The restructuring of the power sector, best gauged from the dismantling of the 70-year monopolistic reign of vertically-integrated National Power Corporation, exceptionally went through a very painstaking process. The developments may be best described as “too frustratingly slow for the first seven years” and then “too fast” in the last two to three years. Both developments had their benefits and shortcomings.

In the initial years, people were dreadfully impatient with the slow pace of privatization, but the upside was that, this paved the way for the institutionalization of the Energy Regulatory Commission (ERC) and the establishment of the Wholesale Electricity Spot Market (WESM). The downside though was the delayed plant sales caused further deterioration in the plants; hence, some turnover arrangements with winning bidders had proved tough in some instances, such as the argument or predicament presented by Suez Energy on the Calaca coal plant before it walked out on the deal in January 2009.

Paradoxically, the last two years saw accelerated sales of the plants reinforcing investors’ interest, even up to the appointment of Independent Power Producer Administrators (IPPAs) for the privatization of NPC’s contracts with the IPPs, a very unique feature of the country’s power sector restructuring program. The disadvantage of such fast-paced divestment process though, as realized eventually, was the lack of time to prepare for situations that could have equipped the newcomer IPPAs in their obligations in the deal, chiefly in their responsibility as procuring entity for the plants’ fuel requirement. Despite that, no one can deny that the privatization exercise has helped in unloading the responsibility of power stability from NPC to the private sector. The privatization, by any yardstick, has been very successful.

Perhaps, the industry could only wish that many of the new entrants should have been able to contribute technical expertise to propel the industry forward. Absent that, we take the process as another learning curve for the entire sector.

Beyond privatization, the challenges ahead are more critical. With supply-demand crossover already anticipated in the biggest island grid of Luzon around 2013 or even earlier; and Mindanao already begging for new investments, the government must take calculated steps if it wants to ensure capital flow. For sure, project sponsors are not willing to foresee that their investments will not have decent return and them being subjected to the whims of fickle policymaking.

‘Holy Grail’

There seems to be a common thread as to the concerns that investors want to be addressed to make the supply-stifled power industry be viable for fresh capital inflows.

The arrays of issues include: the need for clearer regulatory policies on recoverability of costs, especially for purchased power; the proposed establishment of WESM in Visayas and Mindanao to serve the twin functions of creating an alternative market and setting clear price signals; the establishment and putting in the right economic stimulus for the creation of a reserve market (for NGCP to contract for black start and frequency regulation, while the WESM puts up the market for spinning reserves); the implementation of open access; and further down the road, wholesale supply aggregation.

On a more specific note, there have been proposals to tighten the controls on the responsibility of the IPPAs as procuring entity of fuel, referencing on the fuel debacle encountered by San Miguel Energy Corporation at the Sual coal-fired facility in February; on the WESM to act steadfastly on proposed Rules Changes and for its Board to discuss pressing concerns intelligently to address specific needs of the Philippine market situation; for the ERC to finally veer away from political mindset when it comes to tariff-setting or rate application approvals; that the regulation on system operator NGCP be improved in terms of accountability for the congestions due to breakdown of transformers; and there are also proposals for NPC to maintain (under its ownership) certain level of capacity for security.

Particularly on the need for reserves for frequency regulation, Mr. Rolando Bacani, general manager of Korea Electric Power Corporation (KEPCO) noted that the government’s hold on some hydro plants may be crucial for the sake of ensuring “power quality” in the system.

While the policymakers and regulators’ to-do list seem long and endless, the industry has been appreciative enough of the initial accomplishments now pulling the sector ahead into the envisioned competitive marketplace.

“The processes and efforts in the past three years have given us tremendous success,” Mr. Aboitiz has qualified, further articulating that “in the whole scheme of privatization and deregulation that we have been going through, the ‘Holy Grail’ has been the spot market and next will be open access.”

Without these two, he added, “there would have been a problem.”

The anticipated kick-off for the interim open access was in March this year, but due to remaining gaps in rule-making, the process has been encountering further delays. However, with the appointment of IPPA for the Ilijan plant and the privatization of more IPP contracts, the industry can now directly jump into legal open access, as anticipated around June this year.

Merchant market hurdles

At this point, no one wants to go back into the vicious cycle of power crisis and the appetite to revert to government contracting is not also there, given the spotty experience that the domestic power sector went through over the years. The consensus is for the industry to move forward into a free market environment, but are we ready to survive the hurdles?

With fresh expectation of investment influx, the thesis that must be verified, according to former Energy secretary Francisco L. Viray is whether the market or the lenders for that matter are ready to embrace the incursion or eventual reign of a merchant market.

At the end of the day, Dr. Viray who is also president of Trans-Asia Oil and Energy Development Corporation, noted that the policies underpinning a free market “must give investors some measure of stability”, which shall depart from the comfort and guarantees that lenders have gotten accustomed to in the era of single-buyer model of the IPP contracting regime.

Mr. Aboitiz shared that as far as his company is concerned, the merchant market is already a tested set-up for the lenders, citing the cash infusion they have made when they acquired Magat, and Ambuklao-Binga hydro plants as well as the Tiwi and Makiling-Banahaw geothermal plants.

“I don’t agree with perceptions that banks are not willing to lend under a merchant set-up, we did it with Magat even without contracts, and also with Ambuklao-Binga….banks and investors are willing to take risks, they just have to know how to assess those risks,” Mr. Aboitiz stressed, adding that comfort for the lenders could come in many ways. If project finance won’t work, it could be recoursed to the project sponsor’s balance sheet or the track record of the developer or that of the industry if it has a working market.

Other concrete examples are GNPower’s 600-megawatt coal plant project in Luzon; as well as those of projects undertaken by Global Business Power and Kepco-SPC in the Visayas. But while they agreed on a working merchant market set-up, they qualified that the entire process was tough and laborious since you’re practically selling your capacity door-to-door. It was similarly reckoned that “banks may be a little careful with financing power projects if the projections of cash flow indicate too many risks.”

Bilaterals: key for lenders’ comfort

For many, the existence of WESM in Visayas and Mindanao would help in providing an alternative market for future capacity and set price signals in the market.

Mr. Pantangco, for his part, opined though that “banks are willing to finance greenfield power plants provided the bulk of their energy (i.e 60-70%) are covered by bilateral contracts. Both foreign and local financial institutions have accepted the WESM/merchant sales as alternative revenue but only to a limited extent.”

Other players concurred that “it will still be difficult for banks to finance merchant plants until such time, when the WESM has matured.” Mr. Alcordo has cited, for example, that while the Toledo and Naga plants were constructed as merchant plants, they are still largely underpinned by long-term power purchase agreements with various off-takers, like electric cooperatives and industrial users.

As far as the WESM is concerned, investors raised that “if the regulator steps in and caps prices, like what it is doing right now, the investors will stay away in droves and problem will just get worse.”

For some prospective project developers, they are still hankering to corner a pie of what is considered the “juicy Meralco account”, noting that in lieu of the government guarantees (which will no longer be there under the merchant set-up), the next best thing for investors will be a slice of the supply of utility giant Manila Electric Company.

This early though, Meralco first vice president Ivanna G. dela Peña noted that the company has some hurdles in contracting for new supply because of “market uncertainties”, primarily due to the advent of open access and supply aggregation as well as the concern on recoverability of costs for purchased power. She pointed out that beyond the Meralco account, back-to-back contracts between power generators and the licensed retail electricity suppliers (RES), which would then be selling to the customers, may do the trick in a merchant market.

Also, as competition takes its stronghold in the marketplace, caution emerges that “due to the nature of significant capex (capital expenditure) investments required in the generation business, it will likely be the big ones who can afford to develop, construct, finance and operate the baseload plants.” It is also reckoned that medium-sized investors may be able to penetrate the market and compete in peaking investment requirements, as these are normally limited to smaller generating units running intermittently.

In Mr, Aboitiz’s view, the “many buyers and many sellers” envisaged under EPIRA will likely be confined to few players; but these will be the efficient ones and who can meet the demands of the market. If compared to the experience of telecoms and the airlines industries with just two or three competing players, he noted that any market cannot afford having too many players, especially when too many are just rendered inefficient or unable to keep pace with the demands of a competitive market.

“I agree that in the long-term, only generators with strong balance sheets will thrive in a deregulated electricity market. But then, isn’t it the same with the telecommunications industry,” Mr. Alcordo observed.

On the buyers’ side, there are the concerns on the electric cooperatives not being able to carry on with requirements posed by intense market competition, especially during the initial years of open access. Although National Electrification Administration (NEA) chief Edita S. Bueno noted that there is now a growing realization among ECs of what awaits them in a competitive environment, hence strengthening both their financial and technical capabilities remain a pressing concern. “It now becomes mandatory for EC to improve their service delivery in order to satisfy their customers”, she stressed, chiefly referring to the foray of competitive markets.

Eventually, all the market participants have to move to contracts for differences (CfD) and be full WESM members, and this necessitates reforms of the electric coops at the soonest possible time.

Industry’s take on the regulators

Amid all the transition pains, industry players are not also discounting the need for the industry regulator to go along and be attuned to the needed policy reforms. Regulators, it was said, are highly important in the value chain because they are counted upon “to offer the investment market predictability and stability” so investors can assess readiness if they are willing to take new kinds of risks inherent in the restructured market.

Beyond its limited resources, the ERC is expected to efficiently deliver on its sanctioned functions for the deregulated market; and this it can do, by detaching itself from pressures of the political world. There is also a call for the regulator “to attune itself more to the needs of the WESM and the market.”

And once and for all, it should set the demarcation line in the media-feasible and repugnant turf war hurled against it either by the DOE or market operator Philippine Electricity Market Corporation. If these agencies can settle their differences and work harmoniously toward a common objective of improving the workings of the market, the better it gets for the industry and the consumers, it was said.

The ERC had its share of “many mistakes” in the past, especially when it became too dependent on foreign consultants on its decisions, yet the industry put up with those weaknesses. The way forward though will be more rigorous as there is now higher expectation from the regulators to inject stability and predictability of rules in the market. While overhauling the entire Commission many not be feasible, the suggested starting points will be for the “technical staff to gain adequate training” and to elevate their knowledge on their duly-assigned functions.

With all fairness to the regulator, the industry already notes improvements in its performance, in as far as issuing binding decisions on rate applications and for paving the way for an alternative regulatory method, such as the regulated entities’ entry into performance-based regulation (PBR) of tariff setting.

The ERC was also able to carry out its own investigations and impose penalties when it was required.

“We are beginning to see a strong and stable regulatory regime. What is needed by the ERC is a regular source of income (i.e. fees) and significantly lessen its dependence on government budget allocations,” said Mr. Pantangco.

This was echoed by Mr. Aboitiz, noting that the regulator’s bid for fiscal independence be given attention at the legislative front, better sooner than later. “The ERC must have that autonomy. It must be allowed to charge the industry certain fees that it can use to basically strengthen their operations and their efforts,” he stressed.

And above everything else, here’s an industry caution to ERC chairperson Zenaida G. Cruz-Ducut: “We hope that the ERC Chair will not bend to pressure from different quarters and maintain the independence of the regulatory body.” As pundits would say, regulatory capture could come both ways: it is not only from the industry but more so from public pressure or opinion or from the politicians. The ultimate challenge for the ERC then is for it to judiciously exercise balancing act and exhibit some degree of sophistication on its decisions and rules formulation.

Lesson for the next administration

The tragedy triggered by DoE’s planning failure offers prescriptive lesson for the country’s next President – that the energy sector – given its relevance and paramount impact on the economy and Filipino consumers, shall never be entrusted to the inexperienced or to anyone who lacks extensive knowledge about how the industry operates. “That’s like putting a square peg in a round hole and that simply means we’re starting on the wrong foot,” one industry player noted. The general view is that the next Energy Secretary must have the “depth (read: knowledge and intellect) and the integration of skills to be the champion” in instituting policy reforms, especially for an electricity market so critically traversing a transition from years of monopoly into a private sector-driven industry. No pun intended, but policy statements can get shoddy when the official in charge is ill-equipped to understand and navigate the industry’s technical terrain as well as the esoteric nature of the biz.

Primarily for hydro-dependent Mindanao grid, Dr. Viray, who was the government’s energy czar at the height of the 1990s power crisis, underscored the importance of setting spare capacity to account for supply when cyclical El Niño phenomenon strikes. While this is a necessary buffer in an electricity system, he noted that it was a bit unfortunate that some sectors and the critics of the Ramos administration then wrongly considered it as “excess capacity”.

“This drought comes in cycles, so as long as Mindanao derives its power mainly from hydro (which the Renewable Energy Act encourages), sufficient reserve based on a drought condition must be the planning criterion,” he noted.

Still on the planning milieu, new investments are required for all types of greenfield power plants, like baseload, mid-merit and peaking facilities. However, medium-term planning is still being crafted by the DOE, which is the government entity tasked to determine which types of power plants are preferred by the government to attain specified policy objectives. That is a challenge then for Mr. Ibazeta and the next energy chief to contend with.