Meralco’s Self-Dealing is Rent-Seeking on its Distribution Franchise. It is Abuse of Market Power and Harmful to Consumers.

David Celestra Tan, MSK
13 November 2016

Meralco has a franchise and monopoly for the distribution of electricity in the mega area of Metro-Manila and adjoining provinces. Its distribution franchise though did not come with the right to also monopolize power generation. Yet it is on its way to owning through its own generation company, Meralco PowerGen at least 90% of its energy needs. That it is able to do by rent-seeking on its distribution franchise.

Meralco, that serves the largest commercial and industrial hub of the Philippines, has a power demand of 6,000mw and energy requirement of 30 Billion kwh a year. That’s equivalent to 75% of the energy needs of Luzon and by now about 64% of the whole country. It is a lot of buying power! (pun or no pun!). A hulking 800 pound gorilla in the power sector.

Meralco is supposed to be a regulated public service monopoly operating under government fiat. As a Monopoly it is protected from many business risks. Forex and head-on competition in its service area. If it is hit by a typhoon, all repair costs are passed on to the consumers. Power is stolen from it or it loses due its own inefficiency and it is passed on to the consumers as systems loss. Its own expansion under the PBR scheme is charged to the consumers in advance. For all those market risk privileges and guaranteed legal return on investment, its government granted franchise requires that in return it serves the public interest at least cost and not abuse its market power.

Generation Gate Keeper

Its market power and domination by themselves are not evil. In fact they can be used for the public good if only Meralco would be satisfied with its guaranteed legal profits as a public service utility franchise holder and dedicate itself to providing electricity to the public in the “least cost” manner. This can be achieved only if it buys that market volume on arms length basis and transparent and competitive manner. But Meralco is a gentle giant that is not to be. Power generation is so lucrative especially if you negotiate with yourself. I guess the MVP Group cannot help itself. The Epira Law assigned the ERC regulators to protect the consumers and assure competitive and prevent market abuses and cartelization.

The Epira Law under Section 45 allowed Meralco to contract up to 50% of its energy needs with an affiliated company and the law is silent on whether competitive bidding is required although it can do so if it is faithful to its mandate for least cost power. Consequently, Meralco effectively got the power to choose who they will buy from. The veritable gatekeeper to their 6,000mw market power. And since they are the largest market in the whole country, effectively they get to choose who gets into the power generation business. That is true market power.

No Power Supply Contract, No Project. And they are rent-seeking to the fierce extent that even the Lopez Group never dared to go.

Wikipedia says Rent-seeking implies extraction of uncompensated value from others without making any contribution to productivity. In Meralco’s case it is getting unwarranted benefit in power generation projects that it awards for free as a result of its control of the Meralco market as the franchised distribution utility monopoly.

Power Generation Franchise

The foundation of any power generation project is the long term power supply contract. That’s the equivalent of a power generation franchise. In this case it is not the Congress giving the franchise but Meralco at its own discretion by its market power as the distribution utility buyer. Who is really the buyer of the generation supply, Meralco or the consumers? Technically it is really the consumers buying because they are the ones paying the negotiated rates. If something goes wrong with the contract, and if Meralco overcontracts, all the cost consequences are paid for the consumers. Meralco is only acting as buying agent for the consumers. It has serious conflict of interest in buying that power from itself.

Truly independent power generation companies take years and lots of research, pre-engineering, economic and financial packaging work, project development and marketing expenses to win a contract. In the case of Meralco, it can bring to the table the power supply contract in its back pocket because it is the distribution utility with full discretion to choose its projects and partners.

The “Carried Interest” Quid Pro Quo

In the power generation industry the party who brings to the table the power generation contract (or franchise) brings something very valuable and gets compensated either in cash or shares. Of course it has economic value. If its shares ownership of the project company, it is called “carried interest” or free equity. This can range from 15% to 25% of the project ownership. It is on higher side if the power supply contract got sweetheart terms and rates.

The MVP Group is obviously fully aware of this value. Perhaps it was one of the value propositions when the MVP group bought Meralco from the Lopez Group. It is evident that they intended all along to exploit this market power to dominate power generation since early on they already organized the not so subtly named Meralco PowerGen with an openly announced target of 3,000mw.

Given the MVP Group’s legendary “deal making” toughness, we can bet they will exact the highest free equity or economic rent from each Meralco contract they give out.

The MVP Groups ability to exact favorable and lucrative benefits from power generators seeking contracts with Meralco is rent-seeking on the public service distribution franchise that the government granted to Meralco. This is inimical to the public interest since the net result is the consumers would be paying more than what they should have without the economic rent to the MVP group.

In the case of electric coops in Mindanao, consumer groups there are complaining of their EC’s management and board of directors for negotiating high rates on generation contracts. In this case it is unlikely they will get carried interest but other benefits for their power to award the contract. Such is the evil that a serious CSP implementation will prevent.

In the 460mw expansion of the Mauban coal power complex, insiders is reported to have shared that the Thailand owners originally approached Meralco for a power supply contract with a price of P3.80 per kwh. By the end of the negotiations, the project became owned 51% by Meralco PowerGen with a new sweetheart price of P4.30 per kwh. The ERC approved it at P4.26 per kwh still higher than the 3.78 per kwh that the Northern Coops got for only 135mw.

The seven (7) midnight power supply contracts signed by Meralco totaling 3,551mw with five (5) partners are all controlled by Meralco PowerGen with 51% (except the 49% in the JV with Ramon Ang of San Miguel). Most of them were signed in one day on April 26, 2016 with similar language, pricing formula, and legal template.

Those 3,551mw coal plants will have a total project cost of about US$10 Billion (or Pesos 480 Billion). It will probably be financed 75% instead of the normal 70% because of its sweetheart prices and contract terms. So its equity of 25% will be equivalent to $2.5 billion. Do you think the MVP Group will invest 51% (Php 61.2 Billion) of that equity in cash as power generation investors are supposed to? They will not put that valuable power supply contract on the table for free. If they do, their vaunted deal-making shrewdness will not be legendary. Mostly like the MVP Group will only invest in the range of 26% out of the 51% it would control in the project companies. That’s a P31 Billion benefit or economic rent right off the bat.

So why does it matter to Meralco consumers?

Because rent-seeking and free equity or undue benefit will result to higher rates to the consumers. That $10 billion project will officially become $10.6375 Billion or it was a $9.3 Billion project that became $10 billion? That is equivalent to 6.375% of the project cost.

And that is only the cost to consumers of the rent-seeking privilege. Add to that the profits and overcharge due to the sweetheart relationship between Meralco and Meralco PowerGen, the total cost to the consumers is mind-boggling.

In fact even if the MVP Group does not get free equity, the fact that they choose their own power generation company to the exclusion of other non-affiliated projects to contract with Meralco and they negotiate sweetheart terms and prices is still rent-seeking according to the economists definition. Wikipedia also notes that rent-seeking is another form of corruption.

Rent-seeking is an abuse of market power and harmful to consumers.

Matuwid na Singil Sa Kuryente Consumer Alliance Inc.

Matuwid.org

David Celestra Tan is a CPA and utility economist. He was among the pioneers in the private power generation sector and a founder and former President of the Philippine Independent Power Producers Assn. (PIPPA). Towards retirement he is seeking to contribute his knowledge in power strategy and policy towards the national goal of competitive and consumer friendly power sector. His way of giving back to the community. Other than as a consumer he will not benefit financially, directly or indirectly, from any business with Meralco. Para sa Bayan lang po ito.

Authors notes:

Rent–seeking is the use of the resources of a company, an organization or an individual to obtain economic gain from others without reciprocating any benefits to society through wealth creation. (Investopedia)

Wikipedia says Rent-seeking is an attempt to obtain economic rent (i.e., the portion of income paid to a factor of production in excess of what is needed to keep it employed in its current use) by manipulating the social or political environment in which economic activities occur, rather than by creating new wealth. Rent-seeking implies extraction of uncompensated value from others without making any contribution to productivity. The classic example of rent-seeking, according to Robert Shiller, is that of a feudal lord who installs a chain across a river that flows through his land and then hires a collector to charge passing boats a fee (or rent of the section of the river for a few minutes) to lower the chain. There is nothing productive about the chain or the collector. The lord has made no improvements to the river and is helping nobody in any way, directly or indirectly, except himself. All he is doing is finding a way to make money from something that used to be free.^[5]