For centuries, the carrot and the stick approach have been used to induce desired behaviours. It’s a simple mechanism that utilises rewards and penalties to steer actions and outcomes – the same concept that parents use to develop discipline in children, and the same one that employers use to motivate workers.
IBR incentivises energy companies by regulating the cost to supply electricity
Incentive-Based Regulation (IBR) is a regulatory system that uses the same theory to achieve a desired market outcome. Both industry regulators and utilities work together to improve performance through consistent target reviews, with the ultimate goal of providing accessible electricity to consumers at a reasonable tariff. In Malaysia, the system incentivises energy companies to be more efficient by regulating the costs involved to supply electricity to the nation.
However, not all costs are controllable along the electricity supply value chain. In Malaysia, up to 70% of the tariff is comprised of fuel and generation costs, which include costs to acquire coal and natural gas – the prices of which constantly fluctuate. Below, the visual illustrates how the tariff is broken down.
The base tariff includes fixed overhead and operational costs (e.g. building maintenance costs) and fuel and generation costs (costs to acquire coal and natural gas, and the costs to generate energy in power plants).
Since fuel and generation costs make up nearly 70% of our tariff, fuel costs are a vital consideration in tariff pricing. Any number of situations around the world can impact the prices of fuels such as coal and natural gas dramatically. For example, a sharp increase in fuel prices could harshly impact the energy industry, and in turn, affect end-users who rely on a steady supply of electricity to power their lives.
The ICPT offer a flexible way for the electricity industry to respond to changing fuel price sustainably.
That’s where the imbalance cost pass-through (ICPT) mechanism comes in. It’s a mechanism that’s designed to offer a flexible way for the electricity industry to respond to changing fuel prices sustainably. When there is a sharp increase in coal prices, this would be reflected in the surcharge. Similarly, when there is a decrease in coal prices, this could result in rebates for consumers.
This ICPT amount is analysed every six months, allowing the industry to respond to changes in fuel pricing within a particular regulatory period (set at three years). That ensures that power producers can continue to offer sustainable, secure electricity supply, without the financial stability of the industry being undermined by the significant shifts in fuel prices.
With the next ICPT review period set for July-December this year, let’s explore the key factors that affect fuel prices, one of the main components of ICPT.
Factor 1: Budgeted Coal Prices
Coal generates more electricity than any other fuel source in Malaysia, accounting for approximately 42% of electricity generated in 2017. That means coal prices can have a significant impact on overall tariffs. Falling coal costs were a major factor behind the reduction in commercial surcharge in the latest ICPT calculation.
While the cost of coal has fallen compared to the previous six months, average coal prices are still above the RM14.47/MMBTu price that Malaysia’s Energy Commission and Tenaga Nasional Berhad (TNB) had budgeted for the 2018-2020 regulatory period.
That said, the ability for ICPT to adjust to reflect those changing costs demonstrates the importance of a flexible mechanism in the system. Those lowered prices may be reflected through a possible lower surcharge for the next ICPT period – though this is also dependant on other mentioned factors. This leads us to our next factor.
Factor 2: Increase in Regulated Gas Price
Gas is the second most important fuel in Malaysia’s power sector, accounting for roughly 40% of total generation in 2017. The price paid for gas by Malaysia’s power sector is regulated and defined under the Regulated Piped Gas Price. This agreement ensures national oil and gas company Petronas supplies up to 1,000 million standard cubic feet per day of natural gas to Tenaga Nasional Berhad at a subsidised price.
Efforts to reduce subsidisation were introduced under the previous administration, with the aim of increasing the Regulated Piped Gas Price to reach market pricing. The most recent application of this process has seen prices increase by RM1.5/MMBTu every six months since July 2015. While this increase is budgeted under the current regulatory period, it still has a consequential impact on Malaysia’s tariff pricing as the market price of piped gas fluctuates occasionally.
Factor 3: Increase in LNG Consumption
Over the recent regulatory period, several coal-fired plants were closed for maintenance across the nation. Combined with an increase in electricity demand, both factors led to a marked increase in LNG consumption for utilities.
Closing of coal-fired plants and higher electricity demand have increased LNG consumption.
LNG costs are higher than that of comparable coal technology, priced at RM35/MMBTu for Regulated Piped Gas compared to RM15.9MMBTu for the alternative coal. That is also relatively higher than the RM28.70 local gas price. The cost considerations of LNG are also compounded by the gradual subsidy rationalisation highlighted above.
The reduced availability of coal-fire powered generation has seen a 24% increase of gas usage compared to predicted over this period. That has resulted in an additional RM1.152 billion additional cost.
As seen from above, ICPT provides a mechanism to fairly calculate an electricity tariff that is most reflective of current market prices. Equally, ICPT is designed to motivate industry to deliver greater efficiencies and deliver savings to customers when such benefits are realised. Much like fuel prices, the surcharge and rebates set by ICPT can go up or down. What’s important is that an appropriate mechanism exists to respond to those fluctuations as they happen.
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