Is Power Distribution Still a Natural Monopoly?

Photo c/o https://energydemocracyyall.org

In his last State of the Nation Address (SONA), President Rodrigo Duterte asked Congress to pass priority bills including the proposed amendments to the Public Service Act.

Senate Bill No 1441 seeks to amend the Public Service Act to define the difference between “public service” from “public utility.” The amendment will lift nationality restrictions in the investment in areas of transportation, power generation, and supply, telecommunication, and broadcasting, among others. The 1987 Constitution does not define “public utility” and thus limits the allowed foreign investments in various sectors.

Under the bill, public utility will be treated as a mere subset of public service. Only three main industries will be treated as public utilities as they are argued as a natural monopoly. These three include Water Works and Sewerage, Transmission of Electricity, and Distribution of Electricity, which will be covered by the 60-40 rule on foreign ownership.

But my question is, must electricity distribution be considered a natural monopoly? A “natural” monopoly cannot be legislated by Congress. It is a market condition Legislating it as such is tantamount to legislating the law of supply and demand.

A natural monopoly exists because of either powerful economies of scale or high start-up costs in specific industries. It’s when a single entity is technologically capable of serving an entire market at lower costs rather than having multiple firms serve the same market.

According to a paper by Electricity Daily, it was more than a century ago when Samuel Insull, considered a legend in exploiting new technologies, masterfully demonstrated how a single firm could offer power at a much lower cost than the combined multiple small power companies. He invested in large turbines and boilers and connected such generators with many customers.

The paper entitled “Will distributed energy end the utility natural monopoly” stressed that natural monopolies thrived as policymakers embraced the idea of providing power at a lower cost to consumers by giving a single firm a legal monopoly and regulating power prices to recover costs. The policy was to offer exclusive rights to serve and combine it with cost-based regulation.

The study noted that the policy approach to natural monopoly is still highly recommended by economists today. I share the views of the authors of the paper when they said that we can easily confuse legal monopolies with natural monopolies. The Senate bill proposing to classify electricity distribution as a public utility is a testament to that fact. Plus, in the Philippines, only one entity is allowed to distribute in a franchise area.

The monopoly is legally created and is a clear illustration of Nobel Prize winner Vernon Smith’s point that regulators have encouraged monopoly in electricity markets. Economics professor Smith’s paper “Currents of Competition in Electricity Markets” noted that “Regulation has been applied far too broadly to the electric power industry. As a result, policies intended to restrain monopoly power have instead propagated that power.”

The past few decades have shown that technological advances are eroding utilities’ natural monopolies. Take the case of Independent Power Producers (IPPs) that are financed, developed, and operated by multiple independent companies that offered lower-cost power than a single larger counterpart. These IPPs proved that generation can be done by smaller firms at a lower cost, thus breaking the notion that power generation is not a natural monopoly.

We are now seeing the same happen on the distribution side with the emergence of distributed energy resource (DER) technologies and digital technologies.

A study published by the Massachusetts Institute of Technology noted that “DERs and digital technologies dramatically expand the number of potential investors in and operators of power system infrastructure, challenging traditional means of planning and coordinating the construction of generation, storage, and network assets.”

The study entitled “Restructuring Revisited: Competition and Coordination in Electricity Distribution Systems” stressed that there are relatively few barriers preventing investors and even consumers from adopting DERs in most developed power systems.

The authors also noted that “Indeed, many DERs (for example, “smart” HVAC units and water heaters) look more like consumer electronics than power sector resources. Consumers do not need to coordinate with the DNO/SO to install and operate these devices, despite the fact that these devices can have significant impact when considered in aggregate.”

The emergence of new technologies such as battery storage, rooftop solar, and non-wire alternatives (NWAs) are disrupting the long-held notion that power distribution is naturally monopolistic. These technologies are bringing down the fixed costs and high start-up costs in distributing electricity.

We only need to look at the case of NWAs, which use microgrids and DERs to replace the traditional “wire and poles” infrastructure in power distribution. Utilities that opt for NWAs avoid the expensive infrastructure investments.

US-based utility firm, Duke Energy makes a great case for the use of NWAs. The firm built a renewable micro gird on Mount Sterling in Great Smoky Mountain National Park and opted for non-wire alternatives in distributing electricity. The microgrid used 10kW of solar and 05 kWh of storage, allowing the firm to avoid shelling out large investments of a four-mile, 12.47 kV grid-connected distribution feeder.

Another US firm, Con Edison was able to avoid spending $1 billion for infrastructure by using $200 million non-wire alternatives under the Brooklyn-Queens Demand Management program. Con Edison opted for the combination of NWAs, DERs, solar-plus-storage microgrids to provide independent power to an area in Brooklyn while avoiding the high costs of lines and poles.

There are other new technologies available that can remove the barriers to entry in power distribution.

We also now have an Advanced Meter Infrastructure, enabling two-way communication of homes and network providers. The two-way communication allows the system to analyze data and act accordingly. Data that can be aggregated, analyzed, and communicated allows sector players to come up with services and products previously unavailable in the system.

Plus, the decreasing cost of information and communication technologies (ICT) will drive the network to improve resiliency and grid management, and increase competition. The Philippines is in a good position to capitalize on the decreasing ICT costs as the entry of the third telco, DITO will pave the way for more seamless integration of ICT and the power system.

So, must we still consider power distribution as a natural monopoly? New technologies are removing the barriers to entry, enabling more entities to enter the sector. Technological advancements allow multiple firms to serve the market more efficiently and cost-effectively than a single firm these days. Why do we insist that natural monopoly exists when there is a second or third player willing to distribute in the same franchise area?

The 1987 Constitution says that monopolies should not exist when public interest is at stake. The State after all should protect the public interest rather than the regulated or legal monopoly. Maintaining legal monopolies runs counter to what the constitution mandates as monopolies put consumers at a disadvantage. The lack of competition gives no incentive to the franchise holder to lower operating costs or provide excellent power distribution services.

We now have the opportunity to introduce competition into electric power distribution as new technologies offer new opportunities to lower power system costs. Instead, we are continuing to legally create monopolies. Smith’s assertion comes into mind “There are numerous ways to introduce competition into electric power distribution. Perhaps the most obvious is to eliminate state policies which grant distributors exclusive operating permits. Customers should have the right to bypass distributors and contract directly with generator owners.”

Power distribution is not a natural monopoly, we are only viewing it as such. Unfortunately, this view runs counter to the essence of the Electric Power Industry Reform Act (EPIRA), which was signed into law primarily to promote competition. Creating legal monopolies and protecting them also goes against our constitution. Failing to recognize that competition in power distribution exists and is possible with the right regulation is a disservice to Filipino consumers.

ONE YEAR LOCKDOWN: WHAT I HAVE LEARNED

As we saunter into the second year of what may be another year of lockdowns, albeit, in varying degrees, I am compelled to share with you my friends, what I have learned this past year. What seemed to be a broad spectrum in our lives pre-COVID 19 suddenly became very narrow, concrete activities in our daily lives. In fact, for many of us, we lost a very vital aspect in our lives: livelihood. The loss of ability to provide for one’s family is so devastating that it leads one to think: can I make it through? Where can I find help…

Pope Francis in his encyclical, Fratelli Tutti, said it well when he pointed out that “the storm has exposed our vulnerability and uncovered those false and superfluous certainties around which we constructed our daily schedules, our projects, our habits, and priorities .” This hit me most especially because in my attempt to protect that ability to maintain a livelihood, a livelihood that also ensured the livelihood of many, I found there were activities I was engaged in that only led to false and useless ends.

Today, although certainly in a tighter bind than pre-COVID 19 financially, my life is, I believe, in better order. Of course, worries about the uncertainty of the future stare at my face every day. But this pandemic has taught me how to put these worries in context. One can sublimate these worries in human and supernatural terms. There are worries about the vulnerability of one’s health, especially now we are senior citizens. Again, as long as we are prudent in following health protocols and have a healthy attitude towards the inevitability of death, we should be able to sleep soundly at night. My Apple Watch tells me I sleep on the average 7-8 hours every night with 4-5 hours of deep sleep.

So what have I learned?

1. Family Matters: It is Our Basic Social Unit

As obvious as it seems, this was a fact that dawned on me a month after the lockdown started in 2020. In the beginning, everyone thought that the lockdown will be for 30 days. So, I took it for granted that my entire family — down to my grandsons — were with me when the government first announced the lockdown period last March 15, 2020.

However, as the days went into months, and now the months may turn out to be a year, I feel really blessed to have been locked down with my entire family. I found out it is not healthy to be alone. Man, psychologically and physiologically, needs to have that face-to-face contact that is currently being restricted by the pandemic.

This pandemic has taught us that it’s not our officemates who will ultimately determine our surviving this pandemic. It’s not our drinking buddies, and it’s not even our business partners.

This pandemic has made my resolve to protect the family as our primary social unit even more vital. While our constitution protects this basic concept, there are attempts these days to redefine what “family” means. For those surviving this pandemic, there is no other way to define what “family” means — a mother, father, children, and grandchildren.

2. Social Interaction with Friends and Colleagues Matters

Over this last year, I lost 15 friends to COVID-19. Except for one to whom I could send a taped message even when he was intubated, I was never able to visit or talk to the others. I am told of the solitude of those who die from the disease. I am informed of the pain they suffer alone without being able to feel the touch of a loved one or hear the consoling whisper from a spouse, child, or even just a friend.

This is why I feel it is essential to reach out to friends and colleagues. I have regular chats with friends, former classmates. We have no particular agenda, just sharing experiences and reminiscing our past. Of course, we do have regular “ZOOM” meetings with our business colleagues, but just being able to talk will surely help.

You and I, we are all suffering in the strictest sense of the word. Suffering because we cannot do what a normal human being, a social animal, a social being, was designed to do. Therefore, we should reach out to whoever we can. This will help our mental and physical health.

3. Physical and Mental Health Matters

We are lucky to live in a gated community that eventually allowed its residents to use the subdivision roads to walk, run, or simply exercise. Otherwise, we would have been relegated to a small gym and just our room. As the doctors recommend Vitamin D to get from the sun, a year without the sun would have been disastrous. While this may be an exaggeration, one gets the drift.

Regular exercises have kept my body active daily. It’s a daily mental struggle to go out and sweat. The Activity app of my Apple Watch helps, of course. The challenge is finding variety in the activities that I do. After running throughout the village, I often itch to go out of the subdivision and run the way I used to run — in faraway places like the UP oval!

While watching Netflix or Apple TV+ can tend to be addicting, with some self-control, this activity helps balance off my day. I tend to watch crime whodunit series– it makes my brain work, and documentaries to find out more about events and people worldwide.

I have grabbed a couple of books from my library of never-read books. I do not know, but I had this habit of buying books that I never ended up reading at all. This pandemic has forced the issue — what else is there to read except the books I never read?

4. Wine and Music Matters

Some wine and music at the end of the day have kept the doldrums out of our lives this past year. Whether it’s just Joy and me or with the kids, we find every reason to sit back and listen to a Diana Krall or some excellent soothing jazz album. It’s that time of day when she and I can either just throw out nonsense at each other, like daydreaming of traveling soon or seriously talking about our future.

We would sit in different parts of the house to mimic the “tapas crawl” we miss. While enjoying a bottle of Ribera del Duero, we would put on a Bebo and Cigala album to bring us back when we were strolling along the Plaza Mayor of Salamanca. Or maybe a bottle of Chablis or Pouilly-Fumé that can invoke those nostalgic memories. We talk of the times we would walk along the Seine to go to Robert e Louis, a traditional restaurant in 64 rue Vieille du Temple, in Paris.

For the music, I can stream from Qobuz, Tidal, Spotify, or Apple Music. As a platform, I can stream through Roon, Sonos, or Apple Homepods. So between those apps and speakers, my music choices are almost limitless.

I limit myself to classical music as background to my working time: Bach, Mozart, and Chopin are my favorites. I often leave the easy track and dabble with Rachmaninoff, Dvorak, and Tchaikovsky. Then try some unknown composer to test my mental ability to focus on whatever it is I am working on.

As for jazz, I start off late in the afternoon with vocal jazz, then progress into heavier bebop as the night gets late. Often I would go for Bossa Nova. Sometimes I jump into completely unknown artists suggested only by the AI of my streaming apps.

Finally, I have gone back to my guitar playing, and I have learned to play the piano again. All these help me keep a balance during these days of the pandemic. Indeed, music and wine are the two elements of life that translate into the soul’s language. As one writer puts it, “sipping wine while listening to music can be an intense experience that fills our hearts and tickles our minds.”

5. Spiritual Health Matters

From almost the first day of the lockdown, our family started to pray the Holy Rosary every evening. One of the more painful realities of this daily routine is we literally witnessed the demise of the stalwart of the family. As the pandemic days wore on, his ability to pray with us became increasingly difficult for him until we lost him last August. However, as a family, we are grateful that he was with us in prayer until he breathed his last.

This is why during this pandemic, our spiritual life is the most essential aspect of our existence. I have realized that nothing on this earth worth anything. Our branded shoes, our expensive cars, our jewelry, all our wealth, all these mean nothing in the face of this pandemic. When COVID-19 hits you, you die, and you die alone without any strapping of your wealth.

This pandemic and lockdown have allowed us to hear Mass every day. As one writer puts it, the Holy Mass is heaven here on earth. Scott Hahn, in his book “The Lamb’s Supper,” points out the passage from Vatican II that made him realize that in the Holy Mass, we are all in heaven:

“In the earthly liturgy, we share in a foretaste of that heavenly liturgy which is celebrated in the Holy City of Jerusalem toward which we journey as pilgrims, where Christ is sitting at the right hand of God, Minister of the sanctuary and of the true tabernacle. With all the warriors of the heavenly army, we sing a hymn of glory to the Lord. (no. 1090).”

We usually go to the online Mass of the Manaoag Minor Basilica. We alternate this with the noon mass of the Manila Cathedral. In the whole year of the lockdown, we only received Holy Communion once, Ash Wednesday, and just because it was in our village chapel. I was able to go to Confession twice. This is one Sacrament the Church has not allowed to be online.

It has also given me time to do daily spiritual readings and mediation. All these have made me realize that God’s command to “love other as I love you” is a challenging task to accomplish. Given the misery surrounding us, it has compelled us to walk an extra mile in being merciful and compassionate to those around us. At the same time, this mercy and this compassion are precisely the blame that soothes our aching bodies, our tired minds, and our listless souls.

One year has passed, and while the vaccines are here, the end is still uncertain. However, these five lessons I’ve been taught by the pandemic are lessons I will pass on to my 3 grandsons: Emilio, Andres, and Alfonso. In passing on these nuggets of wisdom to the young, I remember again what Pope Francis said in his Encyclical Fratelli Tutti:

“If someone tells young people to ignore their history, to reject the experiences of their elders, to look down on the past and to look forward to a future that he himself holds out, doesn’t it then become easy to draw them along so that they only do what he tells them? He needs the young to be shallow, uprooted and distrustful, so that they can trust only in his promises and act according to his plans. That is how various ideologies operate: they destroy (or deconstruct) all differences so that they can reign unopposed. To do so, however, they need young people who have no use for history, who spurn the spiritual and human riches inherited from past generations, and are ignorant of everything that came before them.”

God bless us all.

Ditching the Notion of Least Cost

In a previous post, I have raised the possibility of Indonesia, our biggest source of coal, closing its ports because of the COVID-19 pandemic. Fortunately, this didn’t happen as we would have major problems given that we source 90 percent of our coal from Indonesia.

But this doesn’t mean that we should refrain from overhauling our energy sector. After all, this pandemic has exposed vulnerabilities in our energy sector especially since we are a fossil-reliant power country.

A study by the Institute For Energy Economics and Financial Analysis (IEFAA) discussed how the COVID-19 pandemic has revealed the weaknesses of the power sector. 

The report entitled “Philippines Power Sector Can Reach Resilience by 2021” stressed that our energy market, which relies heavily on fossil fuels because our energy planners prefer the least cost method, has not delivered on its promise of being the cheapest cost of energy. On the contrary, our reliance on large scale fossil fuel plants with guaranteed contracts have resulted in grid inflexibility, and price instability.

The researchers noted that the sector for so long has focused almost exclusively on mobilizing capital for large volumes of baseload capacity that runs on imported fuel. Unfortunately, coal plants are inherently inflexible, and in the Philippines 80% of baseload coal plants are inflexible.

The lockdown, the IEFAA said, has exposed the downside of the guaranteed contracts with coal plants.

According to the authors, with the depressed demand for power, coal plants are turning to their mid-merit load factors, which have a higher per kilowatt-hour rate. This is all thanks to our power sales agreements (PSAs) that ensure capital recovery for coal plants. 

The study pointed out that our PSAs have provision for capacity payments, which is the payment to ensure that the coal investor can recover their capital “it is designed to ensure IPPs can recover their capital costs and repay their loans on a timely basis. This means that neither the financial sector nor the power sector is liable for the risk they take, as these are passed on to end-users who are ill-equipped to manage such risk.”

And with the depressed demand for power, coal plants are turning to their mid-merit load factors, which in turn increases the cost per kilowatt-hour. Thus, Filipino consumers have to pay more for every kilowatt-hour, thanks to the pass-on cost provisions of the PSAs.

By just how much will consumers have to shoulder for these capacity payments? According to the study, if there is a 10% decline in energy sales volume for 2020 and if power comes from fossil plant with the usual PSA with the capacity payments clause, then end-users will have to fork out PHP9.679 billion (USD 193.573 million) in 2020. Now, that’s a lot.

All this could have been avoided if we had fixed-term contracts where our consumers will pay the same price regardless of the power demand. As I have been saying in the past, these pass-on provisions burden the consumers. I have been proposing for fixed-price contracts to protect consumers. This is the same recommendation of IEEFA of making fixed cost procurement.

Looking at our PSAs will help us understand what we are doing wrong in the energy sector. Having fixed-price long terms contracts will reduce our power rates regardless of technology. And as I have pointed out in previous blog posts, our PSAs are similar to asking Juan deal Cruz to shoulder the risks through the pass on costs, because our energy planners have a faulty appreciation of the least cost. But in reality and as IEEFA has stressed, big-scale fossil fuel plants have not delivered the least cost system but rather caused price instability.

Our least-cost approach has been faulty as we only base our decisions on the cheapest energy to generate by comparing technologies and choosing which sources are ‘cheaper’ than others. We exacerbate the problem by regulating the costs that can be passed on to Juan deal Cruz according to the returns we feel are owed to the investors rather than what consumers deserve.

The IEEFA study emphasized that the COVID-19 pandemic has highlighted the need for the market to turn to more flexible dispatch strategies especially because of the dramatic drop in demand during the lockdown months. It is recommending for the Department of Energy to start pushing for grid flexibility, modular system, a moratorium on new inflexible power, and for the Energy Regulatory Commission (ERC) to remove pass-through cost provisions and carve out curtailments for inflexible plants.

I would add further to these recommendations. As the government orders the immediate development of indigenous sources, our procurement rules should also change as the present rules for evaluating PSAs do not differentiate indigenous and imported energy. Thus, ERC should require distribution utilities to testify during procurement that there are no indigenous resources in the franchise area or that there are no offers from indigenous power producers.

It makes a lot of sense to recommend grid flexibility, modular dispatch, and grid upgrades via the inclusion of more renewable energy. This is nothing new. Renewable energy, after all, offers flexibility to a power system as they are capable of rapid start-up and dispatching adjustable capacity.

Plus, the prices of renewable technologies have been falling in the last few years. IEEFA noted that “The deflationary price trajectory of renewable electricity generation and storage triumphs over the cost of generating and moving electricity from a large fossil-fueled power plant.”  We can also have a fixed price for power sourced from indigenous materials. 

The IEEFA said it best when it noted that “Power sector planners assumed that a large system lock-in such as coal would lead to the least-cost system. Unfortunately, this lock-in for countries that import coal has led to inflexibility, price instability, and high prices.” And as we rebuild our economy, let us build better by addressing the ills in the energy sector. We can start by ditching the notion of least cost where we forget about the risks and only look at the upfront cost.

It bodes well for us to make a swifter transition to renewables. Unfortunately, the COVID-19 pandemic has paralyzed most economic activities. By now we should be working double hard to revive our economy. We can start by addressing the high power rates in our country by replacing traditional sources of power with renewable energy to support businesses as they recover. The construction of renewable power plants will also provide more jobs for Filipinos, too.

Action is Hope

It’s Easter Sunday and also the fourth week since the entire Luzon was placed on Enhanced Community Quarantine or ECQ.  For many Filipinos, most of the Lenten season was probably spent dealing with a variety of emotions. We worry over the health of loved ones, job security and putting food on the table. There’s also a feeling of helplessness, that while many are safe in their homes, our front liners especially the healthcare workers have lost and are still risking their lives to save thousands of our fellowmen.

Indeed it has been a difficult time for us all of these past few weeks. But we Filipinos have always been resilient. And in times of need and despair, we can count on our Bayanihan spirit to pull us through.

American screenwriter and author, Ray Bradbury once said that “Action is hope. There is no hope without action.” And Filipinos, as well as citizens of other nations, went to work. And I don’t mean being business-as-usual with our new work from home strategies. I’m talking about good deeds. Acts of kindness that show compassion for those in need.

We at the University of the Philippines(UP) Vanguard rolled our sleeves and went to work, too. We have been providing food, washing machines, and toilet kits, among others to stranded UP students in Diliman and Los Baños. Likewise, we offer online legal and medical consultations for our brods.

Like many private citizens and organizations, we also look out for the safety of our healthcare workers who have been risking their lives to care for the sick. We have donated hundreds of hazmat and isolation suits, and masks to hospitals, particularly in Amang Rodriguez Hospital and Philippine Heart Center. These two are hospitals where some of our brods hold key positions. Other hospitals in provinces are recipients of these goods, too. 

The UP Vanguard has heeded the call of President Rodrigo Duterte who asked for the mobilization of ROTC trainees to help in the distribution of relief packs to families affected by the ECQ.

All these programs are made possible by the cooperation and donations of our committed 2000-member organization.

I, as the National Commander of the UP Vanguards, share our efforts, not as an act of grandstanding, but rather to stress that the Bayanihan Spirit that the Filipinos are known for is very much alive. So many of us in our country are finding different ways to reach out to those in need and fight the unseen enemy that is COVID-19. The UP Vanguards is one with the Filipinos in fighting and winning the war against this pandemic.

It is not surprising that we are coming together as a nation to mitigate the effects of our ECQ. We may all be affected by this pandemic yet most of us continue to do our best to help one another regardless of what worldly wealth we have. Pope Francis said it best during “An Extraordinary Prayer in the Time of Pandemic” service in St. Peter’s Basilica:

“We have realized that we are in the same boat, all of us fragile and disoriented, but at the same time important and needed, all of us called to row together, each of us in need of comforting the other.”

Easter Sunday is about hope, they say. For us, hope means getting into action. And with our combined efforts, “Together, we can beat COVID-19” just like what our government says.

Happy Easter, everyone! And please stay safe!

Are We Getting Any Closer? Revisiting our Foreign Ownership Rules

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Changing our constitution to allow  more foreign investors is a must if we are to succeed in developing our nation. Hence, we must be fast  in doing so if we are to take advantage of the global development in RE including falling prices.

As early as last year, President Rodrigo Duterte already announced his plans to open various industries to foreign players.

In a speech made during a visit to New Zealand last year, the president said “The only way to make this country move faster to benefit the poor is really to open up the communications, the airwaves and the entire energy sector. My decision now is to open the Philippine economy to other players.

These days, foreign ownership of companies is in the headlines as the government is set to release the upcoming Foreign Investment Negative List ( FINL). The FINL defines which investment areas of the country are still off-limits to foreign investments and open to 40%  foreign ownership. 

Unfortunately, the government can only do so much with its FINL as they need to work within what’s allowed by our constitution.  Perhaps it’s also time to make amendments to the constitution given that times have changed. In this day and age of technology, we need to be more competitive. Unfortunately for us, our laws have not been updated to keep up with the times.

Many economists have already stressed the need for significant changes in our constitutional provisions on ownership

Just recently, former National Economic Development Authority or NEDA chief Cielito Habito has emphasized the need for these changes. “The hope is we will be willing to amend economic provisions of the constitution because that is what really is holding us back. It is outdated. Many of the restrictions in foreign advertising, mass media, education, are really out of date. Given the technology in recent years, those rationales don’t apply anymore to the information age,” he said.  

He further added that we are being left behind by our Southeast Asian neighbors because of the lack of participation of foreign investors. “The reason we continue we to  lag behind our neighbors, in spite of dramatic improvements already made, is still because of these legal constraints to more foreign participation in our industries.”  

The President back then said that he wants changes in the “regulatory requirement and institutional arrangements to hasten the entry of new players in the power industry and energy sector.

And I cannot wait for these changes to take place. We need this if we are determined to shift to cleaner sources of energy. Our progress in moving to more renewables for our energy has been quite slow. We are not getting any closer to our goal of using more RE for our needs. In fact, we seem to be heading in an opposite direction as coal fired power plants are seen to dominate our energy mix in the next 10 years as noted by BMI Research of the Fitch Group. The study revealed that 90% of the 7,300 MW of power projects in the pipeline are coal-fired plants. 

As I have been saying, the review of foreign ownership rules has been long overdue.  I have been vocal in my desire to open up the energy sector to more foreign investors, particularly the renewable energy sector. Mainly because putting up the RE plant has a high up-front cost and as such very few businesses can venture into this area. 

The government must consider limiting the ownership of foreigners of the renewable resources but increasing their ownership in owning the equipment required to convert these resources. 

Around the world costs of RE technologies are dropping. If we want to take advantage of this development in the hope of increasing the RE’s share in our energy mix, then we must act quickly and make the necessary changes in the foreign ownership rules. 

References:

http://www.investphilippines.info/arangkada/constitutional-amendments-needed-to-boost-fdi/

http://bworldonline.com/constitutional-amendments-needed-boost-fdi/

 

 

 

 

 

 

 

 

 

A Gloomy Warning

What would you do if the temperature becomes too hot that you must stay every single day indoors?

Sounds like doom to me, right?

Unfortunately for us, this a possible scenario if we keep up with the business-as-usual in dealing with climate change. Or at least that’s what a climate change expert says.

Hans Joachim Schellnhuber, a member of the Pontifical Academy of Sciences in the Vatican and the Director of Germany’s Potsdam Institute for Climate Impact Research (PIK)  warned us that the Philippines and its neighbors in Southeast Asia could suffer from extreme temperatures daily if countries continue with the present high emission levels.

The Nobel Prize Winner stressed that “All of the tropics will develop conditions that physiologically, humans cannot live outside anymore.”

Schellnhuber was in the country to present the study “A Region at Risk: The Human Dimensions of Climate Change in Asia and the Pacific.” He said that based on modeling and simulation studies from the report, temperatures would keep increasing by 1.7 degrees Celsius above pre-industrial levels by 2030, and up to 2.7 degrees by 2050. By 2070, temperatures could be up to 4 degrees.

According to Schellnhuber, we could “see a complete shift in living conditions,” if people fail to address climate change. He further stressed that we would be facing extreme summer heat, an unusual weather condition, which the Philippines only experience once in every 740 years.

Nations must do everything they can to avoid such extremes, he warns. If not, Schellnhuber pointed out, that millions of people will be forced to flee their homes. “You would actually have to give up the Philippines altogether….Unless you put the entire population into a shopping mall, which would be a very big mall, and by the way, needs a lot of fossil energy to keep air-conditioned, and that would exacerbate global warming, so it is certainly not a solution.”

Gloomy, indeed.

Schellnhuber’s words reminded me of the Pope’s encyclical on climate change two years ago. Pope Francis made strong calls to act quickly on the issue of climate change. “We may well be leaving to coming generations debris, desolation and filth. The pace of consumption, waste and environmental change has so stretched the planet’s capacity that our contemporary lifestyle, unsustainable as it is, can only precipitate catastrophes, such as those which even now periodically occur in different areas of the world. The effects of the present imbalance can only be reduced by our decisive action, here and now.”

Unfortunately, two years after the powerful message of the Pope, little has been done locally to work on reducing our carbon footprint if we are to talk about renewable energy development.

The BMI Research of the Fitch Group recently released its study noting that there will be more coal-fired power plants in the next 10 years. “Growth in the Philippines power infrastructure sector over the next 10 years will be driven by investment in coal-fired generating capacity as companies and the government build a slew of new power plants to support growing electricity demand.”

The report noted that 90 percent of roughly 7,300 megawatts (MW) power plant projects in the pipeline are coal-fired ones.

So, we are in the business-as-usual scenario, still relying heavily on coal for our energy needs.

We certainly have failed to heed the Pope’s call. I can only pray and hope that Schellnhuber’s warning below will not be ignored, too.

Reference:

http://www.interaksyon.com/expert-warns-with-no-cap-on-greenhouse-gas-emissions-going-outdoors-will-be-deadly-by-2100/

REVIEWING CAPM: How to Truly Bring Down Power Rates in the Philippines

I recently came across and found the time to re-read a material written by renowned Energy scholar,the late Simon Awerbuch. I first encountered Awerbuch’s readings a few years ago. That article made me really reflect and understand why our consumer on the street, Juan de la Cruz, is probably getting a bad deal in his electricity prices.

In the material, Awerbuch discussed the Capital Asset Pricing Model (CAPM), and the importance of reviewing the traditional methods used in estimating electricity costs.  He asserted that traditional energy planning fails to consider the risk of price volatility of fossil fuels, which, unfortunately, has a negative correlation with the economy.

We use CAPM in our tariff setting. In my view,  the concept is misused. The reading made me think that if only our energy planners and regulators take the time to understand the concept and make the changes needed, then we will surely have lower power rates

For a long time, we in the power sector have been using the “least cost” approach to analyze which sources of power are cheapest or the most economical to use in the system.  We do this by comparing technologies where we conclude that certain fuel sources are “cheaper” than others. To exacerbate this further, we then go on and regulate what can be passed on to consumers based on the returns we want to give to investors rather than what consumers want nor deserve.

And for the Nth time, I say, we got this all wrong.  This is the reason why we find it extremely difficult to bring down power rates.

We need to look at our Power Sales Agreement or PSAs to understand what we are doing wrong. Reduction of energy cost is simple: regardless of the technology, introducing fixed-price long-term contracts will REDUCE power rates.

To understand the need to introduce fixed-price-long term contract, we first need to review the use of what I call the ‘floating’ power sales agreement.

Generally, PSAs have provisions to “pass through” or “pass on” foreign exchange and fuel prices to the end consumers. It is my contention that once we minimize PSAs with “pass through” or “pass on” rates and replace them with fixed price long-term contracts, we can truly bring down power prices.  Otherwise, as my good friend says, these “pass on” contracts will have to be, in the Visayan language, “pas-an” (to be carried) by the consumers.

In my other articles, I have always asked the question: which is cheaper, a floating PSA that is currently priced at P5.00/kWh or a fixed price PSA that is fixed at P5.10/kWh for 25 years? The traditional analysis will say it is the floating P5.00/kWh.  In fact, the way “rate impact” studies are done, most utilities calculate only the first year tariff and weigh the implications of that tariff when added to the current average tariff of the entire energy mix. The traditional analysis will conclude that, indeed, a floating P5.00/kWh is cheaper than a fixed P5.10/kWh.

Unfortunately, such analysis does not consider the possibility that the floating PSA can reach P10.00/kWh the following year should the value of the peso fall against foreign denominations or prices of fuel or coal significantly increase.

Choosing the ‘floating’ price is counter intuitive. Any businessman or even a housewife would rather pay a known fixed price because, from a budgeting perspective, it is far more convenient.  And more importantly, it is actually, conceptually cheaper. It is cheaper because the cost to hedge either the fuel or forex risk will have to be added on the P5.00/kWh if one is to adjust the cost of a floating PSA to reflect current prices of fuel or value of peso against a foreign denomination. And that is assuming there is such a hedge for 20 years.

But why is this penchant for choosing the floating PSAs embedded in our regulatory framework? For this, we can point to the calculation of the Weighted Average Cost of Capital (WACC) when computing for the Return on Equity (ROE) in the determination of the appropriate tariff for a particular PSA. Our regulators use the CAPM for tariff setting, but unfortunately, use an incorrect value for the beta in the computation. Our regulators assume that the beta has a positive value, which signifies that the return to the generator is positively correlated to the economy.

This indeed is a faulty assumption especially if used in the tariff setting for fossil-powered plants. On the contrary, studies have shown that oil price volatility has a negative relationship on macroeconomic activities. Awerbuch, simplified it best: financial betas of fossil prices must also be negative.

The above point leads me to the bigger, and more important question: why is the rate setting evaluated from the point of view of the generator? Since the consumer is taking the forex and fuel risks anyway, shouldn’t the consumer’s perspective be taken instead?  Shouldn’t we use the beta for consumers for a floating PSA instead of the beta of the generator?

First of all, we need to look at who bears the risk of having a volatile price.  How is Juan de la Cruz compensated for taking on this risk? This question is not even being asked right now.  This has to be asked because, in reality, Juan de la Cruz will end up subsidizing the generators if we insist on assuming a positive of the beta of the floating PSAs.

Given that we are calculating the required ROE in the WACC using a flawed “beta,” then the generators are getting a ROE far greater than they deserve. This leaves Juan de la Cruz in a sorry state.

BUT if we take on the perspective of the consumer, then the entire story changes.

If we want to compensate Juan de la Cruz for taking the volatility risk, then we must consider the financial evaluation of the floating PSAs. Otherwise, the traditional assessment will show that Juan de la Cruz is getting a “cheaper” floating PSA. However, this is a fallacy.  The proof of which can be seen from a mathematical calculation using the CAPM.

Comparison

Take a look at the table above.  Clearly, the floating PSA is riskier for the consumer than the fixed PSA because, again, the consumer bears the cost of the forex and fuel risk. Or to put it simply, the consumers pay more for the fuel and forex upward adjustments.

Now we have to ask: how much is Juan de la Cruz really paying for each type of contract?

A static price comparison obviously is wrong. One cannot compare one price alone, let us say a P5.0/kWh for a floating PSA versus P5.10 for a 20-year fixed-price contract.  We MUST take into consideration the WHOLE contract period.

It is however, IMPOSSIBLE to predict the future prices of fuel and the foreign exchange.  And one cannot possibly put the future prices inside the contract.  This is the reason why these volatile costs are “pass through” or “pass on.”  It is the consumers who will pay for the adjustments above the P5.0/kWh.

This begs the question of how to account for this uncertainty in the evaluation of cost for Juan de la Cruz.

The fixed PSA, on the other hand, is easy to figure out: it is fixed.

So, how can one evaluate what the real cost is for Juan de la Cruz? Common sense will tell you, the fixed price – as long as it is priced correctly – will be always be advantageous to Juan de la Cruz, all other things being equal.

Mathematically it can also be proven.  We still use the CAPM– the very same formula that is being used to determine the appropriateness of the tariff–except that this time, we use the CAPM from the point of view of Juan de la Cruz rather than the one of the generator.

CAPM

The formula above says the discount rate of any asset is equal to the risk-free rate plus a premium.  This premium is represented by the market return (MR) adjusted for the sensitivity of the asset to the return of the market.  Generally, in modern finance, the market return (MR) is defined as the return of the entire stock exchange, and the beta is the correlation coefficient of a particular stock against the return of the market.

If a stock’s price goes up or down with the market, then we say that stock is POSITIVELY correlated with the market.  The beta then will be a POSITIVE number.  If the stock’s price goes up when the market goes down and vice versa, then we say that stock is NEGATIVELY correlated with the market.  Then that beta will be a NEGATIVE NUMBER. If a stock price stays constant regardless of the behavior of the market, then we can say it has NO CORRELATION with the market. Then the beta will be ZERO.

Let us now apply the concept in evaluating the floating PSA versus the fixed PSA.

Let’s start with the easy one – the fixed price.

Since the price of the PSA is fixed (in real terms), then we can say it has NO CORRELATION with the movements in the fuel price or forex.  Or to put it simply from a consumer’s perspective—the consumer will pay the same price regardless of the fuel prices or forex. So, the beta will be ZERO, which means the discount rate we should use will be the risk-free rate. Let me go back to this number later when we do the analysis.

How do we handle the case of the “pass on” or floating PSAs?

Volatile prices, in general, will be NEGATIVELY correlated to the market, so the beta is a negative number. A simpler analogy is this: if the price of fuel or the cost of forex goes up, the value of the PSA goes down (becomes more expensive.) On the other hand, if the cost of fuel or forex goes down, the value of the PSA goes up (becomes less expensive). Clearly, there is a NEGATIVE correlation between a volatile PSA and the market.

Applying this logic to the CAPM, one will see that the discount rate for the fixed PSA will always be higher than the discount rate for the volatile or floating PSA (mathematical proof available upon request.) The reason is simple. In the case of the fixed price contract, we discount the price at the risk-free rate.

On the other hand, in the case of the floating contract, we discount the price at a rate LOWER than the risk-free rate.  Discounting at this lower discount rate will result in a higher price than one that is discounted at the higher discount rate.  That the mathematical truth.

How do we translate this to Juan de la Cruz?

This simply means, ceteris paribus, a fixed price contract will ALWAYS be lower than a floating volatile contract. And any analysis that does not take this into consideration is doing a disservice to the consumers. This also means that putting a fixed price contract into a utility’s energy mix will lead to LOWER power rates.

There is no magic in the CAPM formula. After all, anyone with some basic knowledge of calculus and finance can calculate using that formula. The major shift here is this: we should use the discount rate relevant to Juan de la Cruz rather than to the generator. It is the consumer taking the fuel and forex risks.  Hence, he must be compensated for taking on that risk. Using the generator’s beta (most likely greater than 1) to evaluate the PSA is wrong because the one paying the tariff is Juan dela Cruz and not the generator.

I am not saying that we should totally ignore floating PSAs. Floating PSAs generally are associated with fossil fuel-based contracts. I think the late Prof Awerbuch hit the nail on the head with his article. As he pointed out, “The CAPM analysis highlights some important implications of the negative correlation between energy prices and the economy, suggesting a broader conceptualization of energy security that reflects the deleterious economic effects of fossil volatility. These effects can be measured and reduced by incorporating technologies such as wind, geothermal and PV, whose underlying costs are uncorrelated to fossil prices. Fossil price risk can be mitigated only through such diversification.”

Unless this shift is made, Juan de la Cruz will always be screwed. It will be the consumer who will “pas-an” the generator because of the “pass on” nature of the volatile PSA.

Time to change.

It’s About Time

President Rodrigo Duterte made strong pronouncements after attending the Asia Pacific Economic Cooperation in Peru, promising to open up our utilities to more competition.

In his speech delivered in New Zealand, the president said “The only way to make this country move faster to benefit the poor is really to open up the communications, the airwaves and the entire energy sector. My decision now is to open the Philippine economy to other players.”

He further added that the government is “now also looking into regulatory requirements and institutional arrangements to hasten the entry of new players in the power industry and energy sector.”

This is good news for us, not only for energy players like myself but the rest of the country. I have long been advocating for the opening up of the sector to more players, including foreign ones. I have always been vocal in my desire to lift the 40 percent restriction on foreign ownership to address the energy needs of our country for several reasons.

For one, the building of power plants, particularly renewable energy plants is capital intensive, and there are very few local businessmen who can cough up the needed money to explore and build RE plants. The government no longer spends for the exploration of renewable energy and has left the task to the private sector. Unfortunately, exploration is not a cheap undertaking.

Take the case of geothermal energy where drilling of a single hole can cost $5 million, and that doesn’t include expenses incurred for the feasibility studies before drilling.

What we need are foreign investors who can shell out the money and provide the technologies needed to harness the energy from renewable sources because local businessmen do not have them. What we can do is to limit the foreign ownership of the renewable sources, but welcome more foreign investors to own equipment needed to convert our resources.

There’s another reason why the energy sector is ripe for more foreign ownership. The International Energy Agency or IEA has reported that roughly $165 trillion funds are ready for renewable and efficiency efforts from the years 2020 to 2030 after the government heads last year signed the agreement to reduce and limit carbon emissions to help save the environment.  This means the Philippines can take a share of that pie if we open ourselves to more foreign owners. We are, after all, a natural choice to receive these funds given the country’s abundance of natural resources.

The Philippines has been one of the fastest growing economy in the region and the Duterte administration is determined to keep our economic growth momentum that will be felt by the Filipinos. But the government can only accomplish such by building infrastructure to support our economic growth including power plants for stable and affordable energy supply.

Hopefully, the president can achieve his goals by having a cooperative Congress that will push for the needed changes in the Constitution. This necessary change is long overdue.

Reference:

http://business.inquirer.net/220139/digong-opens-3-sectors-foreign-investors

 

When Big Businesses Unite

Everyone has been calling for more action to address climate change, and many have responded. The corporate sector is one of them. A report revealed that roughly 43 percent of companies belonging to Fortune 500 have set their strategies on helping the environment either through greenhouse gas reduction, renewable energy consumption or energy efficiency.

Businesses have an obligation to provide their clients with quality services and products. But it’s not only the obligation that they have. It is also imperative to provide value to customers by committing to a greater cause: helping improve the lives of many.

And gladly, big firms are doing just that by committing to use renewable energy in their operations under the RE100 initiative.  From soda makers, search engines and clothes manufacturers. It is heartwarming to know that some of our favorite brands are part of a global initiative that is committed to using 100 percent renewable energy.

Here are some of them:

AstraZeneca

This pharmaceutical firm is committed to sourcing 100 percent of its power requirements globally by 2025. In the meantime, it has set a goal of using 100 percent RE for Europe and the US by year 2020.

Bloomberg

A provider of business and financial information, Bloomberg has its vision of using 100 percent RE by 2025.

BMW

German luxury car maker and motorcycle and engine manufacturer wants to buy 2/3 of all its power requirement from RE sources by 2020 and eventually consume 100 percent of RE power in the future.

Coca-Cola

Everyone knows (and probably consumes coke), but few know that this cola manufacturer intends to power its operations using RE by 2020.

Goldman Sachs Group, Inc.

This global investment bank and securities and investment management firm has the goal of using 100 percent RE by 2020.

Google

The number 1 search engine is also the largest firm to use RE and is committed to source 100% of its energy needs from renewable sources. It has also made a commitment to purchase 2.5 GW of RE and invest $2.5 billion in RE projects.

H&M

This fashion retailer is not only a favorite shopping destination in malls, but also a committed firm that intends to go 100 percent RE in the near future.

H&P

One of the biggest computer and print systems maker, H&P wants to increase its RE consumption to 40 percent of its total needs by 2020 and eventually go 100 % RE in all its operational needs in the future.

Johnson & Johnson

The health care company has made a mission of helping individuals and families live longer and healthier. And part of its vision of healthier individuals is its commitment to help address climate change through 100 percent us of RE use by year 2050.

Marks and Spencer

UK-based multinational retailer is already using 100 percent RE in UK and intends to source 100% of its energy needs from RE soon.

Microsoft

Bill Gates- led Microsoft has been using 100 percent RE since 2014 via purchase of renewable energy certificates and offset plus power purchase agreements. The firm is able to generable some amounts of power via their solar panels found in the rooftop of its campus in Silicon Valley.

Nestle

Swiss-based manufacturer Nestle wants to reduce its greenhouse gas emissions by 35% and plans to increase its consumption of RE to achieve this goal.

Nike

Popular for its athletic shoes, Nike also wants to purchase all its energy requirements from RE sources.

P&G

P&G boasts of the strongest household name brands and operates in around 70 countries. It plans to power up its full operations through RE, and in the meantime wants 30 percent of its power requirements sourced from RE by 2020.

Unilever

British-Dutch multinational company and a direct competitor of P&G proudly uses 100 percent RE in Europe and the US. It also aims to source all of its energy needs through RE by 2030, as well in other areas where it operates. In the interim, it intends to use 100 percent of all electricity bought from the grid from RE by 2020.

Wal- Mart

A global retailer with more than 11,000 stores in the world in some 28 countries has a target of buying 7,000 GwH of renewable energy by 2020 and eventually fuel its 100% of operations by renewables.

google-logo

Ivanpah Solar Electric Generating System near the California-Nevada border. Google is one of the major investors of the plant. Photo c/o http://www.ibtimes.co.uk

Choosing to go renewable is a task that requires careful thought. Corporations at first must decide on their targets.  They can choose either to set a percentage target of their overall energy consumption (i.e. power up 50 percent of their total operations through RE sources by 2022); choose to set a procurement target in absolute numbers (i.e. purchase 100 MW by 2022), or identify an investment level ( i.e. spend some $1 billion in renewable energy resources by 2022).

Aside from setting targets, the private firms also have to choose how to execute them. RE targets, after all, may come in the form of Renewable Energy Certificates (RECs), Power Purchase Agreements or Direct Investments.

RECs are tradable commodities in the United States. A certificate is the proof that one megawatt of electricity was sourced from a renewable energy source and was connected and passed through the grid. On the other hand, purchase power agreements are commitments to buy power from an RE supplier or developer for a negotiated price at a specified time period while direct investments pertain to firm’s strategy of developing and operating their own RE power plants.

Clearly, the choice of going green is not a process completed overnight. But just the same, such initiatives of these global brands must not go unnoticed. Reducing our carbon footprint is the responsibility of all. And happily, the private sector is doing its part.

References:

https://www.google.com/green/energy/

https://www.microsoft.com/about/csr/environment/renewable_energy/

http://there100.org/re100

https://www.ceres.org/resources/reports/power-forward-why-the-world2019s-largest-companies-are-investing-in-renewable-energy

Unquantifiable Returns

Corporate Social Responsibility or even sometimes referred as corporate citizenship is defined by Investopodia as a firm’s “initiatives to assess and take responsibility for the company’s effects on environmental and social wellbeing.”

My own definition of CSR, however, is slightly different. I see CSR as a means to provide more opportunities for families. This means working harder to encourage and support opportunities for education, entrepreneurship, and preservation of our natural resources. More so, when more than 25 percent of Filipinos live below the poverty line. In fact, the Philippines has the second highest poverty incidence in the Southeast Asia Region, next to Myanmar, according to the Asian Development Bank.

And it is the thought of helping others through my own endeavors is what, as cliché as it may sound, keeps me pushing harder for success in my business ventures. It was the same when I was with NAPOCOR and facing all the hardship of giving light (literally) to Filipinos. It was the thought that there are plenty who would benefit from the power projects we were putting together.

It is no different now that I am involved in renewable energy development. Our team in EPI reaches out to communities to understand how we can work together. As we build power plants, we are aware that we can make a difference in other people’s lives: we create value by providing them with employment and education.

EPI employs close to 400 individuals with our power plant projects. And on top of generating employment, we are also able to send both children and adults who wish to complete their education after quitting due to poverty.

One example is a 47-year-old Mangyan who recently graduated high school through our sponsored Alternative Learning System Program in Najuan. She, along with other 25 students graduated secondary education through our ALS.   At present, we have some 120 students in the programs who range 17 to 48 years of age.

It is important for us entrepreneurs and other members of the society to find ways to help our fellowmen go to school given that as of 2013, four out of every 10 Filipinos or four million youths are out of school. The Functional Literacy, Education and Mass Media Survey noted that roughly 19.2 percent of the survey participants said that their families could not afford to send the school expenses as the primary reason for quitting their education.

It has always pained me to see our fellow Filipino go abroad to find employment and have their children grow up without their parents’ care and for children to drop out of school to help their poor families. What’s even worse is when these workers end up taking care of other’s children while their own are being nurtured by others.  Our team takes pride that we can help keep families together through our own entrepreneurial initiatives.

Sure, bottom line figures are important for any businessman. But there are other created value through business undertakings that are equally important. Jobs generation that allows our head of families to provide a good future for their children without flying elsewhere and the opportunity to send individuals back to school after being denied of education in their early years top the list.