USAID study: Electricity ‘spot’ market a farce

(First of two parts)

The so-called Wholesale Electricity Spot Market (WESM)—from which Meralco bought 9.5 percent of its power at an unbelievable P33/kwh price in November, resulting in a 20 percent to 25 percent spike in consumers’ electricity bills for December—is a farce.

Transactions in the WESM are mostly not spot transactions: Some 90 percent of power purchases from this market are bilateral agreements specifying the amount, price, and date of delivery of the power.

That’s the conclusion from data and analysis contained in a detailed study released in April 2013 entitled “Challenges in Pricing Electricity Power Services in Selected ASEAN Countries.” The report was produced by the United States Agency for International Development (USAID) and prepared by a team of Filipino and American economists for the Virginia-based US government contractor International Resources Group.

WESM20140106

WESM isn’t a spot market: Only 10 percent of its transactions are spot.

And even if WESM price represent market spot prices, my analysis of the WESM data (available in its website) show, Meralco’s power purchases it reports as WESM prices—and passes on to consumers—are way above the average for the entire WESM.

From January 2012 to October 2013 (the latest data available at the WESM website), the cost of Meralco’s WESM sourced power averaged P11.7 per kilowatt hour (kwh).

That’s more than double the average P5.3/kwh reported as WESM prices. (The WESM strangely hasn’t yet released its report for November, when Meralco reported buying from it at P33/kwh.)

How can Meralco’s purchases from WESM be priced more than double the average for WESM? Either its managers are plain stupid, buying power more expensive than that offered in the market. Or there is collusion, so that the power firms selling at such high prices will generate windfall profits—at the expense of consumers.

The data even suggests that rather than market conditions, the biggest factor that has determined WESM prices paid by Meralco have been the quality of governance under different administrations.

Source: Meralco

Source: Meralco

Meralco’s WESM prices during President Arroyo’s term averaged P5.3/kwh. Despite additions to the supply of power, WESM average prices under President Aquino have doubled to P11.3/kwh.

These data and conclusions raise serious questions on the legality of Meralco’s steep rate hike for December, against which the Supreme Court had issued a temporary restraining order pending its decision on petitions questioning its constitutionality.

Created as one of the key reforms ordered by the Electric Power Industry Reform Act of 2001, the WESM is supposed to be a market in which all power produced (in Luzon and Visayas so far) are offered at generators’ offer prices on an hourly (“spot”) basis, with distributors buying at those prices or just rejecting them.

In theory, that would drive down prices, as generators in order to recover their investments would have to sell as much of the power they produce. Prices would decrease when demand—for a host of reasons, for example, the reduction in air-conditioning usage in December—falls. The bids are even offered on an hourly basis, ostensibly to take advantage of fluctuations in demand and supply throughout the day. “A beautiful experiment,” a naive commentator even seems to have fell in love with WESM.

In theory that is, and as in many things are in our country, the practice is entirely different.

The WESM is a misnomer, as the bulk of electricity transacted in it is sold through the so-called bilateral contracts, not through a bid-based spot system it is supposed to be. An analogy would be if only 10 percent of stock market transactions were actually done on the trading floor through its bidding system, while 90 percent were through private deals agreed upon by holders of the shares with the buyers.

“The WESM allows the direct sale of electricity bilaterally between a seller and a buyer [and] the quantity and price are negotiated outside WESM,” the AID report pointed out. It emphasized: “ Bilateral contracts between buyers and sellers specify quantities and prices of electricity in advance.”

That is, contrary to what the generators and its apologists have been trying to portray, Meralco wasn’t the victim of blind forces such the shutdowns of a few generators because of Typhoon Yolanda. The bulk of the shutdowns had been scheduled, so Meralco could have contracted through bilateral contracts power months ago, so it would not have been so desperate as to buy from generators at an atrociously high price of P33/kwh. Unless of course it wanted to enrich these generators, since after all,  it is passing on the high price to consumers.

That “atrocious” is even an understated adjective is obvious in that this P33/kwh price is 323 percent higher than the average P7.8/kwh WESM price form July 2007 to September 2013.

The AID report explained how WESM’s is hardly a spot market:

“In the first month of trading at WESM, the bilateral contracts quantity (BCQ) was 56 percent of the total electricity traded Within six months, the BCQ share jumped to 83 percent and remained above 80 percent except in January and February 2009 when the BCQ shares were 79 percent and 77 percent, respectively. In the first ten months of 2011, the monthly BCQ shares breached the 90 percent mark seven times and in the other three months the shares were 89 percent and 90 percent. The highest BCQ share occurred in April 2011 at 95 percent.”

This pattern continued in succeeding years, with the monthly reports of WESM (the latest however is only for October 2013) showing that bilateral contracts accounted for 90 to 92 percent of electricity sold at the erroneously called “spot market.” (see image)

The AID report explained: “As the parties involved commercially negotiate these contracts, the terms of the agreements vary. In some contracts, stipulated prices are differentiated by day and time of use; in others, they are not. Some contracts provide a detailed basis of the stipulated price; others do not. Factors that trigger adjustments in contracted prices vary, but whatever the basis, they are meant to reflect changes in fuel prices.”

It concluded: “Of the total quantity traded in WESM during 2011, the proportion settled at bilateral contract prices [rather than spot market prices] ranged from 88 percent [December 2011] to 95 percent [April 2011]. Undoubtedly, the generation component is largely influenced by prices stipulated in bilateral contracts entered into by generation companies and DUs [distribution utilities].” Clearly implied by the AID study there is that WESM prices aren’t determined by spot market conditions.

The AID report said that the intention of the bilateral contracts is “as a hedge against spot market price volatility.” “These contracts are usually contracts for differences [CfDs],’ it explained. “If the spot price is higher than the contract price, the seller pays the buyer the difference; if the spot price is lower than the contract price, the seller collects the difference from the buyer.”

However, Luis Miguel Aboitiz, senior vice president of power generator Aboitiz Power and president of Philippine Independent Power Producers Association claimed there are no such contracts in the WESM.

In an emailed reply to my questions, he claimed: “There is no forward market for power [in the Philippines]. In other countries power is purchased through derivatives or ‘contract for differences’. There are active forward markets through which utilities, generators, and industries can buy or sell “blocks” of power in a forward market.”

Aboitiz appears to have missed the reality that bilateral contracts made by power generators and distributors are intended for the latter to have its necessary electricity supply over the specified contract period at specified prices, or with conditions such as trigger events.

While obviously not a formal forward contract, these provide the utility company a buffer against unfavorable developments in the future—such as unscheduled shutdowns of regular power suppliers. While not called “forward contracts,” the bilateral contracts’ function is obviously the same.

This of course is perfectly understandable for, even required of, distributors such as Meralco in order to avoid the destabilizing impact of volatile market prices—unless they cavalierly think that increases would anyway be passed on to meek consumers.

But if such bilateral contracts account for ninety percent of what is called the Wholesale Electricity Spot Market—as in the present situation—then it is obviously no longer a spot market, with electricity prices down to the consumer level determined not by market conditions but agreements between big corporations.

The likelihood of collusion—of price setting by generators and distributors—is obvious especially considering the fact that the major stockholders of distributors, especially Meralco, are firms which also control power generators themselves.

Maybe that’s a big reason why Meralco Chairman Manuel Pangilinan recently announced that either the firm itself or his Indonesian-controlled holding company Metro Pacific would aggressively be going into power generation this year.

(Part 2 on Wednesday: Why the spot market has been subverted, why the WESM is a damaged version of its model, Singapore’s National Electricity Market, and why the recent Meralco rate hike is illegal and unconstitutional.)