ENERGY Regulatory Commission (ERC) Chairman Francis Saturnino “Nino” Juan does not seem to be a fan of the concept of hedging in electricity supply.
In a brief report by the Philippine News Agency (PNA) this past week, Juan expressed his misgivings about the idea when asked for his views during an interview on the sidelines of the “Preventing Bill Shock” roundtable held recently at the PSE Building in Bonifacio Global City. Any proposal to introduce electricity hedging in the country must be thoroughly studied to ensure it benefits both investors and end-users, Juan said, pointing out that the concept is not addressed by the current gospel governing the power industry, the Electric Power Industry Reform Act (Epira) of 2001. Under Epira, only power supply agreements (PSAs) are allowed, subject to ERC approval.
“We’re getting the impression that these forward contracts are financial contracts, and they’re not actually physical or bilateral supply contracts, as per use in Section 45 (of the Epira Law). So, if these are not, will they still be submitted to ERC?” he was quoted as saying.
Juan also pointed out there was some risk involved in electricity hedging involving derivatives, such as forward contracts, as the price may fluctuate to the disadvantage of those who have locked-in contract prices. While the ERC is “keen on exploring every available mechanism that will ultimately redound to the benefit of the consumers,” he said, the ERC would have to carefully study all the relevant factors such as fuel costs, bilateral contracts, Epira Law, and weather- and demand-related conditions, before coming to any conclusion.
Come on, buddy. Stop trying to fit the square peg of hedging into the round hole of the terribly outdated and, at this point, obstructionist gospel of the Epira. You are dumping cold water on a concept that is easy to implement and has massive benefits for generators, distributors and consumers alike, and you need to embrace some innovation. And the beauty of it is, the best way for the ERC to do that is to do nothing.
It is not really an innovation, either; it just seems that way because the Philippine energy sector is governed by a policy and regulatory mindset that lags a quarter-century behind the modern world. In many countries around the world — I would say most, but I don’t know the actual number, and researching to find out would be an exercise in pedantry that is unnecessary — electricity hedging has been practiced for decades. The concept of hedging itself is almost as old as the concept of capitalism, and is widely used in all manner of industries. For example, the modern air transport industry probably could not exist if airlines were not able to apply hedging to their fuel supply needs.
What seems to worry Juan, at least based on his comments as reported in the PNA’s story, is the risk to distributors — distribution utilities (DUs) or electric cooperatives (ECs) — if the price of electricity from generators dropped after the DU or EC agreed to a locked-in contract with a generator. Under the current system, in which the ERC has virtual veto power over PSAs (and in some cases, even retroactively over spot purchases in the wholesale market), price fluctuations due to fuel costs or unforeseen circumstances can be managed by the commission, usually to the detriment of consumers who end up paying the price for a generator’s or distributor’s bad business decisions.
Indeed, either party in a forward contract arrangement can be caught out by market price changes. Hedging, after all, is a sophisticated form of gambling. If that were not so, everyone who ever involved themselves in any commodities market would be rich as Croesus (I definitely am not).
In a forward contract, a generator and a distributor agree to the sale of a certain amount of electricity supply at some date in the future at a fixed price. For example, an EC may sign a contract to buy 100 megawatts (MW) of supply on March 1 for P4,000 per MW. In forming this contract, the generator is betting that the market price for electricity on March 1 would be lower than P4,000, meaning that it would make more than it would selling that 100 MW to someone else that day. Conversely, the EC is betting that the market price would be higher, so that it would pay less than it would buying the supply from someone else.
The important thing to note, however, and this is why Juan’s comment about the risks in a forward contract are very misleading, is that the amount of money to change hands is already predetermined. The “winning” or “losing” of the bet the supplier and the distributor made is only a comparison to what everyone is paying on the date the contract is due. The hedging arrangement allows for predictability on both sides, and consequently, smoother prices for consumers — not necessarily lower prices, but prices that do not change drastically from month to month. And as a rule, over an extended period prices for end-users do become lower because the existence of forward contracts puts more price information into the wider market, which leads to more accurate forecasts in later hedging and more competition.
If the ERC is truly “keen on exploring every available mechanism that will ultimately redound to the benefit of the consumers,” the only response the ERC should make to the proposal to allow forward contracts for electricity is to do nothing, because any intervention on its part — approving forward contracts ahead of time, or retroactively adjusting them to bail out a generator or distributor who didn’t do their math correctly — would render the system utterly useless.
ben.kritz@manilatimes.net
Bluesky: @benkritz.bsky.social