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Philippine Electric Power Industry Market and Policy Assessment and Analysis of International Markets

Prepared by Prof. Rowaldo D. del Mundo Ms. Edna A. Espos

With Contribution of Ms. Mara Isabel Rodrguez Gonzlez


(former State Undersecretary, National Energy Commission of Chile)

UNIVERSITY OF THE PHILIPPINES NATIONAL ENGINEERING CENTER and U.P. Engineering Research & Development Foundation, Inc.

May 2011

Philippine Electric Power Industry Market and Policy Assessment Final and Analysis of International Markets Report

Table of Contents
Section Title Page No.

EXECUTIVE SUMMARY ........................................................................................................................... 8 I SUPPLY AND DEMAND ANALYSIS OF LUZON GRID ............................................................. 16

1 THE DEMAND SECTOR ................................................................................................................. 17 1.1 1.1.1 1.1.2 1.1.3 1.1.4 1.2 SYSTEM DEMAND OF LUZON GRID ................................................................................................. 17 HISTORICAL DEMAND OF LUZON GRID (MW ............................................................................... 17 ELECTRICITY SALES AND CONSUMPTION IN LUZON (2009) ........................................................ 17 DEMAND DRIVERS OF THE LUZON GRID ...................................................................................... 19 LUZON GRID DEMAND FORECAST (2011-2030) ........................................................................ 20 LOAD CHARACTERISTICS OF THE LUZON GRID ............................................................................. 22

2 THE SUPPLY SECTOR .................................................................................................................... 26 2.1 2.1.1 2.1.2 2.1.3 2.2 POWER PLANTS IN LUZON GRID .................................................................................................... 26 INSTALLED AND DEPENDABLE CAPACITY OF POWER PLANTS ..................................................... 26 PROPOSED POWER GENERATION PROJECTS ................................................................................. 27 OWNERSHIP OF POWER PLANTS AND CONTROL OF IPPA CONTRACTED CAPACITY.................... 29 WHOLESALE ELECTRICITY SPOT MARKET.................................................................................... 31

3 SUPPLY-DEMAND BALANCE....................................................................................................... 32 3.1 3.1.1 3.1.2 3.1.3 3.2 3.3 3.3.1 3.3.2 3.3.3 3.3.4 RELIABILITY PERFORMANCE OF THE GRID ................................................................................... 32 RELIABILITY INDEX AND CRITERIA ............................................................................................... 32 HISTORICAL RELIABILITY PERFORMANCE OF LUZON GRID .......................................................... 34 RELIABILITY PERFORMANCE OUTLOOK ........................................................................................ 34 REGIONAL PERSPECTIVE OF SUPPLY-DEMAND BALANCE............................................................ 35 GENERATION EXPANSION ANALYSIS .............................................................................................. 36 GENERATION EXPANSION METHODOLOGY, CRITERIA, AND SCENARIOS ...................................... 36 EXPANSION PATTERN OF LUZON GRID WITHOUT MALAYA AND LIMAY POWER PLANTS ............ 37 EXPANSION PATTERN OF LUZON GRID WITH MALAYA AND LIMAY POWER PLANTS IN-SERVICE40 HINDSIGHT GENERATION EXPANSION SCENARIO FOR NATURAL GAS PRICE ............................... 42

II ANALYSIS OF THE POLICY AND REGULATORY FRAMEWORK OF THE PHILIPPINE ELECTRIC POWER INDUSTRY........................................................................................................... 44 4 THE POLICY FRAMEWORK OF THE PHILIPPINE ELECTRIC POWER INDUSTRY ...... 45 5 ASSESSMENT OF RESULTS OF EPIRA REFORMS.................................................................. 50 5.1 TOTAL ELECTRIFICATION ............................................................................................................... 50 i

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Philippine Electric Power Industry Market and Policy Assessment Final and Analysis of International Markets Report
5.2 QUALITY, RELIABILITY AND SECURITY OF ELECTRICITY SUPPLY .............................................. 51 5.3 ENHANCED INFLOW OF PRIVATE CAPITAL, PRIVATE OWNERSHIP AND BROADENING OF THE OWNERSHIP BASE ...................................................................................................................................... 54 5.3.1 PRIVATIZATION OF NPC ASSETS AND IPP CONTRACTS ............................................................... 54 5.3.2 ENHANCED INFLOW OF PRIVATE CAPITAL.................................................................................... 55 5.3.3 BROADENING OF OWNERSHIP BASE.............................................................................................. 57 5.4 GREATER UTILIZATION OF INDIGENOUS AND NEW AND RENEWABLE ENERGY TO REDUCE DEPENDENCE ON IMPORTED ENERGY ...................................................................................................... 64 5.5 FAIR AND NON-DISCRIMINATORY TREATMENT OF PUBLIC AND PRIVATE SECTOR ENTITIES IN THE RESTRUCTURING PROCESS ............................................................................................................... 64 5.6 SOCIALLY AND ENVIRONMENTALLY RESPONSIBLE SOURCES OF ENERGY AND INFRASTRUCTURE 65 5.7 EFFICIENT USE OF ENERGY AND DEMAND SIDE MANAGEMENT .................................................. 66 5.8 AFFORDABLE, TRANSPARENT AND REASONABLE ELECTRICITY RATES ..................................... 67 5.9 CONSUMER PROTECTION AND COMPETITION THROUGH A STRONG AND INDEPENDENT REGULATOR................................................................................................................................................ 74 6 ASSESSMENT OF INDUSTRY REGULATION ........................................................................... 75 6.1 6.1.1 6.1.2 6.1.3 6.2 6.2.1 6.2.2 6.2.3 6.3 6.3.1 6.3.2 6.4 6.4.1 6.4.2 6.4.3 6.5 6.5.1 6.5.2 6.5.3 6.6 6.6.1 6.6.2 6.6.3 6.6.4 STRUCTURAL POLICY ...................................................................................................................... 76 VERTICAL SEPARATION OF TRANSMISSION FROM GENERATION AND DISTRIBUTION ................. 76 VERTICAL INTEGRATION OF GENERATION AND DISTRIBUTION ................................................... 76 HORIZONTAL SEPARATION OF GENERATION ................................................................................ 79 OWNERSHIP ..................................................................................................................................... 85 PRIVATIZATION OF NPC ASSETS AND IPP CONTRACTS ............................................................... 85 DEMOCRATIZATION ....................................................................................................................... 86 OWNERSHIP OF ELECTRIC COOPERATIVES ................................................................................... 87 LIBERALIZATION AND DEREGULATION ......................................................................................... 90 GENERATION AND ELECTRICITY MARKETS ................................................................................... 90 STRANDED COSTS .......................................................................................................................... 97 CONDUCT REGULATION ................................................................................................................ 100 RATE SETTING METHODOLOGY FOR TRANSMISSION AND PRIVATE DISTRIBUTION UTILITIES . 100 NEW RATE SETTING METHODOLOGY FOR ELECTRIC COOPERATIVES ........................................ 102 REGULATION OF NON-PRICE CONDUCT: ERC COMPETITION RULES ......................................... 104 WHOLESALE ELECTRICITY SPOT MARKET.................................................................................. 106 OVERVIEW OF WESM ................................................................................................................. 106 PERFORMANCE HIGHLIGHTS ....................................................................................................... 109 ASSESSMENT OF WESM .............................................................................................................. 114 SECURITY OF SUPPLY .................................................................................................................... 120 CAPACITY PLANNING AND PROJECT COMMITMENT .................................................................... 121 PLANNING METHODOLOGY AND CRITERIA ................................................................................. 123 PROVISION OF OPERATING RESERVE .......................................................................................... 125 REPLACEMENT POWER FOR MAINTENANCE OUTAGE ................................................................ 126

7 ASSESSMENT OF INSTITUTIONAL GOVERNANCE FRAMEWORK ................................ 128 7.1 7.2 7.2.1 7.2.2 OVERVIEW OF INSTITUTIONAL GOVERNANCE ............................................................................ 128 APPRAISAL OF INSTITUTIONAL GOVERNANCE ............................................................................ 129 CLARITY OF ROLES AND OBJECTIVES .......................................................................................... 129 AUTONOMY .................................................................................................................................. 131 ii

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7.2.3 7.2.4 7.2.5 7.2.6 PARTICIPATION............................................................................................................................ 131 ACCOUNTABILITY......................................................................................................................... 132 TRANSPARENCY ........................................................................................................................... 132 PREDICTABILITY .......................................................................................................................... 133

III ANALYSIS OF INTERNATIONAL MARKETS........................................................................ 134 8 PURPOSE OF ANALYSIS OF COMPARABLE INTERNATIONAL MARKET .................... 135 9 CHILES ELECTRIC POWER INDUSTRY ................................................................................. 136 9.1 9.2 9.2.1 9.2.2 9.2.3 9.2.4 9.2.5 9.3 OVERVIEW OF ELECTRIC POWER INDUSTRY OF CHILE .............................................................. 136 INDUSTRY RESTRUCTURING AND POLICY REFORMS .................................................................. 140 KEY ISSUES PRIOR TO REFORM ................................................................................................... 140 INSTITUTIONAL BACKGROUND , KEY OBJECTIVES AND ELEMENTS OF THE REFORM ................ 141 POLICY AND REGULATION OF GENERATION ................................................................................ 142 POLICY AND REGULATION OF TRANSMISSION ............................................................................. 149 POLICY AND REGULATION OF DISTRIBUTION.............................................................................. 151 CHILES POST REFORM INSTITUTIONAL GOVERNANCE FRAMEWORK ...................................... 153

10 BRAZILS ELECTRIC POWER INDUSTRY ............................................................................ 155 10.1 10.2 10.2.1 10.2.2 10.2.3 10.2.4 10.3 OVERVIEW OF THE ELECTRIC POWER INDUSTRY OF BRAZIL.................................................. 155 INDUSTRY RESTRUCTURING AND POLICY REFORM ................................................................. 157 POLICY AND REGULATION OF GENERATION ............................................................................. 161 POLICY AND REGULATION OF TRANSMISSION .......................................................................... 166 POLICY AND REGULATION OF DISTRIBUTION ........................................................................... 169 POLICY AND REGULATION FOR RENEWABLE ENERGY .............................................................. 170 BRAZILS POST REFORM INSTITUTIONAL GOVERNANCE FRAMEWORK ................................. 171

11 KEY POINTS AND LESSONS LEARNED FROM INTERNATIONAL EXPERIENCE ...... 174 12 COMPARATIVE MARKET ANALYSIS: CHILE, BRAZIL AND PHILIPPINES ............... 177 IV PROPOSED REFORMS FOR PHILIPPINE POWER INDUSTRY ....................................... 183 13 POLICY AND REGULATORY REFORMS ............................................................................... 184 13.1 13.1.1 13.1.2 13.1.3 13.1.4 13.2 13.2.1 13.2.2 13.2.3 13.2.4 13.2.5 IMMEDIATE REFORMS ................................................................................................................ 184 COMPETITIVE BIDDING OF FORWARD POWER CONTRACTS....................................................... 184 DEFERMENT OF RETAIL COMPETITION .................................................................................... 184 RESTRUCTURING OF THE OWNERSHIP OF ELECTRIC COOPERATIVES ...................................... 185 LIMITING ERCS ADJUSTMENT TO INSTALLED GENERATING CAPACITY ................................... 185 MEDIUM TERM REFORMS .......................................................................................................... 185 PROPER IMPLEMENTATION OF THE PBR RATE-SETTING METHODOLOGY ............................. 185 AMENDMENT OF THE HORIZONTAL SEPARATION POLICY ON GENERATION ........................... 185 INTERCONNECTION OF LUZON, VISAYAS AND MINDANAO ....................................................... 186 STRENGTHENING OF THE WESM ............................................................................................. 186 VERTICAL SEPARATION OF GENERATION AND DISTRIBUTION SECTORS ................................. 186

14 INSTITUTIONAL GOVERNANCE REFORMS ....................................................................... 187 University of the Philippines National Engineering Center iii

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14.1 DOES ASSERTION OF ITS AUTHORITY UNDER EPIRA ........................................................... 187 14.2 STRENGTHENING OF ADMINISTRATIVE CAPACITY OF ERC THROUGH FINANCIAL AUTONOMY AND MAINTAINING A BALANCE OF EXPERTISE ...................................................................................... 187 14.3 FLEXIBILITY IN THE REGULATORY PROCESSES ........................................................................ 188

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List of Tables
Table No. Title Page No.

Table 1. Annual Peak Demand and Growth Rate of Luzon Grid, 2000-2010 ................................ 17 Table 2. Forecasted Annual Peak Demand (in MW) of Luzon Grid, 2011-2030 .......................... 22 Table 3. Plant Cost Parameters for the Screening Curve ....................................................................... 25 Table 4. Load Category of Luzon Grid, 2010............................................................................................... 25 Table 5. Generation Capacity in Luzon Grid According to Plant-Type and Regional Location (in MW) ...................................................................................................................................................................... 26 Table 6. Percentage Dependable Capacity by Plant-Type and Regional Location ...................... 27 Table 7. Capacity of Proposed Power Plants for 2010-2017 Published by DOE ......................... 28 Table 8. Proposed Power Plants for 2010-2017 ....................................................................................... 28 Table 9. Private Ownership of Power Plants and Control of IPPA Contracted Capacities ...... 30 Table 10. Reliability Performance of Luzon Grid, 2000-2010 ........................................................... 35 Table 11. Regional Perspective of Power Supply-Demand Balance of Luzon Grid, 2011....... 35 Table 12. Generation Capacity Expansion Without Malaya and Limay Power Plants (Forecast Demand under Moderate Economic Growth Scenario) .................................................... 38 Table 13. Generation Capacity Expansion Without Malaya and Limay Power Plants (Forecast Demand under Low Economic Growth Scenario) ............................................................... 39 Table 14. Generation Capacity Expansion Without Malaya and Limay Power Plants (Forecast Demand under High Economic Growth Scenario) .............................................................. 40 Table 15. Generation Capacity Expansion With Malaya and Limay Power Plants (Forecast Demand under Moderate Economic Growth Scenario) ......................................................................... 41 Table 16. Generation Capacity Expansion With Malaya and Limay Power Plants (Forecast Demand under Low Economic Growth Scenario) .................................................................................... 41 Table 17. Generation Capacity Expansion With Malaya and Limay Power Plants (Forecast Demand under High Economic Growth Scenario) ................................................................................... 42 Table 18. Generation Capcity Expansion for Hindsight Scenario ..................................................... 43 Table 19. EPIRA Policy and Regulatory Framework ............................................................................... 46 Table 20. Addition to Installed Generating Capacity after 2001 ........................................................ 56 Table 21. Committed Generation Investments as of June 2010 ......................................................... 57 Table 22. Ownership Distribution of Private Generating Plants ........................................................ 59 Table 23. CO2 Emission of Selected Philippine Power Plants (in kTons) ...................................... 66 Table 24. MERALCO Comparative Charges1, 20032-20103 (Pesos) .................................................. 71 Table 25. Brazil Average Electricity Prices, 2010..................................................................................... 73 Table 26. Installed Generating Capacities of the San Miguel Group in the Luzon Grid ............ 84 Table 27. Installed Generating Capacities of Lopez and Aboitiz Groups in Luzon Grid ........... 84 Table 28. Investments for New Generation Projects in Chile ........................................................... 148 Table 29. Installed Generating Capacity in Brazil (2001-2010)...................................................... 155 Table 30. Average Price of Electricity in Brazil (2010) ....................................................................... 157 Table 31. Comparative Analysis of Chile, Brazil and Philppine Power Markets ....................... 177

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Philippine Electric Power Industry Market and Policy Assessment Final and Analysis of International Markets Report

List of Figures
Figure No. Title Page No.

Figure 1. Luzon Grid Energy Sales (MWh) and Consumption by Sector, 2009 ............................ 18 Figure 2. Luzon Grid Energy Sales by Region, 2009 ................................................................................ 19 Figure 3. Luzon Grid Peak Demand, GRDP, Population and Electricity Price (2000-2010) ... 20 Figure 4. Typical One-Day (Hourly) Demand of Luzon Grid ................................................................ 23 Figure 5. Daily Peak Demand (365 days) of Luzon Grid, 2009 ........................................................... 24 Figure 6. Load Duration and Plant Type Screening Curve .................................................................... 24 Figure Figure 7. Variations in Hydro Power generation ....................................................................... 32 Figure 8. Loss of Load Expectation vs. Capacity Reserve of Luzon Grid, 2000-2010 ................ 33 Figure 10. Reliability Performance of Luzon Grid, 2000-2010........................................................... 34 Figure 10. Reliability Performance of Luzon Grid With and Without Expansion ....................... 38 Figure 11. National Gross Power Generation By Resource, 2001 and 2009 ................................. 53 Figure 12. Gross Power Generation By Grid and Resource, 2001 and 2009................................. 53 Figure 13. Weighted Average Price of Malampaya Gas (2002-2009, Quarters).......................... 54 Figure 14. Control of Installed Generating Capacity as of March 2011 , ........................................ 63 Figure 15. Annual Average Effective Rates Rates (2000-2009) ......................................................... 68 Figure 16. NPC Annual Average Effective Rates (2003-2010) ............................................................ 69 Figure 17. MERALCO Average Monthly Generation Cost (2008-2010) .......................................... 72 Figure 18. Chile: Typical Residential Energy Price .................................................................................. 73 Figure 19. Chile: Typical Industrial Regulated Price ............................................................................... 73 Figure 20. Control of 2010 Installed Generating Capacity, Luzon ..................................................... 85 Figure 21. WESM Governance Structure ................................................................................................... 108 Figure 22. Market Transactions (2009,2010)......................................................................................... 110 Figure 24. Pricing Errors ................................................................................................................................. 111 Figure 24. Price Substitution ......................................................................................................................... 111 Figure 25. Supply and Demand Profile (26 June 2009 to 25 June 2010) .................................... 112 Figure 26. Monthly Outage Rate By Resource (July 2009-June 2010).......................................... 112 Figure 27. Price Distribution (June 2009 to June 2010) ..................................................................... 113 Figure 28. Market Price Trend (June 2009 to June 2010) ................................................................. 113 Figure 29. HHI Based on Actual Generation Net of Bilateral ............................................................ 114 Figure 30. Combined Pivotal Supplier-Price Setter Index ................................................................. 114 Figure 31. Generation Capacity Plan of DOE PDP.................................................................................. 124 Figure 32. Governance Structure of the Philippine Electric Power Industry ............................ 128 Figure 33. Energy Production in the Chilean National Grids ............................................................ 138 Figure 34. Generation Profile Per Technology in Chile ....................................................................... 139 Figure 35. Chilean Electricity Market Structure .................................................................................... 140 Figure 36. Percentage Change in Distribution Tariffs From VAD ................................................... 153

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Philippine Electric Power Industry Market and Policy Assessment Final and Analysis of International Markets Report

List of Boxes
Box No. Title Page No.

Box No. 1- Forecasting Model for Luzon Grid Peak Demand ............................................................... 20 Box No. 2 - Excerpt, ERC Resolution No. 21 Series of 2005 ............................................................... 93 Box No. 3 - New Rate Setting Methodology for Electric Cooperatives......................................... 103 Box No. 4 - Excerpt from ERC Competition Rules ................................................................................ 105

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EXECUTIVE SUMMARY1
Objectives of the Study The paucity of new generation investments despite the EPIRA has led to supply shortages that conjure unpleasant images of the electricity crisis of the late 1980s to the early 1990s and increasing calls to amend the law. A number of proposals are now being considered in and out of Congress from minor adjustments to drastic overhaul of the law. This study is intended to contribute to the debate by offering well-considered proposals for policy and regulatory reforms to incent generation investments. It is anchored on the premise that an in-depth analysis of the current state of the industry and its operating and policy environments are crucial in the design of effective policy and regulatory responses that could avoid the crisis and the costly IPP route in the 1990s. Objectives of the Study The study has several parts. Part I is a market and supply study of the Luzon Grid. Part II analyzes the policy framework of the Philippine electric power industry, Part III analyzes the power industry in Brazil and Chile which were chosen as comparators due to their size and reforms initial goals. It also includes a set of proposals for policy and regulatory reforms that were gleaned from the preceding policy analysis. The last part summarizes the reform proposals for the Philippine Electric Power Industry. The market analysis of the Luzon Grid aims to establish the opportunities and threats to new investments in generation capacities. This was achieved by analyzing the demand and supply sectors, the supply-demand balance situation today and in the future as well as the network infrastructure for the transmission of electricity in Luzon Grid.
1

This study was prepared by the Energy Advisors of University of the Philippines National Engineering Center with funding support from AES. The findings, opinions, conclusions and recommendations are of the authors and not necessarily of the sponsor and UPNEC.

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Philippine Electric Power Industry Market and Policy Assessment Final and Analysis of International Markets Report Part II starts with a brief review of the achievements of the industry vis--vis the EPIRAs declared policy objectives. This is followed by an analysis of its policy framework as laid down by the EPIRA and the review of the policies of Brazil and Chile. The analysis is approached from the perspective of policy and regulatory incentive structure. It seeks to determine whether a robust incentive structure is provided in the EPIRA, i.e., one that attract sufficient private investment in generation while achieving its economic efficiency objectives. Economic efficiency refers to allocate, productive and dynamic

efficiency. The strength of the policy and regulatory incentive structure rests on the design of the structural policy; liberalization; ownership; conduct regulation; and, the sequencing of policy reform. In network industries that are naturally monopolistic such as electricity distribution and transmission, the rules that make up the regulatory incentive structure act as proxies to the disciplines imposed by a fully competitive market. An analysis of international markets was undertaken to enrich the study by providing a model for the design of policy reform under reasonably comparable circumstances. Aside from having the longest running and most comprehensive electricity reform after WWII, Chiles reforms which started in 1982 are widely acknowledged to be highly successful and a model for developing countries around the world. Chile has been in the forefront of innovation in the creation of electricity markets. Brazil on the other hand has the largest electricity market in South America. These two countries have the highest access rates in Latin America. While Chiles electricity system shows that effective competition and privatization is possible in a relatively small market, Brazils illustrate that it is possible in a large developing market. Their combined experiences and lessons learned are highly instructive for developing countries like the Philippines that are still grappling with electricity reforms. A brief review of the state of industrys institutional governance is made based on the results of the policy assessment. Corresponding recommendation to address the gaps in this area are included in the report.
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Philippine Electric Power Industry Market and Policy Assessment Final and Analysis of International Markets Report To facilitate the timely completion of the study, the impact analysis for policies and regulations that require historical data was limited to the Luzon grid. The grid accounts for 74% of the installed generating capacity nationwide and 72% of its total demand. The current state of generation in the grid is thus a fair indicator of the strengths and weaknesses of the current policy framework and of the appropriateness of future policy interventions.

Findings
The salient findings of the assessment of the policy framework and institutional markets are : 1) The objectives of the EPIRA, as listed in its Declaration of Policy have not been achieved; 2) Critical disincentives to generation investments are embedded in inappropriate policy designs and gaps in the current policy framework coupled with weaknesses and errors in their implementation ; 3) The sequencing of policy reform in Chile and Brazil prioritized generation adequacy over market liberalization . In the interim, pro-competitive regulatory mechanisms primarily, the public auction of long-term power contracts were put in place to

capture the efficiencies of free market competition; and, 4) Weak institutional governance in the Philippine electric power industry arising from DOEs inadequate engagement and ERCs limited administrative capacity.

Recommendation for Reforms The reform proposals are intended to remedy the weakness of the incentive structure of the policy, regulatory and governance framework and address the gaps in the implementation by the regulator of policies that are set-out in the EPIRA. Except for the amendment to the horizontal policy on generation and on the guarantee authority of NEA; these proposals will only require executive and regulatory actions to implement.
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Philippine Electric Power Industry Market and Policy Assessment Final and Analysis of International Markets Report The policy and regulatory reform proposals are categorized into immediate (within 6 months) and medium term (from 6 months to 2 years) depending on their urgency and expected time requirement to implement.
Policy and Regulatory Reforms a) Immediate Reforms 1 Competitive bidding of forward power contracts All distribution utilities (PDUs, ECs) should contract for 100% of their energy and capacity requirements through a competitive public bidding. The utilities (with the prior endorsement of the ERC and DOE) shall hold yearly public auctions for contracts with a maximum term of 15 years. Purchases from the spot market shall be limited to 5% of the DUs and generators contractual imbalances and shall be subject to the payment of penalties to be determined by the ERC. Standard contract templates to be drawn up by ERC and DOE, generators and DUs. Contract quantities shall have priority over spot ones in case of planned brownouts due to supply shortages (no supply guaranty for uncontracted energy in case of rationing). A sample contract from the Brazil auction is attached.

Deferment of Retail Competition Retail competition must be deferred until such time that the vital requirements laid down in ERC Resolution No. 03, Series of 2007 is achieved: a) Adequacy of generation, transmission networks , and customer switching systems; and b) Promulgation by the ERC of all pertinent rules and regulations governing retail competition and open access. ERC shall determine the timetable with duties and responsible parties in charge of executing the pending requirements to materialize RC&OA. Certainty shall be given to the industry in order to allow proper planning.

Restructuring of the Ownership of Electric Cooperatives 11

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ECs may be restructured and consolidated to a small group of equity investors to strengthen the incentives for productive efficiency. In the interim, the energy requirements of the ECs should be aggregated by grid and tendered in the auction as one. Section 30 of the EPIRA shall be amended by Congress to allow NEA to act as guarantor for the bilateral contract obligations of the ECs, instead of their WESM purchases.

Limiting ERCs adjustment to installed generating capacity Adjustment to generating capacity must be limited to permanent derating to avoid the possible circumvention of the grid limits from the declaration of temporary reductions in capacity.

b) Medium Term Reforms 1 Proper Implementation of the PBR Rate-Setting Methodology Proper implementation of the PBR rate-setting methodology for transmission and private distribution utilities and of the RSEC-WR and proposed PBR for Electric Cooperatives to improve the utilities efficiency and moderate the increases in electricity rates.

Amendment of the Horizontal Separation Policy on Generation Legislative Amendment of the horizontal separation policy on generation such that the grid limit is based solely on control of the installed generating capacity. In this regard, installed generating capacity shall cover IPP capacities whose control were ceded by the NPC/PSALM to the administrators in the IPPA Agreements.

Interconnection of Luzon, Visayas and Mindanao The Luzon, Visayas and Mindanao grids must be interconnected to mitigate the adverse effect on energy security of each grids high reliance on a single fuel/energy resource.

Strengthening of the WESM

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Philippine Electric Power Industry Market and Policy Assessment Final and Analysis of International Markets Report
The wholesale spot market must be strengthened to incent new generation investments by: a) Reviewing the system operation and network reliability protocols to make them consistent with consumer valuation; b) Demand metering to allow consumers to react to changes in the supply and demand balance; c) Raising the price cap and sticking to it; d) Creation of operating reserve, financial hedging, capacity markets and market for transmission rights to mitigate market risks and solve the missing money problem.

Vertical Separation of Generation and Distribution Sectors The generation and distribution sectors must be vertically separated (i.e., remove crossownership) to create robust competition in generation.

Institutional Governance Reforms The weakness of the institutional governance framework has its roots on: (1) the institutional paralysis of the DOE; (2) weak administrative capacity of the ERC; and (3) a litigious regulatory process that does not welcome broad participation and consultations and precludes an effective appeal mechanism to redress grievances.

DOEs Assertion of its Authority under EPIRA The DOE must step up into the plate; assert is authority and deliver on its responsibilities under the law.

Strengthening of Administrative Capacity of ERC through Financial Autonomy and Maintaining a Balance of Expertise Strengthening the administrative capacity of ERC will require first, financial autonomy either through an automatic appropriation of its budget or by allowing the agency to

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Philippine Electric Power Industry Market and Policy Assessment Final and Analysis of International Markets Report
keep and spend its collections instead of these being remitted to the National Treasury; and second, maintaining a balance of expertise in the Commission, i.e., finance rather than accounting (financial policy and strategy is more critical than accounting the Commission level ); power engineers (not just any engineer); regulatory economists (or in their absence, micro rather than macro economists); and lawyers. The present composition of the Commission and its top executive management which is dominated by lawyers should be restructured to achieve a more balanced composition of these disciplines. Regulation of infrastructure industries such as the electric power industry is more about economics rather than law and involves the consideration of the economic, financial, and technical impact of regulatory decisions rather than on the establishment and conformity with legal precedents that may be irrelevant to the case on hand. The current set-up where the Commissioners are appointed by the President need not be changed. However, the names and the curriculum vitae of candidates should be made public, e.g., in the newspapers, in the Malacanang and ERC websites so that a public vetting process takes place before their appointment by the President.

Flexibility in the Regulatory Processes Short of abrogating the quasi-judicial character of the ERC (that will require legislative amendment); what is required is flexibility in the regulators processes that will: (1) invite broad debate of and meaningful participation by all stakeholders; (2) deepen the scope of the debate to relevant economic, technical and social issues instead of confining them to legal procedures and precedents; and (3) provide for an effective appeal mechanism. On the latter, the ERC could hire more arbitrators and conciliators akin to those at the National Labor Relations and Conciliation (NLRCC) Board and the Construction Board rather than requiring all cases to be heard by the Commission and immediately appealed to the Courts. In addition, a single panel of experts, with a permanent chair and varying members depending on the issue on hand could be formed to resolve disputes between the regulator and market agents and among market agents. The dispute settlement mechanism of WESM, GMC and DMC could be constituted as sub-groups reporting to this Experts Panel when the issues arise from or are within their jurisdictions.

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Philippine Electric Power Industry Market and Policy Assessment Final and Analysis of International Markets Report

SUPPLY AND DEMAND ANALYSIS OF LUZON GRID

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Philippine Electric Power Industry Market and Policy Assessment Final and Analysis of International Markets Report

1 THE DEMAND SECTOR 1.1 SYSTEM DEMAND OF LUZON GRID

1.1.1 HISTORICAL DEMAND OF LUZON GRID (MW


The Annual Peak Demand of the Luzon grid grew at an average annual rate of 3.44%. from 2000-2010 as shown in Table 1. While the first five years (2001-2005) and the second five years (2006-2010) grew at almost the same pace at 3.40% and 3.47%, respectively , the last five years showed an increasing trend at 0.36% in 2006 to 8.63% in 2010.
Table 1. Annual Peak Demand and Growth Rate of Luzon Grid, 2000-2010

YEAR 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Annual GWh 34,679 38,184 38,387 37,535 39,854 40,627 41,241 43,620 44,200 44,975 48,845

Consumption Growth Rate 10.11% 0.53% -2.22% 6.18% 1.94% 1.51% 5.77% 1.33% 1.75% 8.60%

Peak MW 5,450 5,646 5,823 6,149 6,323 6,443 6,466 6,643 6,674 7,036 7,643

Demand Growth Rate 3.60% 3.13% 5.60% 2.83% 1.90% 0.36% 2.74% 0.47% 5.42% 8.63% -

3.22%

3.40%

3.00%

3.47%

Source: 2000-2009 (DOE), 2010 (WESM RTX)

1.1.2 ELECTRICITY SALES AND CONSUMPTION IN LUZON (2009)


The total energy sales and consumption (including own use and system loss) in Luzon account for 74% of the total Philippines. Visayas and Mindanao has each 13% of the total energy consumption2.

DOE, 2009 Power Statistics

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In Luzon, MERALCO (the single largest distribution utility) accounts for 71% of the total energy consumption . Its market share (i.e., sales to customers) in 2009 is 61% as shown in Figure 1. The On-Grid Electric Cooperatives accounts for 11% and another 1% in isolated lated islands which are served by NPC-SPUG. The Private DUs sales is only 3% while the combined sales to Directly Connected Customers and Economic Zones is 7%.

Figure 1. Luzon Grid Energy Sales (MWh) and Consumption by Sector, 2009

Figure 2 shows the regional sales of electricity in 2009 to customers of Distribution Utilities (ECs and PDUs) and to Economic Zones and Directly Connected Customers. Fidty seven percent (57%) of the total energy sales was delivered to the National Capital Region (NCR). It must noted that MERALCOs mega-franchise includes part of Region IV-A (south of NCR) and part of Region III (north of NCR). Hence, the diffirence between 61% of MERALCO share in the energy sales and the 57% of energy delivered to NCR accounts for the consumption of the customers in Region III and Region IV-A.

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Figure 2. Luzon Grid Energy Sales by Region, 2009

1.1.3 DEMAND DRIVERS OF THE LUZON GRID


The grids peak demand from 2000 to 2010 is plotted with the gross regional domestic product (GRDP), population and average price of electricity to end-users in Figure 3.3 Population and GRDP are strongly correlated with demand at 0.9686 and 0.9582 correlation coefficients, respectively. Demand has low correlation with end-users price (0.7687 correlation coefficient ) which indicates the inelasticity of demand at the regressed price levels. The regression analysis of demand with both population and GRDP as drivers did not pass the significance of variable tests (t-stat and p-value) indicating auto-correlation. Thus, the peak demand of Luzon can be forecasted either by population or GRDP but not by both population and GRDP in the same regression equation. The sensitivity of the annual peak demand of Luzon Grid to the maximum daily temperature of Manila was also analyzed for the months of April to June from 2000 to 2010. The analysis showed that the peak demand during summer season has little correlation with maximum temperature for the same season. The variations of Manilas temperature
3

The Gross Regional Domestic Product and population of Luzon were obtained by taking the sum total of the GRDP (population) of NCR, CAR, Region I, Region II, Region III, Region IV-A, and Region V. The GRDP and population of Region 4B (MIMAROPA) were excluded because the provinces and islands in this sub-region are not connected to the Luzon Grid.

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throughout the year is not significant in so far as daily peaks are concerned. The temperature factor is only significant with respect to the hourly load variations.

Figure 3. Luzon Grid Peak Demand, GRDP, Population and Electricity Price (2000-2010)

1.1.4 LUZON GRID DEMAND FORECAST (2011-2030)


Several regression models were formulated to establish the best forecasting model for the Grids annual peak demand. The model selected for this study is shown in Box No. 1 which is a simple regression equation with GRDP as variable. The model exibited the highest value of Adjusted R squared (adj. R^2). It is likewise suitable to forecasting a range of possible economic growth scenarios. This model passed the t-stat criterion ( less than -2 or greater than 2) and pvalue (less than 0.1) for the GRDP regressor. The Mean Absolute Percentage Error (MAPE) of the model is 2.37% which is lower than the maximum 3% criterion.

Box No. 1- Forecasting Model for Luzon Grid Peak Demand Forecast Model: L = a + b(GRDP) b 4.83671E-06 adj. R^2 0.895985045 MAPE p-value 2.37% 8.861490813 2.07664E-05

a R^2 0.907542262 University of the2663.389855 National Engineering Centert-stat Philippines

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The annual growth rate of the GRDP of Luzon for the period 2000-2010 is 4.88%. The Philippine GDP growth rate in 2009 was about 1% and in 2010, a hefty 7.3%. Both are aberrations. The economy was hit hard by the financial crisis in its export markets in 2009 while heavy election spending in 2010 boosted the economy. With the gradual recovery of the countrys main trading partners and the added confidence in the country brought about by a change in administration, the anemic 1% growth is not expected to recur. Thus, the 2010 GRDP was set aside in the formulation of the forecasting model. The continued vulnerability of the economy to external shocks and internal structural problems indicate a prudent approach in estimating future demand. As such, demand is forecasted under the low, moderate and high economic growth At 3%, 5%, and 7%, respectively. The demand forecast for 2011 to 2030 in each of these scenarios is shown in Table 2.

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Table 2. Forecasted Annual Peak Demand (in MW) of Luzon Grid, 2011-2030 Low Economic Growth MW 7,487 7,632 7,781 7,935 8,093 8,256 8,424 8,596 8,774 8,958 9,147 9,341 9,541 9,748 9,960 10,179 10,405 10,637 10,876 11,122 MWh* 46,742,269 47,645,730 48,576,295 49,534,776 50,522,013 51,538,866 52,586,225 53,665,005 54,776,148 55,920,626 57,099,437 58,313,613 59,564,215 60,852,334 62,179,097 63,545,663 64,953,226 66,403,016 67,896,300 69,434,382 Moderate Economic Growth MW 7,581 7,827 8,085 8,356 8,641 8,940 9,254 9,583 9,929 10,292 10,674 11,074 11,495 11,936 12,400 12,887 13,398 13,935 14,498 15,090 MWh* 47,327,033 48,862,040 50,473,797 52,166,142 53,943,104 55,808,914 57,768,015 59,825,070 61,984,979 64,252,883 66,634,182 69,134,546 71,759,929 74,516,580 77,411,064 80,450,272 83,641,441 86,992,168 90,510,431 94,204,608 High Economic Growth MW 7,675 8,026 8,401 8,803 9,232 9,692 10,184 10,711 11,274 11,877 12,522 13,212 13,950 14,740 15,585 16,490 17,458 18,493 19,602 20,787 MWh* 47,911,797 50,101,740 52,444,979 54,952,245 57,635,019 60,505,587 63,577,095 66,863,609 70,380,179 74,142,908 78,169,029 82,476,978 87,086,484 92,018,655 97,296,077 102,942,920 108,985,041 115,450,111 122,367,736 129,769,595

YEAR 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030

* Estimate based on 2009 Load Factor of Luzon Grid (71.26%)

1.2

LOAD CHARACTERISTICS OF THE LUZON GRID

The load characteristic of the grid is also a factor in establishing the most economic mix of capacity type and energy production of power generation plants. This study used the 2009 Hourly demand of the Luzon Grid obtained from WESM to analyze its load characteristics . The analysis revealed a 71.26% load factor in 2009. The typical one-day (hourly) demand is illustrated in Figure 4. The Grid has three peaks occurring on a typical day: at 11:00AM (morning peak), 2:00PM (afternoon peak), and 7:00PM

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(evening peak). The off-peak demand on a typical day occurs at 4:00AM. From a binomial timeof-use (TOU) demand point of view, the Grids off-peak period is 10:00PM-9:00AM while the peak period is between 10:00AM and 9:00PM.

Figure 4. Typical One-Day (Hourly) Demand of Luzon Grid

Figure 5 shows the daily peak loads (MW) of the Grid in 2009 . The high peaks occur on weekdays starting in April and is sustained until September. In terms of economic dispatch-merit load category, 71.69% of Luzon Grids demand is base, 19.08% Intermediate, and 9.23% peaking. The corresponding energy for the load categories are 92.41%, 7.40%, and 0.19%, respectively. These values were obtained from
Figure 6 based on the load duration curve (i.e., the 8760 hourly demand in 2009 arranged in descending order) and plant-type screening curve. The screening curve was established by plotting the levelized annual generation cost per MW of base load plant (represented by coal thermal power plant), intermediate plant (natural gas combined cycle gas turbine plant) and peaking (diesel) power plant using the plant cost parameters shown in

Table 3.

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Figure 5. Daily Peak Demand (365 days) of Luzon Grid, 2009

SCREENING CURVE (Levelized Busbar Cost, PHP/MW/YR)


90,000,000 80,000,000 70,000,000 60,000,000 50,000,000 40,000,000 30,000,000 20,000,000 10,000,000 0 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
CAPACITY FACTOR

PHP/MW/YR

Figure 6. Load Duration and Plant Type Screening Curve

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Table 3. Plant Cost Parameters for the Screening Curve


PARAMETER Capacity (MW) Plant Cost (US$/KW) Fixed O&M (US$/KW-YR) Var O&M (US$/KWH) Fuel Cost (US$/MMBTU) Heat Rate (BTU/KWH) Fuel Escalation Rate (% p.a.) Levelizing Period (YRS) WACC (% p.a.) Discount Rate (% p.a.) FOREX (PHP/US$) COAL 300 $1,800.00 $63.00 $0.00500 $5.35 9,800 1.00% 30 CCGT 250 $900.00 $31.50 $0.00300 $10.81 7,800 2.06% 30 15% 12.00% P45.00 DIESEL 100 $650.00 $22.75 $0.01000 $13.28 8,500 6.00% 30

The demand in MW, energy in MWh and load factor for the different load categories for the Luzon Grid in 2010 is shown in Table 4. The base load is 5,480 MW ; intermediate at 1,458 and peaking at 705 MW. The combined energy of the intermediate and peaking loads represent only 7.5% of the total energy. The intermediate load of Luzon Grid can be categorized as peaking load. The slope of the levelized generation cost of CCGT which was used to represent the intermediate plant in the screening curve is high due to its fuel price (US$ per MMBTU) which is about twice the fuel price of coal for base load plant.4 This implies that the dispatch of power plants in the Grid is not achieving the optimal mix because the CCGT plants in Batangas contracted by NPC and MERALCO are base loaded (~80% minimum energy off-take) that translate to about 20% instead of only 7.5% of the total mix.5

Table 4. Load Category of Luzon Grid, 2010 LOAD CATEGORY Base Intermediate Peaking TOTAL
4

DEMAND (MW) 5479.633 1458.022 705.346 7643.000

ENERGY (MWH) 44,091,582 3,531,378 90,443 47,713,402

Load Factor (%) 91.85% 27.65% 1.46% 71.26%

The fuel price for CCGT was taken from the estimate of the 2010 price of Natural Gas from Malampaya which is indexed with international fuel oil. 5 Based on the Power Purchase Agreements of NPC with KEPCO and MERALCO with First Gas that was approved by ERB/ERC

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2 THE SUPPLY SECTOR


2.1 POWER PLANTS IN LUZON GRID

2.1.1 INSTALLED AND DEPENDABLE CAPACITY OF POWER PLANTS


The installed and dependable power generation capacity (in MW) of Power Plants and

Generating Units in the Luzon Grid are summarized according to plant type (fuel and dispatchmerit) in Table 5. The list includes the currently mothballed 70 MW Hopewell gas turbine plant with 30 MW dependable capacity and the 242 MW East Asia/Duracom diesel power plant with dependable capacity of 200 MW. Not included in the list is the 600 MW Sucat oil-fired thermal power plant which was retired for economic and environmental reasons. The Sucat plant, however, could be revived in the short-term (i.e., 2-3 years).
Table 5. Generation Capacity in Luzon Grid According to Plant-Type and Regional Location (in MW)
Region Plant Type Hydro Base Coal Geothermal Wind+Bio Intermediate NG CCGT Oil Thermal/CCGT Peaking Total Diesel GT 242 70 321 200 30 230.93 4654 4124 6408 5376 620 491 600 341 0 0 8.90 0.93 33 0 2831 2700 NCR
Installed MW
Dependable

North
MW Installed MW Dependable MW

South
Installed MW Dependable MW

Total Luzon
Installed MW Dependable MW

1505 2004

1225 1958

764 1875 939

754 1492 431

2269 3879 939 42 2831 620 734 70 11383

1979 3450 431 1 2700 600 541 30 9731

Notes: (1)Dependable Capacity of Wind Power is considered zero (2) Small Embedded Power Plants not included

Self-Generation facilities are owned and operated by industrial companies such as the 18 MW gas turbine of Pilipinas Shell Petroleum Corp. in Tabangao, Batangas and the 24 MW extraction steam turbine of Petron Corp. in Limay, Bataan. Several cement factories have diesel power plants such as the 20.4 MW of Solid Cement in Antipolo . The ERC granted Certificates of Compliance to thousands of self-generation facilities in a list that ran to 140 pages. However, the list contains stanby generating units of commercial and industrial companies which are

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technically and operationally speaking not self-generation as they are intended for reliability back-up during outages in the grid. Table 6 is a matrix of power generation capacity in the Luzon grid by type, location and share of dependable capacity. Fifty six percent (56%) of dependable capacity are baseload: hydro, geothermal and coal thermal plants. Natural gas combine cycle plants that are traditionally considered as intermediate (mid-merit) plants account for 26% of the dependable capacity. The share of the peaking plants in the capacity mix is 18%. It should be noted that this includes the Limay oil CCGT plants and Malaya oil fired thermal plants. These plants were inlcuded in the list of peaking plants due to the price of their fuel although they were originally designed as intermediate and base load plants.

Table 6. Percentage Dependable Capacity by Plant-Type and Regional Location Type \ Region Base Intermediate Peaking Total Total Luzon 60.22% 27.75% 12.03% 100.00%

NCR 0.01% 0.00% 2.36% 2.37%

North 32.71% 0.00% 9.67% 42.38%

South 27.50% 27.75% 0.00% 55.25%

In terms of location, the capacity in the National Capital Region (NCR) is almost nil (2%) and is essentially for peaking only. Forty percent (40%) and fifty eight percent (58%) are located in the North and South of Luzon, respectively.

2.1.2 PROPOSED POWER GENERATION PROJECTS


Commited Projects The following are committed power generation projects in Luzon:

a) Rehabilitation of 40.8 MW Bac-Man I-2 Geothermal Power Plant in 2012 by Lopez Group b) Rehabilitation of 33.55 MW Bac-Man II-1 Geothermal Power Plant in 2013 by Lopez Group

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Philippine Electric Power Industry Market and Policy Assessment Final and Analysis of International Markets Report Commissioning of of new 600 MW Mariveles Coal Thermal Power Plant in 2013 by GNPower Proposed Projects Published by DOE
The DOE published , through the PDPs, the proposals of the private sector to put up new capacity in Luzon. However, these are not really committed projects although in many instances the proponents informed the DOE that they are committed (hence the publication). The proposed projects that were scheduled for commissioning in 2010 to 2017 are summarized in Table 7 according to plant type.
Table 7. Capacity of Proposed Power Plants for 2010-2017 Published by DOE

c)

Plant Type Natural Gas Coal Geothermal Large Hydro Wind

Generating Capacity (MW) 550 1,775 150 530 415

Proposed Projects Published by NGCP


Some serious proposals but no commitment yet were also submitted to NGCP for Grid Impact Studies. The list of proposed projects are summarized in Table 8 according to commissioning year. These proposals were used by NGCP in its Transmission Development Plan (TDP) that was submittted to ERC for approval and inclusion in their PBR rate setting.
Table 8. Proposed Power Plants for 2010-2017

Commissioning Year 2011 2012 2013 2014 2015 2016 2017 2018

No. of Projects 1 10 11 6 3 2 1

Generating Capacity (MW) 105 1001 1557 173 500 675 300 28

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Source: NGCP

2.1.3 OWNERSHIP OF POWER PLANTS AND CONTROL OF IPPA CONTRACTED CAPACITY


The ownership and control distribution of the combined private installed generating and IPPA contracted capacities in Luzon Grid are shown inTable 9. There are three dominant players in Luzon Grid. These are San Miguel Group, the Lopez group and Aboitiz group that owns or controls 28.13%, 16.33.53% and 17.36%, respectively of the total installed/contracted capacity of power plants in Luzon. The market is highly concentrated as these three groups control more than 70% of the generating capacity in Luzon. The share of others including AES, DMCI and Quezon Power Phils. are less than 7% each.

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Table 9. Private Ownership of Power Plants and Control of IPPA Contracted Capacities
Owner A. Lopez Group 1 From Privatized NPC/PNOC Total from Privatized 2 IPP Plants Total IPP Plants 3 IPPA Contracted Capacity Total Lopez Group B. Aboitiz Group 1 From Privatized NPC/PNOC Plant Name Pantabangan-Masiway Bac-Man Sta Rita San Lorenzo Installed Capacity (MW) 112 150 262 1,047 549.1 1,596.10 0 1,858.10 360 330 410 75 100 1,275 0 700 1,975 655.5 0 1,000 1,200 345 2,545 3,201 635 600 511 30 9 18.9 25.6 52 33 4.5 0.96 448 1.8 2.5 8.19 1.11 635.56 100.75 100.75 9,516.41 1,863.00 11,379.41 %Share of Total Capacity

16.33%

Magat HEPP Tiwi GPP Mak-Ban GPP Ambuklao HEPP Binga HEPP

Total from Privatized 2 IPP Plants 3 IPPA Contracted Capacity Total Aboitiz Group C. SMC Group 1 From Privatized NPC/PNOC 2 IPP Plants 3 IPPA Contracted Capacity

Pagbilao CFPP

17.36%

Limay Combined Cycle Sual CFPP Ilijan CCGT San Roque MHPP

Total IPPA Total SMC Group D. AES E. DMCI F. Quezon Power Phil G. Other Owners Angeles Electric Corp

Masinloc Coal I & II Calaca Power Corp Quezon Power Angeles Power Inc Angeles Electric Corp Tarlac Power Corp First Cabanatuan Ventures Corp Trans-Asia Power Generation Corp Northwind Power Corporation INEC-Agua Grande Mini-HEPP Bicol Hydropower Corp Cawayan HEPP Barit HEPP Magat A & B Montalban Methane Power Corp Phil Power Development Corp MHHP

28.13% 5.58% 5.27% 4.49%

INEC SORECO Atty Ramon Constancio ISELCO

Total Other Owners H. Other IPPAs Amlan Power Holdings Total Other IPPAs TOTAL PRIVATE TOTAL NPC TOTAL LUZON

5.59%

Bakun-Benguet HPP

0.89% 83.63% 16.37% 100.00%

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Philippine Electric Power Industry Market and Policy Assessment Final and Analysis of International Markets Report 2.2 WHOLESALE ELECTRICITY SPOT MARKET

The following excerpts from the assessment report of market results for 2010 show how the Big three of the power industry influence the prices in WESM6: Sual CFTPP and Pagbilao CFTPP came out as the two plants with the most number of trading intervals wherein both were setting prices and providing the pivotal supply. There was a significant jump of this measure between 2009 and the first half of 2010. Sual CFTPP was simultaneously setting prices and providing pivotal supply for 7.7% of the time in 2009, and 12.5% of the time in 2010. Likewise, Pagbilao CFTPP was at the same position for 5.5% of the time in 2009, and 13.9% of the time in 2010. This goes to show how critical the market events were during the first half of 2010, especially when prices went up to unprecedented levels. The obvious implication is that the potential for market power exercise is higher for plants that are both price setter and pivotal supplier in a trading interval, especially if their exposure in the spot market is also significantly high. This is true if the concerned plants are aware of their advantageous situation and if they have the strategic resolve to exercise those market advantages. The natural gas plants KEPCO Ilijan and Sta. Rita FGPP were also observed to occupy the same advantaged situation although on a lesser extent since a significant portion of their output are contracted. Sual CFTPP is traded by San Miguel Energy Corp. (SMEC) as the Independent Power Producer Administrator (IPPA). The trading participant is fully contracted even if it parlays 48% of its bilateral obligations to the spot market. Pagbilao CFTPP is traded by Therma Luzon Inc. (TLI) with a generating capacity almost equally allocated between the spot market and bilateral contracts market. Even KEPCO Ilijan, traded by PSALM Team 1, has a spot market exposure of 38%. Sta. Rita, owned by First Gas Power Corporation is similarly situated.

The detailed assessment of WESM is inlcuded in Part 2 (Aanlysis of Policy Framework) of this Report.

From PEMC Report

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3 SUPPLY-DEMAND BALANCE
3.1 RELIABILITY PERFORMANCE OF THE GRID

3.1.1 RELIABILITY INDEX AND CRITERIA


The reliability performance of the generation system, i.,e., the ability of the generation capacity to meet the demand of the power grid was assessed using probability methods. The reliability index used to measure the performance of Luzon Grid is the loss-of-load expecation (LOLE)7 because it captures the probabilistic nature of forced outages and its consistency to measure risks that are associated with variations in capacity, type and number of generating units, the size of the grid, maintenance of power plants and variations of hydro power generation. Figure Figure 7 illustrates the variations in hydro power generation in 2009 that was used in the LOLE calculation. The LOLE is calculated by convolving (i.e., mathematically combining) the

cumulative probability of capacity outages with the demand. In this study, the LOLE of Luzon Grid was measured in expected number of days in a year (days/year) that there will be a loss of load. A loss of load will happen if the available generating capacity will not be sufficient to meet the demand because of the probability of simulataneous outages of generating units of the power plants.

Figure Figure 7. Variations in Hydro Power generation

The power industry has referred to the LOLE as LOLP (loss-of-load probability). Technically speaking, LOLE is not a probability value but an expected value of probabilistic variable.

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The load of the Luzon Grid was represented by its daily peak. Thus, the loss of load in days/year does not connote a total system blackout for that number of days in a year. It simply means that the peak load of some days has a chance of exceeding the remaining capacity after the simultaneous outages of several units. The criteria used in the assessment of reliability performance of Luzon Grid is one day per year (1 day/year) loss-of-load expectation.8 The use of deterministic approach is considered by power system relaibility experts as inconsistent measure.
9

Figure 8 shows the relationship of LOLE and the Reserve of the Grid. It can be deduced that with the current power plant composition (i.e., type, size and number of generating units) and the load variation curve (i.e., daily peak loads) of Luzon Grid, the necesary reserve that must be maintained is about 28.7% to meet the maximum one day per year loss-of-load-expectation. This is higher than the 20.6% operating reserve (spinning and standby) currently used

(apparently based on PDP published) by DOE.

Figure 8. Loss of Load Expectation vs. Capacity Reserve of Luzon Grid, 2000-2010

The 1 day/yr LOLE (or LOLP) was used by NPC as reliability criteria in its power development planning prior to EPIRA. Based on the PEP published by DOE, it appears that the criteria used now in planning are percentage reserve. 9 Billinton, et.al, Evaluation of Power System Reliability, IEEE Press,

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Philippine Electric Power Industry Market and Policy Assessment Final and Analysis of International Markets Report 3.1.2 HISTORICAL RELIABILITY PERFORMANCE OF LUZON GRID
The reliability performance i.e., LOLE, of the Luzon Grid from 2000 to 2010 is shown in Figure 9. The LOLE in 2000 and 2001 were more than 10 days per year but the commissioning of new power plants in 2002 reduced the LOLE to an acceptable level of not more than 1 day per year. It is noted however that since no power generation capacity were added after 2006, the growth in demand led to 4 days/yr LOLE in 2010. This means that in year 2010 the reliability criteria was violated that translated to rotating interruption since there was not enough operating reserve capacity to secure the Luzon Grid.

Figure 9. Reliability Performance of Luzon Grid, 2000-2010

3.1.3 RELIABILITY PERFORMANCE OUTLOOK


The outlook for year 2011 to 2014 as shown in Table 10 is not encouraging inspite of the addition in capacity of the 600 MW Mariveles coal thermal power plant in 2013. The simulation assumed that the Malaya Oil Thermal Plant is retired from service. This imply that the Malaya thermal plant should not be retired until new capacities are added in the system. University of the Philippines National Engineering Center 34

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Table 10. Reliability Performance of Luzon Grid, 2000-2010

Year 2011 2012 2013 2014

Capacity (MW 9583 9624 9657 9657

Demand (MW) 7581 7827 8085 8356

Reserve (%) 26.41% 22.96% 19.44% 15.57%

LOLE (Days/Yr) 5.07 12.08 5.27 82.27

3.2

REGIONAL PERSPECTIVE OF SUPPLY-DEMAND BALANCE

From the perspective of regional location of loads and power generation capacity, the matrix of capacity type and dependable capacity margin shown in Table 11 indicates the mismatch of capacities and demand. This implies that the transmission network must be robust and its security concerns must be considered even in the design of the market (i.e., a nodal market design may not be appropriate).
Table 11. Regional Perspective of Power Supply-Demand Balance of Luzon Grid, 2011 Type Baseload Intermediate Peaking Total Baseload Intermediate Peaking Total Baseload Intermediate Peaking Total Baseload Intermediate Dep. Cap (MW) NCR 4,914 362 495 5,771 North Luzon 2,611 1,114 600 82 341 112 3,552 1,308 South Luzon 2,301 427 2,700 31 0 43 5,001 502 Total Luzon 4,913 6,455 3,300 476 1 0 30 31 -99.98% -100.00% -93.94% -99.46% 134.46% 631.12% 203.62% 171.56% 438.42% 8472.78% -100.00% 896.30% -23.88% 593.77% Demand (MW) Margin (%)

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Peaking Total 371 8,584 651 7,581 -43.01% 13.23%

3.3

GENERATION EXPANSION ANALYSIS

3.3.1 GENERATION EXPANSION METHODOLOGY, CRITERIA, AND SCENARIOS


The generation expansion analysis was conducted to establish the additional capacity, timing and type of power plants needed in the Luzon Grid. The power system models and methodology for the expansion analysis is summarized as follows:

a) Load Modeling. The 2009 hourly load of Luzon Grid was used as the load pattern for all years of the planning horizon. The load model was obtained by normalizing the 8760 hourly demand by the peak demand in 2009. The load variations is modified by the hydro power generation; b) Generating Capacity Outage Probability Modeling. The cumulative value of probability of capacity outage is calculated using recursive algorithm; c) Probabilitic Reliability Evaluation. The LOLE is calculated for a a given annual peak and set of in-service generating units. If the LOLE exceeds 1 day/year in a given year, a generation capacity will be required; d) Optimal Capacity Mix Evaluation. The generating capacity type (i.e., base, intermediate or peaking) needed is evaluated using the power plant screening curve which consider the investment, fixed and variable O&M, and production (fuel) costs; e) Optimal Production Simulation. Based on the available power plants capacity (less capacity on maintenance) the load dispatch for each hour of the 8760 hours in a year are simulated based on merit order f) Generation Cost Calculation. The annuity of the power plant investment, annual fixed and variable O&M, and annual production costs are added and divided by the annual generation of each power plant.
The plant cost chractersitics of the screening curve (Figure 6) in Table 3 was used in establishing the optimal expansion pattern of Luzon Grid.

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Two (2) scenarios were prepared for the generation expansion analysis relative to the retirements of existing power plants, particularly of the Malaya and Limay CCGT power plants. These scenarios were considered because the retirement of the two plants have long been planned. The study establishes the required expansion pattern with these plants in-service or out-of-service (i.e., retired). The expansion analysis also pursued three (3) demand growth scenarios. These are:

a) Moderate economic growth scenario (the GRDP of Luzon will grow 5% annually); b) Low economic growth scenario (GDRP growth rate of Luzon is 3%); and c) High economic growth scenario (7% growth rate). 3.3.2 EXPANSION PATTERN OF LUZON GRID WITHOUT MALAYA AND LIMAY POWER PLANTS
The optimal expansion pattern of Luzon grid with the moderate 5% economic growth driven demand if Malaya oil thermal and Limay CCGT power plants will be retired is shown in Table 12. The security of the Grid will be compromised and to meet the reliability criteria of 1 day/year LOLE, the Grid will require 800 MW of peaking in 2012 and another 900 MW of peaking plants in 2013. The peaking plant requirements is a consequence of the lead time constraints. That is, no baseload power plant can possibly be commissioned before 2015 if the decision to build will be made in 2011. The reliability of Luzon Grid generating capacity with and without the expansion for this scenario is illustrated in Figure 10. The Luzon Grid will require 300 MW of baseload generating capacities for the years 2015, 2016 and 2017. No intermediate generating capacity will be needed for the entire planning scenario. This is due to the high price of natural gas in the country due to its indexation to oil. The economics of power supply implies that the existing CCGTs in Batangas are more than enough for the next 20 years (assuming that the investment expansion decision of the generation sector will follow the least cost or optimal mix based on investment, fixed and variable O&M, and inflating fuel prices).

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Table 12. Generation Capacity Expansion Without Malaya and Limay Power Plants (Forecast Demand under Moderate Economic Growth Scenario)
YEAR 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 TOTAL BASE 0 0 600 0 300 300 600 300 300 600 300 600 300 600 300 300 300 600 300 300 6,900 INTERMEDIATE 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 PEAKING 0 0 200 900 0 0 0 0 0 0 0 0 0 0 400 200 200 0 300 300 2,500 TOTAL 0 0 800 900 300 300 600 300 300 600 300 600 300 600 700 500 500 600 600 600 9,400

Figure 10. Reliability Performance of Luzon Grid With and Without Expansion

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Table 13 shows the expansion requirements in the case of a low economic growth scenario (3% average annual GRDP growth rate) without the Malaya and Limay Power Plants. The peaking plant requirements in 2012 and 2013 will be 600MW and 700 MW, respectively. This is a reduction by 200 MW for each year due to the lower demand in this scenario. In addition to lower capacity requirements to meet the reliability in the immediate scenario, the required basleoad plants will be 300 MW in 2015 . The next 300 MW will be needed in 2017 instead of 2016 WM.

Table 13. Generation Capacity Expansion Without Malaya and Limay Power Plants (Forecast Demand under Low Economic Growth Scenario)
YEAR 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 TOTAL BASE 0 0 600 0 300 0 300 300 0 300 300 300 300 300 300 300 300 300 300 300 4,800 INTERMEDIATE 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 PEAKING 0 0 0 700 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 700 TOTAL 0 0 600 700 300 0 300 300 0 300 300 300 300 300 300 300 300 300 300 300 5,500

On the other hand, if the economic growth of 7% in 2010 is sustained in the future, the Luzon Grid will require 2,100 MW of peaking plants to ensure the security of the Grid. The base load capacity addition needed in the Grid, as shown in Table 14, will be 600 MW in 2015 and another 600 MW in 2016.

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Table 14. Generation Capacity Expansion Without Malaya and Limay Power Plants (Forecast Demand under High Economic Growth Scenario)
YEAR 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 TOTAL BASE 0 0 600 0 600 600 300 600 600 900 600 900 600 900 1,200 900 1,200 1,200 1,200 1,200 14,100 INTERMEDIATE 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 PEAKING 0 0 500 1,000 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1,500 TOTAL 0 0 1,100 1,000 600 600 300 600 600 900 600 900 600 900 1,200 900 1,200 1,200 1,200 1,200 15,600

3.3.3 EXPANSION PATTERN OF LUZON GRID WITH MALAYA AND LIMAY POWER PLANTS IN-SERVICE
The previous section indicated the security implications of retiring Malaya and Limay Plants in the immediate scenario. The optimal expansion patterns of Luzon Grid to meet day/year LOLE reliability criteria are shown Table 15 to Table 17. With moderate demand growth scenario, no additional plants will be required until 2012 provided that rehabilitation of BacMan II-1 unit is completed in 2012 and the maintenance of power plants are optimally scheduled considering reliability requirements. The grid security scenario in 2011 and 2012 will be different from 2010 (El Nino year) if the economic growth will be only a moderate 5%. There is enough intermediate and peaking plants , assuming that the natural gas CCGTs and diesel plants will be dispatched based on the economic supply mix. The Luzon Grid will require a total of 7,200 MW of base load plants from 2015 to 2030 if the nat gas

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price in the Philippines will continue to be indexed to international Brent oil. In 2015 and 2016, the Grid will need additional 300 MW each.
Table 15. Generation Capacity Expansion With Malaya and Limay Power Plants (Forecast Demand under Moderate Economic Growth Scenario)
YEAR 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 TOTAL BASE 0 0 600 0 300 300 300 300 300 600 600 300 600 300 900 300 300 600 300 300 7,200 INTERMEDIATE 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 250 0 250 PEAKING 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 100 300 0 0 300 700 TOTAL 0 0 600 0 300 300 300 300 300 600 600 300 600 300 900 400 600 600 550 600 8,150

Table 16. Generation Capacity Expansion With Malaya and Limay Power Plants (Forecast Demand under Low Economic Growth Scenario)

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YEAR 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 TOTAL BASE 0 0 600 0 0 0 0 300 0 300 300 300 300 300 300 300 300 300 300 300 4,200 INTERMEDIATE 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 PEAKING 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 TOTAL 0 0 600 0 0 0 0 300 0 300 300 300 300 300 300 300 300 300 300 300 4,200

Table 17. Generation Capacity Expansion With Malaya and Limay Power Plants (Forecast Demand under High Economic Growth Scenario)
YEAR 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 TOTAL BASE 0 0 600 0 600 300 600 600 600 900 600 900 600 600 900 600 600 900 600 900 11,400 INTERMEDIATE 0 0 0 0 0 0 0 0 0 0 0 0 0 250 250 0 250 250 250 250 1,500 PEAKING 0 0 0 300 0 0 0 0 0 0 0 0 0 0 0 300 200 0 300 100 1,200 TOTAL 0 0 600 300 600 300 600 600 600 900 600 900 600 850 1,150 900 1,050 1,150 1,150 1,250 14,100

The low economic growth scenario shown in Table 15 indicates that even the baseload power plants must be postponed to 2018 (i.e., if the Malaya and Limay Thermal Plants will not be University of the Philippines National Engineering Center 42

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retired). This is the only scenario that shows the condition that should trigger the retirement of Malaya and Limay plants. In the high economic growth scenario, the Luzon Grid will need 300 MW of peaking plants in 2014 and a minimum of 600 MW baseload plant in 2015.

3.3.4 HINDSIGHT GENERATION EXPANSION SCENARIO FOR NATURAL GAS PRICE


The previous sections has indicated that there will be no adddition of intermediate power plants (represented by Nat Gas CCGTs). The expansion analysis of this section assumes that the Luzon Grid is a greenfield in 2011. The 2010 Luzon Grid was assumed to have an optimal mix of base, intermediate and peaking plants that meets the reliability criteria. The existing renewable energy-based plants (i.e., hydro and geothermal) are also assumed to be in-service. Table 18 shows how the optimal expansion pattern of base, intermediate and peaking plants will take place. A series of 600 MW expansion of baseload plants will be followed by a 250 MW of intermediate. The residual requirements will be provided by peaking plants in 100-300MW capacity addditions.

Table 18. Generation Capcity Expansion for Hindsight Scenario


YEAR 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 TOTAL BASE 0 0 300 300 0 300 300 300 0 300 300 300 300 300 300 300 600 300 300 600 5,400 INTERMEDIATE 0 0 0 0 250 0 0 250 0 0 250 0 0 250 0 0 0 250 250 0 1,500 PEAKING 0 100 0 0 0 0 0 0 200 100 0 0 100 0 100 200 0 0 0 0 800 TOTAL 0 100 300 300 250 300 300 550 200 400 550 300 400 550 400 500 600 550 550 600 7,700

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II

ANALYSIS OF THE POLICY AND REGULATORY FRAMEWORK OF THE PHILIPPINE ELECTRIC POWER INDUSTRY

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4 THE POLICY FRAMEWORK OF THE PHILIPPINE ELECTRIC POWER


INDUSTRY
The policy and regulatory framework of the Philippine electric power industry underwent major changes over the past twenty-five years. It gained momentum in 2001 when the Government pushed for extensive reforms through the passage of Republic Act 9136 Electric Power industry Reform Act (EPIRA) . The primary motivations for the reforms were the fiscal deficit trap created by the contingent liabilities from the IPP take-or-pay contracts that were signed following the power crisis in the early 1990s and the perceived inefficiencies of the industry.

EPIRA restructured the industry and introduced far-reaching policy and institutional reforms. Restructuring broke up the National Power Corporation (NPC) into its constituent generation and transmission components; privatized these assets; established a wholesale power market and introduced retail competition through a policy of open access to the distribution networks. The key elements of the policy and regulatory framework summarized in Table 19. created by the EPIRA are

Institutional reform primarily involved the abolition of the Energy Regulatory Board (ERB) and the creation, in its place, of the Energy Regulatory Commission (ERC). The ERC, like the ERB is an independent and quasi-judicial body with broad powers over the industry that revolves around its exclusive authority to set electricity rates . Its mandate as described in Sec 43 of the EPIRA are to : (1) promote competition; (2) encourage market development; (3) ensure customer choice; and (4) penalize abuse of market power.

The responsibility of ensuring the proper implementation of the EPIRA was assigned to the Department of Energy (DOE). In addition, Section 37 of the EPIRA mandates the DOE to: a) Ensure the reliability, quality and security of electric power supply; b) Facilitate/encourage reforms in the structure and operations of distribution utilities; c) Develop policies and, where appropriate, promote a system of incentives for adequate and reliable electric supply including reserve requirements; d) Establish the WESM; University of the Philippines National Engineering Center 45

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e) Develop policies and programs for energy efficiency; f) Formulate and implement programs for the development and commercialization of non-conventional energy systems;

g) Encourage private sector investment in the electricity sector; and h) Promote the development of indigenous and renewable energy sources.10

The DOE Secretary is also directly responsible for total electrification as Chair of the National Electrification Administration.

Table 19. EPIRA Policy and Regulatory Framework

ISSUE OWNERSHIP Privatization of NPC Assets

POLICY FRAMEWORK NPCs generating , transmission assets and the management and control of the energy output of the IPP contracts are to be privatized according to the guidelines in Sections 47 and 21. NPC prohibited from incurring new obligations to purchase power through bilateral contracts with generation companies or other suppliers. Section 45 prohibits generation companies, distribution utilities (DUs) and their subsidiaries or affiliates or stockholder or official and other entities engaged in the generation and supply of electricity within the 4th degree of consanguinity or affinity as specified by the ERC from having direct or indirect interest in TRANSCO or its concessionaire and VICE VERSA. Point-to-point facilities may be developed and owned or operated by a generation company for its exclusive use and for the exclusive purpose of connecting to the transmission system. Ownership of the facilities shall be transferred to TRANSCO at a fair market price in the event that they are required for competitive purposes. ECs given the option to convert into either (1) stock cooperative under the Cooperatives Development Act or (2) stock corporation under the Corporation Code.

Transmission

Electric Cooperatives (ECs)

10

EPIRA, Section 37

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ISSUE Democratization POLICY FRAMEWORK Holdings of persons including directors, officers, stockholders and related interests in a DU (except Electric Cooperatives) and their respective holding companies limited to at most 25% of the voting shares of stocks unless the utility or company holding the shares or its controlling stockholders are already listed in the Philippine Stock Exchange (PSE) , Provided that controlling stockholders of small DUs, i.e. with peak demand of 10 MW or less, who already own the stocks lists in the PSE within 5 years from EPIRAS enactment. New controlling shareholders to list within 5 years of acquiring ownership and control. Separation of Transmission and Generation No explicit policy statement for or against vertical integration of distribution and generation. That integration is allowed may be inferred from Section 45, 6th para, 2nd sentence to wit: Except as otherwise provided for in this Section, any restriction on ownership and/or control between or within sectors of the electricity industry may be imposed by ERC only insofar as the enforcement of the provisions (i.e., on Cross Ownership, Market Power Abuse and AntiCompetitive Behavior ) of this Section is concerned. Sec 45 limits to at most 50% of total demand that DU can source through bilateral contracts with associated firms except for contracts concluded before the EPIRA As provided in Section 45, no company or related group is allowed to own, operate or control more than 30% of installed generation capacity of a grid and/or 25% of the national installed generating capacity. This restriction does not apply to NPC but applies to IPP Administrators.

STRUCTURE Vertical Structure

Horizontal Structure

LIBERALIZATION Generation

Single buyer arrangement ended . Generation opened to new entrants and de-listed as public utility operation. Franchise requirement lifted. Wholesale Electricity WESM to be established within a year of the laws effectivity. DUs required Spot Market (WESM) to source at least 10% of their demand from WESM in the first 5 years of WESMs establishment. NEA to act as guarantor of Electric Cooperatives purchases and for this purpose, its authorized capital stock was increased to PhP 15 Billion.

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ISSUE Open Access and Retail Competition POLICY FRAMEWORK Within 3 years (5 years for Electric Cooperatives) of the laws effectivity subject to: 1) Establishment of the wholesale electricity spot market; 2) Approval of unbundled transmission and distribution wheeling charges; 3) Initial implementation of cross-subsidy removal scheme; 4) Privatization of at least 70% of total capacity of NPC generating assets in Luzon and the Visayas; 5) Transfer to IPP Administrators of the management and control of at least seventy percent (70%) of the total energy output of power plants under contract with NPC Those with monthly average peak demand during the preceding 12 months of at least 1 MW to be opened to generators and retail electricity suppliers; contiguous areas with aggregate demand of at least 750 kW, 2 years after. A gradual reduction of the threshold until it reaches the household demand level following market evaluation by the ERC. TRANSITION SUPPLY NPC to file with ERC TSC negotiated with DUs within 6 months of the laws CONTRACTS (TSC) effectivity. TSC to contain terms and conditions of supply and rate schedule including applicable adjustments and/or indexation formula. TSC terms shall not extend beyond one (1) year from the declaration of open access. CONDUCT REGULATION A. PRICE/RATE REGULATION Generation Generation and retail supply to contestable market to be deregulated upon implementation of retail competition and open access, except as otherwise provided in the law. Transmission and Regulated . ERC directed to establish and enforce rate-setting Distribution methodology for transmission and distribution. It was allowed to adopt appropriate alternative forms of internationally accepted rate setting methodology that results in non-discriminatory and reasonable price of electricity. B OTHER RATE RELATED POLICIES Mandated Rate NPC rates to residential end-users to be reduced by PhP0.30/kWh upon Reduction the laws effectivity. Lifeline Rates ERC to set rates for marginalized end-users. These lifeline rates are to be exempted from the phase-out of cross-subsidies. Cross-Subsidies All cross-subsidies to be phased out within 3 years from the establishment of the universal charge.

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ISSUE Universal Charge POLICY FRAMEWORK A universal charge on all end users shall be collected within one year of the laws effectivity for the following purposes: Payment for the stranded debt of NPC in excess of the PhP 200 Billion to be assumed by the Government; Payment for the stranded contract costs of NPC and the distribution utilities from contracts approved by the Energy Regulatory Board as of December 31, 2000; Missionary electrification; Equalization of taxes and royalties between indigenous and renewable sources of energy and, imported energy fuels as provided in Section 35; Environmental charge for watershed rehabilitation and management amounting to PhP 0.0025/kwh; a charge for the removal of cross-subsidies to be imposed for not more than three years. To be paid by end-users through the universal charge. This consists of : (1) NPC Stranded Debt. Any unpaid financial obligation of NPC in excess of the PhP 200 Billion assumed by the National Government. (2) NPC Stranded Contract Cost. The excess of NPCs contracted cost of electricity under eligible IPP contracts over their actual selling price in the market. To be eligible, contracts should have been approved by the ERC by December 31, 2000. (3) DU Stranded Contract Cost. The excess of the DUs contracted cost of electricity under eligible contracts over the actual selling price of such contracts in the market. . To be eligible, contracts should have been approved by the ERC by December 31, 2000. C NON-PRICE CONDUCT General Prohibitions Section 44 of the law prohibits any person or participant in the electric power industry from engaging in anti-competitive behavior including but not limited to cross-subsidization, price or market manipulation, or other unfair trade practices Competition Rules ERC directed to promulgate competition rules within one year of the laws effectivity. The rules are intended to ensure and promote competition, encourage market development and customer choice and discourage/penalize abuse of market power, cartelization and any anticompetitive or discriminatory behavior.

Stranded Cost

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Philippine Electric Power Industry Market and Policy Assessment Final and Analysis of International Markets Report 5 ASSESSMENT OF RESULTS OF EPIRA REFORMS

Whether the law has been effective is best examined by comparing the achievements to date with its objectives. Section 2 Declaration of Policy of the EPIRA recites the States policy objectives. These are summarized below to wit: a) Total electrification; b) Quality, reliability and security of electricity supply; c) Enhanced inflow of private capital , private ownership and broadening of ownership base; d) Fair and non-discriminatory treatment of public and private sector entities in the restructuring process; e) Socially and environmentally compatible energy sources and infrastructure; f) Greater utilization of indigenous and new and renewable energy to reduce dependence on imported energy;

g) Efficient use of energy and demand side management; h) Affordable, transparent and reasonable electricity rates; and i) Consumer protection and competition through a strong and independent regulator.

5.1

TOTAL ELECTRIFICATION

The DOE targets 100% electrification of barangays by 2008 and 90% of households by 2017.11 Recent DOE statistics report that 99.4% of barangays had been electrified by 200912. The electrification levels by grid were 99.66 %, 99.53% , 99.67% in Luzon, Visayas and Mindanao respectively.

The accuracy of this data was challenged during the deliberation of the DOE budget at the House of Representatives in September 2010.13 A subsequent briefing by NEA to the House Committee on Energy on November 2010 confirmed the inaccuracy of the official DOE/NEA
11 12

DOE Expanded Rural Electrification Program, www.doe.gov.ph Ibid, Power Statistics 13 Philippine Daily Inquirer

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electrification data.14 NEA reported that 31% of the 100,186 sitios nationwide are still not electrified and set a 100% energization target by 2020.

Neither the DOE nor NEA publish data on the level of household electrification.

5.2

QUALITY, RELIABILITY AND SECURITY OF ELECTRICITY SUPPLY

DOE does not have a working plan or program that will directly address the quality and reliability of electricity supply. It appears to have left this responsibility to the ERC. ERC has set systems loss targets but not those of other reliability and service quality indices in the Grid and Distribution codes. Instead , the latter are merely nominated by distribution utilities and NGCP whose rates are determined under the Performance Based Regulation (PBR) rate-setting methodology, based on their performance in the last three years.

While many distribution utilities made significant reduction in systems losses, power losses as a percentage of total electricity consumption stayed at 12% in 2001 and 2009.15 A thorough assessment of the EPIRAs achievements vis--vis energy security, reliability and quality is made in Section 3.6 that shows serious deficiencies in DOEs planning process. To ensure energy security, the Department will:16 a) Accelerate the exploration and development of oil, gas and coal resources; b) Intensify development and utilization of renewable and environment-friendly alternative energy resources/technologies; c) Enhance energy efficiency and conservation; d) Attain nationwide electrification; e) Put in place long-term reliable power supply; f) Improve transmission and distribution systems;

14 15

NEA Briefing for the Committee on Energy, November 4, 2010 DOE Power Statistics 16 DOE Philippine Energy Plan 2009-2030

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g) Secure vital energy infrastructure and facilities; and h) Maintain a competitive energy investment climate.

Apart from the methodologies described in Section 3.6; security of energy supply is also affected by: (1) fuel diversity , and (2) import dependency. 17 Higher fuel diversity leads to higher supply security. The risk of supply disruption and price volatility is directly related to the level of import dependency especially on oil and gas and lately also coal; fuels that have the greatest price volatility.

Another important indicator is energy efficiency which is measured by energy intensity, i.e. energy consumption per unit of GDP. These three indicators directly correspond with programs 1 to 3 above.

The national picture however hides the fragile state of the countrys energy security relative to power generation. This is largely due to the dominance of a single fuel at the grid level and a pricing policy on key indigenous energy resources that exposes much of power generation to the volatility of the international price of oil and coal. Figure 11 and Figure 12 reveal overreliance in each grid on single resource , i.e., Luzon on natural gas; Visayas on geothermal steam and Mindanao on hydro resources. Just this year, acute power shortages were experienced in the Visayas and Mindanao grids when the old geothermal plants in the former had to shut down for rehabilitation and hydrothermal plants in the latter, due to prolonged drought. The condition was somewhat eased in the Visayas by the 440 MW HVDC transmission line between Leyte and Luzon that allowed for limited imports . Mindanao, which is isolated , did not get a similar reprieve.

17

World Bank Winds of Change: East Asias Sustainable Energy Future May 2010

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Figure 11. National Gross Power Generation By Resource, 2001 and 2009

50000 40000

GWh

30000 20000 10000 0 2002 2009 Luzo Coal Hydro Oil-Based Wind 2002 2009 2002 2009 Mindanao Geothermal

Year Visayas
Natural Gas Biomass

Figure 12. Gross Power Generation By Grid and Resource, 2001 and 2009

The price of Natural gas from Malampaya is indexed to the international oil price while that of geothermal steam from all the steam fields previously held by PNOC-EDC , to the international price of coal. Consequently, the domestic price of natural gas has followed the trend of, and

had not been spared from the volatility of international oil prices as shown in Figure 13. In a departure from the past contracts between NPC and PNOC-EDC that indexed the steam price to University of the Philippines National Engineering Center 53

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domestic inflation only, the steam sales contract in 2006 between PSALM and PNOC-EDC indexed the steam price to the international price of coal as well. This indexation could be behind the nearly 50% increase in steam cost, from PhP 1.7-1.9/kWh in 2008 to PhP

2.8328/kWh in 2009 that the new owners of the Visayas geothermal plants want to recover from customers in the Visayas Grid.

14 12 10 8 6 4 2 0 0 4 8 12 16 20 24 28 32 36

Price (US$)

Quarter
US$/GJ
Source: DOE

US$/MMBTU

Figure 13. Weighted Average Price of Malampaya Gas (2002-2009, Quarters)

5.3

ENHANCED INFLOW OF PRIVATE CAPITAL, PRIVATE OWNERSHIP AND BROADENING OF THE OWNERSHIP BASE

5.3.1 PRIVATIZATION OF NPC ASSETS AND IPP CONTRACTS


Privatization proceeded at a very slow pace and was hobbled by many issues such as pricing, and difficulty in securing the agreement of creditors for the transfer of liabilities from NPC to PSALM. The operation of the transmission assets was finally awarded in 2008 to a private concessionaire after three failed biddings. Sale of the generation assets only gained momentum in 2008-2009 and and is now practically complete at 82.6% of total capacity (based on PSALM plant capacity records; 89% based on ERC plant capacity reports) of total capacity while 80.21

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% of the energy output (76.85% based on ERC plant capacity records) 18 of the IPPs have been transferred to private administrators. Privatization of the remaining IPPs has been derailed by cases filed in the Supreme Court questioning their Constitutionality and/or consistency with the policy objectives and guidelines of the EPIRA.

5.3.2 ENHANCED INFLOW OF PRIVATE CAPITAL


New investments in generation by private investors were less than a trickle. The installed generating capacity as of April 2010 was 15,607.8 MW, a mere 2,222.8 increase from 13,385 MW in 2001.19 Of these new investments , 3,780 MW were in 139.1 MW in the Visayas and 265 in MW20. As shown in

Table 20, except for Northwind Power and Montalban LFG which are driven by renewable
energy policy and program of the givernment, those in Luzon were already committed prior to the EPIRA.

Committed generation investments as of July 2010 as recorded by the DOE were 600 MW in Luzon, 671 MW in the Visayas and 100.50 MW in Mindanao as shown in Table 21. Their target completion dates are from March 2010 (for the expansion of Unit I of the CFB Power Plant) to July 2014 (for the Mindanao 3 Geothermal Power Plant).

Except for a few distribution utilities of local government units, distribution utilities including the Electric Cooperatives had long been privately owned by the time of the enactment of the EPIRA. The privatization of Olongapos public distribution utility in 2010 completed the

privatization of this sector.

18

The variation in plant capacity records of PSALM and ERC stems from ERCs adjustments in installed capacity limit from temporary causes such as outages. On the other hand, there is no baseline record for energy output per se. The baselines used by PSALM/JCPC are a combination of contracted capacities in PPAs and dependable capacities). 19 DOE Power Statistics 2010
20

The discrepancy between the 2010 installed generating capacity and aggregate new investments between 2001-2010 is due to the decommissioning of the Bataan , Manila, Sucat Thermal Power Plants; Cebu II, Aplaya and General Santos Diesel Plants with a combined installed capacity of 1,459.3 MW

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The transfer of the operation of the transmission system to a private concessionaire is expected to enhance the inflow of private capital for rehabilitation and expansion of the network.

Table 20. Addition to Installed Generating Capacity after 2001 Installed Capacity (MW) 50 1,060 1,271 500 345 355 165 .40 33 1.0 3,780 Date Commissioned 2006 Jun 2000/Oct 2011 Jun 2002 Sept 2002 May 2003 May 2004 Apr 2002 Jun 2002 Jun 2005 Jun 2009

Plant Type Luzon Coal Natural Gas Natural Gas Natural Gas Hydro Hydro Hydro Hydro Wind Biomass Total Luzon Visayas Bunker Fuel Bunker Fuel Bunker Fuel Diesel Diesel Biomass Biomass Hydro Total Visayas

Plant Name

Owner

Asia Pacific Energy Corp Sta Rita Ilijan San Lorenzo San Roque Kalayaan 3 & 4 Casecnan Cawayan Northwind Power Montalban LFG

Non-NPC/IPP Non-NPC/IPP Non-NPC/IPP Non-NPC/IPP Non-NPC/IPP NPC-IPP Non-NPC/IPP Non-NPC/IPP Non-NPC/IPP Non-NPC/IPP

Global Business Power Corp (Iloilo) Global Business Power Corp (Aklan) Global Business Power Corp (Aklan) Guimaras Power Project PDPP III (Pinamucan) SPC Power Corp San Carlos Bioenergy First Farmers Biomass Cogen Sevilla Hydroelectric Plant

Non-NPC/IPP Non-NPC/IPP Non-NPC/IPP Trans-Asia Non-NPC/IPP Bronzeaok Phil Inc Non-NPC/IPP Non-NPC/IPP

20 12.5 5 3.4 66.4 8.3 21 2.5 139.1

Feb 2006 Aug 2006 Sept 2006 Apr 2005 Transferred 2005 Feb 2009 Feb 2009 Nov 2008

Mindanao Diesel PB 104 Solar Sitio Lomboy, Cagayan Coal Mindanao Coal I & II Total Mindanao Source: DOE Power Statistics 2010

NPC Non-NPC/IPP NPC-IPP

32 1 232 265

Sept 2005 Sept 2004 Sept & Nov 2006

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Table 21. Committed Generation Investments as of June 2010 Project Luzon 2 x 300 MW Coal Fired Power Plant Total Luzon Visayas 3 x 82 MW CFB Power Plant Expansion Project Cebu Coal Fired Power Plant 2 x 17.5 MW Panay Biomass Power Project Nasulo Geothermal 2 x 82 MW CFB Power Plant Total Visayas Mindanao Sibulan Hydroelectric Power Cabulig Mini-Hydro Power Plant Mindanao 3 Geothermal Total Mindanao TOTAL COMMITTED INVESTMENTS
th

Proponent GN Power

Capacity (MW) 600 600

Target Completion 4 quarter 2012


th

Cebu Energy Development Corp KEPCO SPC Power Corp Green Power Panay Phil EDC Panay Energy Development Corp

246

200 35 20 164 671

Unit I March 2010 Unit II June 2010 Unit III Jan 2011 Unit I Feb 2011 Unit II May 2011 Unit I 2011 Unit II 2012 2011 Unit I Sept 2010 Unit II Dec 2010

Hedcor Sibulan, Inc Mindanao Energy Systems Inc EDC

42.5 8 50 100.50 1,317.5

June 2010 June 2011 July 2014

Source: DOE, 16 EPIRA Implementation Status Report (Period covering November 2009-April 2010)

5.3.3 BROADENING OF OWNERSHIP BASE


Generation Broadening of the ownership base is subject to the installed capacity limits in Section 45(a) of the EPIRA. The law prohibits the ownership, operation or control by a company or related group of more than thirty percent (30%) of the installed generating capacity in a grid and/or twentyfive percent (25%) of the national installed generating capacity. The NPC is exempt from this prohibition.

Data from the DOE and ERC show that while NPCs ownership went down from 74% in 2003 to 51.8% in 2010, the government through the NPC owned plants and IPPs retains majority University of the Philippines National Engineering Center 57

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ownership of the countrys installed generating capacity in 2010. On a grid basis, government ownership in 2010 is highest in Mindanao at 85.6% followed by Luzon and Visayas at 53% and 14% respectively.

The decline in government ownership is primarily due to the sale of NPC owned plants. The ownership distribution of the private generating capacities, i.e. those not under contract with NPC are shown in Table 22.

Control of the output of the installed generating capacities remains largely with the NPC except in Luzon as shown in Figure 14. The San Miguel group now holds nearly 30% (or slightly over 30% depending on the accuracy of the ERC or DOE data on installed capacities) from its acquisition of NPC owned plants and administration of the IPP outputs that were transferred to it from PSALM under the IPP Agreements (IPPA).

Transmission Broadening of the ownership base of the transmission utility would have been possible by selling the three grids to three different parties. While the EPIRA does not preclude this option; the operation of the national network was transferred in 2008 as a whole to a single party on a concession basis only.

Distribution Broadening the ownership base of distribution could have been effected by the juridical separation and sale to different entities of the distribution networks owned by MERALCO but which had their own franchises prior to the EPIRA. Instead Congress passed a law in 2004 consolidating these franchises into a MERALCO mega-franchise. Rather than broadening their ownership base, some of the 109 Electric Cooperatives 21may have to merge to achieve operating efficiency. While DOE has considered this option, it has proven to be politically difficult to implement.

21

As of end 2010, 10 on-grid ECs , 9 of which are in Luzon had registered with the Cooperative Development Authority. These are Pangasinan I, Pangasinan III, Isabela II, Nueva Vizcaya,

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Table 22. Ownership Distribution of Private Generating Plants Installed Capacity (MW) % Share of Total Private

Owner Luzon A. Lopez Group 1 From Privatized NPC/PNOC Total from Privatized 2 Others Total Others Total Lopez Group B. Aboitiz Group 1 From Privatized NPC/PNOC

Plant Name

Pantabangan-Masiway Bac-Man Sta Rita San Lorenzo

112 150 262 1,047 549.1 1,596.10 1,858.10

32.47%

Magat HEPP Tiwi GPP Mak-Ban GPP Ambuklao HEPP Binga HEPP

Total from Privatized 2 Others Total Aboitiz Group C. San Miguel Group D. AES E. DMCI F. Quezon Power Phil G. Other Owners Angeles Electric Corp Limay Combined Cycle Masinloc Coal I & II Calaca Power Corp Quezon Power Angeles Power Inc Angeles Electric Corp Tarlac Power Corp First Cabanatuan Ventures Corp Trans-Asia Power Generation Corp Northwind Power Corporation INEC-Agua Grande Mini-HEPP Bicol Hydropower Corp Cawayan HEPP Barit HEPP Magat A & B MOntalban Methane Power Corp Phil Power Development Corp

360 330 410 75 100 1,275 0 1,275 655.5 635 600 511 30 9 18.9 25.6 52 33 4.5 0.96 0.448 1.8 2.5 8.19 1.11 188.008

22.28% 11.45% 11.10% 10.48% 8.93%

INEC SORECO Atty Ramon Constancio ISELCO

Total Other Owners, Luzon

3.29%

Quirino, Abra, San Jose City, Palawan, Sorsogon II, Negros Occidental. None has converted into Stock Corporations

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TOTAL PRIVATE , LUZON 5,722.61 100.00%

Transmission Broadening of the ownership base of the transmission utility would have been possible by selling the three grids to three different parties. While the EPIRA does not preclude this option; the operation of the national network was transferred in 2008 as a whole to a single party on a concession basis only.

Distribution Broadening the ownership base of distribution could have been effected by the juridical separation and sale to different entities of the distribution networks owned by MERALCO but which had their own franchises prior to the EPIRA. Instead Congress passed a law in 2004 consolidating these franchises into a MERALCO mega-franchise. Rather than broadening their ownership base, some of the 109 Electric Cooperatives may have to merge to achieve operating efficiency. While DOE has considered this option, it has proven to be politically difficult to implement.

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Table 22. Ownership Distribution of Private Generating Plants (cont.) Installed Capacity (MW) % Share of Total Private

Owner Visayas A. Lopez Group 1 From Privatized NPC/PNOC

Plant Name

Tongonan I, Palinpinon I & II Unified Leyte Northern Negros GPP

Total from Privatized 2 Others Total Lopez Group B. Aboitiz Group 1 From Privatized NPC/PNOC 2 Others Total Aboitiz Group C Global Business Power Corp 1 From Privatized 2 Others

305 618.4 49.37 972.77 0 972.77

54.44%

Cebu Private Power Corp East Asia Limited Corp

0 73 50 123

6.88%

Panay Power Corp Cebu Energy Development Corp Panay Energy Development Corp Toledo Power Corp

0 108 167.4 82 134.75 492.15

Total Global Business Power Corp D Other Owners SPC Power Corp BOHECO I SAMELCO I CEBECO I Sta Clara International Corp SOLECO Bronzeoak Philippines Inc ICS Renewables Enervantage Suppliers Co, Inc Total Other Owners, Visayas TOTAL PRIVATE, VISAYAS

27.54%

Bohol DPP, Panay I & II Janopol HEPP/Sevilla HEPP Ton-ok Mini HEPP Mantayupan, Matutinao, Basa Loboc HEPP Henabian MHPP San Carlos Bioenergy Co, Inc Amlan HEPP Enervantage Bunker C-Fired DPP

166.5 7.5 1 1.7 1.2 0.8 8.3 0.8 11 198.8 1,786.72 11.13% 100.00%

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Transmission Broadening of the ownership base of the transmission utility would have been possible by selling the three grids to three different parties. While the EPIRA does not preclude this option; the operation of the national network was transferred in 2008 as a whole to a single party on a concession basis only.

Distribution Broadening the ownership base of distribution could have been effected by the juridical separation and sale to different entities of the distribution networks owned by MERALCO but which had their own franchises prior to the EPIRA. Instead Congress passed a law in 2004 consolidating these franchises into a MERALCO mega-franchise. Rather than broadening their ownership base, some of the 109 Electric Cooperatives may have to merge to achieve operating efficiency. While DOE has considered this option, it has proven to be politically difficult to implement.

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Table 22. Ownership Distribution of Private Generating Plants (cont.) Installed Capacity (MW) % Share of Total Private

Owner Mindanao A. Lopez Group 1 From Privatized NPC/PNOC

Plant Name

Mindanao I & II Geothermal Partnership Bukidnon Power Corp

108.5 1.8 110.3 0 110.3

Total from Privatized 2 Others Total Lopez Group B. Aboitiz Group 1 From Privatized NPC/PNOC

24.63%

Talomo MHEPP Power Barge 117 Power Barge 118 DALIGHT Bajada Power Plant Cotabato Light & Power Co Sibulan A & B

Total from Privatized 2 Others

Total Others Total Aboitiz Group C. CEPALCO Mindanao Energy Systems, Inc Bubunuwan Power Co, Inc Solar Photovoltaic

4.6 100 100 204.6 53.5 9.9 42.59 105.99 310.59 18.9 7 0.95 26.85 447.74

69.37%

Total CEPALCO TOTAL PRIVATE, MINDANAO

6.00% 100.00%

Source: Plant name and installed capacity were based on ERC Resolution No 20 Series of 2010 A Resolution Setting the Installed Generating Capacity Per Grid, National Grid and the Market Share Limitations Per Grid and the National Grid for 2010 issued on October 5, 2010. Information on plant ownership partly sourced from DOE 2009 Power Statistics

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Control of Installed Capacity, Luzon NPC 16% Aboitiz 17% Lopez 15% Others 22%

San Miguel 30%

Control of Installed Capacity, Visayas Global Business SPC Power 8% Aboitiz 17% 14% Lopez Group 17% Others 3%

NPC 41%

Control of Installed Capacity, Mindanao CEPALCO 1% NPC 83% Aboitiz 16%

Source: ERC and DOE Data

Figure 14. Control of Installed Generating Capacity as of March 2011 , Luzon, Visayas and Mindanao

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5.4

GREATER UTILIZATION OF INDIGENOUS AND NEW AND RENEWABLE ENERGY TO REDUCE DEPENDENCE ON IMPORTED ENERGY

The reduction in the share of imported energy in the generation mix was mainly due to the discovery and utilization of natural gas from Malampaya whose share of gross generation jumped to 32.1% in 2009 from 1.8% in 2001. However, the boost to energy security that could have resulted from this development was undermined by the indexation of its price to the international price of Brent oil. DOE targets the doubling of renewable capacity by 2030. From the results so far, it looks like only hydro is on track to meet this objective. The contribution of new renewable energy to the generation mix barely moved: from 0 in 2001 to 64 MW in 2009. Of the old renewable energy, hydro increased by 58% from 3,518 MW in 2001 to 3,291 MW in 2009 while generation from geothermal was practically maintained: at 1,931 MW in 2001 and at 1,953 in 2009. That said, the inordinate focus by the government on renewable energy to the point of loading all possible incentives for investments in the sector is unnecessary and may turn out to be both counterproductive and financially unsustainable. Hydro and geothermal already account for 33% of gross generation while natural gas, a clean resource adds another 31% or a total of 64%. In comparison, countries in Europe that pioneered the adoption of Feed-in-Tariffs (FIT) such as Germany, Spain and France started with less than 5% RE contribution in their generation mix. As it is, they have scaled back their FIT while maintaining their 20% RE target for 2020. Massive fiscal and policy incentives risk the commercialization of renewable resources and technologies in the Philippines that are on the fringe and could potentially undermine the reliability of the countrys energy supply. At the same time, fiscal incentives such as tax exemptions strains the government finances and are thus unsustainable in the long-run.

5.5

FAIR AND NON-DISCRIMINATORY TREATMENT OF PUBLIC AND PRIVATE SECTOR ENTITIES IN THE RESTRUCTURING PROCESS

No report of discrimination reported.

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A target of 32,000 Gigagrams (32 Metric Tons) cumulative emission avoidance of carbon dioxide was set in the Philippine Energy Plan (PEP) for 2004-2013. To achieve this, the DOE planned to: a) aggressively promote Renewable Energy; b) prioritize the conversion of old and retiring oil and coal-fired power plants to natural gas; c) strictly implement the fuel quality standards in the Philippine Clean Air Act; and d) implement energy efficiency and conservation measures.

There is no indication from either the various DOE reports or the DENR on the cumulative avoided emission performance to date vis--vis the target. Power Generation is a close second to Transport in CO2 emissions. The Philippine National Communication to the UN Framework Convention on Climate Change disclosed that of the Total CO2 emission of 50,038 kilo-ton of the energy sector in 1994, 15,888 or 31.7% was from Transport and 15,508 or 31% from Power Generation. The Carbon Monitoring for Action

(CARMA), estimated the CO2 emission of all Philippine power plants, i.e. grid and off-grid including embedded plants of industries, at 24,425,721 kTons in 2000 and 33,067,120 in the current year (as shown in ), a growth of more than twice the 1994 Philippine official figure .22 Of these, 95.6% were from 15 on-grid power plants; 1 from a coal mine and 1 from a mill. At
23

an estimated cost of

$20/tCO2 , the external environment cost of the CARMA derived CO2 emission of Philippine power plants in the current year equals $661,342,400.

22

The CARMA database contains detailed information on the carbon emissions of over 50,000 power plants and companies worldwide. The project is financed by the Confronting Climate Change Initiative at the Center for Global Development, an independent and non-partisan think tank in Washington DC. Emission data for US, Canada, EU and India are based on official reports. Otherwise, emission levels are estimated using a statistical model that was fitted for thousands of reporting plants of these countries. It welcomes comments in its website
23

As estimated in the World Bank Study Winds of Change: East Asias Sustainable Energy Future May 2010

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Table 23. CO2 Emission of Selected Philippine Power Plants (in kTons) Power Plant Sual Pagbilao Calaca Masinloc Quezon Power Santa Rita Ilijan Mindanao STEAG San Lorenzo Naga Toledo Limay Mabalacat Mill Malaya Semirara Power Barge 117 Total (of 17) Total (all PH Power Plants) Source: www.carma.org 2000 6582 3564 3121 3032 2558 1465 0 0 648 604 463 0 303 158 112 23,345,077 24,425,721 Current Year 8181 4415 3851 3766 3192 1843 1435 1268 881 799 742 573 494 240 194 139 33,067,120 34,569,282

5.7

EFFICIENT USE OF ENERGY AND DEMAND SIDE MANAGEMENT

The DOEs energy efficiency and conservation targets as well as their implementing strategies keep shifting. From 82.56 MMBFOE (or an average of 8.256 annually) in the 2004-2013 PEP; it was increased to 23.4 MMBFOE annually for the 2005-2014 planning period; scaled down to 7.5 MMBFOE in 2010 and upped to 9.1 MMBFOE by 2016 in PEP 2007-2016. The target was changed to 10% energy savings on the total annual demand of all economic sectors in PEP 20092018.

There is limited information available on performance against these targets. It was reported that in 2006, the recorded energy savings was at 6.1 MMBFOE which was much lower than the 23.4 MMBFOE target at that time. 24 Energy labeling and efficiency standards generated 2.03

MMBFOE or 33.3% of total savings achieved. Of this, over half , 1.13 MMBFOE came from the

24

PEP 2007-2016

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CFL project. Power losses as a percentage of total electricity consumption stayed at 12% in 2001 and 2009.25 Among the strategies identified by the DOE in PEP 2009-2018 are: a) Power Patrol; b) Partnership for Energy Responsive Companies; c) Energy Standards & Labeling of Appliance/Equipment; d) Government Enercon Program; e) Energy Audit; f) Energy Use Standard for Buildings;

g) Heat Rate Improvement of Power Plants; and h) System-Loss Reduction. In previous PEPs, the strategies also included the aggressive promotion of renewable energy. The program appears to lack focus (some like the heat-rate improvement and energy building standards have not been aggressively pursued) and a comprehensive policy framework that will spell out incentives and penalties for non-compliance. The development of a policy framework for Demand-Side Management that was assigned to the ERC in the EPIRA has not been started. The ERC and the DOE had subsequently agreed that the latter will take charge of this but work on the policy framework has yet to commence.26

5.8

AFFORDABLE, TRANSPARENT AND REASONABLE ELECTRICITY RATES

Whether the electricity rates after the EPIRA are affordable and reasonable is difficult to evaluate inasmuch as the neither the regulator nor the DOE has determined the tariff level that is affordable and reasonable tariff. At the same time, the complexity of the new rate setting methodology for the transmission and distribution utilities and bilaterally negotiated purchase power contracts tend to obscure the true cost of electricity from the public.
25 26

DOE Power Statistics From interviews with ERC and DOE officials

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Data from the DOE shows that the effective electricity rates rose by 28.8% from 2003 to 2009. As shown in Figure 15 and Figure 16, this national average was mirrored in Luzon where electricity rates increased by 29% during the same period, albeit, with peaks that reached PhP 8.00/kWh that were not experienced in the Visayas and Mindanao grids.

9 8 7 6 5 4 3 2 1 0
Luzon

Peso/kWh

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
5.47 5.62 5.18 5.31 5.51 5.71 5.59 5.90 6.80 7.29 6.90 8.05 6.88 8.03 5.77 6.40 7.25 7.73

National 4.69 4.82

Source: DOE EPIRA Reports 2007 Rates are estimate

Figure 15. Annual Average Effective Rates Rates (2000-2009)

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6 5 4 3 2 1 0 2003 2004 2005 2006 2007 2008 2009 2010


Year
Figure 16. NPC Annual Average Effective Rates (2003-2010)

The analysis of MERALCOs 2010 billing statements in Table 24 indicates that generation and transmission costs were behind the rate increases. Generation charges increased by an average of 30% ; transmission by 48%. Distribution had no contribution because MERALCOs 2003 unbundled charges continued to apply until 2010 when the ERC finally allowed the utility to implement its approved rates under the Performance Based Methodology (PBR) . Tariffs are certain to increase more with the implementation of MERALCOs PBR rates where the

distribution charges alone are on average, 60.5% higher than their 2003 level.

The rise in MERALCOs generation costs in 2008 to 2010 as shown in Figure 17 were caused by the increasing prices of its 3 main suppliers, namely: IPPs, WESM, and NPC. WESM average prices per kWh were at PhP 7.79 in 2010, PhP2.86 in 2009 and PhP4.87615 in 2008. Average price of NPC were at its highest in 2010 at PhP 5.24/kWh and lowest in 2008 at PhP3.97/kWh. Purchases from the IPPs had lower price fluctuations than those from WESM and NPC at an average of PhP4.6/kWh during the 3 year period with its highest average at PhP/4.71/kWh in 2008.

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Table 24. MERALCO Comparative Charges , 2003 -2010 (Pesos)
Transmission (per kW except 5 residential) 0.9605 1.28 33.26% 258.31 376.5898 45.79% 290.11 433.898 49.56% 294.57 469.2007 59.28% 300.1 469.2007 56.35% 311.4 503.5579 61.71% 326.12 421.2338 29.17% Supply & Metering (per customer/ 6 month) 5 25.95 419.00% 973.07 1,309.79 34.60% 973.07 14,382.97 1378.10% 973.07 14,382.97 1378.10% 1,096.34 31,509.08 2774.02% 1,096.34 31,509.08 2774.02% 973.07 31,509.08 3138.11%
1 2 3

Service 2003 2010 Change 2003 2010 Change 2003 2010 Change 2003 2010 Change 2003 2010 Change 2003 2010 Change 2003 2010 Change

Generation 4 (per kWh) 3.4029 4.2874 25.99% 3.4029 4.2874 25.99% 3.4029 4.2874 25.99% 3.4029 4.2874 25.99% 3.4029 4.2874 25.99% 3.4029 4.2874 25.99% 3.4029 4.2874 25.99%

Distribution 6 (per kWh) 1.6471 2.23 35.39% 0 0.0259 0 0.0259 0 0.0259 0 0.0259 0 0.0259 0 0.0259

Distribution 6 (per kW)

Residential 201-300 KWh General Service IS Small INDL IS Large Secondary Comm NIS Large Below 13.2 Kv Comm NIS Very Large 13.8/13.2 kV Industrial IS Large 34.5 kV Industrial IS Extra Large 115 kV
1 2

141.87 247.87 0.7472 119.4 247.87 1.076 112.94 188.56 0.6696 123.27 188.56 0.5297 124.62 188.56 0.5131 112.76 151.69 0.3452

Excludes VAT, Energy Tax, Lifeline rate subsidy, special discount, power factor adjustment, power act reduction Based on ERC Order of May 2003 on ERC Case No 2001-900 & 2001-646 Re Application for Approval of Revision of Rate Schedules and Appraisal of Properties With Prayer for Provisional Authority and In the Matter of the Application for Approval of the Revised Rate Schedule in Compliance with Section 36 of Republic Act No 9136 and ERC Order Dated October 30,2001 and for Approval of Appraisal of Properties, With Prayer for Provisional Authority: MERALCO, Applicant 3 Based on MERALCO Summary Schedule of Rates Effective December 2010 Billing Month 4 MERALCO average generation cost in 2009 and ERC approved generation rates in 2003 5 MERALCO average transmission charges in 2010 6 2010 Distribution charges

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NPC 12 10 8 6 4 2 0 0

WESM

NPC & WESM

IPPS

AVERAGE

PhP/kWh

12

16

20

24

28

32

36

Month
Figure 17. MERALCO Average Monthly Generation Cost (2008-2010)

The typical residential energy price and typical industrial regulated price in Chile are shown in Figure 18 and Figure 19, respectively. For the residential customers, generation rate (energy + power) is approximately PhP 5.59/kWh while distribution is approximately PhP 1.72/kWh. For industrial customers, the generation rate comprises of an energy charge of approximately PhP 4.8/kWh; a power charge of approximately PhP43/kW at off-peak or at PhP 365.5/kW at peak hours. The distribution charge is approximately PhP 64.5/kW. The transmission charge is approximately 10% of the combined energy and power charge.

It will be noted that while the generation charge in the MERALCO franchise area is lower than in Chile; the distribution charges for both residential and industrial customers are much higher. For the typical residential customers , MERALCOs distribution charge (exclusive of supply and metering) are at PhP2.23/kWh vs. PhP 1.72/kWh for Chile. For industrial customers, MERALCOs lowest charge , i.e., for Extra Large Industrial Customers is 2.35x that of Chile.
Brazils average tariffs are shown in Table 25. They are lower than MERALCOs charges for all customer classes.

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Typical Residential Energy Price

Figure 18. Chile: Typical Residential Energy Price

Typical Industrial Regulated Price

Figure 19. Chile: Typical Industrial Regulated Price

Table 25. Brazil Average Electricity Prices, 2010 Type of customer Residential Industrial Commercial Average Tariff (US$/MWh) (PhP/kWh) 153.49 6.68 108.55 4.72 147.60 6.42

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5.9

CONSUMER PROTECTION AND COMPETITION THROUGH A STRONG AND INDEPENDENT REGULATOR

Consumer protection and the development of effective competition primarily depend on the strength of the incentives for them in the policy framework and secondarily only on the strength and independence of the regulator. The policy review that follows show that existing policies such as vertical integration between generation and distribution and the improper sequencing of reforms dulls competition and consequently, consumer protection. Since regulation only implements policy, any shortcomings on the regulation side is normally corrected by policy reform. However, there is strong evidence from this assessment and that of the policy framework that the regulator, by its own omission and/or commission may have further weakened consumer protection and competition. Examples of these are in the implementation of the grid limits on generation capacity ; the implementation of the PBR for transmission and distribution; and the fatally flawed Competition Rules and Complaints Procedures. At the same time, the regulator is viewed as having taken its independence too far; to the point of making coordination difficult with other agencies.

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The industrys regulatory system consists of the regulatory policy directions laid down in the EPIRA and its Implementing Rules and Regulations (IRR) and the rules and regulations issued by the regulator to carry them out. The assessment of these regulatory policies will focus on the strength of their incentives to primarily, attract sufficient private investment in generation in the Luzon grid and secondarily, contribute to economic efficiency.

A robust regulatory incentive structure aligns the regulatory objectives of economic efficiency with the profit objective of the regulated firms. Economic efficiency refers to productive efficiency, dynamic efficiency and allocative efficiency. Prices at marginal cost of production

(which includes a normal mark-up) are allocatively efficient. Those above and below are not. The former diverts money from more productive activities while the latter leads to wasteful consumption, insufficient private investment and government subsidies that crowd out other essential public services such as education and health. Economic efficiency is induced by effective competition which compels firms to eliminate slack, innovate, and adopt new processes over time. However, the policy choice is not as straightforward in an industry such as the electric power industry that is characterized by market power or, the ability to set price above the marginal cost of production,. In this situation, economic efficiency is brought about by a policy mix of market competition where it is possible and the regulation of sectors/activities that are not competitive.

The rules that make up the regulatory incentive structure are intended to act as proxies to the disciplines imposed by a fully competitive market that are largely absent from utility/network industries. The principal objective of regulation is thus to ensure that utilities are provided sufficient incentives to invest, increase their efficiency and reduce costs while maintaining or improving the quality of service to their customers. A sound regulatory incentive structure strikes the right balance between ensuring financially viable firms and low electricity rates. It does not underwrite the financial viability of any particular entity if its viability is being undermined by risky financial decisions or poor management performance. Neither does it impose low rates that fail to recover the prudent and reasonable costs of the regulated entities.

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As in other network industries, the strength of the regulatory incentives in the electric power industry rests on the structural policy adopted; liberalization; ownership; conduct regulation; and the sequencing of policy reforms.

6.1

STRUCTURAL POLICY

6.1.1 VERTICAL SEPARATION OF TRANSMISSION FROM GENERATION AND DISTRIBUTION


Transmission was vertically separated from generation and distribution. Section 45 of the EPIRA27 prohibits generation companies, distribution utilities or their respective subsidiaries or affiliates or stockholders or officials or other entities engaged in these businesses within the fourth civil degree of consanguinity or affinity from holding any direct or indirect interest in TRANSCO or its concessionaire and vice versa.

The need for close coordination between transmission and generation favors vertical integration. However, this policy would restrict competition in generation. To promote competition between embedded and independent generators, the transmission company could be required to undertake competitive tendering for additional generating capacity and provide third-party access to independent generators. However these alternatives will require a strong regulator; one with not only the adequate powers but the capacity to monitor and ensure that transactions are arms-length and that the transmission company does not discriminate against independent generators. Vertical separation is the most radical policy alternative but offers the most prospect for the horizontal separation and liberalization of generation. Given the EPIRAs policy mandate to open generation to competition and to sell-off the generating assets of NPC, vertical separation of transmission from generation and distribution was the logical policy choice.

6.1.2 VERTICAL INTEGRATION OF GENERATION AND DISTRIBUTION

27

Section 45 is on Cross Ownership, Market Power Abuse and Anti-Competitive Behavior

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There is no categorical policy statement favoring vertical integration between distribution and generation in the EPIRA. Instead, it is implied in paragraph 3 of Section 45 c) that prohibits ERC from imposing restrictions on ownership and control outside those required to enforce the provisions on competition, market abuse and anti-competitive behavior of this Section. Thus, while a finding of anti-competitive conduct and/or violation of competition rules can force deintegration; vertical separation is not an ex-ante policy . The relevant sentence in paragraph 3 reads:

Except as otherwise provided for in this Section, any restriction on ownership and/or control between or within sectors of the electricity industry may be imposed by ERC only insofar as the enforcement of the provisions of this Section is concerned.

To avoid abuse of market power, Section 45 limits to 50% of its total demand the amount of energy that a distributor can source from bilateral supply contracts with an associated firm except for those contracts concluded before the EPIRA. A distributor is also obliged under Section 2328 to supply electricity in the least cost manner to its captive market which is akin to the economic sourcing obligation imposed in other regulatory jurisdictions abroad.

Except for the reduction of transaction cost, there is hardly any economic justification for vertical integration. There is very little economies of scope between distribution and generation. In contrast, the downside risk of anti-competitive conduct by the integrated utility and disincentive to new entrants are very high. Vertical integration could lead to uneconomic sourcing where the distributor favors its own generation over cheaper competitors, exclusionary conduct and discriminatory access terms to the network. To limit the harm to competition, the vertically integrated utility is: a) subjected to regular audit; b) required to undertake competitive tendering for its energy requirement and to strictly comply with its economic sourcing obligation; and c) required to provide non-discriminatory access to the network. These

safeguards usually require a complicated regulatory oversight to succeed including a skillful and vigilant regulator. Despite these safeguards, regulating a vertically integrated utility is a tough
28

Section 23 is on Functions on Distribution Utilities

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challenge to even the most skillful regulator because the former has both the incentive and the ability to circumvent nondiscrimination rules which are against their self-interest, not the least due to information asymmetry. Thus, vertical separation is the better policy choice in regulatory jurisdictions with limited administrative capacity.

The challenge of regulating a vertically integrated utility is especially difficult in the Luzon grid where nearly 70% of electricity demand is supplied by a single distributor, MERALCO. With its dominance of the grids distribution network and electricity supply, the utility can single handedly influence the entry and profitability of competing generation investments as well as the end-user price of electricity. MERALCO ceased buying from NPC and defaulted on its

contract obligation when its affiliate generators came on stream in 2003. A compromise settlement amounting to PhP13 Billion, down from the original disputed amount of PhP30 Billion, was eventually reached by the two parties with the approval of the regulator. But instead of paying the penalty itself, the regulator allowed MERALCO to pass on and collect the settlement charge from its customers. 29 A study conducted in 2008 by the University of the Philippines using an optimization model found that MERALCO had violated its economic sourcing obligation by sourcing higher priced energy from its affiliates which caused end-user prices to be PhP 0.62/kWh higher than would have been the case had the utility bought from non-affiliated generators instead.30

Ex-post de-integration is difficult to achieve because it threatens to harm private stockholders who can be expected to legally challenge a policy re-direction. Again, this will be particularly difficult in Luzon because of MERALCOs affiliation with generating plants. While the Lopez group has largely divested from MERALCO its place has been taken over by San Miguel Energy Corporation. SMEC owns 27% of MERALCO and now accounts for nearly 30% of Luzons generating capacity.

29

On appeal from the Office of the Solicitor General, the Court Appeals recently ruled that NPC does not have the authority to enter into a settlement 30 Del Mundo Rowaldo, et al Analysis of Power Supply Purchases of MERALCO for the Year st 2007 and 1 Quarter of 2008

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A policy of vertical separation need not be an all or nothing agenda. Since some distribution utilities had integrated to generation under the current policy framework; a standstill agreement may be enforced. That is, distributors need not divest from generating plants that supply their load requirement provided that: a) no new additional investments will be made; b) all bilateral power purchase contracts will undergo competitive public tenders; c) economic sourcing obligation will be strictly complied with; and, d) violation of any one of these conditions and/or the competition rules will result in forced divestment.

6.1.3 HORIZONTAL SEPARATION OF GENERATION


EPIRAs Mandate A policy of horizontal separation of generation was mandated in the EPIRA in order to promote competition and prevent the abuse of market power. An alternative policy option, i.e., vesting contracts is not provided in the law.31 Vesting contracts has the advantage of promoting scale economies while curbing abuse of market power by requiring dominant generators to dedicate a prescribed portion of their capacity to designated end-users at regulated prices pending the achievement of effective competition in generation. However, the regulators inability to correctly implement horizontal separation does not bode well for its ability to grapple with the complexities of vesting contracts. Besides, technological developments in generation have brought down the minimum efficient scale in generation; e,g., it is exhausted at 300-400 MW in CCGT plants.

The policy directive for Horizontal separation is provided in Section 45 of the EPIRA. This policy prohibits the ownership, operation or control by any company or related group of more than

thirty percent of the installed generating capacity of the grid and/or twenty-five percent of the national installed generating capacity. Rule 11 Section 4(a) of its IRR added IPP Administrators among those covered by the prohibition and clarified that the prohibition applies either singly

31

Vesting contracts are bilateral electricity contracts that are imposed by the regulator on large incumbent utilities in order to curb their market power and promote efficiency and competition in the market. With these contracts, the generators are required to sell a specified amount of electricity at a specified price to distribution companies for the benefit of primarily, the captive customers and at times, also to serve a part of the contestable customer demand.

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or in combination. Such restrictions do not apply to PSALM and NPC while their assets are being privatized.

Related group is defined in Section 45a) as including a persons business interests, including its subsidiaries, affiliates, directors or officers or any of their relatives by consanguinity or affinity, legitimate or common law, within the fourth civil degree.32

Rule 11 Section 4 of the IRR prescribes a methodology for crediting the capacity of a generating facility with different owners or where it is owned, operated or controlled by different persons, viz:
(b) The capacity of such facility shall be credited to the entity controlling the terms and conditions of the prices or quantities of the output of such capacity sold in the market in cases where different entities own the same Generation Facility.

In cases where different Persons own, operate or control the same generation facility, the capacity of such facility shall be credited to the Person controlling the capacity of the Generation Facility (underscoring supplied)

Control of the output, i.e., the installed generating capacity is the key determinant of market power. Either by oversight or by design, the Rules extends the prohibition to a Person/group that owns, operates or controls the facility but does not control the prices and/or the level of its output that is sold in the market. This is the situation of the owners and operators of IPP plants whose capacities are, with few exceptions fully contracted to the NPC. Under the current rules, they will be credited with capacities that they do not control and will unnecessarily be prevented from investing in additional generating capacities once they have reached the limit. This logic appears to have guided the ERC in its implementation of the policy , albeit, one that violates the law. Implementation by the Regulator In 2005, the ERC through Resolution No. 26 Series of 2005 came out with the guidelines for determining and crediting the installed generating capacity in a grid. The guidelines amend the
32

EPIRA, Section 45a)

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law and explain why the ERC has not found any company or group to have violated the limits ; why the Lopez group acquisition of Unified Leyte in 200733 and its subsequent purchase of Tongonan I and the Palinpinon plants in 2009 were allowed to proceed notwithstanding that these caused the group to breach the 30% grid limit ; and the San Miguel groups plans to invest in more power plants in the Luzon grid.

Section 4 of the ERC guidelines reads: Section 4. Crediting of Generating Capacity In crediting generating capacity of a generation facility in favor of one or more persons or entities, which own, operate, or control such generation facility, the following rules shall be observed: a. If different entities own the same generation facility, the capacity of such facility shall be credited to the entity controlling the terms and conditions of the prices or quantities of the output sold in the market. b. If an entity owns the generation facility and some other entity or entities operate or exercise control over such facility, pursuant to a maintenance or operating contract, lease, assignment, joint venture agreement , or any other similar arrangement, the capacity of such facility shall be credited to the entity or entities controlling such capacity, to the extent subject of its or their control, and not to the entity owning the generation facility. c. Consistent with the foregoing, in the case of NPC and its independent Power Producers (IPPs), it is the control and not the ownership of the power plants which determines who should be credited with the total capacity under contract as it is NPC that actually controls the quantity (dispatch level) generated from the subject power plants and the price of electricity offered to the market. Thus, NPC will be credited the contracted capacity while the remaining capacity not under contract will be credited to the owner of the plant or the entity exercising control over such remaining capacity, in accordance with the preceding rules. Section 4 c) above is inconsistent with the law and its IRR. The language of the latter is such that the cap separately and equally applies to ownership as well as to the operation or control of the installed generating capacity. Moreover, Section 4(c) of Rule 4 of the IRR only applies to a generation facility with different owners or one which is owned, operated or controlled by separate entities.
33

With the purchase, the Lopez group breached the grid limit

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Based on ERCs data as of October 4, 2010 the Lopez group at that time owned, operated and controlled 54.4% of the installed generating capacity in the Visayas grid. 34 Nearly 69% of this or 668 MW represents the installed generating capacity of Unified Leyte that the group acquired when the government decided to sell its remaining majority stake in PNOC-EDC. While the capacities of the plants are covered by a PPA contract and controlled by NPC; ownership, control and operation of the facility is with the Lopez group. The capacities can only be credited to NPC had the facilities been owned by different entities or had they been owned, operated or controlled by different persons. Since neither of these conditions applies in this case; the Lopez group is caught by the general prohibition against ownership, operation or control of more than 30% of the installed generating capacity limit in a grid and more than 25% of the national grid limit. Had control of the installed generating capacity been the criterion regardless of who owns and operates the facility, the share of the Lopez group of the grids installed generating capacity in October 2010 would have been reduced to 20.7% in October 2010 and 17% in March 2011.

The remaining capacity owned, operated and controlled by the Lopes group in the Visayas are those of the Tongonan I, Palinpinon I and II geothermal plants which were previously owned by NPC and were bought by the group from PSALM in 2009. Unlike Unified Leyte, their capacities are not under covered by a PPA with NPC. Because of this, ERC correctly credited their capacities to the Lopez group. With respect to the IPPs that are now under administration, it is clear from Section 31 of the law that the management and control of the energy output of the plants will be transferred to the Administrator. This is confirmed in the IPPA Agreements. For instance, Annex 5 to Section B Delivery of Power and Energy of the IPPA Agreement for the Sual Coal Fired Power Plant between PSALM and San Miguel states that: 2. The Administrator shall be entitled to the management and control of the Capacity of the Units and shall pay the Monthly Payments in respect of, inter alia, such rights.
34

ERC Resolution No 20, Series of 2010: A Resolution Setting the Installed Generating Capacity Per Grid, National Grid and the Market Share Limitations Per Grid and the National Grid for 2010, Oct 4, 2010

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Like Unified Leyte, these facilities are exclusively owned, operated and controlled by the IPPs. However, since their capacities are now controlled by the administrator by virtue of the IPP Agreement the administrators are caught by the general prohibition against the control of the installed generating capacity in excess of 30% of the grid total and/or 25% of the national grid. But as in the case of Unified Leyte, the ERC wrongly credited these capacities to the NPC in line with Section 4c) of its Resolution No. 26 Series of 2005. Resolution No. 26 further complicates the determination of a breach by defining installed generating capacity in a manner that could not have been remotely envisaged in the law. Section 2 of Resolution 26 acknowledges that the installed generating capacity is its maximum output or nameplate rating. However, in determining the installed capacity of each plant the guidelines adjusts the same by netting out: a) permanent reductions; b) temporary reductions due to plant shut down in the preceding 12 months; and, c) temporary reductions due to transmission constraint that are expected in the next 12 months from the determination. As a consequence, the installed generating capacity of each company/related group as well as the total for each grid as determined by the ERC fluctuates yearly as revealed in a review of its annual determinations from 2005 to 2010. These adjustments are not provided in the law where the limitation strictly applies to installed generating capacity. While the adjustment for permanent reduction or derating may be reasonable; adjustment for temporary reduction is much more problematic and should never be allowed. Aside from complicating the determination of a breach, i.e., a company may be in breach one year and not in the following year; it can be used to circumvent the grid limits and nullify its objective to prevent the abuse of market power by those who may be inclined to do so. ERCs unilateral adjustments to the installed generating capacity makes it difficult to ascertain whether or not a company/related group whose share is in the border of 30% is still within the limit. A case in point is the San Miguel group. Table 26 shows disparate data from ERC, PSALM, and DOE on installed generating capacities now owned, operated and/controlled by the group. The group is well within the limit based on ERCs data but is close to breaching it based on DOEs. Note that DOEs data are based on nameplate rating. University of the Philippines National Engineering Center 84

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Table 26. Installed Generating Capacities of the San Miguel Group in the Luzon Grid

Plant Limay CGCT Sual Ilijan San Roque Total San Miguel Total Luzon Grid San Miguel share (%)

Installed Generating Capacity (MW) ERC 2010 PSALM DOE 603.5 620 620 218 1,000 1,294 36.3 1,200 1,271 66 345 345 923.8 3,165 3,530 10,839 NA 11,863 8.5 NA 29.75

Status
Owned, operated and controlled

IPPA; capacity controlled IPPA; capacity controlled IPPA; capacity controlled

Source: ERC Resolution No. 20 Series of 2005 ; PSALMs declared capacities of generating plants transferred to administrators; DOE List of Generating Plants in 2009.

The installed capacities in Luzon that are controlled by the Lopez and Aboitiz groups are shown in Table 27 Unlike in the San Miguel groups , there is only a slight difference between the capacities recorded by the ERC and the DOE. Figure 20 shows that San Miguel has the biggest capacity from the point of view of control if the IPPA contracted capacity is included in its capacity credit.

Table 27. Installed Generating Capacities of Lopez and Aboitiz Groups in Luzon Grid

Group/Plant Lopez Group Pantabangan-Masiway Bac-Man Sta Rita San Lorenzo Total Lopez Group % to Luzon Aboitiz Group Magat HEPP Tiwi GPP Mak-ban GPP Ambuklao HEPP Binga HEPP

2010 Installed Generating Capacity (MW) ERC DOE 112 36 1,036 526 1,710 15.77 360 169.1 281.25 0 100 112 150 1050 500 1,812 15.27 360 275.69 458.43 75 100

Status

Owned, operated and controlled Owned, operated and controlled Owned, operated and controlled Owned, operated and controlled

Owned,operated and controlled Owned, operated and controlled Owned, operated and controlled Owned, operated and controlled Owned, operated and controlled

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Pagbilao Total Aboitiz Group % Luzon Total Luzon 700 1,610.35 14.85 10,839 728 1,997.12 16.83 11,863 IPPA; capacity controlled

Control of Installed Capacity, Luzon

NPC 16% Aboitiz 17%

Others 22%

Lopez 15%

San Miguel 30%

Figure 20. Control of 2010 Installed Generating Capacity, Luzon

6.2

OWNERSHIP

The main policy mandates on ownership are on the privatization of NPCs assets and IPP contracts and democratization. While the law did not directly address the ownership of Electric Cooperatives; that issue will be examined in this study because of its relevance to the question of incentives and generation investments in the Luzon grid.

6.2.1 PRIVATIZATION OF NPC ASSETS AND IPP CONTRACTS


EPIRA privatized the transmission and generation assets of NPC including its IPP contracts. NPC is allowed to generate and sell electricity from the unsold generating assets/IPP capacity only and is prohibited from concluding power purchase contracts with other generators or suppliers.

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It must conclude transition supply contracts with distribution companies which shall be assignable to its successor generating companies.35 There was no need for a similar policy mandate for distribution utilities which were already privately owned, with the exception of 2 LGU owned utilities that were subsequently sold to private investors.

6.2.2 DEMOCRATIZATION
The law limits to at most 25% of the voting shares of stock of a distribution utility that may be held by Persons, including directors, officers and stockholders and related interests unless the utility or its controlling shareholders are already listed in the Philippine Stock Exchange (PSE) . It requires the controlling shareholders of small distribution utilities to list in the PSE within 5 years from the time they acquire ownership or control and mandates generation companies and distribution utilities to sell to the public at least 15% of their common shares.

Section 28 explains that the 25% limit and the requirement to list are in compliance with the constitutional mandate for dispersal of ownership and de-monopolization of public utilities.... It does not provide any economic efficiency justification for this intrusion into corporate structure and control of private companies. The biggest motivator or incentive in private companies is control. Unless there is compelling evidence that such limitation yields significant economic efficiencies; a better policy course would be to create vibrant financial markets and to remove legal and economic barriers to entry into the electric power industry.

Democratization is not a Constitutional mandate. The State is only directed to encourage equity participation in public utilities by the general public.(underscoring supplied)36. As for monopolies, the Constitution mandates the regulation or prohibition of monopolies when required by public interest. Generation is no longer a monopoly while transmission and distribution are regulated natural monopolies. Monopolization, which describes an

35 36

Sec 67 1987 Philippine Constitution, Art XII(11)

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action/conduct of a monopolist to exclude potential competitors is covered by the prohibitions in Section 45 of the law.

6.2.3 OWNERSHIP OF ELECTRIC COOPERATIVES


There are 120 ECs nationwide. Of these, 55 operate in Luzon including 12 off-grid. Their aggregate electricity sales in 2009 was 5,430,395 MWh or 14.3% of total electricity sales in Luzon that year with a peak demand of 1,272 MW which was 18% of the grid wide peak. Because of their predominantly residential and small commercial consumer base, ECs are expected to continue as retail suppliers to most end-users in these markets even with retail competition. In Luzon, only 3 ECs (INEC, ISELCO, SORECO) have embedded generating plants with combined capacities of 8 MW. ECs are non-profit and non-stock institutions that are exclusively owned by all their consumers. Their operating, maintenance, capital expenses (equal to 5% of operating revenue in tariff allowance) and taxes are fully funded by the consumers through the tariffs. Because consumers provide funding for capital investment and debt service, the tariff does not provide for depreciation and return on investment.

PSALMs statements of account as of December 31, 2010 showed 16 Luzon ECs with power bill payables of more than 60 days; accrued VAT remittances and accumulated interests including restructured accounts . Except for Batangas II Electric Cooperative (BATELEC-II), all the ECs experienced negative operating margins in 2010 as reported in NEAs annual financial statistics.

The average collection efficiency of the Luzon ECs is around 94%. Despite this, 22 on-grid ECs incurred net losses in 2009 and 17 in 2010. They accounted for 46% and 42% of total energy purchases of the Luzon ECs in 2009 and 2010, respectively. The on-grid ECs that incurred losses include 11 of the biggest in terms of yearly electricity sales, i.e.; over 100,000 MWh . ThreePampanga II and III and Albay Electric Cooperatives are among those with huge arrears with

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NPC/PSALM and are being closely monitored by NEA. Due to their size, the thirteen are able to collect annual reinvestment allowance ranging from PhP 30 Million to PhP 79 Million. 37 which rules out lack of investible funds as the cause of their financial difficulties. Among the policy measures taken by the government to strengthen the ECs since the enactment of the EPIRA were: a) Loan Condonation. Section 60 of the EPIRA directed PSALM to assume all outstanding financial obligations that were incurred by the ECs for rural electrification. But in exchange, the ERC was directed to reduce their tariffs by an amount corresponding to the loans condoned over a period of five years. The reduction ranged from PhP0.25 PhP0.40/kWh which further strained the ECs finances. b) Investment Management Contracts Scheme (IMC). The program was conceived for ECs whose operating and financial performance could be turned-around with management expertise from the private sector but with low investment requirement. During the long gap between project conceptualization and implementation however, the financial condition of the eight pilot ECs had deteriorated to the point of requiring massive capital infusion. Few private investors were willing to join a scheme that will require them to invest their own capital without the management control that was retained by the EC Board of Directors. In the end, two contracts were signed. These collapsed prematurely because of interalia; the contracts strayed from the programs guiding principles; weak project oversight by the DOE and resistance from the EC stakeholders. 38 c) New Rate-Setting Methodology. The ERC introduced a new rate setting methodology in 2009 for on-grid ECs. This would have increased the tariffs of 56 by as much as 64% and reduced those of rest. The stiff opposition to tariff reduction moved the ERC to maintain the tariffs of those affected at their old levels. The new

37 38

NEA Status of Financial and Technical Operation as of December 31, 2009 Based on the program evaluation of a member of this study team who was contracted by the DOE to conduct a third-party review of the IMC.

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methodology allows the ECs to collect additional contribution from the members to fund capital deficiency through existing legal procedures. d) Option to Convert into Stock Corporations under the SEC or Stock Cooperatives under the CDA. Only 10 ECs converted to stock cooperatives; 9 of them in Luzon. None has converted into stock corporations. The poor uptake is partly due to resistance from the EC management and employees (and even from some NEA officials/employees); reluctance of some ECs to lose NEAs authority to discipline and remove undesirable Board members that would result with conversion to stock cooperatives and the lack of technical and financial capability of the Cooperative Development Authority (CDA) to support their operations. ECs that joined the CDA were mainly motivated by the continuing tax exemption available from membership that had expired for those with NEA.

These measures do not directly address the possible link between the ECs ownership structure and their operating efficiency. It is generally the case that privately owned firms are more productively efficient than State Owned Enterprises (SOEs) because of their exclusive focus on profitability. The Board of Directors appoints and monitors the performance of the managers to induce them to behave in the owners interest. In companies with dispersed ownership such as public companies, the threat of capital market disciplines such as takeover, regulatory monitoring of their corporate practices makes up for weaker shareholder control and discourage costly managerial discretion.

ECs are privately owned by all their consumers. However, they lack the tight control over management and single-minded focus on profitability that characterizes their PDU counterparts. Instead, their current ownership and management structures have strong built in disincentives for productive efficiency, namely: (1) wide ownership dispersal (many consumers do not even know that they own the utility) without the strict discipline imposed by capital markets ; (2) the absence of a profit motive; and (3) politicization of the Board of Directors that owe their loyalty to their political sponsors rather than to the owners that they are supposed to represent.

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Two benchmarking studies on the ECs technical efficiency showed efficiency scores that were far behind the efficient cost frontier. Both studies excluded power cost from the cost drivers and included the size of the franchise area. Their findings suggest large potential for cost savings by reducing productive inefficiencies. The first study conducted in 2004 covered 105 ECs.39 With data on the ECs operations from 1990-2002, the study employed Stochastic Frontier Analysis (SFA) and Data Envelopment Analysis (DEA) to calculate their relative efficiencies. It found that on average, the ECs were 34% away from the frontier under the SFA and 42% under the DEA. The second study was conducted in 2006 and employed DEA only with data sets from 20012005.40 It excluded all 21 off-grid ECs and 31 on-grid ECs with incomplete data sets.41 Over half of the on-grid ECs excluded were in the bottom-half of the efficiency ranking in the first study. The study recorded a lower average inefficiency score of 19%.

Mitigating the damage on the ECs productive efficiency may require the consolidation of their ownership to a small group of equity investors preferably consumers of the EC, whose profit motive coupled with effective regulatory restraint could induce productive efficiency. The process will necessarily involve valuation of the business as a going concern; buying out the existing owners-consumers and registration either as Stock Corporations or Stock Cooperatives.

6.3

LIBERALIZATION AND DEREGULATION

6.3.1 GENERATION AND ELECTRICITY MARKETS


Generation was immediately opened to competition, de-classified as a utility and exempted from the franchise requirement by the EPIRA. The wholesale and retail electricity markets were liberalized. A wholesale electricity spot market (WESM) was created: WESM Luzon and WESM

39

Lavado, Rouselle Benchmarking the Efficiency of Philippine Electric Cooperatives Using Stochastic Frontier Analysis and Data Envelopment Analysis, 2004. The study states that 119 ECs were covered but only 105 , 6 of them off-grid are in the data sets.
40

NEA/UPNEC/EC-ASEAN Energy Facility Performance-Based Regulation for Electric Cooperatives in the Philippines Technical Report 2: Efficiency Benchmarking of Philippine Electric Cooperatives for Performance Based Regulation, 2006
41

Off-grid ECs do not have substations or have small substations only. They were removed to avoid distorting the efficiency results.

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Visayas went live in June 2006 and in December 2010 respectively. Retail competition will commence as soon as prior-conditions are achieved, namely: (a) establishment WESM; (b) approval of unbundled transmission and distribution wheeling charges; (c) initial implementation of the cross subsidy removal scheme; (d) privatization of at least 70% of the total capacity of generating assets of NPC in Luzon and Visayas; and, (e) transfer of the management and control of at least 70% of the total energy output of power plants under contract with NPC to the IPP Administrators. All these conditions have been met. Generation rates and retail supply are to be deregulated when retail competition sets in. These radical policy reforms were intended to attract private investments in generation, induce competition and create an efficient domestic electricity market. The immediate removal of the legal barriers to entry and the operation WESM in 2006 failed to attract the expected high level of new investments in generation. From 2002 to 2009 only 33 MW from new investments that were committed after the EPIRA was passed were added to the generating capacity in Luzon; 66.4 MW in the Visayas and none in Mindanao. An additional 600 MW is expected to come on-stream in Luzon by 2013; 671 MW in the Visayas and 100 MW in Mindanao.

To understand the underinvestment requires an appreciation of the allocation of the risks associated with large, sunk and long-term investments in power plants in a single buyer regulated environment and in a liberalized, deregulated environment. In the former, the customer bears all the risks as in the case of the IPP contracts signed by NPC. In the other, the risks are internalized and borne by the investor. In order to commit, the investor must have a sufficient degree of certainty on the recoverability and profitability of such investments. In the first place, project finance has to be raised and the financiers have to be assured of payment before extending financing. The collapse of the US wholesale electricity markets in 2001 practically dried up financing for merchant plants without long-term contracts.

Given these altered environment decisions to invest are more than ever based on longterm fundamentals, market design, market structure and policy support that mitigate such risks; not on short-term price spikes such as those that occasionally obtain in the spot market. Since

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radical policy reforms especially one attended by a change-over from subsidized government utilities to privately owned profit maximizing utilities inevitably result in a period of uncertainty and price increases; credible government commitment to the reforms or at least refusal to slide back to populist policies and regulatory capacity to deal with the complexities of new market designs and processes and the problems that these create are critical to the decision to invest. Unfortunately, these were mostly lacking in the wake of the EPIRA and continue to be so. Industry participants, consumers and observers alike are dismissive of the regulators technical and administrative capacity and the DOE has mostly conceded to the ERC even in those areas where it is supposed to lead.42 Concerns over political intervention in regulatory decisions were raised when the then President ordered the NPC/ERC to cap the PPC of IPP contracts at PhP0.40 less than a year into the EPIRA following consumer protests over increased electricity prices.43 The credibility of the reform process was then undermined by missed timelines for major policy initiatives laid down in the law, which were unrealistic to start with. The Spot Market and Generation Adequacy Under idealized conditions, competitive wholesale electricity markets send out efficient price signals that attract a mix and amount of new generation investments consistent with reliability criteria. Experience around the world had shown otherwise. The principal cause appears to be the missing money or net revenue gap, i.e.; the net revenues earned in energy markets over time fail to cover the capital cost of generating electricity.44 This gap is in turn attributed to, in order of importance: (a) system operation protocols and behavior of the system operator to maintain network reliability and prevent network collapse that depress wholesale prices in times of scarcity or hides the marginal social cost of voltage reduction; (b) inelastic prices caused by the consumers inability to react to changes in the supply and demand balance; and (c) price caps, mustoffer obligations and other regulatory interventions in the market to prevent abuse
42

Based on interviews conducted by a member of the study team for an ADB study on the Philippines regulatory policies in the energy sector
43

NPCs unbundled generation rate has 3 components: fuel, PPC and basic charge. IPP contracts were split into PPC that was capped by the President and amortization of capacity fees which falls under the basic charge. 44 For a discussion of the missing money problem, refer to Cramton Peter and Steven Stoft The Convergence of Market Designs for Adequate Generating Capacity, White Paper for California Electricity Oversight Board, March 2006

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of market power.45 Some policy proposals had been advanced by noted international regulatory experts that in combination, will close the revenue gap and incent new investments.46 These include: (a) the adjustment of reliability rules and protocols that were a legacy of vertically integrated utilities to make them consistent with consumer valuation; (b) improved market design such as raising the price cap; (c) forward energy hedging contracts; and (d) forward capacity markets. These proposals are difficult to implement and get right. They will not happen overnight especially not in the Philippines where a liquid and complete capital markets have yet to come out despite years of effort and with its fragile regulatory institutions. Physical Contracts and Generation Adequacy The current supply shortage compels the adoption of solutions that will induce investment in new generating capacities at the soonest possible time even at the expense of postponing some of the efficiency gains from liberalizing the electricity markets. Effective competition and economic efficiency can hardly be expected to materialize with supply shortages even in liberalized electricity markets, anyway.

Under current conditions, forward power purchase contracts for physical delivery has the most potential to incent new investments. It minimizes market risk that then allows investors to raise project finance. ERC Resolution No 21 Series of 2005 [Box No. 2] requires DUs to sign bilateral supply contracts but fails to specify the quantity to be contracted, the duration of the contract, when the contract must be entered into and the penalty for non-compliance. Compliance had been spotty due to these and because the DUs are increasingly averse to being locked in longterm contracts that are often one-sided in favor of the supplier. In addition, long-delays in the approval and ex-post arbitrary changes to the contract terms by the regulator alter their carefully negotiated financial structures and deter prospective investors.

Box No. 2 - Excerpt, ERC Resolution No. 21 Series of 2005

45

Joskow Paul Competitive Electricity Markets and Investments in New Generating Capacity The New Energy Paradigm Oxford University Press, 2007
46

Ibid

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WHEREAS, to ensure that there will be sufficient supply of electricity in preparation for the implementation of the wholesale electricity spot market, a bilateral contract should be entered into by and between the distribution utilities and power suppliers to obtain generation and/or ancillary services of a given type, quantity, duration, timing and reliability over a contractual term

NOW WHEREFORE, BE IT RESOLVED. All DUs are hereby directed to enter into future bilateral power supply contract with power producers to be subjected to a review by the Commission

To incent investment, the requirement for bilateral contracts must: a) be mandatory; b) prescribe the duration of the contracts such as say for the next 10 to 15 years; c) mandate immediate compliance;

d) require 100% coverage of forecast load requirement; and e) impose stiff penalties for non-compliance.

To capture some of the efficiencies of competition, purchase contracts should be publicly auctioned instead of negotiated bilaterally between the DU and the supplier. The regulator can draw-up, with inputs from stakeholders , and prescribe the use of a standard contract that will protect the interest of both the supplier and buyer in the transaction. The contract shall also provide for the carve out of a portion of the capacity contracted, e.g., in an amount equal to the size of the DUs contestable market, from the coverage of the contract without giving rise to stranded costs when retail competition is declared. The general framework of the auction shall be akin to the Chilean framework as follows:47 1 2 Distributors shall be 100% contracted at all times. Contracts shall be for 10-15 years;

47

A detailed description of the Chilean auction framework is provided in Part II of this Study and in Moreno, R et. Al, Auction Approaches of Long-Term Contracts to Ensure Generation Investment in Electricity Markets: Lessons from the Brazilian and Chilean Experiences, Energy Policy (2010), doi:10.1016/j.enpol.2010.05.026

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3 Each distributor shall draw up its own criteria , and auction requirements subject to the approval by the regulator ; 4 Distributors can aggregate and simultaneously auction their requirements; its own

The advantages of public auction over bilaterally negotiated contracts are: a) It captures some of the efficiencies of liberalized markets through the process of competing for the market; b) Transparency and efficient price discovery; c) Minimizes regulatory opportunism because price caps per technology are set exante; d) Ensures that small buyers can contract efficiently because under the system, the aggregated load is bidded out by technology instead of by prospective buyer; and e) Removes self-dealing by integrated utilities by requiring them to auction off all their requirements . Retail Competition and Generation Adequacy Retail competition as directed by the EPIRA shall commence upon the implementation of open access. Electricity end-users with a monthly average peak demand of at least 1 MW for the preceding 12 months shall be immediately allowed to choose their supplier; those with 750 kW, two years after. The threshold shall be subsequently lowered until it reaches the household demand level.

The 1 MW and 750 kW thresholds appear to be arbitrary. More than this, postponing retail competition is inevitable under current conditions. First, there cannot be meaningful customer choice with supply shortage although large industrial customers may have some advantage. Second, the conditions necessary to facilitate actual entry by competing suppliers and customer switching , moderate the advantage of incumbents, and for the efficient working of the retail market are still absent. These conditions were precisely recognized by the ERC as vital requirements prior to declaring retail competition and open access in ERC Resolution No. 3 , University of the Philippines National Engineering Center 96

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Series of 2007 titled A Resolution Indicating the Timelines for Full Retail Competition and Open Access in Luzon. Paragraph 1 of the Resolution describes these vital requirements as:

the adequacy and establishment of all necessary in infrastructures including but not limited to: transmission networks, generation supply and the customer switching systems, and the promulgation by the ERC of all pertinent rules and regulations governing Retail Competition and Open Access.

The conditions necessary to encourage customer switching, facilitate entry of competing suppliers and the smooth working of the retail market should include: a) Publication by the ERC of the full list of contestable customers at least 3 years before retail competition sets in to give new entrants time to market and build new capacities, where so desired . The lists submitted by the DUs are reportedly covered by a non-disclosure agreement. The customers came about as a result of the DUs monopoly positions; not through their own marketing efforts, hence, problems of incentive and confidentiality do not arise from the publication of the list. Nondisclosure impedes entry, maintains the incumbents advantage and runs counter to the laws objective to create retail competition.; b) A requirement for DUs to provide their contestable customers with complete energy information (e.g. hourly meter reading data). These data are not currently provided by the DUs who inform their customers of their aggregate monthly energy data and peak demand for the month; c) Completion by the ERC of the rules and guidelines for the smooth working of the retail market, such as on:

i.

the settlement of imbalances, line rentals, and net settlement surplus between DUs and Retail Electricity Suppliers (RES);

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ii. the performance of duties and responsibilities of the Philippine Electricity Market Corporation as the Central Registry Body for Retail Electricity Supply;

iii.

the settlement of disputes for Contestable Customers;

iv.

the standards for the metering facilities for Contestable Customers, the responsibilities and standards of performance of the DU as the meter service provider therefor, and the rates for such services;

v.

amendment of ERC Res. No. 20, series of 2005 to provide for the imposition of VAT by Retail Electricity Suppliers;

vi.

The installation of WESM compliant metering to all Contestable Customers (capable of tracking energy transactions in each WESM interval for purposes of billing and for the settlement of imbalances, line rentals and net settlement surplus); and

vii.

The installation of the IT platform for the B2B infrastructure required for the business processes which ERC prescribed in the rules for Uniform Business Practices .

The Philippines will not be the first country/jurisdiction to postpone retail competition because the necessary conditions for it to function particularly inadequate generation, were absent.

Latin American countries followed a much slower pace than that envisioned in the EPIRA and do not foresee retail competition at the household level.

6.3.2 STRANDED COSTS


Section 32 of the EPIRA allows NPC to recover stranded contract costs and stranded debts and DUs to recover stranded contract costs through a universal charge on all end-users. Two University of the Philippines National Engineering Center 98

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petitions for the recovery of NPCs stranded costs were submitted by PSALM to the ERC in 2009. The first petition is for the recovery of stranded debts estimated at PhP 471 Billion over 17 years at PhP 0.30/kWh. The second is for the recovery of estimated stranded contract costs amounting to PhP 22.2 Billion over 5 years at a rate of PhP0.0920/kWh. The petitions are still under review by the ERC. No DU has filed a petition.

As defined in Section 32, NPCs

stranded debts are any amount of its unpaid financial

obligations net of the PhP200 Billion assumed by the government. Stranded contract costs are the excess of the contracted cost of electricity under NPCs and the DUs IPP contracts that were approved by December 21, 2000 over their actual selling price in the market. Market refers to the wholesale electricity spot market (WESM). In 2007, the ERC issued the Rules for Recovery of NPC Stranded Contract Costs and Stranded Debts Portion of the Universal Charge.

Outside the Philippines, the term stranded costs refer to those costs incurred by a utility that were previously recovered under a regulated regime but can no longer be recovered with the advent of competition and the removal of price controls.48 These costs were approved or imposed by the regulator in order to improve the service or hold down rates. Since the new entrants are not burdened by these costs, competition could result in lower prices and/or the departure of the utilitys wholesale customers for other suppliers offering lower prices. Either of these developments mean that the utility will not be able to earn enough revenue to recover its long-term investments and other costs, which are then stranded. Only generation costs are stranded . Transmission and distribution costs are not because their tariffs remain regulated. The bulk of stranded costs consists of generation-related assets; long-term contracts for power or fuel and regulatory assets that regulators would have eventually allowed the utility to recover through its regulated rates. The latter includes deferred income tax liabilities, deferred operating expenses, deferred taxes, unamortized debt expenses, and costs associated with issuing or reacquiring debt. While there is no agreement, stranded costs are either borne by the utilities departing customers, the remaining customers, or by the shareholders. While the philosophical debate on recovery has not been settled, the idea that some compensation must

48

See for example Baumol William J and J. Gregory Sidak Stranded Costs Harvard Journal of Law and Public Policy, Vol 18(3) Summer 1995

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be made had gained ground. The arguments for compensation are premised on economic efficiency, legal and political considerations the latter to the effect that compensation has to be made to stop powerful losers from impeding efficient policies.

Applying the internationally accepted definition of stranded cost means that: a) Only NPCs generation-related costs are strandable and may be recovered. Transmission debts absorbed by PSALM do not qualify; b) Costs that were previously disallowed by the regulator cannot be recovered; c) Only those approved generation costs that are stranded by deregulation or the removal of price controls may be recovered; d) Of NPCs total generation costs; only those debts and contract costs assignable to enery traded in WESM , i.e., the spot market volume may qualify for stranded cost recovery. The amount of stranded costs here shall be the difference between the assignable costs/debts and trading revenue. However, this does not consider the possibility that losses were caused by a deliberate strategy to bid low even if NPC/PSALM could have bidded higher, rather than by market forces; e) Debts and contract costs assignable to capacities/energy traded or sold outside of WESM cannot claim stranded costs because their prices continue to be regulated by the ERC. The TOU prices in the TSC were set by the ERC and prices in the bilateral contracts will continue to be regulated until open access sets in. Losses incurred from One-Day Power Sales and similar schemes are business losses , not losses from deregulation and competition; f) Debts and contract costs assignable to privatized generating assets cannot be recovered; except those costs stranded in the WESM prior to privatization; and g) Debts and losses caused by reasons other than deregulation such as politically mandated reductions in rates and/or subsidies cannot be recovered.

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Of the total energy traded by the NPC in 2008, only 22% was spot sales. By proportion, only around PhP0.02/kWh can be claimed as stranded cost if recovery is phased over 5 years as proposed by NPC. The data provided by NPC do not permit a similar approximation of the stranded debts assignable to WESM trades.

NPCs debts are not stranded debts. Many reasons had been given for these debts among them, subsidized tariffs, regulatory disapprovals for recovery through the approved tariffs, management inefficiency including bad deals, and losses from NPCs privatization especially those involving the Administration of IPP contracts. Recovering these debts from the

consumers is without precedent in countries that had similarly privatized their state-owned electricity assets.

6.4

CONDUCT REGULATION

6.4.1 RATE SETTING METHODOLOGY FOR TRANSMISSION AND PRIVATE DISTRIBUTION UTILITIES
Transmission tariffs and those of private distribution utilities (PDU) were set through the cost of service methodology (locally known as Return on Rate Base (RORB) before the EPIRA. The law allows ERC to adopt other appropriate or internationally accepted rate-setting methodologies that ensure a reasonable price of electricity and promotes efficiency. The ERC chose to apply the Performance Based Rate (PBR) methodology, specifically its CPI-X formula to transmission and PDU tariffs starting in 2003 and 2005 respectively.

In the CPI-X formula, the efficient cost of the utility is pre-determined. Tariffs are increased by inflation (CPI) but the increase is abated by efficiency savings (X) which is the calculated cost reduction during the current period from the preceding period. This methodology is most appropriate where there is potential for large efficiency gains or productive efficiency unlike the cost of service methodology which assumes that there is not much scope for efficiency improvement in historical costs. It relies on financial incentives and disincentives to lower

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costs; improve service; and a more rational allocation of risks and rewards between the utility and the utilitys customers. Its main characteristics are: 1) the linking of regulated rates to efficient costs and de-linking them from the individual utilitys cost; 2) the reward/penalty structure; 3) a longer regulatory lag that incent the utilities to cut costs because savings do not immediately lead to tariff cuts; 4) performance standards so that service quality is not sacrificed in the cost-cutting effort. The adoption of this formula abroad especially in the UK led to large efficiency gains and tariff reductions particularly in the first 10 years. The new ERC methodology is not PBR, much less its CPI-X variant. It is not also an internationally accepted methodology. It is still RORB with a twist: costs are based on forecasts instead of historical costs which justifies the consumers complaints that they are now financing the investments and paying the utilities profits on it too; and for nothing. Not surprisingly, it has resulted in sustained tariff increases rather than deep tariff cuts that characterized its introduction abroad. What separates ERCs new methodology from the true CPI-X formula are: a) Unbroken cost-price link. Tariffs for the first regulatory period were based on the utilitys historical cost and for the subsequent periods, on the utilitys own forecast. The cost forecasts are upwards, never downwards. In contrast, the recoverable costs in other regulatory jurisdictions are benchmarked to the efficient cost of a Reference Utility such as in Brazil ,Chile and in other Latin American countires and/or derived in combination with benchmarking methodologies such as the DEA and SFA; b) X does not represent productivity gains. There is no prior determination of the utilitys efficient cost and productivity targets. Thus the X or efficiency factor was 0 in the first year of the first regulatory period and a pure mathematical number that equates the Present Value (PV) of forecast real revenue to the PV of forecast nominal revenue, in the succeeding periods; c) No tariff increase abatement by productivity savings. The automatic yearly rate increases arising from the application of the inflation factor are not abated; University of the Philippines National Engineering Center 102

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d) Short regulatory lag. The regulatory lag is shortened to one year since the utilitys cost and tariffs are reviewed and adjusted yearly. This should have been a disincentive but is not, since there is no requirement to cut cost; e) No performance standards. Performance targets have not been set by the ERC except for distribution systems loss. The utilities performance in the most recent 3 years and their own targets are used instead. The utilities are granted an additional amount in their approved revenue requirement to be used to achieve these targets or to pay the corresponding penalties to the consumers. f) Overly generous valuation of the rate base. The rate base is valued by the Optimized Replacement Cost Method (ODRC) before the start of each regulatory period and indexed to inflation within the period. This results in excessive gains to the utilities especially considering that the return on rate base and depreciation account for 55% to 65% of their revenue requirement. Absolute valuation such as through the ODRC should be limited to the time before a new rate setting methodology is

applied. Thereafter, the rate base should simply be rolled-forward to the succeeding regulatory period , adjusted for the value of new investments and indexed to inflation.

6.4.2 NEW RATE SETTING METHODOLOGY FOR ELECTRIC COOPERATIVES


A new methodology was adopted in 2009 that replaced the cash-flow methodology that was previously used to set the tariffs of the ECs. As shown in Box No. 3, tariffs are group tariffs and are neither based on the utilitys own historical nor forecast cost but are derived through a formula that starts from the average operating revenue requirement of the group where the EC has been assigned. The new methodology is highly arbitrary and has no precedent in the Philippines or elsewhere. The ERC is now preparing to again change the methodology to one that is PBR based. The deficiencies found in the PBR for transmission and the PDUs are also present in the proposed methodology as observed from its latest draft.

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Box No. 3 - New Rate Setting Methodology for Electric Cooperatives 1) Classify ECs into groups according to identified cost drivers, 2) Calculate operating cost per kWh for Distribution, Supply, Metering (DSM) in 2000 by adjusting each ECs DSM unbundled DSM in 2000 by the CPI and the average wage increase. Deduct 5% to net out other revenue income that were included in the 2000 tariff. Set DSM/kWh , the Initial Standard Tariff (IST) at the median of the groups 2008 operating cost, 3) Calculate Operating Revenue Requirement (ORR) of each group by multiplying the IST by each groups 2007 average kWh sale . The derived ORR becomes the basis for calculating the rates per customer class, 4) Functionalize ORR by using the ratio of each groups Distribution, Supply and Metering costs to total cost in 2000, 5) Allocate the functionalized ORR by non-coincident demand for distribution and by the number of customers for supply and metering 6) Convert the functionalized ORR per customer class to peso.kWh by: a) Dividing the distribution ORR by the average kWh sales (kW for >240v consumers) b) Dividing supply revenues vy the average kWh sales (for 220/240v, 10/30 and >240 customers, divide average number of customers of the group to derive corresponding fixed peso per customer per month charge) c) For Residential customer metering charge: first calculate the gross revenue from the PhP5.00/month metering charge (an arbitrary charge included in the 2000 unbundling decision) then divide the same by the average kWh sales to arrive at the variable peso/kWh metering charge. For 220/240v, 10/30 and >240v customers, divide the functionalized metering per customer class ORR by the average number of customers per month d) Set the reinvestment fund, i.e. EC consumer-members contribution to capital expenditure at 22% of the groups 2008 median ORR/kWh

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7) Fund capital deficiency with additional contribution of members, to be collected through existing legal procedures.
Source: ERC Rules for Setting Electric Cooperatives Wheeling Rates Sept 2009

6.4.3 REGULATION OF NON-PRICE CONDUCT: ERC COMPETITION RULES


Section 45 of the EPIRA directs ERC to formulate rules and regulations to encourage market development and customer choice and discourage/penalize abuse of market power, cartelization and any anti-competitive behavior. It specifies that the rules shall define the relevant markets for purposes of establishing abuse or misuse of monopoly or market position.49

ERC issued the Competition Rules in 2006. The rules cover: 1) prohibited agreements; 2) prohibition on the misuse of market power ; 3) acquisitions, mergers and consolidations; 4) clearances and authorizations; 5) disclosure of information; and, 6) penalties. Oddly, it contains two definitions of market as shown below:
means a market in the Philippines in which electricity or other goods or services that are directly or indirectly related to or used in connection with the generation, transmission, distribution or sale of electricity are, or may be, supplied or acquired (Definitions) A market includes one in which goods or services, and other goods and services that are substitutable for, or otherwise competitive with, the first mentioned goods or services, are or may be supplied or acquired (Rule 18 (2) on Interpretation and Application)
50

49 50

EPIRA Section 45 ERC Competition Rules and Complaint Procedures

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The first defines an economic market; not an anti-trust market. The second does embrace the concept of substitutability, a critical element in market definition, but only refers to the product market and excludes the geographic market. Section 3 of Rule 18 states that the geographic area will be considered in determining substitutability but still neglects to define the geographic market.

Correct market definition is at the heart of competition or anti-trust law. Market power, abuse of market power, market share and similar competition concepts are all relative to the market. The Rules also do not clarify these concepts as shown in Box No. 4. As it is, ERCs Competition Rules falls short of providing a workable and legally enforceable framework for the evaluation of anti-competitive conduct. This in turn raises concern over the regulators ability to discharge its responsibility to protect consumers and to create a competitive power market.

Box No. 4 - Excerpt from ERC Competition Rules Rule 5 Misuse of Market Power Section 1. Prohibition. A Person that has a substantial degree of power in a Market shall not misuse that power. In this Rule, a reference to power is a reference to market power. (NB the Rules does not define market power) Section 2. Degree of power; Factors: Without prejudice to the preceding paragraph, a Person is to be taken to have a substantial degree of power in that Market if: (a) an Affiliate of a Person has, or two more Affiliates of a Person; or (b) a Person and its Affiliate, or a Person and two or more of its affiliates, together, have a substantial degree of power in a Market Section 3. Misuse of power; Factors. In determining whether or not a Person has misused its power in a Market, the following factors, among others, shall be considered: (a) that Person would have acted in the way it did, whether or not it had a substantial degree of market power; and (b) the Person was reasonably justified in using its power in the way it did. Section 4. Use/Misuse of power; How done. The circumstances in which a Person uses or misuses its power in a Market may include where that Person: (a) (b) (c) (d) does an act; or (NB act is not described or defined anywhere in the Rules) refuses to do, or intentionally refrains from doing, an act; or makes it known that an act will or will not be done; or refuses to do an act, or to offer to do an act, except on a condition or conditions; or

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(e) makes it known that an act will not be done, except on a condition or conditions; or (f) makes it known that an act will only be done on a condition or conditions. Source: ERC Competition Rules and Complaint Procedures

6.5

WHOLESALE ELECTRICITY SPOT MARKET

6.5.1 OVERVIEW OF WESM


Objectives and Operating Features WESM was established to create a fair, transparent and reliable trading environment that will attract investments and encourage healthy competition that will ultimately lead to cheaper electricity for all consumers by: a) Providing incentives for the cost-efficient dispatch of power through an economic merit system while guaranteeing the security and reliability of the power system; b) Create reliable price signals to assist participants in weighing investment options; and, c) Provide and maintain a fair and level playing field for suppliers and buyers of electricity. WESMs establishment is one of the pre-conditions for open access and retail competition . The market price in WESM shall be the basis for the determination of the stranded contract cost; i.e., the variation between the market price and the contracted price of the quantities transacted in the market.

Trial Operations Program (TOP) was launched in Luzon in April 2005 and was completed in December as the last stage of preparation for its commercial operations. A TOP for Visayas was also launched on October of the same year . Commercial operations in Luzon commenced in June 26, 2006; in the Visayas, on December 2010. University of the Philippines National Engineering Center 107

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WESM is a bid-based energy market only that operates as a gross pool.51 Bilateral contract quantities transacted in the pool can be settled outside the market. Locational Marginal pricing (LMP) is applied where settlement is based on and consumed by time and location at all nodes. the marginal value of all electricity produced

Entities directly connected to the grid are not allowed to inject or withdraw without registering in the WESM.

Participants As of December 2010, there were 99 direct and indirect trading participants comprising of 30 generators, 45 distribution utilities and 24 bulk users. The National Grid Corporation of the Philippines (NGCP) is the network service provider and the system operator (SO) at the same time. It is also the metering service provider pending the designation of the ERC of separate metering service providers. Ancillary service providers will be registered prior to the start of trading of reserves in the market.

Governance a. Regulatory Oversight

Both the DOE and the Energy Regulatory Commission have regulatory oversight of the WESM. Together with the Philippine Electricity Market Corporation (PEMC), the three form the WESM Tripartite Committee as a venue for coordination as illustrated in Figure 21.

The DOE was tasked under the EPIRA to establish the WESM and formulate the WESM rules, together with electric power participants. It was also mandated by EPIRA to form the autonomous group market operator (AGMO) thru the creation of PEMC to establish, govern and initially operate the WESM. To date, the DOE continues to facilitate the development of the market thru its involvement in the WESM as part of the DOE Steering Committee and the Philippine Electricity Market Board.

51

The market is technically an exchange, not a pool, in the absence of side payments.

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The ERC approves the Price Determination Methodology that sets out the principles for the pricing of electricity at the spot market, the market fees to recover the cost of administering and operating WESM, and the administered price determination methodology for pricing of WESM transactions in times of market suspension and intervention. It also sets the criteria for WESM membership and the performance standards based on the Grid code. As the industry regulator, its power and authority extends to the enforcement of the rules and regulations, investigation and action against any WESM participant that violates any law, rule or regulation and impose fines and penalties for any non-compliance with or breach of the EPIRA, IRR and rules and regulations in the market.

Source; WESM

Figure 21. WESM Governance Structure

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b.

Market Governance

PEMC was incorporated to perform the functions of the autonomous group market operator (AGMO) as stated in the EPIRA IRR. It functions as the governance arm of the WESM and is tasked to handle its initial operations until the appointment of the independent market operator (IMO).

The PEMC Board together with the various WESM committees perform the governance functions of the PEMC. During the transition period to the selection of the IMO, the PEM Board is chaired by the Secretary of the DOE. The Secretary also appoints members of the Board. After the transition period, the Chairman of the Board will be elected by the independent members, while members will be elected by PEMC members.

6.5.2 PERFORMANCE HIGHLIGHTS


The ensuing review of the markets performance is based on the results of the Luzon market operations from July 2009 to June 2010 (and for the full year 2010 when data allows). This period is a better indicator that those of prior periods because it was at this time that more private participants entered the market, thus, loosening the control of NPC/PSALM following the privatization of NPC generating plants and the transfer of IPP energy outputs to private administrators. The market highlights are: 52 a) Negligible increase in spot quantity accompanied by substantial increase in spot market value from 2009 to 2010 (Figure 22); b) High occurrences of pricing errors due to contingency violation of N-1 contingency and HVDC related concerns. Real-time prices were applied at 60.2% of the time only (Figure 23);

52

WESM, Market Governance Updates, 4 WESM Annual Participants Meeting, 12 August 2010

th

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c) Frequent price substitution (Figure 24 and Figure 25) ; d) Tight supply condition from the Malampaya shutdown; simultaneous occurrences of forced and scheduled outages; and capacity gap from low capacity offered (Figure 26);
e)

Wide price variability ranging from 0 to negative bids (14.5%) to above 10,000 (10.6%) and clustering at the 0-5000 level (61%) (Figure 27 and Figure 28);

f)

Highly concentrated when measured on the basis on the actual generation of major participants net of bilateral contract quantities; (Figure 29);

g) High risk for the exercise of market power by Pivotal Supplier and Price-Setters with large uncontracted capacities , e.g. (Pagbilao and Kepco Ilijan) (Figure 30);

Source: PEMC

Figure 22. Market Transactions (2009,2010)

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Source: PEMC

Figure 23. Pricing Errors

Source: PEMC

Figure 24. Price Substitution

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Source: PEMC

Figure 25. Supply and Demand Profile (26 June 2009 to 25 June 2010)

Source: PEMC

Figure 26. Monthly Outage Rate By Resource (July 2009-June 2010)

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Source: PEMC

Figure 27. Price Distribution (June 2009 to June 2010)

Source: PEMC

Figure 28. Market Price Trend (June 2009 to June 2010)

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Source: PEMC

Figure 29. HHI Based on Actual Generation Net of Bilateral

Source: PEMC

Figure 30. Combined Pivotal Supplier-Price Setter Index

6.5.3 ASSESSMENT OF WESM

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The market results paint a disturbing picture of a market that is unlikely to deliver on its objectives to incent efficient generation investments and create efficient price signals without radical changes in its current architecture and rules. The assessment of the market will

therefore focus on the required adjustments of its architecture and rules as indicated in the foregoing market results.

Market Architecture Market architecture refers to the design of component submarkets. They are anchored on the market structure and are designed prior to the market rules.

The Philippine electricity market is characterized by: (1) tight supply and demand situation ; (2) increasing dominance of a few large generating groups; and (3) severe transmission constraints in many zones/nodes. Its operating environment includes political leaders that are inclined to intervene in the market to deflect mass opposition to high electricity prices.

The tight supply and demand situation means that uncontracted generators possess a high degree of market power and can exploit this market power through capacity withholding or excessive price bids. Among the pivotal suppliers and price setters in 2009-2010; Pagbilaos uncontracted capacity were approximately 50% while those of Sta Rita and Ilijan were

approximately at 38%. It is interesting to note that these plants are also controlled by the 2 of the 3 largest groups: the Lopez and Aboitiz groups , respectively. To manage this, there should be: (a) as an interim measure, high level physical contracting, say, 100% for loads and

consequently, generators ; and b) in the medium term , the introduction of a long-term financial forward market (forward, futures, swaps, options) that will curb the exploitation of market power by generators and shield trading participants from spot price volatility. Pending the operation of the financial hedging market, the spot market is best designed as a balancing market only to fulfill the contractual commitments of generators and possibly, distributors as well. This solution is also likely to scale-down government intervention in the market. A financial capacity market should be created in the longer term with a corresponding requirement imposed on distribution utilities and large users to contract for a prescribed percentage of their peak capacity requirements.

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Tight capacity constraints also require the operation of a contract operating reserve market to maintain system security and reliability and to encourage investments in additional generating capacity. The pricing of operating reserves is discussed under Market Rules.

Transmission upgrades are critical to relieve transmission congestion. As it is, the market is characterized by wide price separations among nodes that are only partly managed by the collection of Settlement Surplus. In the longer term, a sub-market for Transmission Rights (TR) must be created to manage the trading participants exposure to nodal price risks. It can also do away with Administered Prices, or Price Substitution in cases of transmission congestion. TRs could be physical or financial (although FTRs classified as options - no payment when the flow is reversed, are equivalent to physical transmission rights). The market operator (MO) can periodically auction TRs. Pending the full liquidity of the market, the minimum price of the TRs can be set by the MO and/or approved by the ERC based on estimates of cost from congestion and losses.

Market Rules a) Dispatch Schedule

The current bid-based dispatch schedule is inconsistent with the tight supply situation in the market. It is a disincentive to generation investments and invites gaming to recover capacity costs and start-up costs. A cost-based dispatch would have been more appropriate . The current price distribution in the market shows that many generators are unable to recover their capacity and start-up costs from their spot transactions . This is likely to result in very high bids in an attempt to compensate for losses in the spot market. Markets that adopted cost-based dispatch at the early stages of their operations include Singapore and the PJM . Cost-based dispatch continues to apply in Chile, Brazil and Argentina. b) Pricing Errors Notice (PEN) and Market Re-Runs

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administered prices imposed by the regulator. When PEN occurs, ex-ante prices are re-run using ex-post re-run prices. This induces generators to withhold some capacity from the market because the ex-post prices, by including the must-run units, are almost always lower than the ex-ante prices. A solution would be to use ex-ante input data instead of the ex-post prices for the ex-ante re-runs. c) Must-Run-Units

(i) Dispatch The planned reserve and energy co-optimization should be implemented without delay. The current practice of constraining off individual units to provide reserves and interrupting loads to achieve supply and demand balance could lead to regular under-generation.

(ii) Pricing Must Run (MR) contracts are out of market arrangements that are necessary for the system to withstand various contingencies, particularly security and reliability that are beyond the control of a single generation firm. Must-run generators must therefore be compensated for their above-market costs when they are forced to operate even when the market price is below their operating costs. These costs include fixed operating costs (that may be scaled according to contribution to system reliability) ; opportunity cost from foregone energy or ancillary service revenue; and start-up costs . At the same time, the contract

price/remuneration must be so designed to curb the possible exercise of large market power held by the units providing the service. This requires that : (1) the opportunity cost not be linked to market outcomes ; (2) the must-run energy requirements be announced prior to running the Day-Ahead dispatch schedule; and , (3) Prior to their dispatch as MRU, Must Run generators must choose between their declared MR variable compensation or the market price. There cannot be a higher of the 2 choice to prevent the MRU from leveraging its market power to raise prices in the energy or reserve market.

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according to their contribution) and the generators variable compensation when they are called to run. This variable compensation should at least be equal to the marginal cost of providing the service. The current Settlement Procedure of Must Run Units of PEMC 53 neither guarantees fixed payments nor de-link the MRUs variable compensation to market outcomes. MRUs are paid a Generation Price Index (GPI) which is simply the average market payment during the relevant trading interval(s) . Instead of fixed payments, an MRU has to apply for additional

compensation to cover fuel and variable operating and maintenance cost (to include start-up cost and shut-down costs) if these were not covered in the GPI settlement. Thus, the GPI settlement could either under compensate or over compensate the MRU its opportunity cost depending on the market outcome . d) (i) Regulatory Intervention Market Intervention and Market Suspension

The WESM Manual on Administered Price Determination Methodology of October 2010 describes the conditions for SO intervention and market suspension by the ERC. Intervention or suspension occurs when the grid is in extreme state condition arising from: (a) an emergency; (b) a threat to system security; or, (c) an event of force majeure. It also sets-out the price determination methodology when market intervention or suspension occurs.

Only the ERC can suspend market operations and when any of the following conditions obtain: (a) natural calamities; and, (b) declaration of national/international security emergency by the President. The SO can intervene in the market in an emergency, i.e.; where a situation exists that has an adverse material effect on electricity supply or which poses as a significant threat to system security.54

It is unclear whether prior market suspensions or interventions were mainly motivated by threats to system security or influenced by high prices. Despite the non-inclusion of high prices

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PEMC WESM Manual: Management of Must-Run Units Issue 4, 28 February 2007 WESM Rules 6.3.1.1

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as a condition for market intervention, the definition of emergency in clause 6.3.1.1 of the WESM Rules leaves enough flexibility for the SO and/or ERC to intervene in the market in the event of high prices. The clause defines emergency as existence of a situation which has an adverse material effect on electricity supply or which poses as a significant threat to system security. The phrase has an adverse material effect on electricity supply is ambiguous enough to allow for such a flexibility. Market suspension or intervention due to high prices curtails real market price formation that is essential to signal the need for generation investment and dulls the incentive for such investments. At the very least, the regulatory price cap should be allowed to work and must be hit in emergency situations caused by insufficient supply. On the other hand, extra-ordinary price spreads caused by transmission congestion should be addressed by Transmission Rights instead of market intervention.

Force majeure events are those enumerated in clause 6.7.2 of the WESM Rules: a) major network trouble that caused partial or system-wide blackout; b) market system hardware or software failure that makes it impossible to receive or process market offer/bid information or dispatch the system in accordance with the WESM Rules; and, c) any other event, circumstance or occurrence in nature of, or similar in effect to any of the foregoing.

(ii) Administered Price Determination The Administered Price for generators for each generator node shall be the load-weighted average of the ex-post nodal energy price and metered quantity of the 4 most recent same-day, same hour trading intervals that have not been administered. In case they were administered, they will be replaced with prices that have not been administered for the most recent earlier same or similar day. If prices in these same-day, same hour trading intervals reflect constraint violation coefficient prices or are subject of a pricing error, the WESM Manual for the determination of price substitutes for pricing error shall apply.

The base period for determining the settlement amount is too short . An alternative would be the average of the corresponding prices for the 30 days preceding the market intervention or

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suspension. The methodology for price substitution in cases of pricing errors was previously addressed.

6.6

SECURITY OF SUPPLY

Security of supply refers to the adequacy of capacity to supply demand and the reliability of the generation and delivery systems that should result in affordabale rates to end-users55. The adequacy of supply can be measured in terms of the timely availability of capacity while reliability is best measured in terms of the risk of interruptions of end-users due to the outages in the supply (generation) and delivery (transmission and distribution) systems.

The unbundling of generation, transmission, distribution and supply in the restructured power industry also unbundled the responsibilities for demand forecasting, capacity planning and project commitment in each sector. The Department of Energy forecasts the demand by Grid (i.e., Luzon, Visayas and Mindanao Grids) and prepares indicative generation plan in accordance with the mandate of EPIRA that liberalized the generation sector of the power industry. Unlike before (i.e., prior to EPIRA) where the National Power Corporation prepared a committed plan, the private sector is expected to submit to DOE its proposed generation projects with targets or committed commissioning dates. The Philippine Grid and Distribution Codes prescibe the forecasting and capacity planning for transmission and distribution networks. The transmission and distribution utilities prepare the Transmission Development Plan (TDP) and Distribution Development Plan (DDP), respectively wherein the first five (5) years are committed while those beyond five years are indicative. From the operational perspective, the transmission company is mandated by EPIRA to ensure the security of supply (i.e., to ensure that there is adequate reserve to respond to the outages of generation facilities. The TDP and DDPs are consolidated by DOE together with the generation plan to form the Power Development Plan.

55

Energy security, according to the International Energy Agency (IEA) is characterized by the energy supply and delivery system that is (a) adequate, (b) Reliable, and (c) affordable. The European Commission defines it as Uninterrupted physical availability of energy products on the market, at a price which is affordable for all consumers (private and industrial) University of the Philippines National Engineering Center 121

Philippine Electric Power Industry Market and Policy Assessment Final and Analysis of International Markets Report 6.6.1 CAPACITY PLANNING AND PROJECT COMMITMENT
The DOE has a well defined process and timeline in preparing the Power Energy Plan (PEP) which contains the Power Development Plan (PDP) as mandated by EPIRA (Sec. 37). The PEP planning process starts in January of each year with the review of the implementation of the previous years plan and in updating policy directions and government commitments. In February, DOE conducts sectoral planning and coordination meetings internally together with the attached agencies (i.e., NPC, TRANSCO, PNOC, NEA and PSALM56) to set the key planning parameters and formulate the initial sectoral simulations. Sectoral public consultations are held in March to solicit issues and concerns as well as regional and provincial plans. A strategic planning workshop within the DOE is held in June to present the assessment and draft sectoral plans/programs with the end-view of resolving conflicting policies. By the first week of July, the Energy Plan which integrates and harmonize the energy sub-sector assessment, plans and programs inlcuding supply-demand outlook, investment requirement and legislative agenda is formulated by DOE. The energy plan is presented within the Energy Family and later to the public for review and comments. The DOE finalizes the Energy Plan by end of July. The final version of the annual Philippine Enery Plan is submitted to the Office of the President and Congress on or before September 15. The planning process for the generation sector assumes that the private sector will respond and commit to build the generation capacity based on the demand-supply outlook indicated in the Power Development Plan (PDP). The annual PDP published by DOE since 2001 indicated that there are enough committed generation capacity that will be commissioned to meet the supply requirements. However, these commitments did not translate to actual additional installed capacity according to the timeline or expected commissioning year. A gap exists between the generation capacity planning of DOE and the commitment of private generation developers to build power plants.

Except for a few ECs and PDUs, most of the DUs did not sign bilateral contracts before the expiration of their TSCs with NPC. Those that signed after a long process of negotiation have
56

Planning documents from DOE indicates that PSALM is considered as an attached agency although by law it is an attached agency to the Department of Finance as it is chaired by the Secretary of DOF

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signed short term (1-3 years) contracts with the new owners of NPC power plants and the IPPAs. It is also noted that even MERALCO which represent about 70% of the market in Luzon did not sign new bilateral contracts. Apparently, the Philippine WESM does not really provide an effective signal to Generators to commit in building power plants for new/additional capacity. After four (4) years of commercial operation of Luzon WESM that has been indicating the tight supply situation, there has been no response to the need of the market as no merchant power plant has been committed by any GENCO. A new capacity which will most likely be added in the Grid (based on the stage of plant construction) that can be considered as the only real committed plant by the private sector is covered by long-term contracts, after it was able to convince small DUs to aggregate their demand.

Based on the contracting and WESM experiences so far, it can be concluded that under the current capacity planning and project commitment process in the generation sector, the only modality to ensure the timely availability of new capacity additions is to pursue medium to longterm (i.e., at least ten years) power supply contracting between GENCOs and DUs.

Unfortunately, the GENCOs perceive the power supply contract approval in ERC as a big risk. This is evident in the power supply contracts submitted by the DUs to the ERC which include provisions like ...If the ERC will not approve the Power Supply Agreement, the supplier will not be obligated to supply... and ...If the ERC approved a different rates, the Supplier will not be obligated to supply if the the approved rates will not be financially viable. The financial closure with lenders for project financing is now very much dependent on the regulatory approval of the power supply contracts by the ERC. This issue can be addressed by a government-enabled and regulator-backed competitive selection process through power supply auctions with a preapproved template of power supply contract so that the results of competitive selection process or auction are not subjected to additional regulatory review.

As to the transmission and distribution sectors,

the eventual commitment to build network

capacity is not problematic since the regulatory process assures the investors of recovery and returns for their investment.

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Philippine Electric Power Industry Market and Policy Assessment Final and Analysis of International Markets Report 6.6.2 PLANNING METHODOLOGY AND CRITERIA
The other issue in ensuring security of supply is related to the planning methodology and criteria used by the respective planners in generation, transmission and distribution. It can be gleaned from the PDPs published by the DOE that it adopted a deterministic methodology in generation capacity planning. As shown in Figure 31, the capacity reserve requirements correspond to the Operating Reserve criteria of the transmission utility (NGCP) which is based on the single outage contingency criteria, a deterministic approach. Billinton57 emphasized the deficiency of the deterministic approaches and the need for adopting probabilistic methods in reliability risk assessments of power systems. Hence, the probabilistic methodology are used all over the world even by developing countries. The deterministic approaches do not provide consistent risks assessment because of the probabilistic nature of load variations and forced outages of plant equipment. In addition, the reliability risks are dependent on the number, type and capacities of the equipment as well as the size of the power system. For example, the U.S. and European power systems can adequately address the reliability risks even with less than 10% reserve margin for an expected one loss of load in ten years while the Luzon Grid will require 30% reserve margin for a one loss of load in one year58.

57

R. Billinton, et. al., Applied Reliability Assessment in Electric Power Systems, 1991, IEEE Press. 58 R. del Mundo, Development of Models and Methodology for Optimizing Power System Reliability, University of the Philippines Diliman, 1991

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Source: DOE PDP Figure 31. Generation Capacity Plan of DOE PDP

It must be noted that prior to EPIRA, the National Power Corporation prepared generation plans that meets the one day per year (1 day/yr) loss-of-load expectation (LOLE also called loss-ofload probability or LOLP ) reliability criteria in compliance with the government (NEDA) directive to adopt the results and recommendations of the value of loss-of-load and power system reliability study59. Thus, DOE appeared to have digressed when the generation planning was assigned to them as a consequence of the EPIRA reforms.

The operational reliability criteria for the determination of ancillary services is deficient from the point of view of capacity planning. It does not take into consideration the scheduled maintenance outages of power plants. Based on the Open Access Transmission Service (OATS) and the Ancillary Service approved by the ERC for NGCP, the levels of reserve correspond to frequency regulating (2.8%), spinning or contingency (10.3%) and dispatchable back-up (10.3%) which totals 23.4% ; the level of required reserve margin in the DOE PDP as shown in Figure 31.
59

U.P. National Engineering Center, Optimal Power Supply Reliability for the Philippines, NEDA TDI No. 53, 1991

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The DOE must use a higher reserve level for the reliability criteria. Based on the 1991 study on the optimal reliability for Luzon Grid when the demand was about 3,000 MW, the 1 day per year LOLP correspond to 30% reserve margin. By this time (with about 7,000 MW demand), the reserve margin would correspond to 25-28% reserve margin. It would be best if a Value of Lossof-Load (VoLL) study is conducted which is useful in setting the optimal reserve requirement for capacity planning and in operating reserve planning. In must be noted that the VoLL is also required under the WESM Rules which unfortunately is still missing since day 1 of the operation of WESM. Pagobo and del Mundo60 reported in their study on the application of probabilistic approach to establishing spinning reserve for the Luzon Grid that the optimal spinning reserve (for year 2007) should have been only 85% of the reserve requirement established using the deterministic single outage contingency (i.e., 10.3% of the peak demand). There is therfore an opportunity to reduce the cost of ancillary services if a probabilistic approach is used. The value of loss of load used by Pagobo and del Mundo is the inflation-adjusted cost of power interruptions to industrial consumers in Luzon established in 1991 by del Mundo. It is therefore recommended that the DOE or NGCP conducts an update to the value of loss of load study in 1991. It is further recommended to the NGCP to adopt the probabilistic approach methodology in the determination of operating reserves. The ERC can require the NGCP to undertake this in its submission for the approval and inclusion of rates for ancillary service.

6.6.3 PROVISION OF OPERATING RESERVE


The Operating Reserve (Spinning and Stand-by) is included in the Ancillary Services provided by NGCP as the System Operator (SO) in accordance with the Philippine Grid Code. These reserves address the security concerns resulting from forced outages of generating units. While it is clear that NGCP is responsible for the provision of these reserves, the WESM Rules61 provides that it

60

G. Pagobo, A probabilistic approach in scheduling spinning reserve based on FOR of Generating Units and the Value of Loss of Load, MSEE Thesis (2009), University of the Philippines *Prof. R. del Mundo served as MS Thesis Adviser] 61 WESM Rules clause 3.3.3.2 specifies that The System Operator shall arrange for the provision of adequate ancillary services for each region either: (a) By competitive tendering process, administered by the Market Operator, whereby a number of Ancillary Services Providers can provide a particular category

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must be procured either through contracting or spot market to be administered by the Market Operator (MO). In the meantime that it is not yet adminstered by the MO, the SO sourced it from NPC and other interested GENCOs. The experience of TRANSCO then and now NGCP in the provision of operating reserve indicated that the the actual reserve that were provided are less than the required level approved by ERC. The experience in 2010 is a classic case of this problem. There were interruptions due to forced outages of some power plants. To address the problem of deficient Operating Reserve, the ERC must impose corresponding penalty to the System Operator if the required reserve was not met or provided by the System Operator.

With regards to the administration of the MO for the procurement of the reserve, the Market Rules, assumes that the market will automatically provide the reserve. To ensure the security of the Grid, it is necessary to issue a clear policy that will mandate the System Operator to source the operating reserve through long-term bilateral contracts (say 90% of required reserve) and source only a limited amount from the spot market (say 10%). This is similar to the mandate of the DUs to source 10% from WESM for balancing supply and demand purposes because the security of supply is supposed to be ensured by new capacities resulting from long-term bilateral contracts for 90% of the demand. The premise of this policy recommendation emanates from the fact that trading of energy in WESM did not produce new investment for generation capacity and so it cannot be relied upon for the Operating Reserve. The long-term contract will provide security while the short-term trading in WESM of the balancing requirement could achieve lower cost of ancillary service.

6.6.4 REPLACEMENT POWER FOR MAINTENANCE OUTAGE


The replacement power for generating units maintenance (scheduled) outages are not included in Operating Reserve because EPIRA envisioned that the Wholesale Competition market design (with WESM) will automatically lead to Full Requirements power supply contract (as opposed

of ancillary services; or (b) By negotiating contracts directly with an Ancillary Services Provider who is a Direct WESM Member, where only one Ancillary Services Provider can provide the required ancillary services; or (c) Where applicable, by competitive spot market trading in accordance with clause 3.3.4.

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to the (Generaing Plant-contingent PPA).62 Unfortunately, the contracts signed by DUs with GENCOs for new generating capacities (e.g., GNPower in Luzon and KEPCO and SALCON in the Visayas) indicated that the GENCOs are excuse to supply during plant outages (maintenance or forced) as well as with some new owners of the privatized NPC plants. There is no security problem for the forced outages because it is covered by Ancillary Services. However, maintenance outage allowances in these contracts creates a risk for the DUs as they face either high market price or even lack of supply for the replacement power. Unfortunately, in the same contract, the GENCOs have taken advantage of the market design wherein they can supply from other power plants or from WESM (at their discretion). This is a clear case of selective application of contract provisions from Purchasing Agency or Single Buyer Market model to Wholesale Competition market model. The power purchase agreement (PPA) of IPPs is applicable basically to a the Single Buyer market since as the Single Buyer has the portfolio of power plants to manage forced and maintenance outages. The PPA which is plant-contingent contract does not work to multiple-buyer market. This may apply to MERALCO because it is virtually a Single Buyer in Luzon because of its market share. But this will definitely not work in the context of small private DUs and Electric Cooperatives. The DOE or ERC must issue a policy directive or rules and regulation that power supply contracting under EPIRA shall be Full Requirements contracts and Plant-Contingent contracts are not allowed.

62

Full Requirements contracts obliged the seller (GENCO) to supply 24/7 the buyer (DUs) in accordance with the agreed demand specified in the contract. The seller is not obliged to supply its customers from its generating plants. Plant-Contingent Power Purchase Agreements (PPA) of IPPs obliged the seller to supply only from the sellers Power Plants. Hence, they are excuse during maintenance outages.

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Philippine Electric Power Industry Market and Policy Assessment Final and Analysis of International Markets Report 7 ASSESSMENT OF INSTITUTIONAL GOVERNANCE FRAMEWORK

The preceding review of the achievements of the EPIRA and the assessment of industry regulation do not paint a flattering picture of the state of the industrys regulatory governance. The core contents of regulatory governance are: (1) the objectives and functions of regulation ; and, (2) the specific institutional framework or the design aspect of regulation. The first was reviewed in Sections 2 and 3 of this report. This part will assess the second.

7.1

OVERVIEW OF INSTITUTIONAL GOVERNANCE

The immediate institutional governance framework of the Philippine electric power industry comprise of: (1) the ERC, as the regulator; (2) the DOE , as the policy body; and (3) Congress through the Joint Congressional Power Commission as the oversight body. Decisions of the ERC can only be appealed to the Court of Appeals and ultimately, to the Supreme Court. This structure is presented in Figure 32 below.

Figure 32. Governance Structure of the Philippine Electric Power Industry

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Philippine Electric Power Industry Market and Policy Assessment Final and Analysis of International Markets Report 7.2 APPRAISAL OF INSTITUTIONAL GOVERNANCE

The study applies the criteria developed by Stern and Holder for the assessment of the performance of regulatory systems in the developing countries in Asia.63 The criteria include: a) Clarity of Roles and Objectives; b) Autonomy; c) Participation; d) Accountability; e) Transparency; and f) Predictability.

7.2.1 CLARITY OF ROLES AND OBJECTIVES


This refers specifically to the clarity of the roles and responsibilities between the policy making and regulatory agencies. Clarity is essential to enhance accountability and predictability in the regulatory process.

The EPIRA clearly delineates the roles of the DOE and ERC. The latter has exclusive authority over rates and as detailed in Section (43) has principal responsibility for consumer protection by promoting competition; encouraging market development; ensuring customer choice and by penalizing abuse of market power . The DOE is mandated to ensure the proper implementation of the EPIRA. In addition, Section (37) mandates it to:

a) Ensure the reliability, quality and security of electric power supply; b) Facilitate /encourage reforms in the structure and operations of distribution utilities; c) Develop policies and, where appropriate, promote a system of incentives for adequate and reliable electric supply including reserve requirements;
63

Stern John and Holder Stuart Regulatory Governance: Criteria for Assessing the Performance of Regulatory Systems, An Application to Infrastructure in Developing Countries of Asia, May 1999

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d) Establish the WESM; e) Develop policies and programs for energy efficiency; f) Formulate and implement programs for the development and commercialization of non-conventional energy systems; g) Encourage private sector investment in the electricity sector; and h) Promote the development of indigenous and renewable energy sources.64

The DOE Secretary is also directly responsible for total electrification as Chair of the National Electrification Administration.

Notwithstanding the clear delineation in the EPIRA, the DOE largely relinquished its role, leaving most matters in the hands of the industry participants and to the ERC. The associated

consequence was that the ERC did not have much policy guidance for its regulatory decisions and attempted to fill the void by regulation. A specific example is the adoption of the new rate setting methodology for the ECs. The new methodology is an attempt to address the chronic financial instability of the ECs in the absence of effective DOE policy initiatives to stabilize their financial situation. With respect to the encouragement of private sector investments; the Department has not gone beyond the customary investment missions and fiscal incentives when it could have initiated an in-depth examination that could have led to the identification of weaknesses in the contracting process as a disincentive to investments. The DOE points to a number of factors as being constraints on its ability to effectively perform its responsibilities under the EPIRA.65 These factors include the ERCs insistence on its independence which constraints the DOE from taking the initiative to design policy and undertake programs to address the industrys problems; (a view, incidentally, shared by many in the industry), limited in-house capability (based in large part on its lack of funds to hire additional staff) and the reported lack of police power to enforce its decision to undertake non-price regulation that are

64 65

EPIRA, Section 37

Based on interviews by a member of the study team with DOE officials for a prior ADB study 131

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outside the ERCs authority notwithstanding Section 37 (p) and (q) that explicitly vest the Department with such powers.66

7.2.2 AUTONOMY
This pertains to autonomy from political interference and equally importantly, to security of tenure and financial autonomy. The ERC does not enjoy financial autonomy because its budget must be approved by Congress through the regular budgetary process. Almost 65% of its budget are for salary and personnel expenses. This does not leave much for staff training and to raise salaries to the level of the regulated utilities to attract high quality staff and reduce employee turn-over. Instead, the agency is dependent on external consultants that are mostly packaged with the technical assistance provided by bilateral and multilateral agencies. The annual

appropriation may be augmented if its collection from supervisory, licensing and other fees exceed its revenue target that is set by the government; e.g.; at PhP300 Million for 2009. This process has resulted in a perverse incentive to collect varied and increasing fees from industry participants that are eventually passed on to the consumers.

The ERC is an independent body that is legally free from government interference. The Commissioners have security of tenure. The prevailing opinion is that it has taken its independence to the extreme, i.e.; in a manner that precludes coordination with other executive agencies and meaningful consultations with industry stakeholders.

7.2.3 PARTICIPATION
Meaningful participation by all stakeholders is required to improve the quality of regulatory decisions and to increase the likelihood of support from the regulated entities, consumers and the general public. The ERCs process achieves the opposite effect and is costly to both the utilities and the consumers. It is a litigious/rule making approach that requires petitioners and oppositors to hire lawyers; limits the participants to petitioners, accredited oppositors and
66

Sections 37 (p) and (q) authorizes the Department to formulate such rules and regulations as may be necessary to implement the objectives of this Act and exercise such other powers as may be necessary or incidental to attain the objectives of this Act. University of the Philippines National Engineering Center 132

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intervenors; and, limit itself to considering the facts of the case and avoids the consultative and iterative approach adopted in other jurisdictions (e.g. UK, Australia, UK) where debates are encouraged and a broad range of comments are invited and heard. The ERC claims that its process is called for by the quasi-judicial nature of its decisions notwithstanding that other quasi-judicial entities in the country and in the United States (from where the process was borrowed) undertake wide ranging and non-legal consultations . Aside from being the result of the regulators narrow interpretation of the quasi-judicial process, the litigious process could be a reflection of its limited capacity to undertake comprehensive economic and technical evaluations to support its decisions.

7.2.4 ACCOUNTABILITY
Accountability depends on the availability of an effective mechanism to challenge regulatory decisions. The current appeal mechanism where appeals could be decided by the ERC and/or the courts anywhere from 1 to 5 years does not induce accountability.

7.2.5 TRANSPARENCY
A transparent regulatory framework requires the regulator to explain and justify its decisions and processes in a manner that leads to a clear understanding by all participants of the rules of the game.

Section 21 of the EPIRA on Reportorial Requirements requires the DOE to submit to the Joint Congressional Power Commission (JCPC) a semi-annual report on the laws implementation. The ERCs report to the DOE is submitted to and integrated by the DOE in this report. The final report is published in the DOE website.

The ERC also prepares an Annual Report that is published on its website. The Annual Report and the report to the JCPC detail its accomplishments in the past year and the related pending issues concerning its ongoing work. Feedbacks to the DOE and ERC reports are seldom received from the JCPC.

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The ERCs decision-making process is fairly transparent as the regulator regularly publishes on its website its rules and decisions with their corresponding reasons. However, stakeholders, particularly consumers, complain that the attachments to rate applications that provide the basis for the rate petitions are not published in the website and are not easily accessible at the ERC contrary to the latters claim that they can be easily reproduced for a fee. Even the utilities complain that they are not given access to the ERCs computations/calculations that form the basis of the rate decisions and adjustments in the terms of the power supply contracts that are submitted for approval.

7.2.6 PREDICTABILITY
A predictable regulatory framework precludes regulatory opportunism and/or sudden changes in the over-all legal framework. It does not necessarily mean being welded to set legal precedents to the exclusion of unique economic and technical factors attendant to a case. Industry stakeholders and observers claim that ERC decisions are either too predictable or too unpredictable. Decisions on tariffs, capital expenditure and similar issues are criticised for

failing to take into account differences in operating situations of the utilities. For instance, stakeholders observed that the ERC appears to have a pro-forma decision where only the numbers and the name of the utility are changed (and, in one or two rate decisions, it even neglected to change the name). On the opposite end, generators and distribution utilities cannot predict how the ERC will rule on their power supply contracts. It was also observed that the decisions and/or rules are rarely accompanied by considerations/evaluations of their economic, financial and technical merits.

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III

ANALYSIS OF INTERNATIONAL MARKETS

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Philippine Electric Power Industry Market and Policy Assessment Final and Analysis of International Markets Report 8 PURPOSE OF ANALYSIS OF COMPARABLE INTERNATIONAL MARKET

The analysis of international markets is intended to enrich the study by providing a model for the design of policy reform and empirical evidence for or against certain policies under reasonably comparable circumstances. To that end, the study analyzes the experiences of Chile and Brazil with respect to the: a) Characteristics and issues of the industry prior to reform; b) Institutional framework including legacy economic policies and political structure; c) Approach to and design of the reform; d) Key elements of the reform process as regards to incentives and governance; e) Defining features and characteristics or best practices; and f) Policies to address specific issues relating to generation investments.

Aside from having the longest running and most comprehensive electricity reform after WWII, Chiles reforms which started in 1982 are widely acknowledged to be highly successful and a model for developing countries around the world. Chile has been in the forefront of innovation in the creation of electricity markets. Brazil on the other hand has the largest electricity market in South America. Capacity addition had lagged behind demand growth before the reforms. These two countries have the highest access rates in Latin America. From a policy and regulatory perspective, it is helpful to have a good understanding of how their energy sector copes with such an increase in demand. While Chiles electricity system shows that effective competition and privatization is possible in a relatively small market, Brazils illustrate that it is possible in a large developing market. Their combined experiences and lessons learned are highly instructive for developing countries like the Philippines that are still grappling with electricity reforms.

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Philippine Electric Power Industry Market and Policy Assessment Final and Analysis of International Markets Report 9 9.1 CHILES ELECTRIC POWER INDUSTRY OVERVIEW OF ELECTRIC POWER INDUSTRY OF CHILE

Chiles power sector is organized in four (4) grid systems, namely: a) Sistema Interconectado Central (SIC), the Central Grid, which serves over 90% of the population and covers more than 40% of the countrys area; b) Sistema Interconectado Norte Grande (SING), the Northern Grid, which is mainly thermoelectric and serves mostly the mining industry in the region that accounts for 98% of the systems demand ; c) Aysn and Magallanes Grids, which are both located in the extreme south of the country and serve the remote areas. The combined capacity of both grids represents about 1% of Chiles total generation capacity .

The power sector consists of four private players that interact in the supply chain: Generation, Transmission, Distribution Companies, and Clients. Generation companies produce the energy using different sources (hydroelectric, coal, gas, diesel, wind ) that are sold to distribution companies and non-regulated clients or consumer with consumption greater than 2,000 kW. Regulated clients are obliged to buy electricity from a distribution company while non-regulated clients can buy power and energy from any generation or distribution company.

The structure of the installed capacity is shown in Figure 33. The hydro capacity is very variable due to periodic draughts. During very wet years such as in 2002, the energy supplied reaches 53% of the national load. During dry years such as in 1999 , it supplies only about 36% . The generation profile per technology is shown in Figure 34.

An independent entity, the Economic Dispatching Center (CDEC) coordinates the operation of the systems. CDEC ensures the efficiency, security and sufficiency of the power supply in compliance with applicable regulations. It also calculates the payments between generation,

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transmission and distribution companies. Its board is composed of the representatives of the generation and transmission companies and non-regulated clients. Figure 35 illustrates the structure of the Chilean electrical market.

SISTEMA INTERCONECTADO CENTRAL

45,000 40,000

80% 70% 60% 50% 40% 30% 20% 10% 0%


2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 (*)

Energa generada (GWh)

35,000 30,000 25,000 20,000 15,000 10,000 5,000 0

EMBALSE GNL DESECHOS DIESEL-FUEL Participacin Hidroelctrico 16,000 14,000

PASADA CARBON-PETCOKE DIESEL EOLICA Participacin Gas Natural

GAS CARBON FUEL Participacin Carbn Participacin Diesel 80%

DEL

SISTEMA INTERCONECTADO NORTE GRANDE

Energa generada (GWh)

12,000 10,000 8,000 6,000 4,000 2,000 0 2000 EMBALSE CARBON-PETCOKE FUEL Participacin Gas Natural 60,000 50,000 40,000 30,000 20,000 10,000 0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 (*)

60% 50% 40% 30% 20% 10% 0% 2001 2002 2003 PASADA CARBON DIESEL-FUEL Participacin Diesel 60% 50% 40% 30% 20% 10% 0% 2004 2005 2006 GAS DESECHOS EOLICA 2007 2008 2009 GNL DIESEL Participacin Carbn 2010 (*)

AMBOS SISTEMAS (SIC + SINGI)

EMBALSE GNL DESECHOS DIESEL-FUEL Participacin Hidroelctrico

PASADA CARBON-PETCOKE DIESEL EOLICA Participacin Gas Natural

GAS CARBON FUEL Participacin Carbn Participacin Diesel

Legend
Gas Natural- Natural Gas Carbn Coal Biomasa - Biomass Elica Wind Power Embalse Hydro (reservoir) Pasada- Hydro (run of the river) Derivados del Petroleo Oil Derivatives

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Participacin del total generado

Energa generada (GWh)

Participacin del total generado

70%

Participacin del total generado

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Source: CNE Figure 33. Energy Production in the Chilean National Grids

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CAPACIDAD INSTALADA SIC

Biomasa 58 MW 0.5%

Gas Natural 2,976 MW 26.7% Carbn 999 MW 9.0% Diesel 1,576 MW 14.1% Embase 3,706 MW 33.2%

Elica 81 MW 0.7%

Pasada 1,580 MW 14.2%

Derivados del Petroleo 172 MW 1.5%

CAPACIDAD INSTALADA SING

Gas Natural 2,074 MW 58.0%

Diesel 131 MW 3.7%

Carbn 1,138 MW 31.8%

Derivados del Petroleo 217 MW 6.1% Pasada 13 MW 0.4%

CAPACIDAD INSTALADA TOTAL

Gas Natural 5,050 MW 34.3%

Carbn 2,137 MW 14.5% Biomasa 58 MW 0.4% Elica 81 MW 0.6%

Diesel 1,707 MW 11.6% Embase 3,706 MW 25.2% Pasada 1,592 MW 10.8%

Derivados del Petroleo 389 MW 2.6%

Figure 34. Generation Profile Per Technology in Chile

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Free client Cliente


Free Price

Regulated Client

Cliente

Regulated Client Cliente


Free Price

FreeClient Cliente

Node Price Node Price

Empresa Company Distribuidora Node price

Distribution

Zona Concesin

Distribution

Empresa Company Distribuidora

Node Price
CDEC Marginal Cost Transfers Transferencias a Costo Marginal

Free price Free Cliente client Libre

Free Cliente client Libre

SPOT MARKET

Figure 35. Chilean Electricity Market Structure

9.2

INDUSTRY RESTRUCTURING AND POLICY REFORMS

9.2.1 KEY ISSUES PRIOR TO REFORM


The difficulty of securing project financing in the 1930s caused the industry to stagnate. The government took up the slack left by weak private sector interest and eventually ended up controlling the industry by the 1970s. A non-adjustable pricing scheme was established. The resulting prices did not cover operating costs much less the capital costs of the investments. The losses of the vertically integrated electricity companies were simply absorbed by the State. Tariffs were eventually allowed to rise between 1974 and 1980. This stabilized the financial situation of the State companies but was by itself insufficient to solve the problems that plagued the industry; namely: a) Inefficiency. Being state companies, their structures were large, complex and somehow difficult to control. The investments were planned according to technical criteria that often neglected economic considerations; b) Flawed Pricing Policy. Tariffs were not based on the efficient cost of delivering the service but on actual cost incurred by the utilities. The lack of a standard and uniform rate setting methodology led to differential pricing among the utilities and discrimination among client categories. High inflation in the seventies resulted in

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tariffs that were far below the amounts needed to recover investments. The Tariff Commission progressively lost its influence over the tariff setting process and the task of conducting pricing studies was eventually taken over by the National Commission on Energy. c) Huge Financial Drain on the State Coffers. By 1979, the State owned 90% of generation, 100% of transmission and 80% of distribution. The losses incurred by the State-owned power companies meant that minimal funds were left to maintain and provide quality service to the industrys customers.

9.2.2 INSTITUTIONAL BACKGROUND , KEY OBJECTIVES AND ELEMENTS OF THE REFORM


Reforms were started in 1982 and carried out in a dictatorial regime thus limiting consultation and opposition from affected stakeholders such as the remaining private operators, prospective investors and consumers.

The principal reform objective was to privatize the industry. The process was strongly influenced by the prevailing market ideology of the University of Chicago whose disciples were the prime mover of the reform process. The reform succeeded in creating a vibrant private industry but left lingering structural and institutional weaknesses that remain to be addressed.

Those weaknesses are partly explained by the origins of the reform, such as the decisions on privatization as well as price risks that mainly represent the national electrical system. The energy price risk is directly related to the highly varying hydrology. Frequent droughts also caused huge increases in marginal costs due to the need to replace the hydro power with highcost generators such as diesel.

One major factor to consider in the privatization effort is the presence of ENDESA, the largest generating company of the system plus the water rights that were granted to it. This company also has ownership links to one of the biggest distributors in the country. A really powerful entity was created against whom others, particularly new entrants were at a competitive

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disadvantage. Due to the importance and size of ENDESA, it is very difficult to legislate on topics that could go so far as to harm it.

The General Law of Electric Services that was passed in 1982 unbundled and privatized the industry. The law introduced a liberalized market in generation and third-party access to the transmission network, setting up a system operator to coordinate the operations of competitive generators. The privatization process began in the 80s and was completed in 1998 when the last state-owned utility was privatized.

From the beginnings of the reform, the main investment incentive element has been the establishment of prices that reflect the true costs of providing the service. This was complemented by the provision of a transparent and stable regulatory framework for the industry.

The regulatory commission, National Commission of Energy (CNE) that was created in 1978 was charged with the development of a regulatory environment conducive to the efficient development of the industry and to prepare for its privatization. CNE was provided with wide government support. Its managing board is comprised of 7 of the 21 state ministers, namely: the Secretary of Defense, of Treasury, of Economy, of Planning,, of Mining, the Presidency

Spokesman and the presiding minister of the board who is a member of the armed forces.

9.2.3 POLICY AND REGULATION OF GENERATION


The policy and regulatory framework for generation are contained in two laws, as follows: a) General Electric Services Law or DFL N4 from 2004, LGSE (for its Spanish acronym); and b) ERNC Law or Law N20257 which requires that 10% of consumed energy comes from renewable sources.

DFL N4 Law grants private generators complete freedom in their investment and marketing decisions within the pre-established rules. Any generator with more than 9 MW of installed University of the Philippines National Engineering Center 143

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capacity has the right to access the Energy Spot Market and can buy and sell energy regardless of its installed generating capacity. There is no electricity broker in Chiles electric power market.

Generation companies have two kinds of incomes for its business: Capacity Payment and Energy Income.

The capacity payment is calculated on a monthly basis (US$/kW/month) as the base payment plus the fixed operation costs of a reference gas turbine. This payment is calculated by CNE and applies to the firm power available from a unit to cover the 8 peak load hours of the winter period. The winter period goes from April 1st to September 30th. The capacity to be considered for capacity payments is calculated taking into account the availability of each unit: a) For hydro units, it considers the power they are able to supply during 8 hours per day in the winter period of the driest hydrologic condition registered in the past 40 years. As a result of this calculation, the capacity finally paid (firm capacity) varies between 50% and 70% of the installed power for these types of units; b) For thermal units, calculation takes into account typical unavailability values. The capacity paid (firm capacity) varies between 70% and 85% of the installed power; c) Thereafter, each calculated firm capacity is adjusted by a unique coefficient in a way that the sum of all the firm capacities will be equal to the peak load forecasted for the year. These calculations are performed ex ante, at the beginning of every year by CDEC, therefore the firm power of each unit is independent of its real production during the year; d) The power withdrawn by the generators in the peak load period to meet their contracts is compared with the firm power of its units. If there is a deficit, the generator is seen as a buyer of this power in the spot market in that year and has to pay the power deficit in 12 monthly payments. If the generator had surplus power, then it is considered as a power seller in the spot market and receives every month the appropriate payment. The balance of purchases and sales of firm power is University of the Philippines National Engineering Center 144

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performed at the beginning of the year based on estimations of its withdrawals at the peak load hours. This balance is recalculated once the peak load has happened and then a re-settlement is performed;

The Energy incomes come from different sources: a) Energy sales to the Spot Market; b) Energy sales to distributors companies through open and competitive bids; c) Energy sales to non-regulated costumers, by means of freely established contracts for consumers with demand over 2000 kW; and d) Energy sales by means of freely established contracts with others generation companies;

Energy Sales to the Spot Market The Spot market operates as a balancing market for generators only. Distribution companies and non-regulated costumers do not have access to the Spot Market and can only buy energy through supply contracts.

Generators are allowed to sell their uncontracted capacities and to buy for their contracted commitments. The spot market price or the hourly marginal cost are the variable costs of the most expensive unit in operation. In the event of energy shortage or rationing, the marginal cost becomes the default cost of the system.

The market is operated by the Economic Dispatch Centers (CDECs). Each CDEC plans the operation of their respective systems in the medium and short term; draws up the real time dispatch schedule of the generating units; determines the systems marginal cost and makes up the payments between generators companies.

The generation units dispatch are centrally planned by each CDEC using optimization models to get the lowest operational cost of the system subject to security and quality of service restrictions. Each hydroelectricity generator informs the CDEC of the dam levels and tributary to University of the Philippines National Engineering Center 145

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its run by the river plants. Thermoelectric generators are required to report their operating costs. The reported costs could be audited by the CDEC. The CDEC calculates weekly or at any time that it is necessary, the value of water levels at the dam and determines the hourly dispatch for the following day and by block for the incoming week. It then determines the hourly energy Spot Price of the system or the system marginal price (SMP) and calculates the energy transfers between generators that is valued at the Spot Price. The pay settlements are made directly between the generation companies without the intervention of the CDECs. Generators are paid only when they are dispatched. Payments represent the difference between energy withdrawn for the generators contract commitments and the energy sold to the market. Energy sales to distribution companies Distribution companies must contract for the requirements of the regulated market, i.e. those with demand lower than 2000 kW. The energy tariff for this market was historically regulated and fixed at the node price. However since 2010, the energy and power prices had been determined by auction where the distribution companies bid the required supply for their regulated customers consumption. The tenders are public, open, non-discriminatory, transparent and are supervised by the regulator, CNE, the Fuel and Electricity Superentindence SEC and the Economic Prosecutor.

The main characteristics of the auction are: a) The bidding terms are developed by the distribution companies subject to the approval of the CNE. The quality and safety conditions of service will be unique to all the bidders who can offer special qualities of service or additional benefits in the provision of energy tendered; b) The contract duration must be specified in the bidding document and shall not exceed 15 years. Offers of supply for periods less than or greater than those indicated in the bid terms are not accepted. CNE prescribes the maximum amount of energy that a distributor can contract in each contract and the maximum amount to be contracted per year.

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c) While bidders can bid any price, contract prices are capped at the current node price plus 20%. If the bid fails, a rebidding can be held 30 days later at which time the CNE may authorize an increase of up to 15% of the price cap. The node price is the price at the date of the tender. d) The bidder should show the change from their base bid price from the application of the price indices. The indexing mechanism should reflect the variation of the investment cost of the generating units. The allowable indices are pre-defined and are common to all bidders. Bidders are free to assign the weight factors for each index in their bids; e) The contract is awarded to the bidder offering the lowest price of energy; f) Prices obtained in the bids are established through a decree that contains the basic price and the indices for the duration of the contract; g) The indexed bid price is passed on by distributor to its final customers. The passthrough price of each distribution company cannot be higher or lower than the average price of all contracts in force 5%; and h) In the event that a vendor submits an average price that exceeds the 5% limit, the average price of the distributor is adjusted downwards to this limit. The difference in revenue generated by the adjustment will be prorated among all regulated customers in the distribution systems. The resulting reassessments will be settled between the distributors. Energy sales to non-regulated costumers Sales to customers with more than 2000 kW of demand are not subject to price controls. Generally, clients with less than 20 MW demand are still supplied by distribution companies. The competition for non-regulated customers is tough.

The prices for non-regulated customers were previously lower than regulated prices. This changed in the last 4 years because of higher spot market prices that were passed on by the University of the Philippines National Engineering Center 147

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generation and distribution companies to their non-regulated costumers. This pass through system will be allowed until 2013 when the prices in the Power Purchase Agreements will be actualized with the variations of coal prices and CPI, among others. Energy sales to other generation companies Generation companies contract with other generators to mitigate their risks. For example, a generation company with a high hydro percentage in its generation mix and a high contract volume could enter into a contract with a thermoelectric generator for back-up capacity in order to reduce its costs in the event of non-favorable hydrological conditions such as drought. Contracts between generators are expected to increase with the passage of the Non conventional Renewable Energy (ERNC) Law in 2010 . Non-RE generators are expected to contract for the 10% RE obligation mandated by the law. Policy and Regulatory Incentives for Generation The CNE prepares an indicative plan for generation expansion for the next ten years. This plan is critical to new generation investments because the inclusion of a proposed power generation project facilitates the obtaining of the project finance. This plan was the reference point for the calculation of node prices prior to the adoption of the auction system for supply contracts.

A specific investment incentive mechanism that was in place since the beginning of the reform until the year 2004 was the failure cost. This was the price for the energy transfers between generators in cases where the installed generation capacity was insufficient to supply the total demand of the system and was fixed by the regulator. This mechanism was intended to incentivize generation adequacy by equating prices to the scarcity cost or its economic costs. Generators in deficit who had to buy energy from others with surplus capacity had to pay at these high prices thus encouraging investments in backup generation. Nevertheless, this mechanism was not enforced during the energy deficit period that was caused by extreme drought. This motivated a modification of the law to harden the terms of the obligation but had an unwanted effect: the generating companies avoided signing supply contracts with the distributors because of a negative risk evaluation. This situation was aggravated by the curtailment in the supply of natural gas from Argentina that caused uncertainty over the choice University of the Philippines National Engineering Center 148

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of generation technology to invest in. The crisis motivated another amendment to the law that obliged distribution companies to auction long-term contracts for their energy requirements. This competitive tendering process has proven to be more effective in attracting new generation investment than the Indicative Generation Plan.

Before 2005, the generators were not interested in contracts with distributors as the investment in coal, wind, hydro or geothermal plants were threatened by the possibility of recovery of the gas importations from Argentina. Assuming this was the case, then the non-gas plants would not have been competitive and the regulated prices would have gone down (as the regulated prices were then calculated as the weighted average of the marginal costs for the next 48 months).

The success of the auctions implemented in 2005 in enhancing the generators investment is due to the indexation system. In that system, the generators can choose an indexation based on combinations of the fuel price variations and the CPI.

The indexation system resulted to a huge improvement in the investments generating a large portfolio of projects as summarized in Table 28.

Table 28. Investments for New Generation Projects in Chile

TECNOLOGY
Coal Thermal plants Hydro Power Plants Wind Power plants Geothermal Plants

QUANTITY POWER PROJECTS MW


29 38 18 14 7600 12100 1260 540

TOTAL

21500

It has to be noted that not all those projects have been constructed nor are currently being constructed as the legal and environmental processing is extensive and complex. This significantly affects the timing of the projects, sometimes causing indefinite postponement. This situation specially affects coal plants as well as the hydro plants with reservoirs. University of the Philippines National Engineering Center 149

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Prior to the implementation of the auction system, there were no generation deficits due to the contribution of small investors that installed emergency generation equipment (diesel engines and turbines). Those investors were motivated by the capacity payments and the possibility of obtaining high marginal prices (which actually happened in the period previous to the international economical crisis). The downside was high electricity prices because of the high cost of operating these plants.

9.2.4 POLICY AND REGULATION OF TRANSMISSION


The transmission system in Chile is divided into 3 categories: the Trunk System, Subtransmission System and the Additional System. The Additional System is composed of the transmission facilities, lines and power substations that are primarily intended to transmit electricity to non-regulated costumers and other end-users for which the generators are allowed to inject energy to the interconnected system without being part of the Trunk System.

DFL N4 mandates open access to the transmission system. However, open access to the Additional System is limited to the transmission facilities that use national properties. The transmission charges for the Trunk and Sub-transmission systems are determined by the CNE and valued by the CDECs who inform the companies of the amounts that they must pay. Tariffs are fixed for a 4-year period. Payments for the use of Additional system lines are negotiated between the owner and the user.

The law limits the participation of generators, distributors and consumers in the ownership of the trunk system. The individual participation, directly or indirectly, of companies operating in any other segment of the electrical system or of users who are not subject to price fixing in the main transmission system may not exceed eight percent (8%) of the total investment value of the main transmission system. In addition, the sum of the individual participation of generators, distributors and non-regulated costumers in the ownership of the trunk transmission system shall not exceed forty percent (40%) of the total value of the trunk system.

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The income that transmission companies receive for their existing installations corresponds to the annuity of the investment value (AVI) plus operating, maintenance and administration costs (COMA). The annuity of the investment value of existing facilities is calculated using a discount rate of 10% in real terms (before taxes) and an economic life of 30 years.

Payment for new facilities in the trunk systems is equal to the bid of the winning bidder in a competitive tender. The expansion of existing facilities is assigned to their respective operators and is paid as a function of their declared investment value during the bidding for their construction.

For the Sub-transmission systems, the Annual Investment Value (AVI) and the Annual Operation and Maintenance Costs (COMA) are determined in quadrennial for each demand adapted system.

The privatization of the transmission sector acted as a catalyst for new investment that was reinforced by a tariff process that ensured cost recovery and a fair return on investments.

Both the Trunk and Sub-Transmission systems are subject to price controls.

Prices are

determined in quadrennial studies that consider demand projections and new generation investments. The study, which is undertaken by private and independent consultants determine the tolls to be paid for the use of the facilities; which power lines or substations shall be upgraded; and/or, if new facilities are needed. The toll is a function of the level of investments; the operation and maintenance costs of the facilities, with a 10% average cost of capital over an economic life of 30 years.

These studies are reviewed and approved by a special commission whose members are drawn from the electricity industry and from the government. The construction of facilities that are declared as essential for the operation of the transmission systems goes through an international tender. The tolls to be paid for the use of the new facilities are based on the results of the bidding processes.

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The authority to construct and operate a public distribution network is granted through an indefinite nature concession that obliges the concessionaire to provide service to anyone who requests for it. The concession could be terminated in case of repeated poor service.

Distribution companies must have supply contracts with generators to supply their regulated customers for at least the next three next years. This contract is the result of the bidding process explained previously in this document.

The electricity tariff that apply to regulated customers consists of the prices of energy and power that unifies generation (energy and power), transmission (high voltage line and substation use) and distribution (medium and low voltage line and substation use) costs. The distribution charge is determined by the Distribution Annual Value (VAD). The VAD is calculated as the capital, operating and maintenance costs of an efficient distribution utility, with density characteristics comparable to the utility to whom the distribution charge will apply. Therefore, the distribution tariff under this methodology is de-linked from the utilitys own and actual cost. The capital cost is determined as the new replacement value of the efficient comparable model and the monthly payment is calculated based on a 30 years economic life and 10% real annual cost of capital. The operation and maintenance costs are based on effective management and administration costs while overhead costs; on the number of customers of the company model.

There are different types of cost considered in the VAD calculation: a) Administrative costs due to the existence of the client. This is a fixed monthly fee, regardless of user consumption; b) Cost for energy consumption. Each kWh consumed by the customer requires the company distributor to purchase a kWh plus the corresponding distribution losses; c) Cost of peak power consumption. Each KW consumed by the customer requires the distribution company to buy that KW plus distribution losses corresponding to the system generator; University of the Philippines National Engineering Center 152

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d) Cost per customer power demand in the local peak demand hours of the system. This cost refers to the required capacity of facilities to cope with customer consumption that coincides with peak demand. This requires the distribution company to expand its substations, lines and transformers, high and low voltage to cater for every additional KW customer demand for peaking power; and e) Cost per customer power demand during off-peak hours. This has no impact on investments at substations, transformers and lines away from client but nonetheless affects the investments on facilities that that are near the clients and are more specific to their demand behaviour.

The CNE hires one or several consulting firms to carry out the study while distribution companies undertake the same study with consultants chosen by them, but approved by the CNE. The results are weighted 1/3 for the study of distributor and 2/3 for the study of the CNE. Tariffs are indexed through formulas that run for 4 years.

The VAD calculation mechanism generated the results in Figure 36 based on a reference study conducted by the Pontifcia Universidad Catlica de Chile (2009).

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Figure 36. Percentage Change in Distribution Tariffs From VAD

9.3

CHILES POST REFORM INSTITUTIONAL GOVERNANCE FRAMEWORK

The Ministry of Energy was recently created. It is the agency responsible for the development of plans and policies for energy sector including forecasting the demand and domestic supply of energy. Other institutions that have key governance roles are: a) National Energy Commission, CNE (for its Spanish acronym). It is the entity responsible for setting all electricity prices except those in the non-regulated retail market. The CNE is under the Ministry of Energy. b) Fuel and Electricity Superintendence, SEC (for its Spanish acronym). It is the entity responsible for ensuring the correct operation of the electricity, gas and fuel services in terms of security, quality and price. It oversees the proper implementation of the framework laws for these industries. c) Economic Dispatch Centers, CDEC ((for its Spanish acronym)
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CEDCs are

independent entities that are responsible for the optimal operation of each interconnected electrical systems, called Economic Dispatch Centers. They are also responsible for the valuation of the energy and power transfers between generation companies and for the calculation of the transmission lines toll to be paid by the companies. Their Boards are made up of the representatives of generators companies, transmission companies and non-regulated customers. By their sheer number and by the manner of selection of representatives that is biased for the bigger companies; generation companies particularly the big ones have a large influence over the decisions of the Board. The inclusion of non-regulated costumers adds transparency to the decisions and actions of the CDECs . d) Experts Panel. The panel was an offshoot of the amendment of the Electricity Law in 2004. It consists of 2 lawyers and 5 engineers or economists who are appointed for

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There are two CDEC in Chile, CDEC-SIC that rules the Central Interconnected System, an CDEC-SING in charge of the operation of the Big North Interconnected System.

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6 years who are selected by the members of the Chilean Court of Free Competition. Their work is to resolve differences arising between the authority and the electricity market agents in connection with the application of the rules set out in the Electricity Act and its Regulations. The Expert Panel also solves the differences between the wholesale electricity market agents who are members of CDEC.

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10.1

OVERVIEW OF THE ELECTRIC POWER INDUSTRY OF BRAZIL

Generation The Installed generation capacity and peak load of Brazil from 2001 to 2010 is shown in Table 29. The generation system in Brazil in 2010 has an installed capacity of 112,400 MW . Total energy generation in 2010 was 475,104 GWh ; contracted import capacity at 5,850 MW ; and, a maximum demand at 68,307 MW.

There were 2,336 generating plants in 2010. Of these 72% (80,637 MW) of installed capacity was hydro, 19% (21,003 MW) thermal , 7% (7,826 MW) biomass (mainly sugarcane bagasse), 2% (2,007 MW) nuclear power and 927 MW wind power. It is notable that 79% (89,390 MW) of generating capacity is from renewable energy . An additional 18,000 MW of generating capacity is expected to operate in 2010 to 2011.

Table 29. Installed Generating Capacity in Brazil (2001-2010) Year 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Peak Load (MW) 55,099 50,757 53,515 56,795 59,103 61,782 64,371 65,586 67,442 70,954 Installed Capacity (MW) 74,877 80,315 85,857 90,679 92,865 96,295 100,352 102,949 106,570 112,400 Reserve 36% 58% 60% 60% 57% 56% 56% 57% 58% 58%

The National Interconnected System (SIN) is a system of large hydrothermal base that is predominantly hydro and with multiple ownership. The SIN consists of four major subsystems: South, Southeast / Mid-West (the largest in the country for its application and serves the regions largest population and industrial production centers ), North and Northeast. All the University of the Philippines National Engineering Center 156

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hydro power systems are allowed to maintain a large energy storage capacity during the wet years in anticipation of the dry years. The interconnections between the subsystems allow joint optimization of the generation in different watersheds, thus leveraging on their hydrological diversity. Current configuration allows the SIN to carry all the power generated in any of the subsystems to the demand centers.

The system in the Amazon where energy demand is about 3% of the country is not yet fully inter-connected to the SIN. However, the interconnection in 2001 of the capital city of Manaus substantially reduced the number of non-interconnected systems and confined them to those that are scattered in the Amazon region.

The system in the central Itaipu on the border with Paraguay with a demand of 14,000 MW has a frequency conversion capability that allows Brazil to purchase power from Paraguay at 50 Hz . There are also interconnections with Paraguay for 50 MW; with Argentina for 2050 MW; with Venezuela for 200 MW (not integrated into the national grid in Brazil) and Uruguay for 70 MW. Energy Import Contracts were signed with Argentina and Venezuela in addition to the

agreement to purchase power from the central Paraguay binational Itaipu dam.

Transmission The current transmission system in Brazil has more than 95,000 km of power lines greater than or equal to 230 kV and a transformer capacity higher than 206,000 MVA. The predominance in the system of hydro generation located at long distances from the load centers requires a large and complex transmission. The transmission system has voltage levels of 230, 345, 440, 500, 600 (DC) and 765 kV. The federal government maintains an important role in the sector through its ownership of most of the basic grids.

Distribution Brazil currently has about 70 distribution companies. A large number of major distribution companies have private equity. However, some of the states of the federation maintain ownership of distribution companies. System losses in Brazil range between 8% and 45% in 2008.

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The average sales price of electricity in Brazil in 2008 was approximately US$131.88/MWh. The residential, industrial and commercial sectors registered average sales prices of US$153.49; US$108.55 and US$147.60 per MWh, respectively. The average prices in 2010 is shown in Table 30.

Table 30. Average Price of Electricity in Brazil (2010) Type of customer Residential Industrial Commercial Average Tariff (US$/MWh) 153.49 108.55 147.60

10.2

INDUSTRY RESTRUCTURING AND POLICY REFORM

During the 70s, all the companies in generation, transmission and distribution of electricity were owned either by the federal or provincial governments. During the 80s and the 90s, Brazil suffered a hyper-inflation process that, together with the freezing of the electrical tariffs resulted to a debt of US$ 50,000 MM between the generators and distribution companies. That debt was partially cancelled by the federal government in 1993. By then, the Brazilian state had suffered the consequences of a severe economic crisis as a result of the high external debt. In 1995 during Fernando Cardozos government, it was decided to initiate reforms using other countries such as Chile, England and Colombia as benchmarks.

The modernization of the Brazilian electric sector began in 1995 through the publication of the Law on Public Service Awards (8.987 Act) and regulations related to the electricity market specifically the 9.074 Act. The regulatory body was created in 1996 through the 9427 Act. In 2004 the Brazilian Government decided to make modifications in the operating model of the sector through the enactment of Laws 10847 and 10848.

The key issues that led to the reform were: a) High disinvestment in the electricity sector in the 1970-1990 period; University of the Philippines National Engineering Center 158

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b) Financial and technical inability by the state to provide the necessary system expansions due to the external debt crisis experienced by Brazil in the eighties; c) Dominance of state electricity companies resulting in the need to increase the participation of the private sector; d) Poor quality of service that showed in frequent blackouts; and e) Low tariff levels from inefficient subsidies.

Law No. 8987 of 1995, known as the "Law on Public Service Awards and the Sector Law No. 9047 of 19/5/1995 introduced profound and important changes, namely: a) Opening up the industry to private investors; b) Bidding for new generation projects; c) Creation of the Independent Power Producer; d) Open access to transmission and distribution systems;and, e) Freedom for large consumers to choose their energy suppliers.

Decree No. 1717 of 1995 established the conditions and enabled the extension and consolidation of public service concessions and approved the plans for the conclusion of the suspended work on 22 power generation projects with a combined 10,100 MW of generating capacity.

Decree No. 2003 of 1996 established the "Regulation of the Operation Producers and Self-producers.

of Independent

Other laws were passed in 1997 as follows: a) Law No. 9433, which instituted the National Water Resources Policy and created the National Water Resources Management; b) DNAEE (former regulator) Resolution 466, which consolidated the General

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Code (Law No. 8078, of 1990); c) Resolution MME (Ministry of Mines and Energy) 349, which approved the Internal Regulation of the ANEEL established Control DNAEE management ; and d) Decree 2410, which provided for the calculation and collection of the annual audit of public services by all concessionaires.

Major policy reforms were made in 1998 with the publication of Provisional Measure No. 1531, which authorized the Executive to restructure ELETROBRS and its subsidiaries, the most significant of which were: a) Authorizing the gradual withdrawal of the State from the electricity business; b) Guaranteeing the General Reversion Reserve (RGR) until 2002 investments in Electrobrs (Centrais Eletricas Brasileiras SA); c) Since 2003, concessionaires or authorized may negotiate the amount of energy with gradual reduction, the annual ratio of 25% of amounts relating to the year 2002; d) Authorizing the separation of FURNAS into two companies: one each in generation and transmission; e) Authorizing the separation of ELETROSUL generation and transmission; f) Authorizing the separation of ELETRONORTE into five companies: two generation companies, one transmission and one distribution in the isolated systems of Manaus and Boa Vista, one for generation in Tucurui, and another for transmission; g) Authorizing the separation of CHESF into three companies: two in generation and one in transmission; h) Authorizing ELETROBRS to retain stakes in the generating companies to be created into two companies: one each in to continue the

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from the separation of FURNAS, ELETROSUL, ELETRONORTE and CHESF. In summary, the policy reforms in 1997 resulted in the following: a) Unbundling (Generation, Transmission and Distribution); b) Open access to transmission and distribution systems; c) Creation of a short-term energy market and of the Mercados Atacadista de Energia (MAE) that was responsible for settlements in this market; d) Creation of an independent Regulatory Body; e) Re-definition of operating organisms of the system, with the participation of agents in the system; f) Definition of traders companies and free consumers;

g) Tender for new generation projects. The key elements of reform that were intended to incent investments in the industry by the private sector were the : a) Creation of a stable legal and institutional framework through laws and decrees that permits and facilitates private sector participation in the electricity industry; b) Privatization of distribution companies . The privatization of these non-profitable companies provided greater security to generation investors because it allowed for a better functioning of the long-term power markets; and c) Adjustment of the tariffs to end-users through the removal of subsidies. The immediate results of the reforms highlighted the importance of private participation in the generation and distribution of electricity. From virtually zero in 1995 , private ownership rose to 3% in the generation and 32% in distribution in 1997. Between 1998 and 2000 US$ 10 Billion was invested in the electric system by private companies. During this period, the government successfully tendered 10,000 MW of new hydropower generating capacities. The tender for the generation plants owned by the federal government was however stopped by the political opposition. University of the Philippines National Engineering Center 161

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The central regulatory policy for generation is the requirement imposed on distribution companies and large consumers to enter into long-term contracts with generators . This policy is mainly intended to incent investments in new generating capacities.

Distribution companies are mandated to sign contracts for 100% of their energy requirements. Contracts must be signed for energy to be supplied by existing plants one year before they are required; three to five years before for energy to be supplied from new plants that are still to be built. Generators must have backup power capacity to secure their supply contracts. There are no additional charges for generation capacity. Large consumers (Contestable Consumers) also must contract 100% of energy requirements.

The policy reforms in 2004 created three electricity markets, namely: a) Regulated contracting market for contracts between generation companies and distribution companies for the demand of the regulated markets; b) Free contracting market for bilateral contracts between generators, importers or traders and large consumers and exporters; and c) Energy spot market, where the Chamber of Electric Energy Commercialization (CCEE) calculate the amounts and price differences between contracted and consumed energy.

Regulated Contracting Market Distribution companies must secure their energy requirements through contracts in the Regulated Contracting Market (ACR). ANEEL is responsible for the regulation, organization and conduct of the bidding process directly or through the Chamber of Electric Energy Commercialization (CCEE).

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The winning companies at the auction are those that offer the lowest price per MWh to supply the distribution companies. Regulated Market Contracts are signed between the winning generators and distribution companies.

The main design elements of the auction are: a) Total energy purchases must be made through auction based on the lowest price method; b) Procurement is carried out jointly by distributors through the pooling of their energy requirements in order to obtain economies of scale in contracts associated with new generation projects in addition to spreading the risks; c) Auctions are held separately for new power plants (supply to the expansion of demand) and for existing plants, both by tender.

There are three types of auctions. Given that A represents the starting year for energy supply, the auctions that are held are: a) Auctions (A - 5) performed in the fifth year preceding the year A; b) Auctions (A - 3) made in the third year preceding the year A; c) Auctions (A - 1) made in the year preceding the year to start of supply. Auctions (A-5) and (A-3) are made for the purchase of power from new generation projects and (A-1) for the purchase of energy from existing plants. Additionally ANEEL may conduct Adjustment auctions in order to supplement the supply for distribution companies to at most 1% of their demand. Finally, there are auctions for energy from renewable sources and for backup energy. Sellers in this market must have physical support for their contracted energies from their own plants or through contracts with other generators or electricity traders.

Every year until the first of August the distribution companies, energy traders , and large consumers must submit their forecast demand for the next five years to the Ministry of Mines and Energy . The Ministry determines the sum of the demands of distribution companies and University of the Philippines National Engineering Center 163

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that are to be auctioned (A-5) in the regulated contracting market. The energy needs of other agents are met in the free contracting market.

Distribution companies can change their forecast for the year A, three years before the supply will be required. The limit of this change is 2% of the load. The Ministry determines the total amount of these requirements and may hold an auction (A-3).

Distribution companies can make a new forecast a year before the year A, limited to 5% of its market for the replacement of contracts that are about to expire. The Ministry determines the amount of the new demand and may hold an auction A-1. The amount of energy that the distribution companies can buy from this auction is limited 1% of their total contracted load.

The duration of contracts with new power plants (auctions (A-5) and (A-3)) is at least 15 years and a maximum of 30 years counted from the start of supply. For contracts with existing plants (auctions (A-1)) the duration is at least 5 years and a maximum of 15 years. For supplies from other sources; the contract duration is between 10 and 30 years .

In addition to the regular auctions , Setting auctions may be held for energy requirements within four months after the auction with supply period of up to two years. These are for energy requirements that were not forecasted or caused by unexpected situations that could not be included in the A-5 and A-3 auctions. Setting auctions cannot involve more than 1% of the energy tendered in the regular auctions and are held in the same year as the A-5 and A-3 auctions.

Generation projects identified

by the Energy Research Company (EPE) and approved by

resolution of the National Energy Policy Council (CNPE) are considered priorities for their strategic and public interest and are included in the auction (A-5) and (A-3).

To increase the security of supply, reserve power auctions are held to sell backup power from generation centrals hired by the Chamber of Electric Energy Commercialization (CCEE) for this purpose.

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Generation companies can contract for either energy or availability. Energy is a classical contract in which the generator assumes the risks of not being able to supply the energy (when this happens, the generator will have to assume the costs of buying the energy in the spot market). In such energy contracts, the generator assumes also the risk associated with increasing fuel prices. As for the availability contract, there is a minimum availability to be met by the generator and in the case of non-performance, there are penalties to be paid by the generator. However, the distributor assumes the costs of buying in the spot market or the risk associated with the prices of fuel. In energy contracts, generation companies assume the risk of generating energy in the contracted amount. In availability contracts, the risk in the amount of energy generated belongs to the distribution companies that sign the contract. The Ministry is opting for availability contracts for thermic central where distribution companies assume the payment of fuel.

Free Contracting Environment Consumers with demand exceeding 3 MW that were connected after July 1995 and the consumers with supply voltage exceeding 69 kV and connected prior to this date can buy their energy from any supplier.

Consumers with demand exceeding 500 kW can buy power from the local distribution concessionaire at regulated rates . Alternatively, they are free to enter into power purchase contracts with small generators particularly small hydropower, biomass thermal or wind.

Law 10.848 of 2004 created the Free Contracting Market. In this market, customers conclude bilateral contracts freely with generators, traders and importers. Free Customers should be free agents of CCEE. They can be represented for the purposes of accounting and settlement by other agents of that chamber that means that some agents can act in the name of others (through a power of attorney). This is due to the fact that some free agents do not have enough technical knowledge or economical resources to manage their contracts so they could associate and/or be represented by third parties. It is estimated that 25% of the country's current demand are from free customers. University of the Philippines National Engineering Center 165

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A consumer in the free contracting market who wishes to revert to the distribution company in his/her area for the supply electricity must advise of its intention to do so 5 years in advance.

Energy Spot Market The short term energy market in Brazil can be defined as a generators pool. The transactions and prices not covered by the long term contracts are resolved in this pool. The participants in the spot markets are generators, distributors, traders and free customers.

The Differences Settlement Price (PLD), is used to value energy transactions in the short-term markets and is the difference between contracted amounts and quantities currently generated and consumed. The PLD is derived by the national system operator ONS (Operador Nacional do Sistema Electrico) with the use of power system operation optimization models. There are two models, the NEWAVE model with five years horizon and monthly simulations and DECOMP model with 12 months horizon. The models find the optimal solution using the reservoirs, taking into account the benefit of present water use and the expected future benefit of storing water, reducing fuel costs and future failure.

The PLD is determined weekly for each of the three load steps and for each submarket (North, Northeast, Southeast / Mid-West and South). It is equal to the marginal cost, but must be within floor and ceiling prices that in 2010 were at US$ 7.2 MWh and US$ 350 MW Respectively.

When the level of hydropower reservoirs in each region is below the safety limit, the ONS activates the Risk Aversion curve and prioritizes the entry of thermal and other energy imports even if the marginal cost of hydro generation obtained from the models is less than the cost of these resources. In this case the PLD is equal to the "cost risk", i.e. the price of more expensive energy resources dispatched.

The calculation of the PLD has no transmission constraints within each submarket. As such, energy is assumed to be equally available in all points of the sub-market and the price is unique

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within each submarket. In contrast, the PLD calculation takes into account transmission constraints between the various submarkets.

The calculation of the PLD is based on ex-ante dispatch ,i.e.; prior to the real operation of the system.

The settlement of the income of hydropower in the spot market is done through the Energy Reallocation Mechanism (MRE). The MRE is based on the concept of Assured Energy of hydroelectric plants. The Assured Energy of each hydropower plant is determined by ANEEL by a method of energy allocation to be supplied by the set of hydro plants with a defined probability of occurrence. The MRE assures that all hydro plants receive a minimum income whose calculation depends on its Assured Energy regardless of actual energy production. In other words, hydro plants act as an energy pool to compensate those plants that produce under their assured energy.

If there is secondary energy source in the system, the energy generated over the total committed energy is allocated between the hydro generators in the proportion of their committed energy.

10.2.2 POLICY AND REGULATION OF TRANSMISSION


Transmission concessionaires are responsible for the maintenance and availability of their facilities. The facilities are operated by the ONS. There is open access to the transmission lines subject to the payment contracting procedures. of transmission charges and compliance with operational and

Transmission system planning is performed centrally by the Energy Research Company (EPE). The main studies are contained in the Ten-Year Energy Plan (PDE) and cover a 10 year horizon for the generation and transmission systems and a 5 year horizon for the Transmission Expansion Program (PET) .

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a) Basic Grid (trunk grid): voltage installations greater than or equal to 230 kV; b) Border: transformer facilities with voltage greater than or equal to 230 kV that feeding network with lower voltage distribution at 230 kV; and c) Other transmission facilities (DIT) at any level of voltage for the exclusive use or shared use of generators or exclusive use of free-choice consumers.

The new facilities needed for the expansion of the Basic grid are tendered through an auction while the reinforcements in the existing concessions are approved by ANEEL.

Transmission concession contracts are generally signed for thirty-year periods. Contracts define the pay revisions every four years and annual rate adjustments according to the IPCA index (Indice General de Precios al Mayor General Index for Wholesale prices).

For the purposes of remuneration, the Backbone facilities are divided into: (a) Current Facilities; (b) New Facilities Authorized; and (c) New Facilities Tendered.

The remuneration for current facilities consists of the depreciation expense allowance and return on assets that are based on the regulated rate of return. The revenue associated with these facilities for most companies were defined in 1999 and is subject to adjustments according to the IGP-M index until 2015 at the expiration of their concession contracts.

New transmission facilities are authorized by specific resolution of ANEEL. Their payment includes an allowance for depreciation and return on investments on new and replacement facilities as recommended by the EPE or the ONS to increase transmission capacity or system reliability. The annual remuneration is calculated as an authorized investment annuity in the form of a regulated rate of return that is reviewed every four years.

The construction and maintenance of new assets for existing transmission systems is awarded through an auction. The annual income allowed (RAP) to the transmission agent is based on its

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bid and is paid for a period of 30 years with adjustments as provided in the concession contract. ANEEL determines the maximum values for the acceptable RAP in the tenders.

ANEEL employs the Capital Asset Pricing Model (CAPM) to calculate the return on equity component of the regulated rate of return. Allowable leverage is 63.55% for both existing companies and for new entrants. The real rate of return in domestic currency after tax that was adopted in the second tariff review cycle (2009-2013) was 7.24% for companies existing in 1999, and for projects tendered for construction since 2000. The regulated rate of return is updated every five years (the fifth, tenth and fifteenth year) . It was adjusted in 2010 to 6.00% in real terms and after tax.

Payments are based on the efficient cost of an efficient transmission company that is derived by ANEEL taking into account the actual conditions in the geographic area of the concession. The costs covered in the payments include the operation and maintenance of electrical networks, commercial management, direction and management. The methodology for the second periodic review of cost was approved by the Normative Resolution 386 of December 15, 2009, where operational costs were determined based on benchmarking methods.

The transmission usage fees or tariffs (TUST) are set by ANEEL. The fee structure provides locational signals and imposes higher charges on those using the system in greater proportion.

TUST had two components starting in July 2004. These are: a) The TUSTRB, for facilities of the basic grid with voltage less than 230 kV, which is calculated by the Investment Cost Relating Pricing (ICRP) nodal methodology, and; b) The TUSTFR, for the transformer facilities with voltage greater than or equal to 230 kV, and feeding distribution networks with voltage less than 230 kV, and for other DITs transmission facilities that are shared by distribution concessionaires.

The TUST is calculated from the Nodal Program simulation and computational system. Rates are based on the use of the grid and demand at each node depending on the intensity of use for the University of the Philippines National Engineering Center 169

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injections or withdrawals of power. Charges are based on the long-run marginal costs (LRMC) to inject to or extract 1 MW from the grid. The methodology considers the minimal total investment cost of an ideal grid and assumes that network expansion and re-routing of

transmission lines are performed continuously. As the amount of remunerations calculated by the nodal method does not allow the full recovery of network investments, a constant adjustment factor, R $ (reais) per MW is added to the rates.

Small hydropower (PCHs) and generation projects that use alternative energy sources (such solar, biomass, wind and CHP) with power less than or equal to 30 MW have the right to a discount of at least 50% on transmission and distribution tariffs for the energy commercialized. The exact percentage is determined in their authorizations.

Resolution No. 267, a legislation that was passed in June 2007, changed the calculation of the TUST for new companies that participate in the generation auctions. For energy auctions ANEEL publishes a set of TUST for the new installations with direct connection to the basic network not being in commercial operation.

10.2.3 POLICY AND REGULATION OF DISTRIBUTION


Distribution concessionaires cannot participate or own shares directly or indirectly or perform activities in generation and transmission in the same way that generation concessionaires cannot be controlled by distribution concessionaires. Distributors can sell energy to free consumers except for those located in its franchise area where rates and terms applied to regulated captive customers are used. These restrictions do not apply to distribution companies in isolated systems, or in their own market for market smaller than 500 GWh per year.

Distributors are allowed to charge their customers for energy costs that are up to 3% higher than the contract price in the energy auction. Subcontracting for energy supply is not allowed . A distributor that is in deficit must buy power in the short term market subject to the payment of penalties.

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Distribution tariffs reflect the prudent cost of investments required to deliver the service and to comply with the requirements of the concession contract such as on service quality. Eligible assets determined for a reference network are initially valued at their replacement cost according to a price database maintained by ANEEL and are thereafter adjusted based on a productivity index. The prices in the ANEEL database are the average prices in the last four years by type of equipment on actual purchases made by the concessionaire. The replacement value of assets is then multiplied by a factor called exploitation index. The index reflects the degree to which assets are currently employed and removes the value of not used or not useful assets, e.g. those oversized from the valuation of the rate base.

Operating costs, maintenance, administration and commercial management are de-linked from actual costs incurred and are instead calculated by ANEEL by the Reference Network methodology. An optimal capital structure that was derived from empirical data from

comparable electricity distribution companies in Brazil, Argentina, Chile, Australia and Britain is used in the WACC . This structure allows for 57.16% of debt . The rate of return in real terms is 9.95% after tax.

The pricing methodology is a Wholesale Price Index (WPI) X price cap. Concessions that were signed with power distributors from 1995 provided for initial rates and adjustment mechanisms in the periodic rate revisions, extraordinary rate revisions and annual rate re-adjustment. Rate Review occurs every four years.

10.2.4 POLICY AND REGULATION FOR RENEWABLE ENERGY


Generating capacity from renewable energy increased by 5,200 MW in the period 2004-2009. These were mainly from two resources: bioelectricity cogeneration from sugarcane bagasse, and small hydro from plants with capacities of less than 30 MW. These plants have been participating in the energy auctions carried out by distribution companies to supply their loads; competing with traditional generation companies. In the last two years, 800 MW of wind power were in operation and under construction. An additional 1,800 MW of new capacity was contracted in the 2009 auction.

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The biggest obstacle to the construction of these plants has been the inability of the existing regional grids to accommodate new power injections. It thus became necessary to plan grid reinforcements. To this end, a new regulatory design known as the IGC Scheme was agreed between ANEEL and the RE investors. The agreement calls for: a) Generators to hire a technical team to plan the integration network in cooperation with EPE. The planning of the integration network would be carried out on a leastcost basis through the use of an optimization model to optimally locate the IGC facilities and minimize investment costs. The proposed plan would be subject to ANEELs approval; b) Generators to pay for 100% of the IGC costs plus the basic grid tariff (TUST); and c) Distribution companies to (exceptionally) waive their right to build the IGC assets and an auction will be held for the right to operate and maintain the IGC facilities.

As agreed in the IGC scheme, generators will pay for all integration network construction and maintenance costs. Because the network had a tree structure, it was easy to calculate the fraction of each generators injection that would flow across each circuit. This allowed the application of a MW-mile scheme where each generator pays for the cost of each circuit in proportion to its use.

ANEEL held an auction in 2010 to grant the concession of the ICG facilities that will be used to integrate about 1,800 MW of Wind Power in the northeastern and southern regions of Brazil.

10.3

BRAZILS POST REFORM INSTITUTIONAL GOVERNANCE FRAMEWORK

The governance framework set up by the reform comprised of three institutions: the system operator (ONS), the regulator (ANEEL) and a body responsible for the settlement of short-term market called Mercado Atacadista de Energa (MAE). They are guided and assisted by other agencies that are involved with the electric power industry. University of the Philippines National Engineering Center 172

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MAE is supervised by the Ministry of Energy and Mines. It is however a non-profit private institution,. The President of its Governing Council is designated by the Ministry. The President also has veto power.

The formulation , implementation and monitoring of the electricity sector policies are the responsibilities of the Ministry of Mines and Energy (MME) under the guidelines of the National Energy Policy Council (CNPE). CNPE is chaired by the Mines and Energy Minister. Its principal duty is to recommend to the Brazilian President energy policy, the bidding of special projects in the electricity sector and the definition of safety criteria for electricity supply. Within the Ministry's structure is the electrical energy secretary whose key responsibilities include to coordinate ; provide guidance and control the Ministrys actions with respect to the politics of power sector; security of supply under the established quality standards; continuity and safety; and, the definition of fair rates for consumers and one which encourages medium and long term investments.

Electric Energy National Agency (ANEEL) is the regulatory body. It is responsible for developing regulations and legislation; for the auction of generation and transmission projects and for the power supply of distribution companies.

The Energy Research Company (EPE) is a state-owned enterprise in charge of research and studies of the energy sector planning. The company draws up every year the electrical system expansion plan for the next 5 years.

The National Electric System Operator (ONS) is responsible for coordinating and controlling the operation of the national grid; implementing an optimization of energy resources; ensuring security of supply and service quality standards taking into account the conditions imposed for multipurpose water reservoirs and the limitations of the generation and transmission systems .

The Chamber of Electric Energy Commercialization (CCEE) is an association of electricity market players and institutions. Its main function is to register and manage the electricity supply

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contracts signed between generation companies, trading companies, distribution companies and large users. The most important activity carried out by the CCEE is the calculation and payment of the spot market prices.

The Monitoring Committee Electricity Sector (CMSE) is an institution whose function is to analyze the continuity and quality of power supply in a five years period, and develop preventive measures and actions on the demand side and generation system.

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The policy and regulatory reforms in Chile and Brazil had many aspects in common. Among the most important are: a) Vertical Disintegration of activities where competition between players could be possible (i.e. power generation and commercialization) and the regulated activities (i.e. distribution and transmission); b) Both countries actively fostered competition in generation and commercialization activities in order to reduce electricity prices to the consumers; c) Requirement for distribution utilities and large users to sign bilateral contracts for 100% of their forecast demand through auctions in order to incent generation investments; d) The creation of wholesale spot market that is primarily a balancing market for generators and distributors (plus traders and free customers in Brazil) for their contractual commitments. In these markets the dispatch is based on the variable operating costs of thermoelectric generation units and on the waters opportunity cost for dammed hydro generation plants; e) Decentralization of the investment decisions for the expansion of the transmission grids and new generation capacity; f) Tariffs related to the usage of transmission and distribution grids are benchmarked to the cost of an efficient utility, the reference network, and de-linked from the utilities own cost; g) Open access to transmission and distribution networks is guaranteed by law, once the security and reliability conditions are met. Access tariffs are regulated; and

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h) Strong and comprehensive institutional governance framework that clearly allocates responsibilities for policy, planning, regulation and dispute resolution among government and non-government organizations.

However there are also differences between the two reform processes, the following being the most notable: a) In the Chilean case, power sector privatization was directed at Chilean investments, however during the 90s some companies were bought by international companies. In Brazil national and international companies participated in the privatizations; b) In Brazil, the regulator conducts three types of bids for distribution companies depending on when the supply is needed. In Chile, distribution companies set their own bidding terms but each bid must be approved by the regulator; c) Brazil permits big end users to participate as agents in the electricity market. They can buy in the wholesale market their requirement for the short and long term. In Chile, end users have no access to the wholesale energy market. They have to buy energy and power from a generation or distribution company; and d) Brazilian methodology for the calculation of the regulated transmission tariff is based on the long term marginal cost. In Chile the tariff calculation is based in the short term marginal cost and the market agents use of the grid.

The following highlights the weaknesses of the Chilean regulation reforms: a) In the beginning Transmission and Generation were not separated. This caused innumerable problems and a great barrier to the entry of new players in the electricity market. This weakness was overcome some year later by the Chilean antimonopoly organism who decreed that both activities shall be separated; b) The huge participation of the principal generation company of the system, ENDESA plus the problem that most of the water usage rights are owned by this company. University of the Philippines National Engineering Center 176

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This problem has not been solved; the only partial solution has been a tax for the unused water rights; c) Vertical integration between the principal generation company and the biggest distribution company. This problem still persists but its adverse effects have been softened by the open bids for the distribution companies supply; d) Absence of a regulatory mechanism for the quick resolution of disputes leading to proceedings/litigation of issues that could not be addressed properly by

authorities and to the extent that the authority could not act in properly during the supply crisis. This problem was superseded with the creation of the Experts Panel that solves the conflicts between market agents; e) State entities in charge of the definition and implementation of energy policies, and the regulation and supervision of the electricity sector activities were weak. These problems were gradually addressed by initially, giving more authority to the

superintendents office and later, by the creation of the Ministry of Energy; f) Privatization did not promote investment in power generation as has been proven in Chile. The growth in generation capacity was not sufficient to fulfill demand growth and the supply security needed. This lack of investment is in part explained by the dominant position of the biggest generation company, which is primarily hydroelectric and owns most of the generation water rights, who has extra profits with the delay of generation project; and g) Usually the investments in generation respond to energy prices and supply crisis. The bids for distribution companies supply and new mining projects have worked as incentive for new power generation.

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The power markets of Chile, Brazil and the Philippines are compared in Table 31 below.

Table 31. Comparative Analysis of Chile, Brazil and Philppine Power Markets Market Feature Promulgation of Reforms Chile Main reform in 1982. In 2005 the distribution bids were imposed Ministry of Energy Fuel and Electricity Superintendence Brazil 1995 and 2001 2001 Philippines

Policy and Planning

Regulator

Comisin Nacional de Energa , CNE Independent Experts Panel

National Energy Policy Council (CNPE); Ministry of Mines and Energy; Energy Research Company; Monitoring Committee for the Electricity Sector Electric Energy National Agency (ANEEL) Appointment of Dispute Resolution Administrator and Panel Group; disputes can be raised in court Proposed by the President and approved by Senate Transmission, distribution. Generation through auctions Bilateral contracts through auctions (distributors 100% contracted; Capacity contract optimization model and Spot market based on long run marginal cost (LRMC) National Operator of the Electrical Systema (Operador Nacional do Sistema Elctrico, O N S.)

JCPC Department of Energy

Energy Regulatory Commission (ERC) ERC subject to recourse to the court Sectoral Dispute Resolution Mechanisms in WESM, GMC, DMC Appointed by the President

Dispute Resolution

Designation Process of Regulator

Regulated Activities

Selected by Senior Public Management System and approved by the President Transmission, distribution. Generation through auctions

Types of Power Markets

System Operator

Bilateral contracts through auctions(distributors and free users100% contracted); Centralized SPOT Market (short-term marginal cost based dispatch pool, SMP) Economical Load Dispatching Center (Centro de Despacho Econmico de Cargas, CDEC)

Transmission & Distribution Generation until retail competition and open access declared Negotiated bilateral contracts; Centralized SPOT Market (bid pricebased dispatch gross pool)

National Grid Corporation of the Philippines (NGCP)

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Market Feature Chile Private. Centro de Despacho Econmico de Cargas, CDEC (membership from generation, distribution and free users) SIC: 6200 MW SING: 1900 MW SIC: ENDESA COLBUN AES GENER SING: E-CL(SUEZ AES GENER: GAS ATACAMA: Others Brazil Private. Chamber of Electric Energy Commercialization (CCEE) Philippines Philippine Electricity Market Corporation (PEMC) pending selection of IMO.

Market Operator

70, 954 MW

Peak Demand

ELECTROBRAS, the state company is the major generator and distributor

Major Players in Generation (by % of total demand)

Existence of Supply Sector

generators and distributors

Generators , distributors, traders

Free clients or Contestable Market

Those with demand of at least 2 MW . No provision for retail competition at household level

Demand >3 MW. No provision for competition at household level

Balancing Market. Generators only Type of Pool

Net Pool. Generators, distributors, traders and free customers for energy requirements not covered by longterm contracts

9,472 in 2009 (Country) 7,643 MW (Luzon Grid 2010) Luzon: SMC Group Lopez Group Aboitiz Group NPC/PSALM Visayas: NPC/PSALM Global Business Power Lopez Group Mindanao: NPC/PSALM Aboitiz Group CEPALCO Distributors; and with retail competition, generators, retail electricity suppliers Open Access and Retail Competition is yet to be implemented. Thresholds st are 1 , consumers with demand of 1 MW and nd above; 2 , 750 kW and above 2 years after with rd possible aggregation; 3 , all consumers 7 yrs after nd 2 stage. Gross pool

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Market Feature Chile Direct settlement between generators based on SMP and net balance calculated by CDECs. SMP based on variable cost of most expensive generator dispatched. Thermoelectric generators required to submit operating costs that could be audited by CDECs. Centralized at the lowest cost, independently of the contracts Capacity is remunerated only in peak hours (note that auction price is node price + 20% and bid awarded to lowest energy price) 100% None Brazil Differences Settlement Price (LPD) determined by ONS. PLD subject to floor and ceiling: US$ 7.2 /MWH and US 350 MW in 2010 respectively Philippines Net settlement at nodal prices using the 68 differencing model . Generators bid Prices for each hour.

Method of Settlement in Spot Market

Dispatch

Economic dispatch submit to optimization model

Central scheduling and dispatch using optimization model, independently of the contracts No Capacity Remuneration in WESM; capacity charge included in negotiated bilateral contracts 85% of the total capacity of generating assets in Luzon and Visayas Missionary customers from universal charge; lifeline customers (with consumption of 100 kWh and below) as well as senior citizens are subsidized by non-lifeline and non-senior citizen customers MERALCO (the largest DU controls nearly 70% of the Luzon grid)

Capacity charge

Lowest capacity charge in the auction

Degree of Privatization (in Generation)

10% Residential customers

Existence of Subsidies

Presence of Dominant Power Player Market Share of DUs (based on demand)

ENDESA controls more tan 40% of SIC generation E-CL controls about 50% of the generation of SING 75% del SIC 10% del SING

ELECTROBRAS , the state company is the dominant player in generarion and distribution 70%

99% Luzon; 96% Visayas; 85% Mindanao

68

For a settlement system that works on a differencing basis, each exit point from the transmission network is assigned to a standard retailer, and that retailer has the prima facie responsibility for payment for all energy that passes through that exit point. That energy is purchased at the appropriate reference node pool price multiplied by the loss factor appropriate to the exit point.

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Market Feature Number of Customers in the market Chile More than 4 million For hydro the main barrier is the control of water usage rights by the largest generation company (ENDESA). For Thermoelectrics the main barrier are environmental approvals, people opposition and availability of assured Natural Gas. For small projects the main barrier is the lack of transmission infrastructure. Without restriction Brazil More than 40 million Environmental licensing process still complex; availability of acquisition of natural gas Philippines More than 5 million Complex and multifarious authorization and permitting requirements including health, safety and environmental clearance is still required from government agencies. Highly concentrated Distribution Market with a single DU accounting for ~70% of the main grid.

Generation Barriers

Without restriction

Participation of Generators in the Market

Driver of Growth in Generation

Transmission Expansions

Contracts with distribution companies (Public bidding process) and non-regulated customers. New works are open and competitive to any operator. Expansion of existing works are compulsory for the owner

Auctions in the regulated and in the free market

No Single company, related group or IPP Administrator allowed to own, operate or control more than 30% of installed generating capacity in a grid and/or 25% of installed generating capacity None

Expansion of the system through auctions

Expansion planned & carried out by the National Grid Corporation of the Philippines (NGCP)

Regulatory reform and restructuring in the three countries were motivated by a common need to create an efficient electric power industry. Their broad policy and market architectures and institutional governance frameworks are similar: liberalization of generation; regulation of network services; creation of wholesale and retail markets; and the creation of separate policy and regulatory institutions. They also face the same challenge from dominant utilities. However, the detailed policy, regulatory and institutional market designs markedly varies between Chile University of the Philippines National Engineering Center 181

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and Brazil on the one hand; and the Philippines in the other. These differences may well explain the performance of the markets in the three countries, specifically, on generation investments. Chile and Brazil have achieved generation adequacy; the Philippines has not and is instead facing supply shortages particularly in the Luzon and Mindanao grids. Market size and privatization do not appear to explain these differences. The power markets of Chile and the Philippines are comparable in size and both countries have actively pursued privatization. Brazil on the other hand has a large market and the government continues to hold ownership interests in most of the countrys distribution utilities and generating plants. While these disparate achievements could be partly because the two comparator countries, particularly Chile implemented drastic reforms much earlier than the Philippines that gave them a lead time to assess the effectiveness and re-calibrate their policies; it also signals the need for an in-depth examination and adjustments of the policy and institutional design in the latter.

The distinguishing feature of Chiles and Brazils markets is the sequencing of policy reforms that prioritize the achievement of generation adequacy over wholesale and retail competition. Distributors and large users are required to contract for 100% of their forecasted demand and sign long-term contracts from the public auctions that are managed by the regulator. The regulator sets the price caps and approves the terms (actually draws up the bidding terms in Brazil) of the auction. The system has greatly reduced market risk and the risk of regulatory opportunism which provides a strong incentive for generation investments. Since generators and other suppliers must compete to supply under strict bidding terms including a price cap that is set before the auction ; consumers benefit from the efficiency of competition, albeit, from competition for the market, rather than competition in the market. The exercise of market power by dominant generators and/or distributors is curtailed because both are required to contract by auction.

As a result of the 100% bilateral contract requirement, the wholesale spot market in Chile is a balancing market for generators only while that in Brazil is a net pool for energy requirements of distributors, generators , traders, and large users that are not covered by these long-term contracts. At the same time, both Brazil and Chile have placed higher thresholds than the Philippines for initial retail market contestability at over 3 MW and 2 MW respectively and have

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not mandated contestability at the household levels. In contrast, bilateral contracts in the Philippines are bilaterally negotiated and are predominantly for 1-3 years only. Distributors and eventually, contestable market customers will be allowed to secure their energy supplies from the spot market subject only to the distributors compliance with their economic sourcing obligation under the law.

Construction of new transmission facilities in Chile and Brazil are awarded by auction for which tariffs, like those of distribution, are benchmarked to the cost of an efficient utility or the reference network. Again in contrast, the Philippine PBR methodology for setting

transmission and distribution tariffs does not de-link tariffs from the utilities own cost.

The institutional governance structures in Chile and Brazil are characterized by the clear delineation of oversight, policy, planning and regulatory responsibilities among separate agencies that coordinate closely to ensure the efficient operation of the industry. They also include dispute resolution mechanisms separate from the regulator to facilitate prompt conflict resolution between the regulator and market agents and among market agents. Expert and arbitration panels whose members are drawn from the private sector provide a ready mechanism for the prompt resolution of disputes.

Institutional governance of the Philippine electric power industry to date has been marked by the virtual withdrawal of the DOE from the scene and the regulators insistence on its independence to the extent of making coordination difficult with other agencies. The JCPC is perceived by industry stakeholders to be largely passive. The laws creating WESM, the Grid Management Committee (GMC) and Distribution Management Committee (DMC) all provide for the creation of Dispute Resolution Mechanisms . Apart from catering only to their respective concerns; those of the GMC and DMC have yet to be activated. A dispute resolution mechanism that will mediate all types of conflicts between the regulator and market agents and among all market agents outside the concerns in WESM and the technical concerns covered by the GMC and DMC have not been created.

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IV

PROPOSED REFORMS FOR PHILIPPINE POWER INDUSTRY

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13 POLICY AND REGULATORY REFORMS


The preceding analysis of the industrys policy framework and international markets points to a need for a number of policy and regulatory forms, many of which are urgent. These reforms are categorized into those that needs to be implemented immediately and in the medium term (1 to 3 years) on the strength of their potential to incent new generation investments and are listed by their order of importance. Except for the amendment of the horizontal policy and the scope of NEAs guarantee provision that require legislative enactment, the foregoing requires no more than executive/regulatory actions to implement.

13.1

IMMEDIATE REFORMS

13.1.1 COMPETITIVE BIDDING OF FORWARD POWER CONTRACTS


All distribution utilities (PDUs, ECs) should contract for 100% of their energy and capacity requirements through a public bidding. Therefore the utilities (with the prior endorsement of the ERC and DOE) shall hold yearly public auctions for contracts with a maximum term of 15 years. Purchases from the spot market shall be limited to 5% of the DUs and generators contractual imbalances and shall be subject to the payment of penalties to be determined by the ERC. Standard contract templates to be drawn up by ERC and DOE, generators and DUs . Contract quantities shall have priority over spot ones in case of planned brownouts due to supply shortages (no supply guaranty for uncontracted energy in case of rationing). A sample contract from the Brazil auction is attached .

13.1.2 DEFERMENT OF RETAIL COMPETITION


Retail competition must be deferred until such time that the vital requirements laid down in ERC Resolution No. 03, Series of 2007 is achieved: c) Adequacy of generation, transmission networks , and customer switching systems; and

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d) Promulgation by the ERC of all pertinent rules and regulations governing retail

competition and open access. ERC shall determine the timetable with duties and responsible parties in charge of executing the pending requirements to materialize RC&OA. Certainty shall be given to the industry in order to allow proper planning.

13.1.3 RESTRUCTURING OF THE OWNERSHIP OF ELECTRIC COOPERATIVES


ECs may be restructured and consolidated to a small group of equity investors to strengthen the incentives for productive efficiency. In the interim, the energy requirements of the ECs should be aggregated by grid and tendered in the auction as one. Section 30 of the EPIRA shall be amended by Congress to allow NEA to act as guarantor for the bilateral contract obligations of the ECs, instead of their WESM purchases.

13.1.4 LIMITING ERCS

ADJUSTMENT TO INSTALLED GENERATING CAPACITY

Adjustment to generating capacity must be limited to permanent derating to avoid the possible circumvention of the grid limits from the declaration of temporary reductions in capacity.

13.2

MEDIUM TERM REFORMS

13.2.1 PROPER IMPLEMENTATION OF THE PBR RATE-SETTING METHODOLOGY


Proper implementation of the PBR rate-setting methodology for transmission and private distribution utilities and of the RSEC-WR and proposed PBR for Electric Cooperatives to improve the utilities efficiency and moderate the increases in electricity rates.

13.2.2 AMENDMENT OF THE HORIZONTAL SEPARATION POLICY ON GENERATION


Legislative Amendment of the horizontal separation policy on generation such that the grid limit is based solely on control of the installed generating capacity. In this regard, installed generating capacity shall cover IPP capacities whose control were ceded by the NPC/PSALM to the administrators in the IPPA Agreements. University of the Philippines National Engineering Center 186

Philippine Electric Power Industry Market and Policy Assessment Final and Analysis of International Markets Report 13.2.3 INTERCONNECTION OF LUZON, VISAYAS AND MINDANAO
The Luzon, Visayas and Mindanao grids must be interconnected to mitigate the adverse effect on energy security of each grids high reliance on a single fuel/energy resource.

13.2.4 STRENGTHENING OF THE WESM


The wholesale spot market must be strengthened to incent new generation investments by: e) Reviewing the system operation and network reliability protocols to make them consistent with consumer valuation; f) Demand metering to allow consumers to react to changes in the supply and demand balance;

g) Raising the price cap and sticking to it; h) Creation of operating reserve, financial hedging, capacity markets and market for transmission rights to mitigate market risks and solve the missing money problem.

13.2.5 VERTICAL SEPARATION OF GENERATION AND DISTRIBUTION SECTORS


The generation and distribution sectors must be vertically separated (i.e., remove crossownership) to create robust competition in generation.

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14 INSTITUTIONAL GOVERNANCE REFORMS


The weakness of the institutional governance framework has its roots on: (1) the institutional paralysis of the DOE; (2) weak administrative capacity of the ERC; and (3) a litigious regulatory process that does not welcome broad participation and consultations and precludes an effective appeal mechanism to redress grievances.

14.1

DOES ASSERTION OF ITS AUTHORITY UNDER EPIRA

The institutional paralysis of the DOE is self-inflicted and stems from its misreading of, rather than an actual downgrading of its role under the law. There are anecdotal evidences to support the view that the mass exodus of its staff after the EPIRA was caused more by frustration over the perceived diminution of its role rather than from low salaries. The DOE must step up into the plate; assert is authority and deliver on its responsibilities under the law.

14.2

STRENGTHENING OF ADMINISTRATIVE CAPACITY OF ERC THROUGH FINANCIAL AUTONOMY AND MAINTAINING A BALANCE OF EXPERTISE

Strengthening the administrative capacity of ERC will require first, financial autonomy either through an automatic appropriation of its budget or by allowing the agency to keep and spend its collections instead of these being remitted to the National Treasury; and second,

maintaining a balance of expertise in the Commission, i.e., finance rather than accounting (financial policy and strategy is more critical than accounting ); power engineers (not just any engineer); regulatory economists (or in their absence, micro rather than macro economists); and lawyers. The present composition of the Commission and its top executive management which is dominated by lawyers should be restructured to achieve a more balanced composition of these disciplines. Regulation of infrastructure industries such as the electric power industry is more about economics rather than law and involves the consideration of the economic, financial, and technical impact of regulatory decisions rather than on the establishment and conformity with legal precedents that may be irrelevant to the case on hand. The current set-up where the Commissioners are appointed by the President need not be changed. However, the names and University of the Philippines National Engineering Center 188

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Malacanang , DOE and ERC websites so that a public vetting process takes place before their appointment by the President.

14.3

FLEXIBILITY IN THE REGULATORY PROCESSES

Short of abrogating the quasi-judicial character of the ERC (that will require legislative amendment); what is required is flexibility in the regulators processes that will: (1) invite broad debate of and meaningful participation by all stakeholders; (2) deepen the scope of the debate to relevant economic, technical and social issues instead of confining them to legal procedures and precedents; and (3) provide for an effective appeal mechanism. On the latter, the ERC could hire more arbitrators and conciliators akin to those at the National Labor Relations and Conciliation (NLRCC) Board and the Construction Board rather than requiring all cases to be heard by the Commission and immediately appealed to the Courts. In addition, a single panel of experts, with a permanent chair and varying members depending on the issue on hand could be formed to resolve disputes between the regulator and market agents and among market agents. The dispute settlement mechanism of WESM, GMC and DMC could be constituted as sub-groups reporting to this Experts Panel when the issues arise from or are within their jurisdictions.

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