1

Dist

Trans

Gen

Performance Based Regulation (PBR)

Engr. Alvin Jones Ortega

Chief, Tariffs and Rates Division

Regulatory Operations Service

April 2017

PBR Briefing

Outline

Why did the ERC adopt the PBR?

What are the key features of PBR?

What is the PBR Process?

PBR Briefing 2

Outline

Why did the ERC adopt the PBR?

What are the key features of PBR?

What is the PBR Process?

PBR Briefing 3

Republic Act No. 9136

Electric Power Industry Reform Act (EPIRA)

• Signed: 8 June 2001

• Effectivity: 26 June 2001

Implementing Rules & Regulations

• Signed: 27 February 2002

4PBR Briefing

The industry before and after restructuring

Generation Transmission Distribution SupplyCaptive &

Contestable Customers

Generation & Transmission

Distribution & Supply

Captive Customers

Before After

5PBR Briefing

Unbundled Electric Bill-Sec 36 of EPIRA

6PBR Briefing

How does ERC set the Charges?

Generation

NPC: Return on Rate Base Methodology

IPPs: Individual review of bilateral contracts or PSA

WESM: Price Determination Methodology

Transmission

Performance-Based Regulation (PBR)

Distribution

Private Distribution Utilities

Performance-Based Regulation

Electric Cooperatives

Cash Flow Methodology (Off-Grid)

Benchmarking Methodology (On-Grid)

PBR Briefing 7

f) In the public interest, establish and enforce a methodology forsetting transmission and distribution wheeling rates and retail ratesfor the captive market of a distribution utility, taking into accountall relevant considerations, including the efficiency or inefficiency ofthe regulated entities. The rates must be such to allow the recoveryof just and reasonable costs and a reasonable rate of return on ratebase to enable the entity to operate viably. The ERC may adoptalternative forms of internationally-accepted rate settingmethodology as it may deem appropriate. The rate settingmethodology so adopted and applied must ensure a reasonableprice of electricity. The rates prescribed shall be non-discriminatory. xxx

EPIRA Section 43. Functions of the ERC

8PBR Briefing

Adoption of PBR

• As authorized under Section 43(f) of the Electric Power Industry Reform Act (EPIRA), the ERC, promulgated the Performance Based Regulation (PBR):

– In May 2003, for the transmission utility, thru the Transmission Wheeling Rates Guidelines (TWRG), wherein rates are controlled thru a maximum annual revenue (MAR) cap, later amended as Rules for Setting Transmission Wheeling Rates (RTWR) in September 2009

– In December 2004, for the private distribution utilities, thru the Distribution Wheeling Rates Guidelines (renamed as Rules for Setting Distribution Wheeling Rates, RDWR), wherein rates are controlled thru a maximum average price (MAP) cap.

PBR Briefing 9

10

PBR - Efficiency

PBR is intended to ensure that firms have incentives

to improve efficiency

Achieved by fixing prices/revenue in advance (ex-ante)

Improving efficiency under fixed prices means additional profits

Regulator must ensure that all these gains do not

accrue to the firms

Incentive regulation therefore involves sharing of the efficiency

benefits

PBR Briefing

11

PBR - Service Quality

• Wide recognition that a trade-off exists between

– The service quality at which electricity is supplied

and

– The cost for providing this service

• Under incentive regulation, there is an incentive to

maximise profit

• Profits can be increased by reducing service quality

• Hence, the Regulator also has a societal obligation to

regulate service quality to ensure

– Profits are not taken at expense of quality

– All customers receive a reasonable quality of service (not

only those where it is profitable)

– Acceptable service levels are maintained

PBR Briefing

Performance Based Regulation

EFFICIENCY thru determination of the Annual Revenue Requirement

SERVICE QUALITY thru setting of the Performance Standards

PBR Briefing 12

Outline

Why did the ERC adopt the PBR?

What are the key features of PBR?

What is the PBR Process?

How did ERC evaluate the Rate Application

of the Utilities under the PBR?

PBR Briefing 13

PBR is based on three key formulas. First: Annual Revenue Requirement

ttpttttmtt TaxWACCWCRABegDepnRTaxOpexARR ,, ])[(

This formula :

– determines the allowed annual revenue requirement for a utility

– is based on the so-called “building block” principle

– compensates the utility for efficient expenses

– compensates investors for efficient investment and associated

risk.

14PBR Briefing

Annual Revenue Requirement

Determine forecasted Annual Revenue Requirement

(also called Building Blocks) for a Regulatory Period

OPERATING

EXPENSES

TAXES

RETURN OF

INVESTMENT

RETURN ON

INVESTMENT

INCOME TAX

operating and maintenance expenditures

recurring in the course of providing service

legitimate, necessary, prudent and reasonable

property taxes, business taxes, duties

Weighted Average Cost of Capital (WACC) X rate base

value of optimized assets + working capital

depreciation based on standard asset lives

set to zero

PBR Briefing 15

Capex

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6

Cap/n Cap/n Cap/n Cap/n

X

WACC X WACC X WACC X WACC

Return OF

Investment

Return ON

Investment

+ + + +

Capex

approved

at year -1

Capex

acquired

at year 3

How are Capital Projects considered?

Regulatory Period

16

4-year Annual Revenue Requirement

OPERATING

EXPENSES

TAXES

RETURN OF

INVESTMENT

RETURN ON

INVESTMENT

INCOME TAX

Regulatory Year 1

OPERATING

EXPENSES

TAXES

RETURN OF

INVESTMENT

RETURN ON

INVESTMENT

INCOME TAX

OPERATING

EXPENSES

TAXES

RETURN OF

INVESTMENT

RETURN ON

INVESTMENT

INCOME TAX

OPERATING

EXPENSES

TAXES

RETURN OF

INVESTMENT

RETURN ON

INVESTMENT

INCOME TAX

Regulatory Year 2 Regulatory Year 3 Regulatory Year 4

REGULATORY PERIOD

17PBR Briefing

ERC Review of Annual Revenue Requirement

PBR Briefing 18

RY-1 RY1 RY2 RY3 RY4

Other taxes 241.8 182.2 308.1 249

Corporate income tax 0 0 0 0

Regulatory depreciation 5,214.60 5,752.90 6,063.50 6,317.70

Opex 13,942.50 14,831.60 15,746.30 16,694.50

Return on capital 19,137.00 19,770.10 20,261.30 20,684.90

0.00

5,000.00

10,000.00

15,000.00

20,000.00

25,000.00

30,000.00

35,000.00

40,000.00

45,000.00

50,000.00in

Th

ou

sa

nd

Ph

P

Smoothing the ARR

RY-1 RY1 RY2 RY3 RY4

Other taxes 241.8 182.2 308.1 249

Corporate income tax 0 0 0 0

Regulatory depreciation 5,214.60 5,752.90 6,063.50 6,317.70

Opex 13,942.50 14,831.60 15,746.30 16,694.50

Return on capital 19,137.00 19,770.10 20,261.30 20,684.90

RAW MAP 1.55 1.59 1.55 1.62

Smoothed MAP 1.6464 1.5828 1.5824 1.5821 1.5817

1.00

1.10

1.20

1.30

1.40

1.50

1.60

1.70

0.00

5,000.00

10,000.00

15,000.00

20,000.00

25,000.00

30,000.00

35,000.00

40,000.00

45,000.00

50,000.00

Ph

P/k

Wh

in T

ho

us

an

d P

hP

PBR Briefing 19

2

201120112010

)1(

)1)(1(

WACC

FQXInflXInfl

)( 02009 PMAP

)1(

)1( 20102010

WACC

FQXInfl

3

2012201220112010

)1(

)1)(1)(1(

WACC

FQXInflXInflXInfl

4

20132013201220112010

)1(

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

WACC

FQXInflXInflXInflXInfl

=

The 2nd Formula: Smoothing the ARR

20

Calculate the present value of the allowed ARR resulting from the

MAP that a regulated entity is permitted to charge.

Calculate the allowed price path via CPI-X (slope of the equation)

Present Value of the ARR

MAP applied with (CPI-X)

4

2013

3

2012

2

20112010

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

ARR

WACC

ARR

WACC

ARR

WACC

ARR

PBR Briefing

3rd Formula: price-cap formula

which is a variant of the so-called “CPI-X” form of regulation

It essentially means :

tITA

tK

tSX

tCWI

tMAP

tMAP

}]1{

1[

Next year’s price is capped at this year’s price plus an

allowance for general cost increases, reduced by an

efficiency factor.

MAPt means the maximum average price (for distribution services) for

year t

21PBR Briefing

22

Supply

Distribution Metering

Residential

Commercial

1ø 3ø customers

Industrial

customers

PhP/kWh

PhP/kWh

PhP/kW

Residential

Commercial

1ø 3ø customers

Industrial

customers

PhP/kWh

PhP/cust/mo

PhP/cust/mo

Residential

Commercial

1ø 3ø customers

Industrial

customers

PhP/kWh

PhP/meter/

mo

PhP/meter/mo

PhP/meter/mo

MAP is converted to Revenue

FUNCTIONALIZE

ALLOCATE TO CUSTOMER CLASSES

How does the PBR Methodologyset your rate?

PBR Briefing

Service Quality Measures under PBR

Price-linked incentive scheme

• Depending on network and service performance, a reward is added to the annual price-cap or a penalty is deducted

• System Average Interruption Frequency Index (SAIFI)

• Customer Average Interruption Duration Index (CAIDI)

• Voltage Levels

Guaranteed Service Levels

• Direct compensation to customers if certain service delivery performance standards are not met

• If a Consumer experiences more than specified number and hours of sustained interruptions in a year

• If Consumer is not connected on the specified date of connection

PBR Briefing 23

MERALCO Price-linked incentive

PBR Briefing 24

MERALCO Guaranteed ServiceLevel (GSL)

PBR Briefing 25

Outline

Why did the ERC adopt the PBR?

What are the key features of PBR?

What is the PBR Process?

PBR Briefing 26

The detailed mechanisms of PBR are described in…

• Rules for setting Distribution Wheeling Rates (RDWR), describing:

– All the price-setting calculations

– Price-setting procedures

– Determination of factors on which price-setting is based

– Treatment of external events

• Issues and Position Paper

– Published for each entry group into PBR

– Describes ERC’s view on how the RDWR will be implemented

– Describes timelines and requirements from utilities

– Is used as basis for consultation with utilities

• Diverse regulatory documents, including:

– Weighted average cost of capital

– Working capital and construction work-in-progress

– Performance incentive scheme

• Distribution System Open Access Rules (DSOAR)

– Approved MAP is translated into the retail rates

What are the control mechanisms?

1. A review every 4 years (Reset)

– Determine Annual Revenue Requirement

thru the Building Block analysis;

– To review the actual cost that has been

incurred by the Utility from previous

Regulatory Period;

– To review and adjust the service

performance measures

28PBR Briefing

What are the control mechanisms?

2. Annual Verification

– to ensure that Utility earns only within the

approved constraints;

– to adjust for the actual increase/decrease in

price of commodities (inflation);

– to adjust for the actual increase/decrease in

sales;

– to review the service performance (incentive

or penalty)

29PBR Briefing

YEAR

1

Regulatory Period

Regulatory Year

Regulatory Reset Process

YEAR

-1

YEAR

2

YEAR

3

YEAR

4

PBR Process

30PBR Briefing

Reset Process

Public Hearings

Utility Submits Revenue Application

Position Paper

Public Consultation

Issues Paper

Draft Determination

Public Consultation

Final Determination

Utility Submits Rate Application

Public Hearings

Rate Implementation

Rate Decision

FOR EACH YEAR

OF THE REGULATORY PERIOD

ERC Responsibilities

DUE PROCESS

UTILITY Responsibilities

LEGEND

PBR Briefing 31

TimelinesUtility Current RP Next RP

National Grid Corporation of the Philippines (NGCP) 01 January 2011 –

31 December 2015

(3rd RP)

01 January 2016 –

31 December 2020

(4th RP)

Manila Electric Company (MERALCO) 01 July 2011-

30 June 2015

(3rd RP)

01 July 2015-

30 June 2019

(4th RP)

Dagupan Electric Company (DECORP)

Cagayan Electric and Light Company (CEPALCO)

Cotabato Light and Power Company (CLPC) 01 April 2009 – 30

March 2013

(2nd RP)

01 April 2013 – 30

March 2017

(3rd RP)

Iligan Light and Power Company (ILPI)

Mactan Electric Company (MECO)

Cabanatuan Electric Corporation (CELCOR)

01 July 2010 –

30 June 2014

(2nd RP)

01 July 2014 –

30 June 2018

(3rd RP)

La Union Electric Company (LUECO)

Tarlac Electric, Inc. (TEI)

Visayan Electric Company (VECO)

Ibaan Electric and Engineering Company (IEEC)

Davao Light and Power Company (DLPC)

Panay Electric Company (PECO)

01 October 2011-

30 September 2015

(2nd RP)

01 October 2015-

30 September 2019

(3rd RP)

Subic Enerzone (SEZ)

San Fernando Light and Power Company (SFELAPCO)

Bohol Light Company, Inc. (BLCI)

Angeles Electric Corporation (AEC)

Clark Electric Distribution Corporation (CEDC)

Status of PBR implementation

• In terms of Section 1.9 of the RDWR, the RDWR may from time to time be

changed by the ERC.

• In the course of the implementation of the RDWR, the Commission has

identified certain provisions thereof that may need to be revisited. The

review of ERC’s implementation of PBR is aimed at making the rate

setting mechanism, simpler, less complicated and more responsive to

the evolving electricity industry.

• These issues are described in detail in the Issues Paper dated October

2013, issued and posted on October 14, 2013.

• December 23, 2013 – Deadline of submission of comments on the Issues

Paper

• January 14, 2014 – Public Consultation held in ERC Hearing Room

• February 3, 2014 – Deadline of submission of additional comments

33PBR Briefing

Status of PBR implementation

• In April and May 2014, Focus Group Discussions were conducted to

further solicit the views of the stakeholders on the major issues

identified on the review of PBR (Pasig, Cebu, CDO)

• In 2014 (to 2015), the ERC engaged the services of regulatory experts

(Castalia Strategic Advisors) to assist the ERC to find practical

solutions to a number of regulatory issues relating to DUs - the

distribution businesses regulated by the ERC under PBR.

• April 18, 2016 – the Commission issued the “Draft” documents.

• July 12, 2016 – the Commission adopted the following documents:

– Resolution 25, Series of 2016 - “Rules for Setting Distribution Wheeling

Rates for Privately Owned Distribution Utilities Entering Performance

Based Regulation”;

– “Position Paper: Regulatory Reset for the July 1, 2015 to June 30, 2019

Fourth Regulatory Period for the First Entry Group of Privately-Owned

Distribution Utilities subject to Performance Based Regulation”; and

– “Commission Resolution on the Issues on the Implementation of PBR for

Privately Owned DUs under the RDWR”.

PBR Briefing 34

To meet the obligations of the EPIRA

• In line with its mandate under EPIRA and

based on international experience, the ERC

decided that PBR :

– Is the most efficient available form of regulation of

privately-owned distribution and transmission

companies in the Philippines;

– Will over time provide substantial economic and

reliability benefits to electricity consumers;

– Ensure the continued, sustainable operation of

distribution utilities; and

– Will encourage stability in the market

PBR Briefing 35

36

THANK YOU!

Website: www.erc.gov.ph

Email: tariffs @erc.gov.ph

Telefax: (02) 634-8641

ERC Trunkline: (02) 689-5372

PBR Briefing

• ERC to determine the value of the rolled-forward optimized

depreciated regulatory asset base (RAB)

• RAB going forward will be based on initial opening value and the

approved efficient CAPEX for the regulatory period

• ERC will review CAPEX requirements of utilities, based on:

– information provided by the utilities on historical CAPEX

– CAPEX forecasts provided by utilities

– Justification of CAPEX

– Analysis by independent expert(s) on the information provided

by utilities and the levels of efficiency implied

– Other information at the ERC’s disposal

37

RETURN ON

INVESTMENT = ( WACC) X Regulatory

asset base +Working

capital

Building Blocks

PBR Briefing

ERC to determine working capital allowance

• To compensate utilities for capital tied up in operations

• Based on proportion of OPEX

• Does not include purchased power cost

38

Building Blocks

PBR Briefing

RETURN ON

INVESTMENT = ( WACC) X Regulatory

asset base +Working

capital

ERC to determine regulatory WACC

• Parameters are “locked-in” prior to Regulated Entity’s application

• Based on the most current economic parameters

39

Building Blocks

PBR Briefing

RETURN ON

INVESTMENT = ( WACC) X Regulatory

asset base +Working

capital

Regulatory depreciation

• Based on ERC-approved regulatory life of assets

• Straight-line depreciation

• Treatment of asset at end of standard life, but still in service

40

Building Blocks

RETURN OF

INVESTMENT

PBR Briefing

Capex

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6

Cap/n Cap/n Cap/n Cap/n

X

WACC X WACC X WACC X WACC

Depreciation

Return on

Capital

+ + + +

Capex

approved

at year -1

Capex

acquired

at year 3

How are Capital Projects considered?

Regulatory Period

41

ERC will assess a utility’s reasonable and efficient expenses on:

– Business taxes (other than income tax)

– Duties

– Levies

Review will be based on :

• information provided by the utilities on historical expenditure

• expenditure forecasts provided by utilities

• analysis by independent expert(s)

• other information at the ERC’s disposal

42

TAXES

Building Blocks

PBR Briefing

Building Blocks

– the reasonable operating costs, and

– the reasonable maintenance costs

This decision will be based on :

• information provided by the utilities on historical expenditure

• expenditure forecasts provided by utilities

• analysis by independent expert(s) on the information provided by

utilities and the levels of efficiency implied

• other information at the ERC’s disposal

43

OPERATING

EXPENSES

PBR Briefing

Building Blocks

– Set to ZERO

Why was the Income Tax set to Zero?

Recovery of Income Tax is allowed in other jurisdictions under both

the RORB and PBR methodologies

Supreme Court ruling that Income Tax cannot be recovered as

“operating expense”

44

CORPORATE

INCOME TAX

PBR Briefing

Building Blocks

• The analysis of each building block is

done for each year of the regulatory

period

45PBR Briefing