The MERALCO Franchise: RA 9209

MERALCO is the largest distribution utility in the country.

According to the flyleaf profile in its 2013 Annual Report, MERALCO powers 5.3 Million customers, is home to approximately 25% of the entire Philippine population, accounts for 75% of the Luzon electricity market – 55% nationwide – supplies the power needs for 50% of GDP, 60 % of total manufacturing output.

MERALCO’s sales revenue for 2013 was P298B. Market capitalization was P282B. But we hasten to add that “Equity…” was only P75.1B.

In exchange for this huge chunk of the market, the franchise requires that MERALCO must meet minimum performance standards, such as: the operation and maintenance, in a superior manner, of an open and non-discriminatory electricity distribution system; the supply of electricity in a least cost manner; the preservation of the franchise; the promotion of consumer interest.

Just as important is the negative list in the franchise: “…   MERALCO must not engage in any activity that will constitute an abuse of market power, such as but not limited to, unfair trade practices, monopolistic schemes and any other activities that will hinder competitiveness or businesses and industries.”

Related laws and jurisprudence….

RA 9209 is not our only guide on the cost and quality of service MERALCO must provide us:

  • RA 9136 or EPIRA ordains least cost supply by Distribution Utilities and limits retail rate charges to reasonable and economic costs. Taken together, the franchise and EPIRA provide ample guidance on how we should be charged for our electricity, if only the industry is fairly regulated!
  • The courts, particularly our Supreme Court, Illuminated on the criteria of just and reasonable costs franchised utilities like MERALCO must meet.  In the case of LAMP, Lualhati et al vs MERALCO, the landmark decision that led to the P30B refund in 2002, our right to least cost supply was raised to the level of our right to liberty, with the State enjoined to protect both rights with equal resolve.

Chief Justice Reynato Puno, a Senior Associate Justice at that time, laid down the rules in these clear and unequivocal terms: for cost to be recoverable, he said, it should be a requisite for the operation, recurring and redounding to the benefit of captive customers.

Rate regulation, he said, is the art of reaching a result that is good for the public utility and is best for the public…. Best for the public!

Has MERALCO complied with its franchise obligations?

The question today is: has MERALCO faithfully fulfilled its franchise obligation to supply us electricity in a least cost manner?

Our answer is ….  A resounding NO! And we will amply show why, in this presentation.

MERALCO Rates & Profits Today

The steep climb in MERALCO’s DSM or Distribution, Supply and Metering Charge over the last five (5) years, resulting in the phenomenal spike in MERALCO’s profits and earnings over the same period, is the best proof that we are made to pay an arm and a leg, to allow MERLACO to make money – hand over fist!

As we process MERALCO’s rate charges, please bear in mind MERALCO’s Responsibility to the Public under Sec. 4 of its Franchise – the responsibility to supply us electricity in a least cost manner.

By the end of the 3rd Regulatory Period on June 30, 2015… just three months from now, MERALCO will have collected from us the following charges or rates:

  • Capex or Capital Expense  ----            P37.1B
  • Opex or Operating Expense ----          P61.2B
  • Return on Capital ----                           P79.8B
  • Regulatory Depreciation ---                  P23.3B
  • Under-Recoveries  ---                          P24.1B
  •  Allowance for Working Capital  ---        P4.7B

Note that the highest expense or cost item is Return on Capital at P79.8B.

Opex, an item that could fall squarely with Justice Puno’s definition of recoverable costs – requisite, recurring and redounding to our benefit -- is P61B or P18.6B lower than Return on Capital.

Capex, at P37B… is not even half of Return on Capital.

Opex and Capex, as they are, still need a thorough-going review and audit, as we shall show later.

And where does the fabulous Return on Capital go? It goes partly to the payment of interest on debts but mostly to the dividends of shareholders, including the publicly traded shares.

No doubt, these phenomenal returns are what put MERALCO shares among the darlings of the exchange. But at what cost to captive customers?

All these rates were facilitated under Performance Based Regulation or PBR, which has pegged rate-setting to a four-year period under a process fraught with technicalities, loopholes and a few bottomless pits.

Tracking MERALCO’s DSM Rates

Before PBR and under Return on Rate Base in 2003, MERALCO’s DSM rate was P0.7957 pkwh.

Under rate unbundling – between 2003 and early 2009 – that DSM rate was P0.9657 pkwh.

With the full implementation of PBR in May 2009, that DSM rate climbed to P1.2227 pkwh, aggressively rising year-on-year, reaching its highest in 2014 at P1.6474 pkwh.

In 2010, it was P1.4917 pkwh; 2011, P1.6464 pkwh; 2012, P 1.6012 pkwh; 2013, P1.6303 pkwh.

MERALCO’s fabulous returns that exceeded P1.4B a month in its banner years were driven by the dizzying hikes in MERALCO’s DSM rates.

Question thus arises: are these rates least cost? Is a P20.6B charge for Return on Capital for one year, in 2015, a “prudent and reasonable economic cost”?

Note… that when MERALCO distributes or conveys 33B kwh in one year, and charges us P20.6B for Return on Capital for that year, we are in effect charged P0.6242 pkwh for return on capital alone.

MERALCO rakes in annual net earnings of P17B, or P1.4B per month.

A 250 kwh House Hold, not typical of those in this hearing today but representative of many MERALCO customers, will pay an additional P1, 560.50, to make MERALCO the most dazzling darling of the stock exchange.

Is that rate consistent with least cost under RA 9209?

Guided by Chief Justice Puno’s wisdom, we must say that rate is more than good for the public utility – MERALCO; but can we rightly say it is the best for the public – MERALCO’s captive customers?

Tracking MERALCO’s profits

To better appreciate MERALCO’s annual net earnings, it is best to start with the Return on Capital under PBR.

As approved by ERC in Case No. 2010-069 granting MERALCO its Annual Revenue Requirements for the 3rd Regulatory Period, the following were collected from us as Return on Capital: 2012, P19.137B; 2013, P19.770B; 2014, P20.261B; 2015, P20.684B, or a total of P79.853B.

From such a generous Return, MERALCO reported the following net earnings: 2011, P14.88B; 2012, P16.2B; 2013, P17.023B.

The combined 1st and 2nd Regulatory Periods saw MERALCO’s earnings leap-frog from P2.7B under RORB to P3.1B in 2008 under Rate Unbundling to P7B in 2009, the first year under PBR, thence to P12.155B in 2010, the biggest percentage increase, year-on-year.

Given the phenomenal rise in earnings, undoubtedly boosted by the galloping rate of increase in MERALCO’s authorized Return, will this still pass as least cost, prudent, reasonable, recurring, beneficial cost?

The Under-Recovery Charges

A major item in the so-called Revenue Building Blocks of MERALCO’s current ARR is the Under Recovery, or “Recoveries from the 2nd RP” or Regulatory Period. This amount has remained mysterious for lack of any detailed explanation in the ARR application. It became even more enigmatic as the computation – from the application to the publicly-announced claim and as finally awarded – went thru several permutations.

The total award by ERC is P24.15B – P6.5B in 2012; P6.7B in 2013; P4.5B in 2014; and, P6.3B for 2015.

In an item in Business Mirror, September 1, 2010, MERALCO vice president for utility economics Ivanna dela Pena reported that MERALCO had a claim for P18B of under-recoveries.  This was in a disclosure statement at the Exchange where MERALCO stock is traded.

This was lower than MERALCO’s application (in ERC Case 2010-069) filed in June 2010, for P20.1B.

We would have been happy with MERALCO’s voluntary downscaling of its claim, but that was not to be so, as ERC increased the award to P24.18B.

Given the three computations, which one would be the least cost, the prudent, reasonable and economic cost?

Under recovery, in the Issues Paper put out by ERC in October 2013, is described as follows: “The purpose of this recovery is to correct the maximum average price-cap where under or over recovery of revenue has occurred during the previous Regulatory Year, purely as a result of the actual weighted average tariff per kWh for a regulatory year being found to be higher, or lower, than that approved for that year.  This is an absolutely scary proposition as it portends that there will be NO REGULATORY AUDIT of the previous ARR. A purely arithmetical approach to the settlement/disposition of the PBR- ARR spending and procurement programs, complex and technical as they are, will deprive consumers the chance to check least cost as well as prudent, reasonable and beneficial costs.

All approvals of the ARR are based on the utility’s estimates, presumably challenged and checked by ERC as regulator, but hardly, if at all.

With the approach foisted by ERC, how do we now check MERALCO for compliance with its least cost supply obligation?

Other Outlandish Charges

In addition to the under recoveries, MERALCO also charges us other costs that PBR has spawned -- charges that negate least cost and create new and unheard-of burdens for the captive customers.

  1. Regulatory Liaison & Compliance. This is a new item for which MERALCO charges us P2.2B for the 3rd RP.

ERC’s RDWR or Rules for setting Distribution Wheeling Rates authorizes ERC to “engage the services of an independent expert/external consultant” to assist ERC. We have been asking for copies of the consultancy contracts to assess for ourselves if the contracts are least cost, prudent, reasonable and beneficial to us. In addition, we want to know the expertise of their experts.

In an exchange of correspondence between Nasecore and a senior official of ERC, Nasecore was advised that there were no contracts to show as there were no consultants hired.

That is P2.2B to be accounted for, and to be checked against the least cost supply obligation of MERALCO.

  1. Advertising. MERALCO was granted P1.796B for advertising in the 3rd RP. Based on the ARR and from 2011 to 2013, P1.002B had been collected. But for that period, according to MERALCO’s 2013 Annual Report, only P381.6M was spent.

To the question of whether MERALCO charges us at least cost, the answer must be in the negative, because in this case, MERALCO collected from us money that they did not need for advertising.

What is worrisome in these cases of patently overstated revenue requirements is the footnote in the Capex and Opex Tables annexed to the Order in ERC Case 2010-069, to wit: “The allocation per line is indicative only and the Regulated Entities are not required to adhere strictly to these. Control and verification will occur based on total expenditures.

Such language is pregnant with possibilities, given a total expenditure program that runs into hundreds of billions.

Again, least cost can only be confirmed if we can track and run down the expense items and the costs with due diligence and meticulous attention to verifiable facts.

Did MERALCO violate Sec. 1 & Sec. 13 of RA 9209

Sec. 1 specifies MERALCO’s franchise privileges (distribution) and defines the franchise territory. Sec. 13 prohibits the lease, sharing or selling of these privileges under the franchise.

In a Press Release on March 4, 2013, MERALCO announced a joint venture with First Pacific Company Limited of HK for the acquisition of an 800MW LNG Combined Cycle Power Plant in Jurong Island, Singapore, reportedly a US$488.0M investment.

With MERALCO going beyond operation of a distribution system, did it not violate RA 9209?

MERALCO investing in Singapore, beyond the specified locations in Sec. 1, did it not violate RA 9209?

The franchise grantor – Congress – should be interested in this.

From the captive customer’s perspective, did MERALCO apply any of its rate collections towards the acquisition of the Jurong power plant? If it did, then we have every basis to claim that MERALCO has violated and thus abandoned its franchise.

Such an expense will not benefit us, in any way.

Moreover, given Sec. 13 of its franchise, could MERALCO go into a joint venture with a non-Filipino company given the Constitutional limitations adverted to in the same Sec. 13?

We raise these concerns to the Committee.

Our Conclusions

While we are not prepared at this point to discuss abuse of market power and anti-competitive behavior (some other groups are working on it), we feel that the presentation of MERALCO’s violations of its least cost supply obligation under the Franchise are sufficient bases to conduct a more thorough and in-depth review of MERALCO’s operations.

It is possible that MERALCO will raise PBR in its defense, claiming it is just complying with the ERC issuances.

We hope the Committee will look beyond such flawed reasoning. The infirmities of PBR cannot and should not be used as an excuse or cover for MERALCO’s failure to fulfill its mandate to supply electricity to us in a least cost manner.

In other words, even if, or when, ERC lays down a clear path towards costs higher than least cost, MERALCO under its franchise remains under obligation to supply at least cost and should be held accountable to that standard.

Incidentally, FDC, Nasecore, Nagkaisa and many others in the Power to the People Coalition have persistently pushed for the immediate scrapping of PBR. 

Ang PBR po ay Parusa Sa Bayan, hindi Performance Based Regulation!

The Consumers’ Options

We thank the Committee for initiating this review of the MERALCO franchise.

From this review, we are more convinced that it is now time to turn away from the ungainly bigness like MERALCO and cut its franchise into economic sizes that could yield and share efficiency gains.

Expressed differently, MERALCO’s failure to supply electricity in a least cost manner means that it has not attained the ideal economies of scale in its operations; or having attained it, refuses to share such efficiency gains, as ordained in EPIRA.

Given the foregoing, and as captive customers of MERALCO, here then are our proposed action lines to the Committee:

First, let us review whatever are forthcoming to consumers as refunds from MERALCO, whether from individual deposits or from overcharges as determined in final court orders.

Second, organize and empower the consumers so that short of a takeover, they can have a more participatory and pro-active engagement with the utility.

Third, we hope the Committee can reach out to the Energy Committee so that the underlying and fundamental flaws in the industry that have bred abuse and misuse of franchise power can be corrected.

Finally, the regulatory collapse evident in the crisis in power rates and electricity supply must be addressed by the Legislators. The systematic erosion of public confidence in regulated prices and rates because of PBR can be remedied at the legislative policy level, by providing clearer guidance to the regulators, defining their boundaries and  establishing accountability mechanisms in case of their failure.

With the MERALCO monopsony dismantled and a true and trustworthy regulator in place, the industry might yet flourish.



Prepared for FDC by: BUTCH L JUNIA

Mobile: 09175215611


March 2, 2015

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