Incentive Based Regulation IBR PDF

Incentive Based Regulation (IBR)
Regulatory Economics Department

13th May 2016
Economic Regulation
Base Tariff - 1st January 2014
Imbalance Cost Pass-Through (ICPT)
Performance Indicators
Electricity supply chain
multiform production is more costly than production by a monopoly William J.

Baumol (1977)
A Natural Monopoly will typically have very high fixed costs meaning that is impractical to have more
than one firm producing the goods.
3
What is Economic Regulation
Aims to ensure..
Economic Regulation
Form of government
intervention to address
inefficiencies
arising
from
monopolistic
markets e.g. natural
monopoly sectors of
electricity transmission
and distribution
A
substitute
for
competition
where
competition
is
not
possible
Customers of monopoly are

protected
Prices of Utility charges will be

based on efficient costs
Quality of service and

performance of the companies
assets are maintained
Utility gets the right incentives to

improve their performance and
increase investments on an ongoing basis
Forms of Economic Regulation
Command and Control Regulation
1 2
Rate of Return regulation
4 3
Market Controls Regulation
Self Regulation
1. Command and Control Regulation
Imposition of standards backed up by legal sanctions if the standards are not met
Law is used to define and prohibit certain types of activity or force certain types of action
Standards can be set either through legislation, or by regulators empowered by regulation to

define rules
Advantages
Disadvantages
Can be implemented quickly
Fixed performance standards backed

up in law
Close relationship between regulator

and business could lead to regulatory
capture
Government or regulator to be acting

decisively
Can be complex and legalistic.
Defining acceptable standards can be

difficult
2. Rate of Return Regulation
Regulator constrain a firms monopoly pricing behavior by specifying the maximum rate of return
Fair approach to tariff determination Regulators in Japan and in some US jurisdictions
If the actual revenue earned by the utility firm in the year is too low to meet the specified rate of
return, the regulated price will be adjusted upward for the following year and vice versa
Advantages
Disadvantages
The utility firm still have a degree of

autonomy in running its business to
recover costs
Consumers will be protected from the

overly high prices
Encouraging the regulated firm to

over-capitalise by accumulating a rate
base that is higher than the efficient
level Gold plating (higher tariffs)
3. Self Regulation
It often takes the form of a business or a trade association developing its own rules of
performance, which it also monitors and enforces
Some government oversight of the regulation, but as a rule self-regulation is often seen as a way
of business taking pre-emptive to avoid government intervention
Advantages
Disadvantages
Can be-well-informed, with a high level

of commitment from firms
Could be self-serving/undemocratic
Legalism not necessarily avoided
Cheap for government
Weak enforcement
Easy to change to fit circumstances
Independent oversight difficult
Realistic standards created
4. Market Controls Regulation
Market based regulations can prove cost-effective, and minimize regulatory interference in the
day-to-day operation of companies
Common market-based mechanisms such as:

Competition Laws;
Regulatory by Contract;
Tradable Permits; and
disclosure Regulation
Advantages
Disadvantages
Firms respond
bureaucrats
Applicable across sectors
Flexibility
Low enforcement cots
to
market
not
Uncertainties and transaction costs
Lack of response in crisis
Needs healthy permit market
Can create barriers to entry (disputes

resolved by participants)
Depends a
information
lot
in
reliability
of
Economic Regulation
10
The Energy Commission in 2012 developed the Regulatory

Implementation Guidelines (RIGs) to establish the following
Regulatory Implementation Guidelines
1 The economic regulatory framework for regulating TNB

2 Tariff setting framework and principles for tariff design
3 Incentive mechanisms to promote efficiency and service
standards
RIGs
2012
4 Process of tariff reviews; and

5 The format of regulatory accounts and annual review
process
11
Electricity tariff is regulated by the Government under the

Incentive Based Regulation (IBR) framework
Regulated by
IBR is a framework to set electricity tariff

Government
Customers
Fair, affordable and
transparent tariff
Efficient cost
Value for money for the

excellent service in
providing electricity
Guidelines
Ensure affordability to
Rakyat
Tariff which stimulates
economic growth
Ensure sustainability of
the electricity supply
industry
TNB
Fair return on investment
Incentive to operate
efficiently
Incentive for excellent
performance
Source : Electricity Tariff RIGs, Suruhanjaya Tenaga, Jan 2012
12
TNB is incentivised to increase efficiency in three broad areas
Operational
Efficiencies
- Rewarded for
seeking efficiencies
in operational &
capital expenditure
Financial
Efficiencies
- Rewarded for
maintaining an
efficient capital
structure.
Performance
Efficiencies
- Rewarded for
delivering
improvements in
network
performance.
13
IBR, also known as Performance Based Regulation has been

widely adopted
IBR is widely adopted in Europe
and being introduced in South East Asia
Performance Based
Regulation
Performance Based
Regulation
Cost-plus
No IBR
Sweden
Finland
Myanmar
Norway
Estonia
Latvia
Lithuania
Thailand
Laos
Denmark
Philippines
Ireland
Netherlands
Vietnam
U.K.
Germany*
Poland
Cambodia
Belgium
Luxembourg
Czech R.
Austria
France
Malaysia
Hungary
Romania
Singapore
Slovenia
Monaco
Portugal2
Brunei
Slovakia
Bulgaria
Italy
Indonesia
Spain
Malta2
Greece
IBR is an improvement over the cost plus model as it enables tracking of efficiencies and costs
IBR applies to natural monopoly parts of the power sector such as transmission and distribution networks
Source: McKinsey
14
IBR is a structured way to set electricity tariff
Electricity tariff reviews over the years

After IBR
Before IBR
sen/kWh
(+14.89%)
Announcement Date
24 May 2006
5 June 2008
12 Feb 2009
30 May 2011
2 Dec 2013
11 Feb 2015
Effective Date
1 June 2006
1 July 2008
1 Mar 2009
1 June 2011
1 Jan 2014
1 Mar 2015
Quantum
12%
24%
(3.7%)
7.1%
14.89%
Regulated Gas (RM/mmBTU)
6.40
14.31
10.70
13.70
15.20
15.20
Average Tariff (sen/kWh)
26.2
32.5
31.31
33.54
38.53
38.53
(2.25)
ICPT (sen/kWh)
Before IBR
Tariff setting was on ad-hoc basis

No proper mechanism for tariff review
Less transparent to customers
Tag to gas pricing (Regulated since May 1997)
After IBR
ICPT
ICPT every 6 months
Base
Tariff
Base tariff is reviewed once

in every 3 years
15
Regulatory
Implementation
Guidelines
(RIGs)(RIGs)
Regulatory
Implementation
Guidelines
RIG
Description
Define business entity
Define the tariff setting framework
Revenue requirement principle
Establishment of WACC
Establishment of operating cost, capital cost, asset and

consumption templates
Establish incentive framework for operational performance
Establish cost allocation principles
Establish fuel cost pass through mechanism
Establish tariff design principles
10
Establish Regulatory Accounts process
11
Establish process for establishing revenue requirement and

tariffs
16
RIG 1 : Define Business Entity (1/2)
Under the IBR framework, Managed Market

Model has replaced the traditional vertically
integrated structure of Malaysian Electricity Supply
Industry (MESI)
Identified Five (5) business entities to be
subjected to IBR mechanism:
TNB Generation (TNBG);
Single Buyer (SB);
Transmission;
System Operator (SO); and
Customer Services (CS)
The Independent Power Producers (IPPs) are
collectively the sixth business entity in the
Managed Market Model and contracts the sale of
electricity with the Single Buyer
Electricity
Customers
Electricity Tariff
Customer
Services
Generation
Tariff
SB and SO will be separated identified and ring

fenced from other parts of the business
Transmission
Tariff
Transmission
System
Operations
Tariff
System
Operations
Single Buyer
SLAs and merit
order dispatch
TNB Generation
Flow
of
Funds
PPAs and merit

order dispatch
Independent Power
Producer (IPPs)
Managed Market Model
17
RIG 1 : Define Business Entity (2/2)
The Managed Market Model incorporates 5 business entities

Single Buyer (SB)
Comprises the functions of the existing TNBs Energy Procurement Division

SB procures electricity from IPPs and TNB Generation based on the terms of the PPAs entered into
with the IPPs and Service Level Agreements (SLAs) entered into with TNB Generation
SB dispatches TNBs generation units and the IPPs based on a dispatch merit order
Dispatch merit order is based on the heat rate, fuel costs and variable operating costs
TNB Generation
Includes the ownership, management and operation of generation plants owned by TNB
TNB Generation contracts with the Single Buyer for the sale of electricity based on SLAs
Transmission
Includes the management, maintenance and development of the TNB transmission system for the
transmission of electricity to end customers
System Operator (SO)
Includes the current functions of transmission system operations of TNB
Customer Service (CS)
Includes the management, maintenance and development of the distribution system and the sale of
electricity to customers
18
RIG 2 : Define Tariff Setting Framework
There are 3 choices for setting the tariffs for the five (5) TNB BEs. The choices as per below:
i.
Revenue Cap
ii.
Price Cap
iii. Actual Cost
ST recommended a Regulatory Term of three (3) years (i.e. First Regulatory term 2015 2017)
What it is
Revenue Cap
Price Cap
Actual Cost
BEs operating under Revenue Cap

regime are not exposed to forecast
revenue due to differences between
actual and forecast electricity sales,
prices are adjusted to make up for the
revenue difference
BEs operating under Revenue

Cap regime are exposed to all
revenue risk based on actual
electricity sales varying from
forecasts of electricity sales used
to set price
TNB is allowed to recover all of its

actual costs
The revenue for business entities

will be based on actual electricity
sales which may be different to
projected revenue based on initial
forecasts electricity sales used to
set price.
TNB
Business
Entities
Single Buyer Operations
Customer Services
Prices adjust to reflect changes in

costs to ensure that the regulated
entity does not earn less (or
more) that the cost of providing
services.
Single Buyer Generation
Transmission
System Operations
19
RIG 3 : Objectives and Focus Areas of Revenue Requirement (1/6)

Key Objectives
To establish the
revenue requirement
(RR) principles for
each of the 5
regulated business
entities (i.e. GS, Tx,
CS, SB & SO)
To establish the
incentive framework
for the 5 regulated
business entities
Definition & Focus Areas
Implementation Process
To forecast revenue which each

of the 5 business entities should
recover from electricity
customers (through electricity
tariff)
ST / TNB may review the

revenue requirement as
follows;
Reviews are to be
conducted every 3 years
The RR should enable the

business entity;
to meet its operational,
expenditure requirements,
to invest in new assets,
to pay relevant taxes, and
to deliver a market based
efficient return to investors
Submission needs to be
provided 10 months prior to
the next regulatory period
(submission in Feb17 for
regulatory period Jan18)
Cost Incentives - to pursue efficiencies in OPEX & CAPEX

Financial Incentives -to pursue an efficient capital structure (debt and equity)
Network & Customer Services Performance Incentives - To incentivise improvements in
network performance and customer service (based on targets such as SAIDI, SAIFI, etc.)
Source : Electricity Tariff RIGs, Suruhanjya Tenaga, Jan 2012
20
RIG 3 : Annual Revenue Requirement Principles & Computation (2/6)
Annual
Revenue
Requirement
*
Return on
Regulatory
Asset Base
(RAB) @
WACC
Operating
Costs
Efficiency
Carryover
Amounts
Tax
Payments
Depreciation
i : denotes the regulated business entities
Item
Definition
Operating Costs
Applies to only regulated activities / services

Include cost of services procured from related parties
For SB, the OPEX includes working capital (WC) requirements (Regulatory WACC multiplied by WC)
Return on
Regulatory
Asset Base
(RAB)
Calculated as forecast market return (Regulatory WACC) multiplied by the RAB

RAB includes only fixed assets, used for supplying electricity to customers excluding
Cash or financial assets;
Consumer contributions and customer deposits
Depreciation
Annual depreciation forecasts of the assets are computed based on a straight line basis with reference to its
estimated useful life
Tax Payments
Based on the calculation of taxable income and the applicable tax rates
Capital allowances are based on the applicable capital allowances rates as per the current and relevant
Malaysia Tax Guide
Efficiency
Carryover
Amounts
Base Incentive to retain variance between actual Opex and Capex relative to forecasts
Efficiency Carryover Scheme to provide a continuous and sustained incentive to pursue efficiencies over
Regulatory Term
* Calculation of Annual RR is done via Revenue Requirement (RR) Model Provided by Energy Commission
Source : Electricity Tariff RIGs, Suruhanjya Tenaga, Jan 2012
21
RIG 3 : Establish Revenue Requirement Principles (3/6)
Building block for establishing revenue required
Revenue
Required
Revenue requirement
calculation over a (3
year) Regulatory Term
WACC
Operating
Costs
Tax
Payments
Efficiency
Carryover
Will only form part of the

revenue requirement from the
2nd Regulatory Term
Regulated
Asset Base
(RAB)
Return on
Assets
Depreciation
Applicable to:
Single buyer (Operations)
System Operations
Transmission
Customer Services
22
Revenue
Required
WACC
X
Regulated
Asset Base
(RAB)
SB Generation
Costs
(Actual Costs)
Depreciation
Tax
Payments
Efficiency
Carryover
Single Buyer (Generation)

Comprises the costs of electricity
procurement (EP and CP) under the
PPAs, and SLAs, as well as
Interconnection Agreement
Return on
Assets
Applicable to Single Buyer (Generation)
23
Return on Assets (ROA):

The ROA component should deliver an efficient market based return to investors
in the business entities (WACC X RAB)
WACC
The forecast market return is set as the nominal after tax weighted average cost of
capital (WACC). Is discussed comprehensively in RIG 4.
X
Regulated Asset
Base (RAB)
Return on Assets
Average of starting asset value and closing asset value.

Starting asset value: measure of company investment
Once set, not changed, promotes certainty & lowers risk
Includes only fixed assets such as plant and equipment
Does not include other assets such as cash, financial assets, investment
in subsidiaries, tax assets intangibles and goodwill.
The starting asset values are net of upfront customer contributions or
capital received from governments in the form of government grants or
subsidies.
Closing asset value:
Starting asset value annual depreciation + forecast capital expenditure
24
The Regulatory Asset Base (RAB) comprises the assets used to

provide the regulated services (6/6)
New
Investment
Construction work in
progress
Existing
Assets
Capital
Contribution
RAB
25
RIG 4 : Establishment Return Requirement (WACC) (1/2)
WACC is the economic cost (return) associated with a firm's requirement for capitali.e. suppliers of capital require a
market return on capital provided
Under the IBR mechanism, TNB is allowed to earn a rate of return at least equal to the WACC
WACC will provide an efficient return to the regulated entities and deliver efficient prices to customers. ST will ensure
WACC for the TNB BEs :
based on an efficient capital structure and credit rating
reflects market based returns on debt and equity
adequately reflects regulatory and market risk; and
there is consistency between all the WACC parameters and the underlying cash flows calculated in the
determining the ARR for the relevant TNB BEs
Breakdown of Parameters for WACC determination
Market Risk Premium
4.8 %
Cost of
Equity
x
Equity Beta
1.435
Company Equity Risk

Premium
6.89%
45% of Cost of Equity

+
Cost of Equity
10.85%
Weighted Cost of
Equity 4.88%
Risk Free Rate 4.0%
+
Risk Free Rate
4.0%
Cost of
Debt
+
Debt Margin
2.24%
Levered Company
Cost of Debt 6.24%
x 0.45
Weighted Cost of
Debt
2.57%
Net Cost of Debt

4.68%
WACC
7.5%
x 0.55
x (1- tax rate)

Tax Rate
25%
55% of Cost of Debt

Note: TNB IBR Final Recommendation by ST (21st May 2013)
26
TNBs rate of return approved by the Government under IBR is

on par with other countries (2/2)
Rate of return, Percent
PRELIMINARY
11.30%
France
Ireland
7.00%
7.50%
Brazil
8.67%
7.50%
Malaysia
8.55%
7.15%
7.90%
9.80%
7.13%
Russia
Hungary
Chile
Poland
Source: McKinsey
Philippines
Germany
Developed countries
Emerging markets
27
RIG 6 : Establish Incentive Framework for Operational

Performance (1/2)
Penalty / Incentive Scheme
TNB is monitored by ST for its operational and

customer service performance
Under this performance based scheme, TNB will be

incentivised when BEs exceed the upper
performance targets. In contrary, penalty will be
imposed to TNB when the BEs fails to meet target
Incentive slope
For Trial and RP1 (2014-2017), no incentive or

penalty amounts will be implemented
Penalty slope
28

Performance (2/2)
Business
Customer
Services
Transmission
System
Operator
Code
Performance Indicator
CSPI1
SAIDI
Weightage
(%)
50
CSPI2
Average of MSL Compliance Performance
25
CSPI3
Weighted Average GSL (3, 4 and 5)
25
TXPI1
TXPI2
TXPI3
System Minutes
System Availability
Project Delivery Index
100
40
30
30
100
SOPI1
Wide Area Loss of Supply Event
25
SOPI2.1
Security Limit Compliance: Voltage Limit

Compliance (VLC)
25
SOPI2.2
Security Limit Compliance: Frequency Limit

Compliance (FLC)
25
SOPI3
Dispatch Adjusment
SBP1
System Average Cost

Compliance to Timely Settlement of Generators'
Invoices
SBPI2
Single Buyer
SBPI3
SBPI4
Percentage Compliance to Malaysian Grid Code

(MGC)
Percentage Compliance to single Buyer Rule
(SBR)
25
100
25
25
25
25
100
Note:
MSL: Minimum Service Level
GSL: Guaranteed Service Level
29
RIG 7 : Establish cost allocation principles (to allocate common

costs)
The costs that a regulated entity incurs in the provision of regulated services can be
broadly categorised into either direct costs or joint costs
Direct costs
Joint costs
Costs incurred for activities that are

required solely for providing regulated
services applicable for that specific
regulated entity
Costs for activities performed centrally by

the corporate group for more than one
regulated entity (or a combination of
regulated and non-regulated business
entities)
Ring fenced from other activities of the

corporate group and are recorded and
captured directly in an account category
which belongs solely to the relevant
regulated entity
Centralisation of certain corporate

functions such as corporate IT and
Treasury is often the most efficient
means of delivery
Joint costs related to regulated services

have to be allocated to the relevant
regulated business entities to enable
regulated cost recovery from electricity
customers via electricity tariffs
E.g., costs incurred for meter reading

activities typically are direct costs for a
regulated distribution business entity
30
RIG 8 : Establish Fuel Cost Pass Through Mechanism
Imbalance Cost Pass-Through mechanism

established to enable the recovery of actual
fuel related and other generation specific
costs
ICPT allows TNB to reflect changes (either

increase or reduction) due to the
fluctuations in fuel and generation costs in
the electricity tariff every six (6) months,
subject to Governments decision and
approval.
The key objective of ICPT is for TNB to be
financially neutral (i.e. not be adversely
affected nor benefit) with respect to the fuel
prices volatility and other uncontrollable
costs.
Fuel Cost Pass

Through (FCPT)
Adjustment in
the following 6
month period
Formula: FCPT
(gas and coal
only)
Changes in gas and coal costs
Generation Specific Cost

Adjustment (GSCPT)
Adjustment in
the following 6
month period
Formula: Actual
revenue based on
Generation Specific
Cost = Actual cost of
generation
Changes in:
Other fuel costs such as distillate and fuel

oil
All costs incurred by the SB under the

PPAs and SLAs
Renewable energy displaced cost
31
Benefits of IBR implementation
Customer
Utility
Regulator/Government
Electricity tariff set at efficient

cost of supply
Fair return set at cost of capital

(WACC)
Transparency in the cost

components which make up the
overall tariff
Simulate a competitive
environment for natural
monopoly sectors
Incentive mechanisms which

allow utility to retain full/partial
efficiency gains
Efficiency gains shared with

customers
Transparency in cost
components of the electricity
value chain
ICPT mechanism to passthrough of uncontrollable costs
Performance standards which

commensurate with the tariff
charged to consumers
Better allocation of subsidy

(direct and indirect)
Rewards for exceeding

performance targets
Achieve optimal balance in

meeting both customers and
utilitys needs
32
Economic Regulation
33
The forecasted average tariff for each business entity is based

on the Revenue Requirement model and will be applied and
fixed over the Regulatory Term
Forecasted
Total Annual
Revenue
Requirement
Generation
Specific
Forecasted
Revenue
Requirement
Total
Average
Electricity
Tariff
Generation
Specific Tariff
Single
Buyer
Operations
Forecasted
Revenue
Requirement
Single Buyer
Tariff
Transmission
Forecasted
Revenue
Requirement
Transmission
Tariff
System
Operator
Forecasted
Revenue
Requirement
System
Operator
Tariff
Customer
Services
Forecasted
Revenue
Requirement
Customer
Services
Tariff
34
IBR comprises of two key components for tariff setting:

(1) Base Tariff and (2) Imbalance Cost Pass-Through (ICPT)
sen/kWh
+ ICPT
ICP
+ICP
ICPT
- ICPT
ICPT
- ICPT
Base Fuel and Generation Cost
Base
Tariff
Fixed Cost
2014
Development
Operation
Maintenance
2015
2016
2017
Trial and First Regulatory Period
35
The benchmark fuel prices in Base Tariff effective 1 January 2014
Fuel Component
Domestic Piped Gas
Unit Price
RM15.20/mmBTU
for gas volume 1,000 mmscfd
Imported LNG Gas
RM41.68/mmBTU
for gas volume > 1,000 mmscfd
Imported Coal
USD87.50/MT
At exchange rate 1 USD = RM 3.1
(RM 271.25/MT)
Notes:
mmBTU = million British thermal unit
mmscfd = million standard cubic feet per day
MT = metric tonne
36
Generation component of the Base Tariff is subjected to a

6-monthly revision via ICPT
Base tariff 2014-2017
sen/kWh
38.53
Generation costs
26.39
68.5%
Grid operator costs

Transmission
costs
Distribution and
retail costs
0.19
0.05
3.66
Subject to 6-monthly
revision to reflect
changes in fuel and
generation costs
ICPT
Single Buyer Operation Costs
Fixed for 2014-2017

8.24
37
Tariff increased by 4.99 sen/kWh effective 1st Jan 2014
38.53
Source of tariff increase 2014, sen/kWh
3.92
Piped gas
14.89%
4.99 sen/kWh
LNG
33.54
2013
Percentage of
increase
Gas price
78.6%
LNG:
RM41.68/mmBTU
Piped gas:
increased to
RM15.20/mmBTU
from
RM13.70/mmBTU
Coal
3.4%
Non-Fuel
18%
Increased to USD To account for

87.50/tonne from
USD 85/tonne
capex and opex

for FY 2014 to
FY 2017
2014
The bulk of the
increase was due
to the removal of
gas subsidies
and introduction
of LNG at market
price
38
Economic Regulation
39
IBR Regulatory Period timeline and ICPT review
Interim Regulatory Period
First Regulatory Period (RP1)

2015
2014
Jan
Jul
Dec Jan Mar
Jun Jul
2016
Dec Jan
Jun Jul
Base Tariff
38.53 sen/kWh
2.25
sen/kWh
rebate
2.25
sen/kWh
rebate
1.52
sen/kWh
rebate
Base Fuel Price
(726.99)
RM/mn
(1,085.67)
RM mn
(762.03)
RM mn
Imported LNG
RM 41.68/mmBTU
Imported Coal
2017
Dec Jan
Jun Jul
Dec
ICPT review every

6 months
RM 2.57 billion
Total ICPT rebate passed through up
to June 2016
RM 271.25/MT
Domestic
Piped Gas
RM 15.20/mmBTU
40
ICPT for January June 2016

Fuel Price Trend
(Jan 2014 vs Dec 2015)
Cost Difference between Base and Actual
Imported LNG
RM 41.68/mmBTU
RM 31.32/mmBTU
Generation &
Fuel
Cost Savings
Domestic
Piped Gas
Subsidy
Rationalisation
ICPT
Jan-Jun 2016
Base Tariff
38.53 sen/kWh
Imported Coal
RM 271.25/MT
Rebate of
1.52 sen/kWh
+ RM 560 mn
RM 248.18/MT @4.056 RM/USD
(RM 762 mn)
Domestic Piped Gas

RM 18.20/mmBTU
(RM 1,322 mn)
RM 15.20/mmBTU
The cost savings of RM 762 million has resulted in the electricity tariff rebate of
1.52 sen/kWh for Jan Jun 2016
41
ICPT Rebate Impact to Customers (Jan - Jun 2016)
Domestic
ICPT
1.52
Commercial
sen/kWh
REBATE
Savings*
Impact
4.58
per month
From RM
All customers with consumption

> RM 77/month (>300 kWh/month)
sen/kWh
Industrial
sen/kWh
1.52 REBATE
1.52 REBATE
Savings*
Savings*
Up to
4.0 %
All customers
Up to
5.1 %
All customers
Lifeline Band (0-200 kWh) rate at 21.8

sen/kWh. No change since 1997;
Subsidies
Rate for 201-300 kWh at 33.4 sen/kWh.

No change since 2009;
RM 20 Government subsidy enjoyed
by around 1 million customers
Note:
* Savings in electricity bill due to ICPT rebate as compared to Base Tariff set in 1st January 2014
42
Economic Regulation
43
Performance Indicators under IBR
To ensure TNBs performance are in line with

the whole concept of IBR to promote efficiency
G
T
D
To encourage competition in regulated

business of TNB
Reward and penalty system based on

performance
44
Under IBR, TNB is monitored by ST for its operational and

customer service performance
Guidelines
Penalty / Incentive Scheme
Incentive slope
Penalty slope
Note:
For Trial and RP1 (2014-2017), PIs are only monitored by ST with
no monetary impact
45
Performance indicators for TNB business entities
Business
Customer
Services
Transmission
System
Operator
Code
Performance Indicator
CSPI1
SAIDI
Weightage
(%)
50
CSPI2
Average of MSL Compliance Performance
25
CSPI3
Weighted Average GSL (3, 4 and 5)
25
TXPI1
TXPI2
TXPI3
System Minutes
System Availability
100
40
30
30
100
SOPI1
25
SOPI2.1
Security Limit Compliance: Voltage Limit

Compliance (VLC)
25
SOPI2.2
Security Limit Compliance: Frequency Limit

Compliance (FLC)
25
SOPI3
Dispatch Adjusment
SBP1
System Average Cost

Compliance to Timely Settlement of Generators'
Invoices
SBPI2
Single Buyer
SBPI3
SBPI4
Percentage Compliance to Malaysian Grid Code

(MGC)
Percentage Compliance to single Buyer Rule
(SBR)
25
100
25
25
25
25
100
Note:
MSL: Minimum Service Level
GSL: Guaranteed Service Level
46
IBR performance indicators achievements (I)
Business
Entities
Performance
Indicators
Note:
Status for: Incentives
Status
FY 2015
Status
49.66
min/year/cu
stomer
Incentive
54.95
min/year/cust
omer
Incentive
Average of MSL
Compliance
Performance
84.11% 94.11%
97.36%
Incentive
93.95%
Neutral
Weighted Average GSL

(3,4 and 5)
86.32% 95.5%
99.13%
Incentive
99.71%
Incentive
1.5 5.1 min
0.1328 min
Incentive
0.7741 min
Incentive
System Availability
99.04% 99.48%
99.11%
Neutral
99.73%
Incentive
0 5.47
months
-1.45 months
Incentive
1.38months
Incentive
System Minutes
Transmission
FY 2014
55 70
min/year/cust
omer
SAIDI
Customer
Services
Dead Band
Achievements
Neutral
Penalty
47
IBR performance indicators achievements (II)
Business
Entities
Single Buyer
Dead Band
Dispatch Deviation
FY 2014
Status
FY 2015
Status
0% - 5%
-1.4%
Incentive
-2.5%
Incentive
Compliance to Timely Settlement

of Generators Invoices
99.55% 99.85%
100%
Incentive
100%
Incentive
Non-Compliance to Malaysian
Grid Code (MGC)
2 to 7
occurrences
0 occurrence
Incentive
0 occurrence
Incentive
2 occurrences
Neutral
4.5
occurrences
Neutral
Non-Compliance to Single Buyer

Rule (SBR)
System
Operations
Note:
Status for: Incentives
Achievements
2 to 7
occurrences
Less than 0
occurrence
0 occurrence
Incentive
0 occurrence
Incentive
Security Limit Compliance :

Voltage Limit Compliance (VLC)
90% - 96%
100%
Incentive
100%
Incentive
Security Limit Compliance :

Frequency Limit Compliance
(FLC)
90% - 96%
100%
Incentive
100%
Incentive
Dispatch Adjustment
0.2% - 0.4%
0.0137%
Incentive
0.0156%
Incentive
Neutral
Penalty
48
Incentive and penalty caps for TNB business entities
Incentive
Neutral
An incentive is applicable if
actual performance is above the
upper bound target
No penalty or incentive is
applicable if actual
performance lies between the
lower and upper bound targets
Penalty
10
A penalty is applicable if actual

performance is less than the
lower bound target
BE
Total Incentive
BE
Total Penalty
CS
+0.3% ARR
CS
-0.3% ARR
TX
+0.3% ARR
TX
-0.3% ARR
SO
+0.5% ARR
SO
-0.5% ARR
SB
+0.5% ARR
SB
-0.5% ARR
49
Disclaimer
All information contained herein are solely for the purpose of this presentation only and
cannot be used or referred to by any party for other purposes without prior written
consent from TNB. Information contained herein is the property of TNB and it is protected
and confidential information. TNB has exclusive copyright over the information and you
are prohibited from disseminating, distributing, copying, reproducing, using and /or
disclosing this information.
50
Thank You
51
Regulatory Economics Department

Regulatory Economics and Planning Division
Level 27, NU Tower 1
203, Jalan Tun Sambanthan
KL Sentral
50470 Kuala Lumpur
Telephone : 03-2723 6033

Fax
: 03-2723 6103
Back Ups
53
Incentive-based rating (IBR) links revenues to delivery of OPEX

and CAPEX efficiencies over time
Enforce efficiency
on costs
Description
All operator costs are covered

No incentives to improve
Cost-plus
The utilities set the tariffs to customers.

Resulting tariffs are subject to the scrutiny of
Lefthanded regulation
the regulator who may require mandatory

changes
Initially (at year 1 of tariff), all operator costs are

Performance-based
Rating (IBR)
Does not encourage
covered (including fair cost of capital)

In following years, a cap, either on revenues or
unit costs1, is applied to incentivise efficiency
efficiency
No upside for operators
Need for a careful
monitoring
More flexible, but
uncertain
Ensures fair returns

Forces efficiency
Ensures transparency
1 Applies to controllable system costs that are not subject to market forces (i.e. excluding fuel price)
Source: McKinsey
54
1 Load Forecast
forms the basis
for other
forecasts in IBR
submission
Opening Asset Base
Load Forecast
Generation forecast (GWh)

Sales forecast (GWh)
Demand forecast (MW)
Capex & Opex forecast
Snapshot of the IBR

Process
Tx
CS
SB (O)
SO
Joint Costs
Other parameters
Base Generation Cost
Common parameters e.g

forex, inflation, staff cost
escalation, insurance, quit
rent etc.
Generation-related e.g.
fuel prices forecast, RE
displaced cost, dispatch
plan, PPA/SLA commercial
terms etc.
Inputs for RRM
2 RRM is used to
IBR Rev. Requirement

Model (RRM)
determine the
revenue
requirement for
all BEs and
average tariff
WACC x RAB
Opex
Depreciation
Tax payments
Efficiency carryover
Revenue
Requirement
Average Tariff
COS study
3 Tariff design to
Micro tariff design
and rebalancing
ensure revenue
recovery
Tariff Schedules
Customer segmentation
/profile study
Macro tariff
design
Marginal cost
International tariff
comparison
Impact study
55
ST is embarking on RIGs Review
IBR RP2 Timeline Phase I

Key Milestones
Preliminary Load Forecast/Common
Parameters Assumption
Review and Consultation with ST on RIGs
Draft BEs Submission (for RRM)
(6th
Revised Timeline
IBR Council 25th Apr 2016)
End Feb 2016
May Aug 2016

End May 2016
Completion of RIGs Review
Aug 2016
Final Load Forecast / Common Parameters

Assumption
Aug 2016
Revised BEs Submission (for RRM)
Sep 2016
IBR Report Drafting/Writing
May until Mid-Sep

(4 months)
Draft Final IBR Report
Mid-Sep 2016
JEKs Approval
End Sep 2016
Board of Directors Approval
End Oct 2016
Final IBR Submission to ST
Dec 2016
Base Tariff was set at 38.53 sen/kWh from 1 January 2014
58
This rate of return is necessary to allow for investment in

electricity infrastructure to meet increasing demand
Capital Expenditure
RM billion
10.8
10.0
8.5
7.3
Source: TNB Analyst Briefing 4QFY2015
59
as well as to achieve world class performance standards
Generation
EAF,
%
Transmission
System Minutes,
minutes
2.5%
Distribution
SAIDI
minutes/customer/year
-20%
-37%
0.8
2011
2015
2011
2015
2011
2015
EAF : Equivalent Availability Factor

SAIDI : System Average Interruption Duration Index
Source: TNB Analyst Briefing
60
Actual coal prices in USD/MT show a downward trend
Benchmark price in tariff, USD/MT

Average Coal Price (ACP), USD/MT
USD/MT
Benchmark coal
price set in Jan14
tariff revision
USD/MT
Jan Mar 14
Apr Jun 14
Source: Single Buyer Department, TNB
Jul Sep 14
Oct Dec 14 Jan Mar 15 Apr Jun 15 Jul Sep 15 Oct Dec 15 Jan Jun 16
61
However, it is picking up and approaching the benchmark price after

taking into account the depreciation of Ringgit
Benchmark price in tariff, RM/MT
Average Coal Price (ACP), RM/MT
Benchmark coal
price set in Jan14
tariff revision
RM/MT
271.25
RM/MT
259.85
256.73
250.36
248.18
241.07
236.24
237.19
226.30
Jan Mar 14
Base Fx
Actual Fx
Apr Jun 14
Jul Sep 14
224.55
Oct Dec 14 Jan Mar 15 Apr Jun 15 Jul Sep 15 Oct Dec 15 Jan Jun 16
3.1
3.1
3.1
3.1
3.2273
3.3096
3.2717
3.2468
3.1
3.1
3.1
3.1
3.1
3.3702
3.6304
3.6362
4.0560
4.2950
*Note:
1 - Exchange rate is: 1 USD to RM
62
Liquefied Natural Gas (LNG) was below benchmark price since Q3 2015
Actual price billed by PETRONAS
Benchmark price in tariff
Revised price by PETRONAS1
RM/mmBTU
48.57
47.44
45.84
LNG Price for Q415

(as per PETRONAS)2
Benchmark LNG
price set in Jan14
tariff revision
Jan Mar 14 Apr Jun 14
Jul Sep 14
Oct Dec 14
Jan Mar 15 Apr Jun 15
Note:
1 As per letter from PETRONAS dated 11 September 2014.
2 As per letter from PETRONAS dated 9 October 2015.
63
Piped gas price to the power sector is gradually reviewed as part of

Governments subsidy rationalisation programme
Jan 16:
RM 1.5/mmBTU
increase
Jul 15:
RM 1.5/mmBTU
increase
RM/mmBTU
Benchmark piped gas
price set in Jan14
tariff revision
18.20
16.70
15.20
Jun 11
Jan 14
Jul 15
Jan 16
Notes:
1.From Jan 2014, the regulated gas price is only applicable for gas consumption 1,000 mmscfd. Consumption beyond this will be priced at
64
IBR is a structured way to set electricity tariff
Before IBR
After IBR
Tariff setting was on ad-hoc basis

No proper mechanism for tariff review
Less transparent to customers
ICPT
Base
Tariff
ICPT every 6 months

Base tariff is reviewed
once in every 3 years
Example:
Similar mechanism is adopted for Petrol/Diesel price setting
Managed Float Mechanism
Based on market prices
Monthly revision
65
RIG
2 : Define Implementation
Tariff Setting Framework
(2/2) (RIGs)
Regulatory
Guidelines
Revenue Cap
What it is
Advantage/s
Disadvantage/s
TNB Business
Entities
Price Cap
Regulates the maximum allowable revenue

that a utility can earn
Price cap sets the maximum price that

a utility can charge
It is the utilitys revenue, not its rates, that is

capped
Also called rate caps, price indexing or

rate indexing
More compatible with utilities that are facing

substantial demand response management
programs or energy efficiency reductions in
consumer demand
Provide more pricing flexibility, easier to

implement, and preferable when costs do not
vary significantly with sales volume
Requires accurate forecasts of actual

CAPEX and OPEX
Single Buyer Operations
Actual Cost
Pass-through of all costs for procuring

electricity
Provides the utility a degree of flexibility

on how to optimize specific customer
rates and consider cost allocations
Ensures that the regulated entity does

not earn less than the cost of providing
the services
Utility bears volume risk of any shortfall

in demand (but is also rewarded by
demand growth)
Gains cannot be retained by the entity

and must be returned to customers in
the following regulatory term
Actual cost adjustments take place only

twice a year
Customer Services
Single Buyer Generation
Transmission
System Operations
66
RIG 1 : Define Business Entity (3/x)
Electricity
Customers
Flow of
Funds
Electricity Tariff
The Customer Services business entity

charges electricity customers a bundled
tariff for the use of electricity.
Customer Services pays Transmission,

based on a Transmission Tariff and
System Operations based on System Ops
Tariff
Customer Services pays Single Buyer

based on Generation Tariff (comprising a
generation specific component and a
component for other operational costs of
the Single Buyer). The Single Buyer pays
TNB Generation based on SLAs & IPPs
based on PPAs
Customer
Services
Generation
Tariff
Transmission
Tariff
Transmission
System
Operations
Tariff
System
Operations
Single Buyer
SLAs and merit
order dispatch
TNB Generation
PPAs and merit

order dispatch
Independent Power
Producer (IPPs)
Managed Market Model
67
RIG 1 : Define Business Entity (4/x)
Electricity Customers
Efficiencies achieved by Incentive

based regulation (IBR)
(Connected to the Distribution System)
Electricity Tariff
Distribution
(Customer Services)
Transmission Tariff
Single
Buyer
Tariff
Transmission
System
Ops Tariff
Building block model used to

develop revenue requirement
Appropriate price control
mechanisms developed by the
Energy Commission.
System Operations
Single Buyer*
SLAs and merit
order dispatch
TNB Generation
Others (RE, imp/exp etc)
PPAs and merit

order dispatch
IPPs
Efficiencies achieved by Single

Buyer Rules SBR
Least cost dispatch
Transparent operations
Governance arrangements
68

Performance (3/3)
S-Curve for the performance indicators of business entities
Customer Services
System Operator (SO)
Transmission
Single Buyer (SB)

69
Forms of Economic Regulation
Rate of Return regulation
Command and Control

Regulation
1 2
Market Controls Regulation
4 3
Self Regulation
70

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Incentive Based Regulation (IBR)

Regulatory Economics Department

Incentive Based Regulation (IBR)

Base Tariff - 1st January 2014

Imbalance Cost Pass-Through (ICPT)

Electricity supply chain

multiform production is more costly than production by a monopoly William J.

What is Economic Regulation

Customers of monopoly are

Prices of Utility charges will be

Quality of service and

Utility gets the right incentives to

Forms of Economic Regulation

Command and Control Regulation

Rate of Return regulation

Market Controls Regulation

1. Command and Control Regulation

Standards can be set either through legislation, or by regulators empowered by regulation to

Can be implemented quickly

Fixed performance standards backed

Close relationship between regulator

Government or regulator to be acting

Can be complex and legalistic.

Defining acceptable standards can be

2. Rate of Return Regulation

Fair approach to tariff determination Regulators in Japan and in some US jurisdictions

The utility firm still have a degree of

Consumers will be protected from the

Encouraging the regulated firm to

Can be-well-informed, with a high level

Legalism not necessarily avoided

Cheap for government

Easy to change to fit circumstances

Independent oversight difficult

Realistic standards created

4. Market Controls Regulation

Common market-based mechanisms such as:

Applicable across sectors

Low enforcement cots

Uncertainties and transaction costs

Lack of response in crisis

Needs healthy permit market

Can create barriers to entry (disputes

Incentive Based Regulation (IBR)

Base Tariff - 1st January 2014

Imbalance Cost Pass-Through (ICPT)

The Energy Commission in 2012 developed the Regulatory

Regulatory Implementation Guidelines

1 The economic regulatory framework for regulating TNB

4 Process of tariff reviews; and

Electricity tariff is regulated by the Government under the

IBR is a framework to set electricity tariff

Value for money for the

Source : Electricity Tariff RIGs, Suruhanjaya Tenaga, Jan 2012

TNB is incentivised to increase efficiency in three broad areas

IBR, also known as Performance Based Regulation has been

and being introduced in South East Asia

IBR is a structured way to set electricity tariff

Electricity tariff reviews over the years

Regulated Gas (RM/mmBTU)

Average Tariff (sen/kWh)

Tariff setting was on ad-hoc basis

ICPT every 6 months