Preliminary indications show MER's 3Q kwh sales volume grew 6%, bringing year-to-date (ytd) kwh sales volume to +4.8% at 19,661mn kwh. The ytd is in line with our expectation this year (+4%), excluding any possible provisioning.

A recent article came up regarding MER's P22.8bn losses (broken into P13.3bn generation rate adjustment mechanism underrecoveries, P10bn systems losses etc.) as a result of the company's inability to recover pass-through charges to customers since August 2006 to around September 2007. Said amount is tied to MER's payable to the wholesale electricity spot market (WESM), and has been included in MER's P39bn receivables as of June. So far, no provisioning has been apportioned on this, as these are supposed to be pass-through charges. MER has yet to receive official advise from ERC on the matter, although there are no hard fast rules as to when ERC will give its final call on the issue. Based on our internal simulation, the P22.8bn on a worst-case scenario, would translate to about P0.81/kwh using estimated kwh for the period covered. Note that MER's equity (net of appraisal increase in utility plant) is at P27bn as of June 2007.

Our internal estimates show for every P0.05/kwh +/- change in MER's rate pricing, the resulting change in revenues is at P1.3bn based on annualized kwh for 2007. In terms of incremental net income, every +/- P0.05/kwh would translate to P28mn based on 1H07 net income margin.

The Energy Regulatory Commission (ERC) rationalized electricity rates to do away with artificially low prices. Originally, these rates were based on Return on Rate Base (RoRB) scheme, which served as guideline for Distribution Utilities. However, the maximum 12% RoRB ceiling is no longer deemed reasonable, especially after the Supreme Court (SC) ruled income taxes are not allowed as recoverable expense for rate-making purposes. ERC then adopted the Weighted Average Cost of Capital (WACC) instead of RoRB, as the former provides a return sufficient to maintain financial integrity based on certain risk assumptions. WACC led to an alternative ratemaking methodology called Performance-Based Ratemaking (PBR), which is more market-driven.

MER obtained a P1.167/kwh rate approval from ERC last 31 August 2007. This was lower than what MER sought for at P1.475/kwh. The difference stemmed from ERC's WACC-approved assumption of 12.8% vis-à-vis MER's 15.63%. With ERC's approved P1.167/kwh, that would mean increasing rates by P0.20/kwh immediately upon implementation, P0.10/kwh thereafter. Meanwhile, MER believes that its WACC should hold, as pension costs, other employee benefits and higher inflation should be considered. To date, ERC has no timeline as to when it would rule on this matter.