Windfall Taxes Potential Problems

While many cheered the governments decision to levy the Windfall Tax on Plantation companies riding the Crude Palm Oil prices and also the IPPs because they are enjoying subsidies, I can't help but feel it is unfair for the IPPs to be levied such a tax.

The reason for cheers that the IPPs are being tax now is because of the lopsided Power Purchase Agreement(PPA) signed by the government with the initial IPPs to produce power. The agreement basically states that Tenaga Nasional (TNB) will buy every watt of power the IPPs can churn out from their power plants. On top of that, the IPPs will also be supplied subsidized fuel and gas from Petronas to drive their plants.

Now fast forward 10 years later, the IPPs are running such efficient plants that are producing electricity way beyond the needs of TNB. Also with the increasing fuel oil and gas prices which the IPPs are completely shielded from due to the subsidized rates currently enjoyed due to the PPA. This has irked many common people whom have to pay higher TNB rates due to the increasing fuel price. Since TNB as a company also needs to make money, it pass their costs to the consumers albeit much slower due to government prohibition to tariff hikes since it isn't popular to do so.

Now since TNB can't pass the buck to their consumers, they have to accept the loss incurred whenever the IPPs produces more than they need. And the fact that Petronas which is supplying cheap gas to IPPs makes the matter even more pressing in recent political turmoil.

My view on this is the government has every right to review the taxes it levies on companies operating here and it also should always look for the best interest of the people. I also believe the government should always present itself as the foundation of integrity. This will show investors that it is safe to invest here and the government will be fair to businesses. This includes the integrity of a contract signed by parties during negotiation.


Strong Arm Tactic

When the windfall tax was first announced, I was kind of surprise the IPPs were also targeted. Windfall tax for windfall profits? Since when did IPPs get a windfall profit? So I rechecked profits made from power producing operations and it seems quite consistent growth albeit low steady rate. Where is the windfall?

Conclusion was the government wanted to get back the gas subsidies provided to IPPs in form of taxes because of the ever rising Crude Oil Prices which Petronas can't enjoy to the fullest since it is providing IPPs at a subsidized price. Also the government wants the IPPs to sit on a table with TNB to re-negotiate the PPA so that TNB wouldn't go bankrupt due to the agreement signed by themselves in the first place. And the Energy Minister promised that any IPP that successfully re-negotiated the PPA with TNB will be exempted from the Windfall Tax. Uhh... WHAT?!!??!

How the heck did strong-arm tactics suddenly become legal and alright, especially since it's the government that is doing it. By doing so, the government basically shows it is willing to twist the other party's arm in order for it to sign a re-negotiated contract. So where is this integrity of a contract? Oh I forgot, a contract's integrity isn't important. So it means the government can sign any agreement and agree to any concessions, but can also force you to sign another contract if it doesn't go the government's way.

History

The first PPA was sign in the early 90s with a few initial IPPs (Genting, YTL, Malakoff, Tanjong). With the contract for subsidized gas and 100% buyer guarantee, they companies started raising cash from the bond market and since its the utility business virtually guaranteed by the government, the bonds were probably snapped up pretty quick and construction began for the power plants. Bear in mind that Natural gas prices was steady at USD2 in this period and Crude Oil Price was around USD20 steady.

Now I'd imagine if you are a planner for infrastructure, you try to overestimate your needs to prevent potential shortfall in the future before another phase of construction can begin. So if TNB forecasts it needs at least 3 IPPs to provide it 100% power, the safe bet would be to include 1 extra to offset any potential demand needs or supply shortages. Thus the need for additional reserve. Also this agreement was signed in the early 90s, when Malaysia was one of the Asian Tigers. With the future looking great, TNB probably thought the reserves would be consumed in a few years. The Bakun Dam project was also initiated around this time to meet potential electricity needs of the country in the future.

So when the financial crisis hit Asia in 97/98, Malaysia was stricken with recession with investors fleeing the shores and factories closed down and layoffs of thousands. Suddenly, there was no immediate need for a large reserve of electricity since the growth of the nation was stagnant, the growth of demand for electricity would also stagnate. The Bakun Dam project was halted indefinitely. But the IPPs with their contract in hand suddenly find themselves in a spotlight because they are too damn efficient producing much more than what TNB needs. And so under pressure they were to sit with TNB to try to re-negotiate the PPA to reduce the load for TNB to bear.

Fast forward 10 years later, they still haven't really made any progress. The initial IPPs which make the bulk of electricity are still the beneficiaries of subsidised fuel and 100% buyer (TNB). This coupled with the rising costs of fuel/gas and also the fact that the country is still in excess of electricity reserves made the IPPs even more unpopular. With the rakyat having to content with tariff hikes by TNB and also reduction of subsidies for petrol, the government is feeling the pressure. Natural gas prices have started increasing from year 2002 consistently to the present USD13 and Light Crude Oil up to USD146.

Accused of allowing prices to spiral by the opposition was one of the reason their recent election defeat was historical in Malaysia. And to protect the interest of the Government Linked Companies (GLCs), the government reduced the subsidies of petrol across the board and also introduced levies on companies which is riding the commodity boom and also tax the IPPs which profits are being shielded by the contractual subsidies.

To which we come to the present announcement by the Energy Minister that the any IPP which successfully re-negotiated with TNB are exempted from the Windfall Tax. The government would probably kill 2 birds with one stone if they can make the IPPs pay more to Petronas and TNB pay less to the IPPs. In the end the IPPs loses.

But that's not all, warnings from are being heard from financial analysts of the potential problems with regards to the Windfall Tax on the IPPs.


"Malaysian Rating Agency Corp (MARC), for one, is critical, saying that the introduction of windfall tax challenges the historical assumption of low regulatory risk for IPP financing and introduces an added element of uncertainty due to interim regulatory changes. "

"Datuk Nazir Razak, CIMB Group CEO, says there is actually no winners if the tax is levied, warning that with bond yields rising, and prices pressured down, and investor sentiment hurt, the cost of the tax could far exceed any money the government could hope to raise from its imposition. "

"The one thing that riles investors is moving the goalposts halfway in the game, and Malaysia, it must be said, does not seem to have too good a track record insofar as this is concerned. Indeed, the selldown of bonds, including of MGS, in the past week or so, especially by foreign investors, is a clear sign confidence in government policies is being eroded. "


If government backed bonds can't even garner some support from international investors, how do Malaysian companies plan to raise cash next time it is trying to build new infrastructure. I've said before "We might have cheaper petrol from these measures, but shittier roads to drive in" when additional subsidies for petrol are demanded at the expense of tax collected for infrastructure.

But in this case of screwing their contractual obligations and investor confidence in integrity and credibility of the government, I would say "We might have the best highway but we'd be begging in it for a job".