energy industry

[ANALYSIS] The billion-peso cost to consumers of regulatory dereliction

Dean de la Paz

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[ANALYSIS] The billion-peso cost to consumers of regulatory dereliction

Nico Villarete/Rappler

'While politics has little to do with electricity economics and the RTWR, they constitute incendiary fodder for political grandstanding, where sinophobia substitutes for analysis'

At the start of this month a glaring gap in the supply of baseload power was created when the bilateral contract for least cost power between a major distribution utility (DU) and an independent power producer was terminated. It was compelled by excessive yet avoidable delays in regulatory approvals guaranteeing at least 1,800 megawatts critical to tempering one of the highest power rates in the region.

The attention of energy regulators was called. Given a six-month-long stop-date for approvals, regulators should not have to run out the clock.

Within days the Philippine Center for Investigative Journalism (PCIJ) and Rappler published a piece entitled “Power grid operator NGCP billed consumer P 2.6 billion worth CSR, PR expenses.” The focus shifted to transmission. The amount was incurred during past regulatory periods when these should have been culled had regulators been vigilant.

P2.6 billion bloats unchecked when regulators, without the help of external consultants, do not understand their own Rules for Transmission Wheeling Rates (RTWR).

The National Grid Corporation of the Philippines (NGCP) was granted a congressional franchise to operate and maintain (O&M) transmission assets owned by the National Transmission Corporation. Under the Arroyo administration its O&M was privatized to a 60:40 Filipino-Chinese corporation where 40% is owned by the State Grid Corporation of China (SGCC). SGCC’s senior management and its chairman are appointed by the Central Committee of the Chinese Communist Party and Communist China’s State Council.

Note the DNA. There is no mistaking who literally pulls NGCP’s levers. What security concerns are intrinsic to a union solemnized by recently cashiered officials turn alarming given the worsening geopolitical conflicts percolating in the West Philippine Sea.

While politics has little to do with electricity economics and the RTWR, they constitute incendiary fodder for political grandstanding, where sinophobia substitutes for analysis.

In periods of high energy inflation, periodic price resetting is critical. But these must be fair, non-political, and shorn of hostile designs. Moreover, these must be undertaken by regulators who, like Caesar’s wife, are above suspicion and totally independent.

That has not happened. Energy policy-making and regulatory agencies were peppered with former politicians, crony and campaign donor surrogates, even townmates and classmates. Inborn technical competence remains an unfulfilled requisite.

Fortunately, periodic recalibration of rates are incorporated into the RTWR through a quantitative multi-criteria calculus called Performance Based Regulation (PBR). PBR focuses on award-penalty mechanisms (APM) and forward-looking multiyear rate plans (MRP). The synergies lower energy prices while providing performance incentives.

Unfortunately, our energy regulators have been remiss. And it’s costing us. The last rate-setting exercise was for the regulatory period 2010 to 2015. The 13-year gap is alarming.

From the PCIJ-Rappler report, a frightening and costly collage of regulatory incompetence and dereliction emerges. Digging deeper, analysis shows regulators do not have the internal competence to understand much less periodically carry out requisite MRP audits enough to adjust PBR’s price parameters to reflect current conditions.

PBR relies on an attrition relief mechanism (ARM) that adjusts rates automatically between recalibration periods as a response to inflation and changing economic conditions. During the 13-year blackhole regulators failed to reset rates especially critical during aberrant pandemic periods that bloat policy rates and costs of debt.

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Among the British Commonwealth, multi-year forecasts once approved are subjected to a revenue price index minus X (expenses) formula (RPI-X) before net present values (NPV) are computed to set minimum returns on CAPEX against which a utility’s performance will be assessed. NPV requires multiyear regulator forecasting. Beyond 2015, that was not done.

Since the ARM requires competent forecasting, regulators must review rates at least every five years lest their failure results in anachronistic rate bases, a hard-brake on CAPEX and project expansion impacting negatively on the ARM and billions of belatedly questionable costs.

Ill-informed politicians blame utilities for unfulfilled projects. Yet no one asks how utilities can undertake CAPEX development if regulatory approvals went only as far as 2015?

Now the public is justifiably concerned by operating costs (OPEX) that might have been passed on to consumers during the years regulators failed to recalibrate NGCP’s PBR parameters.

Such OPEX would have been tempered by PBR’s ARM where maximum allowable revenues (MAR), RPI – X, short-term working capital (WC), regulated asset bases (RAB) and costs of capital are price determinants. But this only works under competent and timely regulatory resets.

This segues us into the weighted average cost of capital (WACC) imposed on utilities by regulators. The WACC is integral to any pricing algorithm as it represents the minimum cost an enterprise must cover. Returns are computed by multiplying RAB and WC with the WACC regulators impose.

This limits a utility’s working capital and what a utility can earn. If imposed periodically, OPEX overcharges would automatically be mitigated and prices kept low. As regulators are dumping the whole burden they were a party to on those they regulate, this issue could very well end up in court.

Had regulators understood PBR and WACC they could have simply audited a utility’s Tier One liabilities to determine cost of debt, computed for the current cost of equity using the Capital Asset Pricing Model (CAPM) and finally, compute for the weighted average. For these regulators had to rely on external expertise to do the math. Do they now swallow hook, line, and sinker the numbers they paid for?

Their purchased analysis claims WACC should have been 10.7%. NGCP’s was 12.71%. A misinformed lawmaker declaring “tongpats” within OPEX claims NGCP’s WACC was excessive relative to “comparable risk” with DUs. That’s nonsense. Absent quantifiable basis, that’s nothing but political hyperbole.

RTWR mandates CAPM to determine equity costs within WACC. Lawmakers need to understand that the “comparative risk” factor lies in CAPM’s beta coefficient. Energy analysts place NGCP’s beta at 0.3. Since regulators did not provide WACC ceilings after 2015, NGCP applied a beta of 2.84 in 2021. It is this that accounted for the higher WACC that NGCP had to cover.

A congressman says WACC is a weighted average “cause” of capital. OMG. Without doing the math, he accused utilities of overcharging and, ignorant of economies of scale, he sought to break apart efficiently operating least-cost franchises.

Apparently, the Marcos bureaucracy is populated by unqualified presidential appointees. Unfortunately, so is Congress peppered with the misinformed, from the majority to the opposition. –

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