Toward lower electricity rates

The cost of electricity for Manila Electric Co. consumers reached record highs last December, which eventually led to a temporary restraining order issued by the Supreme Court. Meralco blamed this pass on Wholesale Electricity Spot Market prices, which reached record highs purportedly because of the reduced supply of electricity due to the Malampaya gas fields maintenance shutdown and scheduled and unscheduled shutdowns of other power plants. The general public was outraged, and blamed Meralco for the high electricity costs and the Energy Regulatory Commission (ERC) for its perceived failure to rein in these costs.

Unknown to many, the ERC actually released in October 2013 an “Issues Paper on the Implementation of Performance-Based Regulation (PBR) for Privately Owned Electricity Distribution Utilities (DUs) under the Rules for Setting Distribution Wheeling Rates (RDWR).” The paper presented for comments various concepts underlying  the PBR, which is the methodology for determining the distribution rates that DUs like Meralco can charge. A key item presented in the paper is the basis of the valuation of the network assets of the DUs, which under the PBR uses the Optimized Depreciated Replacement Cost (ODRC )as the basis for determining the return on capital, the largest component of the distribution charges billed to consumers. The ERC appears to be inclined to use the lower historical cost rather than replacement values such as ODRC.

According to the paper: “The aim of the ERC is to adopt a regulatory process which eliminates monopoly pricing, provides a fair return to network owners, and creates incentives for managers to pursue efficiency gains through cost reductions.” The paper further said: “Regulators permit DUs to earn reasonable (risk adjusted) return on their investment capital, provided that market continues to value the services produced with that capital. It is therefore necessary to assess the value of the system and non-system network supply assets so that an appropriate return on assets can be calculated.”

It is in this context that I am sharing my views on whether the historical cost or replacement value is more appropriate in the determination of a fair return to network owners.

The current standards on accounting for Property, Plant and Equipment (PP&E) is International Accounting Standards (IAS) #16, which expressly allows the use of historical cost or replacement value in the valuation of PP&E. IAS #16 also states that the alternative basis for valuing assets when these are rarely sold except as part of a continuing business is a depreciated replacement cost (DRC) approach. The basis underlying DRC is that the asset is so specialized that there is no market value for it. There are three main subsets of such assets: (a) those that are only ever sold as part of a business; (b) those that are primarily used to provide services to the public (whether on a paying or nonpaying basis); and (c) those that are so specialized by the nature of their size or location or similar features that there is no market for them. This description fits exactly the DUs’ network supply assets and thus supports the use of DRC for valuing such assets for rate-making purposes.

The fair return on the DUs’ investment in system and nonsystem network supply assets should thus be determined using replacement value. The historical cost can only be used if it closely approximates the replacement value. This, however, is unlikely in countries like the Philippines, where inflation rates have been historically higher than the more developed countries, and where most of the system network supply assets are imported using foreign exchange which fluctuates widely vis-à-vis the Philippine peso. Investments in the system network are of a continuing nature, and this would not be served if the investors feel that they are not receiving a fair return. The benefit to consumers of using historical cost that could result in lower electricity rates may be short-lived because investments in network expansion would not happen if the depreciation expense using such historical cost is not sufficient to fund the required reinvestments to sustain the network.

As a consumer, and one who wants to see the Philippines become more economically competitive compared with its neighbors and the rest of the world, I am concerned that Philippine electricity rates are the highest or second highest in Asia. I believe, though, that the DU charge, which accounts for 15-20 percent of the electricity rate, is not the major reason for the high electricity rates. The generation costs should be looked into more closely, including the taxes and other levies that the government collects on generation, transmission and distribution charges.

It does not make economic sense at all that the higher generation costs are compounded by a proportionately higher value-added tax, thus exacerbating the pain inflicted on consumers. It would make more economic sense if the government forgoes its taxes on electricity totally, or at least during periods of high global coal and oil prices or power plant shutdowns, to cushion the shock to consumers.

David L. Balangue ([email protected]) is a former chair and managing partner of SyCip Gorres Velayo & Co., and current chair of the Philippine Financial Reporting Standards Council.