Its Time for a new Paradigm on Bilateral Power Supply Contracts

My mother used to say the worst time to go grocery shopping is when you are hungry.  She said you tend to overbuy and overpay. Such wisdom.

Most of the bilateral power supply contracts being signed by the distribution utilities, specially by Meralco with its sister companies, First Gas and the Meralco PowerGen projects, are of the Napocor 1990 power crisis BOT vintage, when the country was not only hungry but starving for power supply.  Part of the reason is most of the practitioners in the independent power producers and their bankers are from that era and have been spoiled by the take-or-pay, guaranteed capacity security of those contracts.

Unfortunately those types of contracts have worked to the disadvantage of consumers, to the undue advantage of the power generators, and the avoidance of accountability by the distribution utilities.

NPC’s BOT type contracts contained features that were essential during that time but should be refined under the current market based power generation industry:
1. Guaranteed take-or-pay capacity payments
2. Maintenance Downtime Allowance (planned outage)
3. No Penalties and responsibilities for excess downtimes
4. Pass on charge for fuel costs

Why they were that way
1. Guaranteed take-or-pay capacity payments
The original power supply contracts in 1990’s were actually BOT types.Buildoperate andtransfer.  The private sector builds the power plant, operate it for an agreed “cooperation” period of say 20 years, and then turn it over to the government.Essentially it is a way for the government to finance building power plants that eventually it will own.

Napocor
In this arrangement, the government owned Napocor buys the fuel and turns it over to the plant operator  who converts it to electricity. For this reason the BOT contracts are structured as an “energy conversion agreement” (ECA).  The plant operator guarantees the government a level of efficiency in converting that fuel into energy. This is called heat rate or kwh per quantity of fuel using their calorific value. But all the risks related to fuel procurement and supply are the responsibility of Napocor.

The purpose of this contract is to assure that power generating capacity is available to meet the demands of the country.  That was the time when it was the main responsibility of Napocor as the generation monopoly.  The plant may not be used fully. It is the responsibility of the government whether the power plants are run and its output dispatched.

This BOT arrangement is essentially a financing scheme for the power plant so the government guarantees that its financing is paid in the form of guaranteed capacity payments or take-or-pay, also called “minimum off-take”. The government intended to own the power plant in the end. Napocor’s obligation to make the payments in turn is guaranteed by the national government that owns it, thus these BOT projects were provided “sovereign guarantees”.

The other variants of this BOT scheme were BOO (build, operate, and own), LROM (lease rehabilitee operate and maintain). Under BOO, the ownership of the plant is not transferred to the government at the end of the cooperation period. Between BOT and BOO, the latter is supposed to have lower rates. LROM is used when the government owns an old power plant but wishes to have the private sector rehabilitate and operate it. The property is leased to the operator.

In these cases also the government contracts for the capacity and still supplies the fuel and sells the power.

Meralco

This is the same scheme that was used when Meralco built the 1500mw of natural gas capacity to assure a market for a minimum 2,500mw market that the Shell consortium wanted for the development of the Malampaya  natural gas pipeline from Palawan. Napocor built the 1200mw Ilijan natural gas power plant as a BOT project with bidding winner Korean Power.   The power plants, the 1,000mw Sta.Rita and the 500mw San Lorenzo, were similarly guaranteed capacity payments and supply of fuel.  These Meralco projects were structured as a 25 year BOO  under which Meralco as off-taker guarantees the capacity payments, the fuel supply, and the dispatch of the power plant and the contracting party, First Gas Power, would build finance and operate the power plant.  They however will not turnover the ownership of the plant at the end of the cooperation period.

Project Bankability and cost impact

Typically the power plant costs are built with debt or long term financing of 20 to 25 years to the extent of 70 to 75%. The balance is put up as equity of the project proponents.  To support the project loan there needs to be an assurance of revenue from a credit worthy off-taker.  This is the main rationale for the guaranteed capacity payments, also called take-or-pay and minimum energy off-take or MEOT.

In the case of Napocor, this resulted to huge losses  from its guaranteed take-or-pay obligations when the power plants were not used fully.  The governments losses were aggravated when Meralco renege on its contract to buy power up to 2005 and the government got stuck with the monthly capacity payments on power generating capacity that was not being used.  A net penalty of P19 billion was supposedly agreed between Napocor and Meralco to settle the case.

In the case of Meralco its obligations under the First Gas agreement is completely passed on to its consumers as part of its total purchase of power.  The monthly increases are passed on as “purchase power adjustment” or PPA. Meralco had to pay the guaranteed monthly payments even if the plant was not operating fully or is not dispatched due to the claimed failure of Napocor to make available transmission capacity to deliver the power to the Metro-Manila load center.  Similarly if there is an interruption in fuel supply from Malampaya, they also get paid.  Meralco’s purchased power adjustment (PPA) alone reached P3.00 per kwh in 2002 and 2003 and it was the first consumer upheaval against the Epira Law of 2001.

During the power crisis of the 1990’s these guaranteed payments were essential to assure bankability of the project and debt service cover for the 10 to 12 year loan period specially if it is a BOT where eventually the ownership of the power plant is turned over to the off-taker.

In the case of Napocor many of its 25 year BOT contracts supposedly had ladder capacity payments where payments are reduced after the original loan period.  It does not look like there is such a thing in the contract negotiated between Meralco and its sister generator.

2. Plant downtimes for Planned and unplanned maintenance

These power plants are allowed annual maintenance downtime allowances of 45 to 60 days. Coal power plants have lower downtime allowances because their boilers are supposed to have an annual maintenance of only 20 days as compared to diesel power plants that uses reciprocal engines with infinitely many more moving parts that need maintenance.

The power crisis era BOT type bilateral contracts pay the power plant their capacity fees even during their downtime allowance period.   Napocor was paying Hopewell/Mirant for Sual and Pagbilao, Ilijan, and Caliraya-Botocan.  Meralco was paying for the guaranteed payments to QPL Mauban and the 1000mw Sta. Rita and the 500mw San Lorenzo natural gas plants.  These cause significant uptick in the average generation cost per kwh that Meralco is passing on to the consumer when those plants are down for maintenance.  Meralco paid San Lorenzo P9.99 per kwh when its output went down 85% in November 2013.

A critical issue on these maintenance downtimes is the lack of transparency in monitoring whether these contract power plants are exceeding their downtime allowances.   Between Napocor and its IPP there is at least an “arms length” monitoring of contract performance including fuel efficiency limits.  In the case of Meralco it is hard to assure when their sister company generators are down.  If they choose to nonetheless pay, they can pass that on to consumers as part of their average generation cost.

PPA has been back!

It is not clear whether the public is aware that the PPA (purchased power adjustment) that tortured them in 2003 and 2004 had actually been reinstalled by the Energy Regulation Commission and is now called AGRA (automatic generation rate adjustment).Lets hope that under the AGRA rules, that there are corresponding safeguards to assure that there is no undue pass on charges and that the DU’s are managing their bilateral contracts properly. It doesn’t seem like there are consumer protection.

3.  No Penalties for excessive downtimes

Maintenance downtime is a complex issue because it is hard to tell whether the boiler leaks were a result of legitimate technical failure or actually neglect or cutting corners on due preventive maintenance that responsible power plants should be spending on. It is hard but it can be detected with honest to goodness and vigilant monitoring system.  Some sectors are concerned that the series of boiler leaks among generators were convenient coincidences happening at the same time.

In any case, under the current bilateral contracts, the IPP is not responsible for the cost consequences of their planned and unplanned downtimes.  It is Meralco and the DU’s who have the burden of buying the replacement power which unfortunately is automatically passed on to the consumers.  Meralco non-chalantly tells the public they are helpless and can’t do anything about it and that they are just collectors and do not make money on the generation side.  It is most pathetic to hear the country’s largest public service utility, which has the franchise to provide power in the least cost manner to its customers, cop out and say that for many years.

4. Pass on charge of fuel costs

Under most of these BOT type contracts, the responsibility to buy and supply fuel is with the off-taker, Napocor or Meralco. Changes in prices of fuel including the fluctuations in foreign exchange are passed on to the consumers.  This is actually not necessarily disadvantageous to the consumers.

Where there is no safeguard for the consumers is when there are interruptions in the supply of fuel, which happens when Napocor’s coal suppliers fail to deliver fuel on time in the right specifications or when Malampaya’s gas supply is impaired due to maintenance or other reasons.  Napocor and Meralco still pay the BOO/BOT generating companies their guaranteed capacity fees and fixed costs.  QPL Mauban contracts its own fuel supply.

Between Napocor and its BOT plant operators there is arms-length validation of the fuel conversion efficiency that is guaranteed by the plant operator.  In the case of Meralco and its sister company First Gas Power however, there is no such “arms-length” guarantee that the fuel efficiency is being met. All fuel costs are passed on to the consumers.  Even in the procurement of substitute distillate fuel during the maintenance downtime of Malampaya’s fuel supply as in November and December 2013,  there are no safeguards to assure that the fuel are procured competitively.

Things were these ways because the country was in power crisis and we needed to encourage foreign investors to quickly come in and build power plants.  We were hungry and had to buy. We are in a new market era now and our distribution utilities need to sign bilateral contracts that have evolved from that power desperate era 20 years ago into something more balanced and respectful of consumer rights.

Next:   A need for a new paradigm in bilateral power supply contracts