China in Pakistan’s Energy Sector: The Hidden Costs Behind Pakistan’s Energy Overcapacity

According to the Economic Survey (2023-2024), Pakistan’s electricity generation capacity is 42,131 MW – almost double the domestic electricity demand. Yet Pakistan remains the only South Asian country suffer from chronic power shortageswith load shedding being rampant even in big cities like Karachi. A Bloomberg report revealed that after electricity rates were sharply hiked in May 2024 to secure an IMF bailout, powering a home in Pakistan could cost more than renting one.

The incongruity of an ample energy supply amid persistent shortages and sky-high costs has flared up again public criticism of Pakistan’s independent power producers (IPPs)particularly Chinese IPPs under the China-Pakistan Economic Corridor (CPEC). At the heart of the problem are the high ‘capacity payments’ imposed by Power Purchase Agreements (PPAs), which oblige the government to pay the IPPs regardless of electricity consumption or even production. The public has increasingly demanded it renegotiation of these agreementsespecially with CPEC energy projects, to address inflated tariffs and reform Pakistan’s energy sector.

Beginning of private energy production in Pakistan

From the beginning, Pakistan relied on hydropower, with US-backed projects such as the Mangal and Tarbela dams. In the 1980s, rising energy demand exceeded infrastructure capacity, which particularly affected the industrial sector. While Nawaz Sharif’s Pakistan Muslim League-Nawaz (PML-N) spearheaded economic liberalization in Pakistan and introduced the first private energy producer HUBCO, Benazir Bhutto of the Pakistan People’s Party (PPP) is credited privatization of the energy sector. The PPP introduced the transformative energy policy of 1994. Titled ‘Policy Framework and Incentive Packages for Private Sector Power Generation Projects in Pakistan’, it aimed to attract foreign investment with support from the World Bank, thus encouraging the growth of independent energy projects.

Policy highlights were 15-18 percent dollar returns on equity, capacity and energy payments by Pakistan Water and Power Development Authority (WAPDA), low taxes and Foreign Exchange Risk Insurance (FERI) from the state bank. These measures led to $6.5 billion in investments, adding 6,500 MW to the grid through the 19 IPPs commissioned under the 1994 policy. The reforms were that internationally acclaimed as a model energy policy, which was even described by the US Secretary of Energy during a visit to Pakistan in 1994 as ‘the best energy policy in the world’.

Contractual obligations had to be met in 1998 became difficult for the PML-N government. Subsequent policies, such as the 2002 Energy Policy, reduced returns to 12 percent and eliminated bulk tariffs but retained capacity payments. Over time, dependence on fossil fuels and dollar-indexed returns has exacerbated Pakistan’s circular debt. In 2013 the The energy shortage peaked at 5,500 MWwith expensive imported thermal fuels putting pressure on reserves and exacerbating the sector’s financial crisis.

Enter CPEC

In 2014, the PML-N government facilitated China’s entry into Pakistan’s energy sector through the China-Pakistan Economic Corridor (CPEC)the flagship project of China’s Belt and Road Initiative (BRI) connecting Gwadar to Kashgar. Initially valued at $48 billion and later expanded to $62 billion, CPEC was hailed as a “game changer” for Pakistan’s economy. Most investments were focused on the energy sector, in line with Nawaz Sharif’s election promise to end electricity shortages.

Of the $62 billion, nearly $35 billion financed 21 energy projects, most of which were coal-fired, contributing as much as 6,000 MW to Pakistan’s national grid. However, these projects increased national debtwith financing structures showing a debt/equity ratio of 75 percent. Many Chinese IPPs reportedly enjoy exorbitant returns on equity – 27 to 34 percent – ​​guaranteed by the government, which is much higher than the 1994 rate of 15 to 18 percent.

While these projects have addressed some energy shortages, load shedding persists even in major cities like Karachi. Critics argue that CPEC energy projects burden Pakistan not so much with investments, but with unsustainable loans and high electricity costs. Despite significant capacity expansions, affordable power remains elusive for households and industries, raising questions about the long-term benefits of CPEC’s power agreements.

The PML-Ns electoral promise and rising energy demand in Pakistan has catalyzed China’s entry into Pakistan’s energy sector. The CPEC signed in 2014 had power generation as one of its key components besides a network of roads, railways and industrial parks. China’s priority was on connectivity projects, but the Pakistani government wanted much of the initial CPEC funding to go to energy. Energy-starved Pakistan under the PML N government was about to do just that Add 30,000 MW to the national electricity grid by 2022, by which time nearly eleven projects had been commissioned, supplying over 6,000 MW to the national grid.

Beijing has poured billions into Pakistan over the past two decades; As a result, Pakistan has the largest Chinese-funded energy portfolio in the world. Auxiliary dataa research institute in the United States, found that Pakistan’s debt exposure to Beijing was as much as $67.2 billion for the period 2000-2021. CPEC has added almost $26 billion to Pakistan’s national debt. CPEC-related foreign and foreign-backed investments are largely, if not almost exclusively, in the form of loans. This caused a balance of payments crisis in Pakistan.

The government of Pakistan Tehreek-e-Insaf (PTI) Prime Minister Imran Khan often is touted for slowing down the pace of CPEC projects. Khan’s government has been critical of the CPEC project from the start. While he approached Beijing for a bailout package when faced with declining foreign direct investment, China’s refusal forced Khan to approach the IMF, securing the first bailout worth $6 billion.

During Sharif’s rule, CPEC acquired the status of a larger-than-life economic project. But under Khan it was a minister openly critical of CPEC and accused the PML-N of signing unfair contracts with Chinese companies. Khan even formed a nine-member committee to evaluate CPEC projects. Some publications such as the Singapore Post reported that Chinese leaders are more comfortable working with the PML-N’s Shehbaz Sharif than with Imran Khan.

Chinese IPPs and Pakistan’s Energy Problems

Amid broader debates over CPEC and Pakistan’s financial situation, IPPs have emerged as a lightning rod. The IPP debate in Pakistan is not new media have emphasized thisbut criticism reached new heights when energy prices soared. Last year saw former interim minister and textile lobby leader Gohar Ejaz calls for the scrapping of IPP contractswho were responsible for exorbitant electricity prices in Pakistan.

The contracts with IPPs, which also include capacity payments and guaranteed returns, contribute to the circular debt in Pakistan’s energy sector. Ejaz highlighted that the capacity payments (fixed payments to power producers regardless of whether the electricity is used or not) paid to IPPs within a month are costing Pakistan a lot of money 150 billion rupees (about $540 million) per month. According to Ejaz, some power stations in Pakistan have received capacity payments despite no power supply. Some plants like it Sahiwal Power Plant and Port Qasim Electric Power Company Limited have increased their start-up costs, taking advantage of Power Purchase Agreements (PPAs) that also allow power producers to self-invoice. The capacity payments to IPPs represent Pakistan’s third largest debt obligation, after defense and external debt.

In an interview with Voice of America, Pakistan’s Energy Minister Awais Leghari admitted that contracts with Chinese energy producers that built and operated power plants in Pakistan need to be reviewed. Before the CPEC power projects started, Pakistan paid 384 billion rupees in capacity payments to the IPPs in 2015. However, after the addition of CPEC IPPs, Pakistan’s capacity payment bill has increased to Rs 2,124 billion per year. Today, the Pakistani government pays more in capacity payments to the Sahiwal coal-fired power plant – jointly built and owned by two Chinese state-owned companies – than it paid to all IPPs combined in 2002.

The CPEC’s energy policies and projects helped Pakistan achieve excess capacity in energy generation, but they failed to deliver on Nawaz Sharif’s election promises. The excessive debts that have piled up – especially Chinese debts – have pushed Pakistan to buy electricity at high rates despite a power surplus. Yet Islamabad’s repeated calls in 2024 to restructure its $15 billion energy debt have fallen on deaf ears in Beijing.