Meralco’s Self-Dealing is Rent-Seeking on its Distribution Franchise. It is Abuse of Market Power and Harmful to Consumers.

David Celestra Tan, MSK
13 November 2016

Meralco has a franchise and monopoly for the distribution of electricity in the mega area of Metro-Manila and adjoining provinces. Its distribution franchise though did not come with the right to also monopolize power generation. Yet it is on its way to owning through its own generation company, Meralco PowerGen at least 90% of its energy needs. That it is able to do by rent-seeking on its distribution franchise.

Meralco, that serves the largest commercial and industrial hub of the Philippines, has a power demand of 6,000mw and energy requirement of 30 Billion kwh a year. That’s equivalent to 75% of the energy needs of Luzon and by now about 64% of the whole country. It is a lot of buying power! (pun or no pun!). A hulking 800 pound gorilla in the power sector.

Meralco is supposed to be a regulated public service monopoly operating under government fiat. As a Monopoly it is protected from many business risks. Forex and head-on competition in its service area. If it is hit by a typhoon, all repair costs are passed on to the consumers. Power is stolen from it or it loses due its own inefficiency and it is passed on to the consumers as systems loss. Its own expansion under the PBR scheme is charged to the consumers in advance. For all those market risk privileges and guaranteed legal return on investment, its government granted franchise requires that in return it serves the public interest at least cost and not abuse its market power.

Generation Gate Keeper

Its market power and domination by themselves are not evil. In fact they can be used for the public good if only Meralco would be satisfied with its guaranteed legal profits as a public service utility franchise holder and dedicate itself to providing electricity to the public in the “least cost” manner. This can be achieved only if it buys that market volume on arms length basis and transparent and competitive manner. But Meralco is a gentle giant that is not to be. Power generation is so lucrative especially if you negotiate with yourself. I guess the MVP Group cannot help itself. The Epira Law assigned the ERC regulators to protect the consumers and assure competitive and prevent market abuses and cartelization.

The Epira Law under Section 45 allowed Meralco to contract up to 50% of its energy needs with an affiliated company and the law is silent on whether competitive bidding is required although it can do so if it is faithful to its mandate for least cost power. Consequently, Meralco effectively got the power to choose who they will buy from. The veritable gatekeeper to their 6,000mw market power. And since they are the largest market in the whole country, effectively they get to choose who gets into the power generation business. That is true market power.

No Power Supply Contract, No Project. And they are rent-seeking to the fierce extent that even the Lopez Group never dared to go.

Wikipedia says Rent-seeking implies extraction of uncompensated value from others without making any contribution to productivity. In Meralco’s case it is getting unwarranted benefit in power generation projects that it awards for free as a result of its control of the Meralco market as the franchised distribution utility monopoly.

Power Generation Franchise

The foundation of any power generation project is the long term power supply contract. That’s the equivalent of a power generation franchise. In this case it is not the Congress giving the franchise but Meralco at its own discretion by its market power as the distribution utility buyer. Who is really the buyer of the generation supply, Meralco or the consumers? Technically it is really the consumers buying because they are the ones paying the negotiated rates. If something goes wrong with the contract, and if Meralco overcontracts, all the cost consequences are paid for the consumers. Meralco is only acting as buying agent for the consumers. It has serious conflict of interest in buying that power from itself.

Truly independent power generation companies take years and lots of research, pre-engineering, economic and financial packaging work, project development and marketing expenses to win a contract. In the case of Meralco, it can bring to the table the power supply contract in its back pocket because it is the distribution utility with full discretion to choose its projects and partners.

The “Carried Interest” Quid Pro Quo

In the power generation industry the party who brings to the table the power generation contract (or franchise) brings something very valuable and gets compensated either in cash or shares. Of course it has economic value. If its shares ownership of the project company, it is called “carried interest” or free equity. This can range from 15% to 25% of the project ownership. It is on higher side if the power supply contract got sweetheart terms and rates.

The MVP Group is obviously fully aware of this value. Perhaps it was one of the value propositions when the MVP group bought Meralco from the Lopez Group. It is evident that they intended all along to exploit this market power to dominate power generation since early on they already organized the not so subtly named Meralco PowerGen with an openly announced target of 3,000mw.

Given the MVP Group’s legendary “deal making” toughness, we can bet they will exact the highest free equity or economic rent from each Meralco contract they give out.

The MVP Groups ability to exact favorable and lucrative benefits from power generators seeking contracts with Meralco is rent-seeking on the public service distribution franchise that the government granted to Meralco. This is inimical to the public interest since the net result is the consumers would be paying more than what they should have without the economic rent to the MVP group.

In the case of electric coops in Mindanao, consumer groups there are complaining of their EC’s management and board of directors for negotiating high rates on generation contracts. In this case it is unlikely they will get carried interest but other benefits for their power to award the contract. Such is the evil that a serious CSP implementation will prevent.

In the 460mw expansion of the Mauban coal power complex, insiders is reported to have shared that the Thailand owners originally approached Meralco for a power supply contract with a price of P3.80 per kwh. By the end of the negotiations, the project became owned 51% by Meralco PowerGen with a new sweetheart price of P4.30 per kwh. The ERC approved it at P4.26 per kwh still higher than the 3.78 per kwh that the Northern Coops got for only 135mw.

The seven (7) midnight power supply contracts signed by Meralco totaling 3,551mw with five (5) partners are all controlled by Meralco PowerGen with 51% (except the 49% in the JV with Ramon Ang of San Miguel). Most of them were signed in one day on April 26, 2016 with similar language, pricing formula, and legal template.

Those 3,551mw coal plants will have a total project cost of about US$10 Billion (or Pesos 480 Billion). It will probably be financed 75% instead of the normal 70% because of its sweetheart prices and contract terms. So its equity of 25% will be equivalent to $2.5 billion. Do you think the MVP Group will invest 51% (Php 61.2 Billion) of that equity in cash as power generation investors are supposed to? They will not put that valuable power supply contract on the table for free. If they do, their vaunted deal-making shrewdness will not be legendary. Mostly like the MVP Group will only invest in the range of 26% out of the 51% it would control in the project companies. That’s a P31 Billion benefit or economic rent right off the bat.

So why does it matter to Meralco consumers?

Because rent-seeking and free equity or undue benefit will result to higher rates to the consumers. That $10 billion project will officially become $10.6375 Billion or it was a $9.3 Billion project that became $10 billion? That is equivalent to 6.375% of the project cost.

And that is only the cost to consumers of the rent-seeking privilege. Add to that the profits and overcharge due to the sweetheart relationship between Meralco and Meralco PowerGen, the total cost to the consumers is mind-boggling.

In fact even if the MVP Group does not get free equity, the fact that they choose their own power generation company to the exclusion of other non-affiliated projects to contract with Meralco and they negotiate sweetheart terms and prices is still rent-seeking according to the economists definition. Wikipedia also notes that rent-seeking is another form of corruption.

Rent-seeking is an abuse of market power and harmful to consumers.

Matuwid na Singil Sa Kuryente Consumer Alliance Inc.
Matuwid.org

David Celestra Tan is a CPA and utility economist. He was among the pioneers in the private power generation sector and a founder and former President of the Philippine Independent Power Producers Assn. (PIPPA). Towards retirement he is seeking to contribute his knowledge in power strategy and policy towards the national goal of competitive and consumer friendly power sector. His way of giving back to the community. Other than as a consumer he will not benefit financially, directly or indirectly, from any business with Meralco. Para sa Bayan lang po ito.

span style=”font-size: medium;”>Authors notes:

Rentseeking is the use of the resources of a company, an organization or an individual to obtain economic gain from others without reciprocating any benefits to society through wealth creation. (Investopedia)

Wikipedia says Rent-seeking is an attempt to obtain economic rent (i.e., the portion of income paid to a factor of production in excess of what is needed to keep it employed in its current use) by manipulating the social or political environment in which economic activities occur, rather than by creating new wealth. Rent-seeking implies extraction of uncompensated value from others without making any contribution to productivity. The classic example of rent-seeking, according to Robert Shiller, is that of a feudal lord who installs a chain across a river that flows through his land and then hires a collector to charge passing boats a fee (or rent of the section of the river for a few minutes) to lower the chain. There is nothing productive about the chain or the collector. The lord has made no improvements to the river and is helping nobody in any way, directly or indirectly, except himself. All he is doing is finding a way to make money from something that used to be free.[5]

IPP’s Surrender to Meralco’s Market Capture and the Rise of the Power Oligarchy

“We know we wanted to deregulate, we just forgot why we are doing it!” a USA regulator lamented. That in a nutshell is the state of the deregulated and privatized power sector in the Philippines, resulting to one of the highest electricity rates in Asia, and headed towards uncontrolled concentration, domination, and abusive rates and terms.

Concept of the EPIRA Law

The whole idea of the EPIRA law of 2001 is to reduce power costs by creating true competition in the different sectors of the Power Industry. Generation was unbundled from transmission and distribution and there was not supposed to be cross ownership among them to assure this healthy competition for the benefit of the consumers.Assuring there is a fully functioning competition especially in the generation sector, and its spot market called WESM, seems an idea that is totally lost now among the government policy makers, regulators, and legislators.

There can be a functioning competition in the generation sector only if there are enough independent players competing against each other. The private sector however will not do it on their own because alliances, market cooperation, and coordinated strategies will tend to be more convenient and lucrative. It is up to the government to create and guard an industry structure where competition among generators is assured to safeguard consumers.

Self-Contradicting Provisions

One of the most self-contradicting provisions of the Epira law is Section 45 that ironically professed to prohibit market domination and anti-competitive behavior but proceeded under its own paragraph b to allow distribution utilities like Meralco to enter into bilateral contracts with affiliated companies up to 50% of their demand and is silent on the need for competition. Hence, negotiation between affiliated companies obviously became allowed. (What the law does not prohibit, the law allows!) This is the handiwork of the powerful lobbyists to tilt the rules in their favor.

That put Meralco the largest power distributor with 5,000mw demand the ability to choose who they will contract with and 50% or 2500mw allowed to be with their affiliated generators. In essence to also choose who gets in to be major players in the generation sector. That is so much market power. Meralco serves 75% of Luzon, equivalent to 62% of the country’s energy needs.

Independent Power Producers (IPP’s)

Until a few months ago the Philippines had an appearance of a robust generation sector with sufficient independence and competition among them. Top tier Power generators San Miguel Corp, Semirara, AES of USA, EGAT of Thailand, Kepco of Korea, TeamEnergy of Japan, Therma Power of the Aboitiz Group, First Gas of the Lopez Group have power supply contracts with the new Meralco but they are nonetheless independent.

There is also Global Business Power that concentrated in the Visayas, the Ayala Energy in coal and wind in Luzon, Transasia trying to do projects in Luzon and the Visayas, the Filinvest Group of Gotianun mostly in Mindanao, the Alsons Group also in Mindanao, Salcon Power in the Visayas, GN Power in Mariveles and Mindanao. Then there are the 2nd and 3rd tier players in renewable energy mainly solar, run of river hydro, wind, biomass and pocket players in diesel plants.

New Era of an Open and Competitive Power Generation Sector

When the Department of Energy passed in June 2015 a new country policy of requiring mandatory bidding for bilateral power supply agreements specially base-load, it ushered in a new era stopping self-negotiated power supply contracts whose sweetheart rates are passed on to the consumers. It was a major boost of commitment to upright regulation when the then new ERC Chairman Jose Vicente Salazar led the issuance of the ERC Resolution 13 mandating that the DU’s conduct a CSP for the power supply contracts that they will submit to the ERC after November 6, 2015.

The CSP rules created an open and competitive power generation sector where the willing and able power generators, local and foreign, can come into the market by being competitive , efficient, and innovative with technology. No barriers to entry. No need to have special connections with the DU. Just good old fashioned competitively priced power.

While the government was promoting the CSP policy the Meralco group continued announcing its target of 3,000mw of power projects for its subsidiary Meralco PowerGen, as if telling the government “stop us if you can”.

The independent power generators were calculating their moves. Some sharpening their organizations for the open bidding that might happen. Others discussing schemes with Meralco and the MVP group, who cannot be ignored because they “control the gold” of the power generation market which is the power distribution utilities, the largest of which is Meralco. Lets remember the “golden rule”. He who controls the gold makes the rules, courtesy of Section 45 of the EPIRA law.

When independent generator, EGAT of Thailand approached Meralco for a 460mw expansion of the Mauban coal facilities, insiders said they only offered P3.80 per kwh. By the time the negotiation was finished, Meralco PowerGen became the 51% owner of the project and the rate became P4.35 per kwh. Within the same timeframe a group of eight (8) electric coops in the north got a bid of P3.78 per kwh for only 135mw of aggregated demand.

After November 6, 2015, Meralco had been lobbying at both DOE and ERC to be allowed to hold their own CSP bidding, for “swiss challenge” biddings where they preselect the original proponents of an unsolicited proposal which most likely will be their own affiliate, and strong lobby against an independent bid administrator to conduct a bidding as envisioned by the DOE Policy. They also threatened both DOE and ERC to take them to court on the CSP policy.

The independent generators were waiting if the government specially the ERC will be steadfast in its commitment to CSP especially when the ERC Chair was quoted to have said “we lament the failure to see the public’s clear benefit from the CSP. We will respect the legal process even as we seriously consider our own legal options to make sure we defend the public interest, as well

Moving the Midnight and Parting the Red Sea

Things changed however when the ERC announced on March 15, 2016 that it was “restating” the effectivity of the CSP requirement to April 30, 2016. This signaled to the power generators that Meralco and the MVP group can really make things happen, like Moses parting the red sea with the wave of his wand. (Actually some of them heard weeks before March 15 that ERC will move the CSP midnight.)

Even the likes of Ramon Ang of San Miguel, who until then have been a staunch competitor of MVP, can see who is the “Moses” in the power generation landscape and will not be so impractical as not to surrender to the MVP group who obviously can make things happen, has market control, and now regulatory capture.

(As a consumer group we were rooting for Mr. Ang because he represented an entrepreneurial force that can bring consumer-beneficial competition in the cellphone sector with Telstra and the power generation sector, two hopes and dreams that banished)

After clearly one of the most frenetic periods of negotiations to finalize 3,551mw of power supply contracts in 60 days, Meralco and their new subsidiaries and allies signed the PSA’s on April 26, 2016 and filed the applications with the ERC at 7am on the 29th, a day before the April 30 midnight set by the ERC.

1. 300mw with RP Energy in Subic with Aboitiz
2. 400mw with St. Raphael in Calaca with Consunji group
3. 1,200mw with Atimonan One. With Aboitiz or Ayala?
4. 528mw with San Miguel’s Central Luzon Premiere in Pagbilao Quezon
5. 528mw with San Miguel’s Mariveles Power in Mariveles, Bataan
6. 70mw with Panay Energy Development in Iloilo with Global Business
7. 600mw with Global Business Power in La Union

While the 3,551mw of contracts represent only 59% of the projected 6,000mw power demand of Meralco, the minimum off take energy total 24.885 Billion kwh is equivalent to 75% of its energy requirement. If we add the 455mw San Buenaventura and the remaining contracts with QPL and former Affiliate First Gas, most of Meralco’s base-load power requirements for the next 25 years are tied up with these negotiated contracts.

The seven (7) power supply contracts have amazingly identical language, pricing formula, and ERC application, apparently using the 300mw RP Energy as the template that was finalized and signed on April 20, 2016. Imagine five (5) of the largest power generation groups and their lawyers in one room hammering power supply contracts that will tie up the Meralco consumers for the next 25 years in a race to beat the new 45 day opening provided by the ERC. Three of them (Ayala, MVP Group, and RSA Group) just had the competitive barrier broken down among them when they signed the Telstra frequency buy off.

If that is not enough, the new Cartel is trying to push an era of non-transparency in the regulatory approval process. Their ERC applications are asking for identical and unprecedented “motion for confidential treatment of Information”. Among the information being withheld from the public? 1) Purchase Power Rate and breakdown of rates, 2) data on operating and maintenance expenses, 3) cost analysis, and 4) operating expenses. These are critical information needed to determine whether the rates are fair and reasonable.

The Rise of the Power Oligarchy and Oligopoly

The Power generators surrender to Meralco’s imposing market (and now regulatory) power is evidenced by the spate of dizzying controlling acquisitions as everyone succumbs to MVP’s “dealmaking” legacy. Now Meralco, the largest utility supplying the energy needs of the center of commerce and industry of the Philippines with 75% market share in Luzon, is now controlled by a few inter-linked generators.

In May 27, 2016, the MVP Groups affiliate First Pacific bought 56% of Global Business Power of the George Ty Group which in turn bought 15.6% of another Meralco affiliate Metro-Pacific Investment (MPIC). MPIC already owns 49.96% in Meralco in addition to a 50% ownership in Beacon that owns 35% also in Meralco.

Two of the seven (7) midnight power supply contracts of Meralco totaling 670mw were signed with Global Business Power. The 70mw is for a coal plant as far away as Iloilo that will go through 800 kilometers of power transmission and several submarine cable systems. One wonders about the technical and economic advantage to Meralco consumers of buying power that far from the Meralco load center when there are so many other options closer to home for 70mw.

In July 14, the joint venture between Meralco and San Miguel was signed on Mariveles Power Generation which got a 528mw contract. Meralco would own 49% and San Miguel 51%. On July 29, Meralco announced a 50:50% joint venture with DMCI/Semirara for the St.Raphael Power Generation Corp. which got a 400mw among the seven (7) midnight contracts.

Redondo Power that got a 225mw contract is owned 51% by Meralco in partnership with Therma Power of the Aboitiz Group. The Atimonan Energy One to which Meralco assigned 1200mw of power is majority owned by Meralco but it is not yet announced who will be its partner with Aboitiz and Ayala as rumored possibilities.

Before these new joint ventures and alliances, the other Meralco owner with 27.1%, favorite white knight JG Summit, bought 30% of Global Business Power where Meralco PowerGen had bought 20% in 2013. New Meralco partner EGAT of Thailand under its investment arm New Growth BV own 49% of the 455mw San Buenaventura. EGAT had bought 40.95% of Meralco supplier Masinloc Power Partners of the AES Group. EGAT owns 98% of QPL Mauban which has a 460mw coal power contract with Meralco.

Even the Visayas Grid will be dominated by four main players Meralco through GBP, Aboitiz Power, Green Core of the Lopez Group, and Kepco.

It’s all now in a family. How can there be true competition in CSP biddings and even in the WESM? If their cartel and interrelated power players get away with the seven (7) midnight contracts there would be no meaningful CSP biddings for Meralco consumers for the next 25 years, only gesture biddings for minor and shorter term contracts like peaking and reserve power. There would not be a credibly functioning power spot market. Sadly, this is happening at a time when the Philippines just passed The Philippine Competition Act (Republic Act 10667) which defines, prohibits and penalizes three types of anticompetitive conduct: anticompetitive agreements, abuse of dominant position, and anticompetitive mergers and acquisitions. If what is being done to the power generation sector is not against all these, we don’t know what is. If this is not a cartel, we also don’t know what is.

What we have is now a Power Oligarchy and Oligopoly. What chance do the consumers have of getting honestly competitive power?

Things will change only if the government recognizes this crime against consumers and country and would be willing to act to prevent it. This actually is the more productive subject of the Senate investigation on power.

Next: How is Meralco able to negotiate most of its power supply with affiliates? Who is the Culprit?

Matuwid na Singil sa Kuryente Consumer Alliance Inc.
Matuwid.org

Disclaimer
David Celestra Tan is a pioneer in the IPP industry and a founder and former President of the Phil.Independent Power Producers Assn. A CPA by education, he has been in the power industry for 35 years and evolved into utility economics. Was active as volunteer in finalizing the Epira Law to some key Senators. Through his blog matuwid.org in retirement he only seeks to share his expertise in power policy and strategy for the public good towards reducing the power cost in the country and eliminating abuses and monopolization. He assures the consumers and participants in the movement that he has no vested interest other than as a consumer and will not benefit financially from any of the advocacies and certainly will not participate directly or indirectly with any potential bidders in a true CSP.

The DOE’s CSP Rules and You ……And Why Meralco Is Fighting it Tooth and Nail

MSK October 24 2015

The Department of Energy, the energy policy making body of the country, passed a Circular on June 30, 2015 requiring distribution utilities like Meralco to open to competitive selection process (CSP) their purchases of power supplies instead of just negotiating them with their sister company generators. It has been a serious conflict of interest.

Passing the Circular was a bold move of then Energy Secretary Carlos Jericho Petilla because it will most likely get the ire of three powerful groups, Meralco, the Lopez Group, and the Aboitiz Group who together control 75% of the power demand of the country.

It is called CSP to cover methods of competition to find least cost power from alternative but qualified sources and feasible technologies. It can include (1) competitive bidding, (2) competitive canvassing (known internationally as Request for Proposals or RFP’s), and (3) if those competitive sourcing fails, to negotiations. The power procurement activities from 1 to 3 is a process that hopefully will allow generators to compete for the requirements. Now Meralco just goes to No. 3 and bypassing 1 and 2. Generators cannot even sell to Meralco unless they agree to a 51% ownership of Meralco PowerGen.

Why should this concern you?

Because the price they negotiated among themselves are paid by you as the electric consumers and what do you expect from brotherly negotiations between the DU and its sister generators? Our organizations study of 2013 to 2015 Meralco rates showed higher charges by affiliated generators of P6.10 billion in 2013, P10.31 billion in 2014, and so far up to September 2015 it is P5.51 billion.

If we go all the way back from 2006 to 2010 when Meralco was still controlled by the owners of First Gas Power, the numbers were way worse. Metro Pacific took over control of Meralco from the Lopez Group in May of 2010.

Now Meralco is fighting tooth and nail to make voluntary or at least delay the implementation of the mandatory CSP. So much obfuscation and hoodwinking have been thrown at the public (and ERC) that you probably got confused and lost interest. Please don’t because it is your pocket that is on the line here (as the vested interests line theirs with free gold).

MSK would like to simplify the issues and their answers
What is the bottomline of Meralco’s efforts to stop Mandatory CSP?

Put simply, Meralco and Metro Pacific would like to retain their royal right to negotiate among themselves the generation rates that they will charge to the Meralco consumers. They want to keep the 6,000mw Meralco generation market closed to only their affiliates and chosen few. They want to deny with chilling callousness the right of the Filipino consumers to competitively determined and market tested rates. They want to monopolize the Meralco generation supply for the next 25 years.

This is akin to having the privilege of dipping into the public’s pockets electric prices that only they among themselves determine, something even the government has no privilege to do in taxation without legislative approval participated in by Congressmen and Senators voted by the people to represent them and approved by the President of the Philippines.

2. Does an ERC regulatory review provide the public the equivalent competitive rates?

This is one of Meralco’s favorite arguments. It of course does not and let us explain.

A regulatory review is for the purpose of determining the fair and reasonableness of the contracted rate it is being asked to approve. While the ERC disallows, as part of its rigorous review, certain project costs and expenses and calculates what it would allow as a fair return on the generators investments for a definitive capacity or energy, what comes out is an evaluated rate that is fair and reasonable.

A competitive and least cost power rate on the other hand considers market dynamics, calculated optimized project costs, operating efficiency, incremental markets, economies of scale, and the investors calculation of a strategic return on investment it is willing to accept to compete with the others. The objective is to come up with a rate that is not fair and reasonable but one that will beat competition.

It is time tested that the existence of a working competition in a free market is a powerful price reducing force and must be allowed, assured, and mandated by the government to work for the benefit of the people. Why deny the electric consumers the benefit of this power competitive force?

CSP should be the main way to determine the contracted rate. An ERC Regulatory review is an added safeguard for the public in case there is a market and bidding aberration.

Metro Pacific as the new controlling group of the nation’s largest utility serving the critical hub of its industrial, commercial, educational, cultural, and government well-being must be satisfied with the profits guaranteed by its public service franchise as a distribution utility. We believe the distribution franchise granted by the people through the government did not come with a royal privilege to monopolize power generation and to further dip into the public’s pockets by self-negotiated prices.

The people and country need both competitively determined contracted rates and the safeguard of regulatory review. For purposes of assuring least cost power however, we have seen that competition beats regulation.

3. Is Mandatory CSP legal?

It is not only legal but a duty of the DOE, ERC, and Meralco.

The Epira Law of 2001 is profuse in its emphasis on the duty of these agencies to promote the public interest and for them to assure that consumers are provided “least cost power”.

Section 45 (b) of the Epira law granted the right of distribution utilities like Meralco to contract 50% of power supply to an affiliated company. It is silent however on how the contract will be awarded, did not require that it would be by negotiation, and neither did it ban the bidding of these contracts. In the light of this ambiguity, the law must be interpreted from the prism of public interest, which is mandated clearly as the duty of the DOE and ERC to promote and uphold. To paraphrase lawyers, “what the law did not prohibit is not prohibited”.

The DOE is within its mandate to put in policies to promote public interest and promote energy development. Opening the closed Meralco, Visayan, and Davao generation market and giving access to private investments will certainly encourage energy investments and introduction of new technologies. The ERC is within its right to mandate competitive bidding because it is not prohibited by the Epira law and it will be in keeping with its obligation to protect the interest of the public.

This is a defining moment for the new ERC under Chair Salazar. Will he for a change at ERC really stand up for the consuming public?

We are not asking the ERC to fully disregard the need of the generation company investors for fair return on their investments. Only that they should truly compete for the business because it is the public paying for it.

4. What is the risk to consumers of the delay in the implementation of the mandated CSP as Meralco is trying to do? Why are they working very hard to delay?

It can only mean they are trying to buy time to sign some mid-night power supply contracts with sister company Meralco PowerGen to probably the tune of 3,000 mw. If that happens the CSP rules would have been bypassed and the electric consumers are effectively denied competitive power for another 25 years.

If Meralco is sincere in their declaration that they only want to protect the interest of the public, we propose that they agree to a “standstill” provision by honoring June 30, 2015 as the applicability date of exempted power contracts. The DOE Circular 2015-06-008 provided that the mandated CSP is applicable to power supply contracts not yet filed or approved by the ERC on June 30, 2015.

We are sure whatever concerns they have on the CSP process including the choice of third party can be resolved within 60 days beyond October 27, not too long to have any adverse impact on any earnest Meralco power development plans.

5. What is the impact of making CSP voluntary as proposed by Meralco?

The current system is already voluntary. Meralco can open their power supply to competitive bidding if they want to. But they don’t prompting the need for a mandatory bidding. Since 2001, Meralco had always negotiated its main power supplies from its affiliated generators.

Making the CSP voluntary is like junking the DOE Circular.

6. Meralco asserts that mandatory CSP will not result to “least cost” power.

Leave it to Meralco’s spin doctors to try to redefine the meaning of “least cost” power.

We are aware that in competitive biddings the “lowest” bid price is not necessarily the winner because they have to comply with the credential, technical, and financial requirements of the bid. World Bank bidding rules defines the concept of “lowest responsive bid”.

A properly and honestly designed and administered bidding terms of reference can address all these concerns.

7. What is the appropriate role of a Third Party transaction adviser?

Meralco is trying to spook everybody on a Third Party because the bidding can be straight and incorruptible. In fact, that is the main need for a Third Party involvement I the CSP process. To assure transparency, objective bidding requirements and rules, evaluated power requirements, judicious evaluation and award. MSK calculates that the Third Party will cost only P0.01 to 0.02 per kwh compared to the benefit of lower generation prices by 0.38 to 1.05 per kwh.The Third Party does not need to be a super body but a facilitator and transaction administrator to assure proper bidding. The ERC Grid Management Committee can be deputized to review proposed capacity additions for bidding. Its Distribution Management Committee can provide the same input for the CSP’s proposed by Electric Cooparatives.

8. The Benefit to the Consumers of Mandatory CSP goes beyond lower rates.

a) It not only will eliminate sweetheart rates but additional pass on charges to the public from sweetheart contract terms and administration of the supply contracts.
b) It will give the government through the DOE and ERC a sustainable degree of check and balance in determining the capacity and energy and service that will be contracted, and the opportunity for these government agencies to infuse a holistic strategy in energy mix, locational, environmental, and technological choices instead of just leaving them at the whim of the sister company generators.
c) By opening the generation market, it will further invigorate sustainable investments in power development and assure long term power supply for the country at competitive rates. It will encourage introduction of more efficient technologies and harness the entrepreneurial ingenuity of the private sector for the benefit of consumers.
d) It will control the simmering but may not be nationally known growing instability at the electric cooperatives as its elected board of directors discover their power to negotiate and as power generators jostle for a increasingly finite number of power supply contracts. It has resulted to bickering at the Board level and worse the signing of misguided contracts that are hurting their consumer members. A mandatory CSP will eliminate most of this and it will provide the government agencies including NEA a mechanism to assist these electric coops in power planning and energy mixing.

9. Meralco’s threat to take legal action against the CSP

Meralco’s controlling stockholders of course have the right to take that action as part of our functioning democracy. However, democracy works only if there is a responsible exercise of freedom.

A lawsuit by Meralco against a government policy that will clearly benefit the consumers would be unbecoming of a public service utility franchise holder and would only foster its image as a heartless utility who will fight tooth and nail to deny its consumers, and kapwa Pinoys, their right to competitive power. Consumers that they are supposed to serve.

In our mind such an action will forever smear the name of Metro Pacific, MVP, and Mr. Oscar Reyes as greedy and heartless businessmen. A “Meralco vs the Consumers” trial and hearings will only showcase undesirable impressions for them. We are not sure they want that image as they also mature and go into retirement.

Unfortunately in this battle for the CSP, while Meralco spends humongous budgets allowed by the ERC and paid for by its consumers on Spin Experts, media operators, lawyers, and sundry subalterns, the consumer and cause oriented groups (well, the true ones anyway), spend their own money as volunteers. There is something unfair in this picture but maybe that’s another issue for another time.

10. Moving Forward

We propose that as a way to move forward that the ERC pass the needed resolution to require the competitive selection process of at least 50% of the base-load requirements of the distribution utilities. Section 45 (b) of the Epira Law of 2001 allowed DU’s to contract with affiliated generators up to 50% of their power supply needs. This should be on all bilateral contracts not yet filed or approved by the ERC as of June 30, 2015.

Without exaggeration, the implementation of the CSP would be a test and defining moment of our government and country to do things right for the people. It will be a very sad national tragedy if the ERC succumbs to pressure and influence from the vested interests to once again jettison the interest of the consumers. With new commissioners at the ERC we had been hoping it would be a new dawn for enlightened regulation. We thank President Pnoy for at least balancing the composition of the ERC that now at least there is reason to hope.

The DOE had already mandated the competitive policy. Now it is up to the ERC.

PS

We reiterate our call for clarity on Section 9 “Repealing Clause” of the DOE Circular 2015-06-008 that contains very disturbing ambiguous language. The last time that kind of vague and innocuous language got inserted, the Epira Law provisions and intentions against monopoly and market domination were illegally perpetuated as Rule 11 of the Epira IRR. We reiterate our call for the repeal of this Rule. But maybe we will need to wait until after new Senators are elected.

Meanwhile, we are holding our breath on whose side the ERC will stand up for.

If you wish to understand more the issues on power, you can read more in our website matuwid.org. – See more at: http://matuwid.org/the-does-csp-rules-and-you-and-why-meralco-is-fighting-it-tooth-and-nail/#sthash.6rHO5p1Q.dpuf

How Much Should Meralco be Allowed to Profit as a Public Service Utility?

by David Celestra Tan
2 January 2015
Part I

Let us start the New Year by going back to the basics of Meralco’s rates, which is how much should they, as a franchised public service utility, be allowed to profit?

The next relevant question is should they be allowed to profit only in the distribution side or also on the generation side?

The electricity rates of Meralco have been skyrocketing since the passage of the Epira Law in 2001. Remember the PPA jolt of 2002? Then Meralco’s distribution rates which increased 40%. All these years the consumers are only being told carefully crafted justifications why the rates in the Philippines are high, why Meralco has no control over it, and why the consumers should consider it fair and reasonable and accept it as part of life in the Meralco area.

Two years ago someone commissioned a study by an Australian consulting firm which in the end claimed and publicized widely that the reason the other Asian nations have lower rates, like Indonesia, Thailand, Malaysia, Vietnam, etc. is because those countries are subsidizing their power and the Philippines is charging true cost of electricity. They may have a point on the fuel subsidy issue but that’s not the only reason our rates are high. We all seem to have fallen for it, including the think tanks, academia, and government policy makers, and conveniently the DU’s themselves. What a carefully crafted ruse!

While our advocacy group, MSK, had come up with specific reforms that will reduce the cost of the pass on charges of Meralco by P3 per kwh or 25%, these are in the areas of power supply procurement and administration process, in regulatory methodologies, spot market rules, in taxation and other government policies, including legislative rectification. All have nothing to do with government subsidies of fuel.

A fundamental question we have not asked is How much should Meralco be allowed to profit as a public service utility? This is central to the issue on what retail rate setting methodology should be adopted in determining Meralco’s distribution charges. It is even more fundamental than whether it should be PBR (performance base rate setting) or RORB (return on rate base).

Beside the percent per annum of returns, should it be based on their “investment” which is the price at which they bought control of Meralco and paid to the previous owners? Should it be based on the assets of Meralco or on the equity of the stockholders that are reflected in the books of Meralco? Should it be return on equity or return on assets? Should the assets be valued at historical cost or reappraised replacement value? Should that return be income tax free or not?

It is clear from the Meralco website that the new owners, Metro Pacific of the Salim group of Indonesia fully expect to make their target returns on investment in both distribution AND generation when they bought Meralco from the Lopez Group. Metro Pacific, led by Filipino Manuel V. Pangilinan, had declared a target generation capacity of 3,000mw under its newly formed Meralco PowerGen.

A. Distribution Wheeling Business

For now let us first tackle the question on how much should Meralco be allowed to profit from the distribution wheeling business?

(In your Meralco electric bill, Meralco’s charges for the distribution wheeling business are the distribution charge, metering charge, and retail charge.)

For regulatory and rate setting purposes to determine Meralco’s allowable profit as a public service utility and balanced between the interest of the consumers and its stockholders, the fair and reasonable measure is return on assets.

Nonetheless, to address Meralco’s inevitable question on whether it is making enough money for its stockholders, we should also measure their return on equity as shown in Meralco’s official financial statement.

Let us start with the basic facts and considerations.

1. The Business – Meralco as a public service utility
The provision and distribution of electricity is a public service that is delegated by the government to the private sector as franchisee. Among the franchisees obligation as a public service utility is to assure it will invest in the necessary facilities and operate and provide the services to assure sufficient power supply and reasonable rates. It assures that it has the financial and management capability to do so.

Under the deregulated and unbundled structure of the power sector under the Epira Law of 2001, the DU’s business is to provide distribution wheeling services., i.e. the service of delivering the power from the generators and delivered to it by the transmission company to its customers through its own distribution lines.

In return, the government guarantees it with a fair return on investment through rates that are passed on to the consumers but are nonetheless regulated by the Energy Regulatory Commission.

2. Market Protection of a DU like Meralco
Meralco as a public service utility is protected by the government from many business risks specially market competition (in distribution wheeling services) that are faced by other business like shopping malls, real estate, manufacturing, banking, etc.

To assure its viability and provide an environment where the DU franchise holder can keep its rates reasonable and at the same time be economically viable for its investors, the government provides it with a monopoly franchise for its service area. Essentially it has little business risk. Protection from Competition in the distribution wheeling business and full recovery of operating costs, financial consequences of foreign exchange fluctuations, cost of fuel and purchased power, and even its own systems loss and collection efficiency and project delays. If their lines are damaged by typhoons, the repairs are passed on to the consumers. Distribution Market monopoly is granted to it by the government on behalf of the people who are also the electric users.

The government guarantees a fair and reasonable rate of return but the utility must accept the fact that it will be subjected to regulatory oversight to protect the public that they are franchised to serve.

3. Return on and of Investment

This is easier asked than answered. To begin with, there are two parts to this. The percentage and the asset base.

a. How much should be their Return on Investment? Should it be 8% or 10% per year or double the local prime interest rate? Entrepreneurs and their investment bankers, typically like to ask, “how much would be my return from alternative investment opportunities?”. Granted, they should also consider that the risk profile for a DU monopoly is lower and hence justifies lower returns. Profit level is a function of market and operating risks.

b. Next is on which asset valuation are they allowed to profit? Internationally, public service utilities should only be allowed to profit from the investments they put into the utility which is called the “rate base”. To be clear, private stockholders of these utilities are allowed to charge a rate that covers their return of investment (profit and capital recovery plus bonafide operating expenses).

This has long been the practice and called RORB (return of rate base). Majority of US public service utilities make 9.5 t0 10%. Prime interest rates in the US is 2.5% and in the Philippines it is 4.5%. So what should be the fair return on investment for Meralco given Philippine financial and economic conditions?

If Meralco is allowed a 10% return on assets plus an average depreciation charge of 10 years or 10% of asset cost, that means a total of 20% annual cash recovery from the consumers. Every 5 years the consumers is full paying for the asset base of Meralco.

c. Due to heavy lobbying, the Epira Law of 2001 opened the doors for alternative rate making which was used by the new Energy Regulatory Commission to adopt a new rate setting methodology called “Performance Based Rate Making” or PBR. In simple terms, PBR entitled Meralco to not only charge the old RORB but allowed it to charge to the consumers their forecasted investments for the next 4 years. And under the rules set by the ERC, it is not mandatory that Meralco actually makes the investment. The pa-consuelo to consumers is they re-evaluate in the next “regulatory re-set” and “reduce” the allowable rate recovery for the next 4 years. (yes they don’t recover the excess in the last four years which could run into billions in excess charges!)

In Pilipino, PBR is LSM. Luto sa Sariling Mantika! (more on this in another article)

4. Rate Base Valuation

If the rates to the consumers would be based on the value of the rate base, the issue for utilities is should it be at historical cost or at their current replacement value?

Do you know that for rate making determination, the old assets of Meralco is re-appraised every so many years?

ERC’s current PBR is based on current replacement value minus depreciation. (Please refer to the ERC PBR Presentation in the reference archives section).

The dissertation is purely from the point of view of fairness to the investor. They don’t discuss what is fair to the consumers who actually has an “equity” in the public utility since they are the ones paying for all its charges and risks including the guarantee of profit. Essentially as the ultimate payors, they are actually the guarantors of the investment recovery and profits of the private investor in Meralco.

Therefore, the consumers are entitled to similar equity and fairness in determining what is the cost of service. This boils down to what is the fair return of investment of the utility investor? Should they be allowed to profit from the periodic revaluations without really investing?

In the case of Meralco, a big part of its capital came from customer deposits which were used to bankroll the capital acquisitions of Meralco. Yet when those assets arose in value like the Meralco property in Ortigas Center, the increase in value goes to the stockholders. Nothing is given to benefit the electricity consumers who practically paid for those assets.

Moreover, the utility has already recovered from them the original cost of the asset base including their profits. Yet, every rate “re-basing” those assets are revalued (of course upwards) and used as a basis to further increase the rates to the consumers. Kawawa naman. They get it coming and going, front, behind, and center!

They only consider the “cost of service” but not really the “affordability of service” to the consumers who do not have the benefit of inflation revaluations.

This is one reason the private distribution utility business is so profitable. They have no risks and they have perpetual recovery from assets that are continually being revalued upwards. With PBR, they even recover in advance their projected capital investments. Things are getting worse for the consumers.

Under PBR the electric consumers are effectively paying for in advance the capital investments of Meralco. What is not clear is whether these assets thus acquired will then become part of Meralco’s asset base on which it will again profit perpetually even if it was the consumers who paid for it?

5. Corporate income taxes

This has long been a contentious issue. Actually this is another issue that has two parts to it.

The question of whether corporate income taxes should be passed on to the consumers is really a matter of how much is the consumers being made to guarantee a fair return on investment of the private utility investor. It can be either net of income tax or gross before tax. Private investors try to compare the profits they will make from other investments and forget that in comparing they are referring to returns that are gross and expecting net after tax returns from the DU business.

Politically though it is not palatable to consumers to be told they are paying for the corporate income tax of Meralco. So the guaranteed return on rate base must be gross before corporate income tax.

The bigger question is the anomalous disparity between what corporate income tax is Meralco passing on and recovering from the consumers compared to what they could be actually paying to the national government AFTER corporate tax avoidance strategies.

In the US, they call this “turning a consumer burden into corporate profits”. From consumer pockets to corporate coffers.

B. Power Generation

On top of this, Metro Pacific would like to profit from the self-negotiated and monopolized power generation supply contracts in Meralco.

The new Meralco (lets call this Meralco III) is evidently expecting to go back to the old Meralco (lets call it Meralco I) under the Lopez Patriarch, the venerable Eugenio Lopez Sr. under whose regime Meralco was both generator and distributor like in the old utility models in the USA. The Epira Laws that was passed in June of 2001 aspired to limit cross-ownership between generation and distribution and market domination and monopoly. Meralco II is the era post-people power when it was returned to the descendants of the old Patriarch until it was sold to Metro Pacific in 2010.

Matuwid na Singil sa Kuryente Consumer Alliance Inc.

Next: The business models of Meralco II and Meralco III. And Meralco’s ROI.