PBR

Performance Based Regulation

PBR Implementation

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

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

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

PBR Implementation

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

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, SUPPLY.
& METERING CHARGES
(25%)

Unbundled
Electric Bill

PBR Implementation

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
PBR Implementation

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 - 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
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updated salaries plus allowable benefits

necessary, legitimate, prudent, continuing, normal
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
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
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property taxes, business taxes

operating and maintenance expenditures

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PBR Building Blocks

RETURN ON
INVESTMENT

Regulatory
asset base

Working
capital

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
INVESTMENT

Regulatory
asset base

Working
capital

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 ERCs 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
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

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Annual Revenue Requirement

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Smoothing the ARR for the RP

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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.

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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

Performance
Incentive
Factor

This years
price per unit of
electricity

Previous
years 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 years price is capped at this years 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
-1

YEAR
1

YEAR
2

YEAR
3

YEAR
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
FOR EACH YEAR
OF THE REGULATORY PERIOD
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Public Hearings
Rate Decision
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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, Inc. (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, Inc. (BLCI)
Angeles Electric Corporation (AEC)
Clark Electric Distribution Corporation (CEDC)
PBR Implementation

Regulatory Period
July 01, 2011- June 30,
2015
April 01, 2009 - March
30, 2013

July 01, 2010 - June 30,

2014

October 01, 2011September 30, 2015

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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

PBR Implementation

Building Blocks
Valuation
WACC

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