With the recent increase in electricity tariffs, there is renewed debate over the rationality of capacity payment charges (CPC) to independent power producers (IPPs).

Previously, only a few voices raised concerns about these charges, but now the debate has expanded, and nearly everyone outside of the treasury benches is discussing the need to renegotiate the capacity payment arrangements with the IPPs to lower electricity tariffs.

The government is in a catch-22 situation. The high cost of electricity has become a contentious political issue, with opposition parties leveraging public dissatisfaction to criticize the incumbent government’s handling of the energy sector. Industrial bodies like the FPPCCI and APTMA are demanding a renegotiation of contracts with the IPPs to lower electricity tariffs so that industry and manufacturing remain competitive.

In the past, the government could have deferred passing on the CPC in the electricity bills, making them part of the energy circular debt, and thus calming the situation. However, to secure the next bailout programme with the IMF, it cannot defer passing on CPC to the consumers. The IMF’s financial assistance is tied to strict fiscal discipline and structural reforms, which include reducing subsidies and increasing cost recovery in the energy sector. These conditions pressure the government to pass on the high costs of electricity to consumers, exacerbating public discontent and economic strain.

Before discussing the way forward, let’s consider how we got here.

The evolution of IPP policies in Pakistan can be broadly categorized into three main phases: the 1994 policy, the 2002 policy, and the 2015 policy. Each of these policies has had distinct features but shares some common elements that have influenced electricity tariff determination.

Pakistan’s reliance on IPPs dates back to the Power Policy of 1994, introduced to alleviate the chronic energy shortages that plagued the country. The policy aimed to attract private investment by offering generous terms. The return on equity was set at an attractive 18 per cent, indexed to the US dollar, with a provision to include capacity payments. These payments are fixed charges made to IPPs to ensure the availability of electricity capacity, regardless of actual electricity generation or consumption. While this model provided the financial security necessary to draw private investors, it laid the........

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