This article first appeared in Forum, The Edge Malaysia Weekly on September 10, 2018 - September 16, 2018

Recently the Minister of Energy, Technology, Science, Climate Change and Environment Yeo Bee Yin called for a reform of the Malaysian electricity industry to achieve cheaper and cleaner energy production. The minister spoke of more opportunities for power sector players, including in transmission and distribution. At first glance, this statement may seem surprising as Malaysia’s electricity industry seems efficient enough. Malaysia was ranked ninth best among 190 economies in the World Bank’s “Doing Business 2018 Report: Getting Electricity” Distance to Frontier Index — a measure aggregating reliability of supply, transparency of tariffs, cost of electricity and ease of set-up.

The reality, however, is that the “efficiency” of our electricity industry is burdened by heavy subsidies for consumers. Firstly, Petronas supplies natural gas to power producers at below-market prices, forgoing substantial revenue. From the Energy Commission price statistics for July 2018, this subsidy is approximately 30% of the price paid by non-power-sector users. Granted, the previous administration has been reducing this subsidy by RM1.50 per million British Thermal Unit (mmBTU) every six months since 2014.

This, however, means rising fuel costs will increasingly be passed on to consumers under the existing Imbalance Cost Pass-through Scheme (ICPT). A second source of subsidies is the Electricity Industry Fund (EIF). In order to avoid tariff hikes being passed on directly to consumers, the government has dipped into the EIF. According to the Energy Commission, the subsidies from the EIF amounted to RM929.37 million in the first half of this year. In July, Yeo also announced further subsidies from the EIF amounting to RM114 million to maintain tariffs and offset an ICPT surcharge over the second half of the year.

The new government faces a dilemma in dealing with these subsidies. On the one hand, it could choose to continue these subsidies or even perhaps reverse the previous administration’s subsidy rationalisation. But, there is increasingly less fiscal room to manoeuvre. The EIF has only about RM500 million left after this year’s subsidies. Already, the government is being forced to prioritise between domestic and industrial or commercial end-users. The minister explained in July’s tariff announcement that subsidising non-domestic users as well would have deprived the EIF of an additional RM250 million over the second half of the year.

On the other hand, the government could decide to pass on the increased cost of electricity to consumers. This, however, would be highly unpalatable politically. The subsidy announcement drew flak from PKR vice-president Rafizi Ramli. He alleged that the unmitigated tariff hike on businesses and industries would result in increases in the prices of goods and be counterproductive to zero-rating the Goods and Services Tax (GST). With razor-thin majorities in some states, and a less than perfectly united coalition at the federal level, this new administration may be more sensitive to populist voters’ concerns.

A more efficient, transparent, equitable and sustainable policy framework to deal with the electricity industry is essential in the long-term interest of Malaysia. In this regard, I am intrigued by Yeo’s speech hinting at possible liberalisation of electricity distribution and transmission. Transmission and distribution accounted for about 30% of the cost components of the base electricity tariff in the 2015-2017 Regulatory Period 1. A similar percentage is projected for the 2018-2020 Regulatory Period 2.

At present, transmission and distribution is wholly owned and controlled by Tenaga Nasional Bhd (TNB), Sarawak Energy Bhd (SEB) and Sabah Energy Corporation Sdn Bhd (SESB). If liberalisation of distribution can result in unlocking significant efficiency gains, we will go a long way in getting a more efficient electricity industry. In this article, we concede that transmission is a key strategic national asset that should remain as a monopoly owned by the government.

A common reflex response against liberalisation of electricity distribution is that it is an archetypical natural monopoly. The high upfront capital investment to lay out a nationwide electricity distribution network is a major barrier to entry. Indeed, once this grid is set up, the marginal cost of adding an additional user is said to be relatively minimal. This cost structure suggests that a single monopoly provider will always provide transmission and distribution at a lower cost than multiple competing firms.

This argument, however, is premised on the assumption that the asset owner is also the operator of services. It need not be so. Distribution assets (wires) could be distinguished and unbundled from distribution services (retailing or customer service). A single monopoly owner providing capital to set up the “wires” can allow access to the grid by multiple retailers competing for end-consumers. Many countries including Finland, Norway, Spain, Sweden, the UK and Australia have successfully adopted variants of this model.

The basic rationale for asset/operator separation in many countries is based on creating a more efficient cost structure for the distribution of electricity. For the Malaysian Energy Commission’s Regulatory Period 2 (2018-2020), operating expenditure was estimated to account for about 60% of the total cost of electricity distribution. In fact, this percentage does not even include opex on “consumer services”, which has been ring-fenced as a separate business unit from “distribution” in TNB. Thus, any improvement in the operational efficiency of electricity distribution is as important as improvements in the allocation and management of capital expenditure.

Another reason often cited in support of a single monolithic operator is that the distribution and retailing operations enjoy economies of scale. In theory, economies of scale would mean total opex holding steady, regardless of the number of customers, giving ever-decreasing average cost per customer. However, global studies — including those by the Energy Institute, University of Texas, and management consulting firm Oliver Wyman — found that total electricity retailing opex increases closely with the total number of customers. In other words, cost savings from being big are less apparent than commonly assumed, especially beyond a minimum viable scale. Thus, at least insofar as distribution and retailing is concerned, it is not so clear cut that a single large retailer is the most economically optimal option for the electricity industry.

In view of the electricity industry’s status as a strategic asset and essential “good”, it is timely for the new government to consider adopting a fresh mind set and perspective towards any reform. I believe our electricity sector needs innovative or creative ways of combining governance, investment and entrepreneurship from both the public and private sectors at all stages of its value chain. Call it public-private partnerships, new public management (NPM) or network governance.

Concepts involving privatisation have faced a litany of criticism in recent months. They have been accused of failing to deliver efficiency gains or, if they do deliver, of failing to pass on efficiency gains to consumers. Further, privatised or semi-privatised companies are said to focus overly on short-term shareholder value at the expense of long-term investment or other important corporate stakeholders such as employees.

At a more macro level, critics point to the “crowding out” of other productive investment opportunities in the private sector and loss of the state’s capability to cross-subsidise between profitable and unprofitable public services, leading to a vicious cycle of privatisation. Even more broadly, at a geostrategic level, such initiatives have been accused of undermining democracy and national sovereignty.

These criticisms are grounded on the fact that there have been mistakes and perhaps, even abuses, in Malaysia’s history of experiments with private sector participation in public goods and services. With respect, the answer cannot be the complete (re)nationalisation of essential public services. Similarly, private ownership in itself, will not necessarily result in businesses or assets being managed better to benefit consumers.

The reality is more complex. Experience globally has shown that privatisation of an asset or a service without a strong regulatory oversight to incentivise performance and penalise breaches has invariably failed to deliver the promised benefits to consumers. A transfer of ownership from the public to private sector without a competitive and sound regulatory framework undermines the value of any privatisation. On the other hand, public ownership does not necessarily mean poor performance if there are right incentives for management to drive improved performance in a more competitive environment.

In Malaysia, we have suffered from a failure to appreciate this reality. In my opinion, the fundamental problem has been a lack of commitment to a more vigorous, transparent and accountable regulatory framework for privatised services. Perhaps the new government should focus on crafting a creative and effective regulatory framework to govern public-private partnerships, instead of focusing on the narrow issue of retaining state ownership.

The need for policy creativity is even more marked, given recent technological disruptions to the electricity industry globally. With the adoption of technologies such as blockchain and Internet of Things, the grid of the future will be smarter and more agile, facilitating the gradual shift from a “hub-and-spoke” industry model to a “peer-to-peer” model.

Innovation at the “distribution edge”, which is everything “behind the meter”, means electricity will increasingly no longer be seen as a commodity by consumers but be bundled with other value-added services, encouraging diversity in the retailing segment of the value chain. Increasing digitisation and automation means that the transaction costs of this exponential increase in complexity can be minimised.

With technologies such as household solar and wind, each consumer may also be a producer, selling excess production to their neighbours. The Malaysian electricity industry seems ripe for disruption in this respect, given our geographic potential and market leadership in solar panel production.

The era of the single vertically-integrated supplier of electricity distribution (whether privately or publicly owned) may need to be examined. While Malaysia may be far from a completely decentralised future, the government and industry need to climb the learning curve in adapting to the impending disruptions. In this context, perhaps liberalising electricity distribution can be regarded as taking the first step on this journey.

Chew Seng Kok is managing director of ZICO Holdings Inc, a company listed on the SGX’s Catalist. He was formerly managing partner of Zaid Ibrahim & Co, Malaysia, where he was involved in advising on many large infrastructure projects, regulatory reforms and commercial transactions. Law graduate Shaun Kua is doing special research for Chew.

Save by subscribing to us for your print and/or digital copy.

P/S: The Edge is also available on Apple's AppStore and Androids' Google Play.