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5
2016
Previously, we addressed in Part 1 what we foresee as the foundation of the Philippine
transformation under the Duterte presidency. Then, in Part 2, we presented the
essential elements to confront unconventional challenges with unorthodox methods
through the public and private sectors’ mobilization of their respective resources and
capabilities to implement an infrastructure program that implies an unprecedented
call on capital. In Part 3, the last of our three-part paper, we focus on the energy
sector, analyzing its ills and the feasible solutions that may lie within and outside the
industry.
BUILDING A BETTER PHILIPPINES TOGETHER (PART 3)
R.A.C.E. towards
prosperity
Ricardo G. Barcelona, Ph.D.
King’s College, London, United Kingdom
Bernardo M. Villegas, Ph.D.
Harvard University, Boston, United States
and
Thomas G. Aquino, Ph.D.
iese Business School, Barcelona, Spain
Ricardo G. Barcelona et al. • R.A.C.E towards prosperity
POLICIES AND ISSUES IN PERSPECTIVE
A publication of the School of Economics, University of Asia & the Pacific, Philippines
UNIVERSITY OF ASIA & THE PACIFIC
ISSN 0116–3515 The Philippine energy sector, particularly the power
industry, is subject to abuse by some vocal critics. When
we talk about Philippine energy, the discussions conjure
images of blackouts in Mindanao, high prices, colluding firms
under oligopolies (often seen erroneously to rip off consumers),
or rent-seeking investors. At least to proponents of these views,
these concerns are legitimate. Unfortunately, energy has become
so ubiquitous that we are confronted with this situation: Ask a
vocal lobbyist, and you get a ton of opinions and conjectures that
pass for “evidence” and “expertise”.
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staff memos 13 • 2012
R.A.C.E. towards prosperity • Ricardo G. Barcelona et al.
staff memos 5 • 2016
This sorry state of affairs has serious consequences.
After years of underinvestment, Mindanao suffered from
continual and severe power shortages from 2010 to 2016,
resulting in a 12-hour blackout on a bad day. The “experts”
saw opportunities for rent extraction by offering emergency
power at Php 14/kWh. To ease the impact on prices, they
offered to spread the excess costs (from Php 4/kWh to Php
5/kWh when normal supplies are available) over several
years. As the argument went, by spreading the sum over long
enough periods, the impact on the price per kWh becomes
imperceptible to the paying consumer. A similar logic is
applied to solar power.
While the approach appears to solve an immediate
problem – increase power supply at minimal impact to
prevailing power prices – the cure creates a more serious
disease by storing problems for the future. Worse, the problem
is diagnosed as a power generation problem. In reality, it fails
to address a basic question: Why are Luzon and Visayas able
to attract investments, while Mindanao struggles to get a
power plant built?
Placed in this context, the answers provide a different
narrative as to what causes the persistent energy problems
that appear to single out Mindanao as the heaviest hit area.
Refocusing power reforms: Fixing the distribution and
regulatory structure
The power industry experiences three areas of challenge:
1. persistently high power prices;
2. limited transmission connectivity in the Visayas
islands and isolated Mindanao grid, which results in
periodic imbalance in supply to meet a given regional
demand; and
3. inefficient and financially weak distribution
cooperatives.
This prognosis is contrary to what is popularly purveyed
by certain interest groups. When power prices are discussed,
critiques of the power sector defaults into attributing the
industry’s ills to the power generators. We beg to disagree and
offer an alternative analysis of the roots of the persistently
high power prices.
Causes of the Present Challenges
The persistently high power prices are essentially caused by:
• ineffective regulation, where the price-setting
mechanism is characterized by a cost-plus type of
pricing1 that rewards inefficiency;
• high distribution losses from lack of investments in
the network, thereby increasing losses in amount of
power distributed; and
1 While the regulation calls for incentive-based pricing, the actual
price-setting system continues to follow (or shadow) a cost-plus regime
as explained in a later section.
• weak finances, which means that interest expenses
account for a high proportion of the power
distribution costs, while investments are kept to a
minimum.
Poor and often uncoordinated execution of transmission
and distribution network investments create bottlenecks that
affect the viability of power investments.
Let us take these specific cases:
Negros Island is a major source of geothermal power that
is sold to Panay and Cebu. In the meantime, rapid build-
up of solar farms has transformed the island into a major
supplier of solar power. However, the transmission capacity
is not upgraded and is largely used up by geothermal power.
This implies that only a limited amount of power from solar
farms could be accommodated for dispatch to Panay and
Cebu. With more than 400 mw of solar power completed
or under construction, the transmission constraint could
result in these solar power supplies being stranded for lack
of an outlet or market. In the meantime, the feed-in tariffs
(FiT) paid to solar power will continue to be paid by the
government, and eventually by the consumers. At present,
solar power enjoys a FiT of Php 8.50/kWh to Php 9.50/
kWh compared with around Php 4.00/kWh for coal, gas, or
geothermal power. Worse, solar power supplies are shed from
the system, or suppliers are asked not to supply because of
transmission constraints. For intermittent supplies such as
solar power, with zero fuel costs, this practice can only spell
financial penalty to suppliers given that solar power is best
used when it is available.
Mindanao is isolated from Luzon and Visayas. This
insulates Mindanao from the surplus or shortages in these two
systems, which allows subsidized power prices in Mindanao
to be sustained. The unintended effect on Mindanao is the
difficulty in attracting investments in a new capacity because
of lower prices compared to Luzon or Visayas. In the process,
being dependent on hydropower, Mindanao suffers from
supply shortages during the dry season. Without being
interconnected to Luzon or Visayas, Mindanao cannot fill the
shortage through the power supply from these two systems.
By contrast, during periods of oversupply, Mindanao cannot
sell its excess hydro power to Luzon or Visayas.
Distribution of power is undertaken by the electric
cooperatives in most locations outside Metro Manila, Metro
Cebu, Metro Davao, and Metro Iloilo. While a number of
cooperatives are better managed than others, the governance
is highly politicized. This management approach results in
poor services, underinvestment in the network, and increasing
losses. Under a “cost-plus” pricing, the power prices are set
by adding the costs allowed by the regulator, and a margin
is added. The margin is usually a percentage of the allowed
costs. In effect, the higher the costs, the higher the allowed
UNIVERSITY OF ASIA AND & PACIFIC
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Ricardo G. Barcelona et al. • R.A.C.E towards prosperity
UNIVERSITY OF ASIA & THE PACIFIC
margin in peso terms. Thus, there is little incentive to be
efficient.
Possible Remedies to the Power Crisis
A. Power pricing and regulation
International experiences, particularly in Europe and a
number of us markets, address the question of power pricing
as follows:
1. Inflation minus X formula for transmission and
distribution: The regulated aspect of the power
system are natural monopolies, hence the regulator
sets prices. Instead of an annual price review that
the Energy Regulatory Commission (erc) conducts,
the European regulators set a reference price and an
escalation formula based on inflation minus an X
factor over five years with optional mid-term review.
Under this system, the price escalation is always lower
than the inflation rate when applied judiciously.
2. Wholesale market prices for generation: The
wholesale electricity supply market (wesm) in the
Philippines only transacts less than 10% of power
traded, compared with 100% in Europe. By letting
the power market set the periodic power prices, the
generator decides how much to dispatch through a
bidding process. The market operator ensures that the
market operates efficiently as indicated by the balance
of supply and demand at any given time. The regulator
simply polices the market to guard against any abuse,
not to unnecessarily interfere in setting prices for power
generation, which is subject to a competitive process.
Under this simplified pricing system, the regulatory
interventions in price setting are minimized. Over time, wesm
should trade 100% of the power supplied to distributors,
where the prices would signal to investors whether or not to
add capacity. By setting the price under inflation minus X
formula, the distributors can plan their capital expenditures
better while encouraging efficiency. The reason is that the
more efficient the cooperatives become, the more profits they
will make given that they keep all the cost savings.
FiTs have to be reviewed and strictly limited to the 500
mw solar capacity contemplated under the present quota.
Indigenous power sources such as hydro, mini hydro, and
geothermal plants offer better economics than solar power.
Expanded volumes enjoying FiTs would eventually affect
power prices adversely.
B. Infrastructure Investments
National Grid Company of the Philippines (ngcp), the
transmission company, is given incentive to expand their
network through a bonus/malus system. By setting a pricing
based on inflation minus X, incentives are given for operators
to work efficiently in their networks. The regulator can
focus on setting capital expenditure targets in coordination
with the power generators and distributors to determine
the infrastructure requirements. Once a simple set of key
performance indicators are agreed, compliance is monitored
where adverse deviations exceeding agreed tolerances are
penalized.
Negros Island transmission lines with Panay and Cebu
need to be expanded and upgraded to recognize the expanded
role of the island as a power supplier.
The Mindanao system requires two essential elements:
a) interconnections with Luzon and Visayas to improve
load balancing management; and b) additional investments
in rural areas. The interconnections may be undertaken
by ngcp, while the rural networks will have to rely on
public spending. In the latter case, rural electrification is
undertaken by two competing agencies: National Power
Corporation’s Small Public Utilities Group (spug) and
National Electrification Administration (nea). These two
agencies may be merged to improve coordination and
reduce costs.
Electric cooperatives are organized as entities with
member-subscribers. To improve their ability to attract
funding, cooperatives may convert their members’
subscriptions into voting shares that can be traded. Financially
viable cooperatives can be listed in the stock exchange so that
investors may purchase shares of selling shareholders, raise
new capital if needed, or issue corporate bonds to fund their
investments. Weaker cooperatives may merge or undertake
a restructuring program to improve their finances and
operational management.
spug and nea can focus on building rural distribution
networks in markets designated as missionary. They may take
over areas where the cooperatives fail to comply with their
supply obligations, or seek voluntary mergers with spug and
nea or other cooperatives. The expanded entity is listed in
the stock exchange to improve their access to capital, while a
professional management team is appointed.
The policy and capacity planning functions should be
streamlined under the Department of Energy (DoE), and all
investment incentives and permitting should be under the
responsibility of a unified body within the control of the DoE
Secretary. This includes the processing of Environmental
Clearance Certificates (ecc) that are undertaken by denr,
and separately by the DoE; permitting at national and local
government units; and reducing overlapping requirements
from different agencies.
C. Wholesale Electricity Supply Market
The wesm needs to be restructured so that 100% of generated
power is traded through the market once the national grid
is fully integrated. In the interim, the Luzon and Visayas
grids are integrated and managed as one system. This process
requires the following:
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staff memos 13 • 2012
R.A.C.E. towards prosperity • Ricardo G. Barcelona et al.
staff memos 5 • 2016
1. Reduction and eventual abolition of bilateral
contracts between generators and distributors. Under
a functioning wesm, the market provides the price.
Thus, there is no need for long-term contracts to
secure prices and supplies. This is how European
markets operate today.
2. Revision of rules of dispatch to eliminate practices such
as passing of fuel pricing risks to consumers (i.e., fuel
costs pass through system) instead of being absorbed
by the generators; must run rules on certain capacity;
and preferred dispatch for renewables. As zero fuel
costs supplies, renewables will always be dispatched
first under the merit order system, where the lowest
marginal costs supplies are dispatched first.
3. Strengthening of the trading capabilities of generators,
distributors, and the market operator to ensure a
smoothly functioning power market.
The proposed changes are best implemented after extensive
consultations with the market players and consumers, which
ensures public acceptance of the power market reforms. Trust
in the market system is essential for its success.
D. Energy Regulatory Commission
The present erc structure sets up the regulatory process to
fail. The regulator under epira sets the rules, executes, judges,
and polices the system. These are contradictory roles that
make the regulator prone to conflicts of interest. To cure
these inherent problems, the erc should instead focus on the
following:
1. Setting the market rules for wesm, and monitoring and
intervening only in cases of market abuse. The erc does
not set the prices for generation under a competitive
wholesale market.
2. Implementing a five-year review period for transmission
and distribution under inflation minus X formula.
This approach substantially reduces the amount of
price applications that overload the erc.
3. Strengthening the institutional framework of wesm
to ensure that a functional power market operates
efficiently.
4. Integrating consumer interest by creating choices in
power supply through market mechanisms.
In effect, the erc focuses solely on price setting for
transmission and distribution, the natural monopoly
components of the system, and policing against market abuse
by dominant suppliers and buyers.
Restoring Faith in the Government
The reform of the power industry was attempted but only
achieved mixed results. While premised on good intentions,
the previous government’s credibility in carrying out, much
less in sustaining the effects of reforms, was often in question.
The situation was not helped by spectacular failures to address
even the most basic of services where the government chose
to intervene.
For this reason, results in other spheres of governance
and actions could serve to reinforce the present government’s
credibility. And with this credibility, the people’s faith in
government could be restored. Interestingly, gaining success
in actions directed at addressing the problems around “low-
hanging fruits that are ripe for the picking” may be a good
place to start.
1. Transparency in governance
We have been frustrated by the non-passage of the Freedom
of Information (FoI) Bill that languished in Congress and
the Senate for far too long. President Duterte’s issuance of
an Executive Order applying FoI guidelines to the executive
branch of the government should be institutionalized by law.
Through our personal examples, we can use this enhanced
access to information as a way to root out corruption and
malfeasance in government. Equally, access to information
should make every Filipino an informed and more effective
contributor to good governance. It is our responsibility to
point out what is wrong in government, but we have the
greater responsibility to contribute solutions that make the
government work better for us.
With feedback informed by facts, we can transform the
ills that we forsake and build on the strengths that make us
great.
2. Transportation and connectivity
A government that cannot supply the basic services to its
people is not acceptable, whatever the reasons may be. Glaring
cases in the previous administration are the Department of
Transportation and Communication’s (DoTC) inability to
supply vehicle plates and drivers’ licenses, and the serious
failures in mrt-3. These matters have become urgent because
of past inactions. The consequences are serious. Vehicles
without license plates make police actions more difficult
against criminal elements. Drivers without proper licenses are
adding to these security concerns. Drivers who violate laws
cannot be arrested if we cannot identify who they are.
Specifically, the government’s actions on the following
areas have become urgent:
a. Rebidding vehicle plate contracts under a bot scheme
subject to Swiss challenge: The Commission on Audit has
rendered the awards as null and void. The new administration
could seek to replace the existing suppliers that consistently
failed to meet their obligations. Unregistered vehicles and
drivers are rampant in the streets. Some of these vehicles
are used in illicit activities such as robbery, kidnapping, and
hold-ups.
UNIVERSITY OF ASIA AND THE PACIFIC • Pearl Drive, Ortigas Center, Pasig City,
Metro Manila, Philippines 1605 • Telephone: 637-0912 to 26; Telefax: 632-7968.
The comments and views expressed in these papers are solely the responsibility of
the authors and do not represent any position held by UA&P. These papers may not
be distributed in full or in part without prior written authorization.
UA&P publishes at least 24 STAFF MEMOS a year. • Issue editor Karen N. Atienza
• Design Art & Copy Communication Design Inc. • Printing Inkwell Publishing
Co. Inc.
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Ricardo G. Barcelona et al. • R.A.C.E towards prosperity
UNIVERSITY OF ASIA & THE PACIFIC
b. Reviewing and enforcing compliance for drivers’
license supply contract: The present supplier’s failure to
comply with their obligations justifies the government’s
cancellation of these contracts immediately for rebidding.
c. Reviewing and enforcing compliance for operations
and maintenance contract for mrt-3: The present supplier’s
non-compliance with their obligations requires immediate
replacement by competent contractors. All options are on the
table to correct the sorry state of non-repair and maintenance
of an essential service. There is no justice in denying
commuters six hours of their day stuck in travel, when they
could fruitfully spend this time with their family and friends.
Internet access in the Philippines sets a record for being
among the slowest in the world. This is ironic for the country
that is known as the world’s text messaging and bpo capital. To
resolve this problem, all communications service providers,
potential technology partners, and the government should
start immediate work on the creation of a cyber highway that
initially interconnects our major regional centers. This cyber
highway should be ultimately broadened to a nationwide
coverage. This effort will dovetail with the country’s thrusts
on placing greater emphasis on regional development and
autonomy under a federal agenda.
The regions need to be interconnected to prosper. An
advanced communication backbone is where we start, along
with modern infrastructure in transportation, energy, and
water services.
Safe and available water is a growing challenge to the health
and well-being of Filipinos. In many rural communities,
safe water supplies are not readily available. The local water
boards are often under-capitalized and highly politicized.
Hence, instead of concentrating on making water available
to the communities, a number of the water boards are more
concerned about perpetuating their tenure. We need to
professionalize and recapitalize these water boards by opening
them to private capital.
3. Decisive steps for empowered regional autonomy
The aspiration to create a federal parliamentary form of
government would require constitutional amendments and
changes to our laws. Some observers see this as a long and
divisive process. If our ultimate goal is to create a government
system that is responsive to the needs of our people, we can
start by taking the first steps to bring the benefits of regional
autonomy to them. Specifically, the following measures are
considered as building blocks:
a. Release of internal revenue allocations (iras) withheld
by the national government: The national government has
withheld Php 600 B worth of iras. The Supreme Court has
ruled on two occasions in favor of the Province of Batangas
on their claims for payment. A pending case for the definition
of the scope of the taxes covered is awaiting Supreme Court
decision. For the sums that are established as owed to the local
governments, an initial disbursement could be authorized
through an Executive Order.
b. Streamlining and enhancement of the power of the
Regional Development Council (rdc): The powers and
authority of the rdc as the focal point for resourcing and
economic development efforts is enhanced. The Secretary
of the Department of Interior and Local Government could
initiate efforts to review and recommend mechanisms to
implement this empowered regionalization approach.
c. Restarting of peace settlement talks in conflict areas:
To sustain regional development, peaceful coexistence and
reintegration of rebel groups into Philippine society must be
sought under a broader framework of regional autonomy.
Working under the precepts of a Filipino-style “social
democracy” and operating under a functioning market
economy, the energy unleashed by the mass support could
be rechanneled as a positive force for societal transformation.
When guided by generally understood sets of principles
accompanied by concrete avenues to contribute, the faith is
not misplaced in the Filipinos’ capacity to deliver prosperity
for the common good.
With this faith, change is given a chance to overcome the
resistance from vested interests, and to successfully deliver on
the reform agenda. SM
Acknowledgment
This paper was prepared with the assistance of James C. Caswang,
Faculty Member, UA&P School of Economics.