Bangladesh Energy Policy Note for the New Government

Bangladesh—Energy Policy Note for the New Government

Abstract—Bangladesh suffers from significant shortages of power generation capacity and natural gas. Addressing these problems will require concerted action to improve services, restructure energy sector finances, and bolster governance. In parallel, fuels and power policymaking coordination should be improved in order to address medium and longer term issues (such as assessing the place of coal-fired power in the generation mix, and considering energy trade options). The World Bank Group is ready to support Bangladesh to address comprehensively its energy sector challenges, complementing the assistance from other development partners.

Development Challenges

Bangladesh is in the grips of a serious energy crisis with multiple dimensions. The country is about 25% short of meeting peak electricity demand, on a capacity basis, and over 10% short of meeting the daily demand for natural gas. The power sector bears most of the brunt of gas curtailments, exacerbating power shortages at peak times. Operationally, the gas and power sectors suffer from high inefficiency and poor governance; as a consequence the sector is financially very weak. The power sector already relies on budget transfers to meet at least 10% of its operating expenses, and generates virtually no internal surplus to contribute to sector investments. The gas sector is now operating at a loss and could become an even greater burden on the national budget without sustained price and other commercial reforms. The national budget is heavily exposed to global energy market price volatility, as was vividly demonstrated by the huge debts rolled up by BPC in 2007 and 2008 during the oil price spike. Meanwhile, the legacy of past political interference and corruption has severely weakened the institutional capacity of the sector and is a direct contributor to almost every problem afflicting the sector. The country is getting neither the affordable, efficient energy needed to power economic growth, nor is it able to sustainablyincrease access to energy services. Reform is urgently needed if investment to the sector is to be attracted.
In spite of the long-standing problems afflicting the energy sector, Bangladesh has been growing at an impressive rate of around 6% over the past decade, and this growth has contributed to poverty reduction and the progress towards meeting the Millennium Development Goals (MDG’s). Many factors will determine whether or not Bangladesh can accelerate its growth rate in a sustainable manner to 8% or higher, which will be necessary for continued achievement vis-à-vis the MDGs. But it is no exaggeration to say that, without solving the energy crisis, it will not be possible to achieve such a structural shift to higher growth rates.
Improving service delivery quickly and sustaining those improvements will require a focus on attracting efficient investment in power generation and natural gas supply. All reform measures – such as financial restructuring, increasing operating efficiency and reducing losses, demand-side measures, regulatory actions, etc. – need to be designed and implemented to maximize impact on attraction of investment, from public and private sources, in the short-term. In parallel, Government needs to advance implementation of public sector gas and power projects that are already financed; and take at least some energy efficiency measures that would allow better use of existing supply, and might reduce future requirements.

Past achievements and the remaining challenges

Bangladesh has had some notable successes in development of its energy sector. At independence, it had only a limited amount of functioning generation and rural areas were almost completely un-electrified. Since then, about 5,000 MW has been connected to the grid by both public and private means, and millions of customers have been added, including about 6-million in rural areas. However, many challenges remain. A household electrification rate of about 40% has been achieved, but only one in five rural households has a connection and service quality is poor. All customers experience at least some load shedding; during peak periods over 1,500 MW of load is shed, because of generation and gas constraints. Bangladesh needs to add generation, but even if current projects are implemented efficiently, power shortages will persist for some years, as the table below shows. And once the country is in balance, there will be a requirement to add 500 to 1,000 MW or more on an annual basis, to keep up with load growth.

Medium-term projection – Bangladesh power sector capacity/peak demand balance 2007-2012
Year / Maximum Capacity (excluding captive) / Peak Demand / Reserve Margin
2007 / 4,200 / 5,000 / -16%
2008 / 4,500 / 5,250 / -14%
2009 / 4,800 / 5,513 / -13%
2010 / 5,100 / 5,788 / -12%
2011 / 5,850* / 6,078 / -4%
2012 / 6,750** / 6,381 / 6%

*assumes one 450 MW IPP, as yet uncontracted. **assumes two 450 MW IPPs, as yet uncontracted.

Source: Bank estimates based on GOB data.

Past projects suggest considerable potential for the Bangladesh energy sector. In the rural sector, REB, supported by government and its donor partners, was able to build an international recognized system for efficiently expanding and operating rural networks. While REB went through a difficult period of governance in recent years, a strategy update is underway and the institution is poised for new growth—provided that adequate generation can be supplied. In the generation sector, the two world-class IPP projects developed in the late 1990s were able to virtually eliminate the supply gap when they came on-line in the early years of this decade. In regulation, BERC was floundering during the period before the Caretaker Government, but it has now shown considerable potential for transparent and credible regulation of the energy sector. On the corporatization front, DESCO and PGCB have thrived, relative to many other entities in the sector, and demonstrate the potential governance benefits of corporatization (and of partial, local market flotation of shares).
The Bank supports public and private investment in generation; in October 2008, the $350-million Siddhirganj Peaking Power Project was approved, and the Bank additionally provided a guarantee for the Haripur Power Project and wholesale financing that allowed IDCOL to provide senior and subordinated debt to the Meghnaghat IPP. These IPPs now account for 20% of Bangladesh’s generation capacity and they have proven be reliable and cost-effective projects. A successful project supporting rural electrification and renewable energy is being extended through the provision of an additional $100-million in financing. Policy and regulatory support is provided through a technical assistance loan which has also recently been extended. A development policy credit, supporting power sector reform, of $120-million in budget support was agreed in June 2008 and was disbursed in full at that time. The Bank has had preliminary discussions with Government concerning possible financing support for projects in energy efficiency, urban distribution, and natural gas production and transmission.
In the gas sector, the country has successfully developed a portion of its onshore reserves, but ultimately exploration, development, and production growth has not kept pace with demand, and Bangladesh is now short of gas. One factor driving demand growth has been pricing—gas prices are set at low levels, when compared with regional and global comparators. Even with recent price increases, average consumer prices for gas in Bangladesh are much lower than competing fuels, and much lower than their economic value. It will therefore be critical that BERC continues to advance price reform. In parallel, a major push will be needed on the exploration and production front that addresses all areas of production—onshore, where national firms and IOCs operate, and offshore, where only IOCs have the right capabilities but where Bangladesh has not been able to attract investor interest (including a disappointing licensing round in 2008). Given the current situation, incremental short-term supplies will need to come mainly from the onshore, both from existing fields and lower risk exploration areas; but in the longer-term, without exploration success offshore, the supply scenario is bleak.
It is vital that reform of energy sector institutions continues. The basic strategic approach of GOB has been corporatization of state-owned operating entities, with the possibility of minority flotation of shares in the local stock market. Given the political economic context, the basic strategy is sound and has been validated in some cases, such as DESCO and PGCB. Institutional strengthening of corporatized entities should continue, in parallel with efforts to build capacity at BERC. Additional challenges will be to agree a corporatization model for the non-operating holding companies DESA and BPDB, and a strategy for Petrobangla and its component pieces. The Bank has supported institutional development in Bangladesh through various means, most recently with the $120-million Power Sector Development Policy Credit that was approved during the tenure of the Caretaker Government and supported financial restructuring, IPP development, commercialization, regulatory reform, and rural electrification strategy.

Reform options and related policy changes

Bangladesh faces the challenges of taking short-term actions that could help reduce the supply gaps in generation capacity and gas supply, while advancing reform and bolstering governance over the medium term. Theseparallel processescan be strongly facilitated through better integration of power and gas sector policy and planning; and a rapid empowerment of BERC to become an effective sector economic regulator. The policy framework that the new government will inherit may not merit wholesale changes. Existing policies recognize the necessity of both public and private investment, the need for governance and corporate reform, the importance of full commercialization of energy services, and the need for equity and social protection concerns to be addressed. In some respects, the nature of the crises afflicting the sector also narrows the range of options that the incoming government will have. The power supply crisis, for example, cannot be addressed unless there are priority actions taken in the gas sector; similarly, the need for financial restructuring in the power sector will limit the range of options related to pricing and subsidies. But the overall policy framework should be reviewed, and tweaked as necessary; and urgent attention does need to be paid to ensuring better implementation.
Combined power and gas sector investment requirements over the next 10 years have been estimated at about $1.5-billion per year, and that amount cannot be financed exclusively from public sources (donors included). Bangladesh will need to find a way to structure investment opportunities so that a significant portion of incremental power generation and gas supply capacity in the country can be privately financed. No policy changes, per se, are necessary to achieve this, as power generation and gas exploration and production are already seen as key sectors for private investment. But Government will need to recognize that the currently low level of private investment in these sectors is a reflection not of the potential of the market, but rather of the problems that have been encountered in implementing policy reforms – especially those that have contributed to sector financial weakness. For new deals to get done, and to get done in a reasonable amount of time, the financial basis for investing in the sector will need to get reviewed, and, as necessary, enhanced.
Policy Status, Coordination and Implementation—During the tenure of the Caretaker Government, some steps were taken to develop policies relating to coal, renewable energy, and public-private partnerships, among other areas; in some cases, as for renewable energy and PPPs, policy guidelines were issued. In parallel, however, pre-existing policies have only been unevenly implemented. The new government will want to develop, relatively quickly, clear priorities so that critical policies are implemented in an effective manner, and so that policy implementation does not become an even greater bottleneck. It will be challenging to determine how rapidly a much more liberal energy market, as envisioned by the recent PPP policy, can be implemented. The full suite of policies will need to be considered in light of overall economic priorities, and allocation of scarce gas and electricity supply will need to be considered in light of these priorities. One immediate concern that can be addressed is coordination across the different divisions of MPEMR, which has often been very poor; the new oversight cell that has been established might help in this regard.
Power Generation Capacity—Generation capacity needs to be added, and existing capacity needs to be more reliable and efficient. The significant pipeline of projects in the public sector needs to be implemented efficiently, and the IPP program needs to be revived. A much more focused and efficient (but still transparent and competitive) effort needs to be mounted to get the private sector back into Bangladesh to build and operate baseload generation. An immediate concern is that, at this point, there is no transaction advisory support for Government; absence of advisory support will affect transparency and quality, and will eventually make transactions either more expensive, or impossible to bring to financial close. GOB needs to enlist a credible transaction advisor so that it can go back to the market in a structured manner.
Gas supply—The chart indicates the challenge facing Bangladesh. The country is gas-prone, but an inadequate investment framework has meant that in practice, not many exploration wells have been drilled. Proven gas reserves may fall steeply after 2011, and new investment is urgently needed to get firm up probable reserves and get them into production, and to find new gas. Immediatedebottleneckingof existing gas supply infrastructure (including existing fields) will help, but new investment for new exploration and development must be attracted. To increase output, GOB needs to look at four areas: 1) current producing areas managed by SOEs; 2) current producing areas managed by IOCs; 3) onshore areas that are reserved for SOEs but are not being exploited; and 4) offshore areas including the deepwater. The terms and conditions governing private sector involvement in all these areas need to be reviewed. This does not mean that there is no role for the state-owned producers, and some public investment in E&P is justified; but public investment alone will not be enough. Should Bangladesh not succeed in changing the outlook for domestic gas supply, there will be a number of important implications. First, the country will need to look urgently at imports. Second, overall power generation costs will increase, as the country turns either to imported gas, or to coal (whether domestic or imported). Third, it is possible that somegas transmission investments will be wholly or partly stranded; GOB therefore needs to be somewhat cautious on expansion of gas transmission.
Natural Gas Consumption by Sector—The demand side also needs to be looked at; burner tip efficiency could be improved, and there is known to be substantial commercial leakage. But the country is reaching the point where the viability of serving some customer segments may be in doubt, and hard decisions may need to be made about how to allocate gas among many competing customer groups. In particular, in the current supply scenario, good policy might argue in favor of hard limits on the allocation of gas to small users and households. Currently, the power sector bears almost the full brunt of the gas shortage, at high economic cost to the country. Government will also need to decide on whether, and how, to manage consumption growth in the CNG sub-sector. Managed allocation would become less necessary, the more that prices were tied closer to market levels; and clearly, the more that exploration can be incentivized and then actually succeeds.
Price Reform and Financial Restructuring—As the chart shows, there is an immediate prospect of BPDB’s finances further deteriorating. If that happens, attraction of new investment in power generation would be affected, because BPDB is the key bulk buyer of power in the market today. Both price and non-price steps will need to be taken. BERC is now leading on adjustments of gas and electricity prices, and the recent steps that have been taken on prices are laying a reasonable foundation on which to build. In parallel GOB agencies (MPEMR and MOF especially) need to advance financial restructuring decisions, so that non-price measures are taken as well (these will have the effect of minimizing the future requirement for upward price adjustment). Price reform and financial restructuring need to go beyond just meeting operating cash needs of entities and, in time, shift to encompass investment requirements, which are well over $1-billion per year in requirements and cannot be met without an increased self-financed component.
Corporatization, Commercialization, and Energy Efficiency—Institutional development is essential for the 6 urban distributors (focusing on advancing corporate and commercial reform) and REB/PBSs (focusing on the on-going strategic review and then seek rapid implementation of core recommendations). This needs to be integrated with the price reform/financial restructuring because these utilities need a firm financial basis on which to operate. Implementation of automated meters (complemented by a dedicated large customer department at utility level) for all large consumers of gas and electricity should be a priority, combined with demand-side management analysis for those same consumers (leading to investment in energy saving equipment or techniques). The 6 urban distributors need to be brought under strengthened BERC regulatory oversight, and an effective regulatory framework for the PBS’s needs to be developed that clarifies the respective roles of REB and BERC.
Regional Energy Trade—within the medium term timeframe, it will be imperative to develop the policy framework within which energy trade possibilities can be developed. An immediate opportunity that could be considered is construction of electricity exchange infrastructure between western Bangladesh and India, because there are immediate financial gains to be made by backing out oil-fired generation (including, where possible, diesel irrigation pump sets) with imported electricity from West Bengal, which ahs surplus capacity. Gas import possibilities do need to be assessed, but the priority should be on increasing domestic gas reserves, not importing gas (or rushing to develop coal). Importing power from India, on the other hand, is something that could happen soon, and, because much of it would back out oil-fired power, would reduce BPDB’s overall expenditures. Other schemes, which might have longer lead times, include consideration of imported hydroelectricity from Himalayan nations, and broader trade initiatives, including energy trade, between Bangladesh and northeast India.
Coal Development—the lead-time for getting new coal mines and associated power plants into operation is such that coal-related developments should not be seen as short-term solutions to the current power generation shortage. The Caretaker Government had been working on a coal policy, and this effort should continue; but it will be advisable to involve key stakeholders, including financiers, in the process. Given the high costs associated with large-scale coal mining and power generation investments, and the environmental and social impact risks, it is essential that Bangladesh adopt a policy that makes sense at both the local and national level. If Bangladesh is able to address its gas policy issues expeditiously and effectively, there is time to get the coal policy right, which will position the country for a more measured move into that fuel when it is needed.
Corporatization/Restructuring of BPDB and Petrobangla—the Bank will not take a position on BPDB Holding Company Corporatization and Petrobangla strategic restructuring until we have had a chance to look at detailed plans and understand the consensus behind such plans. The Bank would be concerned about implementation of suchplans in the absence of technical support from one or more development partners.
Conclusion—Clear priorities will be the key to making an early impact in the energy sector. The new government is on target in identifying gas supply, power generation capacity, and project implementation as the key foci of policy in the short-term, and has created an oversight cell to ensure better coordination within MPEMR and more effective project development and implementation. Financial restructuring and operational and demand-side efficiency measures will contribute directly to meeting these short-term objectives. A range of issues need to be addressed in a medium-term timeframe that can complement and build upon short-term measures. These issues include regional trade, coal, market restructuring, social protection, and further institutional development (including attraction and retention of human resources), among other issues. The Bank is ready to assist, with advice, facilitation, and financial resources, in close cooperation and coordination with other donor partners as required.