the government to continue to adopt structural reforms in the energy sector, including measures to address inefficient pricing and regulatory structures and improve weak management of state-owned entities. Although the authorities over the last year have made some efforts to manage circular debt in the sector and reduce power theft, these will take years to be resolved given their entrenched and widespread nature.  

Keen to secure the EFF, the government remains intent, at least for now, to build on efforts pursued by the former interim government to address deeply entrenched problems in the energy sector. Nonetheless, despite its intent to implement tariff hikes over the coming months, the government is likely to continue to periodically backtrack on its commitments and succumb to public pressure to tackle high inflation and reduce rising living costs.  

Moreover, opposition from the PML-N’s key voting blocs, which have interests in sectors such as cement, sugar and agriculture, will render it difficult for the government to withdraw power and related subsidies. At the same time, progress on privatising loss-making state-owned transmission and distribution companies will remain slow given the fragile nature of the coalition and the opposition of the PML-N’s main coalition partner and traditional rival the Pakistan Peoples Party (PPP) to privatisation.  

Looking for alternative sources  

The acute nature of the energy crisis will sustain Pakistan’s reliance on a variety of sources to meet its energy needs. As a result, the government will continue to pursue multi-pronged efforts to address the crisis, including the promotion of measures to generate energy from domestic sources.  

Some of these efforts will revolve around exploiting domestic gas reserves, including reopening closed wells or capitalising on discoveries in new wells. However, such efforts are unlikely to be a particularly effective or long-term solution, given that domestic gas reserves are declining. 

Meanwhile, to promote the use of domestic coal reserves, Sharif on 15 April directed authorities to explore shifting power plants that rely on imported coal to local coal. The government is also keen to convert furnace oil plants that were expected to be retired over the coming years to be powered by Thar coal reserves from Sindh province.  

There has been some interest among existing operators in the sector around engaging with the government to retrofit power plants. Nonetheless, concerns will persist regarding the technical and commercial feasibility of such plants, as well as the practicality of increasing reliance on domestic coal reserves at a time when a global shift is underway to reduce the use of coal to generate power.  

Even as it looks to increase its reliance on hydrocarbons, the government will also pursue efforts to expand the use of renewable resources. However, despite indicating its intent to harness the potential of the renewable energy sector, the government has made few genuine efforts to facilitate any projects, and limited political will to do so will hinder the sector’s development.  

For instance, despite prioritising several large-scale renewable energy projects, including a 600MW solar energy scheme in Muzaffargarh announced in 2022, the government’s failure to conduct auctions has reportedly left some solar and wind energy projects – which could generate a total 7GW of power – in limbo since 2016. Prioritising large-scale projects, which are seen as a means of attracting foreign direct investment, over existing smaller-scale projects will reduce their attractiveness to existing domestic investors.  

Regulatory shifts, investor challenges  

Despite the improved political stability that has come with the installation of the PML-N government, economic conditions will remain the primary factor of foreign investor interest in Pakistan’s energy sector. Economic challenges in recent years have deterred investors. For example, the 600MW solar power project mentioned above has failed to attract foreign investor interest despite numerous bidding rounds and revisions to incentives. In another example, the government’s Greenfield Policy, which was introduced in 2023 and focuses on setting up new refineries, is yet to garner significant interest from foreign players.  

Notwithstanding the numerous incentives offered by the government for new investors, particularly those associated with Gulf countries – whose investments will continue to be routed through the Special Investment Facilitation Council (SIFC) – and China, ensuring greater economic stability in the coming years will be key to attracting greater interest from foreign investors. 

However, the government is unlikely to make significant revisions to existing energy-sector policies as it looks to ensure policy continuity. Meanwhile, despite the sector’s strategic nature, any new policies or revisions that are introduced by the government are likely to be implemented inconsistently due to a lack of adequate capacity and persistent inefficiencies in government institutions and regulatory bodies.  

Operators whose investments are not facilitated through the SIFC are likely to witness a less favourable regulatory landscape as investors associated with China and Gulf countries are prioritised. They will continue to face bureaucratic hurdles, while the fiscal deficit will continue to translate into payment delays.  

Threats from rising militancy  

Ongoing security threats in regions bordering Afghanistan are likely to further undermine investor interest in projects in these areas. Most recently, a militant attack on 26 March killed five Chinese nationals working on the Dasu dam project in Khyber Pakhtunkhwa province. Such incidents will continue to affect operations and delay projects. Local media outlets in early April reported that work on the Tarbela and Diamer-Bhasha dams had resumed after being suspended for more than a week after the 26 March attack.  

The military will continue to provide multiple layers of security to projects in regions near Afghanistan, particularly those under the USD 62bn China Pakistan Economic Corridor (CPEC), in a bid to allay investors’ concerns. However, a likely increase in militancy in the coming years amid a rise in alliances between threat actors, and improved tactics and weaponry will continue to drive persistent threats for less well-secured personnel, assets and infrastructure such as pipelines and coal fields.