| By Arif Rafiq

Nearly three years have passed since the China-Pakistan Economic Corridor (CPEC) was formally launched. Several projects have come online, and a critical mass of electric power and infrastructure projects will be operational within the next 12 to 18 months. Now, more than halfway through the first of CPEC’s three five-year phases, is an opportune moment to assess how Beijing and Islamabad have fared so far in pushing forward the massive, fifteen-year connectivity project, valued at upwards of $62 billion.

Electric Power Projects Move Forward at Breakneck Speed—But at a Premium

Electric power projects make up the largest share of the CPEC portfolio in terms of cost. The CPEC energy portfolio—presently 17 projects valued at nearly $20 billion—has seen mixed results, including some major successes. But Pakistan’s pursuit of electricity at breakneck speed has come at a cost: it will likely eliminate its electric power shortfall by 2019, but the energy will be expensive compared to regional competitors.

Several electric power projects have been completed ahead of schedule. These include the Sahiwal Coal Power Project, which involved a number of moving parts: the construction of coal jetties at Port Qasim, the procurement of coal hopper cars to transport imported coal upland via Pakistan’s troubled, but improving, state-owned railway, and the construction of last-mile extensions of the main railway line.

Despite the somewhat complicated logistics, commercial operations of the Sahiwal Coal Power plant began roughly a year earlier than is typical for such projects, due to the combined speed of Chinese engineers and the high expectations of Shahbaz Sharif, the chief minister of Pakistan’s Punjab province. According to a report in The Economist, “floodlights were hung from cranes so construction could continue through the night.”

Similarly, the first 660W unit of the Port Qasim coal power project was inaugurated late last year, several months ahead of schedule. The second 660MW unit was put into service in late January of this year. In the Sindh province, three CPEC wind power projects have also come online.

In the remote Thar region of Sindh, two large-scale lignite mining projects have moved forward along with associated mine mouth power plants. Progress on these two projects has given momentum to other mining and mine mouth power plant projects in Thar that had been on more tenuous footing, including a joint venture between Yanzhou Coal and the UK-based Oracle Power PLC.

There have also been some noticeable failures on the energy front, mainly in terms of poor project selection and negotiation of commercial terms.

Shortly after CPEC’s launch, Pakistan attempted to go big and quickly struck out with the massive Gadani Coal Power Project, which consisted of ten 660MW coal power plants totaling 6600MW of installed generation capacity. The jetties for the project would have cost an estimated $1 billion, but Pakistan failed to attract investor interest for the expensive project. Despite this, Pakistan has shown adaptability since Gadani was shelved, opting for regasified liquefied natural gas (RLNG) plants outside of the CPEC framework, which have come online at lightning speed.

Over 70 percent of installed electric power generation through CPEC comes from coal. Efforts to complement coal energy with renewables have lagged. The Quaid-e Azam Solar Power Project remains in limbo due to opposition from the Chinese project sponsor, Zonergy Energy, to the downward revision of the exceedingly high upfront tariff from 14.5 cents/kWh to a more reasonable, but still high, 9.5 cents/kWh. After Zonergy installed 300MW of the 900MW capacity stipulated in its contract with the Punjab provincial government, the project has been stuck in litigation.

Pakistan has poorly negotiated upfront tariff rates and has offered exceptionally high internal rates of return (IRRs)—20 percent for some projects—to encourage greenfield investments in areas like Thar.

Chinese companies and Pakistani cosponsors have benefitted from at least $1.35 billion in tax exemptions through CPEC. But even for CPEC power projects with lower IRRs than in Thar, upfront tariff rates are not meaningfully different from similar projects in other countries. In some cases, they are even higher. This begets the question: what is the benefit of CPEC to the Pakistani electric power consumer?

For example, the levelized tariff of the 1320MW Port Qasim Coal Power Project ($0.0836/kWh) is higher than similar projects in Bangladesh involving Chinese sponsors, such as the 1224MW Banshkahli Coal Power Project ($0.08259/kWh) and the 1320MW Payra Coal Power Project ($0.083089/kWh). CPEC security surcharges added to the electricity bills of Pakistani consumers will make the new electric power even more expensive. The government of Pakistan will likely have to issue bonds to pay end-user arrears to electric supply companies.

The combination of high upfront tariffs and surcharges will complicate Pakistan’s efforts at tariff rationalization, force the state to continue or increase costly subsidies, and make it difficult for Pakistan’s garment exports to compete with exports from Bangladesh and Vietnam. Pakistan’s comparatively high electric power prices can be offset by a concerted effort to combat transmission and distribution losses and an industry-led effort to make manufacturing logistics and supply chains more efficient.

Political Consensus Forged in Pakistan, But Remains Tenuous

Political rivalries and inter-provincial disputes made their way into the CPEC debate early on, largely as a result of missteps by the Pakistani federal government and political rivalries between the Pakistan Muslim League-Nawaz (PML-N)—which rules at the center and in the largest province, Punjab—and the Pakistan Tehreek-e Insaf (PTI), the second largest party in the National Assembly and the leader of a coalition in the Khyber Pakhtunkhwa province.

The disputes mainly stemmed from disagreements over the equitable distribution of CPEC projects. Political forces from Pakistan’s smaller provinces claimed that the allocation of resources was skewed heavily in favor of the Punjab province, where the PML-N is based.

Inter-provincial tensions were quelled in December 2016, when all four of Pakistan’s provincial chief ministers representing the country’s three largest parties attended the Sino-Pak Joint Coordination Committee—the highest bilateral decision-making body on CPEC. At the meeting, infrastructure projects for all provinces were provisionally added to the CPEC portfolio. But there remains a risk that projects in the smaller provinces—including public transport projects in Peshawar and Quetta that require operational subsidies—are not economically viable and may not receive Chinese funding in the end. This would lead to renewed discontent in Pakistan’s periphery.

With general elections slated for later this year, political transition also brings some uncertainty to CPEC. Beijing has tied its fortunes in Pakistan to a democratically-elected civilian government and a single political party unlike ever before. It will have to navigate the choppy seas of Pakistan’s politics leading up to and following general elections as civil-military relations remain tense. The Chinese seem to prefer stability and the status quo, but they have been active in building ties with a broad spectrum of political actors inside Pakistan. One recent manifestation of China’s expansive outreach: the address on CPEC that the new Chinese ambassador delivered to Pakistan’s Parliamentary Committee.

The impending political transition will slow, if not complicate, the advancement of CPEC projects. The most likely impact will be greater reluctance by China to add new projects to the CPEC portfolio. But the election process and its aftermath will test the durability of the fragile CPEC consensus. While the PML-N is the favorite to rule at the center and in Pakistan’s largest province, it could remain in power with a weaker mandate. A lower probability, high-impact scenario would be PTI’s rise to power as part of a coalition in the center. Thus, it is worth examining how CPEC might operate with a new party in power in Islamabad and in the Balochistan province, where Gwadar Port is located. PTI has evinced a different philosophy toward aid, governance, public spending, and even energy. For example, it favors renewable energy over fossil-fueled power plants, though when in power at the center, it may end up embracing an energy policy similar to that of the PML-N.

What to Watch Out For in 2018

Gwadar Momentum Grows

Over the past year, Gwadar Port has averaged about one shipment per month—mainly inbound shipments of construction material. But there are indications that economic activity may pick up. The first phase of the Gwadar Free Zone launched at the end of January. The port operator, China Overseas Ports Holding Company (COPHC), is constructing an additional berth within the year to increase handling capacity and a COPHC subsidiary signed an MOU with Pakistan State Oil to develop an “oil city.” These developments suggest that China may begin using Gwadar for transshipment within the next few years. A clear sign of this will be if COSCO adds Gwadar to one of its regional shipping lines.

Basic, but resolvable, infrastructural deficiencies continue to hold Gwadar back. Gwadar presently has a water deficit of four million gallons a day (MGD). A five-MGD desalination plant for the city has been planned since the earliest CPEC discussions, but Beijing appears disinclined to provide a grant for the project. Pakistan has built water storage dams to service the Gwadar area, but there has been little to no rainfall in recent years. COPHC established a smaller 0.25-MGD desalination plant, and a cheaper option may be to repair an older two-MGD desalination plant. But as the city develops and hundreds of millions of dollars are poured in for commercial purposes, the absence of clean drinking water sends a dispiriting message to locals.

Gwadar’s electricity is currently sourced from nearby Iran. A 300MW coal power plant could be built on a fast-track basis within the next one to two years, but given the desire to build Gwadar as a tourism and natural gas hub, a natural gas-fueled plant may be a better fit.

Impact of Macroeconomic Stress and Poor Planning

The impending surge of CPEC projects coming online will lay bare the quality of economic planning by Pakistan’s Planning Commission, the chief coordinating body on CPEC. The initial indications are not encouraging. The co-produced CPEC Long-Term Plan is a vague, aspirational document that reflects little consultation with Pakistan’s business community and falls short in explaining how CPEC will benefit business. The Planning Commission’s CPEC “Center of Excellence” has functioned mainly as a publicity department, failing to produce serious policy-relevant research. Finally, the Planning Commission’s chief economist has made astounding estimates about the toll revenue that Pakistan will earn through CPEC.

The rise in Pakistan’s current account deficit has been propelled in part by machinery imports due to CPEC. Pakistan has had to float $3.5 billion in Eurobonds over the past few months to shore up its foreign exchange reserves. An IMF bailout may be on the horizon and could put future CPEC projects, including critical railway upgrades, at risk of postponement. In the end, the present pain may be short-term before long run gains. The economy on the whole is forecast to grow around 6 percent into 2020. But Pakistan’s economic planners have failed to demonstrate how exactly they will get over the present fiscal hump. Part of the solution may require some concessions from Beijing in the latest round of the Sino-Pak FTA talks to remove hurdles for Pakistani exports to China.

Multilateralization of CPEC

A host of countries have expressed interest in “joining” CPEC, and non-Chinese foreign investment in CPEC or CPEC-related projects is likely to rise as the initial wave of electric power and infrastructure projects come online. Presently, Qatari and Saudi investors are co-sponsoring two separate CPEC electric power projects, while a British company is co-sponsoring one of the lignite mining and mine mouth power plant projects in Thar. The Saudis, who recently agreed to finance part of the Turkmenistan-Afghanistan-Pakistan-India gas pipeline and blocked a Korean steel investment in Chabahar, appear keen on using geo-economics as a means to counter Iranian influence in Central and South Asia. This could translate into a more pronounced Saudi role in CPEC, leveraging the project not just to exploit opportunities in the Pakistani and Chinese markets, but also to steer regional connectivity away from Iran.

Arif Rafiq (@arifcrafiq) is president of Vizier Consulting, LLC, a political risk advisory company focusing on the Middle East and South Asia, and a non-resident fellow at the Middle East Institute.

His report, “The China-Pakistan Economic Corridor: Barriers and Impact,” was published by the U.S. Institute of Peace last year.