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EPIRA at Ten: Failed Assumptions and Unfulfilled Promises

EPIRA at Ten: Failed Assumptions and Unfulfilled Promises

Jan 14, 2012

EPIRA at Ten: Failed Assumptions and Unfulfilled Promises by Rep. Lorenzo “Erin” R. Tañada III and Atty. Nepomuceno Malaluan On 8 June 2011, the Electric Power Industry Reform Act or EPIRA marked the 10th year since it was approved into law. EPIRA was a landmark measure, mandating the radical restructuring of the electricity industry from one dominated by the government sector (in generation and transmission) to a fully privatized industry. In brief, EPIRA required the government-owned National Power Corporation to privatize its generation and transmission assets, IPP contracts, and all other disposable assets, excepting only those associated with missionary electrification in off-grid areas (called Small Power Utilities Group or SPUG). The privatization was to be done through a liquidating corporation, the Power Sector Assets and Liabilities Management Corporation. Outside of a transition role in the privatization process, EPIRA left government with only the planning and regulatory functions through the Department of Energy and the Energy Regulatory Commission. EPIRA was intended to be the solution to the country’s electricity problems. At the core of these problems was the government’s inability to finance the sector’s investment requirements, setting off a crippling power crisis in the early 1990s. How government envisioned EPIRA to solve the electricity problems can be gleaned, for instance, from the government’s policy statement in support of its loan application to the Asian Development Bank in November 1998. In restructuring and privatizing the power sector, the government believed that competition would happen, generating greater operational and economic efficiency. It would at the same time facilitate the inflow of private capital, thereby minimizing government’s financial and risk exposure. The projected overall result of EPIRA was a reliable, secure, high quality and affordable power supply. These perspectives were reiterated in EPIRA’s declaration of policy. EPIRA was a leap of faith. The belief was that technology, the growing demand for electricity, and a large pool of foreign investors, would combine to make feasible a competitive market in power generation. Ten years into its implementation, we raise serious concerns over EPIRA’s outcomes, and argue that a continued framework of minor tweaking just won’t do. Supply Insecurity Section 2 (b) of EPIRA declares it the policy of the state to ensure the quality, reliability, security and affordability of the supply of electric power. Electricity security has short-term, medium-term and long-term aspects. In the short term, electricity security involves responding to power interruptions, stabilizing frequency and voltage variations, and matching demand and supply on a daily basis. In the medium term, electricity security involves the proper maintenance of generation and transmission/distribution assets two years into the future to maintain appreciable levels of dependable capacity. Beyond two years, there needs to be long-term planning for investments in generation capacity and network expansion to meet projected demand growth and to replace plants and assets in the end of their life cycle. In generation, power plants require between two- and five-year construction lead time, and massive capitalization from US$1 million to as high as US$4 million per MW of installed capacity. It is now apparent that EPIRA is not able to provide an adequate framework to ensure long term supply security. On the one hand, the market has proved seriously inadequate to promptly respond to the sale of existing NPC/PSALM assets, much less to commit and put up new capacity. The first signs of market failure came with the grossly missed privatization targets. Under EPIRA, the NPC plants and/or IPP contracts were to be grouped in a manner that promoted viability, efficiency and competition. Also, at least 70% of capacity of all generating assets and IPP contracts located in Luzon and Visayas should have been privatized within 3 years from the effectivity of the law, or by June 2004. Such level of privatization was a requirement for the implementation of retail competition within the same deadline. However, legal impediments (such as creditor consent), and lack of investor interest and their need for contractual market guarantees, combined to seriously delay the sale of assets. The sale of the bigger plants started to come on stream only in the latter part of 2006. As a result, the establishment of retail competition/open access has overshot deadline by 7 years, with the ERC declaring retail competition and open access for Luzon and Visayas to commence on 26 December 2011 yet (based on a finding that plants representing 79.5% of installed generating capacity, and IPP contracts representing 76.8% of installed capacity have been privatized). But the more serious threat to long term security of supply is the market’s (private sector’s) failure to provide new capacity, frustrating the capacity addition requirements the Department of Energy targeted in its power development plan. Thus, despite the substantial lead time afforded by the oversupply of power after the Asian crisis, reserve power has thinned to below adequate levels. In fact, the Visayas experienced tightening of power supply and Mindanao experienced actual power shortages in 2010. Luzon is already experiencing a thinning of reserves and forecasted to experience critical supply levels in the next two years. Based on the DOE’s 2009-2030 Power Development Plan, between 2009 and 2014 Luzon needs  additional  capacity of 1,050 MW but only 815 MW is expected to come on stream during the period. For Mindanao, 500 MW is required but only 100 MW will come on stream. It is only the Visayas that is foreseen to resolve its power supply outlook for this period. On top of this backlog, the  longer term additional capacity requirements are much higher: 10,850MW for Luzon, 2,000MW for the Visayas, and 2,000MW for Mindanao for 2015-2030. There is as yet no committed capacity for these. But while it is apparent that the market has failed to provide adequate investment, government has immobilized itself.  EPIRA expressly prohibits NPC from contracting or building new capacity. PSALM Hemorrhage Section 2 (i) declares it a policy under EPIRA to facilitate an orderly and transparent privatization of the assets and liabilities of the National Power Corporation. When EPIRA was enacted, the total financial obligations of NPC stood at US$16.39 billion. After selling 91.73% of NPC/PSALM assets for US$10.65 million, the total financial obligations of PSALM still stood at US$15.82 billion as of December 2010. If we count the PhP200 billion NPC debt that was transferred to the national government in 2004 as part of EPIRA, government indebtedness in the power sector has even increased. In other words, in ten years EPIRA’s only achievement has been the privatization of NPC; the liabilities remain with PSALM at almost the same levels, with the national government absorbing huge liabilities to boot! The PSALM financial hemorrhage is not about to stop. The past conversion of the NPC long-term debts into shorter-term commercial loans and bonds meant higher carrying costs compared to the original debt profile of NPC. PSALM assets are depleted and its projected receivables (such as from the Transco concession fees) fall below maturing yearly obligations; it is stuck with continued refinancing and ever-ballooning liabilities. In mid-June this year, PSALM has announced that it secured “a PhP75 billion syndicated term loan facility” for its 2011 financial shortfall. While the country confronts this financial outcome, PSALM has apparently paid excessive amounts in professional fees to legal advisors/consultants/contractors, and in incentives to employees regardless of status. In its 2009 audit of PSALM, the Commission on Audit observed that PSALM’s hiring of legal advisors/consultants or contractors was in violation of COA Circular No. 95-011. This circular prohibits employment by government agencies, including GOCCs, of private lawyers, unless justified under extraordinary circumstances, in which case written conformity by the Solicitor General or the Office of the Government Corporate Counsel and of the Commission on Audit are required. While PSALM secured conformity from the OGCC, COA denied its concurrence as such should have been secured prior to hiring. COA also found the consultancy fees and reimbursable expenses to be excessive. (We do not have information on the exact amounts involved and how these were booked in PSALM’s financial statements, but we note that an entry under Professional Services ballooned to PhP1.16 billion in 2009, up from PhP118 million in 2008 in PSALM’s statement of expenses.) In the same audit report, among the notice of disallowances given by COA were the payment to employees of corporate performance-based incentives for 2008 and 2009, amounting to PhP106 million. Each employee, regardless of status, received incentive pay equivalent to 5.5 months of basic salary. Consumers will face even higher rates EPIRA declares it among its policies to protect the public interest and to ensure that the price of electricity is affordable and reasonable in a regime of free and fair competition. We now have the highest electricity rates in Asia. Our national average rate of PhP8.14 per kWh is considerably more expensive than the PhP5 per kWh rates of our neighbors. But consumers will have to brace for even higher electricity rates. With no assets and inadequate receivables, PSALM can only look to consumers to plug the $16 billion black hole of continuing operational losses. The only mechanism available under EPIRA for this purpose is the universal charge for stranded debt and stranded contract costs. Last 28 June, PSALM already filed its petitions for the recovery of stranded debt and stranded contract cost. For stranded debts, PSALM seeks to recover from consumers PhP65 billion. For stranded contract costs, just for the years 2007 to 2010, PSALM seeks to recover PhP74.3 billion.  Further, new stranded debts and stranded contract costs will be computed yearly for additional charging. Future rate increases do not end there. Certain IPP contracts cannot claim stranded contract cost recoveries. However, there are existing mechanisms for recoveries of contract losses for this, such as the Incremental Currency Exchange Rate Adjustment and the Automatic Recovery of Monthly Fuel and Purchased Power Costs. Additionally, the Feed-In Tariff subsidy for new capacity using renewable energy will also contribute to rate increases. The emerging ownership structure of the industry is another concern. The field is dominated by a few big players, where anti-competitive behavior such as exclusive dealing, dividing territories, vertical and horizontal integration, and price leading could hurt the consumers and public interest at large. Today, San Miguel Energy Corporation has emerged as the biggest player in generation, owning 22% of generating capacity. The Lopez group owns 18%, while Aboitiz owns 14%. In the 17th Status Report on EPIRA Implementation, the ERC finds that no generation company has violated the market share limitations per grid and national grid for the year 2010. However, no data is presented on cross ownership and bilateral contracting where EPIRA also imposes certain limitations. Finally, open access and retail competition is an illusion. The opportunity to participate in retail competition is limited to big players. Only about 700 entities would qualify under the consumption threshold for open access We Need Critical Adjustments Now For years, government has tried to get EPIRA on track with its key components. But the severity of the problem requires critical and major adjustments now. First, we cannot let the electricity insecurity mature into another severe power supply crisis as has happened in the early 1990s. It was a big mistake for EPIRA to completely strip government of any role in power generation. Even as we allow private provision of electricity, reintroducing government in the generation sector will provide the much needed mechanism to address market failures in installing new capacity and to counter-balance any anti-competitive behavior of the big private players. Second, PSALM cannot be left alone to manage its own debts and losses. We urge the executive and Congress to convene an inter-agency, inter-branch and multi-stakeholder process to discuss and decide whether consumers can afford a full pass-on of the PSALM debts and losses, and explore other viable approaches for retiring the obligations of PSALM. Third, we need to evaluate the performance of the Energy Regulatory Commission in the discharge of its regulatory functions. We believe that the political appointments in the Chairmanship of the commission have compromised its independence, and it has become a tool for the executive to postpone unpopular price increases at the expense of the worsening financial conditions of PSALM. We believe that the ERC’s capacity must be upgraded to enable it to adequately monitor the ongoing concentration of ownership in the power sector, and effectively analyze its impact on power rates and electricity security. ERC also needs to be proactive in the disclosure of key important documents necessary for citizens to meaningfully participate in its regulatory process. (Published in Focus on the Philippines July 2011: http://focusweb.org/philippines/fop-articles/articles/534-epira-at-ten-failed-assumptions-and-unfulfilled-promises)

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