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PBR

Performance Based Regulation

PBR Implementation

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Republic Act No. 9136
Electric Power Industry Reform Act
(EPIRA)

• Signed: 8 June 2001
• Effectivity: 26 June 2001
Implementing Rules & Regulations

• Signed: 27 February 2002
PBR Implementation

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EPIRA Section 2:
Declaration of Policy of the State
a) xxx
b) To ensure the quality, reliability, security and affordability of the supply of
electric power;
c) To ensure transparent and reasonable prices of electricity in a regime of
free and fair competition and full public accountability to achieve greater
operational and economic efficiency and enhance the competitiveness of
Philippine products in the global market;
d) xxx
e) xxx
f) To protect the public interest as it is affected by the rates and service of
electric utilities and other providers of electric power.
g) xxx
h) Xxx
i) Xxx
j) To establish a strong and purely independent regulatory body and system
to ensure consumer protection and enhance the competitive operation of
the electricity market; and
k) xxx
PBR Implementation

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38 of EPIRA “There is hereby created an independent. quasi-judicial regulatory body to be named the Energy Regulatory Commission (ERC).ERC Mandate Sec.” PBR Implementation 4 .

ERC Major Functions Promote competition Encourage market development Set the transmission. distribution and retail rates of the captive market PBR Implementation Ensure customer choice Impose fines and penalties for any non-compliance 5 .

SUPPLY. & METERING CHARGES (25%) 6 .HOW ELECTRICITY IS DELIVERED TO YOUR HOME? Where does the peso in your electric bill go? $$$ FUEL IN THE FORM OF COAL OR OIL IS PURCHASED FROM ABROAD AND PAID FOR IN FOREIGN CURRENCY ELECTRIC POWER PLANTS THEN GENERATE ELECTRICITY ELECTRICITY IS THEN CARRIED OVER LONG DISTANCES BY TRANSMISSION CABLES THAT IS TAPPED INTO BY LOCAL DISTRIBUTION COMPANIES YOUR LOCAL DISTRIBUTION UTILITY SETS UP THE POWER LINES IN YOUR COMMUNITY AND SERVICES YOUR NEEDS FOR ELECTRICITY HOW IS THIS REFLECTED IN YOUR ELECTRIC BILL? GENERATION CHARGE (65%) PBR Implementation TRANSMISSION CHARGE (10%) DISTRIBUTION.

Unbundled Electric Bill PBR Implementation 7 .

Performance-Based Regulation  Distribution  Private Distribution Utilities  Previously. Return on Rate Base Methodology  Currently.How does ERC set the Charges?  Generation  WESM: Market  NPC: Return on Rate Base Methodology  IPPs: Individual review of bilateral contracts or PSA  Transmission  Previously. Return on Rate Base Methodology  Currently Performance-Based Regulation  Electric Cooperatives  Previously Cash Flow Methodology  Currently Benchmarking Methodology PBR Implementation 8 .

legitimate. normal  includes operating and maintenance expense and taxes 9 . continuing.based operations should be shared by DU RETURN ON INVESTMENT  12 % of rate base  value of used and useful assets + working capital RETURN OF INVESTMENT  depreciation PAYROLL OPERATING EXPENSES PBR Implementation  updated salaries plus allowable benefits  necessary.How does the Return on Rate Base Methodology set your rate?  Determine Annual Revenue Requirement  Based on a historical test year OTHER REVENUE ITEMS  Revenues arising from asset . prudent.

substantial returns despite fluctuations in the economy or firm composure  Provides earnings stability by guarding against excessive or unduly meager earnings  As practiced. allows reflection of current prices through adjustment mechanisms  Timing of regulatory reviews when utility “under-earns” Disadvantages  Limited incentive for exceptional performance  Encourages cost-padding  Averch-Johnson effect on capital costs:  If allowed return > capital costs = incentive to over-invest  If allowed return < capital costs = incentive to under-invest  Consumers. rather than the regulated firm. "Behavior of the Firm Under Regulatory Constraint". Harvey. Johnson.How does the Return on Rate Base Methodology set your rate?   Advantages  Long standing practice  Fairly constant. (1962). bears much of the market risk  Possible price shocks to consumer *Averch. Leland L. PBR Implementation 10 .

RDWR). later amended as Rules for Setting Transmission Wheeling Rates (RTWR) in September 2009 – In December 2004. thru the Transmission Wheeling Rates Guidelines (TWRG). the ERC. PBR Implementation 11 .Adoption of PBR • As authorized under Section 43(f) of the Electric Power Industry Reform Act (EPIRA). thru the Distribution Wheeling Rates Guidelines (renamed as Rules for Setting Distribution Wheeling Rates. promulgated the Performance Based Regulation (PBR): – In May 2003.

the Regulator also has the legal and societal obligation to regulate service quality PBR Implementation 12 .Performance Based Regulation • PBR is intended to ensure that firms have incentives to improve efficiency • Regulator must ensure that all these gains do not accrue to the firms • Wide recognition that a trade-off exists between – The service quality at which electricity is supplied and – The cost for providing this service • Hence.

Performance Based Regulation • EFFICIENCY thru review of the Annual Revenue Requirement • SERVICE QUALITY thru setting of the Performance standards PBR Implementation 13 .

business taxes  operating and maintenance expenditures 14 .PBR .Annual Revenue Requirement  Determine forecasted Annual Revenue Requirement (referred as Building Blocks) for a Regulatory Period INCOME TAX  set to zero RETURN ON INVESTMENT  Weighted Average Cost of Capital (WACC) X rate base  value of optimized used & useful assets + working capital RETURN OF INVESTMENT  depreciation TAXES OPERATING EXPENSES PBR Implementation  property taxes.

• The return is a mixed of Debt (thru loan) or Equity (investor-infused capital).PBR – Building Blocks RETURN ON INVESTMENT = ( Regulatory asset base + Working capital ) X WACC • The investor expects a return on its investment. • Usually the interest rate in Debt is higher than the Equity • Based on an optimal value of the Regulatory Asset Base plus allowed Working Capital PBR Implementation 15 .

How are Capital Projects considered? RETURN ON INVESTMENT = ( Regulatory asset base + Working capital ) X WACC • ERC to determine the value of the rolled-forward optimized depreciated regulatory asset base (RAB) • RAB going forward will be based on initial opening value and the approved efficient CAPEX. based on: – information provided by the utilities on historical CAPEX – CAPEX forecasts provided by utilities – Justification of CAPEX – Analysis by independent expert(s) on the information provided by utilities and the levels of efficiency implied – Other information at the ERC’s disposal PBR Implementation 16 . • ERC will review CAPEX requirements of utilities.

Review of Capital Expenditure PBR Implementation 17 .

Building Blocks • The analysis of each building block is done for each year of the regulatory period PBR Implementation 18 .PBR .

Annual Revenue Requirement REGULATORY PERIOD Regulatory Year 1 Regulatory Year 2 Regulatory Year 3 Regulatory Year 4 INCOME TAX INCOME TAX INCOME TAX INCOME TAX RETURN ON INVESTMENT RETURN ON INVESTMENT RETURN ON INVESTMENT RETURN ON INVESTMENT RETURN OF INVESTMENT RETURN OF INVESTMENT RETURN OF INVESTMENT RETURN OF INVESTMENT TAXES TAXES TAXES TAXES OPERATING EXPENSES OPERATING EXPENSES OPERATING EXPENSES OPERATING EXPENSES PBR Implementation 19 .

Annual Revenue Requirement PBR Implementation 20 .

Smoothing the ARR for the RP PBR Implementation 21 .

Smoothing the ARR for the RP ARR2010 ARR2011 ARR2012 ARR2013 + + + 2 3 4 (1 + WACC) (1 + WACC) (1 + WACC) (1 + WACC) Present Value of the ARR = ARR applied with (CPI-X) (1 + Infl2010 − X )(1 + Infl2011 − X ) FQ2011 (1 + Infl2010 − X ) FQ2010 + + 2 (1 + WACC ) (1 + WACC ) ( MAP2009 − P0 ) × (1 + Infl2010 − X )(1 + Infl2011 − X )(1 + Infl2012 − X ) FQ2012 + (1 + WACC ) 3 (1 + Infl2010 − X )(1 + Infl2011 − X )(1 + Infl2012 − X )(1 + Infl2013 − X ) FQ2013 (1 + WACC ) 4  Calculate the present value of the allowed ARR resulting from the MAP that a regulated entity is permitted to charge. PBR Implementation 22 .

Service Quality Measures under PBR How are the target performance levels set for the regulatory period?  The utilities’ historical performance of the outcomes of the various performance indicators is reviewed  An assessment is done on the performance indicators that need to be addressed in the regulatory period  Relative weighting on each performance indicator is determined based on the foregoing  The average performance or target performance level is set Average of the previous regulatory period Best of the regulatory Period (see Distribution Code: historical)  Performance steps for reward and penalty are set PBR Implementation 23 .

Service Quality Measures under PBR • Price-linked incentive scheme – depending on network and service performance. a reward is added to the annual price-cap or a penalty is deducted • Guaranteed Service Levels – component of the PIS in which the DUs will compensate a consumer directly if certain service delivery performance standards are not met PBR Implementation 24 .

– to determine/adjust the service performance measures PBR Implementation 25 .What are the control mechanisms? 1. A review every 4 years (Reset) – Determine Annual Revenue Requirement thru the Building Block analysis – to determine/benchmark the actual cost that has been incurred by the Utility.

– to review the service performance (incentive or penalty) PBR Implementation 26 . – to adjust for the actual increase/decrease in price of commodities (inflation). Annual Verification – to ensure that Utility earns only within the approved constraints. – to adjust for the actual increase/decrease in sales.What are the control mechanisms? 2.

reduced by an efficiency factor. PBR Implementation 27 .Annual Verification and Adjustment Performance Incentive Factor This year’s price per unit of electricity Previous year’s price per unit of electricity Correction for revenue over or underrecovery in previous year Index of change in Consumer Prices Correction for tax over or underrecovery in previous year Efficiency factor Next year’s price is capped at this year’s price plus an allowance for general cost increases.

PBR Process Regulatory Reset Process Regulatory Year YEAR -1 YEAR 1 YEAR 2 YEAR 3 YEAR 4 Regulatory Period PBR Implementation 28 .

Reset Process LEGEND Issues Paper ERC Responsibilities Public Consultation DUE PROCESS Position Paper UTILITY Responsibilities Utility Submits Revenue Application Public Hearings Draft Determination Public Consultation Final Determination Utility Submits Rate Application FOR EACH YEAR OF THE REGULATORY PERIOD PBR Implementation Public Hearings Rate Decision Rate Implementation 29 .

(TEI) Visayan Electric Company (VECO) Ibaan Electric and Engineering Company (IEEC) Davao Light and Power Company (DLPC) Panay Electric Company (PECO) Subic Enerzone (SEZ) San Fernando Light and Power Company (SFELAPCO) Bohol Light Company. 2010 . (BLCI) Angeles Electric Corporation (AEC) Clark Electric Distribution Corporation (CEDC) PBR Implementation Regulatory Period July 01.June 30. 2009 . Inc. 2011. 2015 30 . 2015 April 01. 2013 July 01.March 30. Inc.Timelines of Private DUs Entrant Manila Electric Company (MERALCO) Dagupan Electric Company (DECORP) Cagayan Electric and Light Company (CEPALCO) Cotabato Light and Power Company (CLPC) Iligan Light and Power Company (ILPI) Mactan Electric Company (MECO) Cabanatuan Electric Corporation (CELCOR) La Union Electric Company (LUECO) Tarlac Electric. 2011September 30. 2014 October 01.June 30.

Issues Raised – – – – – – – – – – – – Building Blocks approach WACC Determination of RAB (valuation) Correction Factor (k-factor) Side Constraints Working Capital Bad Debts Over/Under Recoveries from previous RP Setting of Po and X – factor Annual Verification Regulatory Intervention Regulatory Reset Experts PBR Implementation 31 .

Next… PBR Implementation Building Blocks Valuation WACC 32 .