Review on

Electricity Tariff in Peninsular Malaysia

under the Incentive-based Regulation Mechanism

(FY2014-FY2017)

Suruhanjaya Tenaga

19th December 20131

OVERVIEW ON INCENTIVE-BASED REGULATION

CONCEPT AND IMPLEMENTATION

Suruhanjaya Tenaga is moving towards the Incentive-based regulation (IBR) in order to strengthen the following:

the economic regulatory framework for regulating TNB;the economic regulatory framework for regulating TNB;

the tariff setting mechanism and principles for tariff design;the tariff setting mechanism and principles for tariff design;

The move towards better regulation:

the tariff setting mechanism and principles for tariff design;the tariff setting mechanism and principles for tariff design;

incentive mechanisms to promote efficiency and service standards;incentive mechanisms to promote efficiency and service standards;

the process of tariff reviews; andthe process of tariff reviews; and

the creation of regulatory accounts and its annual review process.the creation of regulatory accounts and its annual review process.

11 Regulatory Implementation Guidelines were developed for the

implementation of IBR 3

What is incentive-based regulation (IBR)?

• A mechanism or methodology for the electricity tariffdetermination, focusing more efficiency gains and a structured process intariff evaluation

• An effective mechanism that being used globally, sometimes called asperformance-based regulation

• Only the efficient cost (CAPEX and OPEX) in electricity supply will be• Only the efficient cost (CAPEX and OPEX) in electricity supply will beaccounted in the tariff calculation

• Setting key performance indicators for the utility

• Introduction of incentives or penalties on the operational performance

• Efficiency gains will be shared between consumers and utility

4

How will an efficient utility benefit from IBR?

1500

2000

2500

3000

16

00

26

00

20

00 Allowable Opex

Actual

5

0

500

1000

1500

2012 2013 2014

12

00 16

00

12

00

15

00

20

00

Actual

If the utility manages to effect further savings:

• Total saving over 3 years – RM 700 million

• All the savings will accrue to the utility

How will these benefits be shared with consumers?

2500

3000

3500

4000

4500

5000

Without

Efficiency GainWith Efficiency

Gain

Next Regulatory Period Reset

OPEX (RM mill)

6

0

500

1000

1500

2000

2500

2012 2013 2014 2015 2016 2017

GainNew Reset

Benefit to

Consumer

• The efficiency carry-over allows utility to keep the benefit of gains for three years (before the next

regulatory period starts)

Incentive-based Regulation benefits in terms of service quality

Wide recognition that a trade-off exists between:

• The Service Quality and the Cost of Service

Generally higher service quality costs more; lower expenditure will over time lead to reduced service quality levels

7

Under incentive regulation, there is an incentive to maximize profit. Profits can be increased by reducing service quality.

Hence, the Regulator also has a societal obligation to regulate service quality to ensure:-

• Profits are not taken at expense of quality

• All customers receive a reasonable quality of service (not only those where it is profitable)

• Acceptable service levels are maintained

• Separation of TNB business entities’ accounts

• Determination of reasonable return to licensee (WACC of 7.5%)

• Imbalance cost pass-through mechanism for uncontrollable costs (changes in

forecast vs actual cost of generation)

Salient Components of IBR

• Setting of performance targets with incentive/penalty mechanism by regulator

• Efficiency sharing scheme between utility and consumers in the next tariff review

• Structured tariff determination and decision-making process

– Regulatory period from 2014 – 2017

– Establishment of regulatory accounts and reporting mechanism

8

TNB Business Entities under the Incentive-based

Regulation Mechanism (Accounting Separation)

Distribution & Retail Distribution / Customer

Services

Electricity Customers

(Connected to the Distribution System)

Average Electricity Tariff

Transmission Tariff

9

Generation

Transmission Transmission

Single Buyer Generation

Single Buyer Operation

Transmission Tariff

System Operations

TNB Generation IPPs

Single Buyer Tariff

(generation +

operations)

System Operation

Tariff

Base Tariff is set to reflect:

• the construction cost of transmission and distribution system;

• Base fuel and purchasing cost;

• Operation, maintenance and administration costs;

• with certain assumptions related to fuel prices, inflation rates (or CPI), exchange

Electricity Tariff Review = Base Tariff + Imbalance Cost Pass-Through (ICPT)

prices, inflation rates (or CPI), exchange rates.

ICPT:

• adjustment to reflect the change in uncontrollable costs from Base Tariff i.echange in fuel and purchasing cost

10

Revenue

Requirement

=OPEX Depreciation Tax

Return on Assets

WACC (Return)

x

Regulated asset

base (RAB)

+ + +

Will only form part of the

revenue requirement from

the 2nd Regulatory Term

+Efficiency

carryover

amount

Revenue Requirement Building Block Model Under

the IBR Framework

Return on Assets the 2 Regulatory Term

11

Efficiency • testing for efficiencies through benchmarking and trend analysis

• review of historical cost performance

• efficiency and prudency of asset management policies

• consistency with capex and sales forecast

Summary of Tariff Setting Framework under IBR

Single Buyer Generation Actual Cost Adjustment

• Generation Specific Cost

(Capacity Charge, Energy

Payment etc)

• Other Gen Specific cost

(Other PPA/SLA Charges

etc)

Single Buyer Operational

•Operation and maintenance

•Staff cost

•Depreciation

•Taxes

Transmission

•Operation and maintenance cost

•Depreciation

•Staff cost

•Taxes

System Operation

•Operation and maintenance

•Depreciation

•Staff cost

•Taxes

Customer Services

•Distribution operation and maintenance cost

•Depreciation

•Staff cost

•Taxes

Revenue Requirement = WACC x Regulated Asset Base Revenue Requirement = WACC x Regulated Asset Base

12

etc)• Renewable Energy Cost

(displaced cost)

•Taxes

Cost recovery

based on

Revenue Cap

Cost recovery

based on

Revenue Cap

Cost recovery

based on

Revenue Cap

Cost recovery

based on Price

Cap

Adjustment in the next regulatory period

• Incentive to be given or penalty to be imposed in the next

regulatory period

• Efficiency gains to be shared in the next regulatory periodgeneration costs

Cost recovery based on Actual

Cost:

• Fuel cost pass-through

• Adjustment of other specific

generation costs

Adjustment every 6 months

(imbalance cost pass

through)

Decision on Electricity Tariff Review

in Peninsular Malaysia

Tariff Components sen/kWh%

increase

Current Tariff 33.54

TNB Base Tariff 0.90 2.69

Fuel Components:

Average electricity tariff rate in Peninsular Malaysia to be increased by 4.99 sen/kWh (14.89%)

from 33.54 sen/kWh to 38.53 sen/kWh, from 1st January 2014, to cover:

18%↑ on

Return on

Ratebase

(Asset) and

OPEX

13

• Piped gas regulated price

(from RM13.70/MMBtu to RM15.20/MMBtu

@1,000 mmscfd)

0.51 1.52

• Coal (market price)

(from USD85/tonne to USD87.5/tonne

CIF@CV 5500kcal/kg)

0.17 0.51

• LNG RGT market price at RM41.68/MMBtu 3.41 10.17

NEW AVERAGE TARIFF 38.53 14.89

OPEX

82%↑ on

fuels

Average Fuel Price Trend In RM/mmBtu as of Sept 2013

LNG’s market

price plays a

major role in

the electricity

supply cost

LNG CIF Japan

MFO Price

LNG ex-Bintulu

40

50

60

70

RM/MMBtu

14

Gas Price to PGB

Applicable Coal Price (ACP)

Gas Price to GMSB

Gas Price to Power Sector

0

10

20

30

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

Jan

11

Fe

b 1

1

Ma

r11

Ap

r 1

1

Ma

y 1

1

Jun

e 1

1

July

11

Au

g 1

1

Se

p 1

1

Oct

11

No

v 1

1

De

c 1

1

Jan

12

Fe

b 1

2

Ma

r 1

2

Ap

r 1

2

Ma

y 1

2

Jun

e 1

2

July

12

Au

g 1

2

Se

p 1

2

Oct

12

No

v 1

2

De

c 1

2

Jan

13

Fe

b 1

3

Ma

c 1

3

Ap

r 1

3

Ma

y 1

3

Jun

e 1

3

July

13

Au

g 1

3

Se

p 1

3

~70%

subsidy

Cost Components in Electricity Tariff TNB FY 2013 (Historical)

Generation Cost

(75%)

• Capacity Payment (32%)

• Fuel Payment (68%)

Transmission Cost

(7%)

Distribution Cost

(18%)

40

Average Electricity Tariff (sen/kWh)

Average Electricity Selling Price FY 2013

(33.88 sen/kWh)

Fuel Price (gas and coal) is regulated by the Government in

current tariff setting

Capacity Payment is minimised via the competitive bidding

process15

10

15

20

25

30

35

40

Before

2006Jun-06 Jul-08

Mac -09 Jun-11Jan-14

23.526.32

32.531.31

33.54

38.53

Electricity Tariff Structure as of 1st January 2014

under Incentive-based Regulation (IBR) mechanism

Distribution /

Customer Services

Tariff

8.25 sen/kWh

Transmission

Tariff

3.66 sen/kWh

Single Buyer

Generation

Tariff

26.38 sen/kWh

System

Operation

Tariff

0.05 sen/kWh

TNB Generation

Service Level

Agreements

IPPs

Power Purchase

Agreements

Single Buyer

Operation

Tariff

0.19 sen/kWh

Average T & D losses is 8.5%

16

Average Electricity Tariff : 38.53 sen/kWh

Imbalance Cost Pass-Through

in every 6 months

(cost variation of forecast vs actual cost procuring electricity)

Fuel Cost : natural gas, coal, LNG and distillate

All costs incurred by the SB under the PPAs and SLAs ( incentive or bonus payments, liquidated damages, savings etc)

i.e.

Renewable energy displaced cost

Average Industrial

Tariff

36.15 sen/kWh

Average Domestic

Tariff

31.66 sen/kWh

Average Commercial

Tariff

47.92 sen/kWh

Average Overall

Tariff

38.53 sen/kWh

Subject to

Government

Approval

PERFORMANCE INCENTIVE SCHEME

Upper bound

cap

+0.5% of annual

revenue requirement

Revenue

incentive scale

0% of annual revenue

Actual performance

compared to target

• Incentive / penalty

capped at +/- 0.3% to

0.5% of annual revenue

requirement

INCENTIVE SCHEME

Upper bound

targetLower bound

target

Lower bound

cap -0.5% of annual

revenue requirement

Performance

indicator

scale

0% of annual revenue

requirementrequirement

• No incentive or penalty

if performance between

the upper and lower

bound targets

18

Business entities

Total Incentive

and

Penalty Cap

Example :

Amount of Incentive or

Penalty Cap Annually

Revenue

Requirement

Total Incentive

/(Penalty) Cap

RM RM

Example : Total incentive or penalty caps for TNB business entities

RM RM

Customer services /

Distribution±0.3% ARR 10,670,937,304 32,012,812

Transmission ±0.3% ARR 4,345,455,379 13,036,366

System Operator ±0.5% ARR 56,954,047 284,770

Single Buyer Operation ±0.5% ARR 336,151,090 1,680,755

Total 15,409,497,820.39 47,014,704

Note: Single Buyer operation ARR only refers to revenue required for operation of Single Buyer

*excluding power procurement costs of both IPPs (PPA) & TNB Plants (SLA) 19

Equivalent to 0.045 sen/kWh incentive or penaltyARR = aggregate revenue requirement

Code Performance Incentive Scheme Unit Weightage

(%)

Lower Bound

Target

Upper Bound

Target

Customer Services

CSPI1 System Average Interruption

Duration Index (SAIDI)

Mins./cust./year 50 70 55

CSPI2 Average of Minimum Service Level

Compliance Performance

% 25 84.11 94.11

CSPI3 Weighted Average Guaranteed

Service Level (3, 4 and5)

% 25 86.32 95.50

Transmission

TXPI1 System Minutes Minutes 40 5.1 1.5

TXPI2 System Availability % 30 99.04 99.48

TXPI3 Project Delivery Index Delayed month 30 5.47 0

System Operator System Operator

SOPI1 Wide Area Loss of Supply Event No. of wide area

system blackout

incident

25 1 0

SOPI2.1 Voltage Limit Compliance % 25 90 96

SOPI2.2 Frequency Limit Compliance % 25 90 96

SOPI3 Dispatch Adjustment % 25 0.4 0.2

Single Buyer

SBPI1 Dispatch Deviation % 25 0.4 0.2

SBPI2 Compliance to Timely Settlement of

Generators’ Invoices

% 25 99.55 99.85

SBPI3 Compliance to Malaysian Grid Code % 25 98.10 100

SBPI4 Compliance to Single Buyer Rules % 25 95.00 100 20

FAIR RATE OF RETURNFAIR RATE OF RETURN

AND

WEIGHTED AVERAGE COST OF

CAPITAL (WACC) DETERMINATION

Suruhanjaya Tenaga’s Approach

• In reaching the recommendation on whether TNB’s capex and opex forecasts are efficient and prudent, we:

– analyzed TNB’s revenue requirement proposal, tariff setting and other supporting information

– analyzed data and information provided by TNB during the review process

analyzed forecast of total capex and opex, in terms of:– analyzed forecast of total capex and opex, in terms of:• Meeting expected demand

• Complying with all applicable regulatory obligations and requirements

• Maintaining the quality, reliability and security of supply

– considered initial views expressed by KeTTHA

– conducted consultation sessions with TNB’s working level

– compared with data/information submitted under license conditions

– considered consistency of TNB’s proposal with government policies

22

Fair Rate of Return (ROR)

Fair ROR is a level of profit that utility is allowed to earn as determine by the Suruhanjaya

Tenaga based on the following consideration:-

� Maintain service to its customers;

� Maintain and expand the infrastructure to provide the services to customers. The

return should be able to attract capital from investors. Low return - insufficient

capital for growth - consumer unable to receive sufficient level of electricity service;

� Make a fair payment to capital providers i.e interest to bondholders and adequate

dividend to shareholders dividend to shareholders

� conforms to the return of similar investments.

� Promote efficient used of energy, prices should reflect marginal costs;

� Ensure the utility's long-term stability.

� Ensure fairness to all stakeholders. The utility could get capital to provide services

to consumer and at the same time the capital providers receiving fair profits on

their investment.

23

How Average Rate Base (ARB) is Determined

• The objective is to identify the amount of appropriate

capitals/assets and working capital that are prudently required

by the utility company in order to provide the regulated services.

• ST use Original or Historical approach to determine the value of

the Rate Base (RB).the Rate Base (RB).

• The figures is adjusted to exclude consumer contribution and

consumer deposit from RB

• The ARB is calculated by taking the average of the opening and

closing value of the rate base/assets

24

Determine the Fair Rate of Return

The fair Rate of Return is base on Weighted Average

Cost of Capital (WACC) which are determine using

Capital Assets Pricing Model (CAPM).

1. Risk free rate – Yield of MGS1. Risk free rate – Yield of MGSThe risk-free rate of return will be used as a floor of acceptable levels of

expected return from any given investment. Any equity investment should

exceed the risk-free rate of return. There is no reason for investor to take any

investment with inferior to Risk free rate.

2. Market premium to reflect the risk of the utility’s as

compare to the risk free rate.

25

WACC Parameters Actual market Parameters TNB's Proposal Recommendation

Stock TNB Beta 0.92[1] 1.435 1.435 [[4]

Market Return (Rm) 8.8%[2] 12.3% 8.8%

Risk free (Rf ) 4.0% 4.0% 4.0%

Market Risk Premium (Rm - Rf) 4.8% 8.3% 4.8%

Debt Margin (Dm) 2.19% 2.24% 2.24%

Tax Rate 25.0% 25.0% 25.0%

Regulatory WACC for TNB Under IBR (FY2014-2017) is 7.5%

Note:

[1] Based on beta for the period 2004-2012

[2] Rm - Market return of 10 yrs KLSE Index

[3] Average Gearing (2004-2011) is 39.5%

[4] Adjusted to reflect optimal gearing.

Weighted Cost of Capital Calculation

Actual market Parameters TNB's Proposal Recommendation

Capital Structure CostCapital

Structure

Weighted

CostCost

Capital

Structure

Weighted

CostCost

Capital

Structure

Weighted

Cost

Cost of Equity (Ke) 8.38% 60.5% 5.1% 15.91% 45.0% 7.16% 10.85% 45.0% 4.88%

Cost of Borrowing (Kb)[3] 6.18% 39.5% 1.8% 6.24% 55.0% 2.57% 6.24% 55.0% 2.57%

Weighted Cost of Capital 6.9% 9.7% 7.5%

26

IBR - REVIEW OF TNB’S PROJECTED

CAPEX AND OPEX

27

Review of TNB Capital Expenditure Proposal (RM Million)

9,978

18,601 1 108 339 29,027

15000

20000

25000

30000

35000

8,482

14,881 1 108 339 23,810

15000

20000

25000

30000

35000

Initial Proposal Recommendation

18%

28

9,978

0

5000

10000

Tra

nsm

issi

on

Dis

trib

uti

on

Sin

gle

Bu

yer

Op

era

tio

n

Sys

tem

Op

era

tio

n

Join

t C

ost

Tota

l

8,482

0

5000

10000

Tra

nsm

issi

on

Dis

trib

uti

on

Sin

gle

Bu

yer

Op

era

tio

n

Sys

tem

Op

era

tio

n

Join

t C

ost

Tota

l

Capital Expenditure 2014-2017 (RM Million)

3,000

4,000

5,000

6,000

15%

Transmission Capex Distribution Capex

3,000

4,000

5,000

6,000

20%

29

2,4

87

1,7

22

2,4

96

1,9

92

2,4

75

2,2

63

2,5

21

2,5

04

-

1,000

2,000

3,000

TNB's Initial Proposal Recommendation

2014 2015 2016 2017

4,8

70

3,4

56

4,5

53

3,5

77

4,5

73

3,8

13

4,6

05

4,0

35

-

1,000

2,000

3,000

TNB's Initial Proposal Recommendation

2014 2015 2016 2017

Average Rate Base (RM Million)

20,818 46

20,264 41,131

20,000

30,000

40,000

50,000

60,000

2014 2015

21,704 56

21,630 43,393

20,000

30,000

40,000

50,000

60,000

30

- 3

-

10,000

20,000

Sin

gle

Bu

yer

Sin

gle

Bu

yer

Op

era

tio

n

Tra

nsm

issi

on

Sya

tem

Op

era

tio

n

Dis

trib

uti

on

Tota

l

- 2

-

10,000

20,000

Sin

gle

Bu

yer

Sin

gle

Bu

yer

Op

era

tio

n

Tra

nsm

issi

on

Sya

tem

Op

era

tio

n

Dis

trib

uti

on

Tota

l

Average Rate Base (RM Million)

24,096 107

24,347 48,551

20,000

30,000

40,000

50,000

60,000

2017

22,802 69

22,983 45,856

20,000

30,000

40,000

50,000

60,000

2016

31

- 1

-

10,000

20,000

Sin

gle

Bu

yer

Sin

gle

Bu

yer

Op

era

tio

n

Tra

nsm

issi

on

Sya

tem

Op

era

tio

n

Dis

trib

uti

on

Tota

l

- 2

-

10,000

20,000

Sin

gle

Bu

yer

Sin

gle

Bu

yer

Op

era

tio

n

Tra

nsm

issi

on

Sya

tem

Op

era

tio

n

Dis

trib

uti

on

Tota

l

TNB’s Revenue Requirement 2014-2017 (RM Million)

116,273 849

16,189 201

36,541 170,054

80,000

100,000

120,000

140,000

160,000

180,000

200,000

32

-

20,000

40,000

60,000

Sin

gle

Bu

yer

Sin

gle

Bu

yer

Op

era

tio

n

Tra

nsm

issi

on

Sya

tem

Op

era

tio

n

Dis

trib

uti

on

Tota

l

Single Buyer Revenue Requirement (RM million)

17

,42

3

28

,64

9

17

,90

5

28

,89

7

17

,25

5

28

,56

4

10

,06

4

18

,48

4

30

,16

4

20,000

25,000

30,000

35,000

40,000

RM

Mil

lio

n

9,1

20

2,1

06

8,8

34

2,1

58

9,7

48

1,5

61

10

,06

4

1,6

15

-

5,000

10,000

15,000

Capacity Payment Variable cost and

fixed O&M

Fuel Cost Total

RM

Mil

lio

n

2014 2015 2016 2017

33

System Operation Requirement (RM million)

36

.1

40

.6

39

.6 45

.6

43

.6 5

2.7

48

.9

62

.5

30.0

40.0

50.0

60.0

70.0

RM

Mil

lio

n

34

3.4

1.0

-

4.2

1.8

-

5.2

2.8

1.1

8.0

5.6

-

-

10.0

20.0

30.0

Return on

Assets

Depreciation OPEX Regulatory Tax Total

RM

Mil

lio

n

2014 2015 2016 2017

Single Buyer Operation Requirement (RM million)

18

1.6

18

2.8

20

0.2

20

1.3

22

3.8

22

4.8

23

9.9

24

0.5

150.0

200.0

250.0

300.0

RM

Mil

lio

n

35

0.2

1.0

-0.2

0.9

-0.1

0.9

-0.1

0.5

0.0

-

50.0

100.0

150.0

Return on

Assets

Depreciation OPEX Regulatory Tax Total

RM

Mil

lio

n

2014 2015 2016 2017

Transmission Revenue Requirement (RM million)

1,5

61

3,7

25

1,6

28

4,0

10

71

0

4,1

17

1,8

07

4,3

37

3,000

4,000

5,000

RM

Mil

lio

n

1,5

61

96

7

82

1

37

5

1,6

28

1,0

21

85

5

50

5

1, 7

10

1,0

81

89

6

43

0

1,8

07

1,1

47

97

3

41

0

-

1,000

2,000

Return on

Assets

Depreciation OPEX Regulatory Tax Total

RM

Mil

lio

n

2014 2015 2016 2017

36

Distribution Revenue Requirement

4,4

48

8,1

07

4,6

88

8,8

96

4,8

68

9,3

92

5,3

57

10

,14

6

6,000

8,000

10,000

12,000

RM

Mil

lio

n

1,5

20

2,0

14

4,4

48

12

6

1,6

22

2,2

13

4,6

88

37

4 1

,72

4

2,3

96

4,8

68

40

4 1

,82

6

2,6

10

5,3

57

35

3

-

2,000

4,000

6,000

Return on

Assets

Depreciation OPEX Regulatory Tax Total

RM

Mil

lio

n

2014 2015 2016 2017

37

Conclusion : Average Tariff in sen/kWh

26.38 0.19 0.053.66

8.25 38.53

10.00

15.00

20.00

25.00

30.00

35.00

40.00

45.00

38

0.00

5.00

10.00

Sin

gle

Bu

yer

Ge

ne

rati

on

Sin

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Bu

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Op

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Sys

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Op

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Ave

rag

e t

ari

ff

39

Thank�you�