Pakistan’s government revealed that power distribution companies (Discos) purchased electricity from small power producers and captive plants outside the national grid at rates exceeding the national tariff, violating economic merit order principles and prompting an official probe into potential overcharges to consumers and market distortions.
How Merit Order Violations Distort Power Markets and Inflation
The unauthorized procurement bypasses the Independent System and Market Operator (ISMO), which optimizes dispatch based on incremental generation cost. By sourcing power at supra-marginal costs, Discos effectively shift avoidable expenses onto end-users through tariff adjustments or subsidies, exacerbating circular debt. Pakistan’s power sector circular debt reached PKR 2.6 trillion ($9.3 billion) by end-2025, equivalent to 6.2% of GDP, according to the State Bank of Pakistan’s quarterly report. Such off-merit purchases increase the average cost of supply, directly feeding into headline inflation, which averaged 11.4% in Q1 2026, with electricity contributing 280 basis points to the CPI basket.
When distribution companies avoid the competitive merit order stack, they undermine price signals that incentivize efficient generation. This creates arbitrage opportunities for small producers with privileged bilateral contracts, while discouraging investment in grid-scale renewables or efficient thermal plants that cannot secure similar off-market deals. The International Energy Agency estimates that merit order violations in emerging markets can raise system costs by 15-25% compared to optimized dispatch, a range consistent with Pakistan’s observed levelized cost of electricity (LCOE) premiums in isolated distribution zones.
Broader Economic Ripple Effects on Industry and Competitiveness
Industrial consumers, representing 38% of Pakistan’s electricity demand, face disproportionate impacts from off-merit procurement. Textile exporters, already operating at 70% capacity utilization due to energy shortages, cite power costs as a top constraint in the State Bank’s January 2026 Industrial Outlook Survey. Higher electricity prices erode export competitiveness; Pakistan’s textile exports grew only 2.1% YoY in FY25 versus Bangladesh’s 12.4% growth, partly attributed to relative energy cost disparities. The All Pakistan Textile Mills Association (APTMA) reported that energy constitutes 18-22% of production costs for spinning units, with grid electricity averaging PKR 14.2/kWh in March 2026 versus subsidized industrial tariffs of PKR 10.5/kWh under the concessional rate scheme.
This dynamic creates a two-tier system where politically connected or geographically isolated Discos secure expensive off-grid power, passing costs to captive industrial users or residential consumers via cross-subsidy mechanisms. Simultaneously, efficient generators supplying the national pool face reduced utilization, depressing returns on recent investments. Hub Power Company (HUBC), Pakistan’s largest independent power producer, reported a 9.3% decline in FY25 consolidated net profit to PKR 18.1 billion, citing lower plant load factors and regulatory lag in tariff determinations.
Regulatory Response and Market Implications for Reform
Power Minister Awais Leghari’s directive to halt off-merit procurement and align purchases with ISMO dispatch aims to restore price discovery. However, enforcement faces structural hurdles: many Discos operate under long-term power purchase agreements (PPAs) with captive plants predating current market rules, and renegotiation risks triggering litigation or force majeure claims. The National Electric Power Regulatory Authority (Nepra) has initiated proceedings against three Discos for potential license violations, though penalties remain unspecified.
Analysts at JS Global Capital Research note that full compliance with merit order principles could reduce system average procurement costs by PKR 0.8-1.2/kWh, translating to annual savings of PKR 120-180 billion if applied to 15% of total off-grid volumes estimated at 150 million MWh/year. Such savings would directly reduce the fiscal burden of power subsidies, which consumed PKR 420 billion in FY25, or 18% of total federal expenditure.
Investor Perspective on Governance and Sector Risk
“Off-merit power procurement by distribution companies is not merely a technical violation—it represents a systemic governance failure that distorts capital allocation in Pakistan’s energy sector. Until transparent, rule-based dispatch is enforced, investors will continue to demand illiquidity discounts on power sector equities and demand higher yields on related debt.”
This view is echoed by local market participants concerned about precedent-setting opacity. The government’s refusal to disclose which Discos engaged in off-merit purchases or the quantum involved hampers market discipline, as noted in a recent paper by the Lahore University of Management Sciences (LUMS) Energy Institute.
“When regulators conceal counter-party identities in potential market abuses, it undermines price discovery and encourages repeat behavior. Transparency is non-negotiable for credible market reform.”
The Bottom Line
- Off-merit power procurement by Discos adds an estimated PKR 0.8-1.2/kWh to system costs, worsening circular debt and inflation.
- Industrial competitiveness suffers as efficient grid-supplied generators face utilization losses while privileged bilateral contracts distort price signals.
- Enforcing merit order compliance could yield PKR 120-180 billion in annual savings, reducing fiscal pressure from power subsidies.
| Indicator | Value | Source |
|---|---|---|
| Power Sector Circular Debt (End-2025) | PKR 2.6 trillion ($9.3 billion) | State Bank of Pakistan |
| Textile Export Growth (FY25) | Pakistan: 2.1% YoY | Bangladesh: 12.4% YoY | State Bank of Pakistan Industrial Outlook Survey |
| Average Grid Electricity Tariff (Industrial, Mar 2026) | PKR 14.2/kWh | Nepra |
| Hub Power Company FY25 Net Profit | PKR 18.1 billion (down 9.3% YoY) | Hub Power Company |
| Estimated Annual Savings from Merit Order Compliance | PKR 120-180 billion | JS Global Capital Research |
The government’s crackdown on off-merit power purchases addresses a critical inefficiency in Pakistan’s energy market, but lasting reform requires transparent enforcement, renegotiation of legacy PPAs, and strengthened ISMO authority to ensure least-cost dispatch. Without these measures, distortions will persist, continuing to weigh on industrial competitiveness, fiscal balances, and consumer prices.
Disclaimer: The information provided in this article is for educational and informational purposes only and does not constitute financial advice.
