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By Dr. Anjum Siddiqui Senior Advisor & Economist The Hub Power Company Ltd.
Feb 07 - 13, 2000

Hubco, Pakistan's largest foreign private sector investment project of $1.6 billion is in jeopardy. At the heart of the dispute are Hubco's allegedly "high tariffs" which according to WAPDA are the consequence of "overinvoiced" project costs.

Project costs have indeed increased from $1.2 billion in 1991 when the Initial Tariff Agreement was signed with the first Nawaz Sharif government, to $1.5 billion in 1994 when the Agreement was amended through Amendments l & 2 and the Supplemental Deed and which resulted in the Reference Tariff Agreement signed under the Benazir government. Project costs further increased to $1.6 billion in 1997 when the Hubco plant was fully commissioned.

The article presents for the first time, evidence on the Hub Project costs and explains the reasons for their legitimate increase, calling into serious question the "overinvoicing" theory.

WAPDA's bankruptcy: IPPs made scapegoats

Faced with a severe financial crunch, due entirely to its own mismanagement and administrative corruption WAPDA found itself unable to fulfil its contractual obligations towards IPPs, the GoP and its other lenders. The following line of 'reasoning' was coined. Hubco indulged in corruption by way of overinvoicing its project costs which were then recovered through high tariffs and which rendered WAPDA bankrupt.

Corruption of High High WAPDA's

contracts and project tariffs bankruptcy

overinvoicing costs

Let the courts decide the corruption issue (Box 1). My contention is to present evidence on why project costs have increased over time (Box 2), so that readers can judge for themselves, whether Hubco has indulged in crookery to line its pockets. As far as high tariffs are concerned (Box 3), there are at least two independent reports which refute the allegation that Hubco's tariffs are high. Hagler Bailly find that "Hubco's tariffs are competitive with its peers in Asia and a GoP commissioned study by Independent Resources Group (IRG) contends that tariffs of Pakistani IPPs are 0.75 cents less than other sample IPPs in Latin America, Philippines and Indonesia. The IRG report also shows that, had WAPDA constructed the equivalent IPP capacity itself, the WAPDA tariffs would have been "significantly higher" than IPP tariffs.

According to the above WAPDA illogic, WAPDA's bankruptcy (Box 4) is the consequence of high project costs and/or high tariffs which results in huge payments to IPPs. The case made by WAPDA to explain its financial woes fails to stand the scrutiny of logical arguments. As always, WAPDA is looking for scapegoats in IPPs. WAPDA has deliberately ignored their management and operational inefficiencies which have resulted in (i) 40% transmission losses which are the highest in the world, (ii) Billions of rupees of WAPDA's receivables, which are simply unpaid consumer bills, (iii) Thefts of transmission equipment, transformers and wire, noted by the Auditor General of Pakistan, (iv) A huge army of 138,000 workers whose paychecks are a continuous drain on WAPDA's limited earnings, (v) Poor plant maintenance practices which have resulted in a permanent loss of at least 1500 MW generating capacity or approximately Rs. 80-100 billion in national assets and (vi) A tariff structure which subsidizes the domestic sector at the expense of commercial and industrial consumers.

These are the real causes of WAPDA's financial ruin and not IPPs. Nevertheless, WAPDA continues its campaign of disinformation to mislead the common public by conveniently citing its Rs. 19 billion payments to IPPs as the cause of its financial problems. While it costs WAPDA Rs. 19 billion to procure electricity from IPPs, it sells the same electricity for much more including all its surcharges. Thus, theoretically, WAPDA is supposed to make a profit for that sale. However, since WAPDA's receivables are always increasing, it cannot recover the sales proceeds from consumers. Are IPPs to be blamed for WAPDA's ineptness? As the GoP departments owe most of WAPDA's dues, the GoP should help out WAPDA by recovering the dues and desisting from being a free rider at the expense of WAPDA's financial ruin. With what face can WAPDA single out the IPPs as the cause of its cashflow problems, especially given the fact that WAPDA has accepted that it does not even have the money to pay its accumulated debt of Rs. 55 billion owed to the GoP and non-government lenders? WAPDA has recently made a mockery of the accounting practices by asking the government to forgive its debt by converting Rs. 36 billion into equity. Thus, while WAPDA's balance sheet is cleverly improved, cosmetically, the balance sheet of the GoP is worsened further. The real losers are the tax-paying public of the country.

Proving corruption

It is most interesting to note the ease with which commentators pass blanket judgements on Hubco's alleged corruption, by statements that, "there is no doubt that contracts are corrupt". Has anyone bothered to provide concrete proof of corruption or does proof only constitute "I think" or "I know".

Is there any proof of over-invoicing, are there any false receipts, is there any fraudulent billing to WAPDA, any proof of forgery? Are WAPDA's payments to IPPs the cost of purchasing electricity, or is this to be construed as 'proof' of overinvoicing? What have the FIA and the Government auditors found in over one year of investigations, and if they have found anything at all, why are they withholding the 'evidence' against the alleged black deeds of Hubco and other IPPs? What does WAPDA "know", as they claim that they do? It stands to reason that if WAPDA had any concrete evidence of corruption against IPPs and Hubco, they would nailed them by now.

WAPDA simply does not have any evidence and they are merely crying wolf with a view to extracting tariff concessions from Hubco in the same manner that they did with other IPPs. It may be remembered that WAPDA dropped the charges of corruption against all other IPPs to negotiate reduced tariffs, whereas, initially they had all been branded as "corrupt". The strategy was too obvious and Hubco did not fall for it, as Hubco is not corrupt.

The answer to all the unsubstantiated allegations of corruption was most forcefully provided in a Sindh High Court judgement by Justice Shaiq Usmani who ruled that "there were no facts or proof to support the charge of corruption" and that "the plaint filed by WAPDA in Lahore was "devoid of concrete facts" and "appeared to be more a rhetorical rendering of the charge sheet against the previous administration than an averment of facts" (see p. 20 of the Judgement).

Project costs: Where are the kickbacks?

There has been much mystery surrounding allegations of "kickbacks" in project costs. The $244 million increase in these costs between 1991 and 1994 was construed as 'evidence' of kickbacks and contractual wrongdoing.

However, these project cost increases can be justified under legitimate and bonafide cost heads, which were agreed and approved by WAPDA and the GoP and only allowed to increase under strict and specific cost re-openers. It needs mention that the tariff currently charged by Hubco to WAPDA is recovered on the basis of the 1994 Agreement and in which total estimated project costs were 1.5 billion USD plus allowance for permitted expenditures discussed in the table.

Total project costs increased by $243 million between 1991 to 1994 and again by another 109 million between 1994 and 1997 for a total increase of $352 million. Why did these costs increase?

The answer is not that Hubco is a cost-plus project in which all cost increases got automatically built up into high total project costs. In Hubco's contract, costs have been capped by WAPDA and those costs that do not qualify under legitimate cost re-openers are not recoverable through tariff and have to be footed by Hubco. For example, between 1994 and 1997, although project costs increased by $109 million, only a part of these were admissible as permitted expenditures (totalling $51 million) and allowed to be recovered through the tariff. The remaining $58 million had to be absorbed by the Company itself.

It is common knowledge that construction period contracts are based on certain assumptions and are subject to certain conditions. Consequently, all project costs are best guess estimates. As with all other contracts, in the case of Hubco Project also, all parties knew that the project cost and its associated tariff would change depending on changes in the underlying assumptions about economic variables such as fuel costs, inflation and devaluation etc.

Indeed the economic variables turned out to be different from their best guess forecasted values of the 1991 Initial Tariff Agreement. The 1994 Reference Tariff Agreement. Project costs changed due to changes in debt structure, debt sources and elements of construction and development costs that changed due to the long completion period of the project. In addition, the security requirements of lenders were another important factor that changed and resulted in a change in project costs leading to the Power Purchase Agreement of September 1994. Further changes in some underlying variables between 1994 and 1997 can explain the divergence of the 1994 Agreement Costs of $1.5 billion and the actual costs of $1.6 billion upon commissioning. The details of these changes and the reasons for cost escalation are presented below.

Total project costs: From 1991 to 1997, total project costs increased by $353 million or 27%. Project costs increased 66.7% due to construction costs, 19.6% due to other costs and 13.5% due to the reserve fund requirement of lenders.

Construction costs: Over the period 1991 to 1997, construction costs increased by $235.6 million. The majority of the cost increase ($182 million) was from 1991 to 1994. Further increases in costs of $52.7 million were between 1994 to 1997.

Between 1991 and 1994, almost 65% of the increase in construction costs is attributable to devaluation of the rupee. IPPs do not cause devaluation and had Pakistan been a country with a stable currency value, a cost increase of almost $150 million could have been easily avoided.

Between 1994 and 1997 construction cost increased by $52 million. "Contractor's tax liability", "Customs duties" and "Variation in price of construction contract" explain 77% of this increase.

While some construction Costs could be recovered from WAPDA, through the tariff, under Permitted Expenditures, an amount of $25.7 was not recoverable and had to be absorbed by Hubco.

Other costs: These increased by $7 million between 1991 and 1994 and another $62 million from 1994 to 1997 amounting to a total increase of $69 million. Between 1991 and 1994, the increase is mainly emanating from interest during construction, financing fees and other allowed development costs. Between 1994 and 1997, the cost increase is due to insurance, currency and interest rate hedging and project development expenditures. Insurance costs increased due to increase in risk premium by the insurers. Currency and interest rate hedging costs were incurred in accordance with the requirements of the lenders to protect the Company from fluctuations, both in interest rates as well as currency exchange rates, during the construction period.

Reserve funds: Between 1991 to 1997, a notable increase $47 million in project costs is due to Reserve Funds. The Reserve Funds are an additional security requirement of the lenders and were only established on their insistence to provide enough funds for interest payment of project loans. Reserve funds were not part of the Project Costs for the 1991 Agreement because project financing was not complete at that time. Nevertheless, the 1991 Agreement had a provision for any financing costs to be incurred. Financing was largely arranged by the time of the September 1994 Agreement.

Summarizing, we note that although project costs had been locked at US$1.5 billion under the 1994 Tariff Agreement, actual costs increased by another $109.2 million resulting in an actual project cost of $1.6 billion. As explained above, only that portion of these incremental costs could be passed onto GoP that had been agreed in the 1994 contract and subject to very specific cost re-openers. Therefore, only US$ 50 million was charged to the GoP while the remaining US$58.4 million had to be absorbed by the Company without any recourse to compensation through tariff from WAPDA.

Conclusion

The above project cost details demonstrates that there is no truth in the allegation that project costs were inflated due to kickbacks. Each and every cent of the project cost is well documented through audited accounts, which have been approved by WAPDA and GoP through legitimate signatures of high-ranking bureaucrats. To override the statistical evidence presented in this paper with statements that, "all projects in Pakistan are corrupt and involve kickbacks" and "thieves do not leave receipts" are assertions which have no legal value to decide the central question: did Hubco and other IPPs give kickbacks?

If there are kickbacks, the onus is on the accusers to find proof and if found guilty, the Company should be penalized under the laws of the country. If WAPDA has proof, let them show us the amount of kickbacks and the various cost heads where these kickbacks are allegedly hiding. Nevertheless, the State does not have the license to conduct an open ended trial of Asia's largest power plant (Hubco), ruin the economy in the process and adversely affect the well being of our citizens. The issue must be decided soon, as it is already too late.B

HUBCO PROJECT COSTS

In million dollars

Major Cost Heads Tariff Tariff Actual Costs at Increase

Agreement Agreement Commissioning in Costs

June 1991 Sept. 1994 1997 1991 to 97

(1) (2) (3) (3-1)

Construction Cost 862.88 1.045.85 1,098.57 235.69

Other Costs 414.12 421.56 483.54 69.42

Reserve Accounts — 53.35 47.83 47.83

Total Costs 1,277.00 1,520.76 1,629.94 352.94

• June 1991 Project Cost at March 31, 1999 exchange rates

• September 1994 Project Cost & 1997 Project Cost at 1994 Exchange Rates to neutralize the impact of exchange rate changes between 1994 & 1997

• Other Costs include Project Development Costs, Interest & Financing Costs, Insurance & Others