Fuel costs and electricity prices

Inevitably, the price of electricity will increase in tandem with the fuel costs to maintain reliability

(NST) – AS countries around the world emerged from the Covid-19 pandemic lockdowns and restarted their economies, the cost of generating electricity has been skyrocketing, driven by rising fuel prices for coal, gas and oil.

In Britain, which relies significantly on gas for power generation, for example, rising gas prices have resulted in its energy regulator –Office of Gas and Electricity Markets – raising the energy price cap (the maximum allowed charges on standard variable tariffs) by 54 per cent in April.

A further surge is expected at the next review in October.

The extent of disruption is unprecedented largely because the three main causes are each individually unprecedented. Collectively, they create an extraordinary challenge for governments, utilities and electricity customers.

First, was the Covid-19 pandemic. We all know too well of the personal and societal disruptions, and in some cases, hardship and loss.

The pandemic has disrupted global fuel markets.  The contagion made it far more difficult to forecast and plan.  Initially, it was a question of whether there would be a grave recession worldwide.

When the pandemic started, the price of coal, oil and gas fell sharply, leading companies to defer or cancel previously planned energy projects. Perhaps if this were all that had happened, it would not have been so bad. But it was only one of the three major disruptions to regional and global fuel markets affecting Malaysian electricity customers.

Second, China experienced severe electricity shortages in September 2021 due mainly to insufficient coal-fired generations, and as a result, commercial and industrial customers had their power switched off for four to 10 days. The reason: coal-fired power generators could not make enough money selling electricity to cover the cost of the coal they used.

So to cut their financial risk, they reduced their coal purchases. Collectively, this created a systemic shortage and China responded rapidly to the problem by raising the price of electricity and took steps to promote increased restocking of coal supplies.

A spike in China’s demand for imported coal had a significant impact on Asian coal prices.

To complicate matters, Indonesia, the source for most of China’s imported coal, banned exports to conserve coal for its domestic use. The developments in both China and Indonesia threw the regional coal markets in a tailspin, resulting in the mess it is right now.

The third major factor that disrupted fuel markets globally was the Russian invasion of Ukraine. Europe imports vast amounts of coal and natural gas from Russia.

In recent weeks, projected future coal prices had increased even further as global markets continue to anticipate the likelihood of more European shifts away from Russian-sourced coal.

Any one of these three factors is extreme by itself. That they happened together over such a short period is unprecedented.

Prices of the fuel that Malaysia and countries the world over depended on for electricity generation have risen sharply and appear likely to remain so for a year or more. Hence, the recognition of the need for an electricity tariff increase should not be unexpected.

Inevitably, the price of electricity will increase in tandem with the fuel costs to maintain reliability in the sector.

China’s experience was a disruptive reminder that financial integrity is as important to reliable and secure supply of energy as is having adequate infrastructure. China had no shortage of energy infrastructure. It had a major problem aligning prices with costs, however.

Ultimately, businesses must secure the inputs and deliver the outputs necessary to reliably serve their customers and they must do so in a financially sustainable way.

Malaysians are not alone in their concern about rising energy prices. Globally, the cost of generating electricity has increased sharply and quickly.

Many European countries have used government funds to enhance protection of vulnerable customer groups. Even the United States, which benefits from significant domestic natural gas and coal resources, has experienced electricity price hikes of around 10 per cent on average over the past year.

The reality is that the cost of coal to Malaysia’s electricity sector has increased more than 50 per cent in 2021. And over 80 per cent of Malaysia’s electricity generation is from coal and gas, so electricity prices will naturally rise with the increase in the prices of these underlying fuels under present conditions. And Malaysia imports its coal for power generation.

Malaysia’s utility giant – Tenaga Nasional Bhd (TNB) – currently incurs a loss to generate electricity as its costs have exceeded the revenues collected from the regulated tariffs it charges its customers.

Under the Incentive Based Regulation (IBR) regulatory regime set by the government, a change in fuel costs that is outside of TNB’s control is recovered through the “imbalance cost pass-through” every six months. An inability to pass-through higher fuel costs can quickly put TNB in jeopardy.

Financial institutions lend to utilities and shareholders and pension funds invest in utilities on the basis that utilities are diligently regulated in a manner that allows them to efficiently recover the costs that they incur when generating, transmitting and distributing electricity to customers.

When this does not happen, chaos quickly ensues. So in order to ensure there are no disruptions to reliability, a tariff increase should be expected as fuel charges continue their path north.