Philippines: Selected Issues
Author: International Monetary Fund
Publication Date:
20 Feb 2009
eISBN:
9781451831443
Language:
English
Keywords:
ISCR; CR; remittance; bank; investor interest; operation cost; generation cost; investor risk aversion; pace of privatization; Electricity; Fuel prices; Privatization
Download PDF (469.7 KB)

This Selected Issues paper for the Philippines has been prepared by a staff team of the International Monetary Fund as background documentation for the periodic consultation with the member country. Spillovers have been particularly prominent for countries with financial systems with high foreign bank participation, large exposures to ailing global financial institutions and structured products, and high external liabilities, including through wholesale funding. With a nascent capital market, the economy’s exposure to securitization and off-balance sheet activities is limited. The presence of foreign capital remains low in both the capital market and the banking system.

Abstract

This Selected Issues paper for the Philippines has been prepared by a staff team of the International Monetary Fund as background documentation for the periodic consultation with the member country. Spillovers have been particularly prominent for countries with financial systems with high foreign bank participation, large exposures to ailing global financial institutions and structured products, and high external liabilities, including through wholesale funding. With a nascent capital market, the economy’s exposure to securitization and off-balance sheet activities is limited. The presence of foreign capital remains low in both the capital market and the banking system.

IV. The Philippine Power Sector in a Challenging Environment23

A. Introduction

74. A reform for plan in the Philippine power sector has been under way since 2001. The Electric Power Industry Reform Act in 2001 (EPIRA) aims to promote greater competition and attract more private investment by liberalizing the electricity market and privatizing power sector assets. Under the EPRIA, the power sector has been restructured into separate sectors (generation, transmission, and distribution) with tightened supervision applied to each sector. The privatization of generating assets, another main objective of the EPIRA, has been mostly implemented and is planned to be completed in 2009. At the same time, the electricity market is scheduled to liberalize further.

75. The power sector reform has helped bolster electricity supply and brought about substantial revenues from privatization. Power supply has been rising on average at 4 ½ percent per year since 2001, while the total hours of outage—a major problem in the mid-1990s—peaked out in 2002. At the same time, due to the Philippines’ geographical disadvantage (many islands) and high cost of generation, the authorities increased the capacity of geothermal plants in the 1990s and shifted to plants with cheaper costs (e.g., coal and LNG, see chart). Revenue from privatizing the generating assets total to 2 ½ percent of GDP, although the pace of the privatization has slowed in 2008.

Figure IV.1.
Figure IV.1.

Electricity Production by Fuels

(Giga-Watt Hour)

Citation: IMF Staff Country Reports 2009, 063; 10.5089/9781451831443.002.A004

Source: CEIC Asia database.

76. Carrying out the remaining reform agenda will help improve the efficiency of the power sector, although the ongoing global financial turmoil may present challenges. The productivity growth of the industry segment, including the power sector, has lagged behind the cross-sector average. With a high electricity price by regional standards, a more efficient power sector is necessary to support further economic development in the Philippines. Given substantial reliance on foreign investors, capital goods, and technology, attracting foreign investment is key for successful reform. In this context, the ongoing strained global financial conditions and high fuel prices (although rapidly retreating) present significant challenges by raising foreign investor risk aversion and lowering the profitability of the power sector.

Figure IV.2.
Figure IV.2.

Per Capita Production Growth in Sectors, 2004–07

Citation: IMF Staff Country Reports 2009, 063; 10.5089/9781451831443.002.A004

Sources: CEIC Asia database; and IMF staff calculations.

77. This paper provides a summary of developments in the global and domestic power sector and reviews outstanding reform issues for the Philippines. To provide context, the paper examines trends in global electricity prices and key financial indicators of global power companies. It then looks at electricity price trends in the Philippines and discusses the scope for further reform, including to what extent the pace of reform may be impacted by the turbulent global economic environment.

B. The Global Power Sector and the Soaring Fuel Prices

78. Electricity prices rose globally over the last few years. End-use electricity prices for household rose by 6½ percent on average during the first half of 2008 (year-on-year). Reflecting a more market-based system, rates for the industry sector rose by 8 ½ percent during the same period. The pace of price increase was, however, far below the changes in other major fuel prices, with prices on crude oil, natural gas, and coal rising 75 percent, 48 percent, and 127 percent respectively. Although the U.S. dollar has depreciated about 10 percent in nominal-effective term over this period, it only provided a partial offset to the soaring energy prices.

Figure IV.3.
Figure IV.3.

Price Changes in End-use Electricity Price

(1st half 2007-1st half 2008, percent change)

Citation: IMF Staff Country Reports 2009, 063; 10.5089/9781451831443.002.A004

Sources: International Energy Association; and IMF staff calculation.
Figure IV.4.
Figure IV.4.

Key Operational Results of Leading Companies

(Percent change)

Citation: IMF Staff Country Reports 2009, 063; 10.5089/9781451831443.002.A004

Source: Thomson Financial, EDGAR.1/ Comparison between 1H 2007/08.

79. The rising fuel prices put pressure on power company profit margins. Even large Fortune 500 power companies were not immune to the impact from the soaring fuel prices.24 Profit margins narrowed in general as the pace of fuel inflation far outpaced the pace of increase in retail electricity prices. Although the power companies generally recorded higher sales in the second quarter of 2008 compared to a year earlier, net income declined. Some companies have even been recording losses since the beginning of 2008. In many cases, this reflected the inability to pass higher fuel costs on to the retail price, which is regulated by the government in many countries. General taxation and green commitments are also reported to have contributed to pressures on the power sector. With regard to financing activities of the leading companies, aggregate net cash flow from main operating activities already started to fall in 2007 compared with 2006.25 In addition to waning profit margins, this reflected stepped up investment activities, primarily financed from borrowing.

Figure IV.5.
Figure IV.5.

Aggregated Cash Flow of Industrial Leaders 1/

(In billion dollars)

Citation: IMF Staff Country Reports 2009, 063; 10.5089/9781451831443.002.A004

Sources: Thomson Financial; and IMF staff calculation.1/ Total of EDF, Enel, and KEPCO due to different financial year.
Figure IV.6.
Figure IV.6.

Aggregated Financing Activities of Leading Companies 1/

(In billion dollar)

Citation: IMF Staff Country Reports 2009, 063; 10.5089/9781451831443.002.A004

Sources: Thomson Financial; and IMF staff calculation.1/ Total of EDF, Enel, and KEPCO due to different financial year.

80. Key financial indicators reflect these heightened pressures on the power companies. Stock price indices for the electricity companies in major countries fell 5–30 percent since the beginning of 2007.26 Unlike during past downturns, utility stocks have moved more in tandem with the headline stock indices.27 Pressures on the power sector have also been reflected in higher credit risk premia for the sector as reflected in rising credit default swap spreads.

Figure IV.7.
Figure IV.7.

Stock Indices (Headline, Sub-Index on Electric Company)

Citation: IMF Staff Country Reports 2009, 063; 10.5089/9781451831443.002.A004

Source: Bloomberg.
Figure IV.8.
Figure IV.8.

Five-Year Credit Default Swaps: Industrial Leaders

(Basis points)

Citation: IMF Staff Country Reports 2009, 063; 10.5089/9781451831443.002.A004

Source: Bloomberg.

C. Recent Developments in the Philippine Power Sector

81. Retail electricity prices in the Philippines declined somewhat over the last year. In metro Manila area, the average retail rate was 7.75 pesos (per kilowatt hour) for the first half of 2008, slightly lower than P 8.00 average for the first half of 2007.28 The seemingly puzzling decline reflects lagged tariff adjustment, and Philippines’ already regionally high tariff rates:

  • Deferred adjustment and other one-off factors: Any change to prices of the National Power Corporation (NPC) has to be approved by the Energy Regulatory Commission, and the adjustment often takes place with a significant lag, usually up to about a year. NPC prices have dropped around 20 percent since the first half of 2007, reflecting a delayed adjustment to compensate for over-charging of consumers earlier on. Moreover, Wholesale Electricity Spot Market (WESM) prices declined due to weather related factors (i.e., low temperatures and abundant hydropower generation at peak demand season contributed to the lower price).

  • Already (regionally) high electricity rates and limited pass-through: Although electricity prices are difficult to compare across countries due to the existence of various specialized rates (e.g., for different types of users, time, and generating methods), prices appear to be high in the Philippines. For example, according to the Japan External Trade Organization (JETRO), prices in the Philippines are among the highest in the East Asian region. Notwithstanding the fact that there are several special rate programs offered in some part of the country, the high electricity rates, together with concerns about the possible impact on the poor, led to strong calls against major price hikes and contributed to limiting the pass-through of higher fuel prices.29

  • Exchange rate: The peso appreciated about 12 percent against the U.S. dollar, which also provided some offsets against the rising fuel prices.

Figure IV.9.
Figure IV.9.

Unbundled Electricity Rates

(Peso/KWH)

Citation: IMF Staff Country Reports 2009, 063; 10.5089/9781451831443.002.A004

Source: Meralco, quarterly report.
Figure IV.10.
Figure IV.10.

Electric Charge for Household in Selected Cities 1/

(U.S. dollar/kilowatt-hour, January 2008)

Citation: IMF Staff Country Reports 2009, 063; 10.5089/9781451831443.002.A004

Source: JETRO.1/ Price for 200 kwh/month (average of range, if marginal rate is not specified).

82. The high electricity rates reflect several factors, including geography, existing contracts, and a low operating level.

  • More requirements for transmission infrastructure: Among ASEAN 5 countries, the Philippine and Indonesia have relatively high power transmission and distribution losses. The dispersed islands and frequent natural disasters require more resource inputs to build and maintain transmission infrastructure. Nonetheless, there is some room for improvement, as Japan—with numerous small islands and natural disasters—has one of the lowest loss rates in the world. Moreover, although the transmission system operates at high voltage (500 kilo voltage) in some areas in Luzon Island, this type of capacity is limited and most rural areas are still operating on low voltage.

  • Existing contracts with the Independent Power Producers (IPP): Although data on unbundled costs are limited, the share of generation costs in the total retail costs in the Philippines appears to be on the high side.30 This partly reflects high operating costs of some IPPs, which provided urgent power supply in the 1990s but at the cost of somewhat higher rates. Thus, the operation costs of some gas turbines that the NPC is required to use regardless of the fluctuations in oil prices and exchange rates are about twice as high as those of other oil-based plants (Toba, 2003).

  • Uneven electricity demand: The peak demand in the Philippines is more abrupt than in other ASEAN 5 countries. This is partly due to the high swings in temperature and the lack of a strong industrial base that enables the base-load demand to be distributed more evenly on a 24-hour basis (Woodhouse, 2005). This bulky demand pattern results in higher average electricity costs.

Figure IV.11.
Figure IV.11.

Transmission and Distribution Loss

(In percent of output)

Citation: IMF Staff Country Reports 2009, 063; 10.5089/9781451831443.002.A004

Sources: Energy Information Administration; and IMF staff calculations.
Figure IV.12.
Figure IV.12.

Average Operating Level of Generating Assets 1/

Citation: IMF Staff Country Reports 2009, 063; 10.5089/9781451831443.002.A004

Sources: Energy Information Administration; and IMF staff calculations.1/ Average of 2001–05, annual electricity generation / capacity / 365 / 24.

D. Investment Environment

83. The pace of privatization slowed in 2008 and the ongoing global financial turmoil may reduce the pace further. This slowdown in privatization, by scale, partly reflects that major plants have already been sold. However, several domestic investors already invested in the sector have expressed interest in the remaining assets. In addition, a recent proposal to eliminate 40 percent of upfront payments for generating assets could also support the privatization efforts. Nonetheless, privatization may become more difficult near term to the extent domestic and foreign investors’ risk aversion has risen on the back of the global financial turmoil.

Figure IV.13.
Figure IV.13.

Privatization of Generating Assets

Citation: IMF Staff Country Reports 2009, 063; 10.5089/9781451831443.002.A004

Sources: The PSALM, CEIC Asia database; and IMF staff calculations.

84. More market-oriented tariff adjustment is critical for attracting FDI for sustainable investment. As foreign capital has been contributing the majority of capital to the Philippine power sector, FDI is a critical element for sustainable power supply. Beyond privatizing the existing generating assets, the EPRIA envisages that future FDI will be conducted on a more market-oriented basis (Box 1). When the EPIRA is completed, electricity will be traded at a market-determined rate mainly through the WESM. From investors’ viewpoint, the rate must be set on average at a profitable level. This, however, will require timely and cost-based tariff adjustments. As tariffs are currently adjusted with a substantial lag, the NPC continues to supply electricity at rates that are often at odds with the market conditions. If retail prices remain unchanged, the cost would be born by some sections of the electricity supply chain, substantially reducing profitability and attractiveness for potential investors.

EPIRA—Achievement and Future Plans

Majority of these objectives have been achieved so far:

  • 70 percent of generating assets have been sold. The current plan envisages finalizing the privatization in 2009.

  • Electricity rates have been mostly unbundled.

  • The WESM has been operating in Luzon.

To Further ensure sufficient and sustainable energy supply, following tasks remain:

  • Completing privatization of generating assets.

  • Auctioning the right to manage contracted energy output by IPP.

  • Rolling out of the WESM to Visayas.

  • Activating the ‘open access’ stage, where sellers and buyers can trade electricity freely.

85. Revamping infrastructure and evening out daily consumption will also help attract investors. Investors favor a more efficient transmission system. Current low-voltage and limited transmission capacity could be improved. If transmission losses would fall to the ASEAN 5 average, total retail cost would fall by 1.5 percent. Spreading power consumption more equally on a 24-hour basis would enhance operating level.31 In this regard, closer cooperation between generation and retail sectors—with appropriate supervision applied to each sector—would likely help.

86. Long-term power supply/demand should support and be commensurate with economic development. The ultimate objective of the reform is to supply the electricity efficiently as needed. Power demand has been increasing on average 4¾ percent in 2000–07. During this period, demand grew in line with GDP. However, the recent services-led growth resulted in lower electricity demand and elasticity to overall growth of less than one. The authorities demand growth forecast of 4 percent (Luzon) is consistent with staff’s near-term growth of about 4 percent and the unit elasticity. However, this may underestimate demand if strong industry activities lead to higher growth as industry sector’s elasticity is estimated to be above 1 (see table, while others are either negative or insignificant in 1980–2007). In this regard, the impact from growing business-outsourcing industry warrants some attention. Recently, the outsourcing industry has been growing by 50 percent per year, most of which is said to operate on 24/7 days basis. If this trend continues, demand may increase sooner rather than later.

Table IV.1.

Results of Estimation 1/

article image
Sources: CEIC Asia database; and IMF staff calculations.

The following equation is estimated for 1981–2007:

Dt−Dt−1Dt−1=c1+c2G⁢D⁢P—AtG⁢D⁢PtG⁢D⁢P—At−G⁢D⁢P—At−1G⁢D⁢P—At−1+c3G⁢D⁢P—ItG⁢D⁢PtG⁢D⁢P—It−G⁢D⁢P—It−1G⁢D⁢P—It−1+c4G⁢D⁢P—StG⁢D⁢PtG⁢D⁢P—St−G⁢D⁢P—St−1G⁢D⁢P—St−1

Where D = electricity demand, GDP_A = real production in agricultural sectors, GDP_I = real production in industry sectors, GDP_S = real production in services sectors.

E. Conclusion

87. A fuller implementation of the reform plan hinges on global factor as well as domestic efforts. FDIs are necessary for improving the performance of the Philippine power sector, including addressing the low productivity and regionally high electricity prices by regional standards. The lagged price adjustments have sheltered consumers from rising electricity price despite the soaring oil prices. However, this has also hurt profitability of power companies and, thereby, likely dampened investor interest. Therefore, it will be key to introduce a more market-based and transparent pricing mechanism. It will also be important to improve the transmission system and reduce generating costs through higher operating levels. These factors could help attract foreign investors, although the current global economic turbulence may put a damper on investor interest over the near term.

References

  • Fitch, 2008, Credit Analysis Report, Electric-Corporate France (New York).

  • Japan External Trade Organization (JETRO), 2008, A Comparison of Investment-Related Costs in Major Asian Cities (Tokyo).

  • Morgan, JP February 2008, European Utilities Basics—Electricity and Gas Industry Overview (London)

  • Philippines, Ministry of Economy, Trade, and Industry, 2004, Generating Costs Estimated from Financial Reporting, http://www.enecho.meti.go.jp/denkihp/bunkakai/seido_sochi/3th/sanko1.pdf

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  • Toba, Natsuko, 2003, “Welfare Impacts of Electricity Generation Sector Reform in the Philippines,” ERD Working Paper No. 44 (Manila: Asian Development Bank)

    • Search Google Scholar
    • Export Citation

  • Woodhouse, J. E., 2005, “The IPP Experience in the Philippines,” Working Paper No.37, Program on Energy and Sustainable Development (Stanford University).

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23

Prepared by Masaaki Iizuka.

24

Top 10 Fortune 500 companies in 2008 in the utility sector that have large operations in electricity business and publish quarterly financial result were reviewed (e.g., Electricite de France (EDF), Enel, Tokyo Electric Power Company (TEPCO), Korea Electric Power Company (KEPCO), and Scottish and Southern Energy). They mainly deal with electricity business, but their operations are diversified. For example, European companies tend to be energy conglomerates, engaging in generation, transmission, and retail of electricity, as well as other energies. Nonetheless, for example, EDF raises its most profits from regulated sectors. Under the current regulation, French wholesale electricity tariffs are regulated not to rise above inflation (Fitch, 2008.)

25

Due to difference in financial year, the charts only show the sum of EDF, Enel, and KEPCO. However, other companies experience the same developments in their financial year ending in March 2008.

26

The U.S. sub-index comprises only from electric utility companies, while the EU sub-index includes utility companies and Japanese sub-index includes gas and utility companies.

27

Utility stocks have typically a low beta, resilient against overall economic volatility, but their correlation with the headline stock indices have been rising since 2006.

28

Quarterly financial report by the Manila Electric Company (Meralco).

29

Recent proposals for lowering charges include extending preferential treatment to poor household, capping the recovery rate of system losses, and exempting taxes on the electricity charges.

30

The ratios (excluding taxes) are 41 percent in France and 52 percent in Germany (J.P. Morgan), while it is 64-65 percent for the Philippines.

31

Japanese Ministry of Economy, Trade, and Industry (2004) estimated raising operating level to 80 percent from 40 percent would reduce generating costs by about 30 percent.

Same Series

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Cover IMF Staff Country Reports
Philippines: Selected Issues
Author: International Monetary Fund
Volume/Issue:
Volume 2009: Issue 063
Publisher:
International Monetary Fund
ISBN:
9781451831443
ISSN:
1934-7685
Pages:
52
DOI:
https://doi.org/10.5089/9781451831443.002

Electricity Production by Fuels

(Giga-Watt Hour)

Per Capita Production Growth in Sectors, 2004–07

Price Changes in End-use Electricity Price

(1st half 2007-1st half 2008, percent change)

Key Operational Results of Leading Companies

(Percent change)

Aggregated Cash Flow of Industrial Leaders 1/

(In billion dollars)

Aggregated Financing Activities of Leading Companies 1/

(In billion dollar)

Stock Indices (Headline, Sub-Index on Electric Company)

Five-Year Credit Default Swaps: Industrial Leaders

(Basis points)

Unbundled Electricity Rates

(Peso/KWH)

Electric Charge for Household in Selected Cities 1/

(U.S. dollar/kilowatt-hour, January 2008)

Transmission and Distribution Loss

(In percent of output)

Average Operating Level of Generating Assets 1/

Privatization of Generating Assets