Market Testing of
Power Supply Agreements:
In the Spirit of EPIRA
Raul V. Fabella
EPDP and NAST
Comparison of Power Rates
Del Mundo (2014), Understanding and Reducing Power Rates in the Phils.
Possible Reasons for High Power Rates
• Taxes
• Subsidies
 Stranded, FIT All,
Universal Charges (Missionary,
Renewable)
• Low Generation Capacity per Capita: Very Low Reserves and
Lack of Greenfield Investment in the EPIRA Era
• Fuel Mix
• Government Failures: Too much red tape, licensing
requirement, local-national impasses
• Market Failures
 Possible Abuse of Market Power
 Possible transfer pricing with embedded/affiliated gencos
Taxes and Subsidies? “Not so fast” say R del Mundo ( 2014) based on USAID, 2013 data. Others claim that subsidies
especially in Indonesia are crucial.
EPIRA (2001)
• EPIRA: a state response to problems with
state dominated power sector (NPC owned and operated Gencos and
Transmission Grid): fiscal drain (NPC debt
was 28% of GDP in 2003) and high power
prices.
• It sought to open the power sector to
market players, e.g., privatization of NPC
assets, retail competition, spot market
auction (WESM).
EPIRA and the Market
The EPIRA spirit: Let market do its magic!
“(Sec 2c) To ensure transparent and
reasonable prices of electricity in a regime of
free and fair competition and full public
accountability to achieve greater operational
and economic efficiency and enhance the
competitiveness of Philippine products in the
global market.”
Observations on the Classification
• A DU is “regulated”.
• EPIRA provides for Retail Competition (RC).
In the event of full RC, regulation of DUs
may be limited to supply to captive
consumers.
• Generation classified as “competitive”,
though for now this is more an aspiration than
a reality. In some regions
and
grids,
Gencos may have market power. So still
subject to some residual regulation by
ERC.
• Transmission is a monopoly so regulated.
Contracting Problems under EPIRA
Affecting Power Cost
• Capacity Building: The Philippines has lowest
per capita generation capacity in our region.
• EPIRA outlawed certain capacity building
modalities: direct or indirect (via PPP say with
take-or-pay) state procurement except under
emergency and limited bundling. Indirect effect
on prices.
• Power Supply Contracts (PSAs): at present
dominated by negotiated bilateral contracts.
Direct effect on prices.
Contracting Problem wrt PSA
• Mostly Long Term: subject to many random
shocks: technology, feedstock prices, etc.
• Non-Storability: Must use as generated.
• Demand
Fluctuations
and
Supply
Coordination
• Commodity is a Bundle of Characteristics:
 Price
Duration, Delivery Dates, Risk-sharing
Reliability: High cost of failures
Market Testing of PSAs:
Why?
a. What is (are) the market failure
(s) addressed?
b. Will market testing improve
social welfare (lower tariffs)?
Possible Market Failures in
the PSA Contracting
Possible Market Failures in the PSA Contracting
1. Abuse of Market Power
GenCos in some grids
• May enjoy market power
• May dictate PSA terms
and terms of delivery to
small, fragmented DUs
• Weak competition among
GenCos, or
• Possible Collusion among
GenCos, and GenCos
and Dus. Not Easy to
Prove Conclusively
Higher
Tariff for
Captive
Market
Different Case of Large DUs
• Large DUs like Meralco and Veco turn the
market power equation around: Gencos
vie for contracts with them. Large DUs
have a pick on lowest cost suppliers.
• Whether they exercise monopsony power
to benefit consumers is another matter.
• Countervailing Consumer and Political
pressure for lower tariff may tilt DU
behavior towards lower tariffs (Fabella,
1998).
Possible Market Failures in the PSA Contracting
2. Moral Hazard Among DUs
Generation cost being
pass-on, DUs may not
have sufficient incentive
to:
• Resist
high
generation cost
• Procure
from
lowest
cost
suppliers
For March 2015
• The generation charge makes up
47.48% of the cost per kWh of
MERALCO ’ s
residential
customers.
• The average generation cost of
MERALCO
for
its
captive
customers is Php 5.2503
Sources: www.kuryente.org.ph/electric-company/rates/128/2015/march
Computation of the Generation Charge for April 2015, MERALCO
Market Failures in the PSA
3. Moral Hazard for DUs with
Embedded/Affiliated GenCos
DUs
with
Embedded/Affiliated
GenCos may engage
in transfer pricing;
Gencos are not Public
Utilities and thus not
subject to RORB.
•
•
•
•
As of October 2014
Allowed by EPIRA up to 50% of
purchases from owned GenCos
38 Embedded Plants Nationwide
19 plants in Luzon
 145.9 Installed Capacity
 119.2 Dependable Capacity
19 plants in Mindanao
 285.4 MW Installed Capacity
 255.7 Dependable Capacity
Transfer pricing raise tariffs
Source: Department of Energy’s List of Existing Plants as of October 2014 excluding off-grid generators
Market Failures in the PSA
4. Coordination Failure
Small DUs are
unable to
aggregate demand
to offer in an
auction
If Aggregated
GenCos interested Demand of DUs
to bid if:
is Auctioned to
• Aggregate
GenCos
demand large
enough
• Reliability
safeguards
provided
Possible
Lower Tariff
for Captive
Market
Market Failures in the PSA
5. Negative Externality
• PSA contracts do not price in the cost of
negative externality.
• Coal has the highest carbon footprint; RE the
least
• Carbon emissions have global warming
implications.
• But the global warming phenomenon is not due
to PhL carbon footprint.
• RE Law – FIT raises cost of power to
consumers.
Contracting Problem: Capacity Building
CoaseWilliamson
Paradigm
Where contract
enforcement is weak, as
in weak states, armslength contracting may
Vertical Integration
be subject to ex-post
(bundling) can be a
opportunism and thus
market remedy in weak
risky.
governance regimes!
Source: IMF (2004)
Current Regulatory Remedy to
Possible Market Failures in PSA
ERC Regulation
1.Accounting Method: Evaluation and
Verification (with Possible Price
Comparison) of PSA contracts based
submitted documents.
2.Public Hearings to Elicit
Scrutiny
Stakeholder
on
Current Regulatory Remedy to
Possible Market Failures in PSA
3.Difficulty of discovering “fair and prudent
prices”: Intensive in scarce time and talent
resources
4.Always suspected of regulatory capture due
to moral hazard – lack of incentives to
be
thorough.
5.ERC already requires competitive selection
for CAPEX reimbursement to reduce regulatory
task.
Alternative Regulatory Remedy
• Market Testing of PSA Contracts
 Easier to enforce in theory: ERC only verifies and
approves the market test (say, auction) employed.
 Easier to defend in public
• Numerous modalities for market testing:
 Numerous System Architectures (Chile, Brazil, New
England): mandatory vs optional participation;
centralized vs decentralized, etc
 Auction: numerous phenotypes
 Swiss Challenge
o Public Hearing of ERC can already incorporate a Swiss
Challenge
DOE Department Circular No. DC2015-06-0008
“Mandating All Distribution Utilities to Undergo
Competitive Selection Process (CSP)
in Securing PSA”
(Signed 11 June 2015)
Features
1. All PSA contracts must be subject to Auction.
2. Aggregation and Auction of un-contracted demand of
small DUs.
3. Mandatory Participation of DUs, optional for GenCos
4. One contract template; one transactions manager.
State Demand Aggregation and Competitive Selection Process
DOE DC2015-06-0008
Benefits
Will Replace the Accounting
Method with Market Testing
Method
of
Regulation.
Relieves ERC somewhat of
burden.
Possible Problems
1. How will the
idiosyncratic
features (say risk sharing) of
contracts be reflected by a
single template?
2. Is WESM-procured power
compliant with CSP?
3. Does single template not
legally violate the market
principle of “freedom to
contract”?
Experience with Demand
Aggregation and Competitive
Selection: Philippines
Experience in the Philippines:
Private Initiative
Source: del Mundo (2015)
Potential Outcomes of CSP
• Will CSP directly lower the cost of power
in the Philippines? Not guaranteed!
• Will CSP crowd in new generation
capacity? Possibly and may address
capacity building and indirectly lower
power cost.
• Since coal power has cost advantage,
CSP will have to square with other
mandates like the 30% RE share?
• Premium on the simplest architecture for
CSP.
Maraming Salamat!
Mabuhay Kayo!
Tel. Nos. +63 (2) 9279686 loc. 239
Telefax Nos. +63 (2) 9205465
Website: www.upecon.org.ph/epdp
Email: [email protected]
Market Failures in the PSA
Example of Power Purchase Profile – Meralco
April 2015
Source: Computation of the Generation Charge for April 2015, MERALCO