Thinking out of the box about the power shortage

There are two difficult things about the move seeking emergency powers for President Aquino under Section 71 of the Electric Power Industry Reform Act (Epira), to deal with the impending shortage in electricity expected in the summer of 2015. The first is that the conditions leading to such “emergencies” have been known and identified since 2012. And the second, the use of such emergency powers to lease 300-350 megawatts of diesel generator sets does not guarantee that the same “emergency” will not recur after 2015.

Moreover, the unit cost of producing energy from diesel sets will easily hit P16 per kilowatt hour, plus the cost of mobilization and demobilization if they will only be used for a fraction of a year. To imagine the impact, this cost/kWh is more than 2.5 times the average generation cost at the Wholesale Electricity Spot Market today.

Of course, it is difficult, if not unfair, to put all the blame on the Department of Energy. The Epira has effectively taken away the government’s ability to put up power plants or to provide take-or-pay contracts so that these new capacities can be financed. The Epira has limited the government’s response to creating the right environment so that the private sector can be enticed to invest in new capacities. But are the government’s options really just limited to hoping that enough private money will flow into the power sector?

Even with improved fundamentals, there are very few investors brave enough to go “merchant” in our power market. Project proponents have to find several distribution utilities or electric co-ops that will provide take-or-pay contracts to cover a substantial portion of the capacity they are planning to put up. This is probably the hardest part of implementing green-field projects, and is mainly because of three main reasons:

First, the energy market is dominated by incumbents who have their own generation interests to cultivate. Second, many of the smaller distribution utilities are unacceptable credit risks as wholesale buyers of electricity; several of them owe large arrears to generators. Third, many of the utilities are unsure of the total amount of demand that will avail of open access and thus choose a different generation supplier. This makes uncertain the total amount of contracts available to cover the required capacity.

Take-or-pay contracts are required by project lenders who want to see who will buy the plant’s output, what amounts will be sold to whom, and at what price. The conundrum becomes: We cannot build the plant until we can find people who will lend to the project, and who will not lend to the project until they see a contract that stipulates who will buy the electricity produced.

But the reality is that the Epira does not make it impossible for the government to act as an interested lender. Under a public-private partnership framework, the government is in the best position to access low-cost, long-tenor funds to finance power plants. The private sector contributes its innate efficiencies in putting up and running the new capacities. The government has been running surpluses and has built up substantial cash reserves. The option of tapping multilateral credit and the Malampaya Fund are also possibilities. Like any lender, the government can earn a spread between the cost of its borrowing and the interest it lends. As creditor, the government has step-in rights in case the project does not deliver on agreed-upon outcomes.

Given the government’s desire to intervene in what is commonly perceived as a source of structural weakness in the economy, this government lending scheme will probably be the least distorting. For transparency, the government merely puts up the available pool of funds and asks proponents to bid project capacities. Of course, the proponents will still have to provide equity financing to complete the required pool of funds.

The best part of the scheme outlined is that the government can choose to make the plant operate without a take-or-pay contract or go “merchant,” as long as the lender is willing to waive or restructure debt service, or a portion of debt service, when dispatch falls below the minimum required to cover liabilities. Of course, this will be an unusual response from the government. But high electricity prices, high customer willingness to pay but no takers, and no new investments are all signs of market failure. Out-of-the-box solutions for market failures will not be covered by existing regulations.

Finally, the government might not have an alternative to leasing diesel units to cover shortfalls expected next year. But at least the government should have a more concrete response to what happens after the summer of 2015. Finally, given recent knowledge of where tax revenues have been used, making sure we have the necessary power infrastructure in the long term seems to be the best use of public funds.

Nani Roxas is a full-time faculty member at the Asian Institute of Management. He teaches operations management, quantitative analysis, systems thinking, project management, and other basic modules in the degree programs and executive learning programs of AIM.