Performance-Based

Regulation
Agenda

I. What is the Performance-Based Methodology (PBR)?

II. Customer involvement in PBR rate-setting
III. The Legal Basis of the Methodology
IV. Benefits of the PBR Methodology
V. Meralco Experience
VI. Bill Deposit
I. What is the Performance-Based Methodology (PBR)?

• It is an internationally-accepted methodology which uses projections of

operating and capital expenditures to enable the regulator to evaluate
investment in facilities to meet customer requirements and prescribed
service levels.
I. Performance-based regulation offers several potential
advantages over traditional prescriptive regulation:

• Flexibility and Innovation

• Cost-effectiveness
• Adaptability
• Focus on Outcomes
Customer
involvement in PBR
rate-setting
Customer involvement in PBR rate-setting
The PBR methodology has undergone
several public consultations and hearings
since 2003

Transmission Distribution

• 2RP reset: 2003-2006 • 2RP resets: 2005-2012

• 3RP reset: 2009-2010 • 3RP reset: 2010-2011

• MAP/Rate translations: 2009-2015
• RAB guidelines 2006/2010
• 4RP reset: 2016
• 5RP reset 2019
Other related PBR Activities requiring Customer
involvement as part of Due Process

• WACC
• RAB Valuation Guidelines/Handbook
• Risk Adjustment Factor Guidelines
• Hybrid Regulatory Framework to apply
to missed Regulatory Period/Years
The Legal Basis of the PBR
Methodology
The determination of the appropriate methodology
is covered by the
rate-setting function of the ERC under the EPIRA.
• “In the public interest, establish and enforce a methodology for setting transmission and distribution
wheeling rates and retail rates for the captive market of a distribution utility, taking into account all
relevant considerations, including the efficiency or inefficiency of the regulated entities. The rates must
be such as to allow the recovery of just and reasonable costs and a reasonable return on rate base
(RORB) to enable the entity to operate viably. The ERC may adopt alternative forms of internationally-
accepted rate-setting methodology as it may deem appropriate. The ratesetting methodology so adopted
and applied must ensure a reasonable price of electricity. The rates prescribed shall be
nondiscriminatory.” [Section 43(f) of the EPIRA]
Regulatory Framework in the
Rate-Setting Function of the ERC
• “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.” [Section 25 of the EPIRA]
Exercise of Reasonable Discretion in the RateSetting
Function of the Government
• “There is a legal presumption that the fixed rates are reasonable, and it must be conceded that the fixing
of rates by the Government, through its authorized agents, involves the exercise of reasonable discretion
and unless there is an abuse of that discretion, the courts will not interfere.” [NASECORE v.
MERALCO, G.R. No. 191150, 10 October 2016]
Timeline: Shift from the RORB Methodology to
the PBR Methodology

• Old Regime: The Rate on Return Base (RORB) Methodology Under the RORB Methodology, rates are
set to recover the cost of service incurred by the distribution utility plus a reasonable rate of return,
whereby historical costs are used to determine the revenue requirement. [NASECORE v. MERALCO,
G.R. No. 191150, 10 October 2016]
• The ERC, acting in accordance with its rate-setting authority under the EPIRA, and after the conduct of
several public consultations, issued Resolution No. 4, Series of 2003 dated 29 May 2003 signaling its
shift from the RORB Methodology to the PBR Methodology in fixing the wheeling rates of regulated
entities. It began with the promulgation of the Transmission Wheeling Rate Guidelines to apply to
Transmission Company.
Timeline: Shift from the RORB Methodology to
the PBR Methodology

• The ERC subsequently issued the following:

• 1. ERC Resolution No. 12-02, Series of 2004 which promulgated the Distribution Wheeling Rate
Guidelines (DWRG) which would govern the setting of distribution rates of privately-owned distribution
utilities that will enter into the new PBR System.
• 2. ERC Resolution No. 39, Series of 2006 which promulgated the Rules for Setting Distribution
Wheeling Rates (RDWR) for privately owned distribution utilities entering the PBR System.
Factors considered by the ERC in
shifting to the PBR Methodology

A. Concerns and Issues on the RORB Methodology

Since the RORB Methodology uses historical costs, there is no incentive to undertake capital
expenditures since investments to upgrade the system and improve service were not considered until
the next rate application

B. Considerations for the shift to the PBR Methodology

The PBR methodology uses projections of operating and capital expenditures to meet projected
demand.
The PBR methodology reduces regulatory uncertainty and ensures regular upward or downward
updating of rates since detailed regulatory inputs are only required once every four years, with annual
review to account for inflation and market factors.
Reason for the shift to the PBR
Methodology

In its Order dated 12 July 2010 in ERC Case No. 2005-041 RC, the ERC further explained the reason
for adopting the PBR:
“The ERC adopted the PBR methodology since it has strong efficiency incentives for the utility
embedded in its framework to motivate the regulated entity to reduce its cost, thus, become more
efficient while maintaining its service delivery performance.”
“In the light of economic efficiency, R.A. 9136 requires that the rate-setting methodology to be
adopted is one which will promote efficiency. The PBR methodology has other characteristics which
support the implementation of an internationally-accepted rate-setting methodology, such as strong
incentives to reduce the costs of service delivery and maintain service quality and performance which
are akin to price-cap and revenue regulation or variants of incentive-based regulation seen overseas.
The ‘Rate-of-Return Regulation’ has gradually given way to ‘Price-Cap Regulation’ as the preferred
method of regulating public utilities.”
The PBR Methodology: As an accepted
International rate-setting methodology

After the enactment of the EPIRA, the Government requested the Asian Development Bank (ADB) to
provide Technical Assistance (TA) to conduct a study on competition policy in the restructured
electricity sector. The main objective was to create an environment that would encourage efficiency
and reliability in production of electricity without unjustifiable price increases and quality reductions.
Based on the TA provided by ADB in line with international experience, and after public
consultations, the ERC decided to shift from RORB to PBR. The shift considered that the
methodology will, over time, provide sustainable operation of the transmission and distribution
utilities and encourage stability in the market.
PBR is pro-consumer

PBR better serves the interest of the consumers. PBR encourages

CAPEX to improve efficiency and reliability of service:

• Less unexpected price spikes
• Reduced regulatory uncertainty
• Upgraded and improved service
• Efficiency and reliability are incentivized while inefficiency and unreliability are
penalized
The PBR Methodology is consistent with the ERC’s
policy against retroactive rate-making

“The policy underlying the rule against retroactive rate-making is to provide the utilities with some
incentive to operate effectively. The essence of this is that utilities are generally not permitted to adjust
their rates retroactively to compensate for unanticipated costs or unrealized revenues. The process
places both the utilities and the consumers at risk that the rate-making procedures have not accurately
predicted costs and revenues. If the utility underestimates its costs or overestimates its revenues, the
utility makes less money. Accordingly, the bar on retroactive rate-making has no exception for
missteps made in the rate-making process, even though the projection of expenses and revenues for
the test year vary from actual experience.” (ERC Order dated 21 June 2011; ERC Case Nos. 2001-646
and 2001-900)
The policy against retroactive rate-making is
consistent
with the prospective nature of legislation

The rule against retroactive rate-making stems from rate-making’s legislative character: legislative
activity is prospective. The rule ensures the predictability and stability of utility rates and generally
prevents utility companies from recover losses that stem from past company mismanagement or
improper forecasting. A regulatory authority can and does adjust rates only prospectively, to bring the
rates into a zone of reasonableness for the upcoming years. [San Diego Gas & Elec. Co. V. Sellers of
Energy, 127 FERC 61, 191 at p. 9; James H. McGrew, FERC: Federal Energy Regulatory
Commission (2009 ed.), p. 101]
The validity and reasonability of the PBR
Methodology have been previously affirmed by no
less than the Supreme Court.

NASECORE v. MERALCO [G.R. No. 191150, 10 October 2016

• Petitioners therein alleged that the PBR Methodology is inconsistent with and contrary to the
provisions of the EPIRA (i.e., it does not ensure affordable and reasonable rates, contrary to the
EPIRA mandate to protect interest of consumers, allows MERALCO to reap unreasonably high
profits, etc.)
• The Supreme Court also clarified the claim of the Petitioners that ERC’s approval of the rates
therein allowed MERALCO to amass excess profits which is above the 12% return on investment
generally allowed for public utilities pursuant to MERALCO v. Lualhati [G.R. No. 166769, 6
December 2006]
Rate of Return vs. Profits

EPIRA requires the ERC to regulate the return of Transmission

Company and DUs.
▪ Rate of Return is NOT synonymous to Profits.
• Rate of Return under the PBR is a return on investment equivalent to
the WACC approved by the ERC.
• Profit is actual revenues less actual expenses of a DU.
▪ There is NO law, regulation or SC Decision that provides or
mandates the regulator to regulate the profit of Transmission
Company or DUs.
Benefits of PBR
Methodology
Benefits of PBR Methodology

The PBR Methodology is intended to bridge the gap between service quality and distribution cost. By
allowing DUs to recover rates based on projected operating and capital expenditures, DUs are able to
make the necessary investments to improve efficiency and service quality.

It supports the “Build, Build, Build” Program of the present Administration by ensuring that DUs are
capable of building required CAPEX to support the continued development of major infrastructure
and government projects.
It promotes total electrification through the timely and unhampered installation of necessary facilities
to deliver power to as many consumers of electricity within the DU’s franchise area.
MERALCO EXPERIENCE
Performance Incentive Scheme (PIS)

A scheme that rewards (or penalizes) a Regulated Entity to the extent that the actual level of
performance, as measured by specific indices, exceeds (or is below) the target level of performance
for each Regulatory Year.
System-wide
Performance Incentive
Scheme (S-factor)

• Rewards or penalties through an adjustment of

the Maximum Average Price
Customer-specific Performance Incentive Scheme (GSL
Factor)
Determination of Annual Revenue
Requirement (ARR)

“Reasonable compensation for

economically efficient costs and risks
incurred in providing Regulated
Distribution Services”
The ARR is made up of 5 Building Blocks
*Regulatory Asset Base (RAB) increases
with Capital Expenditure The Weighted
Average Cost of Capital (WACC) is set per
Group of DUs **ERC recently ruled that
this be set to zero
Reset applications underwent rigorous evaluation by the ERC and its experts and
subjected to extensive public consultations. After the DU has justified the forecasts,
the ERC approves the forecast that will form basis of rates.
The Annual Revenue Requirement is made up of
building blocks
MAPs are set in the Final Determination and
verified every Regulatory Year
Verified MAP is translated in
Distribution, Supply &
Metering Charges
High power rates cannot be attributed to
distribution charges
Movements in distribution charges under PBR
Distribution rates accounts for one-sixth of the
average electric bill
• 2018 Meralco share of bill components
Bill Deposit
Courts already ruled on the nature of the bill
deposits collected by DUs

• Criminal Case No. 138382, RTC-Pasig, Order dated 6 October 2008

• Dismissed a complaint filed against MERALCO BOD and officers for lack of probable cause;
affirmed by the Court of Appeals
• Bill Deposits are not held in trust by MERALCO for its customers as the relationship between them
with respect to bill deposits is one of creditor and debtor.
• There is no law or agreement dictating that bill deposit should be earmarked and kept in trust by
MERALCO for its customers
• What is clear is that MERALCO and its customers are debtors and creditors, respectively, over the
subject deposits and the former has the civil obligation, which is not denied, to refund the deposits
with interest according the rules and regulations prescribed by the Energy Regulatory Commission
Courts already ruled on the nature of the bill
deposits collected by DUs

• OMB Case No. C-C-18-0002; Office of the Ombudsman; Resolution

dated 20 May 2018

• Dismissed the criminal complaint filed against MERALCO and ERC

• The BDs collected and received by MERALCO create a creditor and
debtor relationship between MERALCO and its consumers; thus, in
the nature of a loan.
• BDs may not be returned to the consumers should the latter fail to
comply with the conditions for its refund.
• BDs should therefore be treated as such that would create a
fiduciary relationship similar to the one between a regular depositor
and a bank on savings deposit.
MERALCO funds its CAPEX through its
distribution rates and not customer bill
deposits

• MERALCO has sufficient funds to cover the bill deposits (BD) and its accrued interests, as
customers can demand its return any time
• BD are not used to acquire long-term assets
• In some cases, MERALCO secures financing to fund its CAPEX program
• MERALCO pays for approved CAPEX via a return on capital and return of capital (building block
components) of the distribution rate
• There is no requirement for segregation of funds coming from BD and revenues coming from
distribution rates.
Interest on Bill Deposits must be
REASONABLE and NOT CONFISCATORY

The interest on BD of MERALCO customers complies with ERC Regulations (i.e., Magna Carta for
Residential Electricity Consumers and DSOAR for non-residential customers). This rate of interest was
fixed by ERC after several public consultations attended by DUs and consumers.
• There is NO legal or factual basis to require DUs to pay interest on BD equivalent to legal interest rate or
the rate of return (WACC). The Bill Deposits do NOT form part of the DUs’ RAB that is entitled to earn a
return.
• A survey of similar regulated (and non-regulated) entities like water, telecommunication, Cable TV,
transportation and others support the collection of BD but WITHOUT INTEREST.
• DUs also pay BD or its equivalent to PEMC, NGCP, GenCos without interest. Imposition of unreasonable
and confiscatory rate on BD will either force DUs to go bankrupt or compel DUs to return the BD and
interest and stop collecting BD for future application, in exchange for higher OPEX and working capital
for Purchased Power Cost.
Thank you
KYLE JEWEL F. IGLESIAS
BSEE – 3A