Epira Essay

Effects Of Electric Power Industry Reform Act (RA 9136) And Performance Based Regulation On Meralco Prepared for BA 219 Corporate Finance Reporting Dr. Helena S. Valderrama PhD Prepared by Mark Alejo S. Bernal September 3, 2012 Table of Contents | Pages| Title Page| 1| Table of Contents| 2| Introduction Introduction History of Meralco| 3| Problem Statement Problem Statement Aim of Research Paper Objectives of Research Paper Relevance of Research Paper Research Process| 4| Electric Power Industry Reform Act | 4| Meralco Pre-EPIRA Data| 6|

Meralco Pre-EPIRA Analysis| 10| Meralco EPIRA Era Data| 11| Meralco EPIRA Era Analysis| 13| Insights| 14| Conclusions| 14| References| 16| Introduction Philippine energy and electrification is a national concern. It is the National Government’s duty, responsibility and obligation. This was the primary purpose of Presidential Decree No. 40 (Establishing Basic Policies for the Electric Power Industry) which took effect in 1972. This same PD founded the National Power Corporation (Napocor) as the implementing agency of the state.

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Napocor acted as the regulator body providing permits to operate to cooperatives, private utilities ad local governments, and other entities. Its main task is to attain total electrification through a series of linked-up generation facilities and power distribution centers. During this period, Napocor, through former Dean and Finance Minister Cesar Virata took control of Meralco and other power generating companies. This lasted until the Marcos Regime was overthrown and a new constitution was passed in 1988. In 2001, the Philippine Government enacted Republic Act No. 136 (EPIRA Law), also called Energy Power Industry Reform Act of 2001. The new law, just like the previous ones, aims to provide better and stricter regulation and government of electricity generation, transmission, distribution and supply. On top of this, the EPIRA Law wants to encourage the private sector to invest in the energy sector (Sec. 9. Functions and Responsibilities). Also, the new law dissolved the old Napocor, and established the new National Transmission Company, referred to as TRANSCO, which will eventually be privatized (Sec. 1. TRANSCO Privatization). In a gist, the government wants two things. First and original of its purposes is to create a nationwide grid that will provide electricity to the majority of its citizens. The second purpose of the government that is more obvious in its new laws that with its old, is the privatization of the energy sector. History of Meralco Manila Electric Railroad and Light Company was established in 1903. Its main business was to provide electricity to the residents of Manila and its nearby towns.

On top of this, Meralco was also the owner and operator of electric street railway system of Manila. Meralco provided this two main utility services to Manila for forty years and up until World War 2 broke out. After the war, Meralco, with its railway systems damaged beyond repair decided to give up its transportation business and concentrate on electricity services. It was an appropriate and timely move because electricity was most needed by the residents of Manila for its postwar redevelopment.

With the Philippines’ independence, Meralco became a very important element of society. It provided the country with the tools for progress, machinery and industrialization. In 1961, a businessman named Eugenio Lopez Sr. bought Meralco. He brought Meralco to a new level of profitability and growth. In the next decades, Lopez expanded Meralco’s reach and coverage outside of Manila and its nearby towns. Meralco started to be nationalized. In less than a decade, Lopez has increase Meralco’s worth five-fold and made it the first Filipino billion-peso corporation.

Meralco experienced a period of dark times during the martial law years of 1972 to 1981. It was annexed by Napocor and made into a state owned corporation through harassment, kidnapping and blackmail. The Lopez family was forced out of its corporation and asked to give up all its shares. After the People Power Revolution, President Corazon Aquino gave back the control and ownership of Meralco back to the Lopez family. Moreover, the Aquino administration created new laws and policies that allowed Meralco to strive in a open market and even compete directly with Napocor.

During this period, Meralco grew in revenues, territory, influence and technology. Meralco became the biggest electricity provider of the country, a position that it originally owned and enjoyed. Problem Statement How have the EPIRA and Performance Based Regulation affected the financial condition and performance of Meralco? The implementation of EPIRA and Performance Based Regulation has direct and indirect effects on the financial statements, financial position, and financial reporting of Meralco. Aim of the Research Paper

The paper aims to show the difference and changes, and to provide explanations for differences and changes. Furthermore, the paper also aims to show if the differences and changes have a positive or negative result. Objectives of the Research Paper The following are the objectives of the Research Paper: * Identify the differences and changes that EPIRA and PBR has brought to Meralco * Explain why there are differences and changes * Discuss the effects of the differences and changes Relevance of the Research Paper The Research Paper may be a reference for other electric companies.

Moreover, the research Paper may also help legislators improve, evaluate and draft improvements and changes in the law. Research Process The research will start with the gathering of as many data and information as possible. This includes the consolidation of all the financial statements of Meralco for the period 1996 to 2005. After the gathering of data, the research will try to analyze the data through three most commonly used techniques: common size analysis, trend analysis, and ratio analysis (using the Du Pont Decomposition of ROE).

Finally, research paper will try to provide its own opinion based on the data, information gathered and results of the analysis. Electric Power Industry Reform Act (RA 9136) The Electric Power Industry Reform Act, also known as Republic Act 9136 was passed in June 8, 2001 under the administration of President Gloria Arroyo. EPIRA was passed with the main objective and purpose of privatizing one of the government’s most problematic and debt-ridden institutions, the National Power Corporation (NAPOCOR). Its second most important objective is the deregulation of the energy sector.

The privatization started with the breakdown of the power industry into four major parts: generation, transmission, distribution and supply. Though this breakdown already existed, the new law emphasized and provided distinct and clear rules, limitations as well as purpose to the different parts. In the past, generation and transmission was solely operated and owned by the government through NAPOCOR. On the other hand, the distribution and supply were operated by the private sector, such as Meralco. SEC. 3. Scope. This Act shall provide the framework for the restructuring of the electric power industry, including the privatization of the assets of NPC, the transition to the desired competitive structure, and the definition of the responsibilities of the various government agencies and private entities. NAPOCOR’s privatization will start with the establishment of TRANSCO (National Transmission Company), which is wholly owned by the PSALMS Corporation. TRANSCO shall facilitate the privatization of all generation facilities of the NAPOCOR.

As of 2010, PSALM has privatized more than 91% of the generation facilities of TRANSCO to San Miguel Energy Corp. , Thermal Luzon Inc. (Aboitiz), Strategic Power Development Corp. (SMC / Meralco), and Amlan Power Holdings Inc. (Vivant). Also part of the EPIRA law is TRANSCO’s main stake in transmission. It must improve and expand its transmission facilities consistent with the Grid Code and the Transmission Development Plan (TDP). Private entities may also develop and build a transmission facility, as long it is a dedicated point-to-point facility connected to TDP.

On top of this, EPIRA stipulates that TRANSCO shall also be privatized by PSALM starting on the sixth month of its operation. There is much to be desired in this task. A generation company may develop and own or operate dedicated point-to-point limited transmission facilities that are consistent with the TDP: Provided, That such facilities are required only for the purpose of connecting to the transmission system, and are used solely by the generating facility, subject o prior authorization by the ERC: Provided, further, That in the event that such assets are required for competitive purposes, ownership of the same shall be transferred to the TRANSCO at a fair market price: Provided, finally, That in the case of disagreement on the fair market price, the ERC shall determine the fair market value of the asset. Sec. 21. TRANSCO Privatization. – Within six (6) months from the effectivity of this Act, the PSALM Corp. shall submit a plan for the endorsement by the Joint Power Commission and the approval of the President of the Philippines.

Even with these stipulations, TRANSCO is still not privatized. Furthermore, TRANSCO has close to complete control of all transmission facilities of the country. The closest to the privatization of TRANSCO is the twenty-five year concession agreement with the National Grid Corporation of the Philippines (NGCP), which is owned by Enrique Razon with the backing of State Grid Corportation of China. Finally, the distribution and supply parts of the industry remain with private sector.

These companies were given authority to charge and impose wheeling charges and connection fees to end-users. On top of this, distribution companies may charge its end-users with retail charges based on the full recovery of economic costs incurred in the efficient and economical distribution of electricity. This means that distribution companies may now charge end-users based on the future or projected performance of their facilities. This new charging method is part of Electric Regulatory Board’s push for a performance-based regulation (PBR). Sec. 25. Retail Rate. The retail rate charged by the distribution utilities of the supply of electricity in their captive market shall be subject to regulation by the ERC based on the principle of full recovery of prudent and reasonable economic costs incurred, or such other principles that will promote efficiency as may be determined by the ERC. Below is a sample of the new billing statement of Meralco compared with a 2001 statement. The new billing statement clearly separates the fees that each part of the industry sector collects: generation, transmission, distribution and supply. Meralco Pre-EPIRA In 1996, Meralco has assets valued more than P62B.

Total of P45B (73%) of these assets were in plants. Five years later, the value of Meralco’s plants increased by P33B. However, the contribution of its plants to total assets even decreased by 10 points to 63%. The P33B increase is due to Meralco’s rapid expansion of territories and coverage. During the same years, Meralco enjoyed a steady growth. The company increased its assets by more than P62B that is equivalent to a 101% increase during the said period. Assets were growing at a steady pace of 22-27% per year with exception of 1999-2000 wherein the company did not procure and built new assets.

The increase in total assets was also brought about by the increase in receivables. Total value increased by more than P12B. This increased the contribution of receivables to 16%. On top of this, other assets also increased its contribution by 10% with an increase in value of almost P14B. These other assets came from deferred credit payments. On the other hand, stockholders equity increased by close to P24B. But its contribution decreased by 13 points to 51%. As a consequence, Meralco had to finance its plants and assets by acquiring additional debts more than P20B and notes payable amounting to P5B.

Both entries increased their contributions to 21% and 5% respectively. The increase in territories, utilities and plants has dramatically increased the revenues of the company. The revenues grew by P46B during the same period. This translates to an 82% growth. Moreover, yearly growth of revenues ranged between 17-23% with the exception of 1998-1999 wherein revenues grew only by 3. 5%. But stockholders were not as delighted. This is because during the same period income decreased by 51% from P5. 0B to P2. 5B. Common shares earnings decreased by 59% from P5. 9 per share to P2. per share. Income decreased dramatically because of a just as dramatic increase in expense. Total operating expenses increased by 90%. Almost the entire P47B increase can be attributed to the increase in purchase power expense. The rest of the increase in expenses can be attributed to the expansion of Meralco. With more plants, Meralco’s operations and maintenance expense, as well as depreciation expense also increased. Furthermore, Meralco spent on the costs of acquiring new real estate properties. The rest of the entries remained stable and contribution percentages did not change.

In 1996 and 2000, Meralco was in a healthy financial position with both years yielding higher than net income net cash from operating activities. In both years, Meralco also showed willingness to invest in construction of new plants and utilities. Meralco also earned from more than P7B in proceeds from short-term debts. This huge amount of proceeds allows Meralco to have a positive increase in cash during the year in spite of the huge investment in plants and utilities. Meralco Pre-EPIRA Analysis Meralco’s profit margins decreased from 9% in 1996 to just 2% in 2000.

Despite of big increase in revenues, almost doubling in just 5 years, the net income of Meralco was halved. Again, a big chunk of the income was eaten up by the increase in purchase power expense that was brought about the increase in new territories and coverage. Being a low profit, high volume company, Meralco’s efficiency in 1996 was 92%. It creates high revenue per peso of asset it owned. This is a significant and valuable characteristic for Meralco because it relies heavily on its plants and utilities to provide revenues and income.

Even though this efficiency declined in 2000 to only 83%, Meralco still earns a lot from its assets. This is on top of the fact that Meralco expanded and spent more than P33B in new plants alone. But the increases in assets are not financed by equity. As we saw in the previous graphs and tables, debts and notes payables increased by more than P25B, making the investment in new plants of P33B possible. Assets increased by 196% during the five-year period. On the other hand, equity only increased by 160%. This raises the leverage rating of Meralco to 196%.

It is now in a risky and limited position in terms of financial leverage. Meralco EPIRA Era Upon the enactment of EPIRA law in 2001, Meralco was not immediately affected. To start with, Meralco’s assets did not changed. Although the contribution of plants and utilities decreased to 58%, the amount was only transferred to other properties and equipment. The new law demands that certain plants and assets be reclassified. Nonetheless, these assets are still declared and part of the financial statement. Thus, there is not much impact on the assets accounting of Meralco.

A significant inclusion to the asset accounting of Meralco is the entry on deferred pass through fuel costs. This are amounts paid for contracted fuels costs that have not been consumed. Most of these deferred pass through fuel costs are caused by purchases and contracts for natural gas requirements of Meralco. These costs contribute 5% to total assets. Similarly, the stockholders equity and liabilities of Meralco did not change much immediately after the implementation of EPIRA. However, new entries have emerged. One of these new entries is operating and other reserves.

These liability items are caused indirectly by the new law. Meralco is required to allocate funds as reserved for unbilled and unpaid taxes. During the next five years after the implementation, Meralco’s reserves increased gradually to almost P17B. In 2005, because of the deferred pass through fuel advancements to suppliers, Meralco also incurred additional expenses. This amounts to a total of more than P4B. Another striking change in Meralco is the contribution of stockholders equity to total. In 2004, total equity is more than half at 51% and with total value of almost P64B.

Right after the enactment of the law, Meralco maintained the contribution percent and increased the value more than P4B. However, after five years, Meralco’s stockholders equity dropped to only 21% with a total value of P32B only. The value declined by P34B. Another unusual entry in 2005 is the refund to customers. This amounts to P11. 7B and contributes 8% to total liabilities. But the most notable change is the big increase in Meralco’s note payables. In 2000 prior to the implementation of the new law, notes payable was 5% with total value amounting to P5. B. The year the new law was passed, notes payable already increased by 1 point with a value of P1. 6B. Five years later, notes payable already contributes 20% to total liabilities with a value exceeding P38B. Revenues of Meralco gradually increased during the five-year period after the enactment of the new law, except in 2002 wherein the revenues declined by P8B. From the year prior to the enactment to the five years after, revenues grew by a P68B. This growth can be attributed to the increasing number of subscribers and territories served by Meralco.

A huge part of the increasing revenues of Meralco can be attributed to increasing kWh per capita of the country. In 2000, the level was only 503. 75. In the next five years after the implementation of the law, the level grew by more than 80 points to 581. 56. The increasing level of kWh per capita allows Meralco to have an gradually increasing revenues. However, this does not ensure Meralco of an equivalent increasing level of net income. In fact, net income of Meralco has been declining from a high of over P2. 5B in 2000 right before the enactment, to P411K in 2005.

Meralco’s biggest loss was in 2004 at P2. 6B. In 2001, Meralco’s quality of income was still very healthy. Its net cash from operating activities exceed its net income by 4:1. Their investments in new plants continue though the amounts decline slowly from 2001 to 2005. By 2005, Meralco has started to earn from these plants. It was able to dispose of some of its plants for a profit of P1. 7B. On the other hand, short term debt income decline throughout the years. Meralco slowly removes its cash from financing activities. Thus, its income from these slowly decline also.

Btw 2005, Meralco has negative income from these short-term debts. Another very noticeable data is Meralco’s 2005 net cash from operating activities. The amount has ballooned to more than P12B while its net income declined to a P411K only. Cash coming in is not flowing into income. Previous graphs and charts did not show any significant or unusual investments in new plants, utilities or assets. The cash collected simply flows out of the company. P171B revenue collected during 2005 went to expenses amounting to P169B. Of these expenses, the biggest is the cost of purchased power, which is already P149B by 2005.

Meralco EPIRA Era Analysis Profit margin of Meralco continues to drop after the implementation of EPIRA from high of 9% in 1996 to the 0. 24% in 2005. Even with the very high collection from customers, increasing kWh per capita, increasing electricity rates, Meralco was still not earning. This is because the new law also required Meralco to pay higher rates for the purchase of electricity. The increases revenues were going back to the producers of power through TRANSCO. In 1992 as previously mentioned, Meralco’s efficiency has at a high of 92%.

Though this declined in 2000 to 83%, the level of efficiency is still very high for its industry. After EPIRA, Meralco’s efficiency further improved. Immediately after the law was passed, Meralco’s efficiency improved to 96%. Five year later, Meralco was already earning more per peso invested in its plants and assets. After EPIRA, it is also remarkable to note that the ratio of assets to equity continues to erode. By 2005, the ratio is already 5:1 and most of Meralco’s assets were already acquired through loans and other types of financing.

Equity continues to fall. Thus, putting Meralco in a very risky situation. In this light, return on equity fell from 12. 72 in 1996 to 1. 26 in 2005. The fall in income is greater and faster than the fall in equity. Meralco needs to be able to convert its revenues into income again. Insights The article / stipulation of EPIRA that affected Meralco’s financial statements most is: Any distribution utility which seeks to recover stranded costs all have a duty to mitigate its potential stranded cost by making reasonable best efforts to: ) reduce the costs of its existing contracts with IPPs to a level not exceeding the average buying price of other land-based electric power generators, and b) submit to an annual earnings review by the ERC and use its earnings above its authorized rate of return to reduce the book value of contracts until the end of the stranded cost recovery period This stipulation allows TRANSCO to collect purchased power adjustment from distribution utilities like Meralco. TRANSCO justified this collection as part of the program to reduce the cost of existing contracts with IPP.

Thus, distribution companies were able to secure their bottom lines by collecting from end-users a competitive rate, justified with the full recovery of economic costs incurred in the efficient and economical distribution of electricity, and the amount allot for the collection of purchase power adjustment to TRANSCO. Conclusion In summary, Meralco’s financial statements were not directly affected by the EPIRA or its result, PBR. The only visible change in the reporting of its financial statements is the addition of a new line item: operating and other reserved. This was created to for the unbilled taxes and unpaid taxes.

Total amount in 2005 was almost P17B. The new liability line item was Meralco’s way of accounting the amount billed by TRANSCO but not yet paid. Meralco treated it as an unpaid tax since the payee was a government institution. Meralco’s financial reports and practices were not changed or affected much by the enactment of EPIRA. Based on the study, the only the percentages and the amounts of the items changed. Some of these had very significant and alarming changes. Of course, many of these could not be directly attributed to new procedures and policies brought about by enactment of EPIRA.

According to one of TRANSCO’s legal counsels, EPIRA was not created to change the way the industry functions. It’s main purpose and function was to fast track the privatization of the government held energy related institutions and facilities. But the mere idea that EPIRA was enacted for the privatization of the government institutions and facilities meant the there would wide and significant effects on the way the stockholders, owners, managers, and other stakeholders would behave in the energy industry. In my opinion, EPIRA affected Meralco indirectly in many ways.

Though the reporting remained constant except for what was previously mentioned, Meralco and its management and shareholders changed its financial outlook. This change in financial outlook caused several items in its financial reporting to drastically change. First major change in financial attitude would be Meralco’s slow down in expansion. During the five-year pre-EPIRA period (1996-2000), Meralco’s plants and utilities increased by P34B. During the five-year EPIRA period (2001-2005), the same line item changed by only P11B. After EPIRA enactment, Meralco just seem to not want to grow in assets anymore.

However, another way to look at this is Meralco’s involvement in Strategic Power Development Corp. This new company was created after EPIRA. It is a consortium of companies that include San Miguel Corp and Meralco. The drop in Meralco’s stockholders equity during the same periods supports this assumption. It grew from P39B to P63B and drop from P67B and P32B. During the eleven years studied, equity actually dropped by P7B. In conclusion, Meralco seem to lose interest in distribution and re-allotted its resources to private power generation, which again is EPIRA’s main purpose.

Second major indirect change in Meralco is huge growth of liabilities. From total of P22B (current and non-current) during the start of the study, Meralco liabilities grew to P119B. This is more than a 400% increase in just 11 years. Majority of the these increase was cause by the increase in the notes payables and other operating and other reserves. In total, these two line items actual contribute more than P55B. These two changes in Meralco’s financial attitude could create uncertainty in the future. High liabilities and low equity means low leverage (debt/equity ratio).

Though in Meralco’s case, this low leverage ratio is not caused by the increase in financial debt, but rather with government debt in the form of unpaid taxes and purchased power adjustments. This low leverage could mean more profits for Meralco’s shareholders in the future. But this could also put Meralco in a path to financial crisis and potential bankruptcy.

Reference and Resources Republic Act 9136 (Electric Power Industry Reform Act), 2001, June 8. | Plofino, Den (2012, August 24), Personal Interview. | Electric power consumption (kWh per capita) in Philippines, http://www. radingeconomics. com/philippines/electric-power-consumption-kwh-per-capita-wb-data. html| Padilla, Arnold, 10 Years of EPIRA: What Went Wrong? (2010, June 6), A Radical’s Nut, http://arnoldpadilla. wordpress. com/2011/06/06/10-years-of-epira-what-went-wrong/| Santiago, Stuart, EPIRA, epic fail (2012, March 30), Stuart Santiago, http://stuartsantiago. com/epira-epic-fail/ | Catapang, Giovanni PhD, Power Failure: 10 Years of EPIRA 2 (2011, June 9), AGHAM, http://www. agham. org/cms/content/power-failure-ten-years-epira-2| SGV,

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