1. 1 Continuing Regulatory Education for the Staff (CREST) ERC Rate-Setting Methodologies December 7, 2010 Rate -Setting Methodologies

2. Energy Regulatory Commission  Created under Section 38 of Republic Act No. 9136 (The Electric Power Industry Reform Act of 2001)  Major Functions:  Sole regulator for electricity industry  Rate Fixing  Protect consumers as they are affected by the rates 2Rate -Setting Methodologies

3. 3 ELECTRIC POWER PLANTS GENERATE ELECTRICITY ELECTRICITY IS THEN CARRIED OVER LONG DISTANCES BY TRANSMISSION LINES TO LOCAL DISTRIBUTION COMPANIES YOUR LOCAL DISTRI- BUTION UTILITY SETS UPTHE POWER LINES IN YOUR COMMUNITY AND SERVICES YOUR NEEDS FOR ELECTRICITY Generation Charge Transmission Charge Distribution Charge Metering Charge HOW IS THIS REFLECTED IN YOUR ELECTRIC BILL? Supply Charge Where does the peso in your electric bill go… Rate -Setting Methodologies

4. How does ERC set the Charges?  Generation  NPC: Return on Rate Base Methodology  IPPs: Review of Individual Power Supply Agreements  Transmission  Previously, Return on Rate Base Methodology  Currently, Performance-Based Regulation  Distribution  Private Distribution Utilities  Previously, Return on Rate Base Methodology  Currently shifting to Performance-Based Regulation  Electric Cooperatives  Cash Flow Methodology  Currently shifting to Benchmarking Methodology 4Rate -Setting Methodologies

5. 5 1.Cash Base 2.Return on Rate Base (RORB) 3.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) Rate -Setting Methodologies

6. 6 Role of Regulation Regulators has to balance the interest of the consumers and industry stakeholders –Seek to maximize a social welfare function to limit the costs that are transferred to consumers –Must also ensure the sustainability and viable operations of a firm Since a regulator can obtain good information about actual costs –It is expedient to set prices based on actual costs –There is little incentive to bring down cost Rate -Setting Methodologies

7. 7 Cash Base Methodology

8. 8 Applicable to Electric Cooperatives (now only for off-grid) Being non-profit, only provides the cash requirement to operate viably plus fund for rehabilitation and maintenance. Rate -Setting Methodologies

9. Cash Base Methodology  Determine Revenue Requirement  Based on a historical test year OPERATING and MAINTENANCE EXPENSES OPERATING and MAINTENANCE EXPENSES PAYROLL REINVESTMENT or CAPEX FUND DEBT SERVICE OTHER REVENUE ITEMS  necessary, legitimate, prudent, continuing, normal  includes operating and maintenance expense and taxes  updated salaries plus allowable benefits Allowable loans obtained from financial institutions or the NEA.  Allowance used to finance capital expenditure program 9  Revenues arising from operations should be shared by DU Rate -Setting Methodologies

10. 10 Return on Rate Base (RORB) Methodology

11. 11 Return on Rate Base 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. Rate -Setting Methodologies

12. How does the Return on Rate Base Methodology set your rate?  Determine Revenue Requirement  Based on a historical test year OPERATING EXPENSES OPERATING EXPENSES PAYROLL RETURN OF INVESTMENT RETURN ON INVESTMENT OTHER REVENUE ITEMS  necessary, legitimate, prudent, continuing, normal  includes operating and maintenance expense and taxes  updated salaries plus allowable benefits  12 % of rate base  value of used and useful assets + working capital  depreciation 12  Revenues arising from asset - based operations should be shared by DU Rate -Setting Methodologies

13.  Advantages  Provides earnings stability by guarding against excessive or unduly meager earnings  As practiced, allows reflection of current prices through adjustment mechanisms  “pass through” of expenses to avoid frequent reviews  Timing of regulatory reviews when utility “under-earns  Disadvantages  Limited incentive for exceptional performance  Averch-Johnson effect on capital costs:  If allowed return > capital costs = incentive to over-invest  If allowed return < capital costs = incentive to under-invest  Information intensive  Costly and lengthy regulatory hearings  Consumers, rather than the regulated firm, bears much of the market risk How does the Return on Rate Base Methodology set your rate? 13Rate -Setting Methodologies

14. “The RORB Rate Case Cycle” Commission Orders new Rates ERC conducts hearings and evaluates filing Utility monitors results of operations Utility files a Rate Case How does the Return on Rate Base Methodology set your rate? 14Rate -Setting Methodologies

15. Why is there a need for another rate setting methodology?  Efficiency gains  Improved dependable quality service  Reduce costs  Provide reasonable rates 15Rate -Setting Methodologies

16. 16 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 price is 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 price is controlled thru a maximum average price (MAP) cap. Rate -Setting Methodologies

17. 17 Performance Based Regulation - 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  Various manners exist in which this benefit is shared Rate -Setting Methodologies

18. 18 Performance Based Regulation – 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 Rate -Setting Methodologies

19. Performance Incentive Scheme 19Rate -Setting Methodologies PenaltyAverageReward Performance IndexUnitsWeightLevel ELevel DLevel CLevel BLevel A Interruption frequency rate (IFR)No0.20 20.1615.405.901.14 Cumulative Interruption Time (CIT) – forced only Hours0.2012.599.563.520.49 Cumulative Interruption Time (CIT) – pre-arranged only Hours0.158.326.191.94 Probability of voltage levels falling within prescribed limits %0.106%5%3%2% System losses%0.05 8.5%7.5%7% Average time to process application for Regulated Distribution Services Days0.10221974 Average time to connect premises to the Regulated Distribution System Days0.107421 Call center performance0.1031.93%25.5%12.66%6.23%

20. Guaranteed Service Level 20Rate -Setting Methodologies

21. Performance - based regulation… –Methodology –Process Rate -Setting Methodologies21

22. Annual Revenue Requirement  Determine forecasted Annual Revenue Requirement for a Regulatory Period OPERATING EXPENSES 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  Weighted Average Cost of Capital (WACC) X rate base  value of optimized used & useful assets + working capital  depreciation based on standard asset lives  set to zero 22Rate -Setting Methodologies

23. Annual Revenue Requirement OPERATING EXPENSES OPERATING EXPENSES TAXES RETURN OF INVESTMENT RETURN ON INVESTMENT INCOME TAX Regulatory Year 1 OPERATING EXPENSES OPERATING EXPENSES TAXES RETURN OF INVESTMENT RETURN ON INVESTMENT INCOME TAX OPERATING EXPENSES OPERATING EXPENSES TAXES RETURN OF INVESTMENT RETURN ON INVESTMENT INCOME TAX OPERATING EXPENSES OPERATING EXPENSES TAXES RETURN OF INVESTMENT RETURN ON INVESTMENT INCOME TAX Regulatory Year 2Regulatory Year 3Regulatory Year 4 REGULATORY PERIOD 23Rate -Setting Methodologies

24. The control mechanisms… 1. A review every 4 years (Reset Process) –to determine forecast revenue requirement –to determine/benchmark the actual cost that has been incurred by the Utility; –to determine/adjust the service performance measures 24Rate -Setting Methodologies

25. 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 (reward or penalty) 25Rate -Setting Methodologies

26. Price-cap formula which is a variant of the so-called “CPI-X” form of regulation It essentially means : Next year’s price is capped at this year’s price plus an allowance for general cost increases, reduced by an efficiency factor. MAP t means the maximum average price (for distribution services) for year t 26Rate -Setting Methodologies

27. Reset Process Public Hearings Utility Submits Revenue Application ERC Values Assets 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 27Rate -Setting Methodologies

28. 28 Timelines on PBR - Transmission  Transmission  2 nd Regulatory Period – January 2006 – December 2010  3 rd Regulatory Period – January 2011 – December 2015  December 18, 2009 – NGCP filed its application for Maximum Annual Revenue for the 3 rd Regulatory Period  July 21, 2010 – ERC issued its Draft Determination  November 22, 2010 – ERC issued the Final Determination Rate -Setting Methodologies

29. Timelines on PBR – Private DUs EntrantRegulatory Period Manila Electric Company (MERALCO) July 01, 2007- June 30, 2011 Dagupan Electric Company (DECORP) Cagayan Electric and Light Company (CEPALCO) Cotabato Light and Power Company (CLPC) April 01, 2009 - March 30, 2013 Iligan Light and Power Company (ILPI) Mactan Electric Company (MECO) Cabanatuan Electric Corporation (CELCOR) July 01, 2010 - June 30, 2014 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) October 01, 2011- September 30, 2015 Subiz Enerzone (SEZ) San Fernando Light and Power Company (SFELAPCO) Bohol Light Company, Inc. (BLCI) Angeles Electric Corporation (AEC) Clark Electric Distribution Corporation (CEDC) 29Rate -Setting Methodologies

30. PBR been successfully implemented… Argentina Australia Brazil Mexico New Zealand United Kingdom United States 30Rate -Setting Methodologies

31. Regulatory Outcomes - Australia Significant price improvements have been experienced in overseas jurisdictions under PBR style price control arrangements – Graph below for DU in Australian state of Victoria  Notes :  Source data from Essential Services Commission, Victoria, Australia.  Po & X Factor from 2006 are from Draft Decision  Actual CPI from Australian Bureau of Statistics, Forecast from EIU  Effective Price Index is in Nominal terms 31Rate -Setting Methodologies

32. Regulatory Outcomes - UK Significant price improvements have been experienced in overseas jurisdictions under PBR style price control arrangements – Graph below for UK DUs  Notes :  Source data from OFGEM, UK.  Po & X Factor from 2005 are from OFGEM Proposal  Actual RPI from Uk Statistics Office, Forecast from EIU  Effective Price Index is in Nominal terms 32Rate -Setting Methodologies

33. NGCP Final Determination for 2011-2015 Rate -Setting Methodologies33

34. What will PBR achieve? What it will do to the utility  Provide you with better service  Improve the quality of electricity delivered to you  Reduce costs due to operational efficiency What it will do for the consumer  Receive better quality of service and electricity from the utility  Share in the utility’s operational efficiency  More value for his money What it will do for the relationship between the utility and the consumer  Make it more equitable, more fair 34Rate -Setting Methodologies

35. 35 Rules for Setting Electric Cooperatives’ Wheeling Rates

36. Vision for Electric Cooperatives Financially self-sufficient Operational Efficiency Member-Consumer responsive Quality Service Streamlined Regulation Rate -Setting Methodologies36

37. RSEC-WR  The Rules was promulgated by ERC on September 23, 2009;  Applicable only to on-grid Electric Cooperatives  Electric Cooperatives’ groupings  Develop for each group –Initial Tariff Cap –Tariff Glide Path Performance Standards Efficiency Rate -Setting Methodologies37

38. 38 DateParticulars September 23, 2009Resolution No. 20, Series of 2009 - A Resolution Adopting the Rules for Setting the Electric Cooperatives’ Wheeling Rates October 12, 2009Start of the period for filing of application January 2010Implementation of Provisional Authority (PA) in accordance with the Order issued by the Commission February - April 2010Jurisdictional hearings for the 94 on-grid EC’s who filed under the RSEC-WR April 2010Formulation and Filing of the Rules Governing the Tariff Glide Path under the RSEC-WR May - October 2010Evidentiary hearings for the 94 on-grid EC’s who filed under the RSEC-WR Background Rate -Setting Methodologies

39. 39 ParticularsDescription EC grouping On-grid ECs clustered into seven (7) groups Policies being implemented Rate -Setting Methodologies

40. 40 Classification of ECs Rate -Setting Methodologies

41. 41 ParticularsDescription EC grouping On-grid ECs clustered into seven (7) groups New Customer Segmentation Residential Low Voltage Higher Voltage Policies being implemented Rate -Setting Methodologies

42. Customer Classes 42 Transition from the present to the Proposed Customer Classes PresentProposed Residential Sale for Resale BAPA Small Commercial Low Voltage Small Industrial Public Buildings Streetlights Irrigation Large Commercial Higher Voltage Large Industrial Rate -Setting Methodologies

43. 43 ParticularsDescription 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) Policies being implemented Rate -Setting Methodologies

44. 44 RSEC-WR Rates Rate -Setting Methodologies

45. Members’ Contribution for Capital Expenditures (MCC) 45  To be used solely for capital expenditure projects  If more funds is needed, the coop may collect additional by securing consent of its member-consumers, subject to the same limitations on its use Rate -Setting Methodologies

46. Regulatory Timelines 46 Jan 2010 Jan 2011 Jan 2012 Dec 2015 Current Rates Transition Rates SIT DSM = TARIFF GLIDE PATH Rate -Setting Methodologies

47. 47 RULES FOR SETTING THE ELECTRIC COOPERATIVES’ WHEELING RATES Standard Initial DSM Charges Members’ Contribution for capital expenditures STANDARD INITIAL TARIFF New DSM (Regulatory Period) Standard Initial DSM ( 1 + I - X + S ) Tariff Glide Path DSM will be adjusted annually based on the Tariff Glide Path Rate -Setting Methodologies

48. 48 Standard Initial DSM Charges x ( 1 + Index “I” – Efficiency Factor “X” + Performance Incentive “S”) An escalation factor to be used in adjusting the rates to reflect current cost provide for the sharing of the ECs efficiency w/ the member-consumers EC shall be rewarded or penalized based on performance RULES FOR SETTING THE ELECTRIC COOPERATIVES’ WHEELING RATES Tariff Glide Path Rate -Setting Methodologies

49. 49 ELECTRIC POWER PLANTS GENERATE ELECTRICITY ELECTRICITY IS THEN CARRIED OVER LONG DISTANCES BY TRANSMISSION LINES TO LOCAL DISTRIBUTION COMPANIES YOUR LOCAL DISTRI- BUTION UTILITY SETS UPTHE POWER LINES IN YOUR COMMUNITY AND SERVICES YOUR NEEDS FOR ELECTRICITY Generation Charge Transmission Charge Distribution Charge Metering Charge HOW IS THIS REFLECTED IN YOUR ELECTRIC BILL? Supply Charge Pass-through GENERATION CHARGES (60%) PBR (Transmission & Distribution) (40%) Where does the peso in your electric bill go…

50. 50 VISION: Asia’s benchmark for excellence in power regulation. MISSION: The Energy Regulatory Commission promotes and protects the long-term consumer interests in terms of quality, reliability, and reasonable pricing of a sustainable supply of electricity. Rate -Setting Methodologies

51. 51 THANK YOU! Tariffs and Rates Division Regulatory Operations Service tariffs@erc.gov.ph, ajmortega@erc.gov.ph 634-8641 www.erc.gov.ph Rate -Setting Methodologies