Power: Pockets of opportunities

by MIDF RESEARCH / pic TMR

ELECTRICITY demand for Peninsular Malaysia continued to recover albeit at a slower pace towards end-2022, with just a +0.2% year-on-year (YoY) growth in fourth quarter 2022 (4Q22). However, full-year growth came in at +6% YoY reflecting reopening of the economy against a low base in the prior year, which was impacted by Covid lockdowns.

Although the growth rate in 2022 exceeded Regulatory Period 3’s (RP3) projected demand growth of +1.7% per annum, the majority of Tenaga Nasional Bhd’s (TNB) regulated revenue is on revenue-cap basis, meaning the bulk of revenue generated from excess demand (beyond the projected +1.7% growth) was returned to consumers via the revenue adjustment mechanism under the incentive-based regulations (IBR).

The Imbalance Cost Pass Through (ICPT) decision in December 2022 was positive, with the government allowing an ICPT of almost the entire ICPT receivables at TNB via a mix of government subsidy and a sharp increase in ICPT surcharge for medium to high voltage non-domestic consumers. In line with the higher ICPT collection and easing fuel prices, we expect both TNB’s ICPT receivables and underlying fuel cost under-recovery in the first half of 2023 (1H23) period to ease, reducing the strain on cashflows and allowing retirement of some short-term debt undertaken previously to fund the elevated fuel cost.

We prefer players in the generation space and liberalised markets. Notwithstanding the recent positive regulatory outcome, we believe independent power producers (IPPs) are better off in the current high fuel price environment (which is still well above RP3 projected fuel cost) given that fuel is a cost pass-through to the off-taker, which is TNB.

Players in this space include Ranhill Utilities Bhd and Malakoff Corp Bhd (non-rated). 

Alternatively, players operating in liberalised electricity markets are also better able to pass through higher costs given the freemarket nature of such electricity markets which allow for a better reflection of underlying cost in market prices. A play into liberalised

electricity markets is YTL Power International Bhd, which operates in the Singapore generation sector — the Singapore electricity market has seen spot electricity prices rise by 200%-300% since 4Q21 reflecting higher fuel prices and tighter demand-supply.

Solar RE Space

The Energy Commission recently approved a four-year Power Purchase Agreement (PPA) extension (to 25 years) to winners of the large-scale solar awards (LSS4) bidding cycle, which has seen project progress halted given rising material cost since the bids were placed in 3Q20. While the impact on project Internal Rate of Return (IRR) is expected to be minimal (as the extension is meant to compensate for higher-than-expected capital expenditure (capex), while still maintaining the same levelized tariffs), the decision nonetheless allows the LSS4 projects to resume progress. 

Commissioning of the LSS4 plants has also been extended to December 2023. This should be a near-term positive for the solar engineering, procurement, construction and commissioning (EPCC) players and project owners. 

New Govt Policies 

Energy sector policies by the new government will be closely watched in the immediate term. While broadly, policies driving renewable energy (RE) growth are likely to continue, an important policy that was put on hold in the past was the liberalisation of the power sector under Malaysian Electricity Supply Industry 2.0 (MESI 2.0), which essentially entails a move to spot market- based power generation supply, third party access to TNB’s transmission and distribution network, and the opening up of the retail space in the sector. 

Another potential policy review is the government’s stance on the current RE export ban which was put in place since late- 2021. In the water utilities sector, a decision on an average 25 sen/m3 nationwide tariff hike for the non-domestic sector was already approved by the previous federal government back in August 2022. However, another tariff review is now being undertaken for the domestic sector, which is a potential catalyst for water operators. 

We remain ‘Neutral’ on the power sector; earnings are defensive in nature, but in a macro upcycle, upside potential is capped by regulatory revenue-caps, while growth catalyst is lacking given an already large excess capacity in the system (Peninsular Malaysia). 

Coupled with still high input cost, we think players operating in liberalised markets especially, are better bets as free market rates reflect both higher input cost and improved demand-supply conditions. Additionally, we like players in the water utilities space as a play into the recent non-domestic sector tariff hike and the upcoming domestic sector tariff review. 

Our sector picks are YTL Power International (‘Buy’, Target Price [TP]: RM1.12), YTL Corp Bhd (‘Buy’, TP: 83 sen) and Ranhill Utilities (‘Buy’, TP: 70 sen). Potential risks are: (1) Aggressive carbon pricing rate introduction and the inability of players to pass this down to end-consumers, (2) A sharp fall in demand which would impact rates in the liberalised electricity markets. (Abridged from MIDF Research Equity Report released on March 31, 2023) 

  • The views expressed are of the research team and do not necessarily reflect the stand of the newspaper’s editorial board. 

  • This article first appeared in The Malaysian Reserve weekly print edition