Malaysia's power utility has too much power and not enough money

Tenaga's electricity rate hikes went into effect yesterday - but perhaps it needs to get its own house in order before it charges customers more to flip on the lightswitch.
Starting June 1 Tenaga Nasional increased its electricity rates by an average of 12% due to the rising price of fuel. But MalaysiaÆs national electricity company, which is flush with power, is still going to need to come up with more cash in the near future.

The rate hike is expected to increase its takings by about M$1.5 billion ($413 million) but that wonÆt be enough to cover the cost of generating electricity going forward thanks to its contracts with the independent power producers, or IPPs. Tenaga pays around M$2.5 billion each year in ôcapacity chargesö to the IPPs, which is simply money it doles out to these companies to have the capacity to make electricity available to the national utility. Put another way: the IPP Malakoff Bhd, is due for a "capacity charge payment" of M$630 million by the end of this year ù thatÆs about half the extra revenue that the tariff hike will raise û and this is for electricity that might not even be supplied.

If Tenaga actually uses some of this electricity from the IPPs û then it pays an energy charge. Together with the capacity charges this costs Tenaga about M$6 billion a year.

Plus, Tenaga plans to invest about M$5 billion annually over the next five years to upgrade its generation, transmission and distribution network, work that needs to be done but it means the expenses are mounting. Despite pre-tax profits last year of M$1.8 billion on revenues of nearly M$19 billion, Tenaga remains nearly M$30 billion in debt.

No wonder then that the national utility is said to be looking at issuing new shares to improve its balance sheet structure. The company plans to issue up to 10% of new equity û though no timeframe for the issuance has been specified as of yet. But analysts are watching closely.

ôWhile we believe that any fresh equity issue could be dilutive to existing shareholders, the added benefits of an efficient balance sheet structure could lead to longer-term benefits in the form of reduced funding costs, among others,ö wrote Prem Jearajasingam in a May 29 Macquarie SecuritiesÆ research report.

An infusion of cash, and the increased takings from electricity bills will help but renegotiating the IPP contracts is essential. The company is set to sit down with the IPPs to discuss capping capacity payments and cutting reserve margins û the government has set a two-month deadline for the companies involved to reach an agreement. But analysts are sceptical that contracts will be renegotiated so quickly.

Tenaga needs to come up with better terms. Most of the contracts were initially negotiated in the mid 1990s before the Asian Financial Crisis when the demand was higher than it is today. These days there is little chance it will use all of the electricity on offer - given that it has a reserve margin of about 38%. There is a plan to reduce the reserve margin requirement to 20-25% by 2010, which would help Tenaga lower its cost of securing generation capacity, but thatÆs a few years down the road û renegotiating the contracts now makes more sense.

Whether or not there will be a steady flow of pressure to do this depends on how angry corporates and citizens become when they get their first post June 1 electricity bill. IPP contracts in Indonesia, India and Pakistan all were eventually renegotiated because of the perception that they were unfair contracts. Malaysian IPPs could face the same fate.

Of course, there are some, such as Fitch Ratings, who take the view that any lower power rates are likely to be offset by upward adjustments in the subsidised gas price from Malaysia's national oil company Petroliam Nasional Berhad, better known as Petronas. The government giveth; it can also take away. In that case, Tenaga would have to continue to pass the cost along to customers.

That said, the last electricity rate rise was an 8.3% increase in 1997. And the price hike that goes into effect tomorrow does try to ease the burden on the poor. The first 200 kilowatt hours, or M$43.60 ringgit on each monthly bill, are exempted from the hike. That means about 59% of the nationÆs households could see their electricity bill stay the same. However, it wonÆt spare corporates who sizzle through electricity and are sure to pass along their costs to consumers.

In general, analysts have applauded TenagaÆs efforts to at least try to sort out its financing. Macquarie Securities still has an ôoutperformö on Tenaga. On May 26, Fitch Ratings upgraded TenagaÆs long-term foreign and local currency issuer default ratings to 'BBB' from 'BBB-'. The agency also upgraded the senior unsecured foreign currency ratings of TNB's outstanding bond issues to 'BBB' from 'BBB-'. Its outlook on all the ratings is stable.

In Fitch's opinion, further restructuring of the tariff mechanism to one that incorporated the cost of fuel from Petronas and how thatÆs passed through to customers would be a further credit positive development. Meanwhile it suggests using any equity funds Tenaga raises to pare down debt, especially those denominated in foreign currencies.
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