Incentivising Economic Opportunity with Incentive-based Regulation

Incentivising Economic Opportunity with Incentive-based Regulation

THIS ARTICLE WAS WRITTEN BY ENERGY WATCH | 06.05.20 | 7:58 PM

Incentive Based Regulation (IBR) was introduced in Malaysia in 2014 as a modernised framework for Malaysia’s electricity supply industry. It was championed as a way to ensure a structured and transparent operational environment that promotes efficiency in every link of the supply chain. The stated goal is to deliver a secure, sustainable, and affordable electricity supply for consumers.


How Does Incentive Based Regulation Work?

Every three years, a base rate is determined by the Energy Commission (ST), taking into account variable factors such as the projected (or ‘budgeted’) prices of fuels, like coal and gas. The base rate also includes costs relating to operations and maintenance of the electricity supplier, such as overhead costs, customer service costs, as well as expenses incurred for infrastructure development.

Within this framework, incentives are embedded to improve the efficiency of operators. The scheme sets performance targets for operators, by linking the tariff price set with national utility Tenaga Nasional Berhad (TNB)’s performance.

Incentives are embedded in the framework to improve the efficiency of operators

It also caps the maximum penalty or incentive imposed, allowing room for TNB to perform effectively with reduced financial exposure or risk. At a time of supressed economic activity, improved efficiency and performance across key economic sectors will be critical. The IBR structure aims to facilitate that – its framework motivates industry operators to perform effectively with a set tariff and budget allocated.

The IBR framework also aims to provide a clear, structured pricing system for customers. While costs associated with electricity production may change frequently, that uncertainty in pricing should not be deflected to consumers. Businesses and families expect a level of stability in their electricity bills every month; hence, to manage costs for citizens while keeping the industry operating, the IBR system was implemented.


Win-win Situation

On top of the base rate, a cost adjustment is also ‘passed through’ to customers every six months, in the form of a tariff surcharge or rebate. This mechanism, called imbalance cost pass-through (ICPT) is operated as part of the IBR framework. Every six months, ICPT analyses the true cost of generating electricity against the initially projected costs.

This mechanism aims to deliver a fair and transparent method of setting prices, by ‘passing through’ any costs or savings back to the end customer. For example, lower fuel prices and generation costs may lead to consumer rebates, while higher generation costs may lead to surcharges. It’s a win-win situation that prevents operators from profiting unfairly when generation costs are low, while also protecting them against unanticipated increases in generation costs.

This transparency contributes to essential customer satisfaction, an important performance measure under IBR. Customer satisfaction has shown demonstrable improvement in recent years, with approval ratings of TNB rising from 7.6 in 2015 to a steady 8.1 in 2016/17/18/19. Transparency will be key in managing consumer sentiment as commodity prices fluctuate.


Measuring Success

Incentives provide the basis for positive performance. That’s the fundamental principle behind the incentive-based regulation (IBR) operating model that forms the foundation of Malaysia’s electricity supply industry. If a system is designed to reward positive behaviour, it incentivises best practice to promote efficiency and enhance service delivery.

Malaysia currently has one of the most reliable electricity systems regionally, and indeed globally. Peninsular Malaysia experienced just 48.13 minutes per customer on the System Average Interruption Duration Index (SAIDI) in 2019. In comparison, the average minutes lost per customer per year in the European Union between 2010-2014 stood at 175 minutes. Malaysia’s minutes lost per customer in 2019 was just over half those experienced in France, Spain, and the United Kingdom averaged over this 2010-2014 period.

Peninsular Malaysia’s electricity ecosystem recorded just 0.27 minutes of system disruption in 2019, and has consistently been below the two-minute measure since 2009. There has been zero load loss in the nation’s critical 500kV systems for over a decade. At the same time, Malaysia has managed to maintain an electricity tariff that is one of the lowest in Southeast Asia.

Malaysia has maintained an electricity tariff that is one of the lowest in Southeast Asia

By any measure, these figures represent impressive performance metrics, with delivery framed by the structural backdrop of IBR. At the same time, these performance indicators have been delivered as part of an increasingly challenging operating environment.

Peak demand in 2018 reached a historic high of 18,388 MW on 15 August 2018. That compares to a previous peak demand of 17,788 MW on 19 April 2016. Overall electricity consumption continues to grow, increasing by 8.9% year-on-year in 2016 alone. Between 2014 and 2017, final electricity consumption in Malaysia grew from 11,042 ktoe to 12,606 ktoe, a rise of 14%. Managing the growing demand will require a structured approach, one centred on principles of efficiency, and transparency.


Incentivising Economic Growth

Malaysia’s central bank (Bank Negara)’s analysis suggests that Malaysia’s economy could shrink by 2% in 2020, or possibly even lower, due to coronavirus COVID-19. Reliable and affordable electricity for industry will be a pivotal part of kickstarting the economic recovery to follow.

While we cannot predict the future, it’s fair to say that an ecosystem built on reliable efficiency can offer an important catalyst for growth. Malaysia’s electricity ecosystem is one built around powering the economy and empowering economic opportunity in its citizens. IBR was designed to facilitate that process. The recent announcement of an electricity discount for all consumers as part of the Government’s economic stimulus package demonstrates how energy and efficiency can operate hand-in-hand with considered economic opportunity.

In the short term, that means meeting and mitigating the economic pressures emerging for the COVID-19 pandemic. In the long term, the success of IBR will be in continuing to provide an adaptive framework that promotes efficiency and ensures transparency to deliver a sustainable electricity ecosystem for operators and consumers alike.

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