Panay-Bohol diesel plants up for sale, effectively scuttling the Palinpinon sale

The privatization agency Power Sector Assets and Liabilities Management Corp. (PSALM) has just released the invitation to bid for a diesel-fired power plant package comprising a 146.5-megawatt (MW) plant in Panay Island and a 22-MW plant in the island province of Bohol.

In its invitation to bid, PSALM said investors interested in bidding for the plants had until July 30 to submit letters of interest. The deadline for submission of bids is on October 29.

Qualified bidders may conduct due diligence studies on the plants from July 17 to Oct. 27 while a pre-bid conference has been set on Aug. 6.

The Panay facility consists of the 36.5-MW Panay 1 and the 110-MW Panay 3 while the Bohol plant consists of four 5.5-MW generating units.

This should be a straightforward sale.

Wait.

Isn't this the Panay plant which was originally bundled with the 192.5 MW Palinpinon geothermal complex, but its sale is now effectively scuttled because of issues surrounding the geothermal resources sales contract (GRSC)?

It is. So, PSALM is implicitly admitting that it couldn't sell the Palinpinon plant under present circumstances. PSALM actually clarified that the sale will not be held this November, but "next year" in a tone already implying that it may not be able to do so.

What is even more worrisome is that the Panay plant is bundled with the Bohol plant. There have been suggestions from PSALM officers themselves that the Bohol plant was to be bundled with the Tongonan I power plant, and that package was next in line of geothermal assets to be sold.

This seems to be a prelude of an anticipated failure to dispose of the Tongonan asset, and possibly, the Bacman geothermal plant.

The dismal scorecard (score:0, after three years) of PSALM in disposing of geothermal assets as part of the mandate of EPIRA law should give our policy makers a wake up call at the very least why these assets seem to be unsalable.

And to think that we already claim to have the bragging rights about geothermal.

The Palinpinon sale: will it ever occur?

By J R Ruaya

For the nth time, the Power Sector Assets and Liabilities Management Corp. (PSALM) has again moved back the sale of the Palinpinon geothermal power plant complex to November this year from the scheduled bidding this August.

PSALM president Jose Ibazeta said the postponement was necessary to give concerned parties more time to iron out issues concerning the geothermal resources sales contract (GRSC). This was primarily a rehash of the same reason given by PSALM for the previous postponements.

The issues surrounding the GRSC for Palinpinon have already been laid out in a previous item here, and the discussion has been amplified in another piece on the aborted Tiwi-Makban sale which also involves similar issues.

Ibazeta said that the Joint Congressional Power Commission (JCPC), which is tasked to approve the sale of the government power assets as stipulated in the Electric Power Industry Reform Act (EPIRA), wanted to renegotiate the existing GRSC between the National Power Corporation, through PSALM, and steam field developer Energy Development Corp. (EDC), formerly a subsidiary of the government-owned Philippine National Oil Company, but now controlled by First Gen Corp. He added that the decision "is no longer in PSALM's hands. It's between the JCPC and EDC."

True. But it seemed to be conveniently forgotten that NPC, the predecessor of PSALM, was the other party to the contract, and EDC president and chief executive officer Paul Aquino claimed earlier that the former was in fact insisting on the contentious provisions.

What complicates the situation is the intransigience of Aquino against amending the contract saying that it was "sacred" and "nonnegotiable".

According to the GRSC, the steam price is benchmarked against coal price, and at the time of contract signing, Aquino said coal prices were declining, putting EDC on the losing end. Now that coal prices (and so with geothermal steam price) have shoot up, EDC apparently wouldn't relinquish its new-found pot of gold, and would rather sit on the contract for as long as permissible.

Result: stalemate.

Aquino may have all the legal weapons on his side, but it takes two to make, or unmake a contract.

Other than the legal issues involved, we maintain that it would be in the best interest of EDC, the power industry and the consumers if EDC accedes to the clamor for ironing out the issues on the GRSC if only to allow the privatization to finally take place.

One, the Palinpinon plant complex can realize its full power potential in the hands of a professional operator which is likely to be a private entity. That means more steam sales for EDC. But no investor would dare touch Palinpinon (also Tiwi-Makban) with a ten-foot pole, if he could not get any money from the table.

With the likelihood of a failed bidding, the privatization of power assets would be stalled, and it would just make a mockery of the aims of EPIRA to fully create an open and competitive electricity market.

Two, it would be favorable for EDC in the long run if the steam price is based on the cost of production. After all, is that not services for gain is all about? EDC has lived with steam sales contracts for Bacman , Tongonan I and Mt. Apo plants in which the steam price is not based on the price of coal or crude oil, but why not Palinpinon?

True, EDC might suffer some hiccups on its bottom line, but with anticipated increased sales upon successful privatization, these hiccups should be more than compensated for. Huge margins as a result of "onerous" terms in sales contracts also conceal inefficiencies within the organization.

As a result of short-term decreased margins, EDC should be forced to streamline its operations to get back at desired profit levels. Properly implemented, gains in efficiency would resonate throughout the organization which should result in improvement in profitability.

If we follow the logic of EDC top management, then we might as well benchmark the price of electricity from hydro to coal. End of the story.

With steam prices decoupled from coal, geothermal electricity would stand on its own against those coming from other sources such as fossil-fuel based coal plants themselves and possibly, with natural gas-fired power plants as natural gas prices have been rising in tandem with oil's.

The only other item which favors EDC in its stand against the contract re-negotiation is, if it insists on the sanctity of the original contract, sale of the Palinpinon plant would be less than palatable to prospective buyers as a result of the GRSC. That would favor EDC itself, which has made no secret of its drolling over the Palinpinon plant complex which straddles its geothermal field. By then, all the GRSC issues would be moot.

Even if the sale pushes through such as when a philathropic organization bids for the plant against EDC, or even if the complex is finally awarded to EDC by default, that victory is pyrrhic.

So, will the Palinpinon sale ever occur?

The answer lies on EDC's top management.

Palinpinon power plant sale hangs

By J R Ruaya

Energy and Chemistry Consultant

According to a report carried by major papers, the privatization agency Power Sector Assets and Liabilities Management Corp. (PSALM) raises the possibility of again having to shelve the auction for the government's 192.5-megawatt Palinpinon geothermal power plant in Negros Oriental province because of problems with the plant’s fuel supply contract.

The PSALM vice president for asset management and electricity trading, Froilan Tampinco, said the amended geothermal resources sales contract (GRSC) for the plant was now being routed for signature among members of the Joint Congressional Power Commission (JCPC).

The plant was originally scheduled to be bidded out 5 December 2007, then to December 19, moved again to first quarter of this year, and now the tentative date of bidding is August of this year. Even this date is clouded by uncertainty, because, according to Tampinco, even if JCPC approves the GRSC, "PSALM could still end up in a stalemate scenario with PNOC Energy Development Corp.(PNOC-EDC), the owner of the steam fields that provides fuel for the Palinpinon plant" if the latter doesn’t go with the amended GRSC. In that case, the Palinpinon sale will have to be shelved again, he told reporters.

The 146.5-MW Panay diesel-fired power plant, previously bundled with the Palinpinon geothermal facility, would be packaged with the 22-MW Bohol diesel-run power plant and sold in July.

Should the JCPC approve the amended GRSC and PNOC-EDC is okay with it as well, the Palinpinon plant would be bundled with the Panay plant once again.

Mr. Tampinco said the sale schedules for the 289-MW Tiwi and 458.5-MW Makban geothermal plants would also be changed.

"We are still accommodating questions from various interested parties regarding the sale contract of the plant which is why we moved the bidding of the Tiwi-Makban from June 4 to June 27. The rescheduling will also give more time for the parties to complete the requirements we are asking," he said.

If one recalls, The Tiwi-Makban complex was first put up for sale in late 2005, then postponed to first quarter of 2006, then temporarily shelved, and now resurrected for June.

Why is the government having difficulty selling these geothermal assets? There are serious interested parties, with some going into the requisite due diligence process.

The issues involved are far-ranging and complex--from the asking base price, steam sales contracts, conditionalities surrounding like compelling the prospective buyers to rehabilitate aging generation units, bundling the assets with non-geothermal plants, land ownership, to constitutional limits to foreign participation in energy resources development. These are all legitimate concerns. Any buyer acquiring a significant asset would like to know what he is getting in the first place. For the investor-buyer, the overriding question is, can he make money out of it?

Each of the assets for sale has its own peculiarities and problems. Here. let us tackle Palinpinon. Tiwi and Makban would be the subject of a future post.

The Palinpinon contracts

The 192.5 MW Palinpinon power plant complex actually comprises a main 112.5 MW plant (Palinpinon 1) and four 20-MW modular units collectively called Palinpinon 2. Because the plants were put up at different times, PNOC-EDC entered into two steam sales contract with NPC, one for Palinpinon 1 and another collectively for Palinpinon 2.

The pertinent key provisions of the original steam sales contract, according to documents submitted by the company to the Philippine Stock Exchange, are the following:

" The steam sales contract for Palinpinon I provides, among others, that NPC shall pay the Company a base price per kilowatt-hour of gross generation, subject to inflation adjustments and based on a guaranteed take-or-pay rate at 75% plant factor. The contract is for a period of twenty years commencing on December 25, 1988."

"In June 1996, the Company and NPC signed a steam sales contract for Palinpinon II’s four modular plants - Nasuji, Okoy, Sogongon I and Sogongon II. Under the terms and conditions, NPC agrees to pay the Company a base price per kilowatt-hour of gross generation, subject to inflation adjustments and based on a guaranteed take-or-pay rate commencing from the established commercial operation period, using the following plant factors: 50% for the first year, 65% for the second year and 75% for the third and subsequent years. The contract is for a period of twenty-five years for each module commencing on December 13, 1993 for Nasuji; November 28, 1994

for Okoy; January 28, 1995 for Sogongon I and March 23, 1995 for Sogongon II."

When the plant complex was readied for auction late last year, the first contract was about to end. To address potential investor concerns regarding the absence of a steam sales agreement, PSALM and PNOC-EDC crafted a new steam sales agreement, now known as the geothermal resources sales contract (GRSC), which would take effect upon the expiration of the original contract or the takeover of new owners. Except that, the would-be owners were not part of the contract drafting, yet they would have to abide by it.

In all likelihood the GRSC, is patterned after existing NPC contracts with steam field operators with slight changes.

During the Congress hearings late last year when the government stake in the geothermal developer was about to be disposed of, Senator Miriam Defensor-Santiago, chairman of the JCPC, stopped the active efforts by PNOC-EDC president Paul Aquino to secure JCPC approval. She said her specific objections include: (1) the price of electricity is set in U.S. dollars, which allows losses due to weakness in peso against the dollar to be passed on to consumers; (2) certain performance incentives given to PNOC-EDC and (3) the steam price being indexed to coal.

Investor groups on the other hand, bewailed the absence of a take-or-pay provisions and expressed apprehensions on its effects on the establishment of the wholesale electricity spot market (WESM) which affects load dispatch.

To be fair to PSALM and PNOC-EDC, some of the concerns were not anticipated at the time of crafting the document.

Tampinco said the existing GRSC that PNOC-EDC submitted last year to the JCPC would have to be amended to adapt to an environment that had a commercially operating wholesale electricity spot market (WESM).

The electric power industry reform law (EPIRA) created the wholesale electricity spot market where electricity, like any other commodity, is traded by the market players --generators, distributors and consumers--according to supply and demand. If a an electricity generator does not have a long-term supply contract with an offtaker, then it has to trade all of its electricity produced into the WESM--but there is no guarantee that his product would be sold at his asking price.

The EPIRA law mandates that only 10 % of the output need be traded in the WESM on its first year of existence. All the rest may be sold on the bases of long-term contracts with buyers.

Instead of a supply agreement that has no take-or-pay provision, there has to be a certain level of steam covered by a take-or-pay provision so that the new owner of the Palinpinon plant will be assured of steady steam supply, he said.

With a take-or-pay provision, the future owner of the Palinpinon plant will have to pay for a specific level of steam, whether or not this is used to run the plant.

“We won’t adopt the original [steam sale agreement] since that was crafted for a non-WESM environment,” Tampinco said. “The contracted steam level for that agreement was 75 percent. For the GRSC now, we’re looking at a take-or-pay level of around 50-60 percent.”

Under the Electric Power Industry Reform Act, geothermal assets of the government’s electricity producer National Power Corp. (Napocor or NPC) and the steam fields that provide fuel to run them will be sold as one package through a public bidding.

However, since PNOC-EDC, the operator of the steam fields, also became fully private, the sale structure approved for Napocor’s geothermal assets was for the plants to be sold, not with the actual steam fields, but with steam sale agreements attached to them.

Why coal?

The reason given by PSALM for indexing the steam price to coal is that for a long time, the country's electricity generation market is dominated by coal-fired plants. Which was true for a time, but with the establishment of the natural gas plants, the contribution by coal plants is no longer dominant.

A side effect of indexing to coal is that, NPC's coal plants will always be competitive vis-a-vis geothermal-- which is starkedly emphasized these days with soaring coal prices in the world market. To put it in another perspective, geothermal electricity, despite coming from an indigenous resource, cannot hope to compete and win against coal under the provision. Which is a strange provision given that each electricity generator has its own price structure. One might as well index electricity price from hydro and natural gas to coal.

Apparently, NPC has some fondness for coal plants, as newspaper columnist Jarius Bondoc implies in his latest column on NPC's coal purchases.

PNOC-EDC president and chief executive Paul Aquino said the geothermal resource supply contract (GRSC) that it signed with PSALM in 2006 was “sacred” and “non-negotiable.” “You forced us into that contract and now you want to change the terms when the market condition changed? “That is not right,” he said. “So, we’re sticking to our guns on that. That is a signed and sealed contract.”

Aquino said that at the time the contract was signed, coal prices were dropping, which put the now-privatized PNOC-EDC at the losing end of the deal, as steam prices are benchmarked on coal prices.

He said that a few months after the signing of the contract, coal prices shot upwards, and so did the price of steam.

“And now PSALM wants to renegotiate it,” he said. “That’s non-negotiable for us. After almost two years of negotiation, [PSALM] never budged until we were forced to sign because of our IPO [initial public offering of stock]. Now that the market has turned around, they want to renegotiate. No way.”

So, the original contract submitted to JCPC must have turned out to be a potential bonanza for PNOC-EDC despite its apparent early misgivings; otherwise Aquino wouldn't be standing firm on his ground and moving heaven and earth for its approval.

While he may have legal grounds to claim sanctity of the contract, he fails to appreciate that he is now heading a private business--not a government corporation-- where the mantra is, the customer (here, the power plant operator) is always right. Or least, he has to be respected and listened to. Always listen to the customer--is this not taught in Business 101?

He also needs some lessons in business negotiation.

Apparently, PSALM listened, and pushed for an amended GRSC instead.

PNOC-EDC also bidding for Palinpinon

It is no secret that PNOC-EDC is also interested in the power plant complex. It has declared its intentions to the public. After all, with the turnover of the build-operate-transfer power plants at Leyte to it from CalEnergy, the previous contractor, PNOC-EDC is now both a steam field and power plant operator. Owning both the plant and the fuel would have economic benefits. That's a no-brainer.

However, the intention has unintended consequences on the bidding process.

One, PNOC-EDC would have undue advantage as far as steam supply information is concerned simply because it is the steam supplier. Two, by being adamant on the GRSC, PNOC-EDC has unduly delayed the privatization process.

For this--or for that matter, any other government asset sale to push through, somebody must leave some money on the table: PSALM, the seller and PNOC-EDC, the other interested party to the deal.

In the end, a prospective private investor always sees the bottom line: will I make money on this deal? To answer the question, he has to factor in a host of things--asset price, economic risks, political risks, public acceptance, cash flow, etc.--before putting the ante on the table.

If the answer is no, he can go to other more hospitable places.