In 2017, I published “Reviewing CAPM: How to truly bring down power rates in the Philippines” (https://gaadsviews.wordpress.com/2017/07/16/reviewing-capm-how-to-truly-bring-down-power-rates-in-the-philippines/). More recently, I followed this up with “Implication of the Supreme Court decision on ODRC asset valuation” (https://insiderph.com/insider-view-implication-of-the-supreme-court-decision-on-odrc-asset-valuation), released earlier this year.
Experts in other parts of the world have argued not only about the wrong use of financial theories like the CAPM but also about the deliberate use of "scientific" and "financial" theories to obscure the deficiencies of the rate-making process.
Practice in Australia
In their 2021 article, “Sophistry and High Electricity Prices in Australia,” David Johnstone and David Havyatt of the University of Wollongong argued that the use of such financial theories in rate setting has, in fact, increased electricity prices in Australia.
According to the authors, modern electricity price regulation in Australia is built around complex financial models that do not determine prices objectively. Rather than being a straightforward scientific process, the current approach uses concepts from finance theory, especially the CAPM, in ways that are internally inconsistent and open to manipulation by interested parties.
Drawing from their experience in Australia, the authors argue that even if regulators do not deliberately use finance language, concepts, and models, and bits of wizardry to manipulate prices, the result is the same: higher electricity prices.
Subjective decisions, political influences
In their analysis, the authors contend that reliance on these esoteric financial models, which appear to be rigorous and scientific, serves a political purpose. These models tend to benefit network owners and state governments, which favor higher revenues, while consumers—as the ultimate electricity users—are left with higher electricity prices.
The regulatory and political arrangement, according to the authors, cloaks subjective decisions and political influences under the guise of objective financial science. This is where the "magic" happens.
One of the most significant risks that utility owners face in Australia is "regulatory risk," i.e., the risk that the regulators will not give them the proper rate approval. This presents a circular dilemma: the regulators are themselves the source of the "regulatory risk." So, how can they price that risk?
Regulatory risks still the key hurdle
In the Philippine context, regulatory risk stands as the single most significant challenge for industry players. Generators go through a complex "Competitive Selection Process" (CSP). After winning the bid, the rate is subjected to a hearing by the Energy Regulatory Commission (ERC). The underlying message of this process is this: the government claims greater competence than the market itself in determining the price of electricity.
I contend that this "regulatory risk" significantly increases electricity costs. The "magic" behind the purported "scientific" CAPM, the Building Blocks Approach (BBA), and the Performance-Based Rate (PBR) setting methodology are financial and accounting instruments that tend to confuse and obfuscate the public but ultimately lead to higher power rates.
The SC decision emphasizes the "end result" principle. Methodologies do not matter - the end result does. Johnstone and Havyatt argue that regulatory choices might be better served by embracing more pragmatic approaches rather than relying on a complex, internally flawed financial model.
A power industry expert with over 40 years in experience as chief executive officer in firms ranging from banking, power, and advisory services.
