WITH costly delays mounting and virtually no avenue to raise financing for Project 3B, it isn’t surprising that 1Malaysia Development Bhd (1MDB) is now looking to Tenaga Nasional Bhd to take over the RM11 billion coal-fired power plant project, which has since been renamed Jimah East.

On one hand, Jimah East cannot be allowed to fail. The country needs the additional 2,000mw base load capacity by October 2018, the original commercial operation date.

But the deadline seems impossible, and the Energy Commission (EC) announced last week that it is looking to extend the power purchase agreements for several key power plants, including two of YTL Power International Bhd’s that are due to expire in September 2015.

Meanwhile, Tenaga’s shareholders will be wondering how the national utility company will make sense of a project that 1MDB decided wasn’t profitable enough to include in the listing of its energy arm, Edra Global Energy Bhd.

1MDB’s inability to finance Jimah East isn’t the only reason it is struggling. According to industry executives, the project is “no longer bankable” in its current state.

“1MDB’s bid for Project 3B (Jimah East) was very aggressive. It was willing to accept an internal rate of return (IRR) of around 6%, maybe less. At those kinds of returns, you have very little room for error. Now, with the delays, not only is the project looking at penalties, costs have also escalated. Even if 1MDB were to somehow get funding for the project tomorrow, it will be tough to make it profitable,” says one industry veteran.

It is now up to Tenaga and the EC to decide what to do with Jimah East by mid-April — 1MDB’s deadline to complete the financial close for the project. Once that deadline passes, Tenaga has the legal right to scrap the project, forcing the EC to call for a re-tender.

The grid, however, cannot afford any more big delays and a full re-tender would take at least six months to a year.

At best, the EC could ask the other original bidders of the project — YTL Power, Tenaga and Malakoff Corp Bhd — to refresh their initial bids and pick the lowest offer. This should save some time since the EC had previously evaluated those bids.

The problem, however, is that every day the project is delayed, there is a direct cost to Tenaga and, ultimately, the country’s tariff payers. According to the Association of Water and Energy Research Malaysia (AWER), for every six months of delay in the commencement of Jimah East, Tenaga will have to bear an estimated RM644 million in additional fuel costs.

If Jimah East were completed on time, it would have been among the lowest-cost plants to dispatch and would have displaced 2,000mw of the most expensive power plants.

New power plants tend to have the lowest tariff once installed in the grid due to improvements in technology and efficiency. Newer projects also have more competitive rates and lower IRR. In Jimah East’s case, it should easily have had the lowest IRR since it is a base load plant that burns coal, which is roughly four times cheaper than burning gas.

Consumers pay either way

Even if Tenaga takes over Jimah East from 1MDB to minimise delays, consumers are still going to foot the bill, industry sources say.

Given its low returns, the only way to make the project feasible is to revise the tariff and grant an extension that will effectively waive the penalties for missing the deadline. But this means that someone, somewhere will have to absorb the additional costs — most likely the consumers.

The maximum liquidated and ascertained damages (LAD) that Tenaga can impose is RM220 million. Given the circumstances, it is unlikely that 1MDB will pay the penalties. In fact, 1MDB’s liability at this stage is estimated to be RM35 million for a development bond and RM70 million to RM80 million in development costs it has spent.

Had 1MDB seen the project to completion, the LAD paid to Tenaga would have been able to offset some of the latter’s higher fuel costs. With these points in mind, Tenaga will have to be very careful how it handles public perception, should it choose to acquire Jimah East, especially when it comes to the amount that it has to pay 1MDB to take over the failing project.

One saving grace for the project is that Japan’s Mitsui & Co, as a 30% shareholder and EPC (engineering procurement and construction) contractor for Jimah East, has remained committed to the project.

“Although the financing hasn’t come through for the project, the Japanese have been paying out of their own pocket to ensure that the delays are minimised. They are old school that way. When they agree to do something, they make sure it gets done,” says one industry player familiar with the project.

Nonetheless, Tenaga needs to generate a minimum amount of return for its shareholders and will likely see a tariff revision to make the project financially viable.

“An open tender would be best, but given the time constraint, it might be better for the EC to revise the tariff so that the IRR is equal to that of 1MDB’s original bid — at around 6% — taking into account the higher costs,” notes an industry veteran.

These terms aren’t completely unattractive.

“With the delays, other independent power producers know that the grid sorely needs power and have been bombarding the EC with various proposals,” says the industry veteran.

They include Malakoff, which is going for listing in May. With the completion of its 1,000mw coal-fired Tanjung Bin 4 power plant, Malakoff will be able to quickly redeploy its contractors and resources to build another 1,000mw block.

Tanjung Bin 4 was also hampered by delays — up to 12 months behind schedule at one point. But following an aggressive catch-up programme, industry sources now expect the project to be completed on time — by March 2016.

Although some may argue that the damage has already been done and the industry needs to work quickly to minimise further cost to consumers, the spotlight is now on the EC, which awarded Jimah East to 1MDB in the first place.

It is not fair to criticise the EC for awarding the project to 1MDB as the regulator may not have been aware of the fund’s mounting financial problems at the time. However, it will be interesting to see if the EC still has confidence in 1MDB to undertake the project, due in 2021, which it awarded to 1MDB on a direct award basis last year.

This article first appeared in The Edge Malaysia Weekly, on March 16 - 22, 2015.

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