energy industry

[OPINION] The ‘tongpats’ fallacy behind high energy prices

Dean de la Paz

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[OPINION] The ‘tongpats’ fallacy behind high energy prices

David Castuciano/Rappler

'Whatever prices in our electricity bills were all authorized by regulatory agencies. Regulators are the final price arbiters.'

Other than the high cost of food, the other inflationary catalyst is the high cost of energy. The former is attributable to the worst ever management of our agricultural sector, while the latter repeats the bloated costs of imported fuels and the shortages of baseload power we suffered under the Arroyo administration.

Like a recurring nightmare, the energy sector remains under the same factotum when fuel prices and the availability of power worsened dramatically between 2005 and 2008. Little has changed. Fuel supply remains import-dependent, and baseload electricity, short and unreliable. Recent attempts to shift to indigenous and renewable sources have failed, worsened by regulatory pricing incompetence.

We either have the weakest memories of past folly or our learning curve is flat. We, however, have new excuses. Current officials explain we have high power rates because we do not subsidize. Citing others, economies subsidize by as much as 50%, within our franchised areas, ceteris paribus, rates are competitive. They cite studies showing that those are due to the “least cost” mandate of our largest private distribution utility.

It is easy to ballyhoo cost advantages among subsidized “apples” and non-subsidized “oranges.” But dig deeper. When officials say we don’t subsidize, that’s a half-truth. The apparent upside is attributable to a private distribution utility’s (DU) “least cost” supply agreements and its end-user billing protocols where it actually charges subsidies to its customers. Outside those private bilateral contracts and those subsidy billings rechanneled as socialized pricing to the poorest as well as off-grid communities, power rates reliant on expensive diesels, despite the subsidies, remain off the charts in non-franchise areas, sometimes tripling those served by the DU.

Aggravating our current reality is the dearth of genuinely effective watchdogs, adept at critical thinking, adequately and appropriately educated to tackle the high cost, high price curses afflicting price-elastic sectors.

Note that the chairpersons of the congressional committees on energy have no real experience in energy much less in its pricing. Among committee members, one lawmaker claims an electricity utility’s regulator-imposed cost of capital metric is too high, yet cannot himself understand its cost calculus.

From the opposite political aisle, another releases press statements denouncing “tongpats” but is ignorant of the pricing formulae. Without any real substance both have nothing but grandstand value.

So where do these leave us among the tall grass?

Check out the charts. In March 2005, oil prices skyrocketed by over 40.82%. Within two years, extending for the next six, these increased to an all-time high. Spanning two energy secretaries, fuel costs bloated by over 300%.

2005 was a distant mirror. Its pricing aberrations continue. Discern the immeasurable costs of ignorance, and the very real costs of seriously compromised balance sheets and expenses burdened on consumers.

Note how current officials allowed at least 45% control of a valuable indigenous power source that provides 20% of our energy surrendered to an under-capitalized start-up whose parent company was not only deep in debt and now hocking crown jewels but was also inexperienced in the upstream field it was allowed in.

While the remaining 55% majority is held by arguably financially-fit and competent hands, a financially frail 45% profoundly compromises the capital structure of a critical power source.

Should the hollow 45% be forced into a foreclosure or liquidation allowing backdoor foreign encroachment on patrimonial wealth, imagine the impact on domestic energy prices.

The question of energy prices is infinitely complex.

There is this simplistic perception that businesses simply incur costs, tack on margins, and then pass these on, lock, stock and barrel. These simplistic pass-on notions are often misapplied to public utility franchises.

For those who understand a tad more, what are considered unavoidably passed-on are what accountants consider as “cost of goods (or services) sold” – arithmetically a function of revenues. Not the other way around.

The crux of the cost-plus pass-on question are in operating costs (OPEX), expenses incurred whether an enterprise earns revenues or not. For franchised electricity utilities, not all own, operate, and maintain (OO&M) OPEX are passed on.  

Depreciation is an example. Typically computed by dividing the purchase cost of capital expenditures (CAPEX) by their depreciable lives, albeit non-cash, these are necessary costs to generate revenues and expand assets – the latter a condition of the franchise grant.

So rigid are the cost controls that every five years, utilities must identify CAPEX prior to regulatory periods, specifying sources of capital, justifying related expenses and return on asset (ROA) cashflows for each capital equipment, record those monthly, and seek approval for the depreciation methodology applied.

When regulators limit returns below the cost of capital, then the utility operates at a loss and does not invest in asset expansion. Unfortunately, asset expansion is critical to the energy sector. Remember how the failure of regulators to reset costs of capital in the last ten years had severely restricted expansion.

Obviously, energy pricing is different. Not all costs are applied a margin and passed-on. Margins are externally mandated. Not all are “tongpats.” In fact, “tongpats” should have been impossible had regulators done their job.

In determining allowable returns on capital, the regulatory gauntlet is extremely narrow but must allow for reasonable returns to incentivize and compel asset expansion.

Regulation-wise, scrutinizing OPEX is the easy part. Determining returns on capital is harder. Costs of capital establish benchmarks upon which margins are predetermined by regulators. Every centavo billed requires prior regulatory greenlighting under mechanisms employing a calculus of performance rewards and punishments, critical expansion incentives, and cost controls. “Tongpats” occur only when regulators are remiss.

Whatever prices in our electricity bills were all authorized by regulatory agencies. Regulators are the final price arbiters. If overbillings occur, then these result from regulatory incompetence or dereliction. Thus, it behooves regulators and critics to learn the arithmetic lest all that noise about “tongpats” simply mimic wolves howling at the moon. –

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.

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  1. ET

    Thanks to Dean De La Paz for this enlightening article, “The ‘tongpats’ fallacy behind high energy prices.” Unfortunately, I have to admit it is hard to understand especially for someone who does not know our Energy Industry. Perhaps, the inclusion of visual aids and even animations will be helpful to ordinary readers like me who have no experience in our Energy Industry.

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