High Electrical Price: Power Dilemma in the Philippines

Background of Power Dilemma

The passage of the Electric Power Industry Reform Act (EPIRA) of 2001
was occasioned by unabated increases in electricity prices, heavy indebtedness
of public electric utilities, and perennial threat of supply problems which the
government had difficulty addressing. It became clear that a centrally managed
electricity system, mainly owned and run by the State, was no longer tenable.
This prompted the restructuring and liberalization of the market.

With the private sector stepping up on the roles previously belonging to

the State, expectations were raised that the sector would become more
efficient, and as a result, electricity prices would decline substantially. But in
the past decade, prices have generally moved in opposite direction so that
Philippine rates remain above those of other countries in the region.1

The liberalization of the Electric Industry caused the proliferation of

numerous Generation Companies and Distribution Utilities, namely:

Generation Companies

1590 Energy Corporation Angeles Electric Corporation

Angeles Power Inc. Asia Pacific Energy Corp.
Bacavalley Energy Inc. Bac-Man Geothermal Inc.
Bicol Hydropower Corp. BPC Inc.
Bronzeoak Philippines Inc. CBK Power Company Ltd.
CE Casecnan Water & Energy Co. CEBECO I
Cebu Energy Development Corp. Cebu Private Power
Central Azucarera De San Anton CEPALCO
City Government of Iligan Cotabato Light
Davao Light East Asia UTILITIES (MEPZA)
Energy Development Corp. Enervantage DPP
FG Bukidnon Power Corp. First Cabanatuan Venture Corp.
First Farmers Holding Corp. First Gas Power Corp.
Green Core/Energy Devt. Corp. HEDCOR Inc.
HEDCOR Sibulan Inc. Hydro Electric Dev’t. Corp.
ICS Renewable INEC
ISECO ISELCO I
ISELCO II Janopol Mini Hydro Corp.
KEPCO (Ilijan) Corp. KEPCO Philippines Corp.
KepCo-Salcon Lucky PPH
LUELCO Luzon Hydro Corp.

1International Energy Consultants (2012), “Regional Comparison of Retail Electricity Tariffs:

Executive Summary,” June. The study used MERALCO prices to represent the Philippines.
Masinloc-Power Partners Ltd. Millenium Energy Inc.
Mindanao Energy System 1 Montalban LFG
NIA-BALIGATAN North Wind Power Dev. Corp.
One Subic Power Generation Corp. Panasia Energy Development Corp.
Panay Energy Development Corp. PANELCO III
People’s Energy Inc. Phil. Power Dev. Co.
Philex Mining Corp. PROSAMAPI Coop.
PSALM Quezon Power Phils.
Salcon Phils. SAMELCO
San Roque Power Corporation SEM Calaca Power Corp.
Sevilla HEP SN Aboitiz Power Hydro, Inc.
SN Aboitiz Power, Inc. SOLECO
SOLECO II Southern Philippines Power Corp.
SPC Island Power Corp. Sta. Clara International Inc.
STEAG State Power Inc. Tarlac Power Corporation
TeaM Pagbilao Corporation TeaM Saul Corporation
Therma Luzon Therma Marine Inc.
Trans Asia Power United Pulp & Paper Co., Inc.
Western Mindanao Power Corp. GN Power Mariveles Coal Plant Ltd. Co.
San Miguel Energy Corporation NPC-SPUG
SEC Sarangani Energy
AMRECO-PSAG LGU
CONAL EEI POWER
13.2 Power PSAGCORP
Mapalad Power Corporation King Energy
Crystal Sugar CGCI 1
CGCI 2 KSPC
KEPCO SIPCOR
SPC-BDPP BSMHC
AEX Transpower Pte. Ltd. TEAM ENERGY
San Luis Eco-market
3 BIDDERS TAO Corp.
IPC Ormin
Dulangan LCMHP
Power One Phase 1 Tail Race
Buriao Hydro Inabasan
Mapamg Wind Power
Power Gen., Inc. Delta IP, Inc.
TLI WESM
SUBIC DPP CPGI
DMPC PEDC
PPC-Nabas PPC-New Wash
SUWECO GPPPI
ENERGREEN PALM CON
NAPOCOR SPCIs
San Carlos ESCI
Therma Mobile Inc. Aboitiz Power Corporation
CALIBU DPP PETERSVILLE DPP
CAWAYAN BUHI-BARIT
AGUA-GRANDE MAGAT A&B
BALUGBOG PALAPAQUIN
INARIHA BANGUI WIND POWER
LAGUNA LFG PANGEA
GREEN FUTURE CIP II
GUIMARAS POWER CEMEX
AMLAN HEP LOBOC
MANTAYUNAN Mini Hydro Plant BASAK Mini Hydro Plant
MATUTINAO CASA
DESCO NATURAL GAS ILIGAN DIESEL 1
ILIGAN DIESEL MINDANAO ENERGY SYSTEM 2
AGUSAN BUBUNAWAN
SOLAR V CABULIG HEP
Catingas Mini-Hydro Power Corp. Mapalad Energy Generating Corp.(MEGC)
Hedcor, Inc. (Upper Talomo) Hedcor, Inc. (Lower Talomo)
GCCI Toledo Power Company
Power One – Phase 2 Mindoro Grid Corp-Calapan
Mindoro Grid Corp.-Bongabong Panay Power Corporation
First Generation Holdings Corp. TSI
FDCUI SoEn
PEAK POWER CSCI
KEGI Aboitiz Energy Solutions, Ins. (AESI)
Vivant Energy Corporation

Distribution Utilities

ANECO BATELEC 2
BENECO CASURECO 1
CASURECO 2 CENECO
COTELCO DASURECO
FIBECO FLECO
MERALCO NEECO 2-Area I
NEECO 2-Area II NONECO
NORECO 1 NORECO 1
PELCO 1 PELCO 2
SIARELCO SIASELCO
SOCOTECO 1 SORECO 2
TARELCO 1 TARELCO 2

Nature and Functions of Energy Regulatory Commission

To ensure the quality, reliability, security and affordability of the supply

of electric power; transparent and reasonable prices of electricity; 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; and protect the public interest as it is affected by the rates
and service of electric utilities and other providers of electric power,2 among
others, the Energy Regulatory Commission (“ERC”) was created3.

ERC in setting charges considers the following:

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
o Previously, Return on Rate Base Methodology
o Currently Performance-Based Regulation
- Electric Cooperatives
o Previously Cash Flow Methodology
o Currently Benchmarking Methodology

ERC originally applied the Rate Base Methodology in setting rates. Now,
ERC used the Performance Rate Base (“PBR”) Methodology in accordance
Section 43 (f) of the EPIRA.

PBR is intended to ensure that firms have incentives to improve

efficiency (thru review of the Annual Revenue Requirement [“ARR”]). 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 (thru setting of the
Performance standards).

The PBR-ARR is composed of the following Building Blocks:

 Return on Capital/Investment
 Operating and Maintenance Expenditures
 Taxes other than Corporate Income Tax
 Regulatory Depreciation
 Corporate Income Tax

2 Section 2 [b, c, and f] EPIRA

3 Section 38, EPIRA
 Return on Capital/Invest is computed through the following formula:

Return on Capital/Invest = (Regulatory Asset Based+Working Capital) x WACC

The ARR is based on the proposed rolled-forward value of the Applicant

Distributions Utilities’s Regulatory Asset Base (RAB). ERC, in accordance with
Article 4.9 of the Amended RDWR, the estimated opening value of the RAB for
RY 2011 is based on the value of the RAB on 31 March 2010 adjusted to the 30
June 2011 value. Also, the RAB used in all applications is an interim value
only because the Valuation Handbook for Optimized Depreciation Replacement
Cost Valuation of System Fixed Assets of Privately Owned Distribution Utilities
Operating Under Performance-Based Regulation (Third Regulatory Period), was
still subject then to public consultation.

Reasons for the High Electrical Prices in the Philippines

The RAB represents the assets used by a Regulated Entity to provide

Regulated Distribution Services and covers the Regulated Distribution System
assets as well as the Non-System Assets.4

Under the PBR, Regulated Entities are entitled to earn a return on the
value of their rolled-forward RAB, as part of the annual allowed revenue
requirement. The value of the RAB therefore has a direct bearing on the price
consumers pay for electricity distribution.5

Section 4.8 of the RDWR describes the approach to the opening valuation
of the RAB, an Optimized Depreciated Replacement Cost (ODRC) valuation
method is adopted. This method is to ensure that only those assets that are
required to provide efficient distribution services and allows efficient planning
and investment in distribution assets are included in the RAB.6

In terms of Clause 4.8.2 of the RDWR, a DU’s asset valuation is to be

undertaken by either:

a) An independent appraisal company engaged by the DU, in which

case the ERC must also retain a Regulatory Reset Expert/s to
review the valuation results and the Valuation Report; or

4 Paragraph 4.15.1 Final Determination ERC Case No. 2010-069RC dated 06 June 2011
5 Paragraph 4.15.3 Final Determination ERC Case No. 2010-069RC dated 06 June 2011
6 Paragraph 4.16.1 Final Determination ERC Case No. 2010-069RC dated 06 June 2011
 b) A Regulatory Reset Expert/s retained by ERC pursuant to Article
XIV of the RDWR for purposes of undertaking the valuation (and
preparing the Valuation Report).7

Nel Consulting Limited (NCL) was appointed as the regulatory reset

expert to undertake the review of the Regulatory Asset Base Valuation
(“Valuation”) of the First-Entry Group of Privately Owned Distribution Utilities
for the Third Regulatory Period (Year 2011-2015) under the Performance Based
Regulation (PBR).8

MERALCO’s Over-valuation of Assets

A Distribution Utility, such as MERALCO, in compliance with Clause

4.8.2 of the RDWR, submit a re-valuation of its fixed assets by hiring an
independent appraisal company. Thus, MERALCO engaged the services of
Asian Appraisal Company, Inc. (“AACI”), which in turn hired independent
valuation expert, Michael J. Emmerton (“Mr. Emmerton”), to re-value its fixed
assets. AACI, through Mr. Emmerton, came up with its Asset Valuation Subject
to Performance Based Regulation of MERALCO (“AACI Asset Valuation”) as of
31 March 2010.

Likewise, MERALCO submitted its proposed capital expenditure

(“CAPEX”) program for the Third Regulatory Period. Therein, it was necessary
for MERALCO to forecast capital expenditures for each Regulatory Year under
the Third Regulatory Period. In order to make a forecast, MERALCO had to
utilize the cost as of 2010 of certain assets, i.e. power transformers, etc., to be
acquired in its CAPEX program.

After MERALCO submitted to the Energy Regulatory Commission (“ERC”)

its Asset Valuation and its CAPEX program for its review. ERC, through Nel
Consulting Limited (“NCL”), reviewed MERALCO’s asset valuation and, through
Sinclair Knight Merz (“SKM”), reviewed MERALCO’s CAPEX.

AACI re-valued MERALCO’s fixed assets, including power transformers.

For power transformers, AACI did not use actual values in the market
to determine their replacement costs but merely based or benchmarked
these on replacement costs of similar National Grid Corporation of the
Philippines (“NGCP”) large power transformers and compared the values to
graphs of observed international market prices for equipment. Hence, AACI
stated:

7 Paragraph 4.15.2 Final Determination ERC Case No. 2010-069RC dated 06 June 2011
8 Paragraph 4.16.4 Final Determination ERC Case No. 2010-069RC dated 06 June 2011
 “In the case of power transformers, these were given
individual replacement costs and added to the replacement costs
of standard modules covering transformer take-off assets, etc.
This was necessary as the transformation voltages vary, with
corresponding variation in MVA capacity. The replacement costs
were determined based on observed international market prices
for equipment. Figure 1 shows the cost per capacity for large
power transformers based on March 31, 2010 replacement costs
of NGCP large power transformers with the same voltage
transformation ratio and capacity.

Figure 1

MERALCO’s Asset Valuation was reviewed by NCL, in its initial review,

stated:

“NCL notes that there are major areas requiring attention

including the following: updating of some of the age profiles
including clear discussions on any trends; fixing potential
ODRC calculation errors in the registers; updating some
assigned standard unit rates; investigating further
optimizations for sub-transmissions assets; revaluation of
power transformers and switchgear; and improving the
statistical analysis performed for field work.”

[Emphasis Supplied]

MERALCO further submitted additional and updated Optimized

Depreciated Replacement Cost (ODRC) values in support of the valuation of its
assets. NCL reviewed the additional documents it found that the Asset
Valuation including additional information did not adhere to the requirements
as stated in the ERC Valuation Handbook.9

The outstanding material issues presented by NCL in its valuation review

report for MERALCO are summarized below:

“1. NCL recommended further action to be required in order

to arrive at efficient and prudent replacement costs for
Meralco’s power transformers and switchgears;10

xxx"

[Emphasis Supplied]

NCL reviewed the aforementioned additional information and identified

items that should further be addressed by MERALCO. Based on the review
conducted by NCL for MERALCO, it was apparent that the Valuation Report
including additional information submitted by the Distribution Utility, did not
sufficiently adhere to the requirements set out in the Valuation Handbook.
Even though there were only some areas that failed to comply, given the
materiality of these areas to the total valuation, the ERC deemed it necessary
to take further steps to rectify the issued. The outstanding material issues
presented by NCL in its valuation review report for MERALCO are summarized
below:

1. NCL recommended further action to be required in order

to arrive at efficient and prudent replacement costs for MERALCO’s
power transformers and switchgears;

2. NCL did not agree with the new age profiles submitted by
MERALCO and recommended that further action be undertaken to
arrive at a more reasonable and efficient asset ages for Poles,
Overhead Conductors (including Pole Tops) and Customer Service
Connections;

3. Given that MERALCO failed to address the inaccuracies

found in all the data sources presented, and with the Handbook
being clear on the matter of register accuracy as this contributes
the greatest to the calculation of the RAB, NCL recommended the
revaluation of the categories for Poles, Overhead Conductors and
Customer Service Connections. 11

9 Page 57 paragraph 4.17.3 of the ERC Final Determination in ERC Case No. 2010-069RC
10 Page 58 paragraph 4.17.4 of the ERC Final Determination in ERC Case No. 2010-069RC
11 Paragraph 4.17.4 Final Determination ERC Case No. 2010-069RC dated 06 June 2011
 That is to say, NCL was of the view that revaluation of MERALCO’s fixed
assets, to reflect just and reasonable costs, must be undertaken in order for
ERC to have a sound basis in coming up with its final determination.

However, not only did ERC fail to take further action for MERALCO to
come up with an actual and correct revaluation of its assets, ERC merely relied
on a simulated value for opening RAB, particularly, a rolled-forward calculation
of the RAB amounting to One Hundred Twenty Four Billion One Hundred
Ninety Million One Hundred Thousand Pesos (Php124,193,100,000.00)12,
submitted by MERALCO, and which was later on adopted by ERC for the Final
Determination subject to the true up during the Fourth Regulatory Period.

(Insert Table 4.12 page 59)

Although the revaluation of MERALCO’s RAB will still be reviewed by the

ERC and subject to a true-up mechanism, it should be noted that the rolled-
forward value of MERALCO’s RAB (which includes MERALCO’s assets)
amounting to One Hundred Twenty Four Billion One Hundred Ninety Million
One Hundred Thousand Pesos (Php124,193,100,000.00), that was used for the
Third Regulatory Period, was much higher than the opening value of the RAB
as of June 30, 2011, which only amounted to One Hundred Nineteen Billion
Four Hundred Sixty Two Million Five Thirty One Thousand Two Hundred
Seventy Six Pesos (Php119,462,531,276.00).

If the inaccuracies found in all the data sources presented by MERALCO

were addressed, the opening value of MERALCO’s assets will not go higher
than the value of its assets as of March 31, 2010. The valuation, should as
much as possible be lower than One Hundred Fourteen Billion Four Hundred
Forty Nine Million One Hundred Seventy Two Thousand Five Hundred Seventy
Nine Pesos (Php114,449,172,579.00) . Consequently, the opening value of the
RAB will be much lower that the rolled forward value.

On the other hand MERALCO’s overstatement in its CAPEX for the Third
Regulatory Period was laid bare when the replacement cost values for 33 MVA,
83 MVA and 150 MVA transformers as compared to the values of the
transformers used by ACCI was much higher.

The price of transformers per MVA, as determined by AACI, were

consistent with Figures 1 and 2 found in pages 14 and 15, respectively of the
31 March 2010 Asset Valuation, as follows:

12 Table 4.12 Opening Value of the RAB as of June 30, 2011

 Appendix C of the ACCI Asset Valuation showed a table of standard types
of MERALCO power transformers and their 2010 replacement cost values, as
follows:
 Meanwhile, enumerating some of MERALCO’s CAPEX program for the
Third Regulatory Period, revealed the following costs of 33 MVA, 83 MVA and
150 MVA transformers:

TYPE OF PROJECT LOCATION TYPE AND PRICE

MVA RATING
OF POWER
SUBSTATION
Renewal Backup 115 kV-13.8 Php51,051,000
power kV, 33 MVA
transformer
for Tagaytay,
Silang and
Imus, Cavite
Replacement Power 115 kV-34.5 Php101,420,663
Transformer kV-13.8 V, 83
No. 2 at MVA
Kamagong
Station
Replacement Power 115 kV-34 Php101,109,106
Transformer kV, 83 MVA
at Malibay
Substation
Development Filinvest 115 kV-34.5 Php104,392,343
Substation kV GIS, 83
MVA
Replacement/Renewal Dasmariñas 115 kV-34.5 Php102,066,000
Substation kV-13.8 kV,
83 MVA
Load Growth Project Development 230-115 kV, Php217,651,134
of Calamba 150 MVA
Substation
delivery point

Bringing together the above-cited figures, a comparison between

MERALCO’s CAPEX allowance for transformers with the replacement costs in
the AACI Asset Valuation for the same transformers, as follows:

MERALCO AACI Difference Percent

Allowance for Valuation of Overst
Tranformers in MERALCO’s ated
the CAPEX for Fixed Assets
the Third
Regulatory
 Period
115 Php51,051,000 Php29,395,30 Php21,655,692 73.67
kV- 8 %
13.8
kV, 33
MVA
115 Php102,248,81 Php57,404,71 Php44,844,099 78.12
kV- 0 1 %
34.5
kV, 83
MVA
230 Php217,651,13 Php86,672,36 Php130,978,76 151%
kV-115 4 5 9
kV, 150
MVA

Hence, comparison of MERALCO’s CAPEX allowance for transformers for

the Third Regulatory Period with that of AACI replacement costs for
MERALCO’s fixed assets showed different pricing ranging from 73% to 151%.

As mentioned, SKM was retained by ERC to review MERALCO’s CAPEX

for the Third Regulatory Period, in its Addendum Review of the Historical,
Budgeted and Forecast Expenditure of MERALCO: Final Addendum Report
(“SKM Addendum Report”) dated May 2011, it stated that MERALCO’s
transformer prices was expensive, to wit:

“SKM found that MERALCO’s power transformer costs were

above recent Philippines benchmark costs, and comparable
with costs for similar sized transformers in Australia. Noting
that many power transformers of this sized in Australia are also
imported, that power transformers are now a global market, and
that in Metro Manila MERALCO will likely face installation costs
higher than other Philippine DUs, SKM has determined the
overall average sources should be used as the most appropriate
benchmark for power transformer prices. On this basis SKM
found that MERALCO’s power transformer prices were 12%
above the benchmark efficient price, and recommends a
reduction in CAPEX allowance for power transformers of this
amount.”

SKM have recommended that an overall adjustment to power

transformer budgets be made by ERC to power transformers
due to be installed or replaced during the Third Regulatory
Period. Details of the impact of this adjustment are provided in
the table below:
 Including the power transformer and other recommended
adjustments, SKM recommends the following allowances for the Major
projects with power transformers shown in the table below:
 [Emphasis Supplied]

In its previous report, SKM already recommended that MERALCO’s costs

for an 83 MVA transformer be reduced to Php102 million or approximately
Php1.2M/MVA, however, in its Addendum Report SKM proposed further
reductions of the CAPEX allowance for transformers by the amount
representing the excess above the benchmark.

However, despite the fact that MERALCO grossly overpriced its existing
fixed assets and capital expenditures and, further, notwithstanding that ERC’s
own Regulatory Reset Expert conclusively confirmed the overstatement of
figures, ERC allowed the apparent fraud.

Furthermore, MERALCO’s CAPEX allowance for its 33 MVA, 83 MVA,

and 150 MVA transformers was 73% to 151% more expensive than those
mentioned by AACI in its ODRC computation, even though both sets of figures
were supposedly based on real 2010 prices. This is proof of CAPEX
overstatement taken right from MERALCO’s records.

As can be seen above, all of the data and information came from
MERALCO, which was in turn reviewed by AACI, with respect to the fixed
assets, and SKM for its CAPEX for the Third Regulatory Period.

As previously discussed all the arguments are proof that MERALCO

overpriced the cost of power transformers.

As clearly pointed out by SKM, power transformers are now a global

market. Since MERALCO by Asian standards is considered as a bulk buyer for
power transformers, it is in the position to buy the cheapest power
transformers from the global market without sacrificing quality. The exchange
rate of US Dollar to Philippine Peso as of 31 March 2010 was Php45.2213 as
against Php43.6914 as of 27 August 201415, therefore, since there was a
decrease in the exchange rate the price for the power transformer should be
lower.

In addition, MERALCO’s Compliance dated 10 June 2015, it submitted a

Write-up on How the Applicant Estimates the Cost of Installing a Power
Transformer, it states that MERALCO based the cost estimate for materials on
the moving average price of the particular equipment to be used in the project,
viz:

13 Page 21 of the Asset Valuation Subject to Performance Based Regulation of Manila Electric
Company (MERALCO) dated 31 March 2010 prepared by Asian Appraisal Company Inc.
14 http://freecurrencyrates.com/en/exchange-rate-history/USD-PHP/2014/yahoo
15 Date of Application filed by MERALCO
 “MERALCO uses a system to come up with the cost-estimate
based on the project’s scope of work, wherein the significant
factors affecting the cost are the prices of equipment and
materials involved, as well as the associated labor costs. The
major drivers of costs for MERALCO substation equipment are
the equipment costs itself and the needed labor for its installation
and commissioning. Furthermore, the cost estimate for materials
are based on the moving average price of the particular
equipment to be used in the project.”

However, MERALCO did not submit any proof or receipts of the previous
purchases, as basis on how they arrived at the said moving average price.

Increase of Price through Power Sales Agreement

A building block, among others, for setting charges is PSA entered by

Distribution Utilities. For example, Iligan Light Power Inc.16 and Mapalad
Power Corporation17 filed a Joint Application for the approval of a Power Sales
Agreement involving the supply by the latter to the former using the Bunker
Oil-Fired Diesel Power Station (“MPC Power Plant”) located in Sitio Mapalad,
Barangay Dalipuga, Iligan City, Province of Lanao Del Norte.

However, this Joint Application is overpriced resulting in the drastic

increase of generation rates.

The Rehabilitation Cost should only be Php36,420,675.00 plus cost of

mandatory replacement parts for each of the power plants used for 4,000
hours or after the first 16,000 hours and every 16,000 hours used thereafter,
but in no way should it skyrocket to Php546,130,000.0018.

The Php36,420,675.00 cost is in accordance with the Warsila

Philippines, Inc. (“WPI”) quotation which previously assessed and studied the
MPC Power Plant.

However, Joint Applicants valued the Rehabilitation Cost at

Php546,130,000.00 despite the fact that it was WPI who performed the
rehabilitation of MPC Power Plants.

(insert 365.10.17 here)

16 Distribution Utility
17 Power Plant Generating Company
18 Par. 29.1 of the Joint Application [ERC Case No. 2013-049RC]