Continuing Regulatory Education for the
Staff (CREST)
ERC Rate-Setting
Methodologies
December 7, 2010
Rate -Setting Methodologies
1
Energy Regulatory Commission
Created under Section 38 of Republic
Act No. 9136 (The Electric Power
Industry Reform Act of 2001)
 Major Functions:
 Sole regulator for electricity industry
 Rate Fixing
 Protect consumers as they are affected by
the rates
Rate -Setting Methodologies
2
Where does the peso in your electric bill go…
ELECTRIC POWER
PLANTS GENERATE
ELECTRICITY
ELECTRICITY IS THEN
CARRIED OVER LONG
DISTANCES BY
TRANSMISSION LINES TO
LOCAL DISTRIBUTION
COMPANIES
YOUR LOCAL DISTRIBUTION UTILITY SETS
UPTHE POWER LINES
IN YOUR COMMUNITY
AND SERVICES YOUR
NEEDS FOR
ELECTRICITY
HOW IS THIS REFLECTED IN YOUR ELECTRIC BILL?
Generation
Charge
Rate -Setting Methodologies
Transmission
Charge
Metering
Charge
Distribution Supply
Charge
Charge
3
How does ERC set the Charges?
 Generation
 NPC: Return on Rate Base Methodology
 IPPs: Review of Individual Power Supply Agreements
 Transmission
 Previously, Return on Rate Base Methodology
 Currently, Performance-Based Regulation
 Distribution
 Private Distribution Utilities
 Previously, Return on Rate Base Methodology
 Currently shifting to Performance-Based Regulation
 Electric Cooperatives
 Cash Flow Methodology
 Currently shifting to Benchmarking Methodology
Rate -Setting Methodologies
4
Rate-Setting Methodologies
1. Cash Base
2. Return on Rate Base (RORB)
3. Performance-Based Ratemaking (PBR)
•
Rules for Setting Transmission Wheeling
Rates (RTWR)
•
Rules for Setting Distribution Wheeling Rates
(RDWR)
•
Rules for Setting Electric Cooperatives’
Wheeling Rates (RSEC-WR)
Rate -Setting Methodologies
5
Role of Regulation
• Regulators has to balance the interest of the
consumers and industry stakeholders
– Seek to maximize a social welfare function to limit the
costs that are transferred to consumers
– Must also ensure the sustainability and viable
operations of a firm
• Since a regulator can obtain good information
about actual costs
– It is expedient to set prices based on actual costs
– There is little incentive to bring down cost
Rate -Setting Methodologies
6
Cash Base Methodology
Rate -Setting Methodologies
7
Cash Base Methodology
• Applicable to Electric Cooperatives
(now only for off-grid)
• Being non-profit, only provides the
cash requirement to operate viably plus
fund for rehabilitation and
maintenance.
Rate -Setting Methodologies
8
Cash Base Methodology
 Determine Revenue Requirement
 Based on a historical test year
OTHER
REVENUE
ITEMS
 Revenues arising from operations should be shared by
DU
DEBT SERVICE
• Allowable loans obtained from financial institutions or
the NEA.
REINVESTMENT
or CAPEX FUND
 Allowance used to finance capital expenditure program
PAYROLL
OPERATING and
MAINTENANCE
EXPENSES
Rate -Setting Methodologies
 updated salaries plus allowable benefits
 necessary, legitimate, prudent, continuing, normal
 includes operating and maintenance expense and taxes
9
Return on Rate Base (RORB)
Methodology
Rate -Setting Methodologies
10
Return on Rate Base
• Cost-of-service Ratemaking
• Regulated Entity are set to recover cost
of service prudently incurred plus a
reasonable rate of return.
• The rate of return pertains to the
percentage which when multiplied by
the allowed rate base, provides a return
that will fairly compensate the company
for the risk inherent to the investment.
Rate -Setting Methodologies
11
How does the Return on
Rate Base Methodology set your rate?
 Determine Revenue Requirement
 Based on a historical test year
OTHER
REVENUE
ITEMS
 Revenues arising from asset - based operations
should be shared by DU
RETURN ON
INVESTMENT
 12 % of rate base
 value of used and useful assets + working capital
RETURN OF
INVESTMENT
 depreciation
PAYROLL
OPERATING
EXPENSES
Rate -Setting Methodologies
 updated salaries plus allowable benefits
 necessary, legitimate, prudent, continuing, normal
 includes operating and maintenance expense and taxes
12
How does the Return on
Rate Base Methodology set your rate?
 Advantages
 Provides earnings stability by guarding against excessive or
unduly meager earnings
 As practiced, allows reflection of current prices through
adjustment mechanisms
 “pass through” of expenses to avoid frequent reviews
 Timing of regulatory reviews when utility “under-earns
 Disadvantages
 Limited incentive for exceptional performance
 Averch-Johnson effect on capital costs:
 If allowed return > capital costs = incentive to over-invest
 If allowed return < capital costs = incentive to under-invest
 Information intensive
 Costly and lengthy regulatory hearings
 Consumers, rather than the regulated firm, bears much of the
market risk
Rate -Setting Methodologies
13
How does the Return on
Rate Base Methodology set your rate?
“The RORB Rate Case Cycle”
Commission
Orders new
Rates
Utility monitors
results of
operations
Rate -Setting Methodologies
ERC conducts
hearings and
evaluates filing
Utility files a
Rate Case
14
Why is there a need for another
rate setting methodology?




Efficiency gains
Improved dependable quality service
Reduce costs
Provide reasonable rates
Rate -Setting Methodologies
15
Adoption of PBR
• As authorized under Section 43(f) of the Electric
Power Industry Reform Act (EPIRA), the ERC,
promulgated the Performance Based Regulation
(PBR):
– In May 2003, for the transmission utility, thru the
Transmission Wheeling Rates Guidelines (TWRG),
wherein price is controlled thru a maximum annual
revenue (MAR) cap, later amended as Rules for Setting
Transmission Wheeling Rates (RTWR) in September
2009
– In December 2004, for the private distribution utilities,
thru the Distribution Wheeling Rates Guidelines
(renamed as Rules for Setting Distribution Wheeling
Rates, RDWR), wherein price is controlled thru a
maximum average price (MAP) cap.
Rate -Setting Methodologies
16
Performance Based Regulation - Efficiency
 PBR is intended to ensure that firms have
incentives to improve efficiency
 Achieved by fixing prices/revenue in advance (exante)
 Improving efficiency under fixed prices means
additional profits
 Regulator must ensure that all these gains
do not accrue to the firms
 Incentive regulation therefore involves sharing of the
efficiency benefits
 Various manners exist in which this benefit is shared
Rate -Setting Methodologies
17
Performance Based Regulation – Service Quality
• Wide recognition that a trade-off exists between
– The service quality at which electricity is supplied
and
– The cost for providing this service
• Under incentive regulation, there is an incentive to
maximise profit
• Profits can be increased by reducing service quality
• Hence, the Regulator also has a societal obligation to
regulate service quality to ensure
– Profits are not taken at expense of quality
– All customers receive a reasonable quality of service (not only
those where it is profitable)
– Acceptable service levels are maintained
Rate -Setting Methodologies
18
Performance Incentive Scheme
Performance Index
Interruption frequency rate (IFR)
Cumulative Interruption Time
(CIT) – forced only
Cumulative Interruption Time
(CIT) – pre-arranged only
Probability of voltage levels falling
within prescribed limits
System losses
Average time to process
application for Regulated
Distribution Services
Average time to connect
premises to the Regulated
Distribution System
Call center performance
Rate -Setting Methodologies
Penalty
Average
Reward
Level E Level D
20.16
15.40
12.59
9.56
Level C
Level B Level A
5.90
1.14
3.52
0.49
Units
No
Hours
Weight
0.20
0.20
Hours
0.15
8.32
6.19
1.94
%
0.10
6%
5%
3%
2%
%
Days
0.05
0.10
22
19
7.5%
7
7%
4
Days
0.10
7
4
2
1
0.10
31.93%
25.5%
12.66%
6.23%
8.5%
19
Guaranteed Service Level
Rate -Setting Methodologies
20
• Performance - based regulation…
– Methodology
– Process
Rate -Setting Methodologies
21
Annual Revenue Requirement
 Determine forecasted Annual Revenue
Requirement for a Regulatory Period
INCOME TAX
 set to zero
RETURN ON
INVESTMENT
 Weighted Average Cost of Capital (WACC) X rate base
 value of optimized used & useful assets + working capital
RETURN OF
INVESTMENT
 depreciation based on standard asset lives
TAXES
OPERATING
EXPENSES
 property taxes, business taxes
 operating and maintenance expenditures
 recurring in the course of providing service
 legitimate, necessary, prudent and reasonable
Rate -Setting Methodologies
22
Annual Revenue Requirement
REGULATORY PERIOD
Regulatory Year 1 Regulatory Year 2 Regulatory Year 3 Regulatory Year 4
INCOME TAX
INCOME TAX
INCOME TAX
INCOME TAX
RETURN ON
INVESTMENT
RETURN ON
INVESTMENT
RETURN ON
INVESTMENT
RETURN ON
INVESTMENT
RETURN OF
INVESTMENT
RETURN OF
INVESTMENT
RETURN OF
INVESTMENT
RETURN OF
INVESTMENT
TAXES
TAXES
TAXES
TAXES
OPERATING
EXPENSES
OPERATING
EXPENSES
OPERATING
EXPENSES
OPERATING
EXPENSES
Rate -Setting Methodologies
23
The control mechanisms…
1. A review every 4 years (Reset Process)
– to determine forecast revenue requirement
– to determine/benchmark the actual cost that
has been incurred by the Utility;
– to determine/adjust the service performance
measures
Rate -Setting Methodologies
24
The control mechanisms…
2. Annual Verification
– to ensure that Utility earns only within the
approved constraints;
– to adjust for the actual increase/decrease in
price of commodities (inflation);
– to adjust for the actual increase/decrease in
sales;
– to review the service performance (reward or
penalty)
Rate -Setting Methodologies
25
Price-cap formula
MAP  [ MAP
 {1  CWI  X }]  S  K  ITA
t
t 1
t
t
t
t
which is a variant of the so-called “CPI-X” form of regulation
It essentially means :
Next year’s price is capped at this year’s price plus an
allowance for general cost increases, reduced by an
efficiency factor.
MAPt means the maximum average price (for distribution services) for
year t
Rate -Setting Methodologies
26
Reset Process
Issues Paper
LEGEND
ERC Responsibilities
Public Consultation
DUE PROCESS
Position Paper
UTILITY Responsibilities
ERC Values Assets
Utility Submits Revenue Application
Public Hearings
Draft Determination
Public Consultation
Final Determination
Utility Submits Rate Application
FOR EACH YEAR
OF THE REGULATORY PERIOD
Rate -Setting Methodologies
Public Hearings
Rate Decision
Rate Implementation
27
Timelines on PBR - Transmission
 Transmission
 2nd Regulatory Period – January 2006 – December
2010
 3rd Regulatory Period – January 2011 – December
2015
 December 18, 2009 – NGCP filed its application for
Maximum Annual Revenue for the 3rd Regulatory
Period
 July 21, 2010 – ERC issued its Draft Determination
 November 22, 2010 – ERC issued the Final
Determination
Rate -Setting Methodologies
28
Timelines on PBR – Private DUs
Entrant
Regulatory Period
Manila Electric Company (MERALCO)
July 01, 2007- June 30,
Dagupan Electric Company (DECORP)
2011
Cagayan Electric and Light Company (CEPALCO)
Cotabato Light and Power Company (CLPC)
April 01, 2009 - March
Iligan Light and Power Company (ILPI)
30, 2013
Mactan Electric Company (MECO)
Cabanatuan Electric Corporation (CELCOR)
La Union Electric Company (LUECO)
Tarlac Electric, Inc. (TEI)
July 01, 2010 - June 30,
Visayan Electric Company (VECO)
2014
Ibaan Electric and Engineering Company (IEEC)
Davao Light and Power Company (DLPC)
Panay Electric Company (PECO)
Subiz Enerzone (SEZ)
San Fernando Light and Power Company (SFELAPCO)
October 01, 2011Bohol Light Company, Inc. (BLCI)
September 30, 2015
Angeles Electric Corporation (AEC)
Clark Electric Distribution Corporation (CEDC)
Rate -Setting Methodologies
29
PBR been successfully implemented…
•
•
•
•
•
•
•
Argentina
Australia
Brazil
Mexico
New Zealand
United Kingdom
United States
Rate -Setting Methodologies
30
Regulatory Outcomes - Australia
•
Significant price improvements have been experienced in overseas
jurisdictions under PBR style price control arrangements – Graph
below for DU in Australian state of Victoria
1.1
Effective Price Index
1.0
0.9
0.8
0.7
0.6
0.5
1995
2000
2005
2010
Calendar Year
AGL

Notes :
Citipow er
Pow ercor
TXU / TRU

Source data from Essential Services Commission, Victoria, Australia.

Po & X Factor from 2006 are from Draft Decision

Actual CPI from Australian Bureau of Statistics, Forecast from EIU
Rate -Setting Methodologies

Effective Price Index is in Nominal terms
United Energy
31
Regulatory Outcomes - UK
•
Effective Price Index
Significant price improvements have been experienced in overseas
jurisdictions under PBR style price control arrangements – Graph
below for UK DUs
1.1
1.0
0.9
0.8
0.7
0.6
0.5
1997
1999
2001
2003
2005
2007
2009
2011
Year Ending June 30

Notes :
Eastern
East Midlands
London
Manw eb
Midlands
Northern
NORWEB
SEEBOARD
Southern
SWALEC
South Western
Yorkshire
Scottish Pow er
Hydro-Electric

Source data from OFGEM, UK.

Po & X Factor from 2005 are from OFGEM Proposal

Actual RPI from Uk
Rate -Setting Methodologies

Statistics Office, Forecast from EIU
Effective Price Index is in Nominal terms
32
NGCP Final Determination for 2011-2015
Rate -Setting Methodologies
33
What will PBR achieve?
What it will do to the utility
 Provide you with better service
 Improve the quality of electricity delivered to you
 Reduce costs due to operational efficiency
What it will do for the consumer
 Receive better quality of service and electricity from
the utility
 Share in the utility’s operational efficiency
 More value for his money
What it will do for the relationship between the utility
and the consumer
 Make it more equitable, more fair
Rate -Setting Methodologies
34
Rules for Setting Electric
Cooperatives’ Wheeling
Rates
Rate -Setting Methodologies
35
Vision for Electric Cooperatives
•
•
•
•
•
Financially self-sufficient
Operational Efficiency
Member-Consumer responsive
Quality Service
Streamlined Regulation
Rate -Setting Methodologies
36
RSEC-WR
 The Rules was promulgated by ERC on
September 23, 2009;
 Applicable only to on-grid Electric
Cooperatives
 Electric Cooperatives’ groupings
 Develop for each group
– Initial Tariff Cap
– Tariff Glide Path
• Performance Standards
• Efficiency
Rate -Setting Methodologies
37
Background
Date
Particulars
September 23, 2009
Resolution No. 20, Series of 2009 - A Resolution
Adopting the Rules for Setting the Electric Cooperatives’
Wheeling Rates
October 12, 2009
Start of the period for filing of application
January 2010
Implementation of Provisional Authority (PA) in
accordance with the Order issued by the Commission
February - April 2010 Jurisdictional hearings for the 94 on-grid EC’s who filed
under the RSEC-WR
April 2010
Formulation and Filing of the Rules Governing the Tariff
Glide Path under the RSEC-WR
May - October 2010
Evidentiary hearings for the 94 on-grid EC’s who filed
under the RSEC-WR
Rate -Setting Methodologies
38
Policies being implemented
Particulars
EC grouping
Rate -Setting Methodologies
Description
On-grid ECs clustered into
seven (7) groups
39
Classification of ECs
Group Characteristics
Group
Number of Coops
A
B
C
D
E
F
G
11
16
5
17
28
15
6
Rate -Setting Methodologies
Consumption
Number of customers
<1
<1
<1
1 to 2
1 to 2
1 to 3
3 to 5
10 to 25k
25 to 50k
50 to 100k
10 to 50k
50 to 100k
20 to 150k
30 to 150k
40
Policies being implemented
Particulars
Description
EC grouping
On-grid ECs clustered into
seven (7) groups
New Customer Segmentation
Residential
Low Voltage
Higher Voltage
Rate -Setting Methodologies
41
Customer Classes
Transition from the present to the Proposed
Customer Classes
Present
Proposed
Residential
Sale for Resale
BAPA
Small Commercial
Small Industrial
Public Buildings
Streetlights
Irrigation
Large Commercial
Large Industrial
Rate -Setting Methodologies
Residential
Low Voltage
Higher Voltage
42
Policies being implemented
Particulars
Description
EC grouping
On-grid ECs clustered into
seven (7) groups
New Customer Segmentation
Residential
Low Voltage
Higher Voltage
Revised Rates
New Distribution, Supply and
Metering Charges
Members’ Contribution for
Capital Expenditures (MCC)
Rate -Setting Methodologies
43
RSEC-WR Rates
GROUP
Distribution
A
Supply
Metering
MCC
Distribution
B
Supply
Metering
MCC
Distribution
C
Supply
Metering
MCC
Distribution
D
Supply
Metering
MCC
Distribution
E
Supply
Metering
MCC
Distribution
F
Supply
Metering
MCC
Distribution
G
Supply
Metering
MCC
Residential
PhP/kWh
1.0557
1.0282
0.5792
0.5324
0.8449
0.7732
0.4569
0.4004
0.7004
0.7156
0.5236
0.3696
0.5143
0.5828
0.3669
0.2508
0.5782
0.6001
0.4326
0.2904
0.4613
0.5376
0.3205
0.2178
0.2748
0.4140
0.3460
0.1518
Rate -Setting Methodologies
Low Voltage
PhP/meter/mo.
PhP/kWh
Higher Voltage
PhP/Cust/Mo
1.1577
PhP/kW
PhP/kWh
302.51
42.82
29.12
5.0000
0.5324
0.9259
42.82
29.12
0.5324
267.90
40.15
28.72
5.0000
0.4004
0.7493
40.15
28.72
0.4004
213.96
34.05
29.91
5.0000
0.3696
0.5134
34.05
29.91
0.3696
190.03
41.61
31.19
5.0000
0.2508
0.7595
41.61
31.19
0.2508
219.68
42.92
35.94
5.0000
0.2904
0.4441
42.92
35.94
0.2904
167.56
46.60
32.78
5.0000
0.2178
0.3748
46.60
32.78
0.2178
118.55
59.73
54.92
5.0000
0.1518
PhP/Cust/mo
59.73
54.92
0.1518
44
Members’ Contribution for
Capital Expenditures (MCC)
 To be used solely for capital expenditure
projects
 If more funds is needed, the coop may
collect additional by securing consent of
its member-consumers, subject to the
same limitations on its use
Rate -Setting Methodologies
45
Regulatory Timelines
P
E
R
I
O
D
T
I
M
E
L
I
N
E
S
Jan 2011
Jan 2010
R
Current
A
Transition
Rates
T
Rates
E
S Rate -Setting Methodologies
Jan 2012
SIT
Dec 2015
DSM = TARIFF GLIDE PATH
46
Tariff Glide Path
STANDARD
INITIAL TARIFF
New DSM
(Regulatory
Period)
Standard Initial
DSM Charges
Standard
Initial DSM
Members’
Contribution for
capital expenditures
( 1+ I - X + S )
DSM will be adjusted annually based on the Tariff Glide Path
Rate
-Setting
Methodologies
RULES
FOR SETTING
THE ELECTRIC COOPERATIVES’ WHEELING RATES
47
Tariff Glide Path
An escalation factor to be used
in adjusting the rates to reflect
current cost
Standard
Initial DSM
Charges x ( 1 + Index “I” – Efficiency Factor “X” + Performance Incentive “S”)
provide for the sharing of the
ECs efficiency w/ the
member-consumers
Rate
-Setting
Methodologies
RULES
FOR SETTING
THE ELECTRIC COOPERATIVES’ WHEELING RATES
EC shall be rewarded
or penalized based on
performance
48
Where does the peso in your electric bill go…
ELECTRIC POWER
PLANTS GENERATE
ELECTRICITY
ELECTRICITY IS THEN
CARRIED OVER LONG
DISTANCES BY
TRANSMISSION LINES TO
LOCAL DISTRIBUTION
COMPANIES
YOUR LOCAL DISTRIBUTION UTILITY SETS
UPTHE POWER LINES
IN YOUR COMMUNITY
AND SERVICES YOUR
NEEDS FOR
ELECTRICITY
HOW IS THIS REFLECTED IN YOUR ELECTRIC BILL?
Pass-through
GENERATION
Generation
CHARGES
Charge
(60%)
Metering
PBR
Charge
Transmission
(Transmission Distribution
& Distribution)
Supply
Charge
(40%)
Charge
Charge
49
VISION:
Asia’s benchmark for excellence
in power regulation.
MISSION:
The Energy Regulatory Commission
promotes and protects
the long-term consumer interests
in terms of quality, reliability, and reasonable pricing
ofRate
a -Setting
sustainable
Methodologiessupply of electricity.
50
THANK YOU!
Tariffs and Rates Division
Regulatory Operations Service
[email protected], [email protected]
634-8641
Rate -Setting www.erc.gov.ph
Methodologies
51