Tariff review may relieve Indah Water’s structural deficit

This article first appeared in The Edge Malaysia Weekly, on February 18, 2019 - February 24, 2019.
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TWO decades after its nationalisation, Indah Water Konsortium Sdn Bhd (IWK) is still haemorrhaging money but relief could be just around the corner.

Last month, the federal government said it was reviewing sewerage tariff rates to accommodate IWK’s rising operational costs. Any upward revision would be the first sewerage tariff increase in 25 years.

On paper, a tariff increase would narrow IWK’s revenue shortfall and alleviate some of its rising cost pressure. It would also reduce the subsidies needed from public coffers to keep IWK ticking.

“Of course, you cannot just look at it from just one dimension because there are other dimensions to look at like the social impact of it,” says IWK CEO Faizal Othman.

Most households are now charged RM8 monthly, while low-cost houses are charged RM2 monthly. In comparison, servicing each household costs between RM18 and RM20, says Faizal in an interview.

That means that IWK is operating at a loss for each customer. Its collection rate is already high at 90%, excluding Labuan, which has hit 94% thanks to a joint-billing initiative that pegs the sewerage charge to the water bill.

This year, IWK in partnership with Ranhill Holdings Bhd plans to roll out joint billing in Johor. It is now engaging other states to do the same eventually.

“[But] even if we collect all the RM8 per household, it will still fall below our operating costs,” says Faizal.

And the deficit is steadily widening through a combination of operational expansion to keep up with population growth as well as modernisation of its facilities.

For perspective, when IWK was taken over by the Ministry of Finance Incorporated (MOF Inc) back in 2000, it had about 3,000 treatment plants. Today, that figure has risen to 6,745 plants.

IWK began as a private company that was awarded the concession for nationwide sewerage services. Today, its services span the whole of Peninsular Malaysia except for Kelantan, Johor Baru and Pasir Gudang. The company says it is in ongoing discussions on taking over the sewerage services for Johor Baru and Pasir Gudang.

The sophistication of its plants has evolved too. In 2000, about half were non-mechanised, but today, IWK has roughly six mechanised plants for every non-mechanised plant.

The mechanisation has been critical in raising IWK’s compliance levels with environmental standards to 97% presently, from below 90% pre-nationalisation. However, mechanised plants also cost more to operate, adding to the company’s steadily growing financial strain, particularly its high electricity consumption.

Electricity makes up the biggest chunk of operating costs at RM260 million annually.

In addition, about 40% of these assets are over 10 years of age, meaning they are overdue for replacement, which means more costs and investments are needed.

This means the much anticipated sewerage tariff review by the Ministry of Water, Land and Natural Resources has been long in coming. The ministry has not given a timeline for the review to be completed.

That said, IWK has undertaken an operational efficiency drive in recent years to mitigate some of the upward cost pressure, and has managed to stabilise its costs for now.

“In terms of pure operating costs, in the last three years, we have contained it to about RM800 million, which includes maintenance capex,” Faizal tells The Edge, adding that the trajectory had been upwards prior to that.

He adds that IWK currently manages RM30 billion in assets, meaning in terms of operational efficiency, its cost-to-asset ratio is just below 2.7%.

Overall, the revenue-cost gap now is about RM150 million a year and IWK has received annual assistance averaging the same amount for the past three years. Faizal says before that, the sum had averaged to RM200 million annually.

“Of course, we would also like to see how we can further reduce that and one day stand free of the government (financially),” he adds.

 

Upward cost trajectory

Despite having stabilised its operating costs at roughly RM800 million, it is likely to be temporary as IWK continues grappling with upward cost pressures.

The company estimates that over the next decade, its operating costs will continue to rise by an average of 6.7% per annum due to a myriad of factors, including inflation.

Among others, its assets are growing by about 200 plants a year thanks to population growth. It also continues to upgrade non-mechanised plants, which bumps its electricity bill, in addition to replacing aging equipment.

This longer-term perspective indicates that a simple tariff revision may not suffice to ensure IWK’s financial sustainability in the long run.

“As it is, just to manage our current operating costs, the tariff would have to be in the region of RM14 to RM16 (per household) and that is without capital expenditure,” says Faizal.

“To ensure our current operating costs are taken care of and also to invest into technology advancements for operational efficiencies, it may have to be around RM18 to RM20,” he estimates.

Even at between RM14 and RM16, the quantum of increase still comes to a staggering 75% to 100%, despite the relatively low sums involved.

Faizal acknowledges that such a drastic increase will obviously not sit well with the public. In addition, it may unduly burden the lower-income households if not properly structured.

This is a deeper quandary facing the federal government. Keeping the sewerage tariffs unchanged may avoid a public uproar, but at the cost of an ever-growing financial burden to make up the shortfall.

In contrast, biting the bullet with an outright tariff increase would narrow the gap but make the government of the day very unpopular.

Based on prevailing industry practices, there are several possible approaches that can be considered, according to Faizal, though the list is not exhaustive.

One is to use a volumetric approach to assess charges by benchmarking against a household’s water consumption, which is practised in Singapore. This means the sewerage charge will directly correlate with water consumption levels, as opposed to a flat rate per household.

“When you use the water, you will eventually discharge it. So there is a cost to bring the water to you and similarly, there is a cost to then treat the water that is discharged,” explains Faizal.

A potential behavioural effect from this approach could be better water conservation, he adds, given that the first tier of water consumption is normally priced much lower to avoid burdening the lower-income households.

“So if people use water conservatively, they can get a lower rate. We would definitely be able to fashion our tariffs accordingly,” he notes.

A second approach is to put into place a mechanism that allows for regular and gradual increases, similar to the operating periods that water suppliers base their business planning on.

Under regulations administered by the National Water Service Commission (or SPAN), water operators need to plan for a three-year operating period and submit the plan a year before the operating period begins.

The plans would include projected capital expenditure and maintenance costs versus revenue estimates, which would then be factored into whether tariffs need to be reviewed for said operating period.

“We are also looking at this and are in talks with the government,” says Faizal, adding that the mechanism would add transparency in terms of the regularity of tariff review as well as allow closer scrutiny by the public on IWK’s costs.

Another area, which IWK is pushing into at the moment, is adopting a circular economy approach to the by-products of its treatment plants to complement any tariff review (see accompanying story).

However, a key challenge that arises regardless of which mechanism is ultimately adopted is to mitigate the impact to the lower-income households, Faizal stresses.

What could come into play is data on lower-income households that is already available through government programmes such as e-Kasih, which is a national poverty databank for household heads earning less than RM1,500 (urban) or RM1,000 (rural).

“We think that if we use government data from programmes like e-Kasih, for example, which some other utilities are also adopting, then we can structure some direct assistance to the group as more of a targeted subsidy,” he adds.

 

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