Malaysian Economic Democratisation – Extract 6

(Extracts from DAP Alternative Budget 2010 launched on 7th October 2009)

9. Thrust II: Rakyat First – Restructuring and Reallocation

9.3 Unfair Public Contracts
The Malaysian economic landscape is littered with many one-sided contracts and concessions under which private entrepreneurs reap supernormal profits while the government or government-linked companies continue to bear considerable business risk. Major privatisation exercises were conducted and concessions granted in manners that were not open, accountable and transparent through public tenders.

An Unfair Public Contracts Act will be enacted and an independent public commission to be known as the Public Contracts Commission will be formed to review such lopsided concessions that are deemed to be against the public interest.

Constitutional and corporate lawyer Tommy Thomas if of the view that such an act will be constitutional as it will be similar in nature to the Land Acquisition Act 1960 which allows the government to take over any private land for public purpose, provided adequate compensation is paid.

Such legislation is not unique to Malaysia. Eminent domain (United of States of America), compulsory purchase (United Kingdom, New Zealand, Ireland), resumption/compulsory acquisition (Australia) and expropriation (South Africa and Canada’s common law system) are examples of the inherent power of the state to seize or expropriate private property without the owners’s consent provided, of course, that due monetary compensation is paid. Eminent domain is not confined to real property. It also extends to franchises, copyrights, contract rights, trade secrets and patents. Thomas argues that if private ownership of land is not sacrosanct, then neither should be highway and utility concessions.

The DAP, after examining the declassified highway toll concessions, concurs that many concessions are unduly lucrative at the public’s expense. Also, the power purchase agreements (PPAs) the independent power producers (IPPs) have with TNB place undue financial and risk burdens on TNB. High transport and power costs are a burden and drag to economic growth. It is imperative that such inefficiencies be addressed for the good of the nation. The restructuring of these contracts are part of the overall economic reform needed for Malaysia to return to an equitable positon for all Malaysians, and forms a critical element in the 2010 budget theme of “economic democratisation”.

9.3.1 Independent Power Producers (IPPs)
The first IPP licences were granted following a nationwide blackout in 1992. Today, IPPs reap the lion’s share of power sector profits while taking very little risks. Fuel costs are passed-through to Tenaga Nasional Berhad (TNB), the national power company.

In addition, TNB also takes on the demand risk. IPP profits are substantially unaffected by actual power demand due to the lop-sided nature of their power purchase agreements (PPAs) with TNB. In situations where power demand falls below expectations, or declines, TNB is still required to pay fixed capacity charges to IPPs and comply with ‘take-or-pay’ clauses in the contracts.

Former TNB chairman Tan Sri Ani Arope characterised the terms of the PPAs as ‘grossly unfair’, in an interview with Starbiz:

“At 16 sen per unit (kWh) and with the take or pay situation, actually it was 23 sen per unit. With 23 sen, plus transmission and distribution costs, TNB would have had to charge the consumer no less than 30 sen per unit. If mixed with TNB’s cost, the cost would come down but that was at our expense because we were producing electricity at 8sen a unit. We can deliver electricity at 17 sen.”

There was undue government intervention in the PPA negotiations between TNB and the IPPs. As Tan Sri Ani said in the interview, “There was no negotiation. Absolutely none. Instead of talking directly with the IPPs, TNB was sitting down with the EPU. And we were harassed, humiliated and talked down every time we went there.”

It was well-known that when discussions between TNB and the IPPs reached an impasse over the allocation of risk, discussions would go offline to another level after which the parties involved would return to the table as if nothing had happened. Arope refused to sign the contracts and left TNB in 1996. Indeed, some IPP plants were even built on sites that TNB had identified and laid the ground work for, “but for mysterious reasons they were offered to IPPs”.

The first 5 IPPs were guaranteed returns of 20% a year even though actual returns were much higher.69 The DAP recognizes that in some cases, the original sponsors and owners of the IPPs had sold their plants and concessions at handsome profits to buyers who based their purchase prices on the basis that the lucrative PPAs would be honoured.

For example, Malakoff Berhad bought the license for the Tanjong Bin power station from a company linked toTan Sri Syed Mokhtar for nearly RM1bn. It is Syed Mokhtar who reaped the supernormal profit from the IPP license. Most analysts estimate Malakoff’s returns on this investment in the low teens, after paying the premium to Syed Mokhtar.

There is no easy solution to this issue. On one hand, there is the principle of sanctity of contract, which the DAP fully supports. On the other hand, allowing the contract to perpetuate would inflict unfairly high costs on millions of Malaysians.

In this case, the DAP’s stance is that this injustice cannot be allowed to continue. The buyers must have realised how one-sided the contracts were and must have been aware of the risk that they may be renegotiated. As early as 1997-98 the government had sought to renegotiate the PPAs, less than 3 years after the very first IPPs came into operation.

Via the newly set up Public Contracts Commission, the DAP in the 2010 budget seeks to review the terms and conditions of all existing IPPs. Where the IPPs which are not amenable towards both reducing the electricity rates specified in the PPAs, and unwilling to share the risk of fuel price fluctuation, we will seek to expropriate these IPPs as per the terms specified in the concession agreements.

Gas subsidies
All PPAs have a fuel pass through clause in that hikes in oil prices are passed on to TNB. When these contracts were initially signed, the Electricity Tariff Control mechanism price formula = CPI – M + Y (Fuel Pass-Through = Y). However, in 1997, this mechanism was withdrawn and the price of gas supply was fixed at RM6.40 mmBTU. Of course, this amount is much lower than gas prices in the global market. Subsidies were absorbed by PETRONAS.

Over the years, IPPs have gained tremendously from the subsidies on top of the outrageous profits the already make. As a matter of fact, IPPs have received more gas subsidies than even TNB, RM35.7 million since 1997. That means almost 60% of all gas subsidies to the power sector have gone to IPPs.

Table 7: Gas subsidy allocation

Gas subsidy Increasing subsidy due to higher volume and price
Gas subsidy	In RM bil
	FY2008	%change	FY2007	Cumulative subsidy since 1997
POWER SECTOR	13.8	17.9%	11.7	62.6
– TNB	5.7		5.0	26.9
– Independent Power Producers (IPPS)	8.1		6.7	35.7
NON POWER SECTOR – including small industrial, commercial, residential users and NGV	5.9	51.3%	3.9	15.3
TOTAL GAS SUBSIDY	19.7	26.3%	15.6	77.9

Additionally, approximately 87% of our electricity is generated from nonrenewable sources contributing to volatility in costs and tariff rates. Unlike IPPs who can pass on the increase in fuel costs when selling to TNB, tariff rates, the prices at which TNB sells to consumers are pre-determined by the cabinet.

The IPPs claim that they do not make any profit from increase in fuel costs since they retain the same margins. Nonetheless, despite being a business enterprise, IPPs do not take on little if none of the risk from oil price volatility. Instead, it is TNB’s profits that are squeezed every time fuel prices skyrocket while IPPs get a free ride.
Very little investments have been made for the research and development (R&D) of renewable energies. And while this is usually a course of action pursued by the private sector as seen by the diversification efforts of most oil majors, Malaysian IPPs have absolutely no incentive to pursue the development of green technology.

As such, EPU Director of Infrastructure, Dato Dr Gan Kuan Poh had argued that “privatisation and liberalisation in the power generation sub-sector did not progress towards market driven efficiency gains in operations and investment or the efficient and effective allocation of resources”.

Excess capacity
Malaysia currently has a reserve margin of about 47%. This means that we currently have a capacity 47% in excess of normal peak demand levels. Indeed, this is not only wasteful but costs of maintaining the additional capacity is ultimately passed on to consumers. Reserve margins usually need only be between 15 – 20%.

Table 8: Malaysia reserve margins

	2005	2006	2007	2008	2010(F)
TNB capacity	6,346	6,346	6,346	0	0
IPP installed capacity	11,277	11,977	13,377	0	0
Total capacity	17,623	18,323	19,723	21,652	23,802
Maximum Demand	12,493	12,990	13,620	14,007	15,602
Excess capacity	41.1%	41.1%	44.8%	54.6%	52.6%

Hence, not only are Malaysians paying a premium for energy from IPPs but we are paying a premium for energy that we do not need! Hence the political will to renegotiate these highly lobsided contracts are imperative, and where renegotiation fails, the IPPs must be expropriated.

9.3.2 Highway Toll Concessions
Highway toll concession contracts will similarly be reviewed and scrutinised by the Public Contracts Commission. For many of these concession contracts however, there already exist expropriation clauses which can be exercised, in the event that a fairer deal for Malaysians cannot be negotiated with the toll concessionaires.

As an example, assuming that toll rates are capped at RM1.60 and no traffic increase for the Lebuhraya Damansara-Puchong (LDP), it’ll cost the Government an estimated RM1.54 billion in compensation alone between now and the end of the concession in 2029. This figure does not yet include the toll fees which are bourne by the motorists which currently amounts to nearly RM300 million per annum, or RM6 billion for the next 20 years. In fact based on the operator for LDP, Litrak’s public listing prospectus, they have anticipated to make RM18.7 billion in net profits after tax over the entire concession period, which is an exhorbitant amount relative to the cost of capital including interest cost of only RM1.327 billion.

However, should the expropriation clause within the LDP agreement be exercised, it is estimated that the Government will only need to pay RM1.4 billion to buy back the LDP. Hence for the LDP after expropriation, toll rates can immediately be reduced to RM1.00 without incurring any further compensation by the government, and the toll collection period can be halved from 20 years remaining to only 10 years. After 10 years, toll may be abolished altogether or toll which is collected shall be channelled towards the National Public Transportation Fund to upgrade and promote the use of our public transport system. Besides the lower toll rates which will immediately benefit the motorists, the savings will also increase Malaysian’s disposable income of up to RM4.5 billion over 20 years which will serve as a natural domestic spending stimulus for the Malaysian economy.

For the purposes of expropriating highway concessions which are generating extraordinary profits at the expense of the commuters, the DAP proposed Budget 2010 will allocate RM10 billion for the exercises. However, the fund shall be raised via Report of Performance and Statistical Information 2006 & 2007 & Tenaga Quarterly Analyst Briefing Presentations government bonds pledged against the cashflow from the highways which have been expropriated and hence it will not add any further stress on the Government’s budget deficit.

North-South Expressway (PLUS)
However, not all toll concessions will have to be scrutinised by the Public Contracts Commission and be expropriated. For PLUS Expressways, which holds the most extensive network of toll highways, which is publicly listed on Bursa Malaysia, can be taken private.

This privatisation exercise will be at zero additional cost to the taxpayer. Currently the Government already owns approximatley 63% of the shares of PLUS. The DAP budget proposes that the Government makes a General offer for PLUS for the remaining shares which it does not already own. It is budgeted that this will cost RM15 billion, including retiring outstanding loans amounting to RM8.5 billion which are taken by PLUS.

As per the LDP expropriation example above, the cost of this buy back can be covered via continuing toll collections at the present rates for another seven years. For example, a return KL-Penang journey will remain at RM86.60 today instead of RM115.30 in 2015 and RM168.80 by 2030. This move in itself will create up to RM14 billion toll expense savings for Malaysians from 2009-2015, thereby increasing consumer disposable income which will act as a stimulus for the domestic economy. This will be the amount saved either (i) by Malaysians using the highway because of no further toll rate increases or (ii) in terms of compensation which would have to be paid by the Government to PLUS Expressways. In fact, should the Government decide to freeze the toll rates for PLUS today, but continue with the concession til 2038 when it expires, the Government will actually have to pay approximately RM68.3 billion in compensation to the concessionaire! Hence it is imperative that the Government exercise this buy back at the earliest possible time to ensure more effective use of Government taxes, greater equity and economic justice for Malaysians.

After 7 years, the Government can choose to abolish toll altogether, or collect only a nominal toll will be collected to finance maintenance and upgrading with excess collections contributed to the National Public Transport Fund. The reduced toll rates and its subsequent abolition will substantially reduce the cost of doing business in Malaysia, increase logistical efficiencies and ultimately make Malaysian companies more globally competitive. Best of all, the plan will stimulate demand and make available substantial funds for public infrastructure development without the Government having to increase the precarious budget deficit further.