Why the WESM will not work

WHEN ONE looks at the conceptual foundations of a wholesale electricity spot market (WESM), the benefits from it can easily awe. The WESM’s skinny alone would tempt anyone, government executives and politicians in particular, who, by default, might be too preoccupied to read beyond a one-page brief, to approve its imposition with neither debate nor discussion save for issues that pander solely to a political agenda.

It is not just the five-or-more-syllable technospeak that comprises the WESM’s attraction or its slick multiscreen trading floor that imbues it with a relative degree of technological sophistication. Beyond its science, more important, its temptations lie in the ideal virtual utopian market that it proposes.

Let us briefly view what it is that politicians, lawmakers and approving authorities saw when the WESM was first proposed under the seminal Electric Power Industry Reform Act (Epira) of 2001, and then just recently repeated, when the Department of Energy, absent law and fundamentally contrary to the Epira, compelled an eleventh-hour Interim Mindanao Electricity Market on a crisis-ridden, blacked-out Mindanao.

Try to keep a straight face. Let’s switch off the lights to see if anything glows. To mimic reality, let us power down those filaments and diodes in our brain related to critical thinking and unrealistically imagine that lawmakers are focused on the common good and have only our best interests in mind.

Being long ravished by monopolies and predatory prices in the electricity sector, imagine, if you will, that under a WESM, markets truly rule where customers choose among power suppliers, effectively pitting one against another, thus inducing and compelling cutthroat competition that forces prices down. Especially where WESM rules mandate that every power provider “must offer” all of its capacities regardless of whether these were generated for the public or are covered by bilateral agreements earmarking electrons for specific buyers, power supply under the ideal WESM should not be a problem. As any sophomore economics student knows, where supply is abundant, prices fall.

Who will not be amazed by a conceptual utopia where supply is indeed plentiful that neither single generators nor cartels can inflict market abuse; where offered prices are tempered by and yield to the consumers’ power to choose their suppliers; where a competent market operator and our expert regulators at the Energy Regulatory Commission (ERC) are not simply political appointees but are eminently educated enough in the industry to strictly ensure that no sellers collude or cartelize?

Now let us switch on the lights previously dimmed, slap ourselves awake from such incredulous Walter Mitty reveries, and view the WESM as it actually operates today.

Plagued by anomaly

Since its inception, the WESM has been plagued by anomaly. At the onset it was an arena for abuse as once, its operator, the Philippine Electricity Market Corp., through its Market Surveillance Committee, accused transitional spot market traders at the Power Sector Assets and Liabilities Management Corp. (PSALM) of colluding and manipulating the market between August and September 2006. Spot market traders had then sat literally in the same room, breathed the same air, and used the same toilets even as they were supposed to trade competitively. Water-cooler camaraderie would eventually develop. While long since addressed, apparently, given resurgent accusations of collusion, the issue of anticompetitive behavior has not been resolved satisfactorily.

Regardless of actual or accused virtual cartelization or collusion, which simply highlights market imperfections but is not necessary for abuse, we see an aberrant tariff-setting gene at the WESM given present-day realities. It is this that the ERC recently addressed in its decision to void the increases that would have been charged consumers last November and December, to which a twice-victimized public cried bloody murder.

To appreciate the pricing controversy and the tariff model that the WESM subscribes to, it will help to discern alternative pricing models and array these against the WESM’s.

The WESM is an exchange where buyers and sellers trade electricity. However, sellers are not limited to electricity generators. On the supply side, these can include buyers such as distributors with power purchase contracts who resell their excess purchases, thus blurring the distinction between demand and supply side economics. This is important because tariffs and clearing prices are derived more from supply-side costs than from demand-side purchasing power, where system capacities are constrained and, down the value chain, the market is more often than not compelled to buy at that price sellers sell.

Where capacities are low and sellers are few, supply-side costs determine eventual tariffs at the WESM. These costs can be true, and actual costs, average or marginal. At the WESM, only the last matters. Neither true generating costs nor average costs that arithmetically scale down the more expensive diesel- or oil-fired peaking plants matter when clearing prices are computed and set those tariffs at which both low-cost and high-cost generators are paid.

Marginal pricing

At work at the WESM is the economics of marginal pricing, where clearing prices are based on the last kilowatt produced and offered to round out requisite demand during peak hours; or when demand is high and supplies are low; or, as occurred late last year, when major base load facilities like PSALM’s 650-megawatt Malaya plant were denied dispatch even as Malampaya underwent scheduled maintenance.

Under the WESM’s marginal pricing model, as low-cost generators enjoy higher clearing prices, the virtual downsides for higher-cost generators are simply slimmer margins and lower volumes. Under the WESM, all and sundry suppliers are happy save for the hapless dolt who pays the inordinately high price. As Adam Smith’s “invisible hand” would have it, nowhere is market welfare factored in, except as subordinated happenstance and afterthought.

Marginal pricing is a legitimate pricing paradigm applicable to spot markets globally. Unfortunately, it works to scale down tariffs only when capacities are high, competition is real and effective, and consumers are empowered by choice—characteristics thus far alien to the Philippine electricity market.

Dean dela Paz is a former investment banker and a consultant to the Joint Congressional Power Commission. He authored a book on energy governance tool kits and teaches finance, investment mathematics, and corporate strategy.