The Controversial DOE Competitive Selection Process Requirement

A recent article about the energy sector caught my attention. In the article, it said that many Distribution Utilities (DUs) especially Electric Cooperatives (ECs) have filed exceptions from adhering to the mandated Competitive Selection Process (CSP) requirement. And in response, the Energy Regulatory Commission (ERC) has said that DUs that have already “negotiated, executed and signed but not filed prior to November 6,” can execute said contracts without the CSP, but rather must undergo a SWISS challenge to ensure fair competition.

Confusing, isn’t it? But confusion is exactly what comes to mind when energy players talk about the CSP. What’s even more mind-boggling is the inconsistencies between the CSP version of the Department of Energy (DOE) and the ERC’s implementing guidelines released last November, which kicked-off the implementation of this scheme.

To recall, shortly before Jericho Petilla left his post as Secretary, he signed a DOE Department Circular requiring all DUs to undergo a competitive selection process or CSP when procuring their power sales contracts. Curiously, the CSP should be conducted – not by the DUs themselves, who will be directly affected by such contracts – but by a Third Party.

Under this CSP Circular, DUs are required to aggregate their un-contracted demand requirements, which will then be bid out by the Third Party. Simply put, under the CSP Circular, DUs can no longer procure their power supply on their own, either through bidding or direct negotiation with power suppliers. On the surface, this looks like it is a good move to ensure a process that will yield the best results for the consumers.

This CSP Circular has caused a stir and is still causing a stir among energy players for a variety of reasons. Industry players are concerned about the undesirable effects on the DUs and their customers, the difficulty of its implementation, as well as the legality of the CSP Circular. Allow me to discuss some of the concerns of energy players like myself about this widely discussed and highly controversial Circular.

Many question the underlying lack of trust of the DOE on the DUs, which is made apparent by DOE’s assigning a Third Party – instead of the DUs – to procure power for electricity consumers. The EPIRA mandates that the DUs enter bilateral contracts to purchase the power they provide to their customers. DUs have been doing this ever since. In removing this duty from the DUs and handing it over to an unknown Third Party, the message sent is that the government believes the DUs are incapable of serving the needs of its customers.

To reiterate, the CSP Circular restricts the DUs’ ability to procure power by requiring that procurement could be made only by a Third Party. It effectively prohibits a DU to procure power on its own.

This new requirement begs the following questions: Why create a new animal (i.e., Third Party) to do what DUs are mandated to do and are capable of doing? Is DOE not adding an unnecessary layer in supply procurement by creating an unnecessary entity instead of strengthening the regulatory power of the ERC and National Electrification Authority (NEA) over DUs and electric cooperatives, if only to better enable them to procure power wisely? Why burden the already burdened electricity consumers with the additional costs of the Third Party when the necessity for such entity has to be established? Why require a Third Party to bid, negotiate, and even to draft power supply contracts, on behalf of the DUs when efforts could be exerted to strengthen the capabilities of the DUs for supply procurement (assuming the DUs are indeed incapable to begin with)?

Ironically, while the CSP Circular makes the Third Party an indispensable party – without which DUs would not be able to procure power – a Third Party incurs no liability whatsoever under the Circular. It behooves one to ask: What will happen if the Third Party fails to secure power supply? What happens if the CSP fails? Should electricity consumers be left empty handed with no power supply, but still obligated to pay the Third Party’s fees?

The CSP Circular appears to debilitate the DUs, to the detriment of the consumers. Again, who else are in a better position to know the requirements of the DUs than the DUs themselves? Certainly not an unknown Third Party.

Many also question the CSP Circular’s inability to be responsive to the needs of consumers. Under the Circular, for a DU to obtain power supply, it must wait out the long process consisting of the selection of the Third Party, the aggregation of its demand with other DUs and finally, the lengthy bidding procedure. Thus, the Circular takes away from DUs the option to immediately contract power to address urgently power shortage or emergencies. A DU that is in need of urgent power supply would have to wait for the Third Party to go through the whole process. It will take many months, even years, to get finally get supply. In the meantime, electricity customers would have to suffer from blackouts or power interruptions, and worse, to pay for higher costs of electricity. Without enough contracted supply, the DUs are most likely to buy power from the spot market despite higher prices to provide its customers with power. In the end, the consumers will suffer from regular power interruptions and end up paying for higher electricity. Without the CSP Circular, DUs can readily contract from an emergency power supply.

Many also see the CSP Circular as favoring the bigger power players and hurting the smaller ones as well as renewable energy (RE) developers.
Contracting based on aggregated demand results in the bidding of large capacity. Only the large power companies – and there are only a few – who can finance power plants with large capacities. So, how can smaller players go head-to-head in bidding for the aggregated demand? In the same vein, RE plants, generally, have a relatively small capacity. Since RE plants will not be able to bid for large aggregated demand, further growth of renewable energy will be stunted.

To illustrate this point more clearly, let us say there are two power suppliers, with one capable of supplying 300 megawatts and another capable of supplying only supply 30 megawatts. What will be the expected result of a bid process if the demand up for bidding is 250 megawatts? Generation facilities with small capacities will be excluded from the bid.

All told, now that DUs are required to aggregate their demand, it is expected that small power players and RE plants would be at a huge disadvantage against big power companies and conventional technologies. Given these, it is no wonder many criticize the CSP Circular as running counter to the essence of the EPIRA, which espouses open competition and broadening the ownership base in the generation sector, to bring power rates down.

From a legal standpoint, the CSP Circular violates the franchise rights of the DUs. Lawyers who shared their legal opinion on the matter with me stressed that denying the DUs of their right to enter power supply contracts on their own is a clear violation of their franchise rights to procure power supply for its franchise area. The DUs’ right and mandate to procure supply cannot be lawfully delegated to another entity with no such mandate, such as the Third Party. DUs are public utilities whose franchise rights were granted by the Congress, and only Congress has the power to amend said franchise rights, according to lawyers.

Many are likewise concerned that the effect of demand aggregation would be unfair to the captive market of each DU.
For example, two DUs are grouped together and win the aggregated demand. The first one makes use mostly of baseload power supply while the other one uses a more peaking power supply, which is far more expensive than baseload. This means that the DU using more baseload power will have lower rates compared to the DU that uses more peaking power. If both are aggregated into one contract, then consumers of the both DUs will have to share one tariff applicable to both. The consumers of the DU that uses the baseload plants with the lower tariff will end up paying more, thereby subsidizing the higher tariff of the other DU. This results in what is called cross-subsidization, which is prohibited under the EPIRA.

Needless to say, the CSP Circular is causing a lot of concern in the power industry, as many of these critical questions remain unanswered. Further complicating this, the ERC recently issued rules requiring DUs to conduct bidding, but without a Third Party as a form of compliance to the CSP. The ERC rules on CSP did not adopt the guidelines of DOE’s circular. This was after much-publicized coordination with the DOE on the implementation of the CSP Circular. As one would expect, DUs are now confused on how they can contract for power supply.

Of course, the DOE must have had good intentions when it came out with the CSP Circular. However, one cannot deny that there is so much uncertainty as to its necessity, legality, and effectiveness. Isn’t it more prudent to share a comprehensive study on the feasibility and legality of a Third Party-managed bidding for aggregated demand to all concerned before its implementation? Doesn’t prudence also dictate that the CSP requirement using a Third Party be made optional rather than mandatory? At any rate, it is best for both the ERC and DOE to thresh out the details of the CSP, and end the confusion for the benefit of all.

A Belated New Year’s Wish List

It might be a bit late (almost two months after the start of 2016), but here is my wish list for the local Energy sector.

 

  • Lift the foreign restriction on ownership

 

At the risk of sounding like a broken record, it’s time for our lawmakers to review and carefully understand the implications of restricting foreign ownership in the renewable energy sector.  Climate change is global problem – therefore, there should be a global collaboration in addressing this problem.

 

We are aiming for a better energy mix consisting of higher energy sourced from renewable sources. However, there are few local businessmen who can shell out the capital needed to put up renewable energy plants.  The country’s goal is to increase our renewable energy capacity to 15,400 MW by 2030. We can focus on limiting the foreign ownership of the resource e.g. the sun, the water resources, wind, and others. The ownership of the equipment we need to convert these resources to energy should be opened up to foreign ownership.  After all, we do not have these technologies.

 

  • For people to dispense the notion that renewable energy is more expensive than traditional sources of energy

 

I wrote extensively on this item last year. The problem lies with our energy planners as they favor the least-cost method, choosing the cheaper energy source based on current prices in energy planning. Again, the least-cost method does not consider risks such as the volatility of oil prices.

 

In the beginning, it may seem cheaper to put up a fossil fuel-based plant. But again, what happens when oil prices spike? Oil prices are down these days, but who knows when and by how much the uptick will be in the future? Businessmen prefer predictability, and this has a cost.

 

  • For our energy planners to review the use of Capital Asset Pricing Model (CAPM) in computing for tariff setting.

 

Again, this is one topic I have been discussing lengthily or arguing for so strongly.  Regulators should realize that the CAPM doesn’t work for non-efficient economies like ours. Similarly, it uses the Beta that supposedly represent the “market”. Unfortunately, there are not enough companies that can fully represent the market.

 

And in the meantime, while our regulators insist on using CAPM, they should understand that their application of the model particularly of the Beta is wrong.

 

Our ERC uses the same Beta, the measure of risk, for all power plant projects when computing for the tariff. This means that a coal-powered plant and geothermal power plant will have the same Beta.  Our regulators assume that all power plant projects have the same risk profile when computing for the cost recovery in setting the tariff.

 

This is wrong, as I have mentioned since the risk, of let us say of a geothermal power developer, will be higher than a coal power plant developer. Exploration for geothermal is more costly and hence its Beta should be higher to reflect the costs of undertaking that risk.

 

  • For anti- renewable energy advocates to stop saying that renewable energy cannot act as a baseload plant

 

Many of those who oppose renewable energy often argue that the renewable energy sources cannot act as a baseload plant. This is an incorrect assumption. Arguably, wind and solar cannot produce energy 24 hours a day, but a geothermal power plant can. The argument that no renewable energy source can act as a baseload plant should have been retired a long time ago.

 

  •  Prioritize long-term stability through a balanced energy portfolio of conventional and renewable energy for Mindanao

 

Mindanao, unfortunately, always figures in the news due to the peace and order situation and its recurring power shortage problem. Last year, discussions on the creation of a Mindanao Power Corporation, as well as privatization of the island’s power plants were lively. However, it is my belief; that government should first prioritize the opening of more power plants—both conventional and renewable energy to secure the power system on the island.  We first should achieve a long-term and stable solution to the power crisis in Mindanao. Only then can we talk about privatization of the island’s power plants.

 

  • A review of the Competitive Selection Process (CSP)

 

Last year, former Energy Secretary Jericho Petilla came out with a circular requiring Distribution Utilities (DUs) to use a third-party entity when securing their power sales contracts. This circular caused a stir among energy players as the CSP is largely problematic. Many argued, including me, that the CSP does not protect the interest of the smaller players, and hence defeats the purpose of EPIRA to promote fair competition among the power players. This is just one of the many arguments hurled against this circular. It is then my wish for the DOE to review and reconsider this rather alarming circular.