Promoting Transparency and Competition for Economic Efficiency in Power Supply Contracting: An EPDP Policy Forum
7 August 2015
by: Romeo Bernardo
Secretary Balisacan, Secretary Monsada ( and her all women power team), USAID Director Gloria Steele, Dean Solon, Prime Minister Virata, my former boss and mentor. Friends in the industry, academe and civil society.
Organizers asked me how I should be identified. I opted for my jobs as consultant, which I have been since leaving the Dept of Finance a long time ago. In the early 90’s, addressing the power crisis was one of the major challenges for government.
In the interest of full disclosure, let me mention my affiliations in the power sector—to establish my credibility (or perhaps in the eyes of some, my lack of it).
I
serve as an independent director in Aboitiz Power, a diversified power company
active in generation, distribution and retail. I am also an Independent
Director in Phinma, a diversified holding company with interests in Trans-Asia,
a power generation company. I am Connected with the Ayala group, as a
Director in BPI and Globe. AC is now quite active in power generation, fossil
fuels and renewables.
I
likewise hold the post of Vice Chair of the Foundation for Economic Freedom,
which has been a loud voice in pushing least cost approaches for the benefit of
consumers and taxpayers in embracing renewable energy.
Finally, I serve as the Private Sector representative in the Steering Committee of the EPDP, the organizer of this forum. I was invited in that capacity, and I guess as a panellist in this forum, based on my broad even if not intensive exposure in power. Hopefully, with biases cancelling each other out. I apologize for any remaining ones. Let me state the obvious – I speak only for myself.
2. I congratulate economics gurus Raul and Ruping for their very comprehensive, insightful, balanced, clear presentations. And Prof Wally del Mundo, my co-panel reactor. Commendations to Secretary Monsada for her presentation, and for now carrying the burden to make this Circular work. Frankly, I thought the Circular could have benefited from waiting for these studies of Prof. Fabella and Alonzo, and more public consultations.
Nonetheless,
it is an improvement vs. an earlier version. In any event perhaps
should be read as general guidance—and it is up to the ERC and others to
flesh it out, and all industry players to work together in crafting
architecture that best meet the objectives of secure,
reliable, quality, least cost electricity for our country.
I will make two general points:
a)
We need to be careful in our diagnosis of why our power cost is relatively
high. And what we need to do to bring it lower.
b) While there can be no disagreement on the value of more competition in supply contracting, the question is, what is the best way of achieving this? I bring out some issues with the way the Circular has approached this.
3. Why is Philippine power cost high? Things to be done. And not done.
A
table in the presentation of Raul shows Philippines’ power cost is much higher,
especially for the residential sector, even after removing taxes and
subsidies. I have come across another study by International Energy
Consultants, an Australian firm, that Philippine power prices are aligned with
the region and elsewhere after correcting for subsidies, taxes etc.
The
differences could perhaps be explained by differing capture or assumptions on
taxes, and especially subsidies, which can be non-transparent. In several
neighbouring countries government policies provide subsidies in excess of 50
percent to consumers. They also provide subsidies in the form of frozen
tariffs, sale of fuel to utilities at below market rates and utility losses
shouldered by government.
In doing such country comparisons, we should also be mindful of the ff:
a)
Load factor – the country with the higher load factor for demand will have
lower rates. In general, the more industrialized the country, the higher the
load factors.
b)
Scale and plant mix—Indonesia, Malaysia and Japan have grids and demand
growth that is large enough to accept larger, more efficient supercritical
plants. The first supercritical plant in the Philippines will only be
built three years from now (Quezon Power 2).
c)
No Flexibility – regulatory rules require supply provided by a plant to a
regulated entity to come from that plant only unless the plant has a forced or
planned outage. If allowed, suppliers can mix and match, and then costs could
be lowered by P 0.15-0.20 /kWh.
d)
Geographical challenges-- Adjustments for density for a country like Singapore
vs. archipelagic like
Philippines.
In
addition to these, we need to be aware of the evolution of the sector since the
introduction of EPIRA that have added to costs and delayed supply, with adverse
power tariff consequences.
e)
Growing pains from regulatory uncertainty, and contracting, approval and
construction bottlenecks have delayed new plants. The average time it
takes to build a baseload power plant in the Philippines is probably
double elsewhere. Just getting approvals, coupled with overcoming NIMBY
opponents, is an ordeal.
f) Legacy costs of stranded assets, delays in privatization of assets, compounding interest costs.
g)
Sharp increases in the price of coal and oil, until quite recently, have pushed
up power rates and led observers to think EPIRA is not working.
We also need to be aware of remaining constraints that need to be addressed: putting in place the enabling infrastructure like WESM (including an independent market operator), building up the transmission system, strengthening NEA guarantees and support for rural cooperatives, etc.
Most
importantly, we look to more progress in rolling out open access. This will
encourage more competition, eventually down to the household level – the holy
grail for a competitive electricity sector. A supportive regulatory
environment is essential.
We should recognize that amidst the challenges, there has been progress. Much more competition is in play. New entrants have been coming in.
This chart shows how much of the new plants are coming in from new players, I have counted around two dozens, from a handful pre-EPIRA.
Finally, not only should we build on this progress, we should not add unnecessarily to the cost of power. I have in mind expensive renewables supported by FIT.
Right now this adds an additional P 0.04 per kWh to our power bill. With a) the drop in the average WESM prices from P 5 to P 3 expected to prevail with lower cost of oil and coal, b) the second batch of installation targets, and c) reserve power and transmission outlays needed to support RE; FIT all can easily add P 0.20 per kWh to our bill.
Our Foundation for Economic Freedom, which counts both Professors Raul and Ruping as Fellows, has been noisily advocating for auctioning these FIT subsidies since over four years ago. If ever a case existed for more transparent and competitive award process, this was it as this involves allocating subsidies – an entitlement from the public. And selling to only one party, government. I am delighted to hear the DoE and ERC now finally committed to this course for any future FIT installation.
.
The
point of all of this is to say that we need to study more carefully the
causes of the observed high cost of power, continue to address those
issues.
4. Let me now go to some observations on the DoE circular, echoing, amplifying issues raised by Dr. Fabella.
a) Demand aggregation. Demand aggregation only works when aggregating the same kind of demand, and even then, some combinations will give you better outcome than a single plant type. Let me illustrate this point with a chart on the cost curve of types of plants—coal, LNG and oil.
As
you can see, depending on plant capacity factor and volume, the economics of
what is the least cost changes. Lowest cost is not least cost. And
that a portfolio of plants may be needed to arrive at least cost. And this
portfolio will differ depending on the size of the DU, customer base. And the
DU’s requirements will differ at various points in time, as individual supply
contracts lapse.
The
demand profile of the various DUs can be very different—think of MERALCO,
electric cooperatives, or DUs serving economic zones with cement and other
manufacturing plants.
Some
utilities are so large relative to their grids that aggregating with any other
utility will not benefit them. They are likely to end up indirectly subsidising
other utilities. Meralco is such a case. It represents 70% of the Luzon grid.
The
differences among DUs are not just in their demand profile, but also their
financial health. Aggregating a financially weak DU’s demand with a
strong one, will result in a less advantageous deal than if the latter
contracted on its own. What does this mean in terms of guarantees that
government will need to provide, and loosening of disciplines on electric
cooperatives?
Where
this leads me is to encourage voluntary aggregation but not mandate it. It can
certainly make sense for the electric cooperatives and smaller DUs with similar
customer profiles to band together. And indeed this is happening with the
support of government/USAID. Prof Wally and his team have been
instrumental in this, deserving of commendation.
b)
How about compulsory auctions under a “uniform template”?
I am
unsure how such a template can be formulated given: a) the differences in
situations of DUs – demand profile, credit profile, timing of
lapses of contracts, etc., and b) the basic heterogeneity of
supply contracts. As well defined by Dr. Fabella, the commodity is a bundle of
characteristics – price, duration, delivery dates, risk-sharing,
reliability, high cost of failures.
Or
what is the role of the Third Party which just adds a layer of cost? It is not
accountable to the DU nor its customers in the event of failures or delays in
the process, nor the selection of an unfit provider without back-up.
c) How do you have a fair, unified, aggregated procurement rules and methodology for plants of different sizes (5MW to 600MW), technologies (coal, gas, geothermal, solar, wind, biomass, diesel, hydro)? This can easily be done in the short term using Contracts For Differences (a derivatives contract covered by standard ISDA provisions ). But wait...this is effectively not allowed under the Circular.
Let me add that there are specific issues I have read in a Meralco position paper that describes complications. Including--
a) Uncertainty due to shifting to Retail Competition
and Open Access of captive consumers may expose DUs to stranded costs, more so
if there is less flexibility as a result of a uniform contract.
b) Implementation of demand aggregation and CSP will prevent DUs from obtaining capacities from WESM when prices are low, resulting in non-compliance to their least cost objective.
c) Lowest price bid may not necessarily be the least cost. There is also the question on the quality of the GenCo participants. ( NB. If I may add, “least cost” is not the same as “least volatile cost”. A utility aiming for least cost over a long period of time can have short term high costs like the recent Nov.-Dec 2013 price spike.)
d) There are legal issues such as the CSP may violate the DUs’ freedom to contract and the DOE overstepping its authority. "
5. I end up pretty much where Dr Fabella did. I am far from sure that CSP will lower cost of power in the Philippines. It may “crowd in” new generation capacity as he said, but I think there are other obstacles that are crowding out capacity that needs to be addressed. I enumerated them in the first part of my remarks.
.
He
puts a premium on the simplest architecture on a CSP. I totally agree with such
an approach. Perhaps it is best to enhance what is in place, instead of
junking it?
And
most importantly, adoption of an enhanced more transparent and competitive
selection process should go hand in hand with doing away with the accounting
method of verification in ERC regulatory practice. An approach based on
accounting cost and profit regulation, and not comparison against market
alternatives, is completely out of sync with the whole idea of a competitive
market driven power sector, the basic underpinning of EPIRA.
Thank
you.
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