On June 8, 2001, Philippine President Gloria Arroyo signed into law a long pending government proposal for the privatization of the National Power Corporation (NPC) and restructuring of the electricity industry. The Electric Power Industry Reform Act of 2001 (the “Power Reform Law”), previously generally referred to as the Omnibus Power Bill, provides for much-needed reforms in the Philippine power industry and will help to attract private investment.

According to Department of Energy statistics, the demand for electricity in the Philippines is expected to grow at an annual rate of 8.9 per cent from 46 262 GWh in 2000 to 99 714 GWh in 2009. For the small island grids, electricity demand will increase at an average annual rate of 10.9 per cent, from 607.3 GWh in 2000 to 1538.8 GWh in 2009. To meet this long term demand for electricity, a total of 9875 MW of new generating capacity will have to be installed over the next decade. Out of this, 5255 MW is already committed in projects while the balance of 4620 MW remains as uncommitted capacity to be met by the liberalized power market.

The private sector is expected to play a major role in financing future energy projects in the Philippines. At least 1.19 trillion Pesos (P), representing about 90 per cent of the investment requirements projected by the Philippine Energy Plan (PEP) 2000-2009, is expected to be undertaken by the private sector. Government funding will be limited to the provision of electricity for remote areas and support programmes.

According to the Philippine government, the new law aims to implement the following key objectives:

Consumer empowerment and open access: Giving consumers the power to choose their source of electricity from a host of generators and suppliers and opening access to transmission and distribution network facilities so that the benefits of competition will trickle down to consumers.

Competition in generation and supply: Providing competition between and among generating companies with market-driven and competitive prices through a spot market for the trading of electricity between buyers and sellers.

Electricity tariff unbundling: Itemizing and segregating various components of electricity tariffs (such as transmission and distribution wheeling charges) to make rates more transparent. With rates unbundled, customers will be able to know how much they are paying for generation, transmission, distribution and other benefits or charges.

Changing structure

The Philippine power industry is presently divided into three major sectors: generation, transmission and distribution. Under this power industry structure, NPC accounts for about 90 per cent of the electricity generated in the Philippines today, with more than half of that coming from NPC power plants and the balance from independent power producers (IPPs) under power purchase agreements with NPC.

NPC also transmits electricity to distributors and large industrial customers over NPC-owned and operated transmission grids.

Figure 1. Pre-power reform structure
Click here to enlarge image

Distribution of electricity at its usable voltage to end consumers is performed by investor-owned electric utilities, a few local government-owned utilities and numerous electricity cooperatives, which sell to households as well as commercial and industrial enterprises located within their franchise areas at retail rates regulated by the Energy Regulation Board (ERB).

Privatizing assets

The Power Reform Law provides the following key provisions for the restructuring of the industry:

Competitive and open electric power generation: The opening of electric power generation primarily involves: (i) removing existing cross-subsidies within grids and classes of customers; (ii) privatizing at least 70 per cent of the total capacity of NPC’s generating assets; (iii) transferring the management and control of 70 per cent of the total energy output of IPP power plants under contract with NPC to IPP Administrators; and (iv) approving the unbundled transmission and distribution wheeling charges. The deadline for the implementation of retail competition and open access is no later than June 26, 2004.

With the exception of the IPPs existing under Executive Order No. 215, power generation and supply have always been considered as public utility businesses and the monopoly of the state-owned NPC. The Power Reform Law clearly spells out that power generation and supply will no longer be considered a public utility business. Power generation and supply activities will therefore no longer be subject to the 40 per cent foreign equity limitation under the Philippine Constitution. While the Power Reform Law does not impose any nationality restrictions on foreign ownership of equity, it does require the remittance into the Philippines of at least 75 per cent of the funds used by foreign buyers to acquire the privatized assets of the NPC.

The law specifically states that power generation companies (gencos) will not be required to obtain a congressional franchise or local license. In addition, upon full implementation of the retail competition structure mandated under the Power Reform Law, prices charged by the gencos will not be subject to regulation by the proposed Energy Regulatory Commission (ERC) to be organized pursuant to the Power Reform Law. Moreover, sales of electricity will be value-added tax zero-rated transactions to help bring down the end users’ cost of electricity.

Regulated transmission business: The transmission of electricity through high voltage transmission facilities will be regulated as a common electricity carrier or public utility business subject to the rate making powers of the ERC. A government owned and controlled company (Transco) will be formed to own all the high voltage transmission assets and facilities of NPC. Transco will assume the authority and responsibility of NPC for the planning, construction and centralized operation and maintenance of its high voltage transmission facilities, including grid interconnections and ancillary services. Transco will in turn be owned by a special asset privatization entity to be called the Power Sector Assets and Liabilities Management Corporation (Psalm). Psalm will manage the sale, disposition and privatization of NPC’s generation assets, real estate and other disposable assets, such as IPP contracts.

Transco will be authorized to award, in open competitive bidding, a concession contract to a qualified party for the operation, maintenance, improvement and expansion of its transmission assets and the operation of any related business for a maximum period of 25 years under an operations and maintenance (O&M) concessionaire contract.

Competitive private distributors of electricity: The distribution of electricity to end users will be a regulated common carrier business and as such, these entities will be required to obtain congressional franchises as public utilities. Distribution of electric power to all end users will be undertaken by private distribution utilities, cooperatives and local government units which are already engaged in the business. They will be subject to regulation by the ERC.

Competitive market for supply of electricity: The Power Reform Law encourages a new player in the industry: the electricity supplier or aggregator. Electricity suppliers will be allowed to buy electricity at wholesale and to resell electricity to end users through a wholesale electricity spot market that is supposed to be established by June 26, 2002.

The ERC will be mandated to identify contestable markets, defined as a group of end users in certain geographical areas with an initial average monthly peak demand of at least 1 MW for the 12 month period prior to such determination and which will have choices of suppliers for electricity (effectively a non-franchised area). The supply of electricity to such contestable markets will not be considered a public utility business and will not require a local or national franchise. However, except for distribution utilities and electric cooperatives with respect to their existing franchise areas, all electricity suppliers will be required to obtain a license from the ERC to supply electricity to these contestable markets. The prices charged by electricity suppliers to the contestable market will not be regulated by the ERC.

The stranded debt issue

The Power Reform Law provides a mechanism for handling NPC’s stranded debts and contract costs. Stranded debts of NPC refer to any unpaid financial obligations of NPC which are not liquidated by the proceeds from the sale and privatization of NPC assets. Stranded contract costs refer to the excess of the contracted cost of electricity under eligible IPP contracts of NPC which have been approved by the ERB as of December 31, 2000, over the actual selling price of the contracted energy output of such contracts in the new electricity market.

The national government will directly assume a portion of NPC’s unpaid financial obligations in an amount not to exceed P200 billion or about $3.8 billion. The ERC will determine the reasonable amounts, manner and duration for recovering the stranded debts and stranded contract costs of the NPC and such recovery will stretch out for a period of between 15 and 20 years.

Within one year from June 26, 2001, the ERC is required to determine, fix and approve a universal charge to be imposed on all electricity end users for the payment of (i) NPC’s stranded debts in excess of the amount assumed by the national government as well as the stranded contract costs of NPC and existing distribution utilities resulting from the restructuring; (ii) NPC’s costs for public service electrification of areas not connected to the transmission system via its Small Power Utilities Group; (iii) equalization of taxes and royalties imposed on indigenous or renewable sources of energy and taxes imposed on imported energy fuels; (iv) an environmental charge of P0.0025/kWh for an environmental fund to be used for watershed rehabilitation and management; and (v) a charge to account for all forms of cross subsidies for a period not exceeding three years. However, starting on June 26, 2001, residential end-users will also be granted a rate reduction of P0.30/kWh from NPC’s pre-Power Reform Law rates.

Market pitfalls

Figure 2. Estimated investment requirements under the Philippine Energy Plan 2000-2009
Click here to enlarge image

As the Philippines moves to implement the deregulation of its electric power market, its regulators should take serious note of the lessons learned from the USA’s experiences in deregulation of electric power industries, particularly in California. California’s deregulated market, for example, is faced with electricity supply shortages and problems of increasing electricity costs brought about by the interplay of factors such as, among others, the accumulated deficiency in utility infrastructure investment, transmission grid constraints, structural consequences of the rules of the California Power Exchange, and bankruptcies of California gencos.

In order to achieve the goals of the restructured power industry, the Philippines’ industry regulators must encourage and ensure that there is sustained private sector investment in power generation and supply to fill up the infrastructure void left by the NPC. The final decision to invest in power generation facilities simply cannot be legislated. Ultimately, in a competitive and open market, the business climate and the rate of return on investments dictate private sector spending in new and upgraded power infrastructure.

While the Power Reform Law was debated by the Philippine legislature, the Department of Energy commissioned a study funded by the Australian government which is being used by the regulators as the basis for the final draft of the Philippine Spot Market Rules and the Philippine Grid Code. In view of the deregulation experiences of California and other parts of the USA, it is important that these draft rules be fine tuned and take into account the structural mistakes made elsewhere in order to avoid future industry problems. It is also important for the Philippine power industry regulators to bear in mind that structures and rules based on other countries’ systems do not work unless they take into account the special social, economic and political environment of the Philippines.

Investment opportunity

The electricity industry reforms under the Power Reform Law, if fully implemented, will provide significant opportunities for direct and indirect foreign investment in the Philippines, particularly with respect to the privatization of NPC’s electricity generation assets; the O&M contract for the transmission of electricity; the wholesale electricity spot market (including the development of financial instruments and derivatives based on the sale of electricity contracts); and the supply of ancillary equipment and services to the gencos, the O&M concessionaire, the wholesale electricity market operator and the electricity aggregators.