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A national power outage between 23 and 24 January, which came amid the ruling Pakistan Muslim League-Nawaz (PML-N)’s energy saving measures, underscores the dire state of Pakistan’s energy sector. In this note, we examine how Pakistan’s energy crisis will prevail and be driven by its sovereign troubles.
  • Pakistan will continue to face difficulties in securing adequate fuel supplies to address its inefficient power sector and cater to growing demand while its foreign reserves remain under strain.
  • The government will likely pursue critical – and unpopular – reforms such as tariff increases to secure urgently needed financial assistance from multilateral lenders.
  • Government efforts to secure financial assistance and foreign investment in the energy sector, especially from “friendly” countries, will therefore remain ongoing. However, concerns over Islamabad’s sovereign challenges will persist and will result in reduced investor confidence.
  • Despite the government’s desire to promote renewable energy, ad-hoc import restrictions will pose challenges to the development of the sector, while local raw material manufacturing will remain limited.

Limited finances, inadequate power

Pakistan continues to bear the costs of a worsening energy crisis that has been characterised by periodic localised power shortages, including in urban areas such as the financial capital Karachi, and on occasion by a national power outage, in the latest case lasting up to 20 hours. Approximately two-thirds of the country’s power is generated through hydrocarbons that are largely secured through imports. Pakistan’s dependence on energy imports is a major factor behind its economic woes – the import bill is significantly higher than exports and remittances while sustaining the country’s current account deficit and adding further strain on its foreign reserves. 

Ongoing fiscal crises and exporters’ concerns over Islamabad’s inability to facilitate payments have left the country with insufficient fuel supplies. Oil refinery companies continue to express concerns over their inability to access capital even as import restrictions were “eased” in early January, with multiple media outlets stating that domestic banks refused to open or clear letters of credit (LCs) under the instruction of the State Bank of Pakistan (SBP). Pakistan has also been unable to procure liquified natural gas (LNG) supplies through spot markets and remains dependent on supplies secured through long-term LNG deals – which themselves are not insulated from exporters’ obvious desire to cater to more lucrative markets such as Europe. For instance, an international energy company on 26 January said it would not be able to deliver an LNG cargo to Pakistan in February under a long-term contract due to a “force majeure”.

Pakistan’s energy troubles have also been exacerbated by inadequate domestic power generation capabilities. While insufficient fuel supplies have led several power plants to either operate below capacity or remain inoperable, insufficient infrastructure has meant that transmission and distribution losses remain high. The sector has acquired massive levels of circular debt due to inefficient pricing and regulation structures, as well as non-payment of dues for unbudgeted fuel subsidies, leaving stakeholders with little capacity to invest in improvements to and regular maintenance of obsolete power infrastructure.

On a downward spiral?

Concerns over default have increased since October 2022 when Pakistan’s ninth review of the IMF’s USD 7bn Extended Fund Facility (EFF) programme was due. The PML-N coalition strayed away from IMF-backed reforms and instead discontinued fuel price hikes while implementing a fixed exchange regime – largely in an attempt to restore its political popularity.

The government’s attempts to introduce short-term measures such as energy conservation policies to reduce fuel imports by targeting electricity consumption remain futile as they failed to address structural issues in Pakistan’s economy – namely high levels of fiscal deficit and low government revenues. Other measures such as import restrictions, when combined with foreign currency shortages and interest rate hikes affected the productivity of the manufacturing sector. . According to the Pakistan Bureau of Statistics, large-scale manufacturing output declined by 5.5% in November 2022 in comparison with the same period in 2021.

The economy’s freefall, marked by rapidly declining foreign reserves, has compelled the government to return to discussions with the IMF. Pakistan has begun initiating efforts such as removing the cap on the exchange rate and increasing fuel prices but will likely have to pursue additional structural reforms to reduce its fiscal deficit, circular debt and raise tax revenues to demonstrate its commitment to the EFF programme.

The government will remain hesitant to introduce unpopular measures such as raising power tariffs while general elections are on the horizon (currently slated for October) and it faces heightened pressure from an emboldened opposition.  However, left with no choice, the government is highly likely to pursue these measures as it looks to secure the next tranche of urgent financial assistance, boost external accounts and manage investor confidence. Progress on IMF-backed reforms pertaining to the privatisation of state-owned enterprises, including for power plants, are likely to see delays due to bureaucratic and regulatory processes during the government’s short tenure.

Reaching out

Pakistan will also continue to remain reliant on its traditional allies such as UAE, Saudi Arabia and China for financial assistance and investment. Saudi Arabia has indicated that it will increase its deposit in the SBP from USD 3bn to USD 5bn, while the UAE has agreed to provide a USD 1bn loan and rollover an existing loan of USD 2bn. The finances – which will help the ailing economy in the short run but will sustain external obligations in the long term – are yet to be disbursed and their materialisation is likely to be contingent on Pakistan’s ability to resolve its deadlock with the IMF.  Foreign investment from these countries will likely be relatively limited while concerns persist over the overall fiscal health of the economy.

No quick fixes

In order to reduce reliance on hydrocarbon imports, the government aims to derive 60% of its energy from renewable sources, including hydropower by 2030. Approximately a quarter of the country’s power is currently generated from hydropower, while one eighth is generated from nuclear energy and about 3% is generated from renewable energy. Despite the government’s desire to promote renewable energy, especially solar and wind power, it is unlikely to achieve its targets. Investors in the renewable sector face a myriad of challenges ranging from ad-hoc import restrictions to frequent tax revisions based on economic priorities. Local media outlets have quoted stakeholders in the sector as stating restrictions on the import of machinery and challenges in securing LC clearance have created hurdles.

In an attempt to address fuel shortages while navigating sovereign challenges, Pakistan has been engaging in talks with Russia over crude oil and petroleum supplies, and on 20 January reached an agreement on oil supply in principle, without mentioning any contractual terms. A “conceptual agreement” on modalities such as logistics, payment and volumes is expected to be developed in March. There are also indications that both countries are discussing payment in a “friendly” country’s currency. As and when a deal materialises and comes to fruition, it will likely ease some pressure on Pakistan’s ailing economy, foreign reserves and power sector.

However, structural inefficiencies in the economy and energy sector will prevail while regulatory efforts and policies, irrespective of which party comes to power in the October 2023 general elections, will likely face hurdles and be dominated by political interests.

Source: Control Risks

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