National Energy Security Conference 2012:

MESI Reform Initiatives

Presentation by YBhg’ Dato’ Abdul Razak Abdul Majid

28 February 2012

Table of Content

1

2

Introduction to MESI Reform

Reform Initiatives

MESI Governance and Agency Roles

Accounts Unbundling

Ring Fencing of Single Buyer and System Operator

Fuel Mix Option and Supply Security

Stabilisation Mechanism

Capacity Planning and Competitive Bidding

Industry Structure

Introduction to MESI Reform

1

History of Changes in MESI Structure

Distribution

“Vertically

Integrated”

Dominated by

National Utility- TNB

Early 1990’s -

Fully Regulated

Transmission and

Distribution by TNB

Privately-owned IPPs

allowed to participate in the

generation sector

Mid 1990’s -

Multiple Generation

Players

Transmission

TNB

Distribution

Retail

Present

Franchised

Retailers

Energy

Commission Generation

Transmission

Transmission and Distribution by TNB

Privately-owned IPPs allowed in

generation and franchised retailers in

limited areas for distribution

Transmission

Distribution

TNB Generation IPPs

TNBG & TNBH IPPs

SO SB

Opinions on the Current MESI

Industry players have requested more transparency in the dispatch process

(source: PA study in 2008)

Current dispatch process is managed by System Operator within TNB

Stakeholders expressed desire to see higher efficiency in the industry

(source: PA study in 2008)

Technical performance of TNB’s supply chain has improved

(source: M&E audit report 2008)

a commonly agreed tariff setting mechanism to be established. Current method of

Revenue Requirement calculation by TNB includes non regulated activities such

as UNITEN campus and value of unutilized asset

(source: M&E audit report 2008)

Presently, there is no formal procedure of implementation of fuel pass-through;

government extended billions of Ringgit as fuel subsidies

Transparency

Efficiency

Tariff Setting

Mechanism

Fuel

Customer

Choice

TNB is sole supplier to majority of end-customers (except for small pockets of

franchised areas)

Lagging Behind ASEAN Neighbours In Terms Of Transparency

Malaysia Thailand Philippines

Tariffs by G/T/D

Fuel pass through factor

• Transparency via:• accounting unbundling for

G/T/D• published capacity planning• competitive award of PPA• ring fenced dispatch

• Institutionalized clear tariff mechanisms (base & pass through)

• Significant growth and incentives for RE supply

• Higher degree of transparency driven by implementation of a market based system with liberalization across G/T/D

• Market based tariff system

• Slow growth in RE due to lack of incentive

• However it has highest tariff in region

Additional info:• system losses • metering

charges • subsidies

charges for environmental fund

Info limited to units consumed

• Lacks transparency across key functions• performance by G/T/D• capacity planning• award of PPAs• dispatching

• Adhoc tariff setting mechanism

• Limited incentives for promotion of RE supply (eg. tariffs for RE has no price escalation)

Example:

A simple

comparison of

electricity bills

Transparency

Tariff Mechanism

Renewable Energy (RE)

x

x

x ?

?

!Source: Respective regulator websites

Project Context and Background

June - Dec 2008

Khazanah’s MESI Study

Jan - Dec 2009

KeTTHA-Khazanah Study

• Khazanah regularly carries out

reviews across industries in which

it has interest – 15 studies

conducted so far

• Study carried out during second

half of 2008:

– To assess the key issues

currently faced by the

industry; and

– To put forth recommendations

for reform

– Priority was on National

objectives, followed by

Khazanah and finally investee

company

• Extensive stakeholder

engagement (over 50 meetings

with KeTTHA, EPU, ST, TNB, IPPs,

amongst others)

• As Khazanah is NOT the natural

owner of MESI reform, outcome of

MESI reform study was handed

over to KeTTHA in early 2009

• Led by KeTTHA and supported by

Khazanah, the study was further

refined and amended to include

the design of an implementation

platform

• KeTTHA to;

• Seriously and urgently

reform MESI

• Form a cross-agency, cross

functional team to plan,

track and manage delivery

of reform recommendations

• 1st Mar 2010: MESI PMO

kickstarted operations; Dato’Abdul

Razak Majid is CEO

• 9th Mar 2011: Incorporation of

Malaysia Programme Office for

Power Electricity Reform

Corporation (MyPOWER)

4 December 2009

Presentation to Cabinet

Case to Reform MESI

Status quo Key advantages of reform

Performance driven

• Regionally competitive on cost and service

quality

• Increased transparency and efficiency

• Streamlined and credible governance

People first

• Long term supply security and quality

• Gradual transition of tariff to be sustainable

and reduce subsidy bill

• Sustainable tariff support for the poor

Congruence in policies for Energy Efficiency

and Conservation, Green Technologies and

Innovation

• Efficient use of Energy

• Flexibility to support ‘Renewable Energy’ in

a sustainable manner

• Align with new economic model

ENERGY

INEFFICIENT

ECONOMY

UNSUSTAINABLE

TARIFFS AND FUEL

UNDER-

PERFORMING

MESI

• High cost (i.e. PPAs, reserve

margins)

• Lack transparency

• Fragmented governance

• Fuel supply risks (load shedding

a real risk)

• Subsidized tariffs equivalent to

~10-15sen/kwh or RM8 to 12b

• Attract industries that competes

based on subsidized energy

Addressing the Components of MESI

G

T

D

SO

ring-fenced

SB

ring-fenced

End user

Stabilization fund

PETRONAS

Market price for

marginal gas

Pass-through

Selective subsidization

and stabilization

Govt

Accounting u

nbundlin

g

4

5

6

7

8

12

3

IPP

Renegotiate/

extension9

New IPPs

Fuel

Ensure “economic dispatch”, with marginal (orunused) gas to be bought/sold at market price, andgradual phase out of subsidies*Address security of fuel supply, with a transparentplan, including guarantee on committed volume topower sector and options to secure additional supplyof gas

7

Market structure

• Secure new capacity via transparent internationalcompetitive bidding processes

8

Tariff

• Separate G/T/D tariff formulas with automaticadjustments for fuel pass through, allowable rates ofreturns and efficiency gains

• Maintain policy-driven end user tariff, with selectivesubsidization

• Establish a stabilization fund as temporary bufferbetween G/T/D and end-user tariff

4

5

6

Governance/Policy

• Separate agency roles for policy, planning, enforcement and operations, with robust processes

• Enforce accounting unbundling of TNB’s G/T/D operations

• Ring-fence Single Buyer and System Operations** within TNB for greater transparency, strengthening supervision of regulator

1

2

3

Evaluate broader options for PPA renegotiations9

Reform Packages

2

MESI Governance and Agency Roles

Fragmented Governance and the Lack of Transparency Over Industry

Performance Further Jeopardizes the Industry’s Sustainability

New investments

Generation

New investment

T&D

Tariff

settingFuel policy Liberalization

• Incumbent utility

• Single buyer of IPP generation

• Full control over system dispatch

• Access to end users

• Formulates energy policy

• Approves and develops

recommendation on capacity expansion

for cabinet approval

• Formulates privatization policy

• Approves end user tariff

• Coordinates implementation of energy

policy

• Minister KTAK chairs JPPPET*

• Implement and enforce electricity supply

law (e.g., Grid code)

• Advisor to KTAK

• Monitors TNB's performance

JPPPET* • Chaired by KTAK Minister, includes

EPU, MoF, MITI, MIDA, ST, MTDCA***,

TNB, SESB, PETRONAS

• Discusses tariff review, plant-up

programme and service standards

Tax and

incentives

• Windfall taxes for IPPs

• Bakun project

Capacity required

PPA awards Gas subsidies

Policies

Energy Commission

PETRONAS on gas

supply

**

**

Influencer

Decision-making

Conclusion from Detailed Lab on Industry Governance and Agency

Roles

Governance

area

Rules

Regulation

Completed between Jan 16th – 20th

• Overall focus areas and key policy aspects that will be handled by single entity

• Initial organisation structure & how entity would interact with other agencies/

departments

• Process flow for policy development, impact assessment, and consultation with

clear roles and responsibilities for each step along with timelines

• Additional key data items needed to be tracked for energy policy development

• Timeline for implementation of FCPT and IBR, with proposed governance structure

• Initial options for operationalising mechanism for stabilising tariffs

• Diagnostic of current process for capacity planning and high-level transition plan of

some functions to ST

• Chapter outline, frequency of publication and key items to include in Statement of

Opportunity

• High-level stock-take of rules

• Process flow for rules development

• Details of of capabilities and skill sets needed to execute rule making process

• High level diagnostic of current regulatory capabilities against upcoming IBR

requirements

Policy

development

process

Capacity

forecast

Tariff

decoupling

& oversight

Rule

making

ST Functional

Assessment

Focus area

Single Entity

for Energy

Policy

1

Electricity

Policy

Energy

Policy

3

5

6

2

4

Accounts Unbundling End User Tariff

Accounts Unbundling End User Tariff

Base

Tariff

related

G/T/D tariffs or

Incentive Based

Regulation (IBR RIGs)

Regulatory

Accounting

Unbundling (RIGs)

Ring Fencing of

SB and SOAgency Roles

Fuel

relatedFuel Mix Policy

• Supports setting of

G/T/D tariffs

• Data for base tariff

• Promotes operational

transparency, efficiency and

competition especially with

implementation of pass-

through and intl. competitive

bidding process

• Enhance industry

governance; focus on

economic regulation

(i.e. tariff setting by ST)

• Promote an efficient and

economically sustainable

MESI via performance based

tariffs (includes cost pass

through)

• Weighted average cost of fuel

consumed for periodic

adjustment

• Pass through formula

calculation

Salient Components of Incentive Based Regulation (IBR)

• Separation of TNB’s business entities and accounts - Managed

Market Model

• Imbalance cost pass-through mechanism

• Threshold for regulator approval for imbalance cost pass-

through

• Incentive mechanism

• Determination of reasonable return to licensee

• Fix tariff determination process and decision (regulatory period)

• Stakeholders /consumers consultation for every tariff review

• Regulatory accounts and reporting

Source: Suruhanjaya Tenaga

Ring Fencing of Single Buyer and System Operator

G

T

D

SO

ring-fenced

TNB

IPPs

End user

PETRONAS

Special

Committeereporting

SB

ring-fenced

Objectives of a Ring-Fenced Single Buyer (SB) and System Operator (SO)

Objective:

– Single Buyer:

• Strengthening the planning process, increasing transparency of scheduling and dispatch, power

purchase settlements

• Establishment of arms-length relationships for power purchase agreements

• Clear separation of functions between SO and SB

– System Operator:

• to increase transparency of dispatch to enable compliance audits by regulators

• to increase stakeholder confidence that even with an automated tariff-pass through mechanism

dispatch will be at optimum cost to system

Fuel Mix Option and Supply Security

Gearing for Energy Uncertainties

• Malaysia’s energy

requirements are set to

increase as the

economy advances

towards benchmarks

seen in advanced

economies

• The ‘path’ of the

expected transition will

put significant pressure

on the energy policies

• The ‘path’ depends on

many factors which can

be modeled through

defined energy

scenarios

Fuel Security – What Do We Mean By Energy Security

Four dimensions of energy security

Accessibility

AcceptabilityAffordability

Availability

Affordability: cost to

users, and risk to the

economy (reliance)

Accessibility: barriers

and constraints (fuel

and supplier diversity)

Availability: resources

and infrastructure

Acceptability:

environmental, social

objectives

Source: Frontier Economics

Examples of Energy Security

Availability

Affordability

Accessibility

● Availability of reserves – not the immediate problem (adequate

gas reserves domestically and potential for LNG imports)

● Availability of infrastructure – first aspect of the problem:

□ Gas – current infrastructure limits gas supplies from domestic fields and

LNG terminal not yet completed

□ Electricity – availability of alternative generation has helped to manage gas

supply issues – reserve oil-fired generation capacity has ensured continuity

of electricity supply

● Gas supply issue is about physical infrastructure rather than

political, economic or technological risks

Understanding current gas supply issues using the four dimensions of energy security

Acceptability

● Greater availability

of infrastructure can

address the gas

supply issue:

□ Infrastructure for

gas supply (incl

LNG); or

□ Alternate generation

● Affordability is the second aspect of the problem:

□ Unavailability of gas means that generators have to rely on more costly oil

□ This results in an increase in the cost of electricity – currently TNB faces

this because cost increase is not passed through to customers

● Alternative ways of

addressing issue

have different impacts

on affordability (eg

LNG may be higher

cost than occasional

reliance on oil)

● Diversity of domestic

supply unlikely, itself,

to address issue

● Gas supply issue not directly related to questions of acceptability

Source: Frontier Economics

Fuel Mix Study For The Power Sector

… outputs provide information to trade-off dimensions of energy security

Fuel inputsGas (including LNG)

CoalOil , Nuclear, Hydro, Renewables, will

all be included in generation options

Generator dataGeneration options

Generation costs

Generation characteristics

Demand projections

WHIRLYGIG

modelling

(present – 2030)

Fuel mixInvestment and operation

of generation by fuel type

EmissionsTotal emissions from

electricity generation

CostsTotal cost, average cost

and marginal cost of

electricity generation

Energy security

metricsChanges in metricsPolicy constraints

Source: Frontier Economics

Frontier’s fuel mix study for the power sector

Modelling inputsElectricity market

modelling Modelling outputs

Electricity Modelling

Source: WHIRLYGIG, Frontier Economics

Example: Fuel Diversity Index (HHI)

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1981 1986 1991 1996 2001 2006 2016 2021 2026

HH

I of

elec

tric

ity

Malaysia

Australia

China

India

Indonesia

Japan

Singapore

South Korea

Thailand

Vietnam

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1981 1986 1991 1996 2001 2006 2016 2021 2026

HH

I of

elec

tric

ity

Malaysia

Australia

China

India

Indonesia

Japan

Singapore

South Korea

Thailand

Vietnam

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1981 1986 1991 1996 2001 2006 2016 2021 2026

HH

I of

elec

tric

ity

Malaysia

Australia

China

India

Indonesia

Japan

Singapore

South Korea

Thailand

Vietnam

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1981 1986 1991 1996 2001 2006 2016 2021 2026

HH

I o

f e

lec

tric

ity

Malaysia

Australia

China

India

Indonesia

Japan

Singapore

South Korea

Thailand

Vietnam

Source: Frontier Economics

Pricing Drivers and Mechanism

Gas price mechanism

Gas volume profile

Fuel mix

Tariffs and Stabilization

• Reflect value of gas to

MESI

• Maximize long run value of

gas

• Sustainability of supply• Optimize

dispatch/capacity mix

over time to minimize

overall cost

• Subject to fuel mix

constraints

• Diversify fuel mix and

source to match

benchmark HHI scores

• Pursue lowest cost

diversification strategy

• End-user tariffs that is

competitive vs. Thailand

• Industry revenues that

reflect efficient costs

• Output based subsidy

management

1

2

3

4

Current Situation of Gas Supply and Pricing to Power Sector

Pressure to increase gas price

• PETRONAS has weak incentive to maintain

or increase domestic gas supply to

Peninsular Malaysia

• Power sector incentivised to use gas for

extensive baseload generation

• Result is gas shortage, system security risk

and reliance on costly oil/distillate

What is an appropriate adjustment?

• Higher gas price provides incentive to

increase supply. There will be a risk of

excess supply if demand falls with

increasing prices

• In long run, higher gas price should

encourage power sector to shift baseload

generation toward coal (reducing demand

for gas)

Power sector willingness to pay

(alternative generation – e.g. Coal)

PETRONAS opportunity cost

(MFO or LNG equivalent)

Implications for ESI dynamics

?

What should be the gas price

for power sector

Conflicting interests between gas

supplier and power sector

Current gas price = RM13.70 mmbtu

Stabilisation Mechanism

Concept Description

• Transparent mechanism to

manage the gap between

• Market pricing

• End user pricing

• Mechanism to move subsidy

delivery from fuel input

subsides to end-user cash

subsidies

Examples

Hong Kong: Stabilization fund

managed by utility

Spain: FADE - Funding of tariff

deficit

US Maryland: Stabilization and

tariff transition plan

Process

1. Move to market pricing for fuel

2. Amounts from Consolidated /

Trust accounts transferred into

‘Stabilisation’ Fund

3. Stab. Funds channeled directly

to targeted consumers on a 6

month or 12 month basis

Remarks:

Currently MESI already has a

stabilization concept (i.e. cost-

sharing, PETRONAS fixed gas

price) – however process is

inefficient and promotes

wastages due to non-

transparent, ad-hoc and sends

incorrect pricing signals

A Stabilisation Fund is a Mechanism That Can Be Used to Manage

Impact of Electricity Tariff Increase to End Users

Stabilization

fund

Basic

Concept

Funding

Process

MESI required revenues likely to be volatile

End-user effective tariffs (TNB tariff less subsidy from stabilisation fund) needs to account for ability of consumers to adapt and government subsidy/incentive policy

System deficits/ surpluses arise when revenues collected are below/above system costs

Stabilisation mechanism required to shock absorb transition and volatility, with temporary deficits being recovered from future surpluses

Required revenues

5 4

Time (years)

Size of stabilisation facility

3

1

2

3 4

Collected

revenues

1

2

A Conceptual Example for Use of Stabilisation Fund

Capacity Planning and Competitive Bidding

Competitive Bidding

Capacity Required Status

Coal Plant

Gas Plant

Completed

1,000 MW Tanjung Bin1,000 MW

In Progress

MyPOWER is working with

Suruhanjaya Tenaga to

secure the capacity required

4,500 MW

Industry Structure

Key Drivers for Change

Government financial constraints – i.e. needs to

reduce subsidy via market pricing of commodities -

Fuel pass-though mechanism

Enhanced public trust and transparency in supply

processes (i.e. Competitive capacity plant-up, rule-

based tariff setting and billing, published customer

service level)

Motivation for private sector investment

Enhanced efficient planning and asset management

by industry

Improved management of fuel supply security

Preparation for regional integration

Environmental compliance / CO2 emissions

Environmentally

sustainable

System

security

and

reliability

Economic

viability –

reflective of

market prices

Industry / Transformation Objectives

Industry Structure for MESI and Drivers for Change

Different Paths and Timeframes

High

Medium

Degree of Generation Competition

Low

None Low Medium High

Degree of Retail Market Competition

None

England/Wales1998

England/Wales

California,Norway,Alberta

Spain1999

Australia1997

New Zealand1997

New Zealand1999

Australia2001

California 1997

Norway 1993

Alberta 1996

Argentina2000

Argentina1992

England/Wales1990

8

3

4

2

4

3

5

4

Starting Base

X Years taken for transition

Portugal,Japan1999

Different Models Experimented Elsewhere

Enhanced Single Buyer

IPP Int. RE

Direct

Regula

tor

End users

Distribution

Retail

Transmission TNB Transmission

SO

Generation TNBG

Current ESI

IPP RE

End users

EGAT Transmission

Direct

customers

TNB Distribution

Generation

Transmission

Distribution

TNB

Gen.

INT.

TNB

Transmission

Partial Competition (PC) Model

Regula

tor

IPP Int. SPP

New

DistcoTNB Distco

30%

Direct

Negotiated

Regulated tariff

End usersEnd users

Distribution

Retail

GencoGeneration

TNB TransmissionTransmission

Competitive Bilateral Contract Model (CBC)

Distco

Direct R1 R2 R3 R4

End users

Negotiated

Regulated tariff

Regula

tor

End users

Distribution

Retail

IPPs Int. SPPGencoGeneration

NewCo TransmissionTransmission

Full Competition (FC) Model

Hydro Gencos

R1 R2 R3 R4

End users

Negotiated

Regulated

tariff

Regulated

tariff

Regula

tor

System operator

Transmission

Distribution

ISO PoolSO

End users

TNB Distribution

SB

Regula

tor

SB

Thank You