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Evolving the Electricity Tariff Cost-Adjustment Mechanism

In many Southeast Asian countries, the electricity industry is regulated by the government, whereby electricity companies must abide by pricing set by the authorities. This differs from countries like the United Kingdom and several states within the United States, where energy companies are responsible for setting prices based on principles of supple and demand. For regulated markets like Thailand, Malaysia, and Indonesia, the benefits include long-term certainty and stable pricing, though few nations have begun taking slow steps towards liberalisation.

In determining electricity pricing, regulators and utilities across the region implement different frameworks, based on principles best suited for their nation. One key principle that underscores each country’s framework is the need for flexibility. When it comes to managing electricity production costs, flexibility is vital for the industry to respond to changing market conditions appropriately. These mechanisms allow regulators and utilities to balance prices in the face of fluctuating fuel costs, like those of coal and natural gas.

Malaysia’s cost-adjustment mechanisms provides customers with a rebate or surcharge

In Malaysia, the electricity cost-adjustment mechanism is called the Imbalance Cost Pass-Through (ICPT). The mechanism works by providing customers with a tariff rebate or surcharge, depending on whether power generation costs fall below or exceed the government’s initially projected costs. The rebate or surcharge is determined every six months, at an amount calculated and approved by the Energy Commission and the government.

There is no universally accepted cost adjustment mechanism, and current models continue to evolve – much like the environment in which they operate. In an era of accelerating data-driven digitalisation, automated cost-adjustment mechanisms are an example of a tool that embraces the benefits of analytics-enhanced decisions, removing the room for human error whilst operating based on principles of transparency and fairness.

Cost-adjustment mechanisms around the world

With electricity being a fundamental aspect to economic activity and social opportunity, the issue of tariff adjustments becomes a national concern. It is imperative to ensure fair and sustainable electricity prices for a nation’s citizens, but that often means adjustments can face lengthy approval processes across multiple stakeholders in industry and government. Countries such as Thailand and Japan have adopted automated systems which aim to smooth out this process.

In 1991, Thailand adopted its Automatic Tariff Adjustment Mechanism to ‘have the actual costs reflected by the tariffs and to reduce impact of the fuel price volatility on the power utilities’ financial status’.

Ensuring a fair electricity price is important but it can be quite a lengthy process.

Like Malaysia, Thailand sets electricity tariffs at a base rate across a defined regulatory period. The base tariff takes into account projected fuel prices, inflation rates, foreign exchange rates, and other contributing aspects of the economy. The adjustment mechanism, or float time (Ft), allows for a flexible pricing that adjusts every four months based on the more volatile component of fuel pricing.

Considerations for these price adjustments include fuel costs from Electricity Generation of Thailand (EGAT) power plants, fuel costs from independent power producers (IPPs), and the cost of purchasing additional electricity from neighbouring countries. It also factors in price changes due to energy policies, such as subsidies for renewable energy adoption.

Electricity tariff automatic cost-adjustment

Over in Japan, utilities such as TEPCO operate an automatic adjustment mechanism under the Fuel Cost Adjustment System. This mechanism operates using a predetermined calculation to adjust tariffs based on fluctuating and uncontrollable fuel costs every three months. This allows for both an automatic downward and upward adjustment based on projected costs compared to actual fuel prices.

Unlike the Thai model, TEPCO’s cost adjustment system utilises a fully-automated adjustment mechanism based purely on the economics of power generation itself. If the actual average fuel price and cost per unit is below that projected amount, then the tariff automatically adjusts downwards, and likewise upwards if costs are above projections. There is no mandatory review by a centralised regulator for adjustments over every three-month period. However, in order to ensure that radical fuel price changes don’t lead to unsustainable prices for customers, there is a price cap of 66,300 yen (USD 617) for low-voltage customers.

Banking on the Benefits of Automatic Adjustment

Electricity tariff automatic cost-adjustment mechanism benefits

Automatic adjustments minimise resources and manpower in approving tariff adjustments

Automatic cost-adjustment mechanisms can be an important step towards a more efficient electricity ecosystem. Automatic adjustments remove the need for valuable resources and manpower in calculating and approving necessary tariff adjustments. Such mechanisms allow fair and comprehensive analysis while enabling an accurate pricing structure that takes into account the complex calculations of electricity supply without prolonging the time needed to review and approve the changes.

For a system that is just beginning to venture into automatic cost adjustment mechanisms, a good first step would be to reduce the levels of approval needed for just one adjustment to electricity pricing. To safeguard the interests of the people served by utilities, an authority or regulator is advised to oversee and control large changes in tariff structures. This should work alongside a hard cap to the amount that a tariff can increase or decrease before needing the express approval of all stakeholders.

The importance of flexibility is equally clear, thrown into greater perspective by the substantial fuel price volatility caused by the recent COVID-19 pandemic. Similar economic volatility was the reason behind a change to Japan’s cost-adjustment mechanism in 2009. A responsive pass-through system like Malaysia’s ICPT is even more relevant in this climate.

A mechanism that passes through costs should be designed to remain neutral between all parties involved – in this case, power generators, operators, and consumers. Transparency should always be a core part of this system, and the calculations behind such a mechanism should be clear to consumers and regulators alike. TEPCO’s automatic adjustment mechanism comes with clear explanation of how, and when, such adjustments may be made. The added benefit of this is the potential to promote positive public perception of tariff determination efforts by both regulators and government.

Evolving ICPT is our Next Step

At the end of the day, ICPT helps appropriately manage fluctuating and uncontrollable costs, resulting in a more sustainable electricity supply system. Constantly finetuning and evolving that mechanism is the logical journey so that the electricity supply industry is able to weather the storms of change with stability and preparedness. In a world where volatility seems to be increasingly common, that’s an essential mechanism to maintain the security, sustainability, and affordability of the nation’s electricity supply.

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