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More power to the IPPs?

Interview - April 23, 2012
ARL Global owns ARL Power Sdn Bhd, an independent power producer in Sabah. Managing Director Tan Sri Datuk Abdul Razak Latiff discusses the challenging position in which IPPs find themselves in Malaysia, and his ideas on how by assisting these companies, the Government would be strengthening the power generation sector

I’d just like to begin specifically on Malaysia’s energy sector. If you could just give us a brief overview because as the population expands, we know there is going to be a lack in supply of electricity by the year 2020. If you could just comment on the New Economic Model that the government has implemented and how you are evaluating it to fit your own business plan.

If you are talking about the New Economic Model, it is just our roadmap really as to how to achieve Vision 2020. In a nutshell, it is how to increase employment, how to increase per capita income commensurate with increase in productivity and only a marginal increase in costs. Our energy sector is not a fully free enterprise market like in the United Kingdom and the United States. The utility authorities are owned by the government and monopolize the generation, transmission and distribution of electricity throughout Malaysia. In Peninsular Malaysia, it is operated and managed by Tenaga Nasional Berhad (TNB), in Sabah by the Sabah Electricity Sdn Bhd (SESB), and in Sarawak by the Sarawak Energy Corporation (SEC). During the premiership of Tun Dr. Mahathir Mohamad, he decided to privatize the generation aspect of the electricity supply industry in Peninsular Malaysia and Sabah due to several delays in plant ups and blackouts. The main purpose is reduce the financial burden of the Government, improve the delivery system to be more responsive to demand and most important, to ensure reliable electricity supply crucial towards the achievement of Vision 2020. Under this privatization concept, the utility authorities i.e. TNB and SESB only guarantee minimum buy-back of electricity from these privatized power producers or IPPs who will be totally responsible for the design, financing, build, construction, ownership and operation of the power plants under the terms and conditions of a Power Purchase Agreement (PPA) signed between these parties.

So with this privatization you’ve had the buy-back scheme for 20 years?

Buy-back for 21 years, of course there is some fine-tuning required when you start going into this power generation business. Basically, to fast track the power generation sector to ensure timely plant ups in Peninsular Malaysia and Sabah and at the same time reduce the financial burden of the Government to meet the electricity needs of the country. So in Malaysia, a number of independent power producers, or IPPs, were created to build, own and operate power plants. In Peninsular Malaysia the smallest is 400MW while in Sabah they are all mainly small players, in the range of 10MW to 190MW. Most of the early generation IPPs in Sabah are running on fossil fuel because at that point in time there was no gas supply. So based on the buy-back guarantee, we raise our own financing, design, build, own and operate the power plants. There is an agreement signed between the utility authorities and the IPPs, called the Power Purchase Agreement (PPA). It is not a free enterprise market for electricity supply as in most developed countries, where you can simply build your own power plant, and then compete for the sale of electricity to the buyers or distributors of electricity solely based on the offered electricity price in the open market, like what is done in the U.K. In Malaysia, we have a modified approach where the electricity price is fixed and escalated based on a guaranteed buy-back by the utility authorities provided we build our plant at the designated sites approved by the utility authorities readily connected to the grid. A dispatch center decides the dispatch regime for each IPP plant guided by the PPA.
The guarantee buyback comes with a fixed monthly payment called capacity payment provided you can prove that you are able to produce that MW capacity through a capacity test carried out every six months. Then whatever electricity they need they will take from you and in addition to the capacity payment the IPP will also be paid for each kWh produced at an “energy price” as determined in the PPA. Of course, the utility authorities will ensure the price purchased will have a margin in relation to the price of electricity to the customers. This modified electricity supply market adopted by Malaysia will work beautifully provided proper planning is being carried out at the utility authorities and Ministry levels.

Is the government providing any useful steps for you to diversify your business, to cut away from fossil fuels and to go into renewable energy sources?

Unfortunately not in terms of offering a replacement plant to our fossil fuel 50MW plant, whose concession will expire in October 2016. This current trend of open bidding did not help us very much. As a small IPP we do not have access to cheap funds and renewable plant technology manufacturers. This, in a way inhibits us in quoting competitive electricity pricing structure to the TNB and SESB vis-à-vis the Government utility authorities. We are however hopeful that TNB and SESB can offer us direct negotiation or exclusivity to replace our aging plant. We believe only in this way the small IPPs can continue to exist in the electricity supply industry. This direct negotiation or exclusivity will enable the small IPPs to “persuade” for competitive terms with EPC contractors and Financiers. This will enable us to offer good electricity price.
We are in Sabah but in Sabah there is a very funny situation where the costs of electricity generation are higher than the electricity price SESB bills its customers. It is a very funny situation compared to Peninsular Malaysia, as TNB managed a positive margin due to good generation mix such as hydro and gas plants where gas is highly subsidized. In Sabah, only 30% of the generation capacity is from gas-powered plants which enjoy subsidized gas price. The Government awarded System Average Interruption Duration Index (SAIDI) grants to reduce the negative margin of SESB.
For reasons mentioned above and our experience in electricity generation, we would definitely like to venture into renewable energy sources provided the SESB or TNB give us direct awards enabling us to obtain good pricing structure for them. This will be a win-win situation.

So in your business model, when you say you are going to touch on renewables which way are you going to go? Are you going to go hydropower, wind power, solar? What sort areas are you looking into at the moment?

There are two ways of looking at it: one, if you are talking about building a new plant, but that is not really in our control. TNB and SESB will decide where the plant-up is. If the Government really wants to sustain the existence of small IPP players, they should come up with a policy to persuade TNB, SESB and SEC to make us an offer requiring us to build a power plant using renewable energy resources at a given price. With this offer, we would be in a position to knock down the cost of building such power plants and at the same time obtain soft financing to offer the pricing structure required by TNB, SESB or SEC. It would also be easier to solicit JV partners and investors. To me, it is a positive way forward if the Government really wants to help small IPPs grow, like us, on the longer term. We are a long-term player in the generation business and wouldn’t mind reaping dividends towards the tail end of the economic life of the power plant provided the pricing structure is sufficient to repay our loan.
Also, in our case we are now laying plans to develop waste-to-energy, for example, which is a new area that is well supported by the Government, because it solves several problems at one go. Our subsidiary company Petrojadi is the leading scheduled waste disposal company in Sabah and a direct award would open the doors for us to incinerate all wastes in Sabah and generate electricity which can help support SESB’s requirements. 

Your outfit is singly owned. Are you going to invite investors in Malaysia or within the Asian region? Is there a possibility of building a new plant once your concession expires in 2016?

Right now I fully own this fossil fuel plant and since this business is in its tail end I don’t think it will be very attractive to investors unless I am able to prove to them I am going to get another IPP plant in the near future. Running on fossil fuels is messy and comes with high operating costs compared to gas plant and hydro. Renewable energy will be the future, but like I said before we need a direct award to be able to build, own and operate a good renewable power plant.
So right now we are just operating to fulfill the terrible shortage of electricity supply in the state of Sabah. Until SESB offers us to build a new power plant on a direct negotiation basis, we cannot continue our mainstay in the energy business. It is quite difficult now because Petronas, the Sabah State Government and the “big boys” from Peninsular Malaysia are coming to Sabah to compete with us. Petronas has a strategic advantage as they have tons of internally generated funds with better transfer fuel costs, and team up with the Sabah government; they will definitely be able to offer good price of electricity. So far there is no light at the end of the tunnel and hopefully we can see some before we reach 2016, the expiry of our concession. We don’t mind partnering with Petronas and Sabah State Government as we have acquired valuable expertise since 1995.

And what is the outlook? How are you feeling about Petronas coming in, will it affect you?

Like I said, it will affect in terms of competitiveness as Petronas may not have to borrow funds and if they do they can definitely get dirt-cheap funds! The outlook to me is not positive for us but we will continue to look for opportunities and be competitive, maybe in the area of O&M of power plants owned by SESB, Petronas or the State Government in Sabah.

But maybe you should put it out more directly and more clearly to the government. Maybe you should say that you are part of the economy, and they need to look out for the small plants to grow?

That’s what we initially did, when we were the first in Sabah. We thought the Government and the authorities would help us grow but now after 15 years in this business, it seems we are required to compete with “big boys” even for small power plants. They have this government regulatory authority called Suruhanjaya Tenaga who is not really regulating the sustainability of existing small IPP players in the energy industry. They eagerly “jump” on IPPs on any regulatory matters but not SESB or TNB all because they are being perceived as part of the Government and implementing government policies. We just want close scrutiny on all players in the energy industry to ensure they are acting in the interest of the country. To us, privatization is an excellent strategy to boost our economy, Vision 2020 and therefore the need to continue to have IPPs in the electricity supply industry. Not only that, even TNB through its subsidiary participated in the tender. Surely, being a Government Linked Company (GLC) they have access to privileged information and have the competitive advantage. Who is there to check whether all TNB and SESB plants are more efficient than IPPs?

But you have to keep up, times are changing yes, but you need to keep up. It’s like Coca Cola, then Pepsi came up, but it is still Coca-Cola. It’s the same thing: ARL Power is ARL Power.

The structure is different here as they won’t offer you a chance to build plants nowadays like how we came in when you have a good consortium. Instead they will go for open tender and like I said before, being a small player we cannot be competitive in terms of obtaining cheap funds, low gearing and access to reputable power plant EPCs. I believe the small players can be competitive in small plants provided the “big boys” do not participate. It is difficult to compete with the big players who are willing to take a loss to control the industry when they already own bigger profitable power plants. There are a lot of opportunities in Sabah. Lots of suppressed demand for electricity, I would say, because they have not yet gone into the rural areas. Some houses cannot get air conditioning because there is not enough electricity supply. In a nutshell, there must be a policy laid down to help small IPPs grow their business in Malaysia.

I understand, but I feel that in Sabah it is a monopoly, and I am not really keen on that. There are smaller ones coming up, like you. Do you agree with me?

This we have been keeping quiet all the while as the energy industry in Sabah is structured in such a way that we are dependent on SESB. Only the Government can help the small IPPs grow by direct award to replace our existing plants, giving us special access to soft funds and gearing so that we can be competitive and offer good price.
The policy must come from the top. In the early days, the policy was that 40% of power generation could be kept in the private sector and we should have small IPPs to generate a broad structure of players in the energy industry. Nowadays the privatization and the Government policies are non-existent. At least they should allow and help people like ARL Power who are already in the generation business to continue with our business as we have created some employment and contributed towards the Malaysian economy in our own small way.

But this is what you have to bring to the prime minister. You have to tell him, you have to pass the ball onto him.

We have been voicing out but on deaf ears. We have this informal meeting where we informed SESB that we are the pioneers of energy industry in Sabah. I can develop a plant of any size if they tell me the price they are willing to pay. But I cannot compete in an open tender. On the other hand, MPs gave a very bad impression of IPPs in the Malaysian Parliament, which I disagree with. IPPs make a lot of money due to their efficiency but mostly the big ones. To me IPPs provided the much-needed electricity with their own funding on a timely basis, which the Government system cannot ensure.
By the same token, it reduces the financial burden of the Government. At least TNB or SESB knows the price of electricity and gets dependable electricity supply for what they purchased. They are not responsible for the management of these power plants when in their organization they have the Unions to work with. What they need to do is to plan the energy capacity correctly and give enough lead-time to the IPPs to deliver the power plant. IPPs can do this much better, as the decision making process is shorter. All this while the reasons why the IPPs are a financial burden to TNB and SESB are mainly due to bad planning in plant ups resulting in excess capacity and “extraordinary” Capacity Payments. They have capacity but TNB cannot take it because of delays in their distribution plant-ups. TNB is supposed to build a 900 MW plant for a certain year and they asked the IPP to build a 1,500 MW plant instead. It is a waste and they blame the IPP for forcing them to buy more than what they want. It is all planning! And TNB and SESB are equally to be blame, not IPPs. May be because TNB and SESB are dependent on the Ministry for policy decisions on plant-ups and such delays can cause bad planning.

Finally, what is the final message that you would like to convey? I understand your point; I would be feeling some frustration in your position.

Concerned really, as I do not know what next after 2016 after my IPP concession comes to an end. On the Economic Transformation Model, the ETP, where at the end of the day you want to create more jobs, you got to create sustainable companies to provide more employment. We are ready to play a bigger part in the ETP but we need attention from the Government to grow our business.
Please don’t get me wrong, as by doing this you may think we are going to be more expensive and not competitive. What I am saying is, direct award can be competitive if we do it the right way and not necessarily in competitive bidding. All we need is the size of the power plant and the price TNB or SESB wants and we can work backwards to squeeze the EPC contractors, financiers and investors. So, we are actually contributing towards the ETP in our own way as we can also provide sustainable employment at the same time bring in new investors.
You can ask Coca Cola to come and build a factory here in Malaysia, but they will use their own model, where, they will reap all the incentives and move out to other countries if they are more there. This locally, home-grown small IPP business can attract investors and create employment if the Government provides incentives for them to grow in the form of minimum guaranteed buy-back of electricity just to break even and be able to repay their loans, that’s all. These small IPPs can earn profits if there are demands for electricity in excess of the minimum buyback. We are not asking to make “filthy” profits but more of a minimum guaranteed business! With this business I am sure I can get many interested investors to invest. This is the type of FDI that I think the ETP should look at.