Expensive Meralco power justified?

MANILA, Philippines - The reality is that Manila Electric Co. (Meralco) customers, particularly those who consume more, do shoulder the most expensive power bills in the country: For example, a household using more than 500 kilowatt-hours (kWh) this month will have to shell out P5,130.64-6,155.64 to keep its air-conditioners and other power-hungry appliances running. Cebu and Davao consumers are better off. For the same consumption, Visayan Electric Co., Inc. (VECO) will charge some P3,500 and Davao Light & Power Co. around P2,900. But when President Gloria Macapagal-Arroyo began her latest attack on Lopez-led Meralco at February’s Philippine Energy Summit — asking why the country’s largest power distributor could not bring its bills down — observers wondered whether she understood the Electric Power Industry Reform Act (EPIRA) at all. The comparison, now part of the arguments being used by government officials to justify a Meralco management shakeup, is at the very least shallow. Meralco gets some 45% of its electricity from plants running on expensive and heavily taxed natural gas. Davao Light relies on hydropower and VECO depends on geothermal energy. Under scrutiny is the manner by which Meralco purchases power, with critics led by Government Service Insurance System (GSIS) chief Winston F. Garcia, a major shareholder, claiming that the supply mix is skewed to favor the Sta. Rita and San Lorenzo plants that are also owned by the Lopezes. Along with power often bought from the electricity spot market and state monopoly National Power Corp. (Napocor) at peak periods when prices are more expensive, Meralco’s purchasing behavior is supposedly keeping electric bills high. Closer scrutiny, however, reveals little elbow room in a heavily regulated sector where prices and profit levels are scrutinized and ordained by regulators and policies largely dictate how business is conducted. ‘Best efforts’ Nine months into office in 2001, Mrs. Arroyo formally switched on the Malampaya Deep Water Gas-to-Power Project off Palawan. At the onshore plant in Batangas, she paid tribute to Meralco and Napocor for playing "key roles in ensuring the viability of this project." Seven years earlier, the Energy department had all but required Meralco provide a captive market for 1,500 megawatts (MW) — half of Malampaya’s expected output — given the necessity of guaranteeing business for what was being hailed as the country’s ticket out of dependence on imported fuel. The Lopezes formed two independent power producers (IPPs): First Gas Power Corp., which would put up the 1,000-MW Sta. Rita plant in 2000, and later FGP Corp. for 500-MW San Lorenzo plant. In her speech at the 2003 opening of San Lorenzo, Mrs. Arroyo praised the combined $1.5-billion investment and said: "I came to this inauguration for several reasons. I want to let the world and the creditors know that Meralco and the Philippine government are not fighting each other. And second, because the San Lorenzo plant and its other twin, the Sta. Rita Power Plant, have far-reaching implications to our national development." By its sheer size and location, Meralco was the natural customer. The two IPPs were given 25-year power purchase agreements, with raw natural gas from Malampaya courtesy of 22-year supply deals with the Shell-led consortium developing the field. Meralco’s IPP contracts, including that with Quezon Power (Philippines) Ltd., were reviewed in 2002 at the height of a public uproar against supposedly onerous power deals entered into by the Ramos administration to solve the crippling 1990s energy crisis. In accordance with the EPIRA, which directed power distributors to make "reasonable best efforts" to bring down IPP costs, Meralco formed a review team that included government directors in its board. The review resulted in renegotiated power purchase deals in 2004, where the firm was absolved of the burden of paying local taxes and given higher discounts on excess power generated, among other concessions estimated to have yielded savings of P10 billion or P0.03/kWh for consumers. Two years later, the amended contracts were okayed by the Energy Regulatory Commission (ERC). Meralco’s IPPs continue to dominate its supply mix, accounting for a little over half of the power bought in the first quarter. Just the same, the Sta. Rita, San Lorenzo, and Quezon Power plants have been beating generation rates charged by Napocor under contract and the Napocor plants selling at the Wholesale Electricity Spot Market (WESM). In March Sta. Rita, running at 82% of capacity, charged an average of P4.16/kWh while San Lorenzo, at 87% dispatch, charged P4.12/kWh. At only 77% dispatch, Quezon Power sought P3.72/kWh. In contrast, Napocor charged an average P4.52/kWh, while power from the spot market cost P5.94/kWh. Overall, Meralco billed its customers P4.40/kWh in generation costs for the month. Generation costs represent the biggest item — about half — of the total Meralco bill, which has become easier to decipher with the EPIRA requiring the "unbundling" of power rates. In the first quarter, the average retail rate was P8.31/kWh for households, out of which P4.40 or 53% went to power suppliers. The rest went to the state firm that transports power from generators to distributors, National Transmission Co. or Transco (11%); taxes and other charges (9%); and system losses (9%). Meralco collects a little over a tenth of the electric bill to cover the distribution charge for bringing electricity to homes. The IPPs have proven to be the least costly for Meralco considering they demand the lowest transmission costs — P0.69/kWh for Quezon Power, P0.64/kWh for Sta. Rita, and P0.53/kWh for San Lorenzo last March. In contrast, Napocor electricity cost almost P2.00/kWh to transmit, and WESM power, P1.65/kWh. Combining generation and transmission costs, electricity from Napocor and WESM was costlier by P2.08/kWh than that of Meralco IPPs. "The Transco rate results in a very attractive transmission charge to the IPPs. That is the main reason why we are optimizing the IPPs," Meralco President Jesus P. Francisco said. The ERC itself, headed by an Arroyo ally, former Isabela congressman Rodolfo M. Albano, Jr., had found that Meralco IPPs would be cheapest if run at their highest possible capacities or "dispatch levels" provided in the contracts — 83-92%. For consumers, this meant savings of up to P0.05/kWh. In the 51-page 2006 decision approving the renegotiated IPP deals with Sta. Rita and San Lorenzo, regulators said "the higher the dispatch of [the plants], the higher will be the benefit for the consumers .... there is a showing also that an increase in the dispatch of the Sta. Rita and San Lorenzo plants will result in more and even bigger reductions for Meralco, and ultimately, the latter’s consumers." Imprudent? The question is whether Meralco can reallocate its supplier mix in a way that will lower the biggest component of Metro Manila power bills, the generation rate. Under the EPIRA, distribution utilities cannot get more than 90% of their power from bilateral contracts with either Napocor or the IPPs. This is why Meralco has been making it a point to get at least 10% of its electricity from the WESM. Market prices were promising at first, with Meralco able to buy power at as low as P3.38/kWh, but volatility set in later. In April, Meralco’s WESM purchases — mostly at peak hours and when power from IPPs could not cover demand — spiked to an average P10.68/kWh from P5.94/kWh in March, bringing the generation rate to P4.92/kWh from P4.40. As a result, Meralco’s WESM purchase prices are higher on the average than prices for the entire spot market, leading WESM chief Lasse A. Holopainen to criticize the utility. A long-time energy industry consultant, James A. Nichols III, said he was "stumped" as to why Meralco was not buying more off-peak energy from the WESM. He said in an interview that whether Meralco’s WESM trading had been imprudent (too much on-peak and too little off-peak purchases) deserved a comprehensive look. Meralco’s IPP contracts, he pointed out, have "minimum off-take" or guaranteed volumes — provisions that have been criticized as unfair but without which power investors won’t come in. "Certainly at peak, when there is not enough IPP capacity to meet Meralco’s load, they will want to take all the IPP energy they can since it will likely be cheaper than WESM peak-period prices. Then they will have to make up the difference with WESM peak period purchases," said Mr. Nichols, who works with electric cooperatives. "The question is, during periods when they have adequate IPP supply to cover load, should they be cutting back on the IPP dispatch and taking cheaper WESM power during those hours? It’s a complex question because their IPP contracts have minimum off-take provisions and if Meralco doesn’t meet those then they may have to pay for power not utilized, driving up the average cost of the power they do take." "So it becomes a question of whether they would save enough on the WESM energy purchase in those cases to offset whatever minimum off-take penalty they may have to pay. Since the IPP doesn’t really care — they get paid their contract payments whether Meralco takes the minimum or not — Meralco and its IPP affiliates seem to have no reason to not make the least-cost rate-payer decision in these cases ... unless they simply want to deny Napocor the opportunity to make a sale in those hours," he added. Mario R. Pangilinan, vice-president for operations of WESM operator Philippine Electricity Market Corp., said Meralco can go beyond the 10% for spot market purchases, since the rule is only a "reverse interpretation" of the EPIRA’s 90% cap for bilateral supply deals. But getting more electricity or even 100% from WESM is "not a guarantee that prices will go down." "If we apply the scarcity theory, if prices on the WESM are low, customers will flock to it. However this will free up electricity demand through the bilateral contracts, which lowers prices," he said. Meralco has suspected the pricing behavior of some WESM suppliers who realize that the utility has no choice but to be a price-taker. "Sometimes, when the IPPs know that Meralco is the customer, their charges are out of the ordinary. Clearing prices would reach P20/kWh," Mr. Francisco said. Meralco brought this to the WESM’s attention in September 2006, "after observing rapid and unexplainable increases in spot market clearing prices." Two months later, the WESM’s Market Surveillance Committee accused Power Sector Assets and Liabilities Management Corp. or PSALM, the state firm tasked to sell government-owned power plants, and Napocor of price-fixing to meet revenue requirements. The ERC cleared PSALM last July but gave Napocor a slap on the wrist with warnings to be more "circumspect." The WESM has appealed and the case is still pending before regulators. Critics say the WESM will work properly only when Napocor’s stranglehold on power generation is finally broken. When the EPIRA took effect in 2001, PSALM was required to sell 70% of Napocor’s generation capacity in three years before consumers are allowed to finally choose their power suppliers under an "open-access" system. But the privatization process has been painstakingly slow, and so far only 11 Napocor plants or 42.8% of capacity have been sold. Ten more plants have been lined up for sale. At only 10% of Meralco’s supply, however, spot market prices should not be too much of a concern. "WESM prices, among other factors, raise Meralco’s prices. But note that [WESM purchases] account for only 9-10% of Meralco’s mix," Mr. Pangilinan said. Mr. Francisco said Meralco does some off-peak purchases from the market. "What they (critics) are saying is we should not buy at peak. But it’s hard for our engineers to be limited to one part of the day. A day ahead, they’ll do a forecast, project requirements," he said. "If the projections fall short, we resort to the market. In the market, we are expecting prices to be [fair]. But sometimes prices reach as high as P20/kWh. Of course our engineers don’t want to buy [at that level] but they are forced to do so, thinking we have a responsibility to get 10% from the market," the Meralco chief explained. The 10% rule, Mr. Francisco noted, is not clear-cut in the first place. "Should it be everyday, every week, or every month? We have raised that the law only says ’at least 10%.’" — with a report from Maria Kristina C. Conti, BusinessWorld