The UFG challenge

Natural gas is the biggest source of primary energy with a share of 46% in the energy mix, followed by oil, contributing another 35%. Pakistan can also boast of one of the largest pipeline networks for gas distribution in the world of more than 145,000 kilometers, servicing more than 8 million customers.

SSGC and SNGPL are the two main gas distribution companies operating in their designated geographical areas. While there may be some small gas pipeline networks by other companies that serve power and fertilizer companies, the two gas utilities that have also recently ventured in the infrastructural development for LNG import, are undoubtedly the energy giants of the country.

Inarguably, every productive body requires a mechanism for maintaining an equilibrium between costs and benefits. It is all the more true for any public sector entity, formed with a vision to serve its customers ethically and professionally.

Globally, the transmission and distribution losses are less than 10 per cent. In case of Pakistan, it is around 15% but may go all the way to 50% in some areas. Let us take the example of SSGC and SNGPL. Compared to other public sector entities, both these utilities have a comparatively clean reputation, especially when it comes to implementing their core activities of transmission and distribution projects in a cost-effective manner, while incorporating best business practices in day to day affairs. They have successfully incorporated state-of-the-art technology in their operations, and have adopted a refreshing customer-centric approach that can be compared to any top utility in the region.

This is just one side of the story, however. For many years, both SSGC and SNGPL have been plagued by a major menace of line losses, which in the natural gas industry parlance is labeled as Unaccounted-for-Gas or UFG. Definition-wise, UFG is the difference between the volume of gas purchased and sold. In other words, UFG is the inevitable imbalance that exists at any given time between the measured gas coming into a utility’s distribution system and the measured gas going out of the same system. This difference is treated as Unaccounted-for-Gas by the regulator – OGRA or Oil and Gas Regulatory Authority in this case – which builds a form of reimbursement for this gas into the utility’s tariff structure.

Ask any manager from one of the two gas utilities about the biggest challenge his company faces and his instant reply will be ‘UFG’. For all intents and purposes, UFG is a serious issue since every 1% increase in UFG takes away around Rs. 1 billion from the gas companies’ profits as a penalty. Gas companies cannot sit over it since the Regulator is watching and watching very intently, wasting no time in penalizing these utilities when they exceed the stipulated benchmark.

While there is no doubt that there is heavy price to be paid for increasing UFG volumes, we also need to look at the factors that have contributed to rising trend. The major contributing factor is gas theft, which constitutes, according to industry estimates, more than 50% of UFG. Probe deeper and one will see that in the case of SSGC alone, the abrupt increase in UFG volume from 38 billion cubic feet (bcf) to 66 bcf in the last five years indicates that rising cases of gas theft, done through direct clamping on supply mains, is primarily due to government moratorium on new connections of industrial, commercial and domestic housing schemes including high-rise buildings. Another contributing factor is the problem of leakages, which make up for around 34% of the UFG pie. Leakages have increased due to an ageing pipeline network, dating back to more than 40 years, diversion of resources that could have been used for rehabilitation to new town gasification as per government directives, third party damages and illegal tapping on the utilities’ distribution network.

In addition, due to mushroom growth of domestic sector, the already existing pipeline network has become under capacity requiring high operating pressures to be maintained, that resulted in higher leakage volumes. Moreover, law and order situation especially in Sindh and Balochistan and in places like Karak in Khyber Pakhtunkhwa, emergence of no-go areas, inability to pay higher bills in winters and increasing cases of meter tampering have also resulted in increasing UFG volumes.

Most of the factors that have contributed to rising UFG levels are beyond the Company’s control. They include illegal connections, gas distribution in economically unfeasible and unmanned areas in Balochistan and KPK, third party damages to pipelines due to non-existence of utility corridor and shift of sale from bulk to retail customers as per the Government policy. On the other hand, dilapidated network, corrosion and weak Cathodic Protection, all of which contribute to underground and overhead leakages, are difficult yet controllable factors.

It is not that the gas companies have remained silent spectators and have not done anything concrete to reverse the poor UFG. For the last five years, while they battled rising UFG and severe OGRA-imposed benchmarks as a consequence, gas utilities have been taking a number of measures to reduce UFG. These steps include indentifying and rectifying underground and overhead leakages as well as measurement errors and conducting regular gas theft raids with the aid of local police and magistrates. There is also a legislation in place to clamp down on theft miscreants, although its outcome has not been very positive. Having said that, the gas utililities still need to do a lot in these areas to arrest the rising UFG trend, through proper monitoring and surveillance as well as by improving the quality of workmanship.

More significantly, since the last several years, for better visibility and understanding of distribution network, the gas companies have created small segments or zones inside the cities to effectively manage, monitor and control the segmented network. At times, they have been able to arrest the declining trend but their delight is generally short-lived. The steep UFG benchmark, as fixed by the Regulator, means that they have a mountain to climb.

UFG disallowance is based on gas losses that are above UFG benchmark fixed by OGRA. The revenue and expenditure of both companies are regulated by OGRA, which decides how much gas is allowed to be ‘lost’ from pipelines. Currently, that benchmark is fixed at around 4.5%. This implies that the cost of any loss over the 4.5% limit is not allowed to be made part of the revenue and the companies have to book it as a loss. For a long time, OGRA has been penalizing both the utilities on account of UFG benchmarks, minimum billing, non- operating costs and non-consumers. SSGC and SNGPL, for instance, were given a temporary court relief for more than three years with a 7% UFG benchmark, that allowed them some profits, before the Regulator fixed the benchmark at 4.5%. It was clearly a case of the companies jumping ‘out of the frying pan and into the fire.’

Weighed down by diminishing returns, both the companies have been crying themselves hoarse at public forums that the benchmark fixed by OGRA at 4.5% is arbitrary and illogical. They argue and for a valid reason too that while they operate under the fixed rate of return of 17%, as determined by OGRA, the actual return for the past few years has remained significantly less than 17% due to disallowances on account of UFG. Perhaps the regulator would do well to consider the ground realities on the home front and not set unrealistic UFG benchmarks that make it difficult for the utilities to operate. Such a formidable benchmark is difficult to meet even in developed economies where the pipeline infrastructure is built on a solid ground and maintenance is a regular affair. In addition, their strong economies mean that the consumers regularly pay their gas bills and not resort to gas theft, for instance. These robust economies can afford to lay down high diameter pipelines that can easily maintain the system at low gas pressures.

While the gas utilities struggle with adverse bottom-line, unreasonable disallowances are not only eroding the gas companies’ profitability but are also wiping out their existing equity. It is about time OGRA seriously reconsidered the UFG benchmark and takes into account the prevalent ground realities by listening to the gas companies’ and direct consumers’ points of views.

It is suggested that OGRA undertakes a comprehensive study aimed at rationalizing the UFG benchmark and bring about an incremental reduction in UFG, by availing the services of a reputable independent consultant that can incorporate in its document relevant feedback with both the Sui companies and other stakeholders. If, however, the existing mechanism of penalty by OGRA continues, the gas utilities, already struggling with a widening demand-supply gap and rising trend of overdues, would be further subjected to a negative cash flow situation.

Gas companies say that they are fighting a decisive war against UFG. The results however are not forthcoming perhaps maybe because they are not as focused as they should be. OGRA too has a major role to play in order avert a national disaster. All it needs is to show a bit of flexibility and seriously reconsider the stringent UFG benchmark that it has imposed on these two companies. If not, the two national treasures, whose contribution to Pakistan’s economy can hardly be overemphasized, would find themselves on the verge of bankruptcy.