Proposed Reforms to the

Capex Approval Process for

Electric Cooperatives

Consultation Paper
Energy Regulatory Commission
December
2015

Copyright Castalia Limited. All rights reserved. Castalia is not liable for any loss caused by reliance on this
document. Castalia is a part of the worldwide Castalia Advisory Group.

Table of Contents
1

Introduction and Summary

1.1

Issues with Capex Approvals

1.2

The Proposed Approach

1.3

Consultation Process

Capex Approval Approach

2.1

Stage 1 Assessment of the overall proposal

2.1.1

2.2

2.3

Primary CriteriaConsistency with an approved

EICPM

2.1.2

Primary CriteriaCapex Spend Benchmark

2.1.3

Secondary Criteria for the Backlog

2.1.4

Stage One Assessment Process

2.1.5

Approval for Future Low Risk Applications

Stage 2 Assessment of projects in Medium Risk

Proposals

2.2.1

Project Assessment Components

2.2.2

Stage Two Assessment ProcessMedium Risk

Proposals

Stage 2 Assessment of projects in High Risk Proposals

2.3.1

Assessment of options

2.3.2

Assessment of demand projections

10

2.3.3

Assessment of supporting technical analysis

10

2.3.4

Assessment of economic evaluations

10

2.3.5

Stage Two Assessment ProcessHigh Risk

Proposals

10

Appendices
Appendix A Capex benchmark model ........................................................................12

Tables
Table A.1: Comparison of Benchmark Capex Model to Actual
Capex Approvals

12

Table A.2: Proposed Capex Model Regression Analysisbased on

approved Capex Proposal

13

Figures
Figure 2.1: NEA HarmonisationOption One

Figure 2.2: NEA HarmonisationOption Two

Figure 2.3: Future ApplicationsStage One Assessment

Figure 2.4: Future ApplicationsStage Two Assessment

Medium Risk

Figure 2.5: Future ApplicationsStage Two AssessmentHigh

Risk

11

Introduction and Summary

2
3
4
5

We have been engaged by the Energy Regulatory Commission (ERC) to address the
process for the approval of the capital expenditure plans of the Electricity Cooperatives
(ECs), proposing measures for a more streamlined and efficient process for future
approvals.

6
7
8

1.1

Issues with Capex Approvals

There have been long delays in the approval of Capex plans and there is currently a large
backlog.

9
10
11
12

The reasons for these delays are many and include variable quality of submissions from
the ECs and the long public consultation and legal approval processes. However, the key
problem is that all proposals, regardless of risk are reviewed in the same complex and
detailed process.

13
14
15
16
17

The proposed changes to the processing of Capex plans will make the process more
efficient and streamlined as the level of review will be tailored to the level of risk. The
level of risk will be assessed as being both the probability that expenditure in the Capex
plan is unreasonable and/or the potential impact of such unreasonable expenditure being
passed on to consumers.

18
19

1.2

20
21

Stage One is a proposal level evaluation that categorises proposals as low, medium or
high risk according to three objective criteria:

The Proposed Approach

The risk based approach has two stages:

22

Primary CriteriaConsistency with an approved EICPM;

23

Primary CriteriaCapex Benchmark; and

24

Secondary CriteriaKPI and Compliance Benchmarks.

25

Those applications categorised as low risk will be approved at the proposal level.

26

Stage One is detailed in Section 2.1.

27
28

Stage Two takes those categorised as medium or high risk and subjects them to a
more detailed assessment at the project level using the following components:

29

options considered;

30

demand forecasts;

31

technical analysis; and

32

economic evaluation.

33
34

Stage Two for medium risk plans is detailed in Section 2.2 and for high risk plans in
Section 2.3.

35
36
37

The calculation of the RFSC Charge is linked to the ERC approval of an ECs Capex
plans. A separate consultation paper will be issued on the proposed changes to setting
the RFSC charge.

38

1.3

Consultation Process

2
3

The aim of this consultation is to get feedback on our proposed changes to the Capex
approval process.

4
5
6
7
8

All interested parties are invited to submit their comments on this consultation paper on
or before 12th February, 2016. Electronic copies may be sent to tariffs.erc.gov.ph. This
consultation paper may be downloaded at the ERC website www.erc.gov.ph or may be
photocopied at cost at the ERC Main Office at the Docket Section, 18th Floor, Pacific
Center Building, San Miguel Avenue, Pasig City.

9
10

Capex Approval Approach

2
3
4

For Capex approvals the proposal is for a risk based approach, categorising applications
as low, medium or high risk based on objective criteria. The criteria will include both
primary criteria and secondary criteria.

Those applications categorised as low risk will be approved at the proposal level.

6
7

Those categorised as medium or high risk will be subject to a more detailed assessment at
the project level.

8
9
10

This process applies to the review and approval of scheduled multi-year Capex proposals
for ECs. It assumes that ECs submit multi-year capex proposals in groups, with each
group to submit in separate years.

11

The suggested approach has two stages:

12

Stage 1 Risk assessment and approval for low risk proposals

13

Stage 2 Project assessment for medium and high risk proposals

14
15
16
17

Stage 1 assesses whether there is a high risk that the Capex proposals exceed the
reasonable needs of the EC. Proposals that are assessed to be low risk are approved at
this stage. Other proposals are classified as either medium or high risk and subject to a
more detailed second stage analysis.

18
19
20
21
22
23
24
25

Stage 1 places considerable reliance on the consistency with the program of works in an
EICPM approved by NEA. This will require greater coordination between NEA and
ERC. Stage 2 assesses the individual projects within the overall proposal in terms of the
option analysis, demand forecasts, technical analysis, and economic analysis. While the
structure of the process is the same for medium and high risk projects, the extent of
scrutiny is greater for high risk projects. The scrutiny of projects in high risk proposals
assesses the details of the supporting analysis and is similar to the current level of analysis
of Capex proposals.

26
27
28
29
30
31
32

The primary objective of a review is to reduce the risk of overspending. Furthermore, the
review process may delay projects and increase the risk of underspending. Hence, the
reviews should be focussed on higher risk proposals. The consequences of over-spending
and under-spending on Capex are the same across the high, medium and low risk
projects but the likelihoods are different. In the absence of a review the likelihood of
overspending is greatest for the high risk proposals and lowest for the low risk projects.
Hence, substantially greater scrutiny is applied to high risk proposals.

33
34
35
36
37
38

The assessment criteria fit closely with the requirements of the Planning Manual. Hence
adoption of this approach would not weaken the ERCs commitment to the proper
implementation of the planning manual, but it would make the testing of its application
through the Capex approval process more streamlined. Some modification of the ERCs
existing rule on the review of Capex programs would be required but this would not be
substantial.

39

2.1

40

The Stage 1 assessment has three elements:

Stage 1 Assessment of the overall proposal

41

Primary CriteriaConsistency with an approved EICPM;

42

Primary CriteriaCapex Benchmark; and

43

Secondary CriteriaKPI and Compliance Benchmarks.

1
2
3
4
5

2.1.1 Primary CriteriaConsistency with an approved EICPM

The first criteria for assessing Capex proposals is whether they are consistent with the
latest approved EICPM. This requires that each of the projects submitted in the
proposed capex plan is part of the program of works in the EICPM so that ERC can
place greater reliance on the approval processes of NEA.

6
7

To be effective this requires the coordination of the submission of Capex proposals to

NEA and ERC.

8
9
10
11
12

Capex proposals that meet this criteria will be assessed as low risk if they meet all the
other criteria. Those proposals that do not meet this criteria will be assessed as high risk.
Given the proposed coordination of the submission of Capex proposals it is expected
that most ECs will meet this criteria if their Capex planning process is well managed and
they meet the procedural requirements.

13
14
15
16

Currently ECs submit Capex proposals to NEA as part of the EICPM every second year
in January and these are approved by the end of March. ERC does not have the
resources to process applications from half the ECs concurrently. Hence, it is proposed
that NEA and ERC harmonise the applications to a three year cycle.

17

The two options for synchronisation are shown in Figure 2.1 and Figure 2.2:

18

Figure 2.1: NEA HarmonisationOption One

19
20

Figure 2.2: NEA HarmonisationOption Two

2
3
4
5

On balance Option 1 is considered likely to be more feasible and a better compromise

between the needs of NEA and ERC.

6
7

2.1.2 Primary CriteriaCapex Spend Benchmark

The proposed Capex benchmarkthe primary criteriais an Asset Based Capex Model.

8
9

The benchmark cost model is tailored to the specific cost drivers of each EC. In
principle a cost function will:

10

Retain the benefit of low cost and low effort regulation;

11

Set a benchmark that is tailored to each EC; and

12

Reflect the specific characteristics of the ECs in evaluating Capex proposals.

13
14
15
16

We have tested a number of different cost models using known drivers of network
capital costs. All cost models were tested against recently approved Capex plans to assess
the predicative power of different models, the significance of cost drivers and to ensure
each coefficient has the correct sign.

17
18
19

An initial model to estimate reasonable capex needs has been developed and shows that
physical measures of the core network assets (network length and substation capacity) are
the best predictors of Capex needs.

20
21
22
23

A non-linear model is preferred to a linear model, given that network costs are non-linear
and because a log-log model is the best fit to the diminishing returns from economies of
scale. The proposed Capex Model will use two core network attributes to calculate a
benchmark for each EC:

24

Total network circuit length in km, and

Substation capacity in MVA.

Based on regression analysis, the benchmark Capex spend will be calculated as follows:

4
[

5
6
7
8
9
10

Growth and asset age measures were not statistically significant in our initial analysis but
may be included in the future to improve the overall performance of the model. The
Capex model will be continually developed and refined over time in a transparent process
so that ECs understand how it is used in the risk categorisation of proposals. A detailed
review of the Capex benchmark model is provided in Appendix A.

11
12
13
14

The aim of the model is to provide a guide to the typical level of Capex that would be
reasonable. Inevitably there will be cycles in Capex so that exceeding the benchmark does
not mean that the program is necessarily too high. But it will provide an indicator of
where further analysis (Stage Two) is warranted.

15
16
17
18

If the Capex proposals are higher than the benchmark they will be assessed as medium
risk as long as they meet both secondary criteria. Otherwise they will be assessed as high
risk. We expect that typically half or more of the proposals would be below the
benchmark.

19
20
21

2.1.3 Secondary Criteria for the Backlog

We suggest that the simple and objective secondary criteria, for future applications be:

22

Are KPIs met? (e.g. submission of data and compliance returns); and

23

Quality of justifications (i.e. assessed to be better than average).

24
25
26
27
28
29

Assessment of quality of justifications

Inevitably this will be some degree of subjectivity and the challenge will be to ensure that
the assessment is undertaken against clear criteria and is consistent. The key point is that
this is a relative assessmentin principle half of the proposals will be assessed as having
better supporting material than average and half having poorer supporting material.
There are two key steps to facilitate this:

30
31
32

Establishment of criteria and standardsthis can draw upon the

development of criteria and standards for the assessment of the supporting
analysis for existing applications; and

33
34
35
36
37

Participation in NEA regional workshops with ECsas part of the

NEAs review process, NEA staff hold regional workshops where they test
the underlying analysis for the ECs proposals. ERC staff would participate in
these meetings as observers. This will be efficient means of assessing the
comparative quality of the underlying analysis.

38
39
40

2.1.4 Stage One Assessment Process

The recommended Stage One assessment process flowchart for future applications is
shown in Figure 2.3.

Figure 2.3: Future ApplicationsStage One Assessment

2
3
4
5
6
7

2.1.5 Approval for Future Low Risk Applications

If they meet the primary and secondary criteria, future applications would fall under the
low risk category, thus they will be approved at the proposal level with no further
scrutiny.

8
9
10

This is because they have been assessed as being consistent with an approved EICPM,
below the Capex benchmark for a reasonable level of expenditure and have been judged
to have above average quality of justification and analysis.

11
12
13
14
15
16

A compliance check with the EICPM is an important measure for reducing ERCs
current burden and to accelerate the approval process. This is because, it incentives the
ECs to submit fully compliant Capex proposal submissions, and avoids unnecessary
interactions in gathering missing information. ECs that do not conform to the EICPM,
would face a more rigorous review of their Capex submission and delays in receiving
ERC approval.

17

2.2

Stage 2 Assessment of projects in Medium Risk Proposals

2
3
4
5
6
7
8
9
10

For those Capex plans that are categorised as medium risk, each of the components of
the underlying analysis is tested against objective, transparent criteriathrough a series
of Yes or No questions. This means that the extent of judgement required is
minimised and detailed analysis of the supporting material is not required. This will
facilitate prompt review and decision-making and standardised decision documents. The
questions focus on the key requirements of the EC Distribution Utility Planning Manual
(ECDUPM). ECs whose Capex programs comply with the requirements of the
ECDUPM should be able to readily demonstrate compliance with the assessment criteria
for medium risk proposals.

11
12

The key difference from the Stage 1 assessment is that the Stage 2 assessment happens at
the project level.

13
14

2.2.1 Project Assessment Components

The components to be assessed are:

15

options considered;

16

demand forecasts;

17

technical analysis; and

18

economic evaluation.

19
20
21
22
23
24

A key part of the assessment will be the reliance on NEAs assessment of the demand
forecasts. This will be made possible by coordinating the submission of Capex proposals
with the EICPM as discussed in Section 2.1.1. NEA places considerable emphasis on the
assessment of the demand forecasts and ensuring the forecasts are consistent with the
requirements of the planning manual. Hence, it is proposed to draw upon this rather
than duplicating the effort of NEA.

25
26
27

2.2.2 Stage Two Assessment ProcessMedium Risk Proposals

The recommended Stage Two project by project assessment for future applications that
are deemed as medium risk is shown in Figure 2.4.

Figure 2.4: Future ApplicationsStage Two AssessmentMedium Risk

Future Standard Applications Medium Risk
Individual
Projects

No
No

Are options
evaluated?

Test: the proposal

includes an evaluation
of options

Yes

No
No

Is demand
forecast
reasonable?

Test: Are the forecasts

consistent with latest
forecasts accepted by
NEA (as part of the
eICPM).

Yes

No
No

Is technical
analysis
adequate?

Test: Is the analysis

consistent with
demand forecasts and
standards?

Yes

No
No

Are economic
evaluations
provided?

Test: Is an economic
evaluation provided?

Yes

Reject

2
3
4
5
6
7
8
9
10
11
12
13
14
15

2.3

Approve

Stage 2 Assessment of projects in High Risk Proposals

This process has the same structure as the assessment of projects in medium risk
proposals but requires a more detailed qualitative assessment of the components, other
than the demand forecast component. The level of analysis may also vary according to
the size of the project. That is, the larger or more unusual projects should be subject to
closer scrutiny than smaller or routine projects.
2.3.1 Assessment of options
Unlike the medium risk assessment, the ERC will consider not just whether options are
considered but whether the options are appropriate. That is, do the options cover a
set of alternatives that are likely to meet the identified needs and include the best
available options? This does not require the reviewing engineer to undertake the option
analysis but if it is determined that the options are deficient it will be necessary to show

1
2

in what way they are and identify or excluded options that could have been considered.
In practice this is likely to be the most critical part of the evaluation of the projects.

3
4
5
6

2.3.2 Assessment of demand projections

Reliance is placed on the NEAs analysis of the demand projections. Further analysis will
only be required if the demand projections are not consistent with the approved EICPM.
This is unlikely, given the proposed coordination with the EICPM.

7
8
9
10
11
12

2.3.3 Assessment of supporting technical analysis

The focus of the assessment of the technical analysis remains on its consistency with the
demand forecasts and network planning standards. In addition, the engineer should test
whether the analysis clearly supports the proposed option over the alternatives. If
inconsistencies are identified that raise questions about the underlying models used these
should be investigated but these models would not normally be reviewed in detail.

13
14
15

2.3.4 Assessment of economic evaluations

For projects in high risk proposals the reviewing engineer is required to assess whether
the economic evaluation is adequate. The key questions in assessing this will be:

16
17

Whether the methodology used is consistent with the requirements of the

planning manual;

18
19

Whether the analysis is consistent with the demand forecasts, quality of

service, and network planning standards;

20
21

Whether the assumed costs of the proposal and options considered are
reasonable;

22
23

Whether the other assumptions that may be used (e.g. discount rate, project
life, and value of lost load) are reasonable; and

24

Whether the analysis supports the proposal over the alternative options.

25
26
27

This focuses the assessment on the methodology and assumptions. The reviewing
engineer would not normally undertake a detailed review of the underlying models unless
the results raise significant questions about the modelling.

28
29
30

2.3.5 Stage Two Assessment ProcessHigh Risk Proposals

The recommended Stage Two project by project assessment flowchart for future
applications assessed as high risk is shown in Figure 2.5.

10

Figure 2.5: Future ApplicationsStage Two AssessmentHigh Risk

Future Standard Applications High Risk
Individual
Projects

No
No

Are options
evaluated?

Test: Are appropriate

alternatives specified
and evaluated?

Yes

No
No

Are the
forecasting
models valid?

Test: Are the forecasts

consistent with latest
forecasts accepted by
NEA (as part of the
eICPM). If not, why?
Are the models valid?

Yes

No
No

Is technical
analysis
adequate?

Test: Is the analysis

consistent with
demand forecasts and
standards? Does it
support the selected
option?

Yes

No
No

Are economic
evaluations
valid?

Yes

2
3
4

Reject

Approve

11

Test: Review the

adequacy of the
evaluation. Are the
methodology and
assumptions valid? Do
the results show the
selected option is the
best?

Appendix A: Capex Benchmark Model

Table A.1: Comparison of Benchmark Capex Model to Actual Capex Approvals

#

EC Acronym

Regulatory
Period

Total Annual
Capex
Approved

Annual
Benchmark
Capex

Variance

AKELCO

2011-2014

41,698,425

63,210,063

51.6%

ASELCO

2011-2013

20,067,089

53,758,919

167.9%

BOHECO II

2011-2014

45,179,360

41,247,827

-8.7%

CANORECO

2010-2014

31,281,111

41,125,910

31.5%

CEBECO I

2014-2018

52,697,961

60,777,917

15.3%

CELCO

2011-2015

3,516,308

2,472,516

-29.7%

CENPELCO

2011-2014

139,503,425

84,564,144

-39.4%

COTELCO

2012-2015

104,213,816

91,358,854

-12.3%

DIELCO

2012-2016

1,871,743

4,716,841

152.0%

10

FICELCO

2011-2015

12,011,318

13,048,544

8.6%

11

FLECO

2011-2014

52,867,089

13,067,593

-75.3%

12

GUIMELCO

2011-2015

16,874,809

9,627,116

-42.9%

13

ILECO II

2012-2013

59,421,046

40,551,718

-31.8%

14

ISELCO II

2011-2015

67,846,860

34,044,893

-49.8%

15

MORESCO I

2011-2014

209,093,055

73,427,510

-64.9%

16

ORMECO

2012-2016

73,230,715

87,372,300

19.3%

17

PRESCO

2010-2013

4,151,599

5,029,895

21.2%

18

PROSIELCO

2011-2015

4,281,836

4,898,268

14.4%

19

SORECO II

2011-2011

6,669,964

20,200,562

202.9%

20

ZAMCELCO

2009-2013

19,111,457

61,102,471

219.7%

21

ZAMSURECO II

2011-2014

62,695,734

39,879,596

-36.4%

3
4
5
6
7
8
9
10
11
12
13

12

1
2
3

Table A.2: Proposed Capex Model Regression Analysisbased on approved

Capex
Proposal
Model 8Coefficiencts
match and all variabale are significant
Regression Statistics
R

0.8535

R Square

0.72846

Adjusted R Square

0.69829

Standard Error

0.31309

Total Number Of Cases

21

LOG (ANNUAL TOTAL ) = 4.0170 + 0.7884 * Log(Ckt length) + 0.5006 * Log(SS)

ANOVA
d.f.
Regression

SS

4.73361

2.3668

Residual

18.

1.76451

0.09803

Total

20.

6.49811

Coefficients
Intercept

4
5
6

MS

2.

Standard Error

LCL

24.14411

UCL

p-level
0.00001

t Stat

p-level

H0 (10%) rejected?

4.017

0.8915

2.47109

5.56291

4.5059

0.00027

Yes

Log(Ckt length)

0.78844

0.3468

0.18706

1.38982

2.27343

0.03548

Yes

Log(SS)

0.50061

0.25437

0.05951

0.94171

1.96802

0.06467

Yes

7
8
9
10

13

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