‘PKR got it all wrong on power rates’

Several IPP managers say that forcing IPPs to renegotiate their PPAs will have serious implications.

KUALA LUMPUR: PKR has gone off the mark when it said that it would slash the power rates if it comes to power, say independent power producers (IPPs).

They were commenting on PKR investment and trade bureau chief Wong Chen’s statement on Dec 7 that Pakatan would reduce the independent power producers’ (IPP) return of investment (ROI) from 19% to 10% if it forms the next government.

Wong has said even if the return of investment (ROI) was at 10%, which is the global benchmark, it was still a lot of money for them (IPPs).

(The ROI measures the profitability on an investment and can help in making investment decisions.)

“What we want is to cut their [IPPs'] obscene profit,” Wong has said.

He said under the current contracts, the IPPs’ return of investment stood at a whopping 19% and a Pakatan government would reduce it to 10%.

However, IPP players said Wong’s notion that renegotiating the PPAs (power purchase agreements) with the IPPs was a silver bullet to ensure power prices remain at current rates in the future was wrong and off the mark.

They said his analysis was probably driven by poor understanding of the power industry.

“It is incorrect, for example, to use take Tenaga Nasional Bhd’s 2011 capacity payment as a proxy for IPP earnings and dividing it by IPPs’ total capital expenditure, resulting in a ROI of 19%,” said a senior IPP manager who did not want to be named.

(Capacity payment is payment received in exchange for making electrical capacity available.)

He said this is because capacity payment is a composition of revenue and not profit, “so it is wrong to treat it as earnings”.

“Capacity payment is primarily used to service debt obligations of the power plant developer, so earnings is derived only after deducting debt servicing payments and other fixed costs such as insurance and taxes.

“The time value of money, which is basic in financial economics, is ignored in his [Wong's] analysis – there is a need to consider capital investment made in a year and also the annual earning streams recurring for 21 years, to work out the true ROI, and not just taking into account one payment in one particular year…,” said one IPP senior manager.

Another IPP manager said Pakatan’s proposal to force IPPs to take a 50% cut on revenues – primarily used to service their debt obligations – has the following serious implications:

It will trigger defaults in the IPP bonds, causing substantial uncertainty in the capital markets;

It will send negative signals to investors and raise the cost of doing business for the entire economy of the country; and

It is also result in capacity shortages and supply interruptions.

‘Tariffs need to go up’
On PKR’s Wong contention that power tariff need not be increased, an IPP manager said: “Tariffs do need to go up. This is due to increasing fuel cost and the capital-intensive nature of the industry. Globally, fuel cost has also been increasing substantially.

“For example, oil has increased from below US$30 per barrel in 2000 to currently above US$90 per barrel [over 200% increase for the period].

“To get an inkling of the capital-intensive nature of the industry, just look up the TNB website and discover the capital expenditure of TNB each year [in the range of RM4 billion to RM7 billion].

“If the opportunity cost of gas were to be added to the present gas price, that alone will raise TNB’s fuel cost by more than RM10 billion annually,” he said.

Another senior IPP manager said that tariffs must reflect the underlying primary costs of supply to maintain a sustainable power industry.

“We can’t continue to artificially keep gas price low as artificially suppressed energy prices will encourage inefficiency,” he said.

“A cheap source of energy will discourage investment in energy-efficient technologies, and promote wastage.

“Under-priced fuel will also discourage investments in ensuring supply adequacy and security. If unchecked, this will result in higher risks of blackouts/brownouts,” he added.

“These distortions in energy prices will then filter through the entire economy, resulting in an economic structure and a population addicted to cheap energy.”

The manager said all these developments would make the power industry unsustainable resulting in Malaysia moving from a net exporter of fuel to a net importer over the next 10 years.

He said that instead of spending RM10 billion annually on keeping electricity prices low, the money should be used for improving education, security, public transport, and healthcare services.

All the senior managers agreed that it was important that for Malaysia to take steps to manage the impact of an eventual tariff increase.

“Renegotiating PPAs with the power producers is not the silver bullet. Even if capacity payments to IPPs is totally waived, it is still not enough to cover the incremental cost of gas,” a senior IPP manager said.