PRIVATIZATION OF KESC AND THE KARACHI CHAMBER

For some time KESC will continue managing and continuously improving both Generation and Transmission.

By MUHAMMAD BASHIR CHAUDHRY
Feb 23 - 29, 2004

The Federal Minister for Privatization, speaking at a dinner hosted in his honour at a local hotel by the Karachi Chamber of Commerce and Industry (KCCI), on 17th January reportedly asked the members of KCCI to form a consortium or a business group and come up with a bid for the privatisation of the Karachi Electric Supply Corporation (KESC), which would be undertaken before June 2004. He said KESC has a monopoly market of some 12 million people and already four expressions of interest (EoIs) have been received. He recalled that Wapda had been restructured into several companies of which Jamshoro Electric Generation and the Faisalabad Electric Company would be privatised within this fiscal year. He said he was in favour of opening up the privatisation process so that more and more people could be brought into the process. According to him, the Privatisation Commission approach is based on transparent process, appropriate price as well as the genuine bidders. The President of the KCCI had earlier presented the welcome address.

The invitation by the federal minister to KCCI for forming a group or consortium and making a bid is an encouraging development. Privatisation process for KESC is already on and now it is matter of a few months, when the Karachiites would know what is in store for them. The Karachi Chamber must realize that the new owners would wish to earn a higher rate of return to them, no matter if the electricity tariff or other charges were raised in the process. KCCI members have to review the process as investors as well as consumers and to act fast if they consider meaningful participation in the privatisation process. For this purpose, they need to actively scrutinize how the privatisation scheme has been structured and if need be register their concerns with the government in good time. They might look at this privatisation scheme vis-a-vis schemes for Wapda's generation and distribution companies. This article touches major aspects about KESC privatisation and offers suggestions for consideration by the government and other investors including members of KCCI.

KESC was incorporated on 13th September 1913 under the Indian Companies Act, 1882 as amended to date under the Companies Ordinance 1984. It is listed on all three Stock Exchanges. The Government of Pakistan (GoP) took its control by acquiring majority share holdings in 1952. The Ministry of Water and Power looks after its affairs. It has a customer base of 1.7 million predominantly urban consumers. The age and condition of the asset base varies considerably. The commissioning dates of generation plants range from the 1960s to the late 1990s. The transmission system has a similar age profile. Although KESC has been progressively replacing the older transmission infrastructure, much of the distribution system is old and requires investment. KESC's own generation cost is relatively lower as compared to the rates at which it is obliged to purchase power for meeting deficit, from Wapda, Kannup, Pakistan Steel and the two IPPs. KESC has converted all generating units of Bin Qasim Power Station on natural gas. The immediate impact will be the reduction in fuel cost.

The government handed over KESC's management control to the Army in 1999. The Army management has made progress in a number of areas, such as reductions in commercial losses, decreases in accounts receivable and restructuring of the organization aimed at increasing the quality of customer services and the profitability of the company. KESC had prepared a comprehensive plan, involving an investment of Rs 13,349 million for improvement of the Transmission and Distribution system and to minimize theft of power. The GoP has already agreed to finance the above investment through Budget Funding. After the completion of these projects, T&D losses and theft of electricity is expected to reduce from existing 41% to 24% by 2006. Sometime ago the government had allocated Rs 1.0 billion for revamping electricity system and now a bigger allocation has been indicated for the purpose.

As against KESC's installed capacity of 1,756 MW, its dependable capacity is around 1,200 MW. In addition, KESC has dedicated capacity of 265 MW from private sector IPPs, and small capacity from Kannup and Pakistan Steel. This is not enough to fully meet the maximum system demand estimated around 1,900 MW. The gap ranging from 250 MW to 500 MW is met with power supply by Wapda under special arrangements. During the next 3-4 years, the power supply deficit is expected to increase to around 1,000 MW and would keep increasing if new power plants were not established or power supply from other sources such as Hub Power Company does not materialize. KESC has been experiencing abnormally high transmission and distribution losses in the past 10-12 years although the position has somewhat improved in the recent years under the Army management. In 1989-90 T&D losses stood at 20.84 per cent. Since then situation deteriorated each year and the T&D losses increased to 40.23 per cent in 1999-00. One can imagine the improvement in profitability if T&D losses were brought down to reasonable level.

KESC suffered a loss of Rs 12.787 billion in 1999-00 that increased to Rs 16.201 billion in 2000-01. For FY 2001-02 and FY 2002-03, KESC experienced loss of Rs 17.741 billion and Rs 8.143 billion respectively. Major portion of the losses has been due to high T&D losses and high interest cost on borrowings. The government had reduced KESC's debts through debt-equity swap and the beneficial impact is evident for reduced losses for the year 2002-03. KESC can turn around and show profits if it is able to reduce T&D losses to about half of the present level. Theft of electricity in the KESC system is cited as one of the reasons for such high losses, despite which KESC survived only due to determined help and financial support from the government. The government has kept KESC operational for the Karachiites by pumping in huge cash as well as supporting its management. Such support, however, is not sustainable.

KESC's total assets have slightly declined from Rs 65.491 billion in 2001-02 to Rs 65.090 billion in 2002-03. During the period, its total liabilities that stood at Rs 103.430 billion in 2001-02 have reduced to Rs 45.999 billion in 2002-03 as a result of capital restructuring. To improve the financial health of KESC and increase its attractiveness to potential investors, major capital restructuring has been implemented whereby Rs 83 billion of debt was swapped for equity by the Government. Additionally, a capital reduction of Rs 57 billion was made to offset the accumulated losses. As a consequence GOP's shareholding in KESC has increased from 65% to about 98%. Due to restructuring, the interest burden has significantly reduced and the deficit on the reserves has been eliminated.

EXISTING PRIVATISATION SCHEME: The government on 7th October 2003 had invited EOIs from qualified utility operators and strategic and financial investors interested in acquiring up to 73% of equity in KESC, with management control. Salient points of the scheme as announced are: (i) Unique opportunity to acquire controlling interest in the integrated power utility for generation, transmission and distribution of electricity to Karachi, the largest industrial and commercial city in Pakistan. (ii) Commitment to continue support by GOP during turn around period. (iii) Possible co-investment by ADB which may also be willing to take an equity interest of 7.67% from available 73% at privatisation. (iv) In addition to Karachi, KESC supplies power to the industrial areas of Thatta (in Sindh) and Lasbella (in Balochistan). (v) In total the KESC franchise area covers approx. 6,000 sq. km with a population in excess of 12 million; and (vi) The government has undertaken to continue with the approved current investment programme (until June 2006) to upgrade transmission and distribution system and to underwrite the formula based tariff regime as determined by NEPRA, in September 2002.

The present scheme of privatisation involves selling it as an integrated electricity utility. All generation, transmission and distribution assets are being offered together as a block to the private investors. The monopolist position of the integrated utility would stay; merely its ownership will transfer through privatisation from public sector to the private sector. If this is the case, the scheme might not deliver full potential benefits of privatisation to the country, the consumers, local businesses and the investors. Competition is essential for ensuring relatively lower tariff and better services to the consumers; this might not be possible immediately but the privatisation process should aim at that. Moreover, privatisation is largely for controlling Distribution losses, as Transmission losses are relatively small. The point is why privatise the Generation and Transmission as well when the problem is mainly with Distribution. Why not start with the spin-off of the Distributing from the main body? Let the private sector assume Distribution function and earn profits through better control of distribution losses.

The factors like shortage of firm generation capacity as compared to demand, snags in buying deficit power from Wapda or other sources, more uncertainties in case of privatisation of Jamshoro Generation, abnormally high T&D losses, financial losses coupled with poor financial position, power system needing major revamp, law and order situation and excessive manpower, etc have a bearing on the privatisation of KESC. The interest so far shown by the international bidders has not been entirely unpredictable as privatisation of integrated utility in one block entails much larger upfront investment outlay, purportedly exceeding their acceptable risk and returns profile. As against usual 51% shareholding sale here 73% shares are on offer while the sale of shares to general public through the stock exchanges has been totally ignored. In stead, a multi-stage approach as described below is expected to attract more investors and is likely to yield better results.

NEW APPROACH TO PRIVATISATION OF KESC: Starting the privatisation process with spin-off of the Distribution function to a number of private sector companies may facilitate participation by local investors; introduce more competition with possibly better sale price to the government and regular supply of electricity to the people at competitive cost. At present the KESC has 50 or so grid stations. Depending on number of consumers and geographical spread, each Power Distribution Company (PDC) may initially be allowed electricity distribution in the area now covered by seven to ten grid stations. For the time being, the KESC will sell power in bulk to each PDC and meters at each grid station will record energy sold. Under this arrangement, there will be arms length relationship with the KESC and / or pother power generation companies and therefore the allegation of pilferage energy at bulk level will be sorted out. This will be the beginning of the competitive pricing at bulk and retail level. Also, each PDC will initially take on its roll all KESC employees associated with the distribution. In due course one PDC may acquire the other PDC or they may decide to merge for better synergy. While continuing purchase of power generated by KESC, the PDC may in due course start bulk power purchase directly from Kannup, two IPPs in the area and other sources that emerge in the meantime. To meet the supply gap, the private sector may install additional generation capacity for bulk power sale to PDCs. This arrangement would be more conducive for privatisation and the local investors would be able to easily finance the investment.

For some time KESC will continue managing and continuously improving both Generation and Transmission. As long as KESC retains its generation and transmission assets, it would have fewer problems in obtaining power supply from Wapda's generation companies as well as from the Hub Power Company. In the next phase the government might sell KESC's generation assets to two or three private sector companies. In the end the KESC will be left with bulk Transmission Grid in its license area. This might in due course be merged with National Grid owned and operated by NTDC, a company that has emerged from restructuring of the Power Wing of Wapda. . Karachi, the port city and financial centre of the country, has a number of large industrial estates in its fold. KESC provides electric power to the city and all the industries located in and around the city. Karachi and KESC, both are of critical importance for the country's economy. One may not flourish for long without prosperity of the other. Therefore, the government and the industrialists / businessmen are all urged to give special consideration for resolving privatisation and rehabilitation issues of KESC, which is much more than a public sector utility. In the circumstances, it is up to the resourceful members of the Karachi Chamber to join hands and take the leadership role for public good of ensuring regular power supply to the consumers at reasonable rates. They are also urged to realize that within the cosmopolitan area there is urgent need to take similar positive initiatives for resolving problems of water, sanitation, sewerage, health and education confronting the Karachiites.