How ERC’s manner of regulation pushes rates up and consumers’ welfare down

June 2011 marks the tenth year of the Electric Power Industry Reform Act or Epira. This Asian Development Bank-sponsored project had two categorical promises to the Filipino consumers—reliability of power supply and lower electricity rates.

Yet, consumers are unable to ride the spike of electricity bills that have more than doubled since 2001. Access to electricity for 40 percent of Filipino households remains a dream. And for the less poor who do have electricity, this year, the tenth anniversary of Epira is expected to signal the removal of lifeline or discounted rates.

The Energy Regulatory Commission or ERC is mandated to protect the interest of electricity consumers. Unfortunately, it seems to have forgotten that consumer interest refers to the general public, not private industry players.

The true cost of regulatory failure

The right of access to affordable electricity is a necessary element of the right to a decent life. Households unable to pay electricity bills resort to candles and gas lamps that cost three times more than on-grid electricity. Many un/disconnected homes must come to grips with sunlight-chasing routines every day. Degraded living standards and constrained economic activity reduce Filipino communities into lives of misery. This is the unacceptable cost of regulatory failure.

Regulation is supposed to acknowledge, determine, and curtail the private sector’s tendency to over-accumulate profits. Regulation is directed towards the wealthy private players that are well-equipped to push their interests, unlike the uninformed and unorganized public. The ERC may consider its mandate to balance private and public welfare, but its obligation to the public is primary and cannot be sacrificed or undermined for private gain. Regulatory failure is what the ERC has shown so far—unmet objectives and more costs than gains.

Un-rectified mistakes

With cross-ownership in generation and distribution utilities allowed by EPIRA, distribution utilities like Meralco can own and buy electricity from its affiliated generating plants and even charge a higher rate at that. The risks of exclusionary behavior, uneconomic sourcing, and dampening new entry are severe because Meralco supplies 70 percent of the 5,000-MW Luzon market.

And the record shows that Meralco has utilized each of these risks to its own advantage.

In the early months of 2002, it gradually reduced its supply contract to buy electricity from NPC and bought electricity from its affiliates which had just started commercial operations (First Gas Sta. Rita, San Lorenzo and QPPL), prompting NPC to lodge a PhP27 billion settlement case in July 15, 2003. Meralco negotiated its obligation down to PhP14 billion and the case was resolved, including pass-through provisions that enables Meralco to pass the cost to its consumers. Instead of taking charge of this case, the ERC tossed it to the court. The court upheld the settlement case but deferred the pass-through provision to the ERC. ERC had no objections, but a 60-day temporary restraining order from the Court of Appeals in December last year stopped further proceedings.

A UP study of Meralco purchases of electricity in 2007-2008 says that generation costs are higher by 62 cents per kWh because of uneconomic sourcing or buying from preferred suppliers. The ERC remains mum on this. After all, which distribution utility can challenge Meralco? Fifty-three electric cooperatives are sharing the remaining 30 percent of the Luzon electricity market.

The Epira, however, has very clear provisions on the maximum share of generating capacity that can be handled by a company and/or affiliates. Section 45 letter (a) of EPIRA states that “No company or related group can own, operate or control more than thirty percent (30 percent) of the installed generating capacity of a grid and/or twenty five percent (25 percent) of the national installed generating capacity. “Related group” includes a person’s business interests, including its subsidiaries, affiliates, directors or officers or any of their relatives by consanguinity or affinity, legitimate or common law, with the fourth civil degree.

This restriction supposedly protect the industry from manipulations of electricity supply, which can have tremendous repercussions on the economy. Further, the IRR states clearly that in cases where different entities own the same generation facility, the capacity is credited to the entity controlling the terms of the prices or quantity of output sold. In addition, when different entities own, operate or control the power plant, capacity should be accounted to the entity controlling the power plant capacity.

Had the ERC properly implemented the rules, it should have realized that by as early as 2007 the Lopez Group had already breached the 30-percent limit as it now commands 54 percent of the Visayas grid, while the San Miguel Group already accounts for 29 percent of the Luzon grid.

The glaring error on the part of the ERC is when it decided that NPC should be credited for the capacity of IPPs with NPC contracts. The decision was applied to all IPPs when it should in fact apply only to those power plants that have shared ownership. Worse, IPPA contracts actually explicitly states that the management and control of the generation capacity is given to the administrator. This means that the ERC should have credited the capacity of IPPs to the new private administrators.

The implications of these two major policy and implementation flaws on electricity prices and reliability of supply are acute. The PhP1.79 per kWh overcharging of the Lopez group in its generation rates for Visayas for instance, takes almost PhP200 from a household consuming 100 kWh per month.

New burdens

The ERC introduced the so-called ‘performance-based’ regulation in 2003 for transmission and distribution to supposedly address the need for another rate-setting methodology that would lower costs and reduce inefficiencies. The specific type of PBR used by ERC is the ‘CPI-X’ variant, where a price cap is set based on the changes in overall price level and the X factor, a measure of expected productivity changes in the utility. [“CPI” is the “Consumers Price Index” which is “a measure of the current prices of a fixed basket of goods and services relative to a base year. The percentage change in CPI is used to indicate changes of price level and of inflation.”]
Three major components crucial for the success of this system are:

• the determination of the X factor;

• the period in which the price or revenue cap will be implemented, also called the regulatory lag; and

• the performance standards.
The X factor should reflect the difference in efficiency gains of the utilities against the average in the economy. This is benchmarked against a reference network or comparable regional or international utilities. [A reference network simulates the operations of the utility to determine the efficient cost of running the utility.] Performance standards are improvement targets that must be achieved by utilities in order to benefit from incentives (or get penalties for under-performance).

These two measures are determined prior to implementation to ensure that the rate computation is based on industry cost levels and attainable efficiency gains. The regulatory lag incentivizes utilities to be more efficient and reduce their costs because they can keep their savings until a new rate is determined in the following period. The normal practice worldwide is a regulatory lag of five years.

ERC’s wrong way

Now, the ERC’s way: the X factor is not benchmarked and no performance standards are set, except for system loss. ERC relies on historical data and forecasts submitted by utilities in determining ‘efficient cost’ levels as well as ‘improvement’ targets. In effect, utilities that are supposed to be regulated determine the terms of their assessment. Regulatory lag is reduced to one year, making it almost impossible for utilities to keep any savings they get from investing in more efficient practices. There no longer exists any incentive to be more productive; after all, there will be price adjustments in no time.

In turn, contrary to global experience that witnessed price cuts and productivity gains, we have rising transmission and distribution tariffs, which accounts for 30-40 percent of electricity bills. Yet again, the ERC’s inability to follow established international standards of conducting performance-based regulation unjustly swells electricity rates.

Another new rate-setting methodology was introduced by the ERC in 2009 for electric cooperatives. They were grouped according to determinants of operating distribution costs, primarily the number of consumers and consumption level. The methodology is unprecedented in history, but was supposed to make regulation simpler and manageable for the ERC. Upon determination of groupings (Group A – G), group tariffs were set based on average costs and initial tariff caps were set for three types of consumers—residential, low voltage, high voltage.

The ERC is yet to justify its new methodology, as experts and utility practitioners are questioning the problematic assumptions and abstract cost levels used in the computations, for instance, the use of 2000 operating costs as the base year and adjusting thereafter based only on inflation and changes in wage levels. The burden, however, is again on the consumers—tariffs rose by as much as 64 percent in 54 electric cooperatives.

Unaddressed realities

Regulation that is effective in protecting consumers must be simple, transparent, and with limited discretion. Foremost, the regulatory authority must understand the law and competently implement its rules and regulations. Before coming out with new rules or methodologies, it must be several steps advanced in terms of technical and personnel capacity. The evident shortcomings of the ERC on these aspects remain unaddressed. Even ERC officials admit their inefficiency and incapacity to cope with the multitude of regulatory issues tailing their doorsteps every day. [Atty. Francis Juan, during the National Electricity Consumers Conference, said so.]

Regulatory capacity is also tied to financial autonomy. Conflict of interests and moral hazard easily arise when utilities contribute to the fees paid to ERC consultants. Worse, reliance on consultants leaves in-house staff untrained and under-skilled. More difficulties arise during implementation because ERC personnel are the ones who directly related with utilities and operators. At the end of the day, regulation must be calibrated against its capacity.

Consumers’ imperative

The ERC’s website proclaims that it is “Asia’s benchmark for excellence in power regulation.” With rising electricity prices, supply shortages, degrading infrastructure, repeated market abuse and price manipulation, the ordinary consumer is hard-pressed in thinking that ERC is headed to that direction.

Much has been said about instituting multiple oversight in the industry by increasing the role of the Department of Energy and Joint Congressional Power Commission. The need for taking ERC processes closer to the people by enabling them to participate and represent their interests has been repeatedly voiced.

Consumers must now go beyond looking at their bills—the causes of soaring electricity prices are several, linked, and systemic. Regulatory failure undeniably weighs heavily on consumers as it undermines welfare and depletes already-constrained pockets. Much of the success of the EPIRA depended on a competent and independent ERC that placed consumer welfare above all else. Obviously, this has not happened. The need to upgrade the ERC is as urgent as the need to overhaul the EPIRA. –Edna Espos, Manila Times

Short URL: http://www.manilatimes.net/?p=4923