The political economy of LNG imports

THE petroleum minister has described as a game changer an initiative to import Liquefied Natural Gas to fuel cars with CNG. Under the proposal the CNG pump operators can set up one or more special purpose vehicles (SPV) to import LNG, which would be re-gasified on arrival at the Port Qasim terminal facility presently under construction. It will then be piped to CNG stations countrywide through the leaky pipelines’ infrastructure of the two gas utility companies.

The minister has claimed this would shave $2.5 billion off the oil import bill, make available a 35pc cheaper fuel for consumers and also save the sagging CNG industry.

That the initiative also proposes to exempt LNG imports from GST and the gas infrastructure development cess (GIDC) suggests that the rate differential between the landed costs of crude oil and LNG may not be very much. That in fact if these are applied, it may squeeze the profit margins of the CNG pump operators down to the bone. This also potentially belies the $2.5bn saving claim.

This is akin to providing a subsidy to a scheme that may not otherwise be viable. The petroleum ministry’s argument that the imported LNG would free up gas that the CNG sector presently receives and this would then be diverted to the textile sector and independent power producers (IPP) where it would continue to yield taxes and the cess is fallacious and a distortion of competition.

While the measure may simultaneously placate PML-N’s traditional constituencies — the textile lobby, IPP owners, CNG station owners and millions of vehicle owners — it violates the principle of neutrality of broad-based taxation. The principle states that GST is a tax on consumption, irrespective of the product being consumed, and is to be paid by the final consumer.

Similarly the cess is meant to be used on developing future gas infrastructure and it makes little sense to exempt LNG because at some stage, if demand picks up, more pipeline capacity would need to be built.

At least transparency and national accounting practices would be better served if the government were to levy the tax and cess with one hand and with the other give a direct cash subsidy to vehicle drivers buying CNG at the stations.

So why have the CNG pump operators, with their SPV and the best of intentions, been unable to make this scheme commercially viable? To comprehend this we need to understand that the international LNG trade is carried on between a closed club, where the buyers and sellers are blue chip entities with A or AA credit ratings. As such, entities with lower ratings should expect to receive less favourable terms.

There are 19 exporting countries, Qatar accounting for a third of global production; and 25 importing countries led by Japan, South Korea and Europe. A limited 400 special LNG tankers ply cargo, spanning the globe from Alaska to Australia, the typical cargo value being $200 million. Among these, smaller size vessels of cargo worth $30m to $80m are also available but buying in smaller lots pushes up the landed cost per unit.

Vessel charter rates are also highly volatile. A good part of the cost in this business is in the supply chain and the handling. Importantly, Qatar with its predisposition for larger cargoes, would mean the SPV will have to pick up cargo from more distant destinations which would further drive up its per unit landed cost.

Even once it arrives, a further 10pc of the gas will be lost (and become part of the unaccounted for gas losses) during distribution. The final price at the CNG pumps, including profit, may well be only a fraction lower than petrol — hence the proposal to exempt it from GST and cess.

A better option may be to capacitate PSO, the country’s largest fuel importer, to handle LNG imports. PSO has a more robust financial position than any SPV the CNG pump operators will be able to come up with. It also has better experience of negotiating contracts, procurement procedures and can source much better deals. PSO will be able to achieve an economies effect and land the product at lower per unit prices.

It makes more sense for PSO to spin off a division to handle LNG requirements of all industrial sectors than for individual sectors to go it alone. The petroleum ministry must ask PSO to conduct a feasibility study on the opportunity.

Utmost, of course, systemic gas losses need to be plugged before piping expensive gas into it. This issue should be addressed head on rather than glossing over it by extending tax subsidies and distorting markets.

2014 – Dawn Media Group

Responsibly please

THAT reservations over the Pak-China bi­la­­teral coal power projects were raised in rabble-rousing forums instead of the sober atmosphere of a parliamentary committee is unfortunate. Whatever the merits of the objections to the proposed deals, they ought to have been raised in a more responsible manner. Further damage can be averted if we clear the air, unbundle some of the issues and see how these project opportunities have evolved.

Last summer the incoming PML-N government released the National Power Policy 2013. As one of the policy objectives, the weighted average cost of producing electricity was to be brought down. To do this the policy proposed to characteristically change the energy mix — from gas, which is a depleting resource, and furnace oil, which is an expensive fuel, to coal.

Over the longer term, the policy proposed to tap the hydropower potential of the Indus Basin cascade at sites like Thakot, Patan and Dasu and subsequently at Bunji and Diamer-Basha. Coal, it was felt was not just economical but also the fastest solution since projects could be commissioned within three to four years from financial close. After whetting by all provinces the policy was approved by the Council of Common Interests and work on implementation began.

A month later, in September 2013, Nepra, the electric power regulatory authority, announced an upfront tariff on coal power projects. The aim was to help the project sponsors arrive at their investment decisions early and then achieve financial close on fast track. That not too many investment decisions were forthcoming; and the one that was, Engro Energy, was unable to achieve financial close; perhaps indicated that the tariff was too low. There was little wrong with Nepra’s conservative approach. Often a ‘reverse auction’ of this sort is an effective method to arrive at fair pricing.

Of course there was the added complication of coal’s deleterious climate effects. No worries, we justified to ourselves, because Pakistan’s grid — thanks to the large share of natural gas and hydro power — is one of the cleanest in the world. Surely we could get away with a bit of coal in the mix. Western financial institutions had a different view. Coal was an absolute no-no. Their stakeholders would have none of it. At any rate, given the chronic circular debt malaise, global financial institutions had little appetite to invest in our power sector.

In the face of these roadblocks the government reached out to the Chinese leadership. A number of projects have been identified that can be jointly developed. These include, among others, two power plants each at Gadani, Sahiwal, Thar and one at Bin Qasim. A coal handling and logistics infrastructure is also part of the parcel as is a transmission infrastructure for evacuation of electricity from the site to the grid.

Amidst a global economic slowdown and the slack demand for coal power plants, Chinese power plant manufacturers didn’t have too many orders either. A meeting point was possible if the Pakistan government enhanced the tariff somewhat and improved the rates of return; the projects would become viable to receive Chinese funding. In June this year, Nepra revised the tariff. To minimise the cost of capital, power projects need to be structured at around 80:20 debt-equity ratio. Chinese government financing could now be provided to cover the debt component.

One reservation that has been aired about the deal is of bypassing of the public procurement rules. These reservations are not valid for private-sector projects in IPP mode. Even for Gencos that may opt for retrofitting for coal conversion and for Greenfield projects involving federal/provincial government equity there is no harm if the government puts such projects under independent boards and empowers these boards to procure through direct negotiations while keeping the global industry benchmarks on cost per megawatt, efficiency and other key parameters in view.

This information is widely and freely available. To further address transparency concerns, negotiated proposals can be made the subject of public hearings before they are signed. The larger consideration is whether the policy objective of bringing down the weighted average cost of electricity production is being met. Another consideration should be that the equipment is of high quality and must perform up to the standard, unlike the earlier experience with Chinese locomotives.

But perhaps even more than capital cost, the mechanism to procure fuel supply contracts needs to be fully transparent because fuel is a recurring and ‘pass through’ cost — passed on to the government — and prices are harder to ascertain for coal than for furnace oil and natural gas.

Pakistan needs affordable energy. A course has been charted, and while differences in viewpoints can exist, issues must not be obfuscated for political gain.

2014 – Dawn Media Group

The last chance

SOUTH Indian-style prawns cooked in spices and coconut milk next to a Lucknavi specialty, galouti kebabs and an array of mouth-watering dishes, signified a celebration of the cuisines of South Asia. And bringing the leadership of the Saarc countries together for his swearing-in was a skilful manoeuvre from Indian Prime Minister Narendra Modi. It signified a celebration of South Asian democracy; all eight Saarc leaders are democratically elected.

The last time India and Europe stood at similar stages of historical development was in the 16th century. As Mughal Emperor Akbar expanded his empire across North India, Europe was experiencing plague deaths as well as terrible massacres and conquests. But at another level, a renaissance of learning and ideas was spreading fast across the continent. Thus began the rise of the Western civilisation. Thereafter, their paths diverged.

Today, South Asia faces the monumental challenge of meeting the basic need of its inhabitants for food, water, energy, healthcare, education and access to justice. In its essence the agenda facing all Saarc countries is the twin challenge of human development and economic betterment of its people: How to get incomes to rise, how to raise revenues for the state, how to build quality institutions and government capacity that can address this agenda.

In 1980, China’s per capita income stood at $300, in line with Saarc countries. Deng Xiaoping’s reforms had only just begun, premised as they were on de-collectivisation of agriculture, opening up to foreign direct investment and enforcement of a one-child policy.

These measures were followed up by privatisation and allowing private enterprise. Today China’s demographic dividend may be running out, but the average Chinese enjoys a per capita income nearly five times that of their South Asian counterpart.

So where next for South Asia? Demographers and development specialists may differ whether South Asia’s demographic dividend would last another two decades or four. At any rate, without jobs this dividend becomes a liability. But these decades may represent South Asia’s last chance.

Modi’s challenges are domestic — slowing growth, rising inflation, an economy that is not creating enough jobs and where government finances are a mess. The expectations from him are huge, as is his burden of responsibility. The fact that India is riddled with corruption and crony capitalism further complicates matters. Economic engagement with Pakistan is probably peripheral, if at all visible on his radar at this stage.

Can Modi deliver? After all, what he did in Gujarat, can it not be scaled up, replicated in the rest of India? Some regard this sceptically; a ‘provincial’ solution to a national problem. True, Modi made Gujarat India’s most favoured investment destination and in 2013 Gujarat bagged nearly a quarter of the country’s industrial investment proposals.

Most of that success can be put down to the favourable incentives Modi’s Gujarat would offer to cut itself a larger slice of India’s cake — and this is not the same thing as India getting a bigger cake.

A case in point would be Tata’s decision to move the location of its automobile assembly plant for the Nano from West Bengal to Gujarat. From the left pocket to the right pocket. Similarly for FDI, once the decision to invest in India had been made in Tokyo, Seoul, London or Rotterdam the next step would be to select the site location. And Gujarat was where land acquisition was the fastest.

Granted, this may be a rather harsh evaluation of Modi’s performance in Gujarat; still the question is, can the South Asian governments in power today (and their successors) deliver in the next couple of decades what has eluded their predecessors in the last six? After all Deng Xiaoping did it in China. But unlike the Communist Party whose party structure was organised from the ground up, from the village commune to the politburo, South Asian governments have to depend on decaying colonial-era state structures for implementation, on bureaucracies and ‘babus’, who themselves represent a force of the status quo.

Beyond this organisational and institutional incapability it is the politics, prejudice, mistrust and territorial issues among states that keep things gridlocked.

Yet there are successful examples of ‘bottom up’ development initiatives in South Asia which include India’s Amul dairy farmers’ cooperative model, Pakistan’s Orangi Pilot Project and Bangladesh’s Grameen Bank and these ought to be replicated across South Asia.

The coming decades cannot afford to be squandered. The consequence of that would be catastrophic and would condemn too much of humanity to permanent backwardness and misery.

2014 – Dawn Media Group

The energy challenge

IT was a freezing winter night in 2010 and I had just checked into the government rest house at the Lal Sohanra national park when the lights had gone out. The caretaker at the premises had lit a bonfire in the sprawling backyard which extended on one side to the edge of a lake.

“This is Nawaz Sharif’s favourite spot sahib, right where you are sitting. Been here several times, and we would chat late into the night sometimes” he told me as we warmed our hands in the bonfire heat. “The younger one is more reserved … he’s a grouch. But the elder one’s very relaxed. Oh, and he loves to listen to the flute” he went on to disclose.

Recently, Prime Minister Nawaz Sharif returned here to inaugurate the Quaid-i-Azam solar park. Situated on the edge of the Cholistan desert near Bahawalpur, the region which is famous for its peacock, gazelle and black buck is now set to become the world’s largest solar park. Investment commitments totalling nearly 1,000 megawatts have already been received from local and Chinese business groups.

Energy requirement and economic growth are strongly correlated. Pakistan’s per capita energy demand is one fifth of the world average. Electric power is a factor of production presently in short supply. And it is holding back economic growth.

The present peak electricity demand is estimated at 25,000MW while studies indicate that to cater to the projected electricity demand, an additional 100,000MW of capacity would need to be installed over the medium term.

One limitation of renewable energy is its fluctuating availability. Solar power is only available during daytime, wind power when there is breeze and hydropower is dependent on the ebb and flow of the water. This keeps renewable energy from becoming the mainstay in the overall energy mix. For this reason the base load in most grid systems is carried by thermal (and nuclear) power stations which can provide a steady supply all day and all year.

One would imagine urban solid waste to be a steadier source of fuel. But scavenging at various stages of the waste management process and inelegant waste disposal and handling mechanisms make it hard to work with. The end result is high cost-per-ton of fuel.

Similarly biomass generated in the agriculture and livestock sector fulfils about a third of Pakistan’s total primary energy requirement. This, like so much else in this country, takes place in the non-commercial sector and remains undocumented. Nevertheless, projects can be conceived and commercialised where crop residues and animal dung is purchased from the farmers for conversion to higher forms of energy while simultaneously creating markets for this energy.

A successful commercial model will be one that can extract more energy from the same quantity of fuel, creating enough value to recompense farmers for the forgone fuel; with which they can buy their energy requirements from the market and still have money left over.

Such a model will bring parts of the rural subsistence economy into the commercial, documented economy. This way, much of the future growth can be based on indigenous fuel.

Contrary to what many believe, all renewable energy is not cheap. The present wind and solar power tariffs are close to what is being paid to oil-based Independent Power Producers and twice as high as the 8.5 US cents that was offered to private hydropower producer, Laraib Energy, a couple of years ago.

Dams at Bunji, Diamer-Bhasha, Dasu and Kalabagh (if consensus can be built) can potentially contribute 20pc of the projected requirement of 100,000MW. Other smaller dams, biomass, wind and solar potential should be tapped to the maximum extent possible. The base load will, however, need to be carried by thermal (including coal) and nuclear.

Assuming a benchmark price of $1.3 million per installed megawatt, the country would need an investment of $130 billion in the next 15 to 20 years. To put this figure in perspective, the total foreign direct investment, or FDI, in Pakistan in the last 50 years in all business sectors is in the region of $20bn.

However, lately, perhaps because of our failure to carry through reforms in the power sector, sensing a lack of seriousness to fix the structural issues, players like Xenel, National Power and AES have left Pakistan after selling off their stakes.

The key to overcoming the energy challenge, then, lies in the governance of the energy sector.

The writer has served the Punjab Board of Investment & Trade as its director general and is assisting the Planning Commission and its working groups in developing Pakistan Vision 2025 and the 11th Five-Year Plan.

2014 – Dawn Media Group

Playing with fire

TO diagnose Saudi Arabia’s fear instincts, one would have to travel back to 1979. That year saw the Iranian revolution, and Ayatollah Khomeini’s subsequent talk of ‘exporting’ the revolution which has left Saudi Arabia with an exaggerated fear of Shia expansionism.

That same year, hundreds of armed extremists seized the Grand Mosque at Makkah. Shortly afterwards, two brigades, roughly 10,000 Pakistani troops, were deployed to Saudi Arabia under a bilateral joint military agreement aimed at protecting the Saudi monarchy.

One part of Saudi Arabia’s anxiety stems from its perception of a growing Shia footprint which now includes the Bashar al Assad regime in Syria, the Hezbollah militia’s strength in Lebanon, the Maliki government in Iraq, and the three years of Shia led pro-democracy protests in Bahrain.

Saudi Arabia is also suspicious of its own Shia population in the Eastern Province, where it fears the radical Hezbollah al-Hejaz is active.

At the same time, it is nervous about any domestic unrest that may be inspired by the Arab Spring uprisings. This nervousness was apparent when it announced a generous financial support package for its own population in 2011.

It is particularly wary of the mobilising capacity of the Muslim Brotherhood, whose political Islamism and grassroots activism are anathema to the House of Saud, whose grip on power comes from keeping religion under its own tight control and patronage.

And even as Egypt’s military junta has ousted the Brotherhood’s government (and received billions of dollars in Saudi largesse), it has stoked much Islamist resentment in the Arab world.

In the clearest sign of this fear, Saudi Arabia has recently declared the Brotherhood as a terrorist organisation and passed new anti-terror laws that Amnesty International regards as a tool to crush peaceful expression.

Saudi Arabia also faces a radical Islamist threat from Al Qaeda in the Arabian Peninsula which is now lodged in Yemen. It is entirely plausible that AQAP has been making every effort to penetrate Saudi Arabia’s state institutions and security forces.

Saudi Arabia promoted the Syrian rebellion against Bashar al Assad. That proxy war has reached a stalemate. The rebellion has been hijacked by jihadist groups who have turned on each other.

The fighting is out of anybody’s control and now Riyadh fears the fire may spread. Many Saudi fighters who had joined the rebellion could become the link between underground Saudi Islamist groups and jihadist groups fighting in Syria. In a royal decree announced last month, Saudi Arabia has banned its citizens from participating in the Syrian civil war.

A prolonged conflict in Syria could also spill over into Egypt where an Islamist movement against the military junta is in early stages. That would further complicate the Kingdom’s threat matrix.

The recent quiet sidelining of Prince Bandar bin Sultan, head of Saudi intelligence (and the mastermind of the campaign to overthrow Assad), is the clearest sign of this reordering of threat priorities. He is no longer to be in charge of Saudi policy on Syria which will now be handled by Interior Minister Prince Mohamad bin Nayef. Nayef’s skill set? Counterterrorism work against Al Qaeda.

Saudi Arabia may yearn for an early end to the war and the establishment of a transitional government in Syria, but is this objective realistic? Would Assad’s ouster necessarily end this war? Are the Russians going to stand by and watch the demise of their only ally in the Arab world? How will they likely respond to anti-Assad rebels receiving shoulder-fired anti-tank and anti-aircraft (and possibly even heavier) weapons, that Pakistan has been showcasing at its IDEAS defence exhibitions?

How will Iran respond as these weapons arrive in Jordan for subsequent issuance to selected rebel groups? There may well be an end user agreement; but do we really intend to monitor and enforce it? Are our trainers and other mercenaries also expected to arrive in Syria? And as the situation further complicates, will our friends in the Gulf expect other quid pro quo?

Some reports indicate that the Saudis are considering a standby force ready to put down Islamist and Shia uprisings whenever and wherever they may appear in the Gulf.

Such questions need to be pondered by our policymakers before further entangling us in this crisis. The parliament is the forum for such debates and policy appraisals.

Our representatives may also want to revisit the reasons why recently the US had hesitated to arm the rebels. They may similarly want to evaluate other risks and repercussions of this engagement. It’s time to open the windows and let in that fresh air.

2014 – Dawn Media Group

Contours of the threat

THE only certainty one can be sure of, they say, is change. And even as we look into an uncertain future, we can see some key trends. Then we look at the forces that are driving those trends and slowly a pattern begins to emerge. These visions make the future look less hazy. Here’s some of what we see:

Pakistan is facing a long war and this is not a war that will produce a victor and a vanquished anytime soon.

Pakistan is fighting a creed. This war is not so much with the Taliban as much as against the Talibanisation of our society — the Tehreek-i-Taliban Pakistan (TTP) representing only the extreme end in that spectrum.

The right-wing narrative is beginning to sound more and more ludicrous. False premises — that this is ‘America’s war’, that drone strikes are a key cause of terrorism and the Taliban are ‘misguided brothers’ — led to flawed prescriptions: block Nato supplies and negotiate with the Taliban. That narrative may well be at risk of becoming unhinged. It is difficult to decide which is more outrageous: Interior Minister Chaudhry Nisar suggesting a ‘cricket match with the Taliban’; or Pakistan Tehreek-i-Insaf chief Imran Khan suggesting that the majority of Taliban are ‘peace-loving’ and the TTP therefore should be allowed to open an office in Peshawar.

The relatively liberal parties are displaying clearer thinking, and a realisation that they may have a story that will better resonate with their constituencies. Expect them to keep churning the wheel to their advantage.

The parties of the right, arranged like dominoes, cannot stray too far from their long-held positions without appearing to be ‘switching sides’. Eventually if they do come round, they will find themselves in a squeeze zone, encroaching on the turf of the liberal parties whose story would be more original and spun to a greater degree of sophistication.

A continuous low to medium intensity conflict is foreseen. This is the ‘steady state’ that the talk-fight-talk-fight sequence appears to be heading towards.

The TTP will mostly strike military targets. The TTP as an Al Qaeda affiliate has been tutored in propaganda by the likes of Abu Yahya al Libi, Al Qaeda’s erstwhile chief information officer. Al-Libi was killed by a predator drone but not before he taught the current TTP chief Mullah Fazlullah that attacking military targets will raise the militants’ prestige without greatly alienating the right-wing civilian population. Only when a strong message needs to be sent to the civilian leadership will the TTP strike a civilian or political target.

The ‘cat and mouse’ game will continue without a decisive outcome. The TTP fighters will escape into Afghanistan when the fighting season ends or if they come under unbearable heat. Other fighters may melt away into the plains and settled areas and remain hidden for a while. This way, the TTP will pose a continuous and sustained challenge. Some factions seek to destroy the state and military, others seek to unravel it through breakdown and desertions and yet others, notably the TTP Mohmand, wish to seize the state intact. Quite likely that some factions will at times break ranks. Meanwhile, on its part, the military has already demonstrated its newer methods and technology and we can expect to see increasing sophistication in surveillance and targeting in the months and years ahead.

Right-wing and religious forces will harness the TTP threat to their advantage and insert themselves as interlocutors in the process. From this position they can leverage their strength and extract maximum concessions from a beleaguered state. As the TTP held the gun to our heads, the Council of Islamic Ideology was recently able to put pressure on us to change laws restricting polygamy and child marriages.

The situation ironically places liberal parties in an enviable position giving them an opportunity to craft a more sensible and sellable narrative with which to win back followers lost to the right.

To contain any such successful thrust from the liberal parties, the TTP will use the threat of violence as it did in the general election last year when it did not allow them to campaign or hold political rallies.

Pakistan will remain part of Al Qaeda’s larger battlefield which includes Afghanistan, Iraq, Syria, Yemen, North Africa and parts of Central Asia. The TTP will not only draw ‘franchise benefits’ but also fully leverage the ‘strategic depth’ available to it in Afghanistan’s Pakhtun territories.

This may yet be a simplified model but one that lets us construct more elaborate scenarios with these building blocks. Such scenarios can help us gain an understanding of the shape of things to come and hopefully prepare pre-emptive policy responses.

2014 – Dawn Media Group