Righting what’s wrong with the Epira

(First of three parts)

Everyone is washing his hands of the Electric Power Industry Reform Act (Epira) of 2001, now that it has reared its ugly head.

People are blaming the Epira and rightly so because it has launched a thousand nightmares, or more like a thousand jolts that it refers to as “price shocks.”

Remember the reviled purchased power adjustment (PPA) of early 2003? It should have been a national wake-up call then. Today, the feared PPA, which required consumers to pay for electricity that power plants did not generate, is back but renamed Agra, or automatic generation rate adjustment.

What we got is not just a shock but a price convulsion from a 74-percent increase in generation cost in Manila Electric Co.’s (Meralco’s) mega-franchise area, the country’s industrial and commercial hub. The increase of P4.15 per kilowatt-hour (kWh) represents P9.6 billion in additional billing to Meralco’s 5 million customers just for last November.

While the focus is on the P4.15 per kWh additional charge for November last year, what is at stake is the country’s competitiveness. Power and energy are important primary production inputs, but their costs are so high, making manufacturing hardly viable in the country.

Making power cost unpredictable that in any one month it can jump 70 percent is more than what the business sector can handle.

Everyone is now calling for amending or even repealing the Epira. We can bet that some changes in Republic Act No. 9136 will be made. Have we, as a people, been so jolted this time that our executive branch will initiate and our legislature cooperate to truly right what’s wrong with the Epira to reduce power costs?

We did not do anything in 2003. Will we do it in 2014? This will be one of the defining moments of our current leadership.

Fire-breathing dragon

When the Epira was signed in 2001, it was like unleashing a fire-breathing dragon that only those who “tinkered with it” knew where it would go.

Unfortunately, the government institutions that implemented it were just going on a wild ride. Even with good intentions, most officials did not really make heads or tails of the beast until they were replaced and a new set took over, each one unwittingly perpetuating what was wrong.

The soaring power costs can be attributed to the following:

— The Epira itself and its IRR (implementing rules and regulations).

— Inadequate regulatory safeguards.

— Defective Wholesale Electricity Spot Market (WESM) structure and rules.

— Market violations or abuse by the industry players and the simultaneous shutdowns of power plants.

— Deficient preventive action of the Department of Energy (DOE) and the Power Sector Assets and Liabilities Management (PSALM).

On the P62 per kWh that was offered on WESM, it will help to break down the problem if Philippine Electricity Market Corp. (PEMC) and the Energy Regulatory Commission (ERC) disclose the bidders and their offers, and whether they are generators or wholesale aggregator traders. PEMC operates WESM.

What should’ve been

The consumer nirvana that the Epira had promised was beautifully spelled out in Section 2, Policies of the State. It even aspired to make the Philippines globally competitive.

Unfortunately, from thereon and because of lobbying, the law lost its way. To quote a US regulator, “We knew we wanted to deregulate…. We just forgot why we are doing it.”

The Epira was supposed to achieve two things—reduce power costs and assure power supply. It was supposed to create true competition and thus deregulation to lower power rates.

The monopoly of government-owned National Power Corp. (Napocor) was dismantled through privatization and the power sector services unbundled into generation, transmission, distribution and supply.

Each one was to be competitive, with cross-ownership prohibited among the unbundled sectors. Market domination and uncompetitive practices were also supposed to be prohibited.

The generation and retail-supply sectors were to be deregulated, but the transmission and distribution sectors would remain regulated because they are natural monopolies.

To protect consumers, the ERC was formed and designated as regulator.

The DOE, in turn, was mandated to establish policy and promote energy supply development. It was tasked with providing a competitive market for short and excess power through WESM. Further, electric end-users would be given the ultimate weapon to reduce power cost—the freedom to choose power sources through “open access.”

Promoting supply dev’t

There was supposed to be an improvement in the regulation of the distribution and transmission sectors, especially in the search for a better rate-setting methodology or refinements to the reviled RORB, or return on rate base.

The Epira is profuse in its mention of the need for and development of power supply. It was supposed to be the main mandate of the DOE to provide the strategy and policy direction for the energy mix and development, and for reducing power costs and ensuring supply.

For good measure, the Epira provided for a legislative oversight to ensure that everyone was doing his job and the law was serving the best interest of the country and the consumers.

The Joint Congressional Power Commission was supposed to assure the public that the law was responsive to the needs of the people and country, and to make amendments when needed.

Such was the nirvana that was promised our consumers.

Epira that we got

The most dangerous provisions were either worded in an innocuous and fleeting way or disguised as protection for the consumers so that they were easy not to realize.

This was where the Epira failed the people from the beginning. There was so much lobbying against strict cross-ownership that it was weakened. Only the transmission company was prohibited from owning generation and distribution assets.

Section 45, under a pretentious premise of promoting true market competition and preventing harmful monopoly and market domination, allowed distribution utilities (the main buyers of power) to enter into bilateral supply contracts with affiliated generators of up to

50 percent of their power requirements.

A senior senator was against any form of cross-ownership but that would require Meralco and Davao Light to divest themselves of generation assets, a sure way to incite formidable opposition to the law.

He compromised on grandfathering the existing generating companies (gencos) and allowed up to 30 percent of generation to be bought from a sister company. Meralco itself had been lobbying only for 35 percent.

It was a mystery how it became 50 percent in the last two days of finalizing the law at the bicameral conference committee.

Sweetheart deals

Section 45 consequently did not mandate competitive bidding for bilateral contracts. This led to the current norm of sweetheart power supply agreements between the people who control the demand of distribution utilities and the supply of their friendly gencos.

Notice that in the Meralco franchise area only those who are in a position to negotiate a power supply contract with the utility announce their projects. Even Meralco formed its own generation company. Since the signing of the Epira in 2001, Meralco has not called a single bidding for power supply.

This is a double-edged sword that slices the consumers two ways. The power cost and terms are not too competitive and truly independent power plant investors face barriers to entry.

The provision thus limits power supply to those who control the distribution utilities, and discourages other supply and competitive options that could benefit the consumers.

It is true that genco investors can be encouraged by the government by streamlining the 100 odd approvals and permits.

Biggest deterrent

The biggest deterrent, however, for new power plant players who can create a truly competitive generation supply is fair access to the market, which does not exist because groups that own gencos control the distribution utilities market.

When some sectors say there is no need to amend the Epira, this is one of those provisions that they don’t want touched.

The Epira imposed restrictions on how much a distribution utility can buy from its affiliated firm.

Supposedly, it also provided for restrictions on market domination under Section 45 (a) that limits concentration of ownership, operation or control of installed genco capacities that any single entity can own to 30 percent of a regional market or 25 percent of the national grid’s installed capacity.

Circumventing limit

This time it was the Epira’s IRR, passed on Feb. 27, 2002, that provided the mechanism for circumventing market domination.

Rule 11 Section 4 (b) of the IRR watered down the clear intent of the law by providing that “in cases where different persons own, operate or control the same generation facility, the capacity of such facility shall be credited to the person controlling the capacity of the generation facility.” Sounds harmless?

The idea of limiting concentration of capacity is to assure that there will be enough players who can truly compete for power supply. This IRR provision, combined with Sec. 45 (b) of the Epira, kills that objective.

All the sister company of a distribution utility has to do is to bring in partners who will “control” the capacities of its various self-negotiated genco capacities and its ownership of the affiliated genco will not count against the utility.

The utility can then own 80 percent of the demand of its sister company in circumvention of the 50-percent limit and this will not count against its capacity concentration limit as long as it does not “control” capacities. Nifty circumvention! This carefully worded stratagem did not end up in the Epira IRR by accident.

Spot market

Section 30 of the Epira that created the WESM is sadly ambiguous on its objective. The section provided just for the activities to create one and for the roles of the ERC and the DOE.

In effect, the Epira mandated only the creation of a wholesale electricity spot market without really making clear what the goal is for the consumers or its role in the grid.

Everything was left to the ERC and DOE to formulate. Under this vacuum of purpose, the private power generators, acting as “market participants,” managed to dominate in writing the rules and in defining the objectives. They created a game where only generators and aggregators win and the consumers lose.

Section 31 of the Epira established open access to reduce power cost by empowering consumers in choosing their generation suppliers.

It was in the name of the pursuit of open access that Napocor’s assets were sold at fire-sale prices.

A three-year target was set and PSALM was regularly put under pressure by interested gencos to privatize the Napocor assets, evidently expecting to buy them for a song.

As examples, one local genco conglomerate bid $362 million for the 600-megawatt (MW) Masinloc coal plant. PSALM did not award it to the genco and rebid it a year later.

A foreign IPP (independent power producer) came in to offer a bid. This time the local group offered $732 million but it still lost because the foreign IPP offered more than $900 million.

Eighteen months later, a 100-MW diesel plant on Panay island that Napocor built for P1.2 billion was privatized for only P250 million, with the buyer getting an assured market from Napocor for P300 million.

All this in the name of achieving the 70-percent privatization target that the Epira set to pave the way for the supposed holy grail called open access.

Much ado about little

Ironically, open access is much ado about little. It will benefit only about 600 industrial and commercial users in the Meralco area who use 750 kW and higher. Worse, the savings on the generation charge are not much and many qualified users, referred to by the Epira as the “contestable markets,” do not find it worthwhile to make the switch.

The rest of us are called the ironic name “captive markets,” those who consume less than 750 kW and have no power to choose their genco suppliers. They have to buy from the distribution utility at whatever rate.

The Napocor losses in the privatization of its assets will end up being charged to the consumers in the form of “stranded contract costs” under “universal charges.” The consumers again will pay.

Under Section 43 (f), the

Epira paved the way for establishing an alternative method for setting retail rates to replace the transparent RORB that had become too inconvenient for Meralco.

It mandated the ERC “in the public interest, to establish and enforce a methodology for setting transmission and distribution wheeling rates and retail rates for the captive market.” The rates must allow a recovery of fair and reasonable return on investment.

“The ERC may adopt alternative forms of internationally accepted rate setting standards as it may deem appropriate. The rate setting methodology so adopted and applied must ensure a reasonable price of electricity,” read the section.

This provision was used to justify the use of performance-based rate setting, or PBR.

Security of supply

This is one of the Epira’s major failings. The main framers of the law were so focused on privatizing Napocor assets for fear that the state-owned firm would hold on to some coveted plants if the government were designated as the “generator of last resort.”

Under a deregulated and privatized environment, there is a need for a backup plan in case the private sector is not meeting the the country’s power needs.

After all, public utilities like power, water, roads and transport are essential services that the people expect the government to provide. The government only delegates these services to private franchisees. If there is a failure, the government cannot say it cannot do anything because the service is privatized. The people still expects the government to step up.

The Epira, under Section 71, allows the government to get involved only in power generation when there is an emergency—an “imminent shortage of supply of electricity.”

This is a very reactive mechanism that will be subject to legislative debate. Considering that it takes four years to build base-load plants, there is little probability that this will ever meaningfully benefit the consumers.

The 600-MW Malaya plant in the Meralco franchise area is still under government control not because of a carefully planned reserve power strategy but because there are no private sector takers.

The company that took over it is an operator subcontractor of PSALM. PSALM itself, under Section 47 of the Epira, has no real mandate to operate the remaining genco assets, especially as an ancillary service provider and calibrator of WESM prices.

(Next: Epira, an imperfect law imperfectly implemented and the right way to amend it if we are to reduce power costs)

(David Celestra Tan, a CPA, is a founding director and former president of the Philippine Independent Power Producers Association. He was a power generation executive from 1993 to 2013. He acted as a volunteer strategy adviser to several legislators during the finalization of the Epira. He is now a consultant on utility economics under Lunas Inc.)