Review power purchase pacts first, not raise electricity tariffs

electricity-transmission-lineCAP once again reiterates its call to the Government to review the power purchase agreements (PPAs) with the Independent Power Producers (IPPs) instead of raising electricity tariffs.

The premise for the review of the PPAs is a simple one.  IPPs have generated excess profits at the expense of the industry and Malaysian consumers, and they are now being asked to cut those excesses for the overall benefit of the country.

Excessive profits were accumulated through arrangements that saw many IPPs prosper in very minimal or an almost zero risk environment.

IMAGINE, being shielded against a myriad of risks right from the construction to the operations stage, as well as in project financing.

The Engineering, Procurement and Construction (EPC) contract took care of risk in price escalation, construction delays, and foreign exchange while penalties such as failure to meet completion date and for underperformance are structured in the O&M agreement with the OEM (Original Equipment Manufacturers).

In addition, almost all of the IPPs’ loans were ringgit denominated.  If IPPs can make such hefty profits with almost no risk involved, they should give some back to the public through a review of the PPA.

Excess Capacity is a Problem because It is Expensive

IPPs side-step the real issue about excess capacity as excess capacity is simply too expensive for consumers to ultimately bear.  This is in turn a direct result of the very high capacity payments TNB has to pay for the capacity built by the IPPs.

Yet the IPPs remain silent about their rates and returns, and are most reluctant to acknowledge that the steep prices paid by TNB and the high profits enjoyed by the IPPs are to a large extent due to the conservative estimates IPPs made and represented at the time of the signing of the PPAs.

The project cost of one of the new IPPs is much lower than the cost used in the determination of the IPP’s capacity rates.  The difference is approximately RM1 billion.

This leads to capacity payments that are far from reflective of the actual costs incurred by IPPs in developing their plants.

This means IPPs are overpaid and are recovering significantly more than what they have invested.

Given the direct impact of IPP-related costs to TNB’s consumer tariffs, this is a gross injustice to the electricity consumers of Malaysia and efforts must be made to remedy it through a review of the PPAs.

A review of a PPA under these circumstances would not be alien to the industry.  TNB’s own IPPs, such as Kapar Energy Ventures Sdn Bhd and TNB Janamanjung Sdn Bhd (TNB Janamanjung), have had their capacity payment rates re-examined and reduced to reflect lower actual project cost.

It has been made to understand that in the case of TNB Janamanjung, this reduction was almost half of its original rates.  There is no reason why a similar exercise cannot be extended to the other IPPs.

High IPP Costs Lead to High Tariffs

IPP payments are linked to electricity tariff increases.  Payments to IPPs account for more than 50% of TNB’s costs, and this is projected to reach RM12 billion in 2009.  It is only logical that IPP payments will play a significant role in any electrticity tariff determination for Malaysian customers.

A simplified determination of electricity tariffs can be explained below:
End Tariff = Base Tariff + Fuel Adjustment

  • The Fuel adjustment will be addressed via a proposed fuel pass-through formula in the tariff.
  • Base tariff, amongst others, consists of the following:

— IPP costs underwritten by TNB
— Fixed and variable costs incurred by TNB in operating the Generation, Transmission & Distribution businesses
— Financing cost, taxes etc.

Efforts to improve performance and lower operations and maintenance costs have been undertaken by TNB and these have resulted in significant cost savings.

However, the amount of savings that can be achieved through this means is limited.  A further point worth mentioning is that the rate of return to TNB is low and regulated by the Government.

As such, the only significant area that has not been explored is the reduction of IPP costs.  As IPP costs constitute a large share of the costs, any reduction will have a positive impact on electricity tariffs.

IPPs’ Call for a “Holistic Review of the Power Industry”

The IPPs have asked the Government to set up an electricity market so that tariffs will reflect electricity pool bid prices.  Yet IPPs have also stated that they want their respective capacity payments to stay intact.  This simply makes no sense.

Having capacity payments that are “intact” under a market environment will only give IPPs more opportunity to increase their profits.

Additionally, IPPs with large market shares can corner the market and cause pool prices to be sustained at artificially high levels.

Electricity is not similar to other commodities.  It cannot be stored and must be produced instantaneously.  A mismatch in demand and supply can impact system security leading to brownouts or even blackouts.

Market structures around the world have proven that whilst competition may initially lead to lower prices, market participants will eventually engage in profit maximising behaviours that cause prices to rise.  The financial meltdown today is a clear example of what can happen if greed is given free rein.

The IPPs’ call for a complicated and time-consuming “holistic review of the power industry” has been used time and again as a tactic to delay any move to reduce PPA profits and channel those profits back to the electricity supply industry.

This delay also means that IPPs will continue to take advantage of the current high returns they are making now.  Electricity tariffs will continue to rise and electricity customers will suffer in spite of TNB’s best efforts to manage its costs.

Structural changes will not be successful in reducing burden to the customers if the underlying reasons for excessive payments to the IPPs are not addressed.

Under the current environment where the country is facing a financial crisis and Malaysian consumers are facing significant increases in the cost of living, lucrative payments to the IPPs are not sustainable.

Furthermore, all other industry participants have played a role, ie PETRONAS via a gas subsidy; TNB via absorbing higher costs; and customers via higher tariffs.

The only one left is the IPPs who have remained largely untouched and continue to rake in huge profits even when the industry is facing problems due to the increasing cost of supply.

The Government in all its wisdom is not asking the IPPs to “return” their lucrative profits that they have made previously.

The PPA renegotiation is intended to look ahead and to review the returns that will be allowed to the IPPs in future, recognising the need to assist the public during these trying times.

Electricity is a necessity and thus excessive profiteering from such an essential commodity should not be allowed lest the quality of life of Malaysians be affected.

In a statement made in January 2009, TNB’s president and chief executive officer, Datuk Seri Che Khaleb Mohamad Noh was quoted as saying that energy and capacity payments to independent power producers in 2009 are expected to rise to RM12 billion and that the re-negotiation of the PPAs was one of the ways to reduce the tariff.

CAP thus calls on the Government to immediately revise and renegotiate the Power Purchase Agreements (PPAs) instead of raising electricity tariffs.