Is IPPA necessary?

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I was asked to speak in a “Mindanao Power Forum” hosted by the Institute of Electrical Engineers in Cagayan de Oro last month. It was a relatively well-attended forum with Congressman Edgardo Masongsong, Energy Regulatory Commission Executive Director Atty. Francis Juan, among others, in attendance.

The topic was about the issues surrounding the privatization of the Agus and Pulangi complexes and the Independent Power Producer Administrator (IPPA) issues. After all, PSALM was ready to bid out the IPPA contracts at that time (PSALM has announced that there are a total of 12 firms that are vying for the IPPA contract of the STEAG coal-fired plant few days after). And it was correct to discuss both the privatization of Agus and Pulangi and the IPPA since these two issues are intertwined.

It was, however, unfortunate that the Power Sector Assets and Liabilities Management Corp. or PSALM was not represented in the forum as it is the agency that can address the concerns raised about the IPPA. During the discussion, Dave Taule, formerly of CEPALCO, delivered an impassioned plea to scrap the plans to conduct a bidding for the IPPA of STEAG, as well as to recall the IPPA for Mt. Apo Geothermal, which was won by Filinvest Group through the FDC Misamis Power Corp. last September.

Despite the discussion on IPPAs, one key question remained unanswered: Is it necessary to sell the remaining energy output of the existing Mindanao power plants to a private IPPA, a broker, who will be allowed to make a margin?

My answer to this question is simple: No.

To understand my answer let me put in context what an IPPA is and its role in a market like Mindanao.

An IPPA is an entity chosen by PSALM, which administers, conserves and manages the contracted power output between an Independent Power Producer (IPP) and the NPC. The IPPA is a post EPIRA invention concocted to supposedly take away the market risk from National Power Corporation or NAPOCOR or PSALM by passing on the risks to the private sector. “Market risk” is present presumably because there is stiff competition and the government is not in a position to take on such risks. After all, the EPIRA’s thrust is for the privatization of government-owned power assets to promote competition among the power sector players.

But what competition are we referring to in Mindanao ? Competition only exists if there are sufficient buyers and sellers in the market and the government is simply ineffective in capturing market share. But is it? And for Mindanao, how can there be competition in a market that has power shortage? Even Davao is suffering from brownouts!

The power situation (or the lack of power supply) has been a perennial problem of the region. At present, the region is experiencing rotating brownouts due to the reduced capacity of Agus 6, low water inflow of Pulangi and the emergency shutdown of one of STEAG’s units. Agus and Pulangi supplies half of the power for Mindanao and both are about to be privatized.

It is unlikely that the power situation in Mindanao will improve any time soon. The power outlook for Mindanao, according to the National Grid Corporation, is usually in yellow alert, which means that the region does not have sufficient power reserves, making it non-compliant to the required reserve-level. So, there is no competition in the power sector in the region to speak of, as of this time. Of course we are all hoping that the ALSONS’ and Aboitiz’s plants will come in on time. Even then, by 2020 my view is we will be short again.

There is another reason why IPPAs are unnecessary: IPPAs increase generation charges unnecessarily.

Keep in mind that IPP generation costs are composed of administration, fixed and energy charges. The administration charge is just an added cost that increases the generation cost.

The Cagayan de Oro forum pointed out the case of the Mt. Apo geothermal power plants. As mentioned above, the said plants were privatized through an IPPA last year. As a result, the generation cost increased from P3 per kilowatt hour (kWh) to P5.37 per kWh, according to the Association of Mindanao Rural Electric Cooperatives or AMRECO.

The AMRECO said that the significant increase in the generation charges was due to the administration cost charged by the IPPA. If these figures are correct, the difference of P2.37/kwh is what we in finance call an “arbitrage” because the profit is made out of an extraordinary market condition. At that spread, one can already put up a coal-fired power plant!

The important question to ask is: why do we have to pay additional costs when the goal of ensuring stable power supply and promoting competition in the market are far from being achieved?

So, no, there is no need to enter into IPPA contracts for now. An IPPA may be helpful if the market conditions are such that the government cannot take a competitive position. In Mindanao, the government has a dominant position and can therefore smooth out the market prices for the benefit of the consumers. Instead of an IPP contract, it is essential for PSALM to secure the market first by stabilizing the power supply and bringing down the cost of power over the long term. This has immediately two advantages: a) it signals the market that the output of all the government plants have already been contracted out and therefore is no longer in play for any competition from new private sector investments in generation; b) it “locks in” the low price that the consumers are enjoying today and over the long-term. Everybody gains, nobody loses.

Just recently, Energy Secretary Jericho Petilla has said that he wants to ask PSALM to defer the bidding of the STEAG power plant, to be moved to next year until such time the power plants of Aboitiz and San Miguel are already in operation, to avoid power spikes in the meantime.

My suggestion is for the DOE to reconsider the plans of selling the remaining power output of the remaining Mindanao power plants to the private sector altogether, and instead, focus on securing the system by stabilizing power supply and bringing down the costs. And putting more renewable energy in the power supply mix for the region is the key to energy security in the region, and elsewhere in the country.

As I said in other articles, this suggestion will be a challenging one to energy planners if they continue to use the traditional “least cost” method. This method favors traditional power plants over renewable energy plants for several reasons. First, traditional power planners tend to compute the least cost of stand-alone plants. Second, renewable energy is deemed “expensive” by many if one is to use the least-cost method of computing for costs of energy generation. As I have always argued, this is wrong.

Studies have shown that renewable energy that contributes to a “fixed price” component into the system increases value to the economy. In fact, it can bring down over-all power cost. A study conducted by the late Shimon Awerbuch, a renowned adviser on electricity market, shows that adding renewable energy in an energy portfolio indeed reduces the over-all cost of energy. This was proven in the case of Mexico, where the cost of energy went down by US$00.038/kWh after increasing wind and geothermal power in the mix by 9 and 10 percent, respectively. This despite the fact that wind generation is US$0.05/kWh higher than gas.

Going back to my point, not only is it wrong to bid out the IPPA contracts for reasons I have already given, we have misplaced our priority as well. We should be focusing on bringing in new power generation to Mindanao and especially a balanced portfolio of conventional and renewable energy power plants. Only when we have attained long-term stability (as required by EPIRA) should we tinker around with privatization.

Privatizing the Agus and Pulangi Hydropower Plants: An Alternative

Published in March 7,2015

For those of you old enough to remember, I was appointed to the National Power Corporation (NPC) Board in 1992 by then President Fidel V. Ramos (PFVR) with an unwritten mandate of finding a permanent solution to Mindanao’s power woes. I ended up running the entire company, mandated to solve the power crisis then and find a long-lasting solution to the power crisis not only for Mindanao, but for the entire country.

For the record, I did try to find a long-term solution to Mindanao’s power woes. The current STEAG Coal-fired power plant (in Misamis Oriental) was the last contract I signed a few days before I retired in June 1998. I fought hard for that plant to the point that many politicians, including our very own who are enjoying the benefits of that plant, said it was a “midnight” deal. Of course, hindsight has a 20/20 vision; Mindanao enjoyed a far more stable power supply with the STEAG plant in spite of the crisis that crops up every now and then.

Discussions back then hovered around the creation of Mindanao Power Corporation, a discussion still very much alive today. Of course, privatization and liberalization issues for the Mindanao grid were hot topics in the past, as it is today. That is a topic I may write about another time. Today, in the solitude of my present life as a private citizen, I cannot help, but with a wry smile, think about the complexities of making certain decisions today like the privatization of the Agus and Pulangi complexes.

The Power Sector Assets and Liabilities Management (PSALM) Corp. said it will proceed with the sale of the Agus and Pulangi plants after the approval of its board last year. In previous interviews, PSALM President Emmanuel Ledesma Jr. said that the sale is due in 2017 — the earliest sale date. He also added that an amendment to the EPIRA is the only way to prevent the sale of the hydro power plants.

Can PSALM privatize Agus and Pulangi plants according to its timeline? In fact, should PSALM privatize the plants according to the government’s current plan?

Probably not. For one, those who oppose the privatization of the power plants of Mindanao are many and they raise valid points. There are many who will push for the private sector’s participation in the sector and I would be one of them. If I have hesitations about this current plan, it is because I know there is a better way of privatizing the plants. Hence, much more thought must be put into the plan.

It is a very big challenge privatizing the Mindanao hydropower complexes.

The hydro plants with a combined capacity of 982 megawatts installed capacity is too large to sell to a lone owner. Having the plant owned by a single entity will result in a near monopoly market structure —a situation that the government must avoid since the essence of EPIRA is to promote fair competition among players.

If PSALM does not sell the entire power plant to a single entity or owner, and then it would be forced to sell the plant in parts or in blocs. This too, seems problematic since breaking up the complex will complicate the water management of the entire complex. The Agus complex is essentially a single complex with cascading power plants downstream from Lake Lanao. It is essential for the operations and maintenance activities of the plants to be optimized and synchronized. This will make the operations complex, and the financial contracts even more complicated.

Is there a viable option in privatizing the Agus and Pulangi Plants, one that will keep the interests of the consumers in mind without sacrificing the efficiency of private sector funding and management? I believe there is a possible option, one that we had planned for Mindanao during our time in government.

Privatizing the hydropower complexes must always bear the consumers’ interests in mind, far above the interests of the private investors and the government’s. This is a policy that should be paramount in the privatization of any government monopoly. In the case of Mindanao, the question is this: how can the Mindanawons of today enjoy the benefits of the Agus and Pulangi hydropower complexes in the years to come?

A few weeks before I retired from NPC in 1998, I implemented a power sales policy in NPC where I sold, proportionately, the output of Agus to all the consumers of Mindanao at some fixed rate for the next 20-odd years. The purpose was to “lock in” the low price of hydropower by way of a contract. Unfortunately, only Davao Light then took on that offer; only Davao consumers benefited from this undertaking.

This time around, PSALM must enter into Power Supply Agreements or PSAs with a life of 25 years before it starts selling the hydro plants. This time, this should benefit all existing customers of NPC – electric cooperatives, private utilities, and directly-connected industries. The reason is simple: PSALM should avoid the pitfalls of the government in previous privatization deals where the government sold plants individually without any PSA. Doing this will result in either of the following situations: a) prices will go up immediately after privatization; and/or b) government sale price will be low. Either way, the government and consumers will be the losers in the equation.

The PSA must be signed by all of the NPCs existing customers at the current price with escalating prices based on the consumer price index (CPI) to reflect inflation. This makes the price of the generated power by the power plants determinable in the next 25 years. This makes the economy of Mindanao more stable with relatively determinable costs. Having this type of a PSA where the price is stable will bring down over-all risks of the Mindanao economy and can contribute to a higher GDP growth for the island.

In particular, this will benefit small and medium enterprises (SMEs) that tend to suffer more than large multinationals in times of uncertainty. Studies have shown that stable and predictable prices have a positive effect on the over-all GDP growth of economies. This will, again, be a topic for another time. Suffice it to say that having a long-term PSAs will benefit everyone – for the government and the investing public, the price is easier to determine and establish. For the consumers, they are protected against price spikes in the long-run and will benefit from the stable price that can come from the hydropower complexes.

As for the water management issue, the best option for PSALM is to first obtain the services of an independent water management body that will oversee the protocols of water management. This way, there will be an independent body that will allocate and manage the water based on safety, security, and economic dispatch protocols. And because the PSAs for the complexes have already been signed, there is no need to even have several small “Agus” power companies competing against each other for customers. Asus can have one company efficiently managing the entire complex and Pulangi can have another private company.

Now the bidders will only have to compete based on their capability to rehabilitate and maintain the power plants. Technical competence backed up by experience will drive the bidding which will make the bidding more interesting and beneficial for Mindanao consumers. The current NPC employees with proper financial and management support can very well run these plants. They are the most experienced and competent in the region today.

With this proposed structure, the government now has an option of privatizing the complexes in various ways since the cash inflow is also predetermined for the coming years. For those of us who are familiar with project finance, the structure lends itself to non-recourse financing. Translation: privatization will no longer require investors with large balance sheets because debt financing can be raised through the established PSAs. This means competition for the privatization will be more intense, hopefully increasing the price that investors will be willing to pay for the assets.

In fact, one can think of a scheme where these assets can be sold by way of share sales reminiscent of the way Petron was sold in the past. In that scheme, ordinary Filipinos were able to own shares through SSS and GSIS financing. Privatizing the Mindanao complexes will even be better and easier because of the PSAs – valuation is easier, making financing even easier. One can design a privatization plan where allocation of shares can be done so that every qualified investor in in Mindanao can own a share in these plants.

We have studies done in the past that showed that consumers can actually afford to buy shares from privatized NPC power plants. Every time we pay our electricity bill, a portion actually goes to the capital recovery of these power plants. So why not allocate a portion of this bill to payment of shares? The shares can then be listed in the Philippine Stock Exchange contributing further to the liquidity of the shares and most likely enhancing even further the value of these shares.

I started by saying we studied the different options of creating the Mindanao Power Corporation. We, in fact, went beyond this. We studied the feasibility of creating a market in Mindanao. We eventually ended with this conclusion: given the economic structure of Mindanao, a competitive market may not be feasible. Placing Mindanao as part of the over-all Philippine electricity market may not also be politically feasible; Mindanao has the ability to survive as an autarky in power. The need to physically connect to Luzon or Visayas was not necessary.

These were studies done close to two decades ago. Whether the findings are still valid today may be interesting to re-visit. Maybe, just maybe, the hydropower complex’s privatization may form the roots of a Mindanao Power Corporation. A Mindanao Power Corporation owned by Mindanawons? A great possibility indeed! Just a thought.