With ADB Support, Reliable and Cheaper Power is Within Reach in the Philippines

An ADB-funded transmission line in Tarlac.

by Xinning Jia and Rita Festin, ADB Philippine Country Office

 

 

 (Published in Manila Bulletin issue of 20 July 2008) 

The Philippines has among the highest electricity rates in Asia, in the company of highly urbanized cities like Japan and Hong Kong. Part of it is due to the country being an archipelago of at least 7,107 islands at high tide, where transmission lines would have to cross bodies of water to be inter-connected to a grid. Another reason would be its high dependence on imported oil, making it vulnerable to price fluctuations and supply problems.   

ADB’s Extensive Role in the Philippine Energy Sector

ADB, being the lead financing agency in the Philippine power sector, has provided to the sector nearly a third of its total cumulative lending to the country of over US$9 billion spanning 37 years.

 ADB’s involvement in the power sector has been extensive, to say the least, ranging from generation, transmission, distribution, and sector development support.   

 Snapshot of ADB Support in Power Sector Development

 The fate of the power sector has been dependent on policy changes of the government.  There was a gap between the Marcos administration and the Aquino administration in the late 1980s with the abolition of the Ministry of Energy, which put the country’s energy program in limbo despite increasing annual demand. With the shortfall, and no new investments in place, the country eventually suffered a crippling power crisis in the early 1990s that forced the Ramos administration to enter into power supply contracts with independent power producers (IPPs) through power purchase agreements (PPAs) in a record two years’ time. These PPAs contained minimum offtake provisions, fuel cost pass-through and foreign exchange adjustments in favor of the IPPs. Hence, when the Asian financial crisis of 1997 occurred, and the projected demand for power did not materialize, the oversupply of electricity in the country resulted in the rise in electricity rates. The situation was further aggravated by the sharp depreciation of the Philippine peso. National Power Corporation (NPC) obligations, which were guaranteed by the government, therefore ballooned and seriously affected its financial health such that it posted a record net loss of P13 billion in 2000.

 In 1998, ADB approved a US$300-million power sector restructuring program loan that prepared the NPC for privatization, separating ownership of generation from transmission, and making it more competitive and more efficient to reduce power costs. The loan was to finance some of the adjustment costs of the restructuring, including its huge debt burden, the incorporation of long-term take-or-pay contracts with IPPs into the competitive framework, and employees’ separation pay. This was later complemented by a US$500-million partial credit guarantee in 2002.    

 By 2001, the current administration decided to embark on market-oriented reforms through the Energy Power Industry Reform Act or EPIRA Law, in what was to be the centerpiece of the restructuring of the power industry. It signaled a radical change in the Philippine power sector by reducing public debt, improving the sector’s efficiency, and promoting competition to bring down the cost of electricity. The key features of the EPIRA law were the unbundling of the industry into generation, transmission, distribution and supply sectors. 

 This resulted in the transfer of the generation and transmission assets of NPC to the Power Sector Assets and Liabilities Management Corporation (PSALM) and the creation of a wholesale electricity spot market (WESM) which would spur competition in the retail supply of electricity. The Energy Regulatory Commission (ERC) was also created to regulate the industry.  

 In 2001, ADB provided a US$990,000 technical assistance grant that enabled the ERC to enforce a performance-based rate-making methodology of the Transmission Sector, which replaced the traditional rate-of-return, based pricing methodology.

 In 2002, ADB provided a US$40 million investment loan to establish WESM, one of the first in developing member countries (DMCs). 

 EPIRA law relegated the role of NPC to being the operator of the Small Power Utilities Group and other non-privatized assets, responsible for providing power generation and its associated power delivery systems in areas that are not connected to the transmission system.  PSALM, principally as liquidator, takes possession of all existing NPC generation assets, liabilities, IPP contracts, real estate and other disposable assets. PSALM takes the responsibility of repaying all existing NPC debts. The transmission and sub-transmission assets of NPC would be transferred to the National Transmission Corporation (TRANSCO), which is wholly owned by PSALM.  ADB’s consent, as well as other NPC creditors, was obtained for this major change. 

From 2001 to 2005, however, privatization attempts were delayed. First, there were the 2 failed biddings to operate TRANSCO’s transmission assets, mainly due to the unpalatable investment climate and complexities from the congressional and judicial branches of government. The target to sell 70% of NPC’s eligible capacity in Luzon and Visayas by June 2004 also fell short. The government’s first successful attempt at privatization occurred only in March 2004 with the sale of the 3.5 megawatt Taolomo hydroelectric plant near Davao City.

In December 2006, ADB provided a US$450 million policy-based loan for the Power Sector Development Program (PSDP) to consolidate the reform process and accelerate the privatization program. In particular, PDSP aims to restore the financial viability of the power sector, by helping the government absorb the NPC’s long-term liabilities, averting a major fiscal crises and improving the country’s fiscal imbalance and investment climate. The PDSP assists the government’s privatization of generation systems, introduces a competitive electricity market, and reduces unsustainable government subsidies to the power sector. The Program loan came in at a critical time as the country would have faced power outages had the reforms not been undertaken.

Lessons Learned

There are a number of factors that have affected the ongoing privatization program. First, since the adoption of EPIRA law and the start of the privatization program in the Philippines, many traditional US and European investors in the power sector encountered serious financial difficulties, some of them filing bankruptcy while others scaled down their investments particularly in the developing countries. The commercial lenders that suffered losses from their earlier investments in the 1990s also cut their exposure in the power sector. On top of these external factors, there are also perceptions of high country and regulatory risks associated with the political events and judicial interventions in the Philippines. Specifically, for the privatization of NPC’s generation assets, there are some inherent flaws in the EPIRA law that contributed to the slow pace of privatization. In those countries that have successfully implemented the privatization of publicly-owned generation assets, bilateral supply contracts were generally attached to the generating assets for privatization since this would offer a viable market for investors and a bankable project for lenders. Without such contracts, investors are unable to mobilize long-term financing from commercial banks.

ADB’s New Assistance to Power Sector

In December 2007, ADB’s Japan Special Fund provided a US$550,000 grant to prepare the Rural Electric Cooperatives Development Project to help the country achieve a 100% rural electrification coverage by 2009. At the end of 2008, about 97% of the nearly 42,000 villages in the Philippines had access to electricity.

In January 2008, ADB provided a US$200 million private sector loan to the winning bidder in the privatized 600-megawatt Masinloc coal-fired power plant, the largest power plant privatized by the government so far. This will result in the rehabilitation and expansion of the privatized plant’s present capacity that will encourage more competition and thereby bring down power rates. It will also ease the debt burden of the NPC. 

The Way Ahead:  Challenges and Opportunities

“It’s a long process and the design of policy reforms should recognize the need for a steady approach with a phased and realistic implementation schedule,” says Yongping Zhai, ADB principal energy specialist. A reliable supply of secure, affordable electricity is particularly important to promote sustainable growth in the country.

The Philippine Energy Summit in early 2008 discussed options with all stakeholders on how to mitigate the impact of high-energy prices on the general public. The Summit noted that while the introduction of competition through open access[1] can reduce electricity tariffs in the short term, a more effective solution would be through a combination of increased use of indigenous renewable energy generation (such as geothermal, biomass, wind and hydropower) and the promotion of energy efficiency. The government plans to develop a range of legislative measures that will reduce import dependence by promoting increased use of indigenous energy resources, accelerating competition in the energy sector, building awareness and incentives for energy efficiency at all levels, and exploring alternative fuel options for the transport sector.

To support the government’s initiative, ADB is considering provide assistance in developing a financing scheme that will support these energy efficiency and conservation programs. It aims to (i) identify and finance projects that can easily be replicated in the other parts of the country, (ii) encourage market-based financing mechanisms, and (iii) support projects that could claim carbon credits.

As generation and transmission will be operated by the private sector when the restructuring is complete, ADB will consider providing support to strengthen the distribution sector in the rural areas to support the government’s rural electrification program.

As the privatization gets underway, and more and more power plants are rehabilitated and capacities are expanded or at least doubled by their new owners, ADB sees power rates in the country finally coming down to more reasonable levels and make supply more reliable.

 ADB is committed to seeing the whole process through.

 

 

 

 

 

 

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[1]   Open Access means that the utility’s wires are “open” and can be used by a customer to receive electricity from an alternative source.  Open Access gives a customer the choice to shop around for a “cheaper” source of electricity and “bypass” the incumbent utility’s average cost of generation, switch directly to the cheaper alternative, and pay the incumbent only for regulated transmission and distribution charges.