Project Completion Report: Philippines, Power Sector ...

Completion Report

Project Number: 37752 Loan Number: 2282 August 2010

Republic of the Philippines: Power Sector Development Program

CURRENCY EQUIVALENTS

Currency Unit – peso (P)

At Appraisal At Program Completion 2 November 2006 30 June 2009

P1.00 = $0.0200 $0.0208 $1.00 = P49.800 P48.129

ABBREVIATIONS

ADB – Asian Development Bank CSP – country strategy and program DOE – Department of Energy DOF – Department of Finance DSCR – debt service coverage ratio EPIRA – Electric Power Industry Reform Act (2001) ERC – Energy Regulatory Commission IMO – independent market operator IPP – independent power producer MW – megawatt NPC – National Power Corporation PCR – program completion review PEMC – Philippine Electricity Market Corporation PSALM – Power Sector Assets and Liabilities Management Corporation PSDP – Power Sector Development Program TransCo – National Transmission Corporation WESM – wholesale electricity spot market

NOTES (i) The fiscal year of the government ends on 31 December. (ii) In this report, “$” refers to US dollars.

Vice President C. Lawrence Greenwood, Jr., Operations Group 2 Director General K. Senga, Southeast Asia Department (SERD) Director A. Jude, Energy and Water Division, SERD Team leader Y. Zhai, Lead Professional (Energy), SERD Team members C. Bellinger, Lead Cofinancing Specialist, Office of Cofinancing Operations K. M. Emzita, Senior Counsel, Office of the General Counsel S. Hasnie, Principal Energy Specialist, SERD

In preparing any country program or strategy, financing any project, or making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgments as to the legal or other status of any territory or area.

CONTENTS

Page

BASIC DATA ii

I. PROGRAM DESCRIPTION 1 II. EVALUATION OF DESIGN AND IMPLEMENTATION 1

A. Relevance of Design and Formulation 1 B. Program Output 1 C. Program Costs 3 D. Disbursements 3 E. Program Schedule 3 F. Implementation Arrangements 3 G. Conditions and Covenants 4 H. Performance of the Borrower and the Executing Agency 4 I. Performance of the Asian Development Bank 5

III. EVALUATION OF PERFORMANCE 5 A. Relevance 5 B. Effectiveness in Achieving Outcome 5 C. Efficiency in Achieving Outcome and Output 5 D. Preliminary Assessment of Sustainability 5 E. Institutional Development 6 F. Impact 6

IV. OVERALL ASSESSMENT AND RECOMMENDATIONS 6 A. Overall Assessment 6 B. Lessons 7 C. Recommendations 7

APPENDIXES 1. Program Design and Monitoring Framework 8 2. PSALM’s Liability Management Program 14 3. Development Policy Letter and Policy Matrix for the Program Cluster 15

BASIC DATA A. Loan Identification 1. Country 2. Loan Number 3. Program Title 4. Borrower 5. Executing Agency 6. Amount of Loan 7. Program Completion Report

Number

Philippines 2282 Power Sector Development Program Republic of the Philippines Department of Finance $450,000,000 PCR:PHI 1171

B. Loan Data 1. Appraisal – Date Started – Date Completed 2. Loan Negotiations – Date Started – Date Completed 3. Date of Board Approval 4. Date of Loan Agreement 5. Date of Loan Effectiveness – In Loan Agreement – Actual – Number of Extensions 6. Closing Date – In Loan Agreement – Actual – Number of Extensions 7. Terms of Loan – Interest Rate

– Maturity (number of years) – Grace Period (number of years) 8. Terms of Relending (if any) – Interest Rate – Maturity (number of years) – Grace Period (number of years) – Second-Step Borrower

7 August 2006 25 August 2006 18 October 2006 20 October 2006 8 December 2006 11 December 2006 11 March 2007 19 December 2006 0 30 June 2009 30 June 2009 0 London interbank offered rate (LIBOR)–based, variable 15 3 Not applicable

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9. Disbursements a. Dates Initial Disbursement

20 December 2006

Final Disbursement

20 December 2006

Time Interval 0

Effective Date

19 December 2006

Original Closing Date

30 June 2009

Time Interval

30 months

b. Amount ($ million) Category or Subloan

Original

Allocation

Last Revised

Allocation

Amount

Canceled Net Amount

Available

Amount

Disbursed

Undisbursed

Balance 01 450 450 0 450 450 0 Total 450 450 0 450 450 0

10. Local Costs (Financed) - Amount ($) Not applicable - Percentage of Local Costs - Percentage of Total Cost C. Program Data

1. Program Cost ($ million) Cost Appraisal Estimate Actual

Foreign Exchange Cost 750 750 Local Currency Cost 0 0 Total 750 750

2. Financing Plan ($ million) Cost Appraisal Estimate Actual ADB-Financed 450 450 JBIC-Financed 300 300 Total 750 750

ADB = Asian Development Bank, JBIC = Japan Bank for International Cooperation

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3. Cost Breakdown, by Program Component ($ million)

Component Appraisal Estimate Actual Not applicable

4. Program Performance Report Ratings

Ratings Implementation Period

Development Objectives

Implementation Progress

31 Dec 2006 to 28 Feb 2007 Satisfactory Highly satisfactory 1 Mar 2007 to 30 Jun 2009 Satisfactory Satisfactory D. Data on Asian Development Bank Missions

Name of Mission

Date

No. of Persons

No. of Person-Days

Specialization of Membersa

Reconnaissance/Fact-Finding 19 April 2004–

17 June 2005 10 a, b, c, d, e, f,

g, h, i Appraisal 7–25 Aug 2006 a Consultation (Cofinancing) 29–31 Aug 2006 1 3 a Monthly Meetings with Government

January 2007–30 June 2009

2 2 a, b

a a = project team leader/energy specialist, b = financial specialist, c = counsel, d = senior commercial cofinancing specialist, e = private sector development specialist, f = governance specialist, g = power specialist consultant, h = macroeconomist consultant, i = financial analyst consultant

I. PROGRAM DESCRIPTION

1. In 2006, the restructuring of the power sector in the Philippines had reached an important juncture. The legal, regulatory, and institutional framework for privatization and competition was largely in place. But, for restructuring to succeed, the sector had to regain its financial viability, improve its regulatory performance, and inspire greater confidence in private sector investors. The government needed the support of the Asian Development Bank (ADB) in all these areas to strengthen the restructuring process. In December 2006, ADB approved the Power Sector Development Program (PSDP)1 to (i) correct the long-term financial problems in the sector, (ii) reinforce regulatory performance, (iii) improve the conditions for privatization, and (iv) increase public confidence in the reforms.

II. EVALUATION OF DESIGN AND IMPLEMENTATION

A. Relevance of Design and Formulation

2. In July 2005, the Board endorsed the Philippine country strategy and program 2005–2007 (CSP).2 The CSP drew clear links between the development constraints and the three sector policy reform targets—power, financial markets, and governance. Support for the power sector in particular would sustain fiscal consolidation. In close consultation with the government and other stakeholders, ADB developed the PSDP to deal with the largest sources of the fiscal imbalance in the public sector caused by losses among the public power agencies. The PSDP was seen to reduce the losses at the National Power Corporation (NPC) and make the Power Sector Assets and Liabilities Management Corporation (PSALM) more creditworthy, and to create the necessary conditions for the privatization of major power sector assets. At the completion of the program, its design was assessed to be sound and its formulation adequate. The PSDP as implemented remains highly relevant to ADB’s country strategy and the government’s development objectives. 3. At appraisal, the PSDP was designed as a cluster program consisting of two subprograms. The objectives of subprogram 1 were to (i) provide financial assistance to the government, through a program loan, to help meet part of the costs of power sector restructuring; (ii) create the necessary conditions for substantial progress in privatization under subprogram 2; (iii) boost confidence in regulatory performance; and (iv) smooth the transition to competitive markets. Subprogram 2 was envisaged to include a partial credit guarantee to support PSALM’s debt management, and a political risk guarantee to facilitate private sector investment in power generation and transmission. The success of subprogram 1 and substantial progress of the privatization program, however, prompted the government to decide not to pursue subprogram 2 as planned.

B. Program Output

4. The table below summarizes the program’s output at appraisal and at program completion. Further details of program achievements can be found in the Program Design and Monitoring Framework (Appendix 1).

1 ADB. 2006. Report and Recommendation of the President to the Board of Directors: Proposed Program Cluster

and Program Loan to the Republic of the Philippines for the Power Sector Development Program. Manila. 2 ADB. 2005. Country Strategy and Program: Philippines, 2005–2007. Manila.

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Output of the Power Sector Development Program At Appraisal At Completion (as of May 2010) 1. Ensuring the financial viability of the power sector DSCR of 1.0 achieved in PSALM’s operations from 2009 onward

As the universal charge was not approved by ERC, the DSCR was only 0.76 in 2009. PSALM is implementing a liability management program to enable it to achieve a DSCR of 1.0 by 2010 .

2. Strengthening the regulatory framework for the sector ERC’s institutional capacity strengthened by the end of 2008

ERC’s credibility has improved, and appeals and complaints against ERC’s rulings have dropped significantly in number. Improved ERC institutional capacity has drawn private sector investors, as the success of the privatization program shows.

3. Restructuring the market toward competition WESM operations expanded to the Visayas by the end of 2007

WESM trial operations started in May 2009. But commercial operations have not been launched because of power generation shortages in the Visayas grid.

Consumer choice program for TOU rates started in 2007 for consumers with 1 MW or higher loads in Meralco’s franchise

The Customer Choice Program was implemented in the Meralco franchise area in January 2007 and extended to all ERC franchise areas in January 2010 through the issuance of the rules for the implementation of the Power Supply Option Program (PSOP). All consumers with monthly average peak demand above 1 MW are eligible for PSOP.

4. Promoting private sector participation in the power sector Significant part of NPC’s eligible generation assets (at least 30%) sold by the end of 2008

By the end of 2008, 2,172 MW of generation capacity had been privatized.

The rest of NPC’s eligible generation assets sold by the end of 2010

By 30 May 2010, 3,365 MW of generation capacity, or 91% of total eligible assets for privatization in Luzon and the Visayas, had been privatized. Five IPP administrators (for 2,146 MW, or 44% of the contracted capacity of the IPP contracts for Luzon and the Visayas) had been appointed.

TransCo concession awarded by the end of 2008

TransCo concession was awarded in December 2007 and turned over to the winning concessionaire in January 2009 after Congress approved the TransCo Franchise Law.

5. Improving consumer welfare and protection Adequate social protection mechanism for the poor implemented by the end of 2007

ERC studied lifeline rates for poor consumers. Lifeline rates have been approved for all distribution utilities. To give more protection to vulnerable consumers, ERC in December 2009 proposed changes in some provisions of the Magna Carta for Residential Electricity Consumers.

DSCR = debt service coverage ratio, ERC = Energy Regulatory Commission, IPP = independent power producer, Meralco = Manila Electric Company, MW = megawatt, NPC = National Power Corporation, PSALM = Power Sector Assets and Liabilities Management Corporation, TOU = Time-of-Use, TransCo = National Transmission Corporation, WESM = wholesale electricity spot market

5. In summary, the output of the privatization program largely exceeded expectations, with 3,365 MW of capacity already awarded at the time of the program completion review (PCR) mission, and the output related to the regulatory framework and market competition also substantially achieved. A major concern is PSALM’s failure to achieve a debt service coverage ratio (DSCR) of 1.0 in 2009 (though improved from 0.38 in 2008 to 0.76 in 2009) because of the

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timing mismatch between the receipt of such privatization proceeds and maturities of PSALM’s obligations as well as delay in the approval by the Energy Regulatory Commission (ERC) of universal charges for PSALM’s stranded cost and debt. ERC is holding public hearings on PSALM’s application for universal charges, which was filed in June 2009.

C. Program Costs

6. The PSDP helped the government finance part of the adjustment costs of power sector restructuring in support of the implementation of agreed policy actions. At the time of appraisal, the government was expected to need about $9.2 billion in 2006–2010. In addition to ADB’s program loan, the Japan Bank for International Cooperation provided cofinancing of $300 million in February 2007. The privatization proceeds from 2006 to 2009 amounted to $3.71 billion, while the remaining gap was covered mainly by PSALM’s commercial borrowings with government guarantee. The privatization proceeds and PSALM’s commercial borrowings enabled the corporation to prepay various loans including the outstanding balance of the ADB loan for the Masinloc Coal-Fired Thermal Project, 3 which was successfully privatized in 2008. The prepayment helped reduce NPC’s aggregate debt from $7.01 billion at the end of 2007 to $5.8 billion at the end of 2008. 7. However, about $4.55 billion (in principal and interest) of PSALM’s debt was due to mature in 2009–2011. As this amount was almost twice the expected privatization receipts (about $2.56 billion) during the period, a shortfall of about $2.2 billion would result in 2009–2011. PSALM established a liability management program to help it to meet the DSCR of 1.0 covenanted under the ADB loan. Without the program, PSALM’s DSCR would be 0.28 in 2010 (versus 1.2 with the program) and 0.14 in 2011 (versus 0.9) (Appendix 2).

D. Disbursements

8. The loan took effect on 19 December 2006 and was disbursed promptly on 20 December 2006 as provided in ADB’s simplified disbursement procedures.4 The government certified that the expenditures were made for the purposes specified in the loan agreement.

E. Program Schedule

9. At appraisal, the PSDP was designed as a program cluster consisting of two subprograms—one for 2007–2008 and another for 2009–2010 (tentatively). But the success of subprogram 1 and better-than-expected proceeds from privatization led to a decision not to pursue subprogram 2 as planned (para. 3). The loan was closed as scheduled on 30 June 2009.

F. Implementation Arrangements

10. The government created the Energy Executive Committee to implement the program cluster. It had representatives from the Department of Energy (DOE), PSALM, the Philippine Electricity Market Corporation (PEMC), NPC, the National Transmission Corporation (TransCo), the National Electrification Administration, and the Philippine National Oil Company. The program implementation arrangements were adequate for the delivery of the expected output.

3 ADB. 1990. Report and Recommendation of the President to the Board of Directors: Proposed Loan for the

Sixteenth Power (Masinloc Thermal Power) Project in the Philippines. Manila. 4 ADB. 1998. Simplification of Disbursement Procedures and Related Requirements for Program Loans. Manila.

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G. Conditions and Covenants

11. All 22 policy actions required for the effectiveness of subprogram 1 were fulfilled before the Board consideration on 8 December 2006 (Appendix 3). Of the 12 policy actions to be implemented under subprogram 1, 10 had been fulfilled at the time of the PCR. The two policy actions that have not been fully accomplished involved (i) the expansion of the wholesale electricity spot market (WESM) to the Visayas, and (ii) the establishment of effective safety nets and consumer protection. As mentioned in the table under para. 4, WESM trial operations in the Visayas started in May 2009. But power generation shortages in the Visayas grid have held back commercial operations. The DOE has issued policy guidelines for the implementation of the Visayas Supply Augmentation Auction Program to deal with the supply deficit in the interim and smooth the transition to the implementation of the WESM in the Visayas grid. The expected operation of the 246 MW coal-fired power plant in Toledo, Cebu, in 2010 will improve the power supply and make it possible for the WESM to start commercial operation in the Visayas grid in the first half of 2011. 12. ERC studied lifeline rates for poor consumers under subprogram 1, and is looking into ways of protecting the vulnerable. To strengthen the rights of consumers, ERC proposed changes in some provisions of the Magna Carta for Residential Electricity Consumers. Among the proposed amendments are provisions that identify options, set parameters, or clarify concerns related to (i) applications for power connections, (ii) transfer and termination of electricity service, (iii) liabilities of the house owner in case the applicant is a tenant of the premises to be energized, (iv) billing and billing errors, and (v) filing of protests. The amended Magna Carta is expected to be issued by September 2010. 13. Although subprogram 2 of the PSDP was not pursued, the government has made substantial progress in implementing the policy actions envisaged before subprogram 2. Among the seven policy actions, five have been completed: (i) ERC’s use of part of the fees collected, (ii) start of the Customer Choice Program, (iii) issue of guidelines on open-access distribution to allow retail competition to start, (iv) issue of notice of award for TransCo’s concession contract, and (iv) issue of notice of award for the sale of a significant part of generating assets. Three of the policy actions are yet to be fully achieved: (i) appointment of an independent market operator (IMO) for WESM, (ii) start of the collection of universal charges for stranded debt and costs, and (iii) appointment of independent power producer (IPP) administrators. Regarding the appointment of an IMO, DOE and PMEC are doing a study of governance with ADB assistance to plan the transition from the present DOE-driven market operator to an independent market operator. DOE intends to appoint the IMO, on the basis of the study, in the first half of 2011. To collect universal charges, PSALM applied to ERC in June 2009 for the introduction of such charges. At the time of the PCR, ERC was still holding public hearings, as some consumer groups opposed the charges. As for the appointment of IPP administrators, five plants with a total capacity of 2,145 MW, or about 44% of the contracted capacity of the IPP contracts for Luzon and the Visayas, have been successfully bidded out. PSALM plans to complete the bidding by the end of 2010 to achieve 70% of the capacity, the last condition for open access at the retail level.

H. Performance of the Borrower and the Executing Agency

14. The government submitted progress reports periodically to ADB and kept it informed about the progress in implementing the program. The PSDP was closed on 30 June 2009 as scheduled in the loan agreement. The Department of Finance (DOF), as the borrower and

5

executing agency, coordinated effectively with stakeholders and supervised the implementation of the program. Overall, the performance of the DOF was satisfactory.

I. Performance of the Asian Development Bank

15. ADB supported the design and formulation of the PSDP and closely monitored the implementation of the program. Instead of yearly review missions, monthly meetings were held with the DOF and the DOE (the implementing agency). In fact, the proximity of ADB’s headquarters to DOF allowed constant coordination on key policy issues during the processing and implementation of the PSDP. ADB also worked closely with other development partners in the power sector in the Philippines. The performance of ADB in the implementation of the program was satisfactory.

III. EVALUATION OF PERFORMANCE

A. Relevance

16. The PSDP was highly relevant to the government’s goal of achieving a financially sustainable, efficient, and secure power supply to stop the drain on the government’s finances, free up resources for the social sectors, and minimize the risk of power shortages that would impede economic growth. The PSDP was consistent with ADB’s CSP 2005–2007 for the Philippines (footnote 2), which identified power sector reform as one of the main interventions that would ease the most important development constraints, such as the fiscal imbalance and the poor investment climate. As the lead financing agency in the sector, ADB has continued to conduct policy dialogue, and to review and monitor power sector reform and privatization.

B. Effectiveness in Achieving Outcome

17. The power sector restructuring made substantial progress in wholesale competition and privatization under the PSDP. But retail competition has not been fully implemented, and electricity rates are still relatively high compared with those in other countries in the region. Overall, the PSDP is considered partly effective in achieving outcome.

C. Efficiency in Achieving Outcome and Outputs

18. As summarized in the table under para. 4, the strengthening of the regulatory framework induced substantial private sector investments in the power sector during the implementation of subprogram 1. As a result, 91% of NPC’s generating assets were privatized, while the appointment of IPP administrators for the Luzon and Visayas grids was at 44% at the time of the PCR. Nevertheless, despite the high electricity rate, PSALM has not achieved a DSCR of 1.0 because of the historical debt burden and delayed approval of the universal charges by ERC. Overall, the achievement of the PSDP’s outcome and output is considered partly efficient.

D. Preliminary Assessment of Sustainability

19. The restructuring of the power sector as envisioned in the PSDP is fundamentally sound, and has had a significant positive impact on the sector and on the overall economy. With the large-scale privatization and introduction of a competitive electricity market, the government has had its role reduced to that of policy maker and planner. Further, except for the electrification of unviable rural areas, its unsustainable subsidies to the power sector have been eliminated.

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Thus, as a major fiscal crisis has been averted, more financial resources are being freed up for social services and infrastructure. Restoring financial viability to the power sector is essential to fiscal consolidation, and to new investments in the power sector. Therefore, the power sector restructuring is considered sustainable in the long term. 20. The government is, however, facing some challenges in the short and medium term. While the objective of the Electric Power Industry Reform Act (EPIRA) (2001) is to provide sustainable and affordable power supply to all consumers, the electricity rate is the key parameter that affects both consumer welfare and investment profitability. Electricity rates in the Philippines are still among the highest in Asia. The most effective way to bring down the rates to a more reasonable level is through further reforms that would increase market competition at the retail level and, at the same time, put in place a legal framework to protect the interests of consumers.

E. Institutional Development

21. The power sector’s legal and institutional accountability framework is generally adequate. Within the framework of the EPIRA and supported by various ADB assistance programs including the PSDP, the following institutions have been created:

(i) TransCo, to take over NPC’s transmission assets and operations (its operations have now been taken over by a private sector concessionaire);

(ii) PSALM, to (a) oversee and manage the privatization of NPC’s generation assets, (b) award the concession for TransCo’s transmission operations, and (c) take over the debt liabilities and non-transmission assets of NPC;

(iii) An independent ERC, to set rates for the captive market, and for transmission and distribution, which are regulated parts of the electricity supply business;

(iv) PEMC, to supervise the establishment of the wholesale electricity spot market, which started commercial operations in June 2006; and

(v) A reorganized DOE, to perform its expanded mandate of power sector planning and supervision of power sector restructuring.

22. Among the above institutions, PEMC is still in a transition stage, as the appointment of an IMO under EPIRA, a required policy action under the PSDP, is still to take place (para. 13).

F. Impact

23. Power sector restructuring has contributed to the fiscal consolidation of the country. With the deficit declining from 2.7% of gross domestic product (GDP) in 2005 to 0.9% in 2008, the government is performing a delicate balancing act of mounting an adequate fiscal response to a deteriorating growth outlook in the near term while sustaining market expectations of fiscal prudence and credibility in the medium term. Sound debt management, particularly in the power sector, led to a decline in national government debt as a ratio of GDP during the implementation period of the PSDP, reduced dependence on commercial borrowing, increased access to official development assistance, and eased debt servicing costs.

IV. OVERALL ASSESSMENT AND RECOMMENDATIONS

A. Overall Assessment

24. In summary, the concept and design of the PSDP were consistent with ADB’s country strategy and energy policy, and with the long-term vision of the government for power sector

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development in the country. Under the PSDP, substantial progress was achieved in strengthening power sector institutions and privatizing sector assets, but financial viability is still a challenge for the short and medium term. Overall, the program is considered successful.

B. Lessons

25. The design of PSDP took into account the lessons learned from previous ADB operations in the power sector.5 In particular, the preparation of the PSDP benefited from the sector assistance program evaluation of ADB’s assistance to the Philippine power sector.6 On this basis, the PSDP envisaged two subprograms with 2-year time horizons, covering 2007–2008 and tentatively 2009–2010. Target dates were set only for subprogram 1 to allow flexibility in the overall implementation schedule. The government chose not to pursue subprogram 2 mainly because of the better-than-expected progress of the privatization program, with private sector investments being made without the assistance foreseen under subprogram 2. However, without subprogram 2, the government was able to defer a key policy action that was required for the implementation of the subprogram—the introduction of universal charges for stranded debt and cost. As a consequence, PSALM could not achieve a DSCR of 1.0 in 2009 as required in the policy matrix.

C. Recommendations

26. Future monitoring. The financial situation of PSALM remains a key concern. The implementation of its liability management program should be monitored closely, as this will significantly affect the country’s fiscal situation. 27. Covenants. The covenants in the program loan agreement should retain their present form during the repayment period of the program loan particularly with regard to PSALM’s DSCR. A concrete action plan with clear milestones will be required from PSALM when a waiver for its failure to achieve the required DSCR of 1.0 in 2009 is considered. 28. Further action or follow-up. A key milestone to follow up is the timing of the introduction of universal charges for stranded debt and cost. At the same time, ERC should strengthen the mechanism for protecting the welfare of consumers, particularly the very poor. 29. Additional assistance. The assessment of key sector issues and the progress of the power sector restructuring indicates that additional assistance may be considered in the following strategic areas: (i) continued support for power sector restructuring, mainly through the private sector lending window; (ii) strengthening of electricity distribution sector through public sector operations; (iii) promotion of renewable energy and energy efficiency through public and private sector partnership; and (iv) targeted support for the rural poor, particularly in Mindanao, through technical assistance. 30. Timing of the program performance evaluation. It is recommended that the program performance audit be undertaken in 2011 after the expected completion of the privatization program by the end of 2010.

5 ADB. 2004. Completion Report: Power Sector Restructuring Program in the Philippines. Manila. 6 ADB. 2005. Sector Assistance Program Evaluation: Assistance to the Philippine Power Sector. Manila.

8 Appendix 1

PROGRAM DESIGN AND MONITORING FRAMEWORK

Design Summary

Performance Indicators and Targets Monitoring Mechanisms

Assumptions and Risks Actual Achievement

Impact Financially sustainable, efficient, and secure power supply to stop the drain on the government’s finances, and minimize the risk of power shortages

Government financial support for NPC, currently exceeding $1 billion per year, reduced by 2010 to subsidies required for power supply on small islands not connected to the three main grids (SPUG) No power supply shortage

National Expenditure Program prepared by the Department of Budget and Management PSALM’s and NPC’s annual reports audited by COA DUs’ annual reports; DOE’s statistics as contained in the Philippine Energy Plan

The power sector restructuring contributed to the fiscal consolidation of the country, The fiscal deficit declined from 2.7% of GDP in 2005 to 0.9% in 2008. No country-aide power shortage, except power shortages experienced in some parts of Visayas and Mindanao due to drought situation in early 2010.

Outcome Consolidation of the power sector restructuring

Wholesale electricity competition started, substantial progress in privatization, and retail competition in line with EPIRA by the end of 2010

Semiannual progress reports prepared by DOE to JCPC on the EPIRA implementation

Assumptions Macroeconomic and political stability Strong fiscal stabilization program Support of reforms by stakeholders other than the government Risk Weakening of the political will in the executive and legislative branches of the government to proceed with the restructuring

Power sector restructuring made substantial progress with over 90% of asset privatization and the wholesale competition started in Luzon. The retail competition is expected to be implemented in the first half of 2011.

Outputs Assumption 1. Financial viability of the power sector restored

Debt service coverage ratio of 1.0 achieved in PSALM’s operations from 2009 onward

PSALM’s annual reports audited by COA

ERC approval of needed tariff increases and universal charges, and successful debt management by the government and PSALM

Debt service coverage ratio of 1.0 not achieved in 2009. PSALM is implementing liability management program to achieve debt service coverage of 1.0 from 2010.

Appendix 1 9

Design Summary



2. Regulatory framework and performance improved

ERC’s institutional capacity and financial autonomy strengthened by the end of 2008 Regulatory framework for wholesale competition completed by mid-2006

Feedback from regulated utilities and ERC annual report Rules and guidelines as issued by ERC

Risk Political and judicial interference with ERC’s decision making Assumption Continued support for ERC from USAID and other development Partners

ERC’s institutional capacity has been strengthened, and it has issued necessary rules and regulations for the wholesale competitive market, performance-based regulation for transmission and distribution, and retail competition. However, the ERC’s budget still depends on the budget allocation.

3. Market restructured toward competition

WESM operations started in Luzon in July 2006, accounting for at least 10% of total sales

PEMC’s audited annual reports

Risk Technical problems with the start-up Assumption Technical and financial readiness of WESM participants

WESM operations started in Luzon in July 2006, accounting for about 15% of total sales in 2009.

WESM operations expanded to the Visayas by the end of 2007

PEMC’s audited annual reports

WESM trial operations in Visayas started in May 2009. Commercial operations are expected to be launched in the first half of 2011.

Consumer choice program for TOU rates started in 2007 for consumers with loads of 1 MW or more in Meralco’s franchise area

Signed contracts between suppliers and eligible consumers

Assumption Technical readiness of DUs

In January 2007, Meralco started the Customer Choice Program. The scheme was extended to all franchises by ERC through the issuance of rules for the Power Supply Option Program (PSOP) in January 2010. All customers with monthly average peak demand above 1 MW are eligible for PSOP.

10 Appendix 1

Design Summary



4. Private participation in power generation and transmission increased

Significant part of NPC’s eligible generation assets (at least 30%) sold by the end of 2008

Signed contracts between PSALM and private investors

Risk Lack of investor interest

The remaining part of NPC’s eligible generation assets sold by the end of 2010

Signed contracts between PSALM and private investors

By 30 May 2010, 3,365 MW of generation capacity, representing 91% of the total eligible assets for privatization in Luzon and the Visayas, was privatized. Five independent power producer administrators (for 2,146 MW, or 44% of the contracted capacity of the IPP contracts for Luzon and the Visayas) have been appointed.

TransCo concession awarded by the end of 2008

Signed contract between PSALM and the Concessionaire

TransCo concession awarded in December 2007

5. Consumers informed and protected

Rights and obligations of consumers promulgated by the end of 2005

Magna Carta and remedial procedures for consumers as issued by ERC

Magna Carta and remedial procedures for consumers issued by ERC; amendments proposed in December 2009

Adequate social protection mechanism for the poor implemented by the end of 2007

ERC-approved retail tariff schedule

ERC conducted a study on lifeline rates for poor consumers. Lifeline rates have been approved for all distribution utilities.

Activities 1. Financial viability of the power sector

a. Ensuring financial recovery of NPC

Generation tariffs increased and operating costs reduced to levels required to eliminate NPC’s losses

ERC-approved generation tariffs NPC’s annual reports audited by COA

Risk Tariff increases contested in courts by consumer groups

Generation tariffs have been regularly adjusted to reflect the fuel price and currency fluctuations.

b. Establishing creditworthiness of PSALM

Action plan adopted to increase PSALM’s debt service coverage ratio to at least 1.0 by 2009

Action plan approved by the government

DOF approved PSALM’s liability management program in May 2009.

Appendix 1 11

Design Summary



P200 billion of NPC’s debt liabilities absorbed by the government selected and transferred by the end of 2005

Legal instrument to effect the transfer

Assumption Effective fiscal management by the government

P200 billion of NPC’s debt liabilities absorbed by the government selected and transferred in December 2005

Universal charge introduced by January 2008 to cover NPC’s stranded costs and debt

ERC-approved wholesale and retail tariffs

Risk Universal charge contested in courts by consumer groups

PSALM filed application of universal charge for stranded costs and debt in June 2009. Public hearings are in progress.

2. Regulatory framework and performance

a. Enhancing ERC’s independence, efficiency, and technical competence

Rolling strategic plan for ERC adopted by October 2006

Strategic plan adopted by ERC

ERC has adopted a Medium-Term Strategic Plan for 2008–2011.

ERC allowed to use fees levied on regulated entities for funding prescribed regulatory activities

Approved ERC budget Delays in Congress ERC’s budget has been approved on a timely basis, without resorting fees levied.

b. Completing the regulatory framework for wholesale and retail competition

Guidelines on pricing methodology for WESM, system loss cap for DUs, transmission capacity development, and open access for distribution, issued by mid-2006

Guidelines issued by ERC Price determination methodology issued in June 2006, with bid cap of P64 per kWh

Performance-based regulation implemented by the end of 2006 for TransCo and DUs

Guidelines issued by ERC, and applications of TransCo and DUs approved

Performance-based regulation issued by ERC, and implemented by TransCo and eligible DUs

12 Appendix 1

Design Summary



Regulation for ECs simplified and an approach developed for reducing their number by the end of 2008

Guidelines issued by ERC Risk Political resistance at local level to EC consolidation

A simplified benchmarking system for setting ECs’ wheeling rate was adopted in September 2009.

3. Market restructuring toward competition

a. Preparing the start of wholesale competition

Negotiation of transition supply contracts completed by the end of 2006

ERC-approved signed contracts between NPC and DUs

Risk Inability of the parties involved to arrive at mutually acceptable solutions

All transition supply contracts were concluded in 2007.

Independent operator for WESM appointed by the end of 2008

Signed contract between PEMC and the WESM operator

ADB-funded consultant is assisting DOE in appointing IMO by the first half of 2011.

Mechanisms established by end-2006 to mitigate offtake risks, allow participation of smaller DUs, and ensure power supply in case of DU suspension from WESM

Consultant report and DOE’s and PEMC’s decision on its recommendations

Assumption Implementation of DOE action plan with the support of a World Bank loan and TA to manage creditworthiness risk of DUs, particularly ECs

National Electrification Administration set up a mechanism to encourage participation of ECs in WESM. NPC was appointed the supplier of last resort for ECs.

4. Private participation in power generation and transmission

a. Ensuring reliable power supply during the transition period

NPC’s and TransCo’s investments prioritized by mid-2006

Government-approved revised investment plan of NPC and TransCo

Government approved NPC and TransCo’s investment plans before their privatization.

Contingency plan put in place by the end of 2006

Contingency plan prepared by DOE

The government adopted a contingency plan for dealing with the power crisis. The plan was partly applied during the drought of March 2010.

Appendix 1 13

Design Summary



b. Paving the way for asset sale

Relevant plans regularly updated and made consistent

Philippine Energy Plan, Power Development Plan, and Transmission Development Plan issued or approved by DOE

DOE issued Philippine Energy Plan, Power Development Plan every year; TransCo issued Transmission Development Plan.

Award of TransCo concession by the end of 2008

Semiannual progress reports prepared by DOE to JCPC on the EPIRA implementation

TransCo’s concession awarded in December 2007

Bids called in a phased manner for NPC’s power plants

Invitations to bid and bid documents issued by PSALM

Invitations to bid for privatization of all of NPC’s eligible generation assets were issued.

5. Consumer information and protection

a. Conducting public information campaigns on the rationale for power sector restructuring

Public understanding of the matter improved

Surveys of the general public by DOE

Regular public information campaigns were conducted in June every year on the anniversary of EPIRA. DOE prepared the EPIRA status report every 6 months to inform the public about the progress of power sector reform.

b. Assessing the social impact of the power sector restructuring

Existing social protection mechanism for lifeline tariffs reviewed and, if necessary, modified by mid-2008 to better target the poor

ERC’s review report and ERC’s decision

ERC conducted a study on lifeline rates for poor consumers. Lifeline rates have been approved for all distribution utilities.

Inputs ADB loan: $450 million PCG, PRG amounts to be determined

The loan was disbursed on 20 December 2006.

ADB = Asian Development Bank, COA = Commission on Audit, DOE = Department of Energy, DOF = Department of Finance, DU = Distribution Utilities, EC = Electric Cooperatives, EPIRA = Electric Power Industry Reform Act, ERC = Energy Regulatory Commission, GDP = gross domestic product, JCPC = Joint Congressional Power Commission, Meralco = Manila Electric Company, MW = megawatt, NPC = National Power Corporation, PCG = partial credit guarantee, PEMC = Philippine Electricity Market Corporation, PRG = political risk guarantee, PSALM = Power Sector Assets and Liabilities Management Corporation, SPUG =Small Power Utilities Group, TA = technical assistance, TOU = Time-of-Use, TransCo = National Transmission Corporation, US= United States Agency for International Development, WESM = wholesale electricity spot market

Appendix 2

14

PSALM’s LIABILITY MANAGEMENT PROGRAM Projected DSCR Calculations

(P million) Without Liability Management Program 2009 2010 2011 Internal Cash Generation a (7,142) 7,851 (15,380) Privatization Proceeds 93,544 25,887 28,935 Funds Available for Debt Service 86,401 33,738 13,556 Debt Service 65,111 83,012 58,123 Lease Obligations 48,756 36,232 37,575 Debt Service Requirement 113,868 119,244 95,698 DSCR 0.76 0.3 0.1 With Liability Management Program 2010 2011 Internal Cash Generation a 7,851 (15,380) Privatization Proceeds 25,887 28,935 Cash Flows from LMP Securitization Proceeds 23,698 96,768 Less: TransCo Concession Fee Receivables (14,257) (17,922) Bond Exchange Proceeds Peso Bond Issuance 19,800 US Dollar Bond Issuance 47,000 Funds Available for Debt Service 109,980 92,402 Debt Service Existing Debt 83,012 58,123 Less: Bonds Exchanged (28,800) Interest on New Bonds of Bond Exchange 1,560 3,185 Interest on Peso Bonds 2,813 4,688 Interest on Dollar Bonds 3,920 Lease Obligations 36,232 37,575 Debt Service Requirement 94,816 107,491 DSCR 1.2 0.9

DSCR = debt service coverage ratio, LMP = Liability Management Program, PSALM = Power Sector Assets and Liabilities Management Corporation, TransCo = National Transmission Company. a Excludes universal charge that PSALM is seeking approval for from the Energy Regulatory Commission. Its

application will improve PSALM’s DSCR. Source: Power Sector Assets and Liabilities Management (PSALM)

Appendix 3 15

DEVELOPMENT POLICY LETTER AND POLICY MATRIX FOR THE PROGRAM CLUSTER

(Implementation Status as of 31 December 2009)

Action Required for Completion by

Area

Action

Agencies

Before Board consideration

During Subprogram

1

Before Subprogram

2

During Subprogram

2 Actual Status

A. Financial viability of the power sector

1. Start charging the generation tariff adjustment authorized by ERC.

NPC

X

Continuing compliance

2. Timely adjustment of regulated generation prices through application of a formulaic approach for incremental fuel and power purchase costs.

ERC and NPC

X

X

Continuing compliance

3. Continue to implement measures to lower NPC and TransCo’s operating costs; prioritize NPC’s and TransCo’s capital expenditure requirements for the period prior to privatization consistent with revised demand forecasts and having regard to demand-side and distributed generation potential.

PSALM, NPC, and TransCo

X X Continuing compliance

4. DOF to coordinate with (a)DOE for the issuance of a

detailed action plan on the following: (i) by PSALM and NPC, the use of privatization proceeds to reduce borrowings; (ii) by PSALM and NPC, application for universal charges for stranded costs and debt; (iii) by PSALM and NPC liability management and iv) by PSALM and NPC reimbursement of non-

DOF, DOE, NPC, PSALM, and DBM

X Completed in Nov. 2006 DSCR of 1.0 not achieved in 2009

16 Appendix 3


Area

Action

Agencies


During Subprogram

1

Before Subprogram

2

During Subprogram

2 Actual Status

power costs for multi-purpose projects.

(b)DBM in providing the assistance to PSALM, when necessary and in accordance with budgetary process, to (i) help PSALM achieve DSCRb of at least 1.0 starting in 2009.

5. Complete the transfer of about P200 billion of NPC debts to the government.

DOF, PSALM, and NPC

X Completed in April 2005

6. Issue guidelines for universal charge (UC) for stranded contract cost and stranded debt, respectively.

ERC X Completed in Feb. 2007

(a) Filing the universal charges for stranded debt and costs.

(b) Start charging the universal charges authorized by ERC.

PSALM and NPC PSALM and NPC

X

X

Completed in June 2009 Not yet done

7. Issue guidelines for introduction of TOU tariffs at the wholesale level.

ERC X Completed in June 2005

8. Approval to remove inter-grid and intra-grid cross-subsidies and inter-class cross-subsidies in electricity tariffs.

ERC

X Completed in Oct. 2006

9. Issue guidelines, for all regulated market participants, a uniform system of accounts that is internationally accepted for private DUs, and enforce the use thereof.

ERC X Completed in Sept. 2009

10. DOE to coordinate and issue a detailed action plan to

DOE, NEA, and

X Ongoing implementation

Appendix 3 17


Area

Action

Agencies


During Subprogram

1

Before Subprogram

2

During Subprogram

2 Actual Status

implement clear restructuring steps where ECs are not financially viable, including such actions as mandatory NEA or NPC transitional management / participation in Board of ECs, as appropriate, and investment management contracts (IMCs), for ECs that have to rely on wholesale supplier of last resort and fail to cure the problems within a specified period.

PSALM of the action plan adopted in Dec. 2006

B. Regulatory framework and performance

1. Adopt and implement a rolling strategic plan for ERC with respect to institutional and capacity improvement, efficiency and technical competencies, regulatory achievements and indicators for public confidence levels.

ERC

X

ERC Medium-Term Strategic Plan 2008–2011

2. Issue Rules of Practice and Procedure to ensure efficient hearing and investigative procedures that have clear time periods.

ERC X

completed in June 2006

3. For ERC’s budget (a) Timely provision and release

of regular budget based on applicable law in line with budgetary process and regulations.

(b) ERC to use fees collected in excess of their revenue target for the year in accordance with budgetary

ERC and DBM

X

X

Completed on time No progress reported

18 Appendix 3


Area

Action

Agencies


During Subprogram

1

Before Subprogram

2

During Subprogram

2 Actual Status

process and regulations. 4. Request and obtain a

general deputization consent for ERC to represent itself at all levels of judicial proceedings.

ERC X Completed in Dec. 2006

C. Market restructuring toward competition

1. Design mechanisms that facilitate and provide incentives to demand-side participation in WESM and provide technical support

DOE and PEMC

X Only 18 ECs out of 119 registered for WESM

2. Put in place a contingency plan to ensure reliable power supply in line with Sec. 71 of EPIRA without disrupting the development of a competitive energy market.

DOE X X Plan in place

3. Issue guidelines on performance-based regulation for TransCo and selected DUs

ERC X Completed in March 2006

4. Issue guidelines on recoverable system loss methodology for DUs to improve energy efficiency.


5. Issue guidelines on price determination methodology for WESM


6. Issue competition rules and complaint procedure


7. Issue guidelines to enable small and/or weak suppliers to purchase energy through wholesale aggregators.


8. Start WESM commercial operations in Luzon.

PEMC X Completed in June 2006

Appendix 3 19


Area

Action

Agencies


During Subprogram

1

Before Subprogram

2

During Subprogram

2 Actual Status

9. Start customer choice program with time-of-use tariff for consumers with average peak demands of 1MW or more in ERC approved franchise area.

NPC and ERC

X Ongoing

10. Issues guidelines on a streamlined approach to regulation of ECs to reduce the number of individual price reviews required

DOE, PEMC, and ERC

X Issued in Nov. 2009

11. Expand WESM operations in Visayas, if warranted by the initial experience in Luzon and the power supply situation.

DOE and PEMC

X Expected 1Q 2011

12. Expand WESM operations in Mindanao, if warranted by the initial experience in Luzon and the power supply situation.

DOE and PEMC

X Not considered

13. Appoint an independent operator for WESM.

DOE and PEMC

X Expected 2Q 2011

14. Issue guidelines on open access for distribution to allow retail competition to start.

ERC X Issued in Sept. 2009

D. Private participation 1. Timely updating of power sector development plan to ensure consistency and adequacy of information needed for investment decisions

DOE X X Regularly updated

2. Engagement of consultant to study on the option of having a trading advisor to advise on trading strategies

PSALM and NPC

X

Study completed in June 2007

20 Appendix 3


Area

Action

Agencies


During Subprogram

1

Before Subprogram

2

During Subprogram

2 Actual Status

as a transition to establishment of the IPP administrator

3. Appoint IPP administrators. PSALM and NPC

X 41% of capacity awarded

4. Call for bids for the TransCo concession.

PSALM X Completed in Sept. 2008

5. Issue notice of award for the TransCo concession contract.

PSALM X Completed in Dec. 2008

6. Complete the process of negotiation and conclusion of transition supply contracts between NPC and the DUs

PSALM and NPC

X Completed in Dec. 2007

7. Issue resolution to require DUs to negotiate bilateral supply contracts with power generators.


8. Issue resolution to impose a premium on sale prices for those DUs without transition supply contract and relying on the default wholesale supplier arrangements


9. Call for bids for the sale of eligible NPC’s generation capacity.

PSALM X

Completed in 2006–2009

10. Issue notice of award for the sale of a significant part of generating assets.

PSALM X

91% awarded

E. Consumer welfare and protection

1. Conduct public information campaign on the rationale for power sector restructuring, privatization and regulatory framework.

DOE and ERC

X

X

Ongoing

2. Promulgate a bill of rights of ERC X Completed in

Appendix 3 21


Area

Action

Agencies


During Subprogram

1

Before Subprogram

2

During Subprogram

2 Actual Status

residential electricity consumers.

June 2004

3. Issue guidelines on supplier of last resort in case of retail electricity supplier’s suspension from WESM and appoint a default temporary wholesale supplier of last resort to supply to DUs and ECs that are unable to participate in the WESM and the contract market.


4. Publish complaint procedure, establish consumer complaint desk at ERC and consumer welfare desks at all electric utilities; and conduct training to all consumer welfare desk officers.

ERC and DUs

X Completed in June 2006

5. Establish periodic review and report on the impacts of the reforms on consumers (in terms of access and quality of supply as well as price) and the effectiveness of safety nets and consumer protection.

DOE and ERC

X

X Included in EPIRA progress report

ADB = Asian Development Bank, DBM = Department of Budget and Management, DOE = Department of Energy, DOF = Department of Finance, DSCR = debt service coverage ratio, DU = distribution utility, ERC = Energy Regulatory Commission, EPIRA = Electric Power Industry Reform Act, IPP = independent power producer, NEA = National Electrification Administration, NPC = National Power Corporation, TransCo = National Transmission Corporation, PEMC = Philippine Electric Market Corporation, PSALM = Power Sector Assets and Liabilities Management Corporation, TOU = time of use, WESM = wholesale electricity spot market a These conditions are indicative of the general direction subprogram 2 might take. They need to be reviewed and, if necessary, modified or deleted on the basis of the results of subprogram 1. b DSCR is defined as internally generated cash (including privatization proceeds and universal charges) divided by debt service. Sources: Department of Finance, Department of Energy, and Asian Development Bank

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