It is crucial for Pakistan to innovate its power purchase agreements (PPA) for renewable projects and provide price stability in order to restore investor confidence, according to a recent report by Haneea Isaad, an Energy Finance Analyst at the Institute for Energy Economics and Financial Analysis (IEEFA).
The report analyzed the effectiveness of incentives provided to the country’s solar and wind projects in recent years and put forward recommendations to address market inefficiencies and project risks before implementing auctions.
Haneea Isaad emphasized the importance of considering the local market context when determining the right incentives. Examples were given of countries like the United Kingdom and Vietnam, where a Feed-in Tariff (FIT) has successfully stimulated renewable energy growth, and countries like South Africa and India, which have achieved remarkable success with reverse auctions. To replicate this success, Pakistan must mitigate risks before introducing any such scheme.
In October 2022, the Government of Pakistan initiated the Fast Track Solar PV Initiatives 2022, a program aimed at replacing fossil-fuel-based power capacity with around 10,000 Megawatts (MW) of solar power. However, despite multiple deadline extensions for the flagship 600 MW solar power project in Muzaffargarh, no bids have been received so far. This lack of interest from project developers can be attributed to the high-risk environment and a low benchmark tariff.
Haneea Isaad highlighted that the removal of the upfront tariff scheme and the delay in initiating auctions have created policy uncertainty, leading to a loss of investor confidence in the stability of renewable energy markets in Pakistan.
As the government moves towards competitive bidding for future solar and wind power projects, it is essential to conduct an honest assessment and address the country’s risk premium. This should account for the high-policy lending environment and financial instability currently experienced by Pakistan.
In Pakistan, solar and wind power projects have traditionally followed two tariff regimes. The first is a Feed-in Tariff (FIT) that guarantees a fixed price over the project’s lifetime or the stipulated duration of the power purchase contract (usually 25 years in Pakistan’s case). The second is a cost-plus tariff regime, which allows developers to recover their initial project costs along with a mutually agreed rate of return.
Haneea Isaad explained that solar power projects in Pakistan have typically followed the upfront tariff introduced in 2014. However, the tariff was gradually reduced until it was discontinued in 2016 when the National Electric Power Regulatory Authority (NEPRA) mandated a shift towards competitive bidding for renewable energy projects.
Similarly, wind power projects in the country have mostly been installed under a cost-plus tariff regime. However, since 2016, the government has decided not to extend this scheme as it transitions towards a competitive model.
The sudden shift towards auctions created a policy vacuum in the renewable energy market, leading to a significant decline in investor confidence and stalling the development of approximately 7 GW of solar and wind energy. Although the government categorized these projects as a transitional mechanism, the decision came after a three-year delay (projects at an advanced stage of development could still proceed under the cost-plus tariff).
While some of these pending projects have recently become operational, others are still awaiting their fate through auctions expected to be conducted in the coming months.
According to Haneea Isaad, when assessing the optimal tariff for solar projects, various underlying conditions are taken into account. Through calculations, a benchmark range of 4.3-5.8 US cents per kilowatt-hour (USc/KWh) has been identified. Furthermore, a shorter power purchase agreement (PPA) duration may be more appealing to developers as it allows for quicker debt repayment and higher short-term profits.
From the perspective of a state-owned off-taker, reducing the PPA duration by five to ten years may result in a slightly higher tariff at present. However, it offers the government the flexibility to negotiate a lower rate in the future when signing a new power purchase agreement. This approach also provides protection against technological advancements, as renewable energy technologies improve over time, leading to lower prices.
In comparison to the marginal cost of production for various types of fossil fuel-based power plants, the calculated tariff range still demonstrates a difference of 5-15 USc/KWh. This solidifies the conclusion that even with a higher tariff, solar energy remains beneficial due to the cost differential between fossil-based power production and solar energy.