What Meralco’s rate hike tells us about the power sector

MANILA, Philippines – It was the country’s highest power rate hike in history, and it came at the worst time: Filipinos were reeling from a super typhoon that killed thousands, displaced millions, and brought unprecedented losses to the economy.

For some, it was inconsiderate and downright insensitive. For others, it was a much-needed wake-up call.

The P4.15 per kilowatt-hour (kWh) rate hike imposed by the Manila Electric Company (Meralco) last December put a spotlight on the problems of the power sector. Among them are the possible collusion among industry players, flaws in the structure of the Wholesale Electricity Spot Market (WESM), and gaps in regulation.

It also revived calls to revisit the sector’s privatization through the Electric Power Industry Reform Act (EPIRA) of 2001, which critics claim failed on its promise to bring down electricity prices in the country.

Meralco’s rate hike covering the power supply month of November was equivalent to at least P9 billion in additional billing for over 5 million customers of Meralco, the Philippines’ largest power distributor.

Regulators recently intervened to administer prices, which means the rate hike, and customers’ bills, would still go down.

But while the hike is the immediate concern, it is crucial that regulators address its underlying causes to better protect consumers.

Based on statements by stakeholders in congressional probes and before the Supreme Court (SC), where a case against Meralco is pending, we can say that the following caused the rate hike:

• The Malampaya natural gas facility shutdown, which coincided with the shutdown of other power plants
• Exorbitant WESM prices
• WESM violations committed by power generation companies (gencos)
• Faulty WESM structure
• Insufficient regulation by government
• Tight supply situation

Malampaya shutdown

The bulk of Meralco’s P4.15/kWh rate hike was accounted for by the generation charge, which represents the cost of power Meralco buys from gencos and distributes in its franchise area.

Meralco has two power sources: the 10 regular gencos with which it has bilateral contracts; and WESM, a centralized system for the buying and selling of electricity in Luzon and the Visayas established under EPIRA in 2006.

Meralco said the generation charge spiked because it sourced more power from WESM at exorbitant prices. The company did this due to two reasons:

• The Malampaya facility in Palawan went on a scheduled 30-day maintenance in November and was unable to supply gas fuel to 3 of Meralco’s regular suppliers.
• Some of its other regular suppliers implemented simultaneous and unscheduled outages.

The generation charge represents around 57% of a consumer’s monthly electric bill, depending on how much that consumer uses. The rest are charges, such as distribution and transmission costs, systems loss, and taxes.

As a distribution utility (DU), Meralco does not earn from the generation charge, which is a pass-through charge –  meaning, Meralco collects this from consumers and remits it to gencos.

This charge is adjusted on a monthly basis as prescribed under the Automatic Generation Rate Adjustment of AGRA rules issued by regulator Energy Regulatory Commission (ERC). AGRA allows Meralco to automatically pass on fluctuations in generation charges to its consumers.

Much of the criticism against Meralco points to its failure to provide a good first line of defense for consumers by ensuring that the “least cost” of electricity is passed on to them as mandated by EPIRA. After all, Meralco is what connects consumers to the country’s energy chain.

The company has monopoly over power distribution in Luzon, serving nearly 5.2 million customers in 34 cities and 77 municipalities, including Metro Manila, where major industrial and commercial hubs are. Meralco accounts for 75% of Luzon’s and 55% of the country’s power sales.

Why didn’t it raise a howl when it saw the unusual spike in WESM prices? Did Meralco take measures to mitigate the effect of the Malampaya shutdown? Did it have contingency measures for cases when its regular suppliers implemented outages?

During oral arguments at the SC, Meralco lawyer Victor Lazatin said the utility firm had consumers in mind when it asked the ERC to exempt it from AGRA rules and implement its rate hike on staggered basis. But this was not enough, argued Bayan Muna Representative Neri Colmenares, petitioner in the SC case. “Meralco should have asked ERC to investigate the spike in prices,” he said.

In preparing for the Malampaya shutdown, the company took remedial measures, such as signing a bilateral contract with Aboitiz-led genco Therma Mobile Incorporated (TMO), to limit its exposure to WESM, Lazatin explained. He said Meralco also asked two of its regular suppliers that were dependent on Malampaya to run, albeit on more expensive liquid fuel.

The unscheduled outages, on the other hand, were something beyond Meralco’s control. “You don’t know until they happen,” said Larry Fernandez, head of utility economics at Meralco.

That’s why Department of Energy (DOE) Secretary Carlos Jericho Petilla pointed out that Meralco’s bilateral contracts should have included a provision on replacement power. Such provision, Petilla said, would have required gencos implementing outages to supply Meralco the same volume under their contracts by buying power from WESM at no extra cost to Meralco.

Meralco usually sources 90% of its power from bilateral contracts and only 10% from WESM. Would it have been better then if Meralco had contracted 100% of its capacity from bilateral contracts to avoid exposure to WESM during the Malampaya shutdown?

Due to the string of reasons that affected supply, perhaps yes. But that’s in hindsight.

Fernandez said, to protect consumers from volatility in WESM prices, they successfully brought down the WESM percentage from 38.62% in 2006 to 6.18% in 2013.

They cannot contract 100% because there are “fixed costs” associated with these contracts. “If you contract 100% of forecast demand and actual demand goes below, the fixed costs you’ll pay will be huge. Consumers will pay for costs of power they didn’t use.”

Watch Fernandez’s interview on Rappler’s #TalkThursday below.

How does WESM work?

Gencos basically dictate prices, especially in situations when there is tight supply.

This is particularly true in WESM, where DUs like Meralc buy power when there’s a shortfall in supply from their bilateral contracts.

What is WESM and how does it work?

WESM is a platform that allows gencos to sell excess capacities – or capacities not covered by bilateral contracts. Unlike in bilateral contracts where prices are fixed and negotiated between gencos and DUs, prices in WESM are “spot” or dictated by the demand-supply situation on an hourly basis.

However, it’s not only excess capacities that are traded in WESM. All power used in Luzon and the Visayas in a day – whether excess or covered by bilateral contracts – passes through the system. This means all gencos are required to offer their maximum available capacities in the market. This is called the must-offer rule.

While excess capacities sold are settled at spot prices in the market, capacities covered by bilateral contracts are settled at their fixed prices outside the market.

Let’s look at how WESM works in the context of the country’s daily energy chain. (Hover your pointer over the buttons to understand the process)

During the Malampaya shutdown and outages of several plants, the average WESM price ballooned to P33.216/kWh in November and P36.08/kWh in December, against only P13.74/kWh in October.

(See Meralco’s generation charge table below)

What jacked up prices?

Clearing prices hit the market cap of P62/kWh several times, which means the most expensive plants where dispatched to complete demand. There were times that P62 was cleared during off-peak hours, for example, Sunday dawn. For the hour that P62 was cleared, all plants that were dispatched in that hour were also paid at P62.

Among the plants whose offers were cleared at P62 were Aboitiz-led TMO, Limay and Bauang plants – all diesel and peaking plants. Peaking plants are called such because they are meant for use during peak hours (e.g. 11 am, 2 pm and 7 pm), when electricity demand is highest.

TMO alone was cleared at P62 25 times in November and December. TMO has a bilateral contract with Meralco, which means its capacity is owned by the utility. TMO’s spot market bids were dictated by Meralco itself as specifically provided for under their contract.

Why Meralco-TMO was bidding at P62

Meralco clarified that it and TMO did not earn from their P62 bids in the market. All of TMO’s capacity is contracted by Meralco so even if their P62 bids were cleared, the amount Meralco paid and passed on to consumers was only P8.65/kWh, the agreed price in their contract.

However, even if the P62 bids had no impact on Meralco’s contracted capacity, it still raised prices in WESM where Meralco bought the rest of its power requirements. In other words, the P62 bids of Meralco-TMO, along with the other high bids, push up the WESM component of Meralco’s charges.

Meralco said they were bidding P62 during off-peak hours because they didn’t want TMO to run during those hours.

“We want all our contracted capacity running during peak hours, when demand is high so we avoid buying from WESM. WESM prices are high during peak hours, day time, office hours,” said Fernandez. “We maintain our plants during off-peak hours.”

The WESM operator schedules dispatch of plants based on bids. You bid low, you get dispatched first.

“If I’m offering at P62, I’m effectively telling the market, don’t dispatch me. I don’t want to run at this hour,” said Fernandez.

Given that P62 cleared the first time, was it prudent for Meralco to keep bidding at this price knowing it could pull market prices up? Fernandez said their hands were tied. “We couldn’t take a chance. Pag nag-bid low kami off-peak hours at tumakbo, wala kami lalong magagamit during peak hours. Mas mahal for consumers.” (If we bid low during off-peak hours and it ran, it would have been more expensive for consumers.)

Market violations of players

WESM prices usually go up during Malampaya shutdown because supply is tight, but never to the level seen last year. Since the spot market’s creation, they say the cap of P62 was cleared only 12 times. That gives you a probability of only 1.5 times a year. And from January to October 2013, P62 cleared twice – during summer.

NGCP insisted that despite the Malampaya shutdown from November 11 until December 10, available power supply was still sufficient to meet demand.

This was corroborated by DOE in a report submitted to the SC. “It should be noted that comparing with the October 2013 billing period, the situation is relatively not different, supply- and demand-wise,” the report read.

What could be the reason why P62 was frequently hit this time?

Initially, aside from the unscheduled and simultaneous outages of some plants, the non-dispatch of the Malaya thermal power plant handled by state privatization agency Power Sector Assets and Liabilities Management Corporation (PSALM) was tagged as culprit.

During a congressional hearing, PSALM president Emmanuel Ledesma Jr admitted that despite making an offer in the market, the Malaya plant failed to dispatch power, a violation of the real-time dispatch rule. When a plant fails to dispatch, naturally, NGCP calls on the next one with a higher bid in the schedule prepared by PEMC.

Ledesma said running the plant would have resulted in losses that would have also been passed on to consumers in the form of the universal charge since the plant is owned by state firm National Power Corporation (Napocor).

He also said that the plant has technical limitations such as “slow start-up time and low fuel replenishment rate” that’s why it couldn’t be immediately dispatched when needed.

He said market players, including Meralco, knew that Malaya was on “open breaker” status for sometime and was functioning as a must-run unit, which means it was dispatched only when told by NGCP to address insufficient supply.

The Malaya plant was unavailable in November, but it ran from December 2 to 6.

For a time PSALM bore most of the blame. Results of a DOE probe, however, later on showed there were other plants – over 30 of them – that were “under-offering” their capacities in the spot market. This was a violation of the must-offer rule.

For instance, on November 13, when Malaya wasn’t running, DOE said in its report to SC that there were “substantial capacities not offered in the market….”

“This ranges from 1,546 MW to 2,703 MW. During the hour with the highest market clearing price at 10 pm trading interval, the capacity not offered was 2,085 MW, thus the market cleared during the interval was at a very high price,” the report read.

On December 5, when Malaya was already running, “there were more intervals wherein the clearing prices [were] high.”

“The capacities not offered range from 2,078 MW (at 10 am) to 3,148 MW (at 2 am). This explains the reason for the high prices because there [were] significant capacities not offered during the period.”

DOE declined to name the power plants that committed violations, saying the reasons of some of them could be valid.

On March 11, the ERC finally ruled there was WESM failure and ordered PEMC to administer “regulated” prices, which could cut WESM prices by up to 70%. It said lack of competition as evidenced by the under-offers resulted in a “contrived supply shortage.”

The question now that regulators need to answer is whether or not there was collusion among players to artificially raise WESM prices.

Two things are subject of investigations now: the simultaneous outages of some plants, and the under-offers in the spot market.

Faulty WESM structure

The problems with WESM are basically a result of its flawed structure, critics conclude.

First, the P62/kWh cap. It’s way above actual production costs of power plants – around P4/kWh for baseload plants, P5-P5.50/kWh for intermediate plants, and P10-P20/kWh for peaking plants.

What was the basis for the cap? According to PEMC head Mel Ocampo, it was a result of a study in 2006 that looked at the cost of operating a diesel plant and what could be a reasonable return for trading in WESM.

The biggest factor behind the number was what they call “capacity factor” or the “number of hours a generating plant will be able to operate” given competition in the market.

“That time, we considered a 6% capacity factor for the year, equivalent to around 1 hour and 20 minutes in a month.”

“We anticipated there will be competition and not all of them will be scheduled and dispatched 24/7. If I’m the investor and I won’t be dispatched all the time, I need to recover so I will be able to stay in the market.”

Second, the “gross pool, net settlement” system wherein all capacities must be offered, even the ones covered by bilateral contracts, but only excess capacities are settled in the market. While bilateral contracts are settled outside the market, this rule allows them to still influence clearing prices, like in the case of Meralco-TMO. Some are suggesting we do away with the must-offer rule and only offer excess capacities in the market.

But Ocampo said there’s wisdom in the must-offer rule. “The government wants to avoid withholding of capacity. Because if you withhold capacity, there’s a chance there will be brownouts. If a supplier is allowed not to offer because he doesn’t like the price in the market, where is the protection of consumers? It’s better you see everything so you know what’s there.”

Third, the price-setting scheme at the WESM. Sellers dictate prices and buyers are only price-takers. It’s not like the stock market where buyers say at what price they are willing to buy a certain stock, sellers place their bids, and transactions only happen when there’s a match.

Insufficient regulation

In some of the points above, debating parties argue their sides well.

The key lies in finding the right balance and making sure there are enough safeguards for consumers. This is the role of regulators.

In the case of the high bids at WESM, for instance, Ocampo said it was all about “behavior.” The high bids were still within cap and allowed under the rules. Whether or not this behavior could be considered abusive, given the supply situation, is for regulators to determine.

“This is behavior. Market shows that. Kung sino man si regulator, dapat nakakahabol s’ya sa gano’n,” noted Ocampo. (The regulator should be able to catch up with changes in behavior.)

ERC has taken most of the flak for being remiss in its duty to protect consumers.

EPIRA put the burden of ensuring sufficient power is distributed to consumers at the least cost on ERC’s shoulders.

ERC approved Meralco’s staggered rate hike petition and withdrew it only after allegations of collusion surfaced.

Petitioners in the SC case said ERC violated due process by approving the rate hike without even investigating why prices were abnormally high. After all, the EPIRA says the agency should “motu proprio, monitor and take measures… to penalize abuse of market power, cartelization, anti-competitive and discriminatory behavior by any market participant.”

Besides, whose duty is it to monitor WESM trading? There’s a Market Surveillance Committee (MSC), which submits assessment reports to ERC, but ultimately, the chain of command stops with ERC.

ERC lawyer Francis Juan told Rappler: “Last stage kami ng monitoring. ERC relies mostly on reports from MSC. They say we can act motu proprio, but we can only do this ‘pag may facts na or reports na.” (We’re on the last stage of monitoring… They say we can act motu propio, but we can only do this when the facts or reports are in.)

The workings of WESM and its rules, in the meantime, fall under DOE’s responsibility.

Regulators took “stop-gap” measures to address high electricity prices such as lowering the WESM price cap to P32/kWh and officially assigning Malaya plant as a must-run unit.

Tight supply situation

Stakeholders say one of the major things that ails the power sector is lack of more than enough power supply. Ideally, more supply will make the market competitive, eventually bringing down prices.

According to ERC, demand for electricity in the Luzon grid increased by 2,659 MW from 2001, when EPIRA was passed, to 2013, while no corresponding substantial increase in supply was seen.

Thus, it said the power sector cannot be considered fully competitive.

“From the time when government had monopoly over the generation sector until today where there are 4 major players in the market, a tightness of supply despite its privatization is still felt,” said ERC.

Shoring up supply and bringing down electricity prices are EPIRA’s main goals. 

But more than a decade after the law’s passage, electricity prices in the Philippines remain to be the highest in Asia and among the highest in the world. – Rappler.com