PBR

Performance Based Regulation

PBR Implementation 1
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

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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
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ERC Mandate
Sec. 38 of EPIRA

“There is hereby created an

independent, quasi-judicial regulatory
body to be named the Energy Regulatory
Commission (ERC).”

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ERC Major Functions

Encourage market Ensure customer

Promote competition
development choice

Set the transmission,

Impose fines and
distribution and
penalties for any
retail rates of the
non-compliance
captive market

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 HOW ELECTRICITY IS DELIVERED TO YOUR HOME?
Where does the peso in your electric bill go?

$$$

FUEL IN THE FORM OF ELECTRIC POWER ELECTRICITY IS THEN YOUR LOCAL DISTRI-
COAL OR OIL IS PLANTS THEN CARRIED OVER LONG BUTION UTILITY SETS UP
PURCHASED FROM GENERATE DISTANCES BY THE POWER LINES IN
ABROAD ELECTRICITY TRANSMISSION CABLES YOUR COMMUNITY AND
AND PAID FOR IN THAT IS TAPPED INTO SERVICES YOUR NEEDS
FOREIGN CURRENCY BY LOCAL DISTRIBUTION FOR ELECTRICITY
COMPANIES

HOW IS THIS REFLECTED IN YOUR ELECTRIC BILL?

GENERATION TRANSMISSION DISTRIBUTION, SUPPLY.
CHARGE CHARGE & METERING CHARGES
(65%) (10%) (25%)

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Unbundled
Electric Bill

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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
 Distribution
 Private Distribution Utilities
 Previously, Return on Rate Base Methodology
 Currently Performance-Based Regulation
 Electric Cooperatives
 Previously Cash Flow Methodology
 Currently Benchmarking Methodology
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How does the Return on
Rate Base Methodology set your rate?

 Determine Annual Revenue Requirement

 Based on a historical test year
OTHER
 Revenues arising from asset - based operations
REVENUE
should be shared by DU
ITEMS
RETURN ON  12 % of rate base
INVESTMENT  value of used and useful assets + working capital

RETURN OF  depreciation
INVESTMENT

PAYROLL  updated salaries plus allowable benefits

OPERATING  necessary, legitimate, prudent, continuing, normal

EXPENSES  includes operating and maintenance expense and taxes

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How does the Return on
Rate Base Methodology set your rate?
 Advantages
 Long standing practice
 Fairly constant, 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, bears much of the market risk
 Possible price shocks to consumer

*Averch, Harvey; Johnson, Leland L. (1962). "Behavior of the Firm Under Regulatory Constraint".

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

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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, the Regulator also has the legal and
societal obligation to regulate service quality
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Performance Based Regulation

• EFFICIENCY thru review of the Annual Revenue

Requirement
• SERVICE QUALITY thru setting of the
Performance standards

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PBR - Annual Revenue Requirement

 Determine forecasted Annual Revenue Requirement

(referred as Building Blocks) for a Regulatory Period

 set to zero
INCOME TAX

RETURN ON  Weighted Average Cost of Capital (WACC) X rate base

INVESTMENT  value of optimized used & useful assets + working capital

RETURN OF  depreciation
INVESTMENT
 property taxes, business taxes
TAXES

OPERATING  operating and maintenance expenditures

EXPENSES

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PBR – Building Blocks

RETURN ON Regulatory Working

INVESTMENT = ( asset base + capital ) X WACC

• The investor expects a return on its investment;

• The return is a mixed of Debt (thru loan) or Equity (investor-infused
capital);
• 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

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How are Capital Projects considered?

RETURN ON Regulatory Working

INVESTMENT = ( asset base + 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.
• ERC will review CAPEX requirements of utilities, 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

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Review of Capital Expenditure

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PBR - Building Blocks

• The analysis of each building block is

done for each year of the regulatory
period

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 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 RETURN ON RETURN ON RETURN ON

INVESTMENT INVESTMENT INVESTMENT INVESTMENT

RETURN OF RETURN OF RETURN OF RETURN OF

INVESTMENT INVESTMENT INVESTMENT INVESTMENT

TAXES TAXES TAXES TAXES

OPERATING OPERATING OPERATING OPERATING

EXPENSES EXPENSES EXPENSES EXPENSES

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Annual Revenue Requirement

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Smoothing the ARR for the RP

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21
Smoothing the ARR for the RP
ARR2010 ARR2011 ARR2012 ARR2013
+ + +
(1 + WACC) (1 + WACC) (1 + WACC) (1 + WACC)
2 3 4

Present Value of the ARR

=
ARR applied with (CPI-X)
(1 + Infl2010 − X ) FQ2010 (1 + Infl2010 − X )(1 + Infl2011 − X ) FQ2011
+ +
(1 + WACC ) (1 + WACC ) 2

( 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.

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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

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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

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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 determine/adjust the service performance
measures

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What are the control mechanisms?

2. Annual Verification
– to ensure that Utility earns only within the
approved constraints;
– to adjust for the actual increase/decrease in
price of commodities (inflation);
– to adjust for the actual increase/decrease in
sales;
– to review the service performance (incentive
or penalty)

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Annual Verification and Adjustment
Correction for Correction for
Performance revenue over tax over or
Incentive or under- under-
Factor recovery in recovery in
previous year previous year

This year’s Previous Index of change Efficiency factor

price per unit of year’s price per in Consumer
electricity unit of Prices
electricity

Next year’s price is capped at this year’s price plus

an allowance for general cost increases, reduced by
an efficiency factor.
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PBR Process
Regulatory Reset Process

Regulatory Year

YEAR YEAR YEAR YEAR YEAR

-1 1 2 3 4

Regulatory Period
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 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

Public Hearings
FOR EACH YEAR
OF THE REGULATORY PERIOD
Rate Decision
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Rate Implementation
Timelines of Private DUs
Entrant Regulatory Period
Manila Electric Company (MERALCO)
July 01, 2011- June 30,
Dagupan Electric Company (DECORP)
2015
Cagayan Electric and Light Company (CEPALCO)
Cotabato Light and Power Company (CLPC)
April 01, 2009 - March
Iligan Light and Power Company (ILPI)
30, 2013
Mactan Electric Company (MECO)
Cabanatuan Electric Corporation (CELCOR)
La Union Electric Company (LUECO)
Tarlac Electric, Inc. (TEI) July 01, 2010 - June 30,
Visayan Electric Company (VECO) 2014
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) October 01, 2011-
Bohol Light Company, Inc. (BLCI) September 30, 2015
Angeles Electric Corporation (AEC)
Clark Electric Distribution Corporation (CEDC)
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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
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Next… Building Blocks
Valuation
WACC

PBR Implementation 32