The Economics of Electric Energy: IPPs, the PPA, and the Electric Power Industry Reform Act (EPIRA)

ATENEO DE MANILA UNIVERSITY

Graduate School of Business

Economics for Managers

TERM PAPER

The Economics of Electric Energy: IPPs, the PPA, and the Electric
Power Industry Reform Act (EPIRA)

November 7, 2011

Submitted to:

Enrico C. Mina, DBA

Submitted by:

Quizon, Louie Mark R.

[THE ECONOMICS OF ELECTRIC ENERGY: IPPS, THE PPA, AND THE
ELECTRIC POWER INDUSTRY REFORM ACT (EPIRA)] November 7, 2011

I. Introduction

The Philippine Electric Industry has developed and evolved from being a state monopoly

to a deregulated and private industry. But this transformation however, did not come without

much controversy, criticism, and concern. From the imposition of EO 215 (Executive Order 215)

in 1988 to the Electric Power Crisis Act in 1993, the BOT (Build-Operate-Transfer) Law in 1994,

and then the EPIRA (Electric Power Industry Reform Act) of 2001, the benefits of private firm-

produced electric power has not yet been felt by the people. The efficiency promised by the

EPIRA has not yet been realized. This research paper aims to investigate the accrued effects of

the electric power industry reforms since 1988 to the Philippine economy.

As of February 7, 2011, the Philippines has surpassed Japan in having the most

expensive electricity rates in Asia1.This should come as no surprise since the electricity rates in

the Philippines has long been regarded as one of the highest in Asia. How this came about is

arguably not that much unexpected. This paper shall discuss the various reasons why our

electricity rates are very high and why this should be a cause for economic concern.

1
“Study shows Phl has the highest electricity rates in Asia.” The Philippine Star Website. October 10, 2011
Ateneo Graduate School of Business 1

November 7, 2011 ELECTRIC POWER INDUSTRY REFORM ACT (EPIRA)]

Table 1: Retail Electricity Tariffs across Selected Asian Countries June 1998 (in Php)

Source: Myrna Velasco, Surviving a Power Crisis (2005) from The Philippines Electricity Market
Investment Context

Figure 1: Residential Retail Electricity Tariffs, Selected Asian Economies (USc/KWh), 2010

Source: Arangkada Philippines: A Business Perspective

2 Ateneo Graduate School of Business


Figure 2: Industrial Retail Electricity Tariffs, Selected Asian Economies (USc/KWh), 2010

Source: Arangkada Philippines: A Business Perspective

The discussion will start from the origins of the Philippine IPPs (Independent Power

Producers) leading to the rationale behind the PPA (Purchased Power Adjustment), then

followed by the various reforms under the EPIRA. The paper then details the economic effects

of the implementation of the EPIRA and the Wholesale Electricity Spot Market (WESM), the

present state of competition of the Philippine Electric Industry and how it is affecting the high

electricity rates that the Philippines have been facing. Finally, the reasons why electricity rates

are high will be presented as well as some recommendations on how to mitigate its

macroeconomic effects.



II. Thesis Statement

The existence of the IPPs and the PPA has been justified by the state of the economy

and budget deficit position of the government during the early 1990s but the over-commitment

to the IPPs contributed significantly to the high electricity prices during the late 1990s.

Together with the IPPs and PPA, the Philippine Electric Industry’s transition from

monopoly to oligopoly is the primary cause why our electricity prices today are the highest in

Asia, notwithstanding other factors such as taxes, the transmission system, and dependence on

imported fuel.

III. Body

Independent Power Producers – History and Rationale(Woodhouse, 2005)

EO 215

During the first Aquino administration, it has been forecasted that there will be an

electric power shortage. This prompted the government to pass EO 215. This order effectively

ended NPC’s (National Power Corporation) monopoly in the country by allowing private

companies to build power plants and supply power to NPC and the local distribution utilities.

Table 2 shows the electric power industry sector ownership.



Table 2: Electric Power Industry Sector Ownership

Source: Woodhouse, E. J. (2005, June). The Philippines Electricity Market Investment Context

According to the World Bank, this has been one of the first public-private partnerships

(PPP) done by the Philippine government. During this period however, only Hopewell’s Navotas

I power plant project reached financial closure and was commissioned in 1991.

Electric Power Crisis Act and the BOT Law

The effects of the deficiency on added power plant capacity brought by EO 215

culminated during the Ramos administration. In 1992, the lack of added capacity resulted to

rolling blackouts. Because of this, in 1993, Congress passed the Electric Power Crisis Act that

authorized the executive branch to contract IPPs on a fast track basis. Since it was on a fast

track basis, most of the IPPs that were contracted have generating capacities that were based

on combustion turbines and diesel engine technologies. It is important to note that these

power plants have short construction times compared to other technologies like coal thermal

and hydroelectric and that these power plants have low capital costs and can be operational

within a year. These power plants however, have high operating costs.



Although these power plants became quickly available to address the electric power

shortage, these plants were dispatched as base load units (ran 24 hours a day) rather than their

typical use as peak units (only during peak hours) making the overall dispatching of power

plants very expensive. Based on the economic dispatching of generating units, diesel and

combustion turbines (different from combined cycle technologies) should be dispatched only

during peak hours because of their high heat rates (BTU per kWh, a measure of efficiency) and

high operating costs2.

Figure 3 shows the typical demand curve that is unbundled according to base,

intermediate, and peak. Each classification of demand ideally uses particular set generating

units that would result to a lower overall cost. Baseload power plants typically include nuclear,

geothermal and coal. Intermediate power plants are combined cycle gas turbines that run on

natural gas. Peaking plants include combustion turbines, diesel, and sometimes hydroelectric.

This is the economic dispatching of power plants.

Figure 3: Illustrative Load (Demand) Curve

Source: Stan Kaplan, CRS Report on Congress: Power Plants: Characteristics and Costs,
November 13, 2008

2
Stan Kaplan, CRS Report on Congress: Power Plants: Characteristics and Costs, November 13, 2008


When the power crisis ceased, high economic and demand growth was projected so IPP

contracting continued. These power plant projects include large baseload plants like Sual (1200

MW), Pagbilao (700 MW), and hydroelectric and natural gas plants such as Ilijan became online

in the late 1990s.

Nature of the IPP Contracts

IPPs that are operational during 1988-2001 sell their output energy either to the

government (through NPC, PNOC, or NIA) or to distribution utilities such as MERALCO. Their

operations are covered by contracts that can take the form of either a Power Purchase

Agreement or an Energy Conversion Agreement in which the government purchases fuel and

pays the IPP for the electrical conversion of that fuel.

The nature of these contracts is such that all risks except the construction and operation

of the power plants are shouldered by the government. Given the power situation at that time,

the government was of no position of strength and therefore had to make the contracts

attractive to the investors. The common elements of the risks that are assumed by the

government include:

Market Risk

o This refers to the MEOT (minimum energy off-take typically in the range of 70-

85% of power plant capacity factor) in which NPC can pass to the consumers, the

costs attributed to the take-or-pay provisions. This means that consumers would

have to pay for power that they did not actually consume



Fuel Risk

o The ECAs have this provision in which the price and availability risk are passed on

to consumers

Foreign Exchange Risk

o Most IPP contracts have dollar-denominated components on fees and the risk of

the Peso-Dollar exchange rate is also passed-through

Other Payments

o Pass-through payments involving cost recovery and operations and maintenance

Sovereign Guarantee

o Most IPP contracts are backed by a sovereign guarantee

Effects of the IPP Contracts(Woodhouse, 2005)

Asian Financial Crisis

The Asian Financial crises proved to be a blow for the Philippine government and

electricity consumers because the IPPs were contracted based on a very high GDP growth

forecast by NPC. GDP growth is a good indicator for electricity demand growth. According to

the Power Sector Study of the World Bank, during that time, NPC based its projections on a high

forecast of 12% while the World Bank used a more conservative approach and used the 9.5%

figure. Figure 4 shows Philippine’s historical GDP and it shows the steep drop in output during

the Asian Financial Crisis. Actual demand against projected demand is seen on Figure 5 and it

also includes the annual levels of installed and dependable capacity of generation.



Figure 4: Philippine historical real GDP and GNP growth rates, 1981-2009

Source: Joint Foreign Chambers of the Philippines, The Philippine Economic Landscape in 2010: Faster
Growth is Essential Advocacy Paper, December 2010

Figure 5: Electricity Demand and Supply Profile (1986-2001)

Source: Vince S. Perez, The Philippine Electricity Sector, DOE June 24, 2002



Because of the fall in GDP, electricity demand fell and there was a huge oversupply in

generation capacity. This resulted to higher per KWh electricity ratesthat NPC is paying because

of the take-or-pay provision of the contracts. And since this is a pass-through provision,

consumers were burdened for paying electricity that was not consumed.

Devaluation of the Peso

The devaluation of the Peso worsened the electricity price situation because of the

foreign exchange risk provision in the IPP contracts. In addition, since the Philippines has no

extensive domestic reserves of fuel, NPC had to import most of its fuel needs.

Figure 6 illustrates the historical foreign exchange rate of the Peso relative to the Dollar.

The Asian Crisis resulted to a huge devaluation of the Peso. As long as we have IPP contracts

that have dollar-denominated payments and imported fuel, electricity prices will remain at risk

of the foreign exchange rate.

Figure 6: Historical foreign exchange rate (Php/$)

Adapted from: BangkoSentralngPilipinas Website, Online Statistical Interactive Database, October 16,
2011



Purchased Power Adjustment (PPA)(Department of Energy)

The PPA is the automatic cost recovery system to cover for the adjustments in cost not

included by the basic rate of NPC. To state it in another way, the PPA is the mechanism that

NPC uses to pass to the consumers all the various risks borne by the government in all of its IPP

contracts. These include the risks in minimum energy, fuel procurement, and foreign exchange.

The PPA is charged by the distribution utilities or electric cooperatives like MERALCO

and BENECO and just mirrors what NPC is charging these utilities and cooperatives. What NPC is

charging are all the adjustments based on the risks and indexation provisions in NPC’s

generation costs and IPP contracts.

NPC’s cost recovery adjustments are generally divided into two parts: the FPCA (Fuel

and Purchased Power Cost Adjustment) that covers the minimum off-take and fuel risks, and

the FOREX (foreign exchange) which covers the foreign exchange risk. Figure 7 illustrates NPC’s

charges. Figure 8 on the other hand, shows what NPC adjustments look like for the customers

of MERALCO.



Figure 7: NPC Charges and their Purpose


Figure 8: NPC Charges translated to the Distribution Utility




The Burden of PPA

Because of the multitude of risks that are passed on to the consumers, the effects have

been so far condemning. The Asian Crisis taught us how expensive NPC’s generation rate can

be. Recall that during the Asian Crisis, the Philippines experienced a slowdown in demand

which meant a higher rate because of the minimum off-take IPP provision. In addition, the

devaluation of the Peso also contributed to the rate increase because of the FOREX component

of the PPA. Figure 9 shows how the PPA grew over time.

Figure 9: NPC Charges translated to the Distribution Utility




EPIRA (RA 9136)(Philippine Electricity Market Corporation, 2005)

Despite the PPA, NPC did not succeed in passing on to the consumers all its costs. Aside

from the fact that in 2000, NPC had around $6.6 Billion in outstanding loan facilities of which

50% is US dollar denominated and 45% is Yen denominated3, regulation prevented NPC from

passing on to consumers all of its PPA adjustments.

With the ballooning deficit of the government and the intent to privatize the huge

capital expenditures and risks of the electric power industry, the government pushed for a

reform in the electric power industry. This came into fruition in 2001 when Congress passed the

EPIRA or the Electricity Power Industry Reform Act.

The EPIRA has the following objectives:

Ensure the quality, reliability, and affordability of the supply of electricity

Ensure transparent and reasonable prices of electricity in a free and competitive

market

Enhance the inflow of private capital and broaden the ownership in the power

generation, transmission, distribution and supply sector

To assure socially and environmentally compatible energy sources and

infrastructure

To promote the utilization of indigenous, new and renewable energy resources

in power generation in order to reduce dependence on imported energy

3
Woodhouse, E. J. (2005, June). The Philippines Electricity Market Investment Context


Provide an orderly and transparent privatization of NPC assets and liabilities

To accomplish all these objectives, the electric power industry needs to be

restructured.The restructuring mainly involves the separation of the competitive and the

monopolistic components of the industry. The competitive components of the industry are the

generation and retail sectors while the monopolistic components are the transmission and

distribution systems. EPIRA also involves the unbundling of electricity tariffs to ensure

transparency.

Before restructuring, there are basically just three sectors in the industry. These are the

generation, transmission, and distribution sectors. Figure 10 illustrates the electric power

industry before EPIRA while Figure 11 shows the new structure. The retail function has been

handled by the distribution sector. It will be opened up to Retail Electricity Suppliers (RES) once

“Open Access” has been put into commercial operations.

Figure 10: Electric Power Industry Before EPIRA

Source: L. Quizon, “EPIRA Report”, Trans-Asia Oil and Energy Development Corporation,
January 28, 2008



Figure 11: The New Electric Power Industry Structure

Philippine Electricity Market Corporation. (2005). WESM Commercial Operations Training Module 1.

For the new industry structure, the EPIRA declares the generation of electric power

competitive and open and shall not be subject to regulation by the ERC (Energy Regulatory

Commission). The transmission and distribution sectors will still be subject to the ratemaking

powers of the ERC. The supplier sector, or the retail sector, is also not regulated although

entities under this category will be required an ERC license.

Along with the industry restructuring, the EPIRA created the National Transmission

Corporation (TRANSCO) which shall assume the electrical transmission function of NPC.

TRANSCO is the lone entity in the transmission sector.

Another entity, the Power Sector Assets and Liabilities Management (PSALM)

Corporation, is also created by the EPIRA to administer the privatization of all disposable assets

of NPC (including TRANSCO) except SPUG (Small Power Utilities Group). PSALM is also

responsible for liquidating all financial obligations and stranded contract costs of NPC.


The EPIRA has provisions on cross-ownership between sectors of the industry, market

power abuse, and competitive behavior. According to this law, no generation company or

distribution company shall be affiliated with the transmission sector entity TRANSCOor its

concessionaire (now National Grid Corporation of the Philippines or NGCP).

Aside from breaking the state monopoly, the EPIRA was envisioned to transform the

industry into a more competitive marketplace. Aside from deregulating generation and supply,

the law also established the Wholesale Electricity Spot Market or WESM to achieve this aim.

WESM

The Wholesale Electricity Spot Market was established to provide the mechanism for

reflecting the true cost of electricity outside of bilateral contracts. The aim of the WESM is to

establish a competitive, efficient, transparent, and reliable market where:

A level playing field exists among WESM Participants

Trading of electricity is facilitated among WESM Participants within the Spot Market

Third parties are granted access to the power system

Prices are governed as far as practicable by commercial and market forces

Efficiency is encouraged



The basic features of the WESM are:

Gross Pool

o All energy transactions are scheduled through the market

Net Settlement

o Bilateral Contract quantities transacted in the pool can be settled outside of the

market

Locational Marginal Price

o Marginal price computed at each node or location to reflect transmission loss

and/or congestion

Reserve Co-Optimization

o Reserve and energy offers are scheduled at the same time

Demand bids

o Customer’s choice to buy energy lower than a specified price

Mandatory Market

o EPIRA mandates procurement of at least 10% from the market for distribution

utilities and electric cooperatives



How the WESM Works

The WESM basically allows the price and electricity volume to be determined through

the interaction of supply and demand “on the spot”. Since electricity cannot be stored,

transactions should be done in real time. A basic illustration is showed in Figure 12, where the

market-clearing price (MCP) and the market-clearing volume (MCV) are determined by market

forces.

Figure 12: Basic Illustration of MCP and MCV

Philippine Electricity Market Corporation.(2005). WESM Commercial Operations Training Module 1.

The market bids (demand) and offers (supply) are actually arranged in MW (megawatt)

energy blocks. The supply and demand curves look like step ladders as shown in Figure 13. The

WESM also determines the actual merit order of dispatch of the generators. The generators

that offer the least will get to be dispatched by the system first. The market clearing price is the

price that would be paid by all customers and paid to all generators. The cheapest plants will

have the incentive of having a bigger producer surplus.



Figure 13: WESM Demand/Supply Curves and Dispatch Scheduling


The current market, however, does not include demand bids yet. The unavailabilty of

customers’ historical metered demand makes it difficult for them to make meaningful bids, that

is why until now, demand bids are not yet in effect4.

But note that electricity demand is like demand for oil. It is highly inelastic. Meaning, at

any given point in time, we can assume that demand is a vertical line and the intersection of the

supply energy blocks and demand determines the market clearing price. The market clearing

volume will always be equal to demand.

An example is shown in Figure 14. Suppose that the demand for a given trading interval

is 400 MW. Generator A offers 100 MW at a price of 1000 Php/MWh. Generator B offers 250

MW at 1500 Php/MWh and Generator C offers 500 MW at 2000 Php/MWh. The generators will

be dispatched according to merit order (cheapest plants will be dispatched first) until supply

meets demand. In this case, only 50 MW will be taken from Generator C and Generator C is the

4
Philippine Electricity Market Corporation. (n.d.). WESM Faqs. Retrieved October 21, 2011


marginal clearing plant or just simply, marginal plant. The market clearing price is 2000

Php/MWh and this is the same price that would be paid to Generators A and B.

Figure 14: Supply/Demand Interaction without Demand Side Bidding


The WESM is fairly simple and theory suggests that if an electricity market is

competitive, the spot market will encourage efficiency and lower prices. But will this system

work if the industry has a high market concentration? We now turn to this and examine the

current industry concentration.



Market Concentration and Oligopoly

Almost every time that MERALCO raises its generation charge, very seldom do you not

hear that WESM played a vital role. Last June 7, 2011, Meralco again raised its generation

charge with WESM as one of the reasons for the increase.5

The WESM provides an avenue for buyers and sellers of electricity to trade electricity

like a commodity. In a perfectlycompetitive setting, the WESM like any other commodity

market, should demonstrate efficiency in which electricity is allocated at the least possible cost.

However, like in many cases, the WESM is imperfect.

The generation sector, according to the Market Assessment Group of the Philippine

Electricty Market Corporation (PEMC), has an industry concentration that is between the

moderate and high levels depending on the measurement used (based on registered capacity,

offered capacity, actual generation, etc.).

Market concentration is measured using the Herfindahl-Hirschman Index or HHI. HHI is

the standard measure of industrial concentration used by the United States since 1982 6 and is

adapted by the Market Assessment Group of PEMC as one of the ways to measure competition

and assess the spot market condition. The HHI is calculated by expressing the market share of

each firm in the industry as a percentage, squaring these figures, and summing. 7

5
Manila Electric Company. (2011, June 7). News and Updates. Retrieved November 1, 2011, from Meralco
6
Liberty Fund, Inc. (n.d.). Industrial Concentration by William F. Shughart II. Retrieved November 1, 2011
7
Case, K. E., Fair, R. C., & Oster, S. (2009). Principles of Economics (9 ed.). Jurong, Singapore: Prentice Hall.


In the WESM, an HHI of below 1000 indicates no concentration. An HHI of between

1000 and 1800 is moderately concentrated. An HHI that is between 1800 and 2500 indicates a

concentrated market while an HHI that is above 2500 is highly concentrated.

The generation sector is currently dominated by four firms: First Gen Corporation of the

Lopez group, Aboitiz group, and San Miguel Corporation, and PSALM Corporation. Figure 15

shows the market share of the generation sector suppliers of the Philippines. Figure

16illustrates the major suppliers’ historical market share by registered capacity while Tables 3-4

shows the Major Participant grouping for Luzon and Visayas indicating the affiliation of the

generation companies.

Figure 15: Market Share of Generation Sector Suppliers by Dependable Capacity

Source: “Strategic Planning Presentation 2011” Trans-Asia Oil and Energy Development Corporation,
October 2011



Figure 16: Share of Registered Capacity by Major Participant July 2009 to June 2011

Source: Philippine Electricity Market Corporation. (August 9, 2011). 5th Annual WESM Participants
Meeting: Market Assessment. Quezon City

From 2009 to 2010, the market share of PSALM has gradually decreased. This is

reflective of the decrease of the monoplostic market share of NPC. The decrease of NPC’s, or

PSALM’s in this case, market share is the result of the sale of NPC’s generation assets. The



assets have been acquired by various industry players including new entrants such as San

Miguel Corporation.

As PSALM’s dominance decreased, a new market power emerged. Excluding PSALM, the

largest suppliers are First Gen Corporation, the Aboitiz group, and San Miguel Corporation. The

once monopolistic structure of the industry has produced a new kind of imperfect market

structure: Oligopoly.

Oligopoly is a form of industry structure characterized by a few dominant firms. Market

concentration tends to lead to pricing that is above marginal cost at equilibrium and output is

below the efficient level8. Just how concentrated is the generation sector? Figure 17 shows the

HHI by Luzon major participants from June 26, 2009 until December 25, 2010. The year 2009

shows the dominance that PSALM is enjoying during that time and as generation assets were

sold, the market share of other participants grew and it resulted to a decrease in industry

concentration.

However, if the measurement is based on registered capacity that is net of outage,

offered capacity in the market, actual generation and spot market transaction, the HHI level will

reach the concentrated to highly concentrated level. Figure 18 shows the HHI of the Luzon grid

from June 26, 2009 to December 25, 2010.

8


Table 3: Major Participant Grouping: Luzon (July 2010 – Jun 2011)


Table 3: Major Participant Grouping: Visayas (July 2010 – Jun 2011)




Figure 17: Herfindahl-Hirschman Index based on Registered Capacity (Jun 26, 2009 – Dec 25, 2011)


Figure 18: Herfindahl-Hirschman Index based on Various Scenarios (Jun 26, 2009 – Dec 25, 2011)




Residual Supply Index

The residual supply index (RSI) provides a measure of the degree of pivotal supplier

power based on fundamental economic intuition9. The pivotal suppliers are the suppliers who

can raise the market price substantially by withholding generation capacity10. The RSI measures

the collective capacity of all generators as a percentage of total demand but excluding the

largest generator or supplier. A measure of below 100% indicates that the largest supplier is

pivotal. The lower the value, the higher is the pivotal power of the pivotal supplier.

Figure 19 shows the RSI of the market between June 26 to December 25, 2010. In this

period, pivotal power is above 60%.

Figure 19: RSI for WESM based on Offered Capacity (Jun 26, 2009 – Dec 25, 2011)


9
Brandts, J., Reynolds, S., & Schram, A. (2011, January 31). Pivotal Suppliers and Market Power
10
Genc, T., & Reynolds, S. (n.d.). Supply Function Equilibria with Pivotal Suppliers


Pivotal Supplier and Price Setting Frequency

Besides the market abuse case against PSALM that was filed by PEMC’s board of

trustees (a 73% increase in prices but ERC junked the case on June 6, 2007 because of lack of

evidence), there has been no filed complaints against market abuse. Because of the high

concentration and RSI of the market however, it is very possible that some market power is

being exercised by the firms who hold the largest market shares.

There are two measures of market power. One is the Pivotal Supply Index in which a

particular supplier (the pivotal supplier as discussed earlier) has an integral role in supplying the

demand for electricity at any time. If the pivotal supplier chooses not to generate, then there

may be adverse effect in market that would raise the clearing price. In fact, market power due

to the presence of pivotal suppliers has been documented to contribute to high prices and

inefficiency in wholesale electricity markets and is a significant concern for public policy toward

the electric industry11

The next measure is the Price Setting Index. It measures the frequency of market-

clearing price setting of a particular supplier. If a supplier is both a pivotal supplier and price

setter above marginal cost, then you have an exercise of market power.

Table 4 shows the Pivotal Supply Index of the power plants from July to December

2010. This research will only concentrate on Luzon for simplicity. The values are the percent of

the time each month that a power plant is considered a pivotal supplier. Table 5 shows the

11
Brandts, J., Reynolds, S., & Schram, A. (2011, January 31). Pivotal Suppliers and Market Power


average percent of the time that the power plants of the three major generator groups namely,

San Miguel, Aboitiz and First Gen have been considered as pivotal suppliers.

Table 4: Pivotal Supply Index Luzon based on Offered Capacities (July – Dec 2010)


Table 5: Average Percentage of being Pivotal Suppliers of the three Major Participants (July – Dec 2010)
Major Participant Average Percentage
San Miguel 42.31
Aboitiz 26.19
First Gen 29.27
Adapted from: Philippine Electricity Market Corporation. (August 9, 2011). 5th Annual WESM
Participants Meeting: Market Assessment. Quezon City



Taking the average of all the power plants of the three major participants, we can see

how their sizes influence the dependence of the Luzon grid to their power plants. In Table 5, of

all three major participants, San Miguel has the highest average percentage of being a pivotal

supplier.

Table 6 shows the Price Setting Frequency Index of the Luzon power plants from July to

December of 2010. The values here only shows the instances where the market clearing price is

above Php 5 per KWh or Php 5000 per MWh. Table 7 on the other hand, reflects the average

percentage of the time that the power plants of the three major participants have set the price

in the spot market.

Table 6: Price Setting Frequency Index July – Dec 2010 (Php 5000 per MWh and above)




Table 7: Average Percentage of being Market Price Setters
for the three Major Participants (July – Dec 2010)
Major Participant Average Percentage
San Miguel 5.97
Aboitiz 5.65
First Gen -
Adapted from: Philippine Electricity Market Corporation. (August 9, 2011). 5th Annual WESM
Participants Meeting: Market Assessment. Quezon City

Table 7 shows that at the price range of above Php 5000 per MWh, only San Miguel and

Aboitizhave set the price in the market.

With the market hovering between the concentration levels of moderate to high and

the residual supply index falling below the level of 100% at least 60% of the time between July

to December 2010, it is quite possible that some market power has been exercised. The price

setting frequency of the three largest pivotal suppliers sets a warning for Market Surveillance

Committee to continue their monitoring for market power abuse.

The data presented however, is not enough evidence that market power has indeed

been exercised. But the values clearly show that the present industry structure where you have

a moderate to high industry concentration is very prone to market power abuse and there is a

high probability that it can be exercised. That is if it has not been exercised yet.

So far, there has been no word yet if the Market Surveillance Committee of PEMC has

proven market power abuse of the three largest suppliers. But this intensifies the call for them

to keep a closer look on these suppliers.



IV. Conclusion

Why Philippine Electricity Rates are high(Woodhouse, 2005)(Freedom from Debt Coalition,

2009)

The IPP structure that resulted to the PPA, and the oligopolistic structure of the

generation sector are the top reasons why electricity rates in the Philippines are now the

highest in Asia.

The following is a list of why the electricity rates in the Philippines are high.

1. The Oligopolistic Structure of the Generation Sector

The market concentration of the generation sector clearly indicates that the sector is

oligopolistic in structure. Although the evidence is not complete in proving that the largest

suppliers are exercising market power, economic theory suggests that in any oligopoly, there is

a tendency that the resulting price is higher than that of the perfectly competitive market and

output is below the efficient level. This structure is also prone to tacit/explicit collusion

between participants

2. Structure and Implementation of the IPP program

Because of the risks that were eventually passed on to the consumers, the PPA became

very expensive and has now been comparable to the base rate charge. The rapid build-out of

the peaking power plants, the minimum off-take requirements, and foreign exchange risk has

increased the cost of electricity substantially.


3. No Extensive Domestic Reserves of Fuel

With the exception of our natural gas requirements which is supplied domestically

through the MalampayaDeepwater Gas-to-Power Project (which is operating at near capacity),

our requirements for coal and oil have to be sourced from foreign countries. Transportation

costs plus the foreign exchange rate can significantly increase the cost of fuel needed to

produce electricity.

4. Transmission Infrastructure

The transmission system investment is relatively higher in the Philippines compared to

other countries primarily because of the challenge of transmitting electricity over hundreds of

dispersed islands. Inter-island connections are typically connected through submarine high-

voltage DC systems. The cost is made worse because of the need to build transmission lines

that can withstand earthquakes and tropical storms.

5. Lack of Local Capital Markets

The lack of local capital markets has resulted to firms and even the government itself, to

borrow abroad for most of its finance.

6. The Country’s Electricity Demand Curve is “Peaky” Compared to other Countries

The lack of a strong industrial electricity base demand on a 24-hour basis does not help

in reducing the cost of installing generating facilities to cover the peak demand.



7. No Domestic Source of Equipment

As with coal and oil, almost all major equipment used to produce and transmit electric

power must be sourced abroad and is exposed to foreign exchange risk.

8. EPIRA allowed the existence of Distribution Utilities sourcing its electricity requirements from

its sister IPPs

Critics argue that the EPIRA “had” to be crafted to accommodate some of the existing

industry structure before 2001. One of which is the cross ownership of generation and

distribution companies. We have MERALCO and First Gen in Luzon and VECO and Aboitiz Power

in the Visayas. According to the Freedom from Debt Coalition (FDC), MERALCO pays its IPPs

more than what it would have paid NPC if it bought the electricity from NPC. Another

controversial topic of this structure is the existence of a similar “take or pay” provision of

MERALCO’s contract with First Gen, which the Lopez family both have shares with.

9. Value-Added Tax (VAT)

VAT now includes oil and electricity. The consumption tax regime before exempted oil

and electricity because of its “socially-sensitive” nature, meaning raising its prices will raise the

price of other commodities.

Another controversial application of VAT is on system loss. System loss is electricity

which had been generated but not used such as line losses (natural losses of electricity in lines

that are converted to heat), pilferage, and station use.



10. Royalty Taxes on Indigenous Fuel Sources

According to the July 3, 2009 press release of the Senate of the Philippines by Senator

Juan Ponce Enrile, royalty taxes have amounted to 1.79 Php/KWh. This is eight times higher

than the importation tax of oil and coal which is not higher than 0.22 Php/KWh.

There have been calls by various stakeholders to scrap or at least reduce the royalty tax

on natural gas. According to Dr. Francisco Viray, President and CEO of Trans-Asia Oil and Energy

Development Corporation and former Energy Secretary, proceeds from the royalty tax can be

used to subsidize the electricity costs of the industries that are vital to the macro-economy,

such as export industries so they can be competitive.

V. Recommendation

To lower electricity rates, the following should be considered:

1. Increase GDP to increase electricity demand

To counter the effects of the generation sector’s oligopoly structure, the government

should introduce other incentives to spur growth in GDP that would increase the demand of

electricity. Although it may seem at first that increasing GDP to lower the electricity rates is a

“chicken and egg” situation, the government can use proceeds from the VAT and royalty taxes

to create incentives for firms to increase their output. The incentives can be in the form of


subsidized electricity rates so their products can be more competitive especially against foreign

competitors.

With electricity subsidies, the government can encourage investment and thus increase

GDP. The resulting increase in demand for electricity will not only improve the demand curve of

the country which can lower the per KWh cost of covering the facilities to cover the peak

demand, but it can also dilute the market share of the largest suppliers of electricity. With

increased demand, other competitors can increase their market share and can thus lead to an

industry with a lower HHI. A lower HHI is needed to achieve a market structure that is closer to

perfect competition.

2. Remove oil and power from VAT coverage

If proceeds from VAT cannot be used to subsidize targeted industries, it should be

removed. According to the FDC, removing the VAT will effectively reduce electricity rates by at

least 0.80 Php/KWh. With this reduction, firms will be more competitive and households can

increase their consumption thereby increasing GDP.

3. Renegotiate IPP contracts

Although this has been done before, a new agreement is still possible to lower the

impact of the PPA.

4. Encourage investments in natural gas and geothermal power projects



The success of the Malampaya project automatically provides a bright picture for the

future of oil and gas exploration in the country. Government should craft policies that would

further encourage oil and gas exploration and infrastructure investments.

The Philippines is very rich in geothermal resources and this should be optimized.

Currently, the country is the second largest producer of geothermal power next to the United

States.

With investments in natural gas and geothermal power, the Philippines can effectively

decrease its dependence on imported coal and oil and this could help lower electricity rates.

VI. Bibliography

Bangko Sentral ng Pilipinas. (2011, October 16). Online Statistical Interactive Database. Retrieved
October 16, 2011, from Bangko Sentral ng Pilipinas:
http://www.bsp.gov.ph/dbank_reports/ExchangeRates_1_rpt.asp?frequency=Annual&range_fr
om=1988&range_to=2011&conversion=Average

Brandts, J., Reynolds, S., & Schram, A. (2011, January 31). Pivotal Suppliers and Market Power.


Department of Energy. (n.d.). The Purchased Power Adjustment (PPA). Retrieved October 15, 2011, from
DOE Portal: The official website of the Philippine Department of Energy:
http://www.doe.gov.ph/faq's/ppa.htm

Energy Regulatory Commision. (n.d.). Retrieved October 17, 2011, from Energy Regulatory Commision
Website: http://www.erc.gov.ph/pdf/811_pub-icera.pdf

Freedom from Debt Coalition. (2009). Dark Power Rising. The Philippine Power Industry Nine Years under
EPIRA (RA 9136) (1 ed., Vol. 13). PAID (People Against Immoral Debt).



Genc, T., & Reynolds, S. (n.d.). Supply Function Equilibria with Pivotal Suppliers. Retrieved November 7,
2011, from Cite Seer X Beta:
http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.72.2804&rep=rep1&type=pdf

Joint Foreign Chambers of the Philippines. (2010, December). Retrieved October 16, 2011, from
http://www.investphilippines.info/arangkada/wp-content/uploads/2011/06/The-Philippine-
Economic-Landscape-in-2010-Faster-Growth-is-Essential.pdf

Joint Foreign Chambers of the Philippines. (n.d.). Background (power). Retrieved October 15, 2011, from
Arangkada Philippines: A Business Perspective:
http://www.investphilippines.info/arangkada/infrastructures/power/background-power/

Joint Foreign Chambers of the Philippines. (n.d.). sss.

Kaplan, S. (2008, November 13). Federation of American Scientists. Retrieved October 16, 2011, from
http://www.fas.org/sgp/crs/misc/RL34746.pdf

Liberty Fund, Inc. (n.d.). Industrial Concentration by William F. Shughart II. Retrieved November 1, 2011,
from Library of Economics and Liberty:
http://www.econlib.org/library/Enc/IndustrialConcentration.html

Manila Electric Company. (2011, June 7). News and Updates. Retrieved November 1, 2011, from Meralco
Official Website: http://www.meralco.com.ph/pdf/newsandupdates/2011/NW03011.pdf

Perez, V. S. (2002, June 24). Retrieved October 16, 2011, from DOE Portal.

Philippine Electricity Market Corporation. (2005). WESM Commercial Operations Training Module 1.

Philippine Electricity Market Corporation. (August 9, 2011). 5th Annual WESM Participants Meeting:
Market Assessment. Quezon City.

Philippine Electricity Market Corporation. (n.d.). WESM Faqs. Retrieved October 21, 2011, from
Wholesale Electricity Spot Market: http://www.wesm.ph/page.php?p=80

Senate of the Philippine. (2009, July 3). Press Release. Retrieved November 6, 2011, from Senate of the
Philippines: http://www.senate.gov.ph/press_release/2009/0703_enrile1.asp

Woodhouse, E. J. (2005, June). The Philippines Electricity Market Investment Context. Retrieved October
15, 2011, from Stanford University: http://iis-db.stanford.edu/docs/59/Philippines.pdf


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