Title of Presentation (36) Name of Presenter (24) Date of ... · WACC Infl X Infl X Infl X Infl X...

1

PBR Performance Based Regulation

PBR Implementation

Republic Act No. 9136

Electric Power Industry Reform Act (EPIRA) • Signed: 8 June 2001 • Effectivity: 26 June 2001

Implementing Rules & Regulations

• Signed: 27 February 2002

2 PBR Implementation

EPIRA Section 2: Declaration of Policy of the State a) xxx b) To ensure the quality, reliability, security and affordability of the supply of

electric power; c) 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;

d) xxx e) xxx f) To protect the public interest as it is affected by the rates and service of

electric utilities and other providers of electric power. g) xxx h) Xxx i) Xxx j) To establish a strong and purely independent regulatory body and system

to ensure consumer protection and enhance the competitive operation of the electricity market; and

k) xxx

PBR Implementation 3

ERC Mandate

Sec. 38 of EPIRA

“There is hereby created an independent, quasi-judicial regulatory

body to be named the Energy Regulatory Commission (ERC).”


ERC Major Functions

Promote competition Encourage market development

Ensure customer choice

Set the transmission, distribution and

retail rates of the captive market

Impose fines and penalties for any non-compliance


FUEL IN THE FORM OF COAL OR OIL IS PURCHASED FROM ABROAD AND PAID FOR IN FOREIGN CURRENCY

$$$

ELECTRIC POWER PLANTS THEN GENERATE ELECTRICITY

ELECTRICITY IS THEN CARRIED OVER LONG DISTANCES BY TRANSMISSION CABLES THAT IS TAPPED INTO BY LOCAL DISTRIBUTION COMPANIES

YOUR LOCAL DISTRI- BUTION UTILITY SETS UP THE POWER LINES IN YOUR COMMUNITY AND SERVICES YOUR NEEDS FOR ELECTRICITY

GENERATION CHARGE

(65%)

TRANSMISSION CHARGE

(10%)

DISTRIBUTION, SUPPLY. & METERING CHARGES

(25%)

HOW ELECTRICITY IS DELIVERED TO YOUR HOME?

HOW IS THIS REFLECTED IN YOUR ELECTRIC BILL?

Where does the peso in your electric bill go?


Unbundled Electric Bill


How does ERC set the Charges?

Generation WESM: Market NPC: Return on Rate Base Methodology IPPs: Individual review of bilateral contracts or PSA

Transmission Previously, Return on Rate Base Methodology Currently, Performance-Based Regulation

Distribution Private Distribution Utilities

Previously, Return on Rate Base Methodology Currently Performance-Based Regulation

Electric Cooperatives Previously Cash Flow Methodology Currently Benchmarking Methodology


How does the Return on Rate Base Methodology set your rate?

Determine Annual Revenue Requirement Based on a historical test year

OPERATING EXPENSES

PAYROLL

RETURN OF INVESTMENT

RETURN ON INVESTMENT

OTHER REVENUE

ITEMS

necessary, legitimate, prudent, continuing, normal includes operating and maintenance expense and taxes

updated salaries plus allowable benefits

12 % of rate base value of used and useful assets + working capital

depreciation

9

Revenues arising from asset - based operations should be shared by DU

PBR Implementation

Advantages Long standing practice Fairly constant, substantial returns despite fluctuations in the economy or

firm composure Provides earnings stability by guarding against excessive or unduly meager

earnings As practiced, allows reflection of current prices through adjustment

mechanisms Timing of regulatory reviews when utility “under-earns”

Disadvantages Limited incentive for exceptional performance Encourages cost-padding Averch-Johnson effect on capital costs:

If allowed return > capital costs = incentive to over-invest If allowed return < capital costs = incentive to under-invest

Consumers, rather than the regulated firm, bears much of the market risk Possible price shocks to consumer *Averch, Harvey; Johnson, Leland L. (1962). "Behavior of the Firm Under Regulatory Constraint".

How does the Return on Rate Base Methodology set your rate?


11

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, thru the

Transmission Wheeling Rates Guidelines (TWRG), later amended as Rules for Setting Transmission Wheeling Rates (RTWR) in September 2009

– In December 2004, thru the Distribution Wheeling Rates Guidelines (renamed as Rules for Setting Distribution Wheeling Rates, RDWR).

PBR Implementation

Performance Based Regulation

• PBR is intended to ensure that firms have incentives to improve efficiency

• Regulator must ensure that all these gains do not accrue to the firms

• Wide recognition that a trade-off exists between – The service quality at which electricity is supplied

and – The cost for providing this service

• Hence, the Regulator also has the legal and societal obligation to regulate service quality PBR Implementation 12

Performance Based Regulation

• EFFICIENCY thru review of the Annual Revenue Requirement

• SERVICE QUALITY thru setting of the Performance standards


PBR - Annual Revenue Requirement

Determine forecasted Annual Revenue Requirement (referred as Building Blocks) for a Regulatory Period

OPERATING EXPENSES

TAXES



INCOME TAX

operating and maintenance expenditures

property taxes, business taxes

Weighted Average Cost of Capital (WACC) X rate base value of optimized used & useful assets + working capital depreciation

set to zero


• The investor expects a return on its investment; • The return is a mixed of Debt (thru loan) or Equity (investor-infused

capital); • Usually the interest rate in Debt is higher than the Equity • Based on an optimal value of the Regulatory Asset Base plus allowed

Working Capital

15

RETURN ON INVESTMENT = ( WACC ) X Regulatory

asset base

+ Working capital

PBR – Building Blocks

PBR Implementation

• ERC to determine the value of the rolled-forward optimized depreciated regulatory asset base (RAB)

• RAB going forward will be based on initial opening value and the approved efficient CAPEX.

• ERC will review CAPEX requirements of utilities, based on: – information provided by the utilities on historical CAPEX – CAPEX forecasts provided by utilities – Justification of CAPEX – Analysis by independent expert(s) on the information provided

by utilities and the levels of efficiency implied – Other information at the ERC’s disposal

16

RETURN ON INVESTMENT = ( WACC ) X Regulatory

asset base

+ Working capital

How are Capital Projects considered?

PBR Implementation

Review of Capital Expenditure


PBR - Building Blocks

• The analysis of each building block is done for each year of the regulatory period


Annual Revenue Requirement

OPERATING EXPENSES

TAXES



INCOME TAX

Regulatory Year 1

OPERATING EXPENSES

TAXES



INCOME TAX

OPERATING EXPENSES

TAXES



INCOME TAX

OPERATING EXPENSES

TAXES



INCOME TAX

Regulatory Year 2 Regulatory Year 3 Regulatory Year 4

REGULATORY PERIOD


Annual Revenue Requirement


Smoothing the ARR for the RP


++

−+−+2

201120112010

)1()1)(1(

WACCFQXInflXInfl

×− )( 02009 PMAP

++

−+)1(

)1( 20102010

WACCFQXInfl

++

−+−+−+3

2012201220112010

)1()1)(1)(1(

WACCFQXInflXInflXInfl

420132013201220112010

)1()1)(1)(1)(1(

WACCFQXInflXInflXInflXInfl

+−+−+−+−+

=

Smoothing the ARR for the RP

22

Calculate the present value of the allowed ARR resulting from the MAP that a regulated entity is permitted to charge.

Present Value of the ARR

ARR applied with (CPI-X)

4 2013

3 2012

2 2011 2010

) 1 ( ) 1 ( ) 1 ( ) 1 ( WACC ARR

WACC ARR

WACC ARR

WACC ARR

+ +

+ +

+ +

+

PBR Implementation

How are the target performance levels set for the regulatory period? The utilities’ historical performance of the outcomes of the various performance indicators is reviewed An assessment is done on the performance indicators that need to be addressed in the regulatory period Relative weighting on each performance indicator is determined based on the foregoing The average performance or target performance level is set Average of the previous regulatory period Best of the regulatory Period (see Distribution Code: historical) Performance steps for reward and penalty are set

Service Quality Measures under PBR


Service Quality Measures under PBR

• Price-linked incentive scheme – depending on network and service performance, a

reward is added to the annual price-cap or a penalty is deducted

• Guaranteed Service Levels – component of the PIS in which the DUs will

compensate a consumer directly if certain service delivery performance standards are not met


What are the control mechanisms?

1. A review every 4 years (Reset) – Determine Annual Revenue Requirement

thru the Building Block analysis – to determine/benchmark the actual cost that

has been incurred by the Utility; – to determine/adjust the service performance

measures


What are 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 (incentive

or penalty)


Annual Verification and Adjustment

This year’s price per unit of electricity

Previous year’s price per unit of electricity

Index of change in Consumer Prices

Efficiency factor

Correction for revenue over or under-recovery in previous year

Correction for tax over or under-recovery in previous year

Performance Incentive Factor


Next year’s price is capped at this year’s price plus an allowance for general cost increases, reduced by an efficiency factor.

YEAR 1

Regulatory Period

Regulatory Year

Regulatory Reset Process

YEAR -1

YEAR 2

YEAR 3

YEAR 4

PBR Process


Reset Process

Public Hearings

Utility Submits Revenue Application

Position Paper

Public Consultation

Issues Paper

Draft Determination

Public Consultation

Final Determination

Utility Submits Rate Application

Public Hearings

Rate Implementation

Rate Decision FOR EACH YEAR

OF THE REGULATORY PERIOD

ERC Responsibilities

DUE PROCESS

UTILITY Responsibilities

LEGEND


Timelines of Private DUs Entrant Regulatory Period

Manila Electric Company (MERALCO) July 01, 2011- June 30, 2015 Dagupan Electric Company (DECORP)

Cagayan Electric and Light Company (CEPALCO) Cotabato Light and Power Company (CLPC) April 01, 2009 - March

30, 2013 Iligan Light and Power Company (ILPI) Mactan Electric Company (MECO) Cabanatuan Electric Corporation (CELCOR)

July 01, 2010 - June 30, 2014

La Union Electric Company (LUECO) Tarlac Electric, Inc. (TEI) Visayan Electric Company (VECO) Ibaan Electric and Engineering Company (IEEC) Davao Light and Power Company (DLPC) Panay Electric Company (PECO)

October 01, 2011- September 30, 2015

Subic Enerzone (SEZ) San Fernando Light and Power Company (SFELAPCO) Bohol Light Company, Inc. (BLCI) Angeles Electric Corporation (AEC) Clark Electric Distribution Corporation (CEDC)


Issues Raised

– Building Blocks approach – WACC – Determination of RAB (valuation) – Correction Factor (k-factor) – Side Constraints – Working Capital – Bad Debts – Over/Under Recoveries from previous RP – Setting of Po and X – factor – Annual Verification – Regulatory Intervention – Regulatory Reset Experts


Next… Building Blocks Valuation WACC


Title of Presentation (36) Name of Presenter (24) Date of ... · WACC Infl X Infl X Infl X Infl X...

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