Economics of Electric EnergyIPPs, the PPA, and the Electric Power

Industry Reform ActPatrick Cesar T. BallesterosEconomics for Managers

ATENEO-REGIS MBA PROGRAM

What Happened?

҉&In 1990, the Philippines was confronted with a crisis of insufficient electrical generating capacity.

҉&Metro Manila and the 33 provinces in Luzon power grid experienced brownouts of up to 4 hours a day.

҉&The root of the problem was the decision by Marcos regime to build a 620 megawatt nuclear-power plant on the Bataan Peninsula.

҉&The Aquino government decided not to use the facility mainly because it was located in a seismic fault.

҉&As a result, a badly needed expansion of generating capacity in Luzon, which accounted for 75% of national electric consumption, did not come on line.

Cont..҉&The then president Fidel V. Ramos acted upon the

situation and addresses the congress through his state of the nation address to enact a law that would create an energy department that would plan and manage the Philippines’ energy demands.

҉&The congress responded by not only creating the Department of Energy but also giving FVR emergency powers to resolve the energy crisis.

҉&President Ramos eventually issued licenses to Independent Power Producers (IPP) to construct power plants in 24 months. He also issued supply contracts that guaranteed the government would buy whatever power the IPPs produced under the contract in U.S. dollars to entice investments in power plants.

҉&This solved the power crisis and created a stable supply of electricity in a growing & developing economy of the Philippines.

Cont..҉&In 1997, the Asian Financial Crisis affected the

Philippines and other countries in Southeast Asia.

҉&This has led to closing of some companies which created a surplus in electricity.

҉&Also because of the crisis, Philippine Peso devaluated rapidly leaving a great concern for the contracts of IPPs.

Independent Power Producers

҉&An entity which is not a public utility, which owns facilities that generate electric power for sale to utilities and end users.

҉&The National Power Corporation or NPC secured the accreditation of more than 40 Independent Power Producers or IPP contracts.

҉&The 1994 World Bank study notes that the average price of some 13 projects it analysed was 6.52 U.S. cents/kWh, which the World Bank conceded was quite high compared to the 6.37 U.S. cent/kWh bulk energy tariff of the NPC at that time.

Cont..҉&IPPs were largely petroleum based, with lower installation

costs but higher fuel costs.҉&Not only did the government throw out its energy mix program

of relying more on indigenous energy sources, the consumers were subjected to high fuel price risks in imported petroleum that consumers assumed through fuel adjustment clauses for tariffs in the IPP contracts.

҉&There is likewise an exchange risk in pegging the wholesale tariff to the dollar.

҉&The government and the consumers also assumed the market risk through generous take or pay guarantees.

҉&In addition to the initial high cost of the IPPs, the Asian Crisis also dramatically upset all the economic growth of the country and foreign exchange assumptions of the IPPs.

҉&This meant much higher fuel costs and oversupply of electricity capacity.

҉&investors are fully covered by the fuel cost adjustment mechanism and take or pay guarantees for which end users are now paying a heavy price.

Purchased Power Adjustments

Purchased power adjustment or PPA represents the increase in the cost of power purchased from the National Power Corporation (NPC) and other suppliers or IPPs. The PPA is a cost adjustment mechanism approved by Energy Regulatory Commission (ERC) to reflect changes in the cost of power bought from NPC and IPPs.

Currency Exchange Rate Adjustment

Currency exchange rate adjustment or CERA is another type of cost adjustment mechanism approved by ERC. This aims to recover the change in foreign denominated operating costs and principal debts repayment due to exchange rate movements.

Impact of PPA & CERA

҉&PPA and CERA are additional monthly costs being shoulder over and above the daily consumption of electricity and expenses to meet the needs of every member of the family such as food and clothing, education, health and transportation expenses, water and shelter.

҉&Everyone was affected by the imposition of PPA & CERA҉&Generally electricity rates in the Philippines, with PPA

included, are higher compared to neighbouring nation.҉&This makes investments in the Philippines hard to

materialize.

Supreme Court Intervention

The Supreme Court of the Philippines ruled to compel distribution utilities like MERALCO to refund its customers billions of Pesos perceived to be PPA payments of its consumers and to abide by the Court’s decision with respect to payment of taxes which formed part of the Company’s operating expenses.

Republic Act 9136 Electric Power Industry Reform Act

҉&As the Philippines experience power outages enough to be regarded as a national crisis, Ramos Administration turned to private sectors for solutions.

҉&Using the 1987 Executive Order that allowed the private sector to generate electricity, and by enacting a Build-Operate-Transfer (BOT) law in infrastructure projects, the government opened the floodgates for contracts with private generation companies or Independent Power Producers (IPP).

҉&After the onslaught of the Asian Financial Crisis, in 2001 Republic Act 9136 or the Electric Power Industry Reform Act was signed in to law.

Section 2 of EPIRA declares the objective of the law

҉& To ensure and accelerate the total electrification of the country;҉& To ensure the quality, reliability, security and affordability of the

supply of electric power;҉& To ensure transparent and reasonable prices of electricity in a regime

of free and fair competition and full public accountability to achieve greater operational and economic efficiency and enhance the competitiveness of Philippine products in the global market;

҉& To enhance the inflow of private capital and broaden the ownership base of the power generation, transmission and distribution sectors;

҉& To ensure fair and non-discriminatory treatment of public and private sector entities in the process of restructuring the electric power industry;

Cont..҉&To protect the public interest as it is affected by the rates

and services of electric utilities and other providers of electric power;

҉&To assure socially and environmentally compatible energy sources and infrastructure;

҉&To promote the utilization of indigenous and new and renewable energy resources in power generation in order to reduce dependence on imported energy;

҉&To provide for an orderly and transparent privatization of the assets and liabilities of the National Power Corporation (NPC);

҉&To establish a strong and purely independent regulatory body and system to ensure consumer protection and enhance the competitive operation of the electricity market; and

҉&To encourage the efficient use of energy and other modalities of demand side management.

Unbundled҉&NPC’s generation and transmission functions were

unbundled. ҉&National Transmission Corporation (TRANSCO) was

created to own and operate the transmission assets and perform the transmission functions previously under NPC.

҉&A fully privatized corporation which is National Grid Corporation of the Philippines took over TRANSCO’s responsibilities.

҉&The missionary electrification program is undertaken by NPC through the Small Power Utilities Group (SPUG)

҉&PSALM Power Sector Assets and Liabilities Management Corp. was created to liquidate the assets and liabilities of NPC

5 Types of Privatization of the Power Industry

Build-Operate-Transfer (BOT)

contracts

Divestiture (full privatization) through asset

sale

Management contract

Corporatization of electric

cooperatives

Concession agreement

Problems in EPIRA

EPIRA

Competition Policy

Regulatory Issues

Consumer Representation

Transparency

Institutional Intervention

Vested Interest

Status Report on EPIRA Implementation

Prepared by the Department of Energy, the most recent is on it’s 18th edition covered the month of November 2010 to April 2011. It serves as a summary update of particular developments in pursuit of the Government to restructure and privatize the power sector.

Privatization҉&The 18th status report stated that the activities

in the privatization of NPC/PSALM generating assets and IPP contracts were deferred with the new administration’s call for a review of the Privatization Plan and the need to address the seasonal supply interruptions.

҉&Also stated in the status report are the developments on PSALM’s continuing activity for the completion of the remaining legal, financial and technical requirements for the smooth turn-over of the privatized power plants and IPP contracts as follows:

Privatization of Generating Assets

Transfer of NPC-IPP to IPPA

PSALM/NPC Effective and Basic Generation Charges

Distribution Utility Rates

Distribution Utility Rates

Distribution Utility Rates

Distribution Utility RatesMERALCO

Lifeline Subsidy Program

kWh Consumption Bracket Lifeline Discount

0 – 20 kWh per month 100%

21 – 50 kWh per month 50%

51 – 70 kWh per month 35%

71 – 100 kWh per month 20%

Electrification

Barangay Electrification Status as of 31May 2011 Region Potential

Barangays Electrified Barangays Unelectrified Barangays Electrification Level (%)

CAR 1,176 1,176 0 100.00% I 3,265 3,265 0 100.00% II 2,311 2,311 0 100.00% III 3,102 3,102 0 100.00% IV-A 4,010 3,983 27 99.33% IV-B 1,458 1,458 0 100.00% V 3,469 3,469 0 100.00% NCR 1,695 1,695 0 100.00% SUB-TOTAL LUZON

2,0486 2,0459 27 99.87%

VI 4,050 4,050 0 100.00% VII 3,003 3,003 0 100.00% VIII 4,389 4,389 0 100.00% SUB-TOTAL VISAYAS

11,442 11,442 0 100.00%

IX 1,904 1,904 0 100.00% X 2,020 2,020 0 100.00% XI 1,160 1,160 0 100.00% XII 1,194 1,194 0 100.00% CARAGA 1,310 1,310 0 100.00% ARMM 2,459 2,441 18 99.27% SUB-TOTAL MINDANAO

1,0047 1,0029 18 99.82%

TOTAL PHILIPPINES

41,975 41,930 45 99.89%

“Our Company’s gain will be the Philippines as well, borne by MERALCOs intrinsic role as

a major contributor to nation building”

Manuel M. LopezMERALCO Chairman

The End