energy industry

[ANALYSIS] On the eve of yet another energy policy failure

Dean de la Paz

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[ANALYSIS] On the eve of yet another energy policy failure

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'EPIRA’s failure was not simply in its implementation but also in policies that effectively sabotaged its objectives'

Ironically, its genesis was the Electric Power Industry Reform Act (EPIRA) passed nearly a quarter of a century ago under some of today’s regurgitated officials. An anachronistic failure still invoked as a basis for policies and contractual terms of reference.

In government, without the strict vetting of political appointees, there is always the danger of perpetuating failures spanning decades. Like the agricultural sector, electricity is one that needs technocrats steeped in the science and its quantitative nuances and economics. Literal and figurative loyal soldiers or conflicted political partisans and pawns, however devoted to their appointing authorities, will not do.

Among EPIRA’s objectives was to catalyze the construction of state-of-the-art generating plants to replace decrepit and pollutive monstrosities whose dependable capacities were not only far below acceptable, but the electricity they produced was also expensive. Under serial incompetents, as EPIRA was implemented, rather than reduce electricity cost, ours bloated to be one of the most expensive in the region. 

EPIRA’s failure was not simply in its implementation but also in policies that effectively sabotaged its objectives.

An important factor was the competence issue. Among those handed the reins, whether as policymakers or as implementors, were lawyers, military men, college classmates, school dropouts, media personalities, and nominees from influential players out to tilt the table in their favor.

Another was the failure of energy officials from EPIRA’s passage to today in attracting sufficient generating capacity to match the agencies EPIRA created. This colossal and continuing failure remains at the core of the chaos the sector wallows in. Note how EPIRA spawned a Frankenstein’s monster when it prematurely established a Wholesale Electricity Spot Market (WESM) absent a sufficient number of competing generators to effectively reduce power rates at the WESM. 

To forestall WESM’s inequitable marginal pricing, it is necessary to build sufficient generating capacity. Here, energy officials have been remiss.

It is not so much from their failure to attract interest as it is their failure to understand energy economics further aggravated by policies based on those shortcomings.

Let us validate that in the aftermath of the Department of Energy’s (DOE) serial failures in their recent Renewable Energy (RE) auctions. 

Officials spun these successive failures as a result of the bidder’s recurring inability to comply with documentary and technical requisites. Bidders say otherwise. They point to inherent policy flaws and poor arithmetic within the terms of reference.

The internal rate of return (IRR), net present values, breakeven and payback periods, discounted cashflows, and overall viability are critical to any contract offered by the DOE. In the failed RE auctions, the allowable Feed-in-Tariff representing what an investor can charge must earn reasonable IRRs over the contract life. Hence contract periods are as critical determinants as are prices and the capitalization of earning assets or RE capital expenditures (CAPEX). Had the arithmetic of the auctions yielded reasonable IRRs, then more would have bid, this time complete with technical requisites that justify their CAPEX’s return on assets.

The inherent flaws underlying these failed auctions is about to be repeated on a grander scale. 

Regulators have released a draft of the policies and implementing guidelines for power supply agreements (PSA) between distribution utilities (DU) and generators.

In it, under Article V Sections 13 and 15, they suddenly want PSAs drastically slashed to 10 years from its normal 15, 20, and 25 years. For the duration, prices are to be fixed. Never mind that such terms have been proven unviable given uncontrollable inflation, the DOE’s own failure to secure sufficient energy capacities, and unforeseen changes in the economic environment in the real world. We remain vulnerable to these because of our continuing dependence on imported fuels, the volatility of oil prices, and the depletion of our gas reserves.

Under Section 17, the draft also mentions the creation of tariff benchmarks to regulate price proposals. Unfortunately, these benchmarks do not yet exist. 

How was the 10-year period determined without a benchmark rate? Apparently, no one is doing the math. Term, tenor, and benchmark rates are necessary in the series of equations to determine IRR. 

Price controls and caps have never worked. Benchmark rates are aggregates of costs. They include ever-changing macroeconomic debt costs, FOREX fluctuations, volatile fuel costs, and inflation risks. It is delusional to think these can be fixed. This time the delusional lynchpin is an irrational 10-year contract period – a factor as important as maximum returns on weighted average costs of capital (WACC) and benchmark bid prices tempered to supply and demand.

The negative effects of this proposed policy will effectively shackle and chain consumers to WESMs high strike prices. It will also poison WESMs generation mix with decrepit, inefficient, dirty, and expensive fossil-fueled plants. 

That was the painful lesson taught by the bullheaded insistence on fixed PSA prices amid radically volatile economic conditions where regulators forced businesses to operate at a loss. Never mind heavy-handed regulatory capture and the culpability of energy officials who failed to mitigate the impact of debilitating economic conditions by adequately diversifying away from our imported fossil-centric energy mix.

Officials have likewise failed to learn from the serial failures of DOE’s RE auctions. By attempting price controls using rates unresponsive to economic conditions, they risk openly disincentivizing both RE and liquefied natural gas greenfield investors by ensuring losses due to an offtake period shorter than the asset life or financing period of generation CAPEX. Asset lives range from 15 to 25 years. Financing periods for off-grid facilities are 15 years. The imbalance created by a forced 10-year contract term catalyzes contract failures leading to litigious court cases.

In the darkest shadows behind this proposal, energy officials effectively provide existing aging and high-priced fossil-fueled facilities entry to WESM’s inequitable high price regime. This benefits pricey generators and grants them extraordinary advantages to the detriment of consumers. This has happened before. The proposal simply institutionalizes the anomaly. –

Dean de la Paz is a former investment banker and managing director of a New Jersey-based power company operating in the Philippines. He is the chairman of the board of a renewable energy company and is a retired Business Policy, Finance, and Mathematics professor. He collects Godzilla figures and antique tin robots.

1 comment

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  1. ET

    Thanks to Dean De La Paz’s analysis of Marcos Jr. Government’s
    energy policy and administration, which accordingly will lead to an
    Energy Crisis. If the Rice Price Crisis continues and while
    it continues – the Energy Crisis will then arise – this would
    result to a deadly combination of Price of Rice-Cost of Energy Crises.
    With the continuing appointment of incompetent and corrupt officials,
    diversion of meager funds to the Confidential and Intelligence Funds
    in civilian offices, etc., is the Marcos Government ready to confront a
    combined Price of Rice-Cost of Energy Crises?

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