The Economic Costs of Lopsided Power Contracts: Evidence from Pakistan
The vast majority of electricity in developing countries is produced and sold through bilaterally negotiated long-term contracts between independent power producers (IPPs) and the state-owned off-taker that are seldom disclosed, making it difficult to ascertain whether value-for-money has been achieved. In a first-of-its-kind effort, we compile a novel dataset of the universe power purchase agreements signed in
Pakistan since private participation began in 1994. We find that the terms of these contracts remove the incentive for IPPs to pursue efficiency improvements because (i) IPPs can pass on all increases in fuel and input costs to the state-owned off-taker via the cost-plus tariff structure, and (ii) IPPs receive monthly fixed payments irrespective of generation alongside a guaranteed return on equity. These contracts were not competitively procured and have resulted in substantial lock-in given their 25-40 year tenures. We further find that IPPs take advantage of the cost-plus structure and low state capacity to conduct regular audits, by artificially inflating their costs. Using confidential financial disclosures on actual revenues and costs for a subset of IPPs, we find that some IPPs earn annual real returns on equity above 80%, far beyond what is contracted (which is typically 20%) and on average, actual profits are 83% higher than what is contracted. We calculate how much cheaper electricity would be if no IPP lied about costs and size the welfare loss of cheating in terms of allocative and productive efficiency. Our results empirically underscore the importance of writing incentive-compatible contracts and the risks of excess de-risking for private investors.
Date: 19 May 2025, 14:15
Venue: Manor Road Building, Manor Road OX1 3UQ
Venue Details: Seminar Room C
Speaker: Sugandha Srivastav (Smith School of Enterprise and the Environment, University of Oxford)
Organising department: Department of Economics
Part of: Environment and Resource Economics Seminar
Booking required?: Not required
Audience: Members of the University only
Editor: Edward Clark