DOE's Demand Aggregation and Supply Auctioning Policy

As a fan of the DOE website, I saw this post about the Demand Aggregation and Supply Auctioning Policy (DASAP) draft Department Circular. Upon reading, I noted the following features:

• It reiterates the provision in the Electric Power Industry Reform Act (EPIRA) that distribution utilities (DUs) have the responsibility of supplying electricity in the least-cost manner to its captive market (i.e., its customers);
• It shall be the platform to allow a yearly venue to auction the baseload and peaking requirements of DUs
• DUs will be required to aggregate their power requirements, which will then be auctioned to independent power producers (IPPs) for comparatively longer term (i.e., in contrast to sourcing it from WESM); and 
• Promote price stability. 

To understand DASAP, let's look at concrete examples.

According to this article, Meralco usually sources 90% of its power requirements from power supply contracts. Power supply contracts provide Meralco with constant supply of electricity which Meralco sells to its customers. Aside from reliable supply of electricity, power supply contracts allow Meralco have stable cost of electricity - from these power supply contracts. 

The remaining 10%, Meralco sources from WESM, or the Wholesale Electricity Spot Market. 

For consumers in Meralco area, the 90% sourcing of electricity from power supply contracts is a boon. This means that 90% of their electricity consumption is sourced from a provider that has a stable cost.Only the remaining 10% is sourced from WESM, which offers fluctuating price at every hour.

However, for some other distribution utilities, their power supply contracts only account for less than 50%, which means that more than 50% is sourced from the price-volatile WESM.

DUs would most probably want power supply contracts with IPPs, however, IPPs, businesses as they are, want to have proof that they can pay at the end of their billing period. This "proof," is a big amount of money or assets, which poorer distribution utilities cannot afford. Unfortunately, this situation drives the DUs to source their power requirements from WESM, driving the cost of their electricity up. 

(WESM also requires proof, called "prudential requirements." However, it is not as demanding as that for long-term power supply contracts with IPPs. )

To allow (or require? but also provide a supporting environment) these DUs to enter into power supply contracts, even if they may not have financial state required by IPPs, DASAP will aggregate all the uncontracted power supply requirements of the DUs, and then auction them to IPPs. 

The primary concern of DASAP is supply of electricity of DUs. However, as supply is addressed, price of electricity is expected to become more stable. With DASAP, DUs will no longer source so much electricity from the price volatile WESM, Instead, they will have like two power supply contracts: first, for longer term (e.g,. 5 years or more), and second, for shorter term power requirements, like annual projected requirements, The regular power supply contract, for example, may provide the baseload demand, while DASAP will  take care of the peak demand requirements.  Only very small power demand not projected by the DUs will be sourced from WESM, which is the primary cause for price fluctuation.

Determining Price of Electricity in WESM

First and foremost, the price of electricity as paid by the customers is regulated by the Energy Regulatory Commission, as mandated by Republic Act 9136, or the Electric Power Industry Reform Act of 2001. Part of the amount customers pay is the generation charge, which itself has to be approved by the ERC. Usually, the ERC approves a formula so that distribution utilities don't need to get ERC approval every billing month.

How does the generation charge come about? A distribution utility (whether a private distribution utility like Meralco or an electric cooperative) may source its power from two main sources: its own contracted power supply (through power supply agreements with independent power producers, or IPPs) and from the Wholesale Electricity Spot Market, or WESM. While the price of the electricity a distribution utility gets from its contracted power supply is fixed (e.g., P9/kilowatt-hour for 10 years), the price of electricity the distribution utility sources from WESM fluctuates as the WESM is, well, a "spot market." Among other things, this means that its price is determined every interval of time (in the Philippine situation, every hour).

As a market, this means there are many consumers and many suppliers. Due to the technical limitation of electricity (i.e., electricity goes where the circuit leads to, not necessarily to who ordered the electricity), determination of price of electricity in WESM is based on "least-cost solution meeting demand." Here is how it works:

1. NGCP forecasts demand level (including reserve requirement and customer submitted demand in WESM) for each hour. 
2. IPPs submit their bids, including capacity and price offer (baseload and peak).
3. The bids are arranged from lowest-priced to highest-priced to determine which generator will be dispatched first.
4. The market price of electricity is determined by the price of the bid at the level of capacity (based on price bid) that addresses the demand, and all bidders (including lower price bids) will be paid that price. Those generators which priced their bid too high would not be dispatched, hence, not paid.
5. Reserve capacities dispatched will be priced based on the highest priced. 

To illustrate the determination of price and how demand level and supply interact to determine price of electricity in the spot market, you may see this online simulation. (You can play with the elements.)

In this simulation, you can see that the price of electricity in the spot market will be the price of the bid that meets the demand level. If the demand for electricity lowers, it is possible to have the price of electricity go down, because the next higher bid price will be dispatched. 

This says two things, among others:

1. For the IPPs, there is an incentive to increase operational (i.e., production) efficiency (i.e., lower the price). If you are an IPP and you bid at a lower price (presumably, because you have the operational efficiency to do so), when someone else with a higher price gets approved, the price of that higher offering IPP will be the price that will be paid to you.
2. For the consumers, there is an incentive to increase energy efficiency. The lower the demand, the lower the price of electricity that will be cleared (i.e., selected as that which meets demand).

However, as a free market, the determination of price is limited on the assumption of rational decision making to pursue the most cost-efficient level. This means that the WESM methodology of price determination is not exempt from outlier behavior of an IPP pursuing individual higher revenue by creating an artificial shortage of supply in one power plant and bidding a very high price on another, knowing that the artificial shortage will ensure dispatch of the highest price bid.

Reminder: Most distribution utilities source their power from power supply agreements, or contracts with IPPs. Usually, they get only 10% or unexpected demand from WESM, unless 1) their power supplier goes down or 2) there is an unexpected higher demand that their power supplier cannot provide.

Disclaimer: The above is an unofficial and non-technical interpretation of how the WESM works. WESM operation is a very complicated integrated process of economics and engineering. There are other rules and limitations in WESM that have not been included here. The above is just an attempt to  focus on the economic side of determining price of electricity. Corrections and comments will be appreciated.

What is ILP?

The  DOE published on its website the announcement that the Interruptible Load Program, or ILP, will be rolled out in Luzon to address the apparent power generation capacity shortfall in light of the projected increase of demand during the summer months.

The program is a demand-side management system* that allows large power consumers (e.g., industrial plants, malls) which have their own generators to get compensation if they use them. Through ILP, the participating end-users (or the participants) agree with their distribution utility (DU) or electric cooperative (EC) to disconnect from the distribution network (i.e., not get their electricity needs from their DU or EC) and use their generators at agreed times. During such period, the freed up power capacity can then be made available to non-participants, who will pay an additional cost as compensation for the participants. The additional cost is approved by the ERC, based on the formula set in ERC's Resolution No. 8, series of 2010.

The ILP is a manifestation of the economic truism: as demand of goods exceeds its supply, its price will increase. In ILP, this is manifested by the situation that non-participants will have to pay for the electricity consumption of the participants just to enjoy availability of electricity.

You may ask: How come the non-participants have to pay for the fuel used by the participants, considering that the non-participants were not present in the arrangement (i.e., during the participants' application with their distribution utility or electric cooperative.)? Where is the justice in making the smaller users pay for the use of generator of the larger consumers. Is this like against the idea of inclusive growth?

The rationale is that the participants may incur higher costs in the use of their generator sets, and the non-participants get the benefit of avoiding brownouts.

While I cannot argue with the point of "avoiding brownouts," the rationale of compensation for the costs of using the generator sets is questionable for me. Don't businesses consider generator sets as assets, which have to be used to generate revenue? Which means their consumers actually pay for them for every object they buy from that establishment as part of their good's price. I am sure they do. Also, as assets, they have insurance, which the consumers also pay for (again, included in the price of goods).

Just my thoughts.


*Demand-sidemanagement refers to strategies done to reduce demand or affect pattern of demand for electricity. My own rendition only.