pproaches 37357 M a y 2 0 0 6 N o t e N u m b e r 1 0 Output-based aid in the Philippines Improving electricity supply on remote islands by Sanjay Grewal, Shobana Venkataraman, Julie Bayking, Alfonso Guzman, and Seini O'Connor T he Philippines has introduced an output-based With the diseconomies of small-scale systems and aid (OBA) subsidy scheme to improve electricity high fuel and overhead costs, serving these remote supply on remote islands as a way to enhance living islands is expensive. But fully recovering costs from standards in the poor communities there. The subsidy, to come the local population would be difficult. Annual per from a national fund financed by a surcharge on all electricity capita income in these areas is around $450--less users, will be paid to private generators selected through than $2 a day and less than half the national average competitive bidding, and disbursed on the basis of the energy ($1,170). Most families survive on subsistence fishing they supply. These generators will take over from the govern- and farming. ment provider, entering into a supply agreement with the The difference between SPUG's costs and its rev- cooperatively owned distribution utility on each island. The enues has been covered in part by a subsidy funded competitive bidding process should ensure that the costs of from a surcharge on all electricity users in the country. supply, and thus the required subsidy, will be lower. That will The rest has traditionally been absorbed by the National allow subsidy funds to be used more efficiently, benefiting more Power Corporation, leading to financial difficulties. communities. The quality of electricity service should also These difficulties were mirrored by national elec- improve. The International Finance Corporation worked with tricity sector funding issues, spurring comprehensive the government to establish a framework ensuring delivery of sector reform. The Electric Power Industry Reform electricity supply and transparency in subsidy payments. The Act, passed in 2001, calls for a classic market reform: first transaction, focusing on three pilot areas, has been unbundling the sector vertically and horizontally, successfully completed. privatizing generation and transmission, creating a The Philippines has more than 85 million people, wholesale electricity market, and introducing retail spread over some 7,100 islands. Most parts of the competition. So far the government has made modest country, and all large municipal areas, have access to progress toward these ambitious goals. electricity, but around 8 percent of the country's The reform includes policies to improve electrifica- 42,000 barangays (villages or neighborhoods) re- tion in rural areas, including most remote islands. mained unserved in 2005. Roughly half of these are in These propose investment management contracts as a remote rural areas. The government has set a goal of way of enabling underperforming electricity coopera- bringing electricity to all barangays by 2008. tives to bring in private capital and management The country's main (on-grid) electricity supply is expertise. The policies also require opening SPUG- through three major grids, with a total installed supplied areas to private generators, to be selected capacity of 16.8 gigawatts. For more remote islands, through competitive bidding, and inviting "qualified where connecting to a major grid is not viable, the third party" providers (private or public) to supply Small Power Utility Group (SPUG), part of the state- electricity in unserved areas that local electricity owned National Power Corporation, generates cooperatives cannot supply. Importantly, all new electricity using small, isolated diesel plants. SPUG sells the power to local electricity cooperatives, which Sanjay Grewal is the Program Manager with IFC Advisory Services distribute it to member consumers. SPUG serves 74 in East Asia, Julie Bayking and Shobana Venkataraman also islands with a total installed capacity of about 170 work with IFC Advisory Services. Alfonso Guzman is the President megawatts (MW). Its costs are inefficiently high, and of Castalia Americas, and Seini O'Connor is an Analyst with its supply unreliable. Castalia. Supporting the delivery of basic services in developing countries pproaches providers would be allowed to recover the full cost of electricity cooperatives (set by the Energy Regulatory service from a combination of tariffs and output-based Commission, or ERC) and a subsidy to cover the differ- aid (OBA) subsidies. ence between the full-cost and subsidized tariffs. Designing the subsidy Developing a framework The gap between the full-cost and subsidized tariffs The International Finance Corporation (IFC) was was expected to be large and unlikely to narrow in the appointed in early 2004 as transaction adviser for near future. IFC suggested a transitional subsidy to opening SPUG areas to private generators. Its initial cover the gap, one that would decline as tariffs gradu- focus was on developing a framework for rural electri- ally rise in line with customers' ability to pay. The ERC fication projects, including a model power supply decided against using this approach initially, because it agreement and regulatory guidelines to govern the did not want to commit to automatic tariff increases. transactions (figure 1). An ongoing consumption-type subsidy (in this case a Under the framework private generators would be production subsidy) was deemed most appropriate for selected through competitive bidding based on the the project areas. lowest full-cost generation tariff. The bidding process Recognizing that the performance of electricity would be technology and location neutral: bidders could cooperatives would play a big part in achieving better propose the fuel and the location they believe would lead service outcomes, the government targeted the best- to the lowest-cost generation. A generator's obligations performing ones when choosing areas for the OBA would be defined on the basis of a supply commitment, scheme. This approach ensures that the OBA subsidies not a capacity commitment (often used in large-scale will go to areas where electricity supply, not distribu- power purchase agreements). That means that the tion, is the key problem. Some 45­70 percent of power generator would be required to meet all the supply outages in the target areas are attributable to problems requirements (base, mid, and peak load) of the electric- and failures in generation, reflecting SPUG's poorly ity cooperatives, installing sufficient capacity to do so. maintained and inadequate generation facilities. The winning bidder would enter into a power supply Addressing payment risks agreement with each electricity cooperative to be served, placing a performance bond to backstop its obligation. The existing structure for administering subsidies The generator would be paid a subsidized tariff by the involves three key entities: the ERC, SPUG, and the Power Sector Assets and Liabilities Management Corporation (PSALM), which administers a fund for all subsidies collected through user Figure 1. Framework for rural electrification projects charges. Under sector law only SPUG may petition for (and receive) payments from the Selected on competitive PSALM-administered subsidy fund. IFC saw All basis: lowest bid price = two key risks in this arrangement: First, a risk true cost generation rate electricity (TCGR) that SPUG would not pass on (or would delay) users subsidy payments to private generators. Sets surcharge Surcharge $ ERC Second, a risk that the funds collected would be less than expected--for example, if con- Output-based sumption fell short of projections or user subsidy Regulates Subsidy Private $ tariffs and payments were not collected or passed on. Fund Provider services Knowing that these risks could deter interest Subsidized among potential private generators or lead to Power Supply $ approved higher electricity prices, the IFC team worked Subsidy= Agreement generation rate TCGR -SAGR (SAGR) closely with PSALM, the Department of Energy, and SPUG to design a new process for adminis- Improved reliability: Electricity Rates at standards and performance tering subsidies. The process includes several Cooperative affordable level contractually guaranteed mechanisms to mitigate the subsidy payment risks and meets the policy and administration Source: Castalia. concerns of each of the parties (figure 2). Supporting the delivery of basic services in developing countries pproaches Figure 2. Process for administering subsidies considering consumer concerns did the ERC adopt the guidelines. ERC 2. ERC sets surcharge Implementing the framework to meet subsidy requirement Having established the framework, the government PSALM faced the challenge of implementing it. Three of the 74 1. NPC-SPUG SPUG-supplied islands were selected to pilot the 4. PSALM collects files "petition" to surcharge funds 5. PSALM ERC for subsidies framework: Marinduque, Romblon, and Tablas. These disburses islands, each served by a different electricity coopera- subsidy tive, have a total capacity requirement of 21 MW. SPUG Electricity The bidding process was launched, aimed at Cooperative (EC) selecting a single private generator to supply the three 6. Provider paid Subsidy subsidy based on islands. Twenty-five developers and equipment suppli- 3. EC collects Agreement outputs surcharge ers registered their interest in the transaction, 17 Filipino-owned companies and 8 international. Five Electricity Private were renewable energy generators. From this group, users Provider three submitted financial proposals, which were Source: Castalia. required to offer a single tariff for all three areas. Of the three bidders submitting proposals, one was disqualified on technical grounds, having submitted This process is set out in a subsidy administration its proposal a few minutes past the deadline. The agreement to be signed by SPUG, the private generator, other two proposals, judged to be technically compli- and the electricity cooperative in each area. Under this ant, were evaluated on the basis of their proposed agreement SPUG commits to petitioning for a subsidy tariff. The winning bidder, a consortium of local sufficient for both its own generation outputs and energy and transport companies, offered a full-cost those of the private provider and to ensuring that the tariff of 7.17 pesos, or $0.128 per kilowatt-hour provider receives the subsidy for which it is eligible. (kWh). Its proposal envisaged a hybrid wind-diesel Putting this process for subsidy payment into a con- system, with about 30 percent of installed capacity tract increases its transparency and provides private provided by wind generation.1 generators with a guarantee. Creating a regulatory regime The outcome Before the project began, the Philippines had no Because the ERC-approved generation tariff for the regulatory framework for private generation in off-grid three islands is $0.10 per kWh, the winning bidder will areas. The IFC team provided capacity building receive a subsidy of $0.028 per kWh once it begins to assistance to help the ERC develop regulatory guide- supply electricity. That implies a subsidy for the first lines for selecting and approving private generators. year of around 23 percent of the provider's total cost These guidelines call for a competitive bidding process of generation, or $2.8 million. With about 60,000 to determine a "true cost" generation tariff for each households connected to electricity service in these area. islands, the subsidy will amount to around $50 per Before the guidelines could be officially endorsed, household a year, around 3 percent of annual house- the public had to have a chance to provide input. A hold income. public awareness campaign was launched in the areas Private generation is expected to lead to both big open to private participation to educate local stake- savings and big improvements in electricity supply holders about the project, the power supply agree- (table 1). The private provider will supply power to the ments they would need to sign with the private genera- tors, and the changes in electricity supply standards 1The winning bidder and the electricity cooperatives on the three they could expect. With support from the IFC team, islands have executed power supply agreements, and the conditions the ERC held "consumer hours"--public hearings needed to make the agreements effective have been met. The parties allowing communities to ask questions. Only after are awaiting ERC approval, expected to be relatively straightforward. Supporting the delivery of basic services in developing countries pproaches Table 1. Key expected outcomes for the three pilot islands Before transaction (SPUG) After transaction (private provider) Poor reliability Good reliability · Power supply interruptions: 196 hours (8 full days) · Contractually and financially committed to supplying a month on average electricity 24 hours a day, 365 days a year Low capacity Sufficient capacity · Dependable capacity: 15 MW (30% rented) · Dependable capacity: 24.7 MW · 26% of potential demand unserved · Reserve capacity for system reliability High cost Low cost · Cost of generation: $0.23 per kWh on average · Cost of generation: $0.13 per kWh (including cost of larger capacity and environmental compliance) High subsidy requirement Lower subsidy requirement · Subsidy required in 2005: $9.9 million · Subsidy required in first year: $2.8 million electricity cooperatives at about half the cost of the implicit subsidy required has been $0.13 per kWh SPUG's power, with contractual commitments to (the difference between SPUG's generation costs of improve service quality and comply with environmental $0.23 per kWh and the approved tariff of $0.10 per laws. The subsidized tariffs paid by the electricity kWh). Moreover, SPUG has only 15 MW of dependable cooperatives will not change, but the lower cost of capacity on these islands, while the winning bidder supply will mean a sharply lower total subsidy. Initial offered 24.7 MW. Another way to look at the gain: estimates point to savings of around $7 million in the before the OBA scheme $1,000 of aid would have first year. In addition, through a combination of funded only 1.5 kW of capacity, while with the scheme, generation tariffs and subsidy payments, the full cost because of lower generation costs and better generation of supply will now be covered. SPUG had been operat- investments, $1,000 would fund 8.82 kW of capacity. ing at a loss in these areas, threatening its Pleased with the success in the three pilot areas, the sustainability. government recently started to prepare a second The project does much to improve aid effectiveness. package of three more areas to be opened to private With SPUG supplying electricity on the three islands, participation. About OBApproaches OBApproaches is a forum for discussing and The case studies have been chosen and presented disseminating recent experiences and innovations for by the authors in agreement with the GPOBA supporting the delivery of basic services to the poor. management team, and are not to be attributed to The series will focus on the provision of water, GPOBA's donors, the World Bank or any other energy, telecommunications, transport, health and affiliated organizations. Nor do any of the conclu- education in developing countries, in particular sions represent official policy of the GPOBA, World through output, or performance,-based approaches. Bank, or the countries they represent. To find out more, visit www.gpoba.org The Global Partnership on Output-Based Aid Supporting the delivery of basic services in developing countries