CAP wishes to refer to the Feb 12, 2009 news report highlighting the latest opposition mounted by the Association of Independent Power Producers of Malaysia (Penjanabebas) against a revision of their power purchase agreements (PPAs).

taman wahyu tnb electrical power cables tower 051206 02 Penjanabebas’ statement signifies yet another attempt by the Independent Power Producers (IPPs) to obstruct the restructuring of their largely one-sided and lucrative PPAs.

This new effort closely follows Penjanabebas’ successful resistance to the government’s steps to remedy their contracts via the imposition of a windfall tax or a PPA renegotiation.

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.

Competitiveness, business savvy and innovation do not account for the financial successes of the IPPs as much as Penjanabebas would like Malaysian to believe. The PPAs were formalised on the basis of direct negotiations and through favourable policies that cushioned and continue to protect IPPs from a range of risks.

These PPAs then propelled many IPPs like YTL Corporation Bhd and Malakoff Corporation Bhd from relative obscurity to great wealth and fame. Yet very few of these IPPs have used the profits they gained from these contracts to give back to the industry. In some cases, the profits were instead used to expand business empires and finance ventures overseas.

More interestingly, these 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.

Side-stepping the real issue

The 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.

Bearing all these factors in mind, it does not take a rocket scientist to figure this out. 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.

IPPs are overpaid

In their most recent media statement, Penjanabebas say it is unfair to hold them responsible for excess capacity in the system, and they point their fingers at other authorities instead.

By doing so, they conveniently side-step the real issue about excess capacity, and 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.

As an example, the actual 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.

tenaga nasional and electricity 031208 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

Contrary to what Penjanabebas have said, it is not unfair to link IPP payments to electricity tariff increases. Payments to IPPs account for more than 50 per cent 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:

(1) IPP costs underwritten by TNB;

(2) Fixed and variable costs incurred by TNB in operating the generation, transmission & distribution businesses; and

(3) 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.

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.

Profit maximising behaviour

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 behaviour 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 high inflation and significant increases in the cost of living, lucrative payments to the IPPs are not sustainable.

Furthermore, all other industry participants have played a role i.e. 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.

We do not begrudge the IPPs for the money that they have made nor the successes they have attained internationally. Neither do we question why the IPPs have chosen to invest abroad rather than plough their investments into the country. We are proud that their foray into international businesses has been successful. But enough is enough: the IPPs have had their day in the sun.

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.

CAP thus calls on the government to immediately revise and renegotiate the Power Purchase Agreements (PPAs).

SM MOHAMED IDRIS is president of the Consumers Association of Penang.