Epira an imperfect law imperfectly implemented

(Second of three parts)

To be fair, deregulating the power sector is a daunting task. The dynamics of the sector are complicated by our country’s political and moral landscape.

Deregulation required the creation of new organizations and new thinking on the part of the Energy Regulatory Commission (ERC) and the Department of Energy (DOE). We ventured into an entirely new world called the spot market when the country had no experience and regulatory infrastructure even in commodities spot markets.

The devil is in the details and the killer is in the implementation.

Deregulating power is a complex undertaking. Many issues were not resolved when the Electric Power Industry Reform Act (Epira) was finalized in early 2001. Instead, the bicameral conference committee made the ERC the default solution partly because the framers of the Epira seemed so averse to giving part of the task to the DOE.

Things that could not be resolved were left with the ERC, like the search for judicious rate setting and the definition of “fair and reasonable” rates. Even the ministerial preoperating certification for compliance of the generating companies was given to the ERC instead of the DOE.

The ERC struggled mightily under its formidable task as the guardian of public interest. As it lumbered through the learning curb of deregulation and rate setting, it became susceptible to vested interests. It has been observed resolving very complex rate-setting issues of Manila Electric Co. (Meralco) quickly and yet it takes so long to pass simpler rules for other distribution utilities and electric cooperatives.

The ERC went through a revolving door of four heads over the past 12 years or an average of 3 years per chair although the tenure is supposedly 5 to 7 years. After the upright ERC Chair Fe Barin was kicked upstairs, the commission as a consumer protector was thrown off-course. The short term of the second chair, Manuel Sanchez, saw the ERC giving Meralco, the country’s biggest power distributor, everything it wanted. Since then, the agency has not regained its true regulatory soul.

Power rate regulation is a work in progress. Under a privatized and deregulated power sector, the public needs the protection of an alert regulator. The ERC has an obligation to pursue its mandate to ensure that providers of power services are viable and that consumers are charged fair and reasonable rates. It should not hesitate to improve its own rules. It got lost through the maze of its own complex rules and lost sight of these two main objectives.

Scourge for consumers

The ERC approval of the performance-based rate making (PBR) is one reason for the soaring rates on the distribution side. While the Epira allowed the ERC to consider “alternative” rate-setting methods, the law also required that the alternative be better for the consumers and that it results in more reasonable rates.

The opening for an “alternative methodology” provided by Section 43(f) of the Epira led to the junking of the more transparent return on rate base (RORB) and the adoption by the ERC of PBR. Under PBR, a distribution utility is allowed a return on investment on installed facilities and on future investments. The future investments are not mandatory as long as the utility achieves a level of “performance.” It will be penalized if it doesn’t achieve this level of performance (thus the nice name “performance-based”).

When Meralco announces a multibillion-peso capital investment, the consumers are hit twice—they pay for it and give the utility a return on investment that was already part of the rate base or historical costs.

In the first year of PBR, Meralco gained an additional revenue of P6 billion although it “suffered” a P300-million penalty for nonperformance. Businessmen would take that cost-benefit tradeoff anytime.

PBR, which allows rate recovery on investments not yet made by Meralco, is contradictory to Section 25 of the Epira that says that “retail rates shall be based on the principle of full recovery of prudent and reasonable costs incurred.”

Undeserved profits

If the regulators’ hearts were in the right place, the operative word should be “incurred” costs. Projected investments are not costs incurred but allowed by PBR, resulting in undeserved profits for the distribution utility and an unfair burden on the consumers.

Although the Section 25 also provided an opening for “such other principles that will promote efficiency as may be determined by the ERC,” it behooves the regulatory agency to construe this strictly to the best interest of the electricity end-users. As it is, PBR promotes efficiency only in overcharging the consumer.

Automatic adjustment

PBR is purchased power adjustment by another name. The issue, however, is not that the generation rate is automatically passed on to the consumers but that there have not been enough safeguards in the bilateral contracts and the Wholesale Electricity Spot Market (WESM) to protect the consumers from exorbitant generation charges. The rules are stacked against the consumers.

The adage “if we introduce gaming into the system, it will be gamed” is very true in the case of the WESM.

At the time the Epira was being sold to the public, one of the major claims was that a wholesale electricity spot market would reduce power cost. Now the spot market operator, Philippine Electric Market Corp. (PEMC), says its main goal is assurance of transparency and order in the trading of electricity.

The WESM is a large bureaucracy and its inner workings are hard to figure out and hence “nontransparent.”

The trading rules were set by the “power participants” and dominated by power generators. The WESM has failed the consumers because of a faulty structure, a lack of true safeguards for the public and opportunistic market practices of participants.

The “market-clearing” price system where suppliers are even paid higher than their bid prices is patently anticonsumer. The theory is that there will be so much power supply on the WESM that the market-clearing price will drop, as if the power generators, a close-knit group, will invest to oversupply the market and shoot themselves in the feet. (Duh!)

Sadly, at the time the Philippines was so determined to deregulate its power sector in 2000 and 2001, deregulation was already failing in California. And we did not even pause to find out why and learn the pitfalls.

Wholesale aggregators

In search of the culprit for the horrendous spike in WESM prices, there seems to be an expectation that it would be one or more of the power generators. Maybe, but it would be their market trading business as wholesale aggregators.

Their business is buying and selling capacity, and playing them on the WESM. They have significant market influence and more to gain from the P62 per kWh price spike when power generators went on simultaneous shutdowns, while the Malampaya gas pipeline, which provides natural gas to Meralco’s suppliers, was closed for maintenance.

PEMC itself has not satisfactorily explained its perplexing charge called “line rentals” on top of WESM price that bloat power costs in the Visayas.

Everyone seems to agree that part of the solution is to amend the Epira. The question is how to do it right. Let us assume that we, as a nation, have the courage to bring down power costs and ensure power supply and correct the Epira so that it is aligned toward these objectives.

Proposed amendments

The following are some of the main amendments that can be made:

1. Promoting true competition and opening the generation market

a. Section 45 needs to be amended, especially subsection b to require that henceforth bilateral contracts intended to serve the captive market should be subjected to competitive bidding.

The Epira is an imperfect law imperfectly implemented.

The DOE can develop an upgraded capability to conduct the bidding in a truly competitive and transparent manner. Cross-ownership between distribution utilities and power generators should be prohibited.

The bidding process will give enforcement capability to the DOE’s strategic and policy-making mandate so it can better realize its generation mix strategy.

Moreover, this will open up the generation market and encourage more investors, foreign and local, who can provide real competition. This is the real key to more investments in the country’s power-generating capacity.

Many of the power rate increases stem from the lack of arms-length transactions between electric distributors and generators. Columnist Neal Cruz referred to these as the evils of cross-ownership.

The interest of the consumers and the industrial competitiveness of the country would be better served if the electric distributors dedicate themselves to “providing power in the least cost manner” as the Epira mandated under Section 23.

This they can do better if the relationship between the distribution utility and the generators are on an arms-length basis and untainted by conflict of interest.

b. Rule 11, Section 4(b) of the Epira implementing rules and regulations (IRR)

This gaping loophole that was clearly intended to circumvent the intent of the Epira to moderate market domination and concentration of capacity, needs to be deleted from the IRR by the Joint Congressional Power Commission.

As a compromise, instead of crediting the capacity to only one owner or operator, the credit of capacity can be based on prorated ownership for purposes of computing limits on concentration of capacity in case of several owners and operators.

This is not perfect but much better than the current rule 11-4(b). Certainly the “control of capacity” by energy traders must be factored in the whole scheme of determining “concentration of capacity” to reduce manipulation and market collusion.

c. Foreign investors in power generation

Some local lobbyists interested in buying the power generation assets of state-owned National Power Corp. (Napocor) managed to insert a provision in Section 47 that foreign bidders or buyers of these assets must finance the acquisition with at least 75-percent inward remittance.

This provision, which deterred many foreign bidders, must be reduced to a reasonable 40 percent to remove the barrier for foreign investors.

As mentioned earlier, the government got $900 million for the Masinloc plant from a foreign buyer instead of the original $362 million offered by a local generation conglomerate.

2.  Security of supply and role of government

Security of supply is something that the Epira addressed inadequately.

Section 71 can be amended to expand the role of Napocor as the ready generator of last resort. Instead of disposing of Napocor’s power generation assets at fire-sale prices, maybe some of those can be strategically retained to act as the calibrator of supply and spot market prices.

These government-owned facilities can be the provider of ancillary services as reserve and emergency power to the national grid transmission company. It does not have to be a losing proposition.

Under a clearly defined service role in the grid, the 600-MW Malaya plant could have been dispatched properly not just when there was short supply but also when needed to act as calibrator of WESM prices for the protection of the consumers.

It can be made available at a trigger WESM price of say P20 per kWh. Of course, under such a program, the government needs to ensure that the reserve capacities are of the right technologies. Fast-starting capacity can be diesel and gas turbines that use liquefied natural gas when it becomes available.

Power is an essential public service. Privatization or not, it is still ultimately a government responsibility. When it is in short supply or too expensive, the people demand answers and actions from the government, which might as well have ready capability to answer the call to augment supply or keep the prices reasonable.

Napocor is still full of competent power people. We just need an enlightened definition of their role in the power grid.

3. Rationalize roles of the DOE and the ERC.

The ERC is overburdened and the DOE has broad responsibilities but insufficient teeth. Toward balancing the objectives of assuring supply through the encouragement of private investments and assuring “fair and reasonable” rates for consumers, the DOE can be made to focus on the former and the ERC on the latter.

The ERC needs to be streamlined and the DOE must assert itself and strengthen its bureaucracy to align the organization toward a clearer vision.

The DOE also needs to step up and review the rules of the WESM.

There may also be a need to rethink the current requirement that future ERC heads need to be lawyers. Although it is a quasi-judicial body, its leadership must be steeped in economics, which is the substance of rate-making. The process can be provided by a capable legal team.

4. Reinstate the VAT exemption of power

The Epira did the right thing and exempted power generation from the value-added tax under Section 6 for the “objective of lowering power costs to end-users.”

Power and energy are primary inputs in industrial production and commercial activity, and determine the country’s manufacturing competitiveness. However, after the national coffers were depleted in the aftermath of the 2004 midyear elections, the government passed a VAT law in May 2005 that removed the tax exemption of power generation costs.

If we truly want to reduce power rates, the VAT on power generation should be phased out. The P30 billion in annual revenue to be lost from exempting power from the tax can be recovered from increased revenue from the resulting growth in the manufacturing and commercial sectors that can be invigorated by more competitive power costs.

The government, of course, cannot make this national sacrifice unless we stop the abuses of the private sector.

5. Pass on of cost of inefficiencies

The Epira vaguely introduced in Section 43(f)(iv) the concept of not allowing distribution utilities to pass on to the consumers, as part of their installed investments, the cost of management inefficiencies and misjudgments that result in higher cost to consumers. This has not been sufficiently enforced by the regulators and may need to be emphasized in an amendment to the Epira.

Given our legislature and the logistical power of those who will be adversely affected, it is unrealistic to hold out hope for structural amendments to the Epira that protect consumers unless we find the courage to really change it the right way.

(To be continued)

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(Editor’s Note: David Celestra Tan, a CPA, is a founding director and former president of the Philippine Independent Power Producers. He was a power generation executive from 1993 to 2013.)