Tuesday, January 13, 2009

Hydel power Royalties conundrum

Hydel power Royalties conundrum.

The issue of hydro-power royalties has been a bone of contention among NWFP government,WAPDA and Federal government .Article 161 of the constitution of Pakistan provides for royalty on gas and hydropower profits to be given to the producer provinces .For some strange reasons, there is no mention of such royalties on mineral and coal .And even more so oil has also

been ignored .It is understood that 12.5% royalty on gas is being paid to the provinces. However Baluchistan laments for past over-dues not having been paid and the reference gas price on which the royalty is being computed being too low,Rs. 131 per unit, as opposed to elsewhere where this figure is more than double.

On hydro profit, the constitution speaks of “ net profit “ at bus-bar. Various interpretations of the constitutional provision have been made .The late redoubtable AGN Kazi gave a formula ,which has been termed unrealistic and outdated. As per formula, annual net profit of RS.6.00 billion was computed in 1991.NWFP claims an amount of Rs.595 billion in arrears, including a principal of Rs 293 billion and Rrs.302 billion interest. Interestingly NWFP Government led by MMA did not mind claiming interest or” Riba”.

A tribunal had been formed under Justice Ajmal Mian, which upheld the big claim of Rs. 193.76 million, disallowing markup. The award of the tribunal did not solve the technical problem. WAPDA says it is in red. Paying such big sums would mean enhancement of already very high tariffs .In this space ,we will try to interpret the constitutional provision in an economic perspective and examine various strains emanating from it. We would also apprise the reader of other possible formulae and international evidence in this respect.

The constitution speaks of “bus-bar”, ( station to put it simply)which implies it means whole sale electricity sales to purchasers, whether it is WAPDA or its subsidiary or any other body. There would be problems of computation ,if whole- sale does not take place and WAPDA retails itself. Barring some initial years ,WAPDA has been in red. GOP is currently subsidizing at a rate of Rs.1.60 ,as per TV statement of the current minister of water and power, which means a loss to the same effect. Under current and recent dispensation ,Central Power Purchasing Authority(CCPA) purchases electricity. If it purchases hydro-electricity separately from every production unit computation of net profit is not very difficult. As per NEPRA rules, a 15% return on equity is provided. But is return on equity a net profit? Some people ask. Some argue that the cost of capital(12%) should be subtracted from it, which makes it 20% of the return on equity.

Internationally, the practice is simple and similar to royalty computation in other resources mineral or oil or gas, that is , a certain percentage of output or revenue at the point of output. It may be in cash or in kind. Normally it is taken as cash on prevailing sales prices. In India it is flat 12%,easy and simple and there are no disputes. The amount goes straight to the kitty of the provincial governments. In Nepal the formula is a bit more complicated .In initial years (10-15 yrs) 2% of the royalty plus a capacity charge is levied as royalty. In later years (15-30 yrs),royalty rate goes up to 10 % plus a capacity charge. The total average effect should be the tune of 10-12% on output/sales at the bus bar rate or whole- sale rate to put it simply. In Brazil , the royalty rate is 6 % on output , which is shared among the federal , provincial , and local governments respectively as 10% ,45 % and 45% . In Turkey m, there is no royalty and in many other countries , it is only 4 %.We would recommend , a rate of 12% which is presumably highest in the world . At this proposed rate of 12 % , and at Rs. 4 per unit, which is the current cost for new power plants ,the royalty would be Rs 0.48 per unit, indeed quite a good and reasonable figure .

A third approach proposed for consideration by the authorities is the payment for the energy content of the hydel electricity. Let us try to understand this through the UCH-2 thermal power plant (gas) which was recently advertised by NEPRA for public hearing. An energy charge of EPP Rs 3.2338per unit and a capital charge (CPP) of Rs.2.007 per unit has been asked for. The hydro power is giving a benefit of Rs.3.2338 per unit as being free(no fuel). Normalising for load factor(capacity utilization) differences (40% LF for hydro and 80% for thermal),the normalized energy charge for hydel comes about to be Rs.1.6164 per unit. This is the fuel value of hydropower in the parlance of oil and gas, with which one is familiar .A 12 % royalty on this, comes out to be RS.0.20 per unit (KWh).For 3428 MW of tarbela , with an estimated 12 billion units of electricity sold at bus –bar, the claim of NWFP government comes out to be RS.2.4 billion per year.

A simple rendition of this approach would be “6% of the average EPP charges for the same year of thermal power plants” .It may please be noted that 12.5% is the international royalty charge rate on oil and gas including Pakistan.

Royalty is to be received by every producer province and paid by all utilities not just WAPDA. IPPs should also pay. Currently NEPRA does not seem to have provision for royalty, although water user charges to the tune of Rs.0.15 per unit have been provided in a recent hydro power project for which a petition for Nepra has been submitted. This may be termed as a royalty of about 3-4% on sales. If the constitutional provision is to be followed brutally, the profits would go to the provincial governments and not to the investors. End of IPPs in the hydro sector! Hence inappropriatness of the net profit approach. The constitutional provision should be either amended or CCI be convened to make a determination keeping in view the constitutional spirit along with economic realities, common sense and international practice.

Conceptually, royalty is a rent or presumptive tax. It is not a share in profit. It is to be paid even if there is no profit. It is a part of the cost of production. Hence conceptually, the net profit approach is misleading, ambiguous and impracticable. It is to be replaced and brought in line with widely practiced international approaches based on a percentage of output or sales. The question of course would be ,reasonably ,how much is reasonable? What is the norm? What would be politically acceptable in the light of varying claims at extremes.

There are two further issues that need to be sorted out;

a) sharing of royalty among provinces where utility is in both the provinces that is Ghazi Barotha ;

b)the share of district(s) from the provincial royalty income, where the resource is actually located and faces the environmental brunt and dislocations of the project This issue would be specially relevant for Skardu and Northern areas, where many new dams are to be built. All these issues are solvable There is enough international evidence available, provided rationality and flexibility is applied. Postponement can only complicate the problems and not solve them.

Analyzing AGN Kazi Award of Rs. 6.billion per year on an annual generation of 6.0 billion units in 1990-1991 ,when award was given, royalty rate or profit ,whatever be the semantics ,comes out to be Rs.1.00 per KWh. For 1990-1991,this is a strange figure, when probably the whole retail tariff was under Rs.1.00 per unit. At current level of Tarbela generation of 12 billion units per year, the NWFP profit/royalty would be Rs.12 billion per year, as per this grotesque formula . Even in 1990-91 prices and without any markup or escalation ,the total NWFP claim would be Rs.326 billion. This is killing the goose that lays the golden eggs.

If a-la India , royalty rates of 12 % ,which in fact are very liberal ,are assumed and current hydro costs of Rs. 4.00 are taken into account , a case for 48 paisas per unit of royalty is made. To give the reader an idea of how low or high the rate of 12% is , in many business sector a profit rate of 7 % is a norm . At this royalty rate current royalty claim of NWFP would come out to be Rs.6.00 billion per annum ,the level at which NWFP royalty has been capped .By the way who says , hydro electricity is cheap. The current spot prices of electricity (firm and at peak) at Henry –Hub in USA are 5.7 cents.

Even the industrial tariff in many states is about at the same level.

Thus there would be no justification of increase or escalation .If retrospective calculations are made, based on an average of Rs.1.35 per unit whole sale tariff, and 12% royalty rate , a claim of RS.48 billion units is generated on a total electricity generation of 326 billion units to date. Add to it a mark up at 10% per annum ,a sum of rs.28 billion, the total NWFP dues come out to be RS.76 billion ,which WAPDA has already paid. Please note that Rs.1.35 is a weighted average of 30 paisas,Rs.1.00 andRs.2.00 per unit respectively for the period 1977-91,1992-2000,2001-2007. In fact these are quite realistic even liberal values.

NWFP leaders would be well advised to look forward to other income from other hydro-projects, which can only be realised through a realistic and affordable, and logical formula. Total hydro power generation these days exceeds 25 billion units per year, generating a royalty of about Rs.12 billion ,based on the proposed formula. Hydro capacity would be doubled in the next ten years ,which would mean an additional royalty income of RS.25 billion at current prices and much more on the then prevailing prices. Efforts should also be made for uniform applicability of the royalty ,irrespective of public or private sector IPPs, which currently is not the case, as said earlier , the latter pay only water use charge amounting to 3-4 % royalty , if you will .

Sindh’s Opposition to Dams;

Sindh has been opposing construction of dams and thus hydroelectricity for a variety of reasons ,including supply risks, environmental consequences in the delta areas and the loss of land. This is not a place to examine the merits of the arguments and losses feared by Sindh. Practically, no hydel capacity could have been added after Tarbela and Mangla and Ghazi Barotha .All major projects are being opposed .Zia and Musharraf both tried their best to get Kalabagh dam implemented. Present government, for reasons of politics of consensus, have not touched the issue and have not made any budgetary allocation for Bhasha or Basu .Only Neelum Jehlum is due for implementation. Why not involve and placate Sindh through a share in royalty on new hydro projects, especially the ones that may come up in Punjab or Northern areas, where the royalty issue has not been completed or has not arisen yet. After royalty is a kind of compensation for loss or consumption of resources, and to the associated environmental and other risks. It has come out that such consequences are not only at the site of the hydro dams , but also affect the delta areas where the rivers fall into the sea. Would a share of 10 % in royalties please the sindh government and the public and political parties? A share of 10 % would mean an annual income of Rs.600 million, if a major hydro scheme is implemented in the northern areas. One could double it , without aggrieving the northern areas as theses are small territories with small populations .This money could be utilized to compensate private and public losses and used for enhancing the incomes and employment in the interior of Sindh. This should not be converted in to cheap slogan of attempts to buy the province. This is a scientific and reasonable approach. If they are lucky, they (sindh) would not get more than Rs. 1200 million from thar coal project of 1000 MW.

Constitutional Ammendment

It is said that article 151) was hastily drafted in 1973 , to solicit support of late Wali Khan of ANP in the atmosphere of coaxing and cajoling which is normal for such bargaining processes. The drafting was bad. Those were difficult times , whoever was available at hand did the job. After the political agreement is reached with the political parties , article 151 a) should be amended, in fact repealed. And article151b) should be modified to include hydel and other mineral resources to be eligible for royalties with gas. The issue of rates and computation to be the domain of administrative matter , as is the case with gas already.

Saturday, January 10, 2009

Coal Power Royalties and Provincial Autonomy

Syed Akhtar Ali


Federal government should sort out the royalty issue on the exploitation of natural resources,so that the lacunae in this respect are removed and the investors feel secure in making their investment decisions. Although the 1973 constitution lays down some guidelines with respect to royalty payments ,these are either vague or outdated
by the events that have subsequently taken place. Take the example of NWFP royalty in hydel power.The matter has been a subject of debate and contention for along time.there have been inputs from late Ghulam Ishaque Khan,AGN Kazi formula,Council of Common Interests’ determinations and tribunals. The constitution provides for the “net profits” from hydel sales to be given to the province where it is located ie., for the time being NWFP.Net profit is avague term.NAPDA is not making any profit It subsidizes
electricity.Government is paying as revealed by consent of minister for water and power,a subsidy of Rs.1.67 per unit.It does not mean that the NWFP should not get royalty.The intent of the law makers should be seen and decisions on specific rates should be left to the administration.There are several approaches which could be
adopted. and a rational and just one adopted through consensus.
Our orthodox bureaucracy may not be in a position to evolve
a suitable formula,neither do they have the ability or capacity.
We have seen foreign consultants coming for even drafting Terms and
References for studies which in a way seems to be a better solution
than beating about the bush and coming out with half baked solutions.
Energy content of the hydel power needs to be rewarded with
royalty.This is not the time and space to discuss technical
details.However,one would like to briefly mention some outlines,so as
to guide the discussion of the issue which has defied solution for
more than two decades.

The possible royalty approach may have the following components;
Firstly, the main premise that has to be accepted is that the energy
content of hydel power is to be rewarded to the producing province
and region(including districts) at par with other energy
resources.Although at par or more or less may be decided according
to relative economics,it has to have some relevance and comparison
with the competing resources.

Secondly,measurement of energy content of hydel power being easier
said than done.in one view the EPP charges of abasket of thermal
resources of thermal plants measures the corresponding energy
contribution of a hydel plant.12 % of the earlier mentioned ought
to be the hydel royalty. The same rate of royalty applies to oil and

Coming to the oil and gas sector,luckily the royalty rates well
defined.But then again there are the issues of well-head provinces.
For some historical reasons,the well-head prices of PPL-Baluchistan
gas are fixed at an incredibly low rate. Baluch leaders are very
angry over this as this does not result in a just and meaningful
revenue,the natural gas pices at well-head being much higher in other
provinces.The royalty could be and should be calculated at the
generally prevailing well-head prices in the country,even if the
fixed well-head prices are to be maintained for contractual reasons.

Similarly the royalty issue on coal and other natural resources is to
be sorted out. At least part of the tusle on Thar coal between the
provincial and the federal government comes out from the
uncertaineties in this respect.due to alack of the public
information system and transparency,we only hearof rumours in this
respect.Vague statements on sindh to get a big royalty or news of
cajoling on a paltry sum of Rs.60 per ton as royalty is heard.We
would recommend a royalty rate of 12% at coal minehead prices,as is
the case in oil and gas,although the general rates are between
5-8%.as in India and Australia.In Bangladesh ,it is variable
between6-16% depending on the coal prices.Indonesia being a more
relevant country ,charges 13.5%.of mine head prices. In Indonesia
also now there are issues related to mine-head prices,which they are
trying to tackle through developing a coal price index.

A framework of other provincial taxes on coal such as excise (in
American parlance severance tax),property and other local taxes
should be discussed..In Wyoming,USA in addition to
royalties,additional taxes almost equal to royalty or more are
levied.A total revenue of 850 million dollars,is revised in a
production of 350 million tons,such taxes should be fixed and
guaranteed for a period of ten years.