This article first appeared in Forum, The Edge Malaysia Weekly on November 16, 2020 - November 22, 2020

Pacific Gas & Electric Co (PGE), the monopoly supplier of electricity to California, is being subjected to close scrutiny for repeated power cuts and causing wildfires in the state. Persisting with obsolete transmission towers, lacklustre monitoring and inadequate trimming of vegetation at risk of igniting when rubbed against high voltage wires, are among the long list of operational issues attributed to PGE’s inability to maintain a reliable supply of electricity.

Concurrently, PGE, a company listed on the New York Stock Exchange, is being accused of compromising maintenance in order to prioritise profits, while the California Public Utilities Commission is cited as a regulator that has repeatedly failed to hold PGE accountable for its history of failures.

These failures have thus been acknowledged as systemic and a consequence of the apparent flaws in the governance ecosystem surrounding PGE as a monopoly service provider, including PGE’s nature of ownership, the industry’s structure and the competence of the regulator.

Malaysia unfortunately also has a history of monopoly service mishaps. The freshest on the minds of households in the Klang Valley would be the repeated water disruptions of early September and October, and now in November, the latest in a series of water management calamities over the years. Access to water for more than a million account holders of Air Selangor has been affected — a shocking state of affairs in the 21st century.

Air Selangor, however, is not alone among Malaysia’s monopoly service providers to have been centrally involved in mishaps surrounding the supply of public utility services. Without going too far back in history, one could point to short-term power outages by Tenaga Nasional Bhd (TNB) in Johor Baru, Ipoh, Klang and Segamat in the last several years and the breakdown of KLIA’s Total Airport Management System, operated by Malaysia Airports Holdings Bhd (MAHB), which crippled the airport terminal’s operations for a week in August last year, and MAHB’s spotty track record for maintaining clean washrooms prior to the Covid-19 pandemic, as other examples. While no doubt Air Selangor, TNB and MAHB have also done much good, the track record of Malaysia’s monopoly service providers leaves more to be desired given the criticality of those services.

Each of these service failures can be attributed to operational reasons. Given their frequency, however, we should refer to PGE’s case and query whether behind these unfortunate occurrences are systemic weaknesses existing within the governance frameworks surrounding each of these monopoly service operators. If so, the country’s focus should be on matters that are strategic and structural, rather than merely operational.

Zooming in on miscreant factories or lax operational risk management practices is well and good. Competence in regulating compliance with technical requirements, one of the responsibilities of sector regulators Suruhanjaya Perkhidmatan Air Negara and the Energy Commission (EC), is indeed a need.

It would nevertheless be worthwhile to revisit questions of industry structure, competition, funding, ownership, regulation, ministry role or even the accountability of Boards of Directors, all of which are interdependent and need to be underpinned by clear government policies, to form a fuller and more effective framework for governance surrounding how such critical service providers and their respective sectors should be governed and incentivised.

The methodology behind the raising of income to cover the cost of delivering these services provides a useful illustration on the links between the various components of a governance framework and the quality of service delivery.

An early factor to determine is industry structure, namely whether competition should be introduced and a monopoly broken down. Incumbents could justifiably point towards the benefits of natural monopolies and operational networks as reasons to deliver their services in the lowest possible cost to the consumer. These presumptions should anyhow be challenged and subjected to some study. The telecommunications industry, for one, once comprised solely Jabatan Telekom, before evolving into the thriving competitive sector it is today.

Should a monopoly structure remain preferred, tariffs or fees payable by users to monopoly service providers should be regulated, as they are rightly in Malaysia. Rightly because such regulation serves to thwart any abuse of monopoly power in the form of excessive pricing, which a single industry operator could be tempted to impose if it goes unchecked. Electricity tariffs, for instance, are regulated by the EC while airport charges by law would be set by the Malaysian Aviation Commission (Mavcom).

Those tariffs, if premised on certain performance targets and appropriate economic principles, should generate adequate revenues for the monopoly operator to cover its planned operating and capital expenditures and, in fairness to the operators’ shareholders, a reasonable rate of return on capital. Setting tariffs with these objectives in mind ensures there is available funding to cover the cost of running and maintaining the operations necessary to supply water, electricity or airport services to consumers. It also aligns the incentives of the operators with those of consumers, regulators and investors.

Lowballing these tariffs, say, by delinking them from costs, will compromise those objectives and likely necessitate a decrease in cost by the operators, giving rise to a risk of underinvestment or neglect in maintenance, ultimately disrupting services. Landing on the right cost base is therefore key, and requires competent regulator and stakeholder input. Failure to meet performance targets would result in some form of punitive measure by the regulators or shareholders. In other words, a carrot and a stick. A correctly set cost base, tariffs and incentives should therefore create a conducive environment for a successful delivery of services.

These mechanics in fact largely describe the Incentive Based Regulation framework implemented by the EC in setting electricity tariffs, and the Regulated Asset Base framework meant to have been introduced by Mavcom (until the government in December 2019 decided to shut the regulator down), and indeed many other regulators of monopolies globally.

The outcomes of successful implementation of such frameworks would be operators that are correctly incentivised, adequately funded, have put in place an operating and capital plan, have little excuse for service failures and would be held accountable by the regulator and shareholders for such failures. These are presumably outcomes desired by all stakeholders, including consumers.

The prerequisites for successful implementation would include clear government policies on industry structure, clear regulations and enforcement on safety and quality of service, transparent stakeholder engagement and an independent and competent regulator. These would be the ingredients of a strong governance framework, each interdependent on another, which happen to be encapsulated within the context of a price-setting mechanism.

In the case of Malaysia, tariffs for water, electricity and airport services are among the lowest, if not the lowest, in Southeast Asia. This is possible primarily as a consequence of government subsidies, for instance on the price of gas and airport infrastructure costs. Electricity tariffs and airport charges therefore have a lower cost base to cover.

Clear government policies on subsidies for these purposes and actual follow through, especially during a period of fiscal constraint, are therefore similarly critical for a strong governance framework to facilitate sustained and reliable delivery of services by monopoly operators. Otherwise, tariffs that are set unrealistically low will eventually manifest in the form of inferior services.

This is, of course, one example of a governance ecosystem at work which seeks to hold a monopoly operator to account. An independent and competent regulator will likely feature prominently, what more with a pandemic and demands on sustainability.

It is worth noting that the single operator of air traffic control (ATC) services in Malaysia is the Civil Aviation Authority of Malaysia (CAAM), which is also the technical regulator for the aviation industry in Malaysia. CAAM in effect “regulates” itself. It is quite incongruous that this clear conflict and flaw in governance persists today and was not addressed by the Ministry of Transport when the Department of Civil Aviation was corporatised and renamed as CAAM in 2018.

Little wonder that Malaysia’s ATC services, which also impose the lowest air navigation facility charges in the region on airlines, were associated with the incident involving an aircraft and a ground vehicle at Subang Airport in April 2019. In addition, questions were raised on the ATC’s role during investigations into the disappearance of MH370 in March 2014, while CAAM’s air safety rating was downgraded by the Federal Aviation Administration in November 2019 due to its shortcomings as an aviation regulator.

So, quite aside from management and operational considerations, whether or not a monopoly operator delivers good service and prevents disruptions such as those experienced in the Klang Valley for water, is or at least could be dependent on a multitude of interdependent external factors related to the governance framework surrounding the monopoly operator.

The next time your home runs out of water, or experiences a power outage, or you have to put up with a dirty washroom at the airport, it may be due to a failure in the governance framework. Malaysia will do well to equally give attention to the strength of this ecosystem if these services are to be delivered properly to the Malaysian public.

Azmir Zain, a chartered accountant, was an economic regulator in his former role as chief operating officer at the Malaysian Aviation Commission. He was also a director of investments at Khazanah Nasional Bhd.

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