ERC Rate-Setting Methodologies

Continuing Regulatory Education for the

Stakeholders (CREST) for Visayas Journalists

8 September 2016

Engr. Alvin Jones Ortega Gen

Chief, Tariffs and Rates Division
Trans
Regulatory Operations Service
Dist

ERC Rate Methodologies 1

 The industry before and after
restructuring

Before After

Captive
Generation & Distribution & Captive &
Transmission Supply Customers Generation Transmission Distribution Supply
Contestable
Customers

ERC Rate Methodologies 2

 Electric Power Industry
Restructuring
•  Generators (157)
–  NPC/PSALM
–  San Miguel Energy Corporation
–  Aboitiz Power
–  FirstGen
–  Filinvest Development Corp
•  Transmission (1)
–  Previously, TransCo
–  Now, National Grid Corporation Captive
&
of the Phils (NGCP) Generation Transmission Distribution Supply
Contestable
Customers
•  Distribution (140)
–  MERALCO
–  Visayan Electric (VECO)
–  Panay Electric Co. (PECO)
–  Iloilo I Elec Coop (ILECO I)

ERC Rate Methodologies 3

 t ion
e r a
v e gen
iti
pet
Com

 Reformed  
Power  Sector  
ERC Rate Methodologies 4
 HOW ELECTRICITY IS DELIVERED TO YOUR HOME?
Where does the peso in your electric bill go?

$$$

YOUR LOCAL DISTRI-

ELECTRICITY IS THEN
FUEL IN THE FORM OF ELECTRIC POWER BUTION UTILITY SETS
CARRIED OVER LONG
COAL OR OIL IS PLANTS THEN UP
DISTANCES BY
PURCHASED FROM GENERATE THE POWER LINES IN
TRANSMISSION
ABROAD ELECTRICITY YOUR COMMUNITY
CABLES
AND PAID FOR IN AND
THAT IS TAPPED INTO
FOREIGN CURRENCY SERVICES YOUR
BY LOCAL
NEEDS
DISTRIBUTION
FOR ELECTRICITY
COMPANIES

HOW IS THIS REFLECTED IN YOUR ELECTRIC BILL?

GENERATION TRANSMISSION DISTRIBUTION, SUPPLY.

CHARGE CHARGE & METERING CHARGES

ERC Rate Methodologies 5

Unbundled
Electric Bill

ERC Rate Methodologies 6

Unbundled Electric Bill
Generation* 53%
Transmission* 6%
Systems Loss* 7%
Distribution Distribution System Charge 20%
Supply System Charge

Metering System Charge

Metering Retail Charge

Subsidies / Discounts* Lifeline Subsidy / Discount 1%

Senior Citizen Subsidy / Discount

Government Charges* Local Franchise Tax 8%

Value Added Tax

Universal Charge Missionary Electrification 4%

Environmental Charge

NPC Stranded Debts

NPC Stranded Contract Costs

Feed- in- Tariffs 1%

Note: *adjusted monthly subject to ERC post verification

ERC Rate Methodologies 7

Regulatory Principle

Section 25, Chapter 2 of Republic Act No. 9136 or the

Electric Power Industry Reform Act of 2001 (EPIRA)

RETAIL RATE. The retail rates charged by

distribution utilities for the supply of electricity in
their captive market shall be subject to regulation
by the ERC based on the principle of full
recovery of prudent and reasonable economic
costs incurred, or such other principles that will
promote efficiency as may be determined by the
ERC.

ERC Rate Methodologies 8

Why regulate electricity
distribution (transmission)?

Electricity distribution (& transmission) is a natural

monopoly service
•  Generally not feasible to introduce competitive networks:
•  Lack of economies of scale prohibits parallel networks
•  Physical restrictions (space in the streetscape; access to buildings)
•  Inefficient use of resources (duplication, non-optimal utilisation)

Economic theory indicates that monopoly providers have

incentives to extract “monopoly rent” from consumers
•  Even if not seeking excess profit, monopolies have lower incentive to:
•  Optimise efficiency
•  Strive for customer service excellence
•  Be innovative and pursue new, better solutions

ERC Rate Methodologies 9

Why regulate electricity
distribution (transmission)?

To address this situation, it is widely accepted that some form of

control over the monopoly situations is required
•  Hence the need for regulation

In economic “speak”:

•  Regulators seek to maximise a social welfare function to limit the rents that are
transferred from consumers (or taxpayers) to a firm’s owners and managers

Regulators must also ensure the sustainability and viable

operations of a firm.
•  A firm not earning enough to provide its services, will cease to operate
•  Investors not receiving an adequate return (commensurate with their
investment-risk), will withdraw funds
•  Inadequate infrastructure investment limits service capacity & reliability - this
inhibits economic growth
ERC Rate Methodologies 10
ERC as the Industry Regulator

•  Rules/standards in
providing services
Technical
Regulation

Economic
Regulation
•  pricing of services
quasi-judicial
and quasi-
legislative

•  Order/Decision and Rules

ERC Rate Methodologies 11

How does ERC set the Charges?

Generation (157)
•  NPC: Return on Rate Base Methodology
•  IPPs: Individual review of bilateral contracts or PSA
•  WESM: Price Determination Methodology

Transmission (1-NGCP)
•  Performance-Based Regulation (PBR)

Distribution
•  Private Distribution Utilities (18)
•  Performance-Based Regulation
•  Electric Cooperatives (120)
•  Cash Flow Methodology (Off-Grid) (21)
•  Benchmarking Methodology (On-Grid) (99)

*COST TO SERVE*
ERC Rate Methodologies 12
Rate-Making Methodologies –
Regulated Business

Cash Base

Return on Rate Base (RORB)

Performance-Based Ratemaking (PBR)

•  Rules for Setting Transmission Wheeling Rates (RTWR)
•  Rules for Setting Distribution Wheeling Rates (RDWR)
•  Rules for Setting Electric Cooperatives’ Wheeling Rates
(RSEC-WR)

•  “…principle of full recovery of prudent and reasonable

economic costs incurred…”
ERC Rate Methodologies 13
Cash Base Methodology

Applicable to Electric Cooperatives (off-grid or

SPUG areas)

Being non-profit, only provides the cash

requirement to operate viably plus fund for
rehabilitation and maintenance.

ERC Rate Methodologies 14

How does the Cash Base
Methodology set your rates?

§  Determine Revenue Requirement

§  Based on a historical test year

•  Allowable loans obtained from financial institutions or

DEBT SERVICE the NEA.

REINVESTMENT
or CAPEX FUND §  Allowance used to finance capital expenditure program

PAYROLL §  updated salaries plus allowable benefits

OPERATING and
§  necessary, legitimate, prudent, continuing, normal
MAINTENANCE
§  includes operating and maintenance expense and taxes
EXPENSES

ERC Rate Methodologies 15

Return on Rate Base (RORB)

Cost-of-service Ratemaking

Regulated Entity are set to recover cost of service

prudently incurred plus a reasonable rate of return.

The rate of return pertains to the percentage which

when multiplied by the allowed rate base, provides
a return that will fairly compensate the company
for the risk inherent to the investment.

In order to establish just and reasonable rates,

regulators identify costs incurred during a “test
year”, which is a snapshot of ongoing utility costs.

ERC Rate Methodologies 16

How does the RORB Methodology
set your rate?

§  Determine Annual Revenue Requirement

§  Based on a historical test year

RETURN ON §  12 % of rate base

INVESTMENT §  value of used and useful assets + working capital

RETURN OF §  depreciation

INVESTMENT

PAYROLL §  updated salaries plus allowable benefits

OPERATING §  necessary, legitimate, prudent, continuing, normal

EXPENSES §  includes operating and maintenance expense and taxes

ERC Rate Methodologies 17

Regulation of electricity
distribution (transmission)

Since a regulator can obtain good information about actual costs,

•  It was expedient to set prices based on actual costs

•  This has to be done backward-looking (or ex-post) at regular intervals

However, there are a number of issues with this:

•  If there is no benefit to control costs (all surplus rent is lost), this can increase
costs to above efficient levels
•  Incentives exist to increase costs (“gold-plating”)
•  Requires regular resets, with associated regulatory interference
•  Averch-Johnson effect on capital costs:
•  If allowed return > capital costs = incentive to over-invest
•  If allowed return < capital costs = incentive to under-invest
*Averch, Harvey; Johnson, Leland L. (1962). "Behavior of the Firm Under Regulatory Constraint".

ERC Rate Methodologies 18

 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, thru the
Transmission Wheeling
Rates Guidelines (TWRG),
later amended as Rules for
Setting Transmission
Wheeling Rates (RTWR) in
September 2009
–  In December 2004, thru the
Distribution Wheeling Rates
Guidelines (renamed as
Rules for Setting
Distribution Wheeling
Rates, RDWR).
ERC Rate Methodologies 19
Performance Based Regulation

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

Wide recognition that a trade-off exists between

•  The service quality at which electricity is supplied vs

•  The cost for providing this service

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

ERC Rate Methodologies 20

Performance Based Regulation

EFFICIENCY thru review of the Annual

Revenue Requirement

SERVICE QUALITY thru setting of the

Performance Standards

ERC Rate Methodologies 21

Annual Revenue Requirement
§  Determine forecasted Annual Revenue Requirement
(also called Building Blocks) for a Regulatory Period

§  set to zero

INCOME TAX

RETURN ON §  Weighted Average Cost of Capital (WACC) X rate base

INVESTMENT §  value of optimized assets + working capital

RETURN OF §  depreciation based on standard asset lives

INVESTMENT
§  property taxes, business taxes, duties
TAXES

OPERATING §  operating and maintenance expenditures

EXPENSES §  recurring in the course of providing service
§  legitimate, necessary, prudent and reasonable
ERC Rate Methodologies 22
4-year Revenue Requirement

ERC Analysis of each Building Block for the REGULATORY PERIOD

Regulatory Year 1 Regulatory Year 2 Regulatory Year 3 Regulatory Year 4

INCOME TAX INCOME TAX INCOME TAX INCOME TAX

RETURN ON RETURN ON RETURN ON RETURN ON

INVESTMENT INVESTMENT INVESTMENT INVESTMENT

RETURN OF RETURN OF RETURN OF RETURN OF

INVESTMENT INVESTMENT INVESTMENT INVESTMENT

TAXES TAXES TAXES TAXES

OPERATING OPERATING OPERATING OPERATING

EXPENSES EXPENSES EXPENSES EXPENSES

ERC Rate Methodologies 23

PBR Process
Regulatory Reset Process

Regulatory Year

YEAR YEAR YEAR YEAR YEAR

-1 1 2 3 4

Regulatory Period
ERC Rate Methodologies 24
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

ERC Rate Methodologies 25

Price-linked incentive

ERC Rate Methodologies 26

Guaranteed Service Level

ERC Rate Methodologies 27

 The Rate Reset review by the ERC

ARR and MAP

2nd Regulatory Period 3rd Regulatory Period
100 2.3 2.5
1.99 1.9
90 1.77 1.83
1.71 1.71 2
80 1.47
1.5
70 1.58 1.58 1.58 1.58
1.47 60.9
1.36 59.2 58.0
1.26 1
60 1.16 52.9 54.9
52.0 50.5
47.6 45.3 47.5 47.2
50 43.7 0.5
35.6 36.6 37.3
40 34.3 0
30
-0.5
20
-1
10

0 -1.5
2008 2009 2010 2011 2012 2013 2014 2015

Proposed ARR Approved ARR Proposed MAP Approved MAP

ERC Rate Methodologies 28

Customers have benefited from PBR. It
has led to lesser average number of
brownouts experienced by consumers.
Frequency of brownouts*
9
8.25 times in a year
8 Performance
standard
7
6.97 times in a year
6

5
Significant
4 improvements;
outperforming
3
ERC standards
2

0
2007 2008 2009 2010 2011 2012 2013 2014 2015

*As measured by SAIFI – System Average Interruption Frequency

Index
ERC Rate Methodologies 29
Customers have benefited from PBR. It
has led to shorter average length of
brownouts experienced by consumers.

Duration of brownouts*
250

198.4 minutes in a year

200
Performance
standard
150

126.5 minutes in a year

100
Significant
improvements;
50 outperforming ERC
standards
0
2007 2008 2009 2010 2011 2012 2013 2014 2015
*As measured by SAIDI – System Average Interruption Duration
Index
ERC Rate Methodologies 30
 Timelines
Utility Current RP Next RP
National Grid Corporation of the Philippines (NGCP) 01 January 2011 – 01 January 2016 –
31 December 2015 31 December 2020
(3rd RP) (4th RP)
Manila Electric Company (MERALCO) 01 July 2011- 01 July 2015-
Dagupan Electric Company (DECORP) 30 June 2015 30 June 2019
Cagayan Electric and Light Company (CEPALCO) (3 RP)
rd (4th RP)
Cotabato Light and Power Company (CLPC) 01 April 01, 2009 – 01 April 01, 2013 –
Iligan Light and Power Company (ILPI) 30 March 2013 30 March 2017
Mactan Electric Company (MECO) (2nd RP) (3rd RP)
Cabanatuan Electric Corporation (CELCOR)
La Union Electric Company (LUECO)
Tarlac Electric, Inc. (TEI) 01 July 2010 – 01 July 2014 –
30 June 2014 30 June 2018
Visayan Electric Company (VECO)
(2nd RP) (3rd RP)
Ibaan Electric and Engineering Company (IEEC)
Davao Light and Power Company (DLPC)
Panay Electric Company (PECO)
Subic Enerzone (SEZ) 01 October 2015-
San Fernando Light and Power Company (SFELAPCO) 01 October 2011-
30 September 2019
30 September 2015
Bohol Light Company, Inc. (BLCI) (3rd RP)
(2 RP)
nd
Angeles Electric Corporation (AEC)
Clark Electric Distribution Corporation (CEDC)
 Regulatory Reset Process
LEGEND
Issues Paper ERC Responsibilities
Public Consultation DUE PROCESS

Position Paper UTILITY Responsibilities

Utility Submits Revenue Application

Public Hearings

Draft Determination

Public Consultation

Final Determination

Utility Submits Rate Application

Public Hearings
FOR EACH YEAR
OF THE REGULATORY PERIOD
Rate Decision
ERC Rate Methodologies 32
Rate Implementation
RSEC-WR

The Rules for Setting Electric Cooperatives

Wheeling Rates was promulgated by ERC on
September 23, 2009;

Applicable to on-grid Electric Cooperatives (98

ECs);

Benchmarking Approach (Yardstick Model)

ERC Rate Methodologies 33

RSEC-WR : Objectives

Develop a tariff setting methodology that would be

more responsive to the needs of the Electric
Cooperatives (ECs) given the objectives of the
EPIRA;

Encourage reforms in the structure and operations

of the ECs for greater efficiency and lower costs;
and

Introduce the framework that will allow efficiency

gains to be shared between the EC and the end-
users.

ERC Rate Methodologies 34

 Policies being implemented

Particulars Description
EC grouping On-grid ECs clustered into
seven (7) groups

ERC Rate Methodologies 35

 Classification of ECs

Group  Characteristics  
Group   Number  of  Coops  
Consumption   Number  of  customers  

A   11   <  1   10  to  25k  

B   16   <  1   25  to  50k  
                       C   5   <  1   50  to  100k  
D   17   1  to  2   10  to  50k  
E   28   1  to  2   50  to  100k  
F   15   1  to  3   20  to  150k  
G   6   3  to  5   30  to  150k  
 

ERC Rate Methodologies 36

 Policies being implemented

Particulars Description
EC grouping On-grid ECs clustered into
seven (7) groups

New Customer Segmentation Residential

Low Voltage
Higher Voltage

ERC Rate Methodologies 37

 Customer Classes
Transition to the New Customer Classification

Previous Current
Residential
Sale for Resale Residential
BAPA
Small Commercial
Small Industrial
Public Buildings Low Voltage
Streetlights
Irrigation
Large Commercial
Higher Voltage
Large Industrial

ERC Rate Methodologies 38

 Policies being implemented

Particulars Description
EC grouping On-grid ECs clustered into
seven (7) groups

New Customer Segmentation Residential

Low Voltage
Higher Voltage

Revised Rates New Distribution, Supply and

Metering Charges

Members’ Contribution for

Capital Expenditures (MCC)

ERC Rate Methodologies 39

 RSEC-WR Rates
Residential Low  Voltage Higher  Voltage
       GROUP
PhP/kWh PhP/meter/mo. PhP/kWh PhP/Cust/Mo PhP/kW PhP/kWh PhP/Cust/mo
Distribution 1.0557 1.1577   302.51  
Supply 1.0282 42.82 42.82
A
Metering 0.5792 5.0000 29.12 29.12
MCC 0.5324 0.5324 0.5324
Distribution 0.8449 0.9259   267.90  
Supply 0.7732 40.15 40.15
B
Metering 0.4569 5.0000 28.72 28.72
MCC 0.4004 0.4004 0.4004
Distribution 0.7004 0.7493   213.96  
Supply 0.7156 34.05 34.05
C
Metering 0.5236 5.0000 29.91 29.91
MCC 0.3696 0.3696 0.3696
Distribution 0.5143 0.5134   190.03  
Supply 0.5828 41.61 41.61
D
Metering 0.3669 5.0000 31.19 31.19
MCC 0.2508 0.2508 0.2508
Distribution 0.5782 0.7595   219.68  
Supply 0.6001 42.92 42.92
E
Metering 0.4326 5.0000 35.94 35.94
MCC 0.2904 0.2904 0.2904
Distribution 0.4613 0.4441   167.56  
Supply 0.5376 46.60 46.60
F
Metering 0.3205 5.0000 32.78 32.78
MCC 0.2178 0.2178 0.2178
Distribution 0.2748 0.3748   118.55  
Supply 0.4140 59.73 59.73
G
Metering 0.3460 5.0000 54.92 54.92
MCC 0.1518 0.1518 0.1518
 Article 7 of the RSEC-WR :
TARIFF GLIDE PATH (TGP)

During the Regulatory Period, the rate of the EC per group shall be
adjusted using the formula:
•  Tariff x [ 1 + Index “I” – Efficiency Factor “X” + Performance
Incentive “S”]

It is intended that the TGP is a cap and the EC may move up the
cap, if it is a positive adjustment. If the cap is lower that the current
average tariff, a reduction must be implemented.

Resolution No 8, Series of 2011 – Adopting the Rules Governing the

Tariff Glide Path Pursuant to Article VII of the RSEC-WR

ERC Rate Methodologies 41

To meet the obligations of the EPIRA

In line with international experience, the ERC

decided that PBR :
•  Is the most efficient available form of regulation of 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 utilities
•  Will encourage stability in the market

ERC Rate Methodologies 42

 THANK YOU!
Regulatory Operations Service

Website: www.erc.gov.ph
Email: regulatory@erc.gov.ph
tariffs@erc.gov.ph
Telefax: (02) 634-8641
ERC Trunkline: (02) 689-5372
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