Philippines - Energy sector survey (Vol. 1 of 2) : Main report

(Nv, Report No. 3199a-PH la L FILE C OP Y Philippines Energy Sector Survey (In Two Volumes) Volume 1: Main Report February 12, 1982 East Asia and Pacific Regional Office Projects Department; in association with The Asian Development Bank FOR OFFICIAL USE ONLY Document of the World Bank This document has a restricted distribution and may be Llsed by recipients only in the performance of their official duties Its contents mav not otherwise be disclosed without World Fank authorization.  ABBREVIATIONS AND ACRONYMS ADB - Asian Development Bank BED - Bureau of Energy Development BEU - Bureau of Energy Utilization BISUDECO - Bicolandia Sugar Development Corporation BOE - Board of Energy BOI - Board of Investments BPD - Barrels per (calendar) day BTU - British thermal unit CASUCO - Cagayan Sugar Corporation CNED - Center for Nonconventional Energy Development DBP - Development Bank of the Philippines EDC - Energy Development Corporation ENERCON - Energy conservation (an industry-sponsored energy conservation movement) ENMAP - Energy Management Association of the Philippines GDP - Gross Domestic Product GNP - Gross National Product GOP - Government of the Philippines GWh - Gigawatt hour ISA - International Sugar Agreement km - Kilometers KV - Kilo volt kWh - Kilowatt hour LPG - Liquid petroleum gas LRMC - long run marginal cost MMBOE - Million barrels of oil equivalent MECO - Manila Electric Company MOE - Ministry of Energy MTOE - Thousand tons of oil equivalent MW - Megawatt NASUTRA - National Sugar Trading Corporation NCA - National Coal Authority NEA - National Electrification Administration NEDA - National Economic Development Agency NGO - Non-governmental organization NPC - National Power Corporation OMS/OMY - Output per manshift (output per manyear) PAEC - Philippine Atomic Energy Commission PANELCO - Pangasinan Electric Cooperative PCCP - Philippines Chamber of Coal Producers Inc. PGI - Philippine Geothermal, Inc. PHILSUCOM - Philippine Sugar Commission PNAC - Philippine National Alcohol Commission PNB - Philippine National Bank PNOC - Philippine National Oil Company R&D - Research and Development SWIP - Small-scale water impounding projects TOE - Tons oil equivalent TPA - Tons per annum USAID - United States Agency for International Development WASP - Wien Automatic Systems Program  FOR OFFICIAL USE ONLY Page 1 of 2 Table of Contents Page Preface SUMMARY AND RECOMMENDATIONS ....................................... i - xiii - 1. INTRODUCTION TO THE SECTOR .................................... 1 Origins of the Survey ......................................... 1 The Energy Background ......................................... 2 Commercial Energy Consumption ................................. 2 Consumption of Petroleum Products ............................. 5 Consumption of Electricity .................................... 7 Noncommercial Energy Consumption .............................. 8 2. COMMERCIAL ENERGY SUPPLY ...................................... 11 Overview . ...................................................... 1 The Supply of Petroleum Products .............................. 12 Refined Products .............................................. 13 Coal: Present Levels of Production and Consumption .... ....... 15 The Supply of Electricity ..................................... 17 Hydroelectricity .............................................. 18 Geothermal Electricity ........................................ 19 Transmission and Distribution ................................. 20 3. ENERGY PRICING, TAXES AND SUBSIDIES ........................... 22 Introduction .................................................. 22 Petroleum Products ............................................ 22 Fiscal Contribution of the Sector ............................. 23 The Power Sector .............................................. 25 NPC Wholesale Rates ........................................... 25 Retail Power Rates ............................................ 27 4. ENERGY SECTOR ORGANIZATION AND INSTITUTIONS ................... 29 Overview . ...................................................... 29 The Ministry of Energy ........................................ 29 The Hydrocarbon Sector ........................................ 31 The Philippine National Oil Company ....................... 31 The Power Sector .............................................. 31 National Power Corporation ................................ 31 National Electrification Administration ................... 32 Other Organizations ........................................... 32 The Philippine National Alcohol Commission ................ 32 Noncommercial Energy ...................................... 33 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Batik authorization.  Page 2 of 2 Table of Contents (Cont'd.) Page 5. ENERGY DEMAND IN THE 1980s ..................................... 34 Overview ............ ........................................... 34 Sectoral Composition of Demand ................................. 34 The Consumption of Petroleum Products .......................... 35 The Demand for Coal ............................................ 39 The Demand for Electricity ..................................... 40 6. ENERGY SUPPLY IN THE 1980s ..................................... 43 Overview ............ ........................................... 43 The Supply of Petroleum ........................................ 44 The Supply of Coal ............................................. 46 Nonconventional, Renewable Energy .............................. 48 The Electric Power Expansion Program ........................... 48 The Alcogas Program ............................................ 50 CHARTS: 1. Organizational Chart, Ministry of Energy 2. Functional Chart, Bureau of Energy Development 3. Functional Chart, Bureau of Energy Utilization 4. Organizational Chart, Philippine National Oil Company 5. Functional Chart, Board of Energy ANNEXES appearing in Volume II: 1. The Outlook for Biomass Alcohol Production 2. The Coal Sector 3. Petroleum: Exploration and Production 4. The Electric Power Expansion Program (1980-89) 5. The Outlook for Reducing Petroleum Demand in the Transport Sector 6. The Industrial Demand for Petroleum Fuels (Including Prospects for Conservation and Conversions) 7. Nonconventional Renewable Energy  Preface More than a year and a half has elapsed between the date of the Energy Sector Mission (May, 1980) and the issue of its final report. During this period there have been some changes in the energy situation and in some of the Government's programs. Domestic oil production has fallen far short of expectations, and projections of future output have been radically reduced, which is disappointing; but oil consumption has also been lower than expected, which is heartening. Indeed, the total demand for commercial energy fell in 1980, and again in 1981, despite continuing growth in the economy. An important new open-pit coal deposit appears to have been proved up on Luzon. The alcogas program has been trimmed back sharply, but a new coco-diesel program has been given high priority. Incentives for industries that invest in energy-conservation plant and equipment have been strengthened. The Government has recognized the need to rationalize retail electricity rates, and to increase the bulk tariffs of the National Power Corporation so that investment contributions from the national budget can be phased out. There are signs of better coordination in investment planning between the National Power Corporation and the National Electrification Administration. Two new versions of the Government's energy program have been published, reflecting the Government's close monitoring of its energy problems and its willingness to make changes in targets and programs to make them more realistic. No attempt has been made to rewrite the report to reflect all the changes that have occurred since the field work was done. Some updating has been done, sometimes in the text, sometimes in footnotes. But, except where explicitly stated otherwise, the report reflects the situation as of May, 1980. Perhaps the most important updating fact to note is the continuing difficulty being experienced by the Government in deciding how rapidly to invest in new oil-replacing generating capacity. The Bank and the Govern- ment are in continuing discussions on this inherently difficult, and financially very important, problem.   - i- PHILIPPINES ENERGY SECTOR SURVEY SUMMARY AND RECOMMENDATIONS Introduction 1. A joint World Bank/Asian Development Bank mission/l visited the Philippines in April-May 1980 to conduct an energy sector survey in response to a Government request to provide it with an independent review of the country's energy prospects. A secondary objective was to identify ways in which the two banks, singly or together, might assist the program during the next few years. The Ministry of Energy (MOE) had already published a major analysis and target-setting document, the Ten Year Energy Program, 1980-89; the Survey used this as its point of departure and main fram of reference. In July, 1980, after the mission's return to Washington, the Government com- pressed its Ten-Year Program into a new Five-Year Program and issued a new document. A year later, an updated and revised version (The National Energy Program: 1981-86) was published. Some of the subsequent projections are more optimistic than those in the 1980 Ten-Year Program (e.g. for oil explora- tion activity, proving up coal reserves, geothermal development, reduced oil consumption in electricity generation, reduction in the overall demand for oil); other projections are less optimistic (e.g. 1985 coal output is cut by a third and oil output by over 50%). The mission's findings and recommenda- tions are not significantly affected by the new numbers presented in either the 1980 Five-Year or 1981 Six-Year Programs. Overview of Major Findings and Recommendations 2. The Government has in place a sound organization for energy plan- ning, has an adequate legislative basis for dealing with energy questions, and has an able staff of senior planners who have given the Government a clear sense of direction for the handling of its energy concerns. There is /1 The mission consisted of: B.K. Abadian, economist M. Ahmed, economist G.B. Baldwin, economist, Chief of Mission P. Bodora, transport economist (ADB) J. Cavallotti, power engineer/system planner V.V. Desai, rural energy economist (ADB) (M. Perlas, economist, ADB, assisted Mr. Desai) T.J. Goering, agricultural economist P.H. Halstead, geologist/geophysicist (consultant) R.J. Piggott, mining engineer (consultant R.H. Sheehan, power engineer/system planner  - ii - a keen appreciation of the need to limit the demand for commercial energy, especially for oil, and to substitute domestic primary sources for imported energy. Government has moved with commendable vigor to push up oil prices; it has moved much less vigorously to increase electricity prices or to eliminate inequities in the electricity tariff structure. One result is continuing chronic weakness in the financial condition of the National Power Corporation (NPC), the country's largest public corporation; NPC will account for over half the country's energy investments during the coming decade. 3. There is little hope of major relief from the present heavy energy- pressure on the balance of payments. If anything, the pressure may increase slightly. While unlikely to improve, the outlook is not grim, however: the country should be able to live with the high bills for energy imports which world conditions have forced on many countries. The economy will re- quire several more years to adjust to the new facts of world energy scarcities. The Government must strengthen demand management by making all forms of energy progressively more expensive for everyone, constantly pressing the limits of political acceptability and of the economy's need for more energy to support growth. The conservation program may be starting to take effect, for commercial energy consumption dropped slightly in 1980-81 despite continued, although slower, growth of the economy. In the spring of 1981 steps were taken to strengthen the conservation activities. A new law imposed mandatory audits (paid for by the companies) on firms using more than 1 million liters of oil per annum; they must also submit annual reports on past and future energy consumption. Earmarked concessional loan funds to encourage energy-donser- vation investments were introduced. The Government has also moved to re- align the relative prices of petroleum products in order to (i) forestall undesired substitutions and (ii) assure that domestic fuel oil (Bunker C) costs will be competitive with other industrializing countries of the region. On the supply side, the main need is to strengthen the move from general plans to detailed programming of sub-sectoral programs. More detailed comments on what needs to be done in each of the sub-sectors are presented at the end of the Summary and in the text. Oil Dependence and Oil Imports 4. In 1979 the country depended on imported oil for 92% of its com- mercial energy supplies./l The main objective of the Energy Program is to reduce this high dependence on imported petroleum by (a) limiting the growth of demand for oil-derived forms of energy and (b) developing domestic energy sources that can substitute for imported energy. The country appears to have relatively favorable domestic energy resources (more favorable, in all probability, than Thailand, Korea, or Japan although less favorable than Indonesia, Malaysia, or Australia). The Energy Program has set ambitious targets for energy-resource development. The Government has organized its energy program effectively and has adopted sensible and pragmatic policies to guide its own and private-sector activities. The Survey nevertheless found that the amount of balance-of-payments relief achievable by 1990 /1 With domestic oil production starting in 1979, rising in 1980, then falling steeply in 1981, dependence on imported oil has dropped to around 85%.  - iii - through development of domestic resources, while substantial, is much less promising than is suggested by the Ten-Year Program./l 5. Projecting future oil imports is highly speculative, since they will depend on a number of factors all of which are undergoing rapid change (e.g. overall growth of energy consumption, substitution against oil in some major uses, the discovery and exploitation of domestic oil resources, the mixing of oil with other liquid fuels). It is nevertheless possible to make some plausible "guestimates." The starting point is 1980 when oil consump- tion was 77 mn. bbls. (57 mn. consumed in non-power uses, 20 mn. for power generation). It is reasonable to assume that power-sector use may fall to 5-10 mn. bbls. by 1989. Non-power use should continue to rise, however, al- though at a rate slower than GDP. If we assume a 6% growth rate for GDP and a (low) 3% growth rate for non-power oil consumption, then the 57 mn. bbls., used in 1980, would rise to 74 mn. bbls. in 1989, and total consumption would be somewhere between 79-84 mn. bbls. Domestic oil production in 1980 was 3.8 mn. bbls. or about 5% of total consumption (it fell to 1.8 mn. in 1981). Estimates of end-of-decade domestic oil output vary as widely as 1-20 mn. bbls. A figure of 5-6 mn. bbls. is perhaps a reasonable "most probable" estimate; this would be 6% of total needs, giving a 94% import requirement. Using the above figures, oil imports in 1989 would come to some 74-79 mn. bbls., the same level experienced in 1980-81. It is possible but unlikely that events could turn out so favorably that oil imports would actually be significantly lower in 1989 than in 1980. They might well be higher. Furthermore, there will be some new energy imports, of coal and of nuclear fuel, beginning in mid-decade. Thus total energy imports seem likely to fall in the range of 25-30% of total goods and service exports (vs. 35-40% in 1980-81). The im- provement in the ratio would come not from an absolute reduction in oil im- ports but from rising exports and rapid growth of non-oil energy sources. 6. The Ten-Year Energy Program of 1980 made projections of future oil production, and of imports, which the Bank judged far too optimistic. In 1979, the first year of domestic oil production, domestic consumption was about 240,000 bbls. per day. The Government's 1980 projections of future discoveries and production looked forward to reaching an output of 120,000 bbls. a day by mid-decade, a level that would have allowed all the growth of demand, plus some replacement of today's demand, to be met from domestic pro- duction. The Survey found that such an outcome is highly unlikely, mainly for geologic reasons: the three commercial finds made to date, and the most probable future finds, are small fields whose recoverable oil will be exhausted quickly (the initial Nido field is believed to be the smallest producing off- shore oilfield outside the United States). There is a very small chance that a big find may be made, but this is not a prospect that can provide a basis for planning; even if a big find were made early in the decade, it could not be brought into production for seven or eight years. By the spring of 1981 the Government had made tentative new estimates of domestic oil production and consumption which were both somewhat lower than those the Survey had made /1 Figures on future production in the Ten-Year Program are Government tar- gets, not predictions of what it expects will actually occur. While Government officials acknowledge that performance will almost certainly be much lower than the targets, they believe it useful to have quanti- tative targets. The Bank agrees, but only to the extent that targets have some chance of being met.  - iv - a year earlier. The Government was even wondering if oil demand may have peaked and might actually be lower in 1990 than in 1980. While possible, the Bank feels such a trend highly unlikely. Energy Use 7. Not counting energy from humans and animals, total energy consump- tion is estimated to consist of about 75% commercial and 25% noncommercial forms; the latter is divided between household and industrial use and con- sists almost entirely of locally-available biomass materials (mainly fire- wood, rice hulls, and coconut husks). Noncommercial energy uses have not yet been well studied in the country, and relatively little attention has so far been given to them beyond some technological experimentation funded by the Center for Nonconventional Energy Development (CNED). Commercial energy is consumed primarily in three sectors, commercial/residential (22%), industry (45%), and transportation (33%), with agriculture and residential consumption of non-electrical energy being small. As in many other countries, the use of commercial energy was growing much faster than GDP until the initial oil shock of 1973/74. Since then, the elasticity of commercial energy has fallen from around 1.5 to well under 1.0./1 This figure is even reported to have become negative in 1980 and 1981. Such sharp initial reductions in the elasticity figure are likely to be temporary, however. They reflect the adop- tion of relatively easy, low-cost adaptations throughout the economy to higher energy prices. The elasticity figure may be expected to turn upward again as the economy exhausts the available non-cost and low-cost conservation oppor- tunities. A reasonable estimate is that the Philippines should expect an elasticity ratio of between 0.75 and 1.0 over the coming decade; this range would still be a considerable improvement over the pre-1974 figure. One of the biggest gains in the decade will be a reduction in the degree of depend- ence on imported oil. By 1990 the present ratio of around 85% is expected to fall to 55-60%, reflecting slow or no growth in oil consumption but very rapid development of domestic energy sources, including some oil but, especially, of geothermal, coal, and hydro resources. Despite the expected gain in the oil- import dependency ratio, the bill for oil imports will probably continue to grow (as noted in para. 5 above). 8. The Government has relied primarily on the price system to encourage conservation and changes in energy use. The promptness and vigor with which the Government has increased domestic petroleum-product prices compares favor- ably with most other countries of the region. There have been 12 general in- creases in petroleum product prices since 1974 and today the index of such prices (including new taxes which have been introduced) is well above the level to which world crude prices alone would have pushed them. Changes in relative product prices have been carried too far, however, and have caused a reduction in gasoline consumption, and an increase in diesel, that has led to gasoline surpluses that can probably be eliminated only by changing rela- tive gasoline/diesel prices. Electricity prices have also been raised sub- stantially (oil is used to generate 68% of the country's electricity); the level and structure of electricity tariffs are less satisfactory than in petroleum, however. NPC, the country's largest public corporation, is in a weak financial condition: it needs a further increase in its wholesale /1 Percentage growth in energy use over percentage growth in GDP.  v rates -- plus better control of costs -- to give it even a minimally accept- able cash flow; to permit higher wholesale rates, retail rates would also have to rise. Excessive inequities among regions and neighboring distribu- tion co-ops should be reduced; and the subsidies given to residential con- sumers in Metropolitan Manila appear unnecessarily large. 9. Both the Government and private industry have mounted education campaigns to encourage household and (especially) industrial and commercial users to use and waste less energy. Energy-intensive industries have been required to submit quarterly reports of their energy use and of steps they intend to take to increase the efficiency of energy use. In mid-1981, the Government formally approved new tax incentives to encourage investment in energy-saving plant and equipment. The big gains in industrial energy savings have yet to occur; they will arise not from the cumulative effect of small changes widely spread throughout industry but from major changes made in the small number of industries that use large amounts of energy and in which energy forms a large part of total costs. The 1979 round of oil price in- creases has made investment in oil-saving equipment, or in conversion to coal, so profitable that several large companies are moving to take advantage of the new cost-reducing opportunities. Much the largest potential reduction in oil use in industry lies in cement manufacture, where only one or two of the coun- try s 17 cement plants now use coal. This is the one industry where the Govern- ment has ordered a shift from oil to coal; no shifts have yet taken place, but a program has been worked out which should see a substantial reduction in that industry's oil consumption by 1985. A large part of industry's future coal supplies are likely to come from abroad, so the net savings in foreign ex- change from conversions will be far less than the savings on oil imports; they will nevertheless be substantial (roughly one-third). 10. Saving foreign exchange through oil-to-coal conversion and conser- vation in industry will not be as large as in electricity generation, however. Although electricity uses about two-thirds as much oil as industry, the oppor- tunities for substituting other primary energy sources are larger in power than in manufacturing and mining. In addition, careful planning of the electricity industry's investment program can save the country huge amounts of foreign exchange: electricity will account for two-thirds of the country's energy investments during the next decade, is much the largest spender of public capital, and receives much of its funding from foreign sources, which involves heavy debt-service obligations. About 85% of capital spending in power is carried out by the NPC, the Government corporation responsible for all new generating and transmission activity in the country. Although new management is slowly strengthening NPC, its long-run planning, its finances, and its procurement practices all need improvement if this large program is to realize its potential contribution to national foreign exchange savings. A recent review of its program for investment in new generating facilities has shown how the program could be reduced or stretched out; uncertainty still ,) surrounds the size and composition of the program, however. The Outlook for Developing Domestic Energy Resources 11. In addition to its (probably modest) oil and gas resources, the country has some excellent hydro potential, among the most promising geo- thermal reservoirs in the world, a considerable amount of coal, and a large  - vi - and varied amount of biomass materials for the production of alcohols (ethanol and methanol), charcoal, and fuelwood. With its combination of natural and human resources, the Philippines has the capability of becom- ing a world ,leader in the development of both geothermal and biomass energy applications. 12. In looking ahead at primary sources of electricity generation, geothermal, coal, and nuclear power all seem very close together, costwise, for base-load plants. This statement is based on 1980 prices. As coal is expected to increase in relative price during the decade, geothermal and nuclear possibilities seem likely to become even stronger candidates for development (the country's first nuclear plant has resumed construction after an 18-month interruption following the accident at the Three Mile Island plant in the United States). The role of large-scale hydro storage projects will not clarify until NPC extends its planning horizon from 10 years to 15 years and commissions additional feasibility studies to increase its inventory of projects available for final decision. 13. The Bank and NPC have examined intensively the question of how rapidly existing oil-fired base-load plant should be moved to higher posi- tions on the load curve or completely retired. It is clear that oil-fired units are no longer the least-cost method of producing base or intermediate load electricity. Therefore, as soon as new non-oil fired power plants are constructed to meet load growth the existing oil-fired units will gradually be displaced to higher positions on the load duration curve, automatically reducing oil consumption. The key question facing NPC and the Government is whether or not it is economically advantageous to increase the investment pro- gram over and above the level needed to meet load growth in order to speed up the displacement and retirement of existing oil units. The Bank's analysis showed that there would be no clear advantage to the economy in investing heavily for accelerated retirements: the present-value differences between the most attractive programs to accomplish this objective, and limiting in- vestment to that needed only to meet load growth, are too small to give any clear answer. Decisions must therefore be made on grounds of finance,/l NPC's ability to manage an accelerated program, and certain technical considerations. Even without an accelerated program, the power sector will be using 25-30% less oil in 1989 than it used in 1981. While many diesel sets (mostly private) will be retired when cheaper bulk supplies become available from NPC, a few new diesel units will continue to be built during the decade in remote loca- tions where no cheaper alternative exists. 14. Hydro energy: The main potential for large-scale development lies on the islands of Luzon and Mindanao. There are major differences in the resources of these two large islands: Luzon has more seasonal rainfall and is more mountainous; its major hydro opportunities consist of storage dams whose reservoirs, in almost all cases, would have to serve the needs of irrigation as well as power generation. With irrigation holding priority, Luzon's prospective hydro sites can serve peak or intermediate loads but not base-loads. The four projects under consideration for construction will be large and very expensive and can be justified today only as multipurpose projects. On Mindanao, on the other hand, a high annual rainfall is well- distributed through the year, permitting the construction of much cheaper run-of-river generating plants. Five such plants, with a combined capacity of 600 MW, are under construction and will be commissioned by 1985. /1 The Government is in fact under considerable financial pressure to limit its public investment program.  - vii - 15. Mini-hydro plants of up to 5 MW constitute an important part of the generation program planned by the National Electrification Administra- tion (NEA) in order to make each rural co-op self-sufficient in its elec- tricity supply. While the self-sufficiency objective is highly question- able, there is no doubt that small-scale run-of-river hydro schemes (many of about 1 MW) can produce power inexpensively at many locations, and deserve encouragement. 16. The geothermal resources of the Philippines are associated with its volcanic geology. Known and potential sites are widely distributed, and a subsidiary of the Philippine National Oil Company (PNOC) has already de- veloped three sites to the point where the country today has geothermal power generation second only to the United States. By the end of the decade, the Philippines may well become the world's leading producer of geothermal elec- tricity. Such energy is not much cheaper than coal-fired or nuclear power, how- ever, since it requires heavy investment in wells and in steam-gathering pipes (a 55 MW geothermal plant needs 10-20 wells costing c.$1.5 mn. each, plus c.$15 mn. of piping). Some sites have been developed through use of a foreign firm, which sells steam to NPC for US dollars (the dollar cost per kWh generated is about the same as for coal-fired generation). To the extent that PNOC can develop its own capability, the foreign exchange cost of geothermal steam will be greatly reduced (drilling and pipe costs will continue to require some for- eign costs). PNOC is already developing two sites under its own responsi- bility. One (at Tongonan, on Leyte) is among the largest geothermal fields in the world; the field's potential output of around 900 MW will be severely limited until the time comes, perhaps soon, when an interconnection between Leyte and Luzon can be justified. In the Visayas, an interconnection is tenta- tively planned between southern Negros and Cebu which will permit use of Negros' geothermal steam on two islands now heavily dependent on oil-fired and diesel generation. The top priority area for near-term geothermal development is central or northern Luzon, where potential sites are close enough to the dominant Metro Manila market to use existing transmission lines. 17. Coal: The Ten-Year Energy Program set a target of 6.0 million tons of output by 1989; the Five-Year "compressed program" aims at producing 2.3 million tons by 1985. Both targets seem too ambitious; an output of 2.0 to 2.5 million tons by 1989 would be more realistic and would represent a highly creditable achievement./l In 1980, the industry produced about 300,000 tons from 36 underground mines, none of which yet produces over 100 tons of coal a day (25-30,000 tpa). Coal deposits are fairly widely distributed and, al- though not yet well inventoried, appear sufficient to permit at least 50 years of exploitation at 2.5 million tons a year. Only two important sites for opencast mining have been identified, so the sector's ambitious target is unlikely to be met from this relatively quick-yielding and low-cost source. On fairly optimistic assumptions, two large opencast mines may be producing 1.5 million tons by 1989. The most that can be expected from a modernized set of about 10-12 of today's underground producers is another 1.0 tons. The increase of just over 2.0 million tons a year which is judged feasible will require investment of around US$100 per ton for a total of over US$200 mil- lion; this does not include investment in mine-to-market roads, a substantial /1 This range represented the mission's views as of mid-1980. Increased attention being paid to coal since then, plus apparent confirmation of an important open-pit deposit in Central Luzon, suggest that the projected 1989 output may be somewhat higher, say between 2.5 to 3.5 million tons.  - viii - amount of which will be necessary to permit the volume of truck transport needed to move the greatly-expanded volume of output. At present, no de- tailed program has yet been drawn up for expanding the industry and little thought has yet been given to how the industry's needs will be financed. 18. With coal use expected to grow rapidly in the power, cement, and a few other industries, total consumption will probably fall between 4-6.5 million tons by the end of the decade. Perhaps half this amount will have to come from imports; the MOE has recently begun negotiations with Australia to secure necessary supplies under long-term contracts that will avoid the necessity of buying on the spot market as needs develop. The importation, and domestic distribution, of substantial quantities of coal will be a new experience for the country and is creating many requirements for new invest- ment in coalhandling facilities (loading and unloading at ports, mixing-plant and washeries, inter-island barge capacity, trucks). A study of these re- quirements, by Australian consultants, has recently been completed. To remove some of the uncertainty that has held back the coal-conversion plans of cement producers the Government has guaranteed them that PNOC would supply them with coal at a price no greater than 65% of the cost of Bunker C fuel oil. In September, 1980, the Government established a new agency, the National Coal Authority (NCA), to assume responsibility for coal imports and distribution (but not for domestic production). It now appears that the NCA will exercise an exclusive responsibility for coal imports and will resell to domestic buyers under a pricing policy yet to be determined (NCA is ex- pected to cover its costs from sales margins). Domestic coal will continue to be sold under private trading but probably within a price band set by NCA. 19. Alcogas: The existence of a large sugar industry has stimulated Government interest in following Brazil's lead in mounting a major program for alcohol production to displace about 20% of gasoline requirements./l The Ten-Year Energy Program fixed a target of nearly one billion liters of alcohol by 1989 from nearly 50 distilleries grouped into three classes (the "compressed program" aims at about 400 million liters, from 25 new sugar distilleries, by 1985). The Philippine National Alcohol Commission (PNAC) has been established to direct the program and a small staff has been appointed. The program is having difficulty getting launched, however. A key problem has been weak interest in the program on the part of the sugar industry which, prospering with the high world sugar prices of 1980, had little to gain by dedicating either present or expanded capacity to alcohol production at lower rates of return. No good study has yet been made of the economics of the alcogas pro- gram; on the scattered figures now available, the Survey found reason to doubt that the program would be economic when sugar prices are strong. Distillation technology is also changing rapidly, and it is reasonable to expect considerable reductions in investment requirements during the next few years. As a result of these uncertainties, it would seem unwise to proceed now with the large investments outlined in the initial program. But continuation of the program deserves encouragement, although scaled down to a research and development, or pilot project, basis during the next few years. 20. Nonconventional energy: A Center for Nonconventional Energy Develop- ment (CNED) -- originally part of the MOE but transferred to PNOC late in 1981) is supporting a number of R&D activities designed to identify innovative, /1 Recently, the Government has greatly intensified its interest in producing a coconut oil that can be blended with diesel fuel. See Chapter 6.  - ix - low-cost energy-producing or energy-saving devices that can be offered to the private sector for manufacture and distribution. The Center is too young for any of its projects yet to have resulted in any successful com- mercial products; nevertheless, the Center has had strong support from both the United States and German Governments, and is a useful speculative in- vestment in broadening long-run energy options. An unrelated program for developing nonconventional energy, in the electric power sector, has been mounted by NEA. The NEA has launched an ambitious program for generating electricity in small-scale hydro and dendro-thermal (wood-fired) plants. More than US$60 million in bilateral loan assistance has been secured from Britain and France, and a technical assistance agreement has been signed with the Peoples' Republic of China. As much as 400-500 MW of new generating ca- pacity may be installed under this program by 1989; this would add about 15% to the capacity to be added by NPC. If NPC and NEA can coordinate their in- vestment and generating programs, and if NEA is willing to be selective in- stead of autarchic in its generating program, mini-hydro and dendro-thermal plants can make a useful contribution to reducing oil-dependence at acceptable costs. SUMMARY OF SPECIFIC RECOMMENDATIONS 21. The Survey's specific recommendations are summarized below: A. ENERGY SUPPLY (1) Coal (a) Original plans for expansion of coalmining were weak and unrealistic and relied mainly on under- ground production. In 1981 the Government wisely increased its attention to finding and exploiting new open-pit deposits (as private mines). Without blending, open-pit coal is often unlikely to be suitable for uses other than power generation. It therefore remains important to help underground producers to expand their output. We suggest the engagement of a small team of experienced mining engineers to assist in preparing a national program for expansion of underground output. An initial contract of three or four months, followed by periodic visits over a three or four year period, should be sufficient. (b) Coal industry expansion and modernization will re- quire substantial investments. The industry is not in a healthy financial condition and needs access to long-term funds from one or more institutions that understand the industry's problems. We are uncer- tain whether or not the industry will need prefer- ential financing; a study of the industry's financial needs should be made while the operational program is being prepared.  x (c) The Government should remove any remaining un- certainties in the minds of coal users as to the relative roles of government and private agencies in the expanding coal market. (For nearly two years major private buyers did not know whether or not they were free to enter into direct negotiations with foreign or domes- tic producers or would be required to buy from a government agency and, if so, under what pricing principles.) By mid-1981 the Government had decided that coal importing would be a gov- ernment monopoly. Policy had not yet been estab- lished on the prices at which imported coal would be sold to private buyers or on how much freedom major buyers would have to enter into direct con- tracts with domestic producers. (2) Electric Power (a) The Government should continue to increase its investment in finding and assessing domestic energy resources; this is the only way to de- velop an inventory of candidate projects whose relative attractiveness can be periodically com- pared for inclusion or exclusion from NPC's in- vestment program. For this decade, the problem is most urgent on Luzon, since there will be large economies from identifying generating sites that can meet the needs of this large market without incurring heavier-than-necessary transmission costs. (b) NPC should probably not attempt to implement, by 1986, the Adjusted investment program which has been proposed for reducing oil consumption by ex- ploiting the geothermal resources on Leyte. The same objectives will be achieved about four years later if investments are implemented not as a "crash" program to replace oil but on a stretched-out sched- ule that does not give quite so high a priority to accelerated oil replacement. The financial costs of the proposed accelerated program appear heavier than the Government should allocate to power gener- ation; the program would also severely tax NPC's planning, design, and implementation capability. (c) In addition to strengthening its work on domestic resources, the Government should accelerate detailed study of additional investment in atomic power, which may emerge as the lowest-cost source of base- load energy for large-scale plants. Cost will be only one of several factors to consider, however.  - xi - (d) NEA is planning to develop small-scale mini- hydro and dendro-thermal electricity genera- tion. The present policy of achieving gener- ating self-sufficiency for each cooperative appears highly questionable, however. We recommend a selective policy that would pursue local generation only if this is cheaper than the (economic) cost of NPC generated power. As the National Economic Development Agency (NEDA) has recognized, coordination between NPC and NEA must be improved; a joint technical liaison committee should be set up. (e) NPC should extend its planning horizon from 10 to 15 years in order to assure more adequate and timely consideration of costly, long-ges- tating hydro and nuclear projects. (3) Oil (a) Future oil production is highly dependent on successful drilling activity by international oil firms. The Bureau of Energy Development (BED) should review the terms of its standard service contracts for the oil industry with a view to increasing incentives to accelerate drilling rates. (b) PNOC should engage a small team of experienced seismic and aeromagnetic experts to increase its data-gathering and data-interpreting capability. (4) "Nonconventional" Sources (a) A vigorous research and development program for the development of alternative and supplementary liquid fuels is well justified. It would be premature and potentially very costly, however, to invest heavily in alcogas production facilities that go beyond the pilot-plant stage during the next few years. The R&D program recommended here should be closely linked to work in other coun- tries both at the agricultural, distillation, and engine-manufacture levels. The work on coconut oil as a diesel substitute now going on also deserves encouragement, although coconut oil may be more attractive as a market for surplus coco- nuts than as an economical substitute for diesel (unless petroleum prices go up considerably more).  - xii - (b) Mini-hydra and dendro-thermal sources of power generation deserve encouragement; they should be pushed selectively, however, since they will often be more expensive than other modes of generation. (c) Recent changes in the leadership and organiza- tion of CNED reflect a transition status of the country's main instrument for organizing work in this area. In the past, CNED has needed a clearer sense of R&D priorities and more effec- tive policies and mechanisms for following through when its work produced promising results. New plans to link CNED more closely to a larger and better-established institution (PNOC) may overcome these past weaknesses. It is also im- portant that senior officials of the MOE pay closer attention to work-programs and perform- ance in nonconventional energy. (d) Maximum encouragement should be given to private- sector participation in developing and spreading nonconventional energy applications. Such encour- agement should include individuals, private firms, and voluntary agencies. "Encouragement" should include financial and tax incentives, the con- tracting-out of much of the Government's R&D work, a clear statement of policy on the role of private agencies in this field, and assisting in the ex- change of information through publications and workshops. B. CONTROLLING DEMAND (1) The Government should continue to place primary emphasis on the price system to limit growth in energy demand and to persuade users to shift to cheaper sources of energy. (2) "Social pricing" (i.e., the use of subsidies to favor the poor) is well-justified, particularly if financed by cross- subsidization within the sector. There is a widespread feeling that subsidies on household electricity prices in Metro Manila are excessive and should be reduced. There is less appreciation of the adverse consequences that have developed from the application of social pricing to diesel oil and industrial fuel oil. These two product prices should be allowed to rise moderately in relation to other petroleum product prices to reduce the structural gasoline surplus that has developed and to increase industrial in- centives to save oil energy and to switch to coal.  - xiii - (3) Within the transport sector, this could be supplemented by the increased use of duties and taxes on fuel-ineffi- cient vehicles to encourage the growth of a more fuel- efficient fleet regardless of whether vehicles use.gaso- line or diesel fuel. (4) The Government should frame a program of tax credits, and of earmarked financial assistance, to strengthen its in- dustrial oil-conservation efforts. No momentum has yet built up for large-scale energy-saving in industry despite a three-year-old program of compulsory energy reporting laid on some 90 energy-intensive firms. We suggest that phased increases in the price of industrial fuel oil be announced at the same time, to increase the attractiveness of oil-saving investments. (5) Greater attention should be paid to household energy con- sumption, both urban and rural, commercial and noncommer- cial. This is needed to develop a better understanding of the interrelationships among LPG, kerosene, electricity, fuelwood, charcoal, and other biomass fuels, especially the effects of pricing decisions on household budgets on the one hand and on environmental pressures on the other (through depletion of fuelwood resources). General re- sponsibility for expanding work on household energy should probably be placed in the Bureau of Energy Utilization (BEU); much of the data-gathering work would of course be contracted out. One field of particular importance from a welfare view- point is the household cooking needs of poor people, both urban and rural. The marriage of supply and demand consider- ations must reflect not only the technical concerns of econ- omists and environmentalists but contributions from sociol- ogists and/or home economists to help define what improve- ments are needed and to judge the acceptability of devices (such as the Lorena stove) that appear promising on purely technical grounds.   1. INTRODUCTION TO THE SECTOR Origins of the Survey 1.01 Starting in 1978, the Government of the Philippines has published annually a Ten-Year Energy Program./l This document is a "rolling restate- ment" of the Government's plans for reducing the country's present very high dependence on imported petroleum as the primary source of all forms of commercial energy for industry, agriculture, electricity generation, trans- port, and households. In 1980 about 90% of the Philippines' commercial energy had its origin in imported oil; with the oil price increases of the past decade, the country's high oil-dependence now requires it to spend around 35% of all import-payments for oil. In 1973, the figure was 12%. The Ten-Year Energy Program presents the Government's strategy for winning gradual relief from this mounting pressure. The Philippines has better prospects than many other countries for winning such relief, for nature has endowed it with a promising range of domestic energy resources only a few of which have yet been developed. 1.02 In 1979 the Government invited the Bank to review the country's energy situation and submit a report on the adequacy of the energy program as reflected in the latest (January 1980) Ten-Year Energy Program. The Bank suggested that the review be conducted jointly with the Asian Development Bank (ADB), which has also been active in assisting power and energy develop- ment and which, like the Bank, expects to increase assistance to the sector in the future. A joint Bank/ADB Energy Sector Survey mission visited the country from mid-April to mid-May, under an arrangement that assigned the lead role to the World Bank./2 In July, an Aide-Memoire was sent to the Government, giving it the mission's preliminary findings and recommenda- tions. The principal finding of the mission was that the targets set in the Ten-Year Program had been set too high and that consequently the coun- try must expect to remain heavily dependent on imported energy considerably longer than the Program assumes. Because the Government has recognized the gravity of the problem and has taken certain measures to restrain energy demand and to develop domestic resources, energy-pressure on the balance of payments in 1990 should be no greater than it is today; no significant relief is in sight, however. The mission's main recommendations were that (i) there appears room for additional constraint of electricity demand through removal of some excessive subsidies in the present price structure, /1 In July, 1980, the January, 1980, Ten-Year Energy Program was reissued (with minor changes) as a Five-Year Program: 1981-85 (a compressed pro- gram for energy self-sufficiency). In August, 1981, the latter document was updated by publication of The National Energy Program: 1981-86. /2 Unless indicated otherwise, the two participating banks will hence- forth be referred to as "the Bank."  (ii) an even higher priority should be put on the development of geothermal resources than the Government had set, (iii) the early retirement of exist- ing major oil-fired stations and construction of substitute capacity would cost more than it would save, and (iv) that in the ambitious coal and alco- hol programs less attention should be paid to target-setting and more to working out the details of program design and implementation. Overall, the mission gave the Government high marks for the measures it had already taken to get on top of its energy problem. In May, 1981, discussions were held with the Government on the draft report; this revised report takes account of those discussions. The Energy Background 1.03 The 1980 Energy Sector Survey is not the first occasion on which the Bank has attempted an overall view of this sector. The 1975 Economic Report, coming one year after the initial "oil shock," included an annex on "The Role of Energy in the Philippine Economy." That initial review noted the rapid growth of energy consumption in the country (some 50% faster than the growth of GNP during the 'sixties), the sudden jump in the share of oil in the country's import-bill (from 12% in 1973 to 21% in 1974), and the introduction in 1974 of a new energy plan which, for the first time, gave emphasis to oil conservation and to the development of domestic energy sources. The projected growth rate in the consumption of commercial energy, 1974-85, was 10%, with electrical energy projected to grow at 10.7%. With few possi- bilities for cutting out "luxury" uses of petroleum or substituting other fuels in industry, and many years being required before the power industry could shift to non-oil-based primary sources, the 1975 outlook was for an unavoid- able continuation of a relatively high growth in oil imports (the then as- sumption was that no domestic oil discoveries would be made, or could be brought to production by 1985). Experience since 1975 has shown that energy users (particularly in transport and industry) appear to have a considerably greater ability to economize in energy use than was previously judged possi- ble, without slowing down the growth of the economy. As a consequence, the 1980 Bank/ADB Survey is projecting growth-rates for total commercial energy, and for electric power, that are 25-30% lower than was thought feasible five years ago. These lowered projections, plus the discovery and bring- ing into production of modest domestic oil resources, will limit the further growth of oil imports to a level the country should find manageable. The Survey's projections show oil accounting for 30-35% of total imports by the end of the decade; this is a modest improvement over today's 35-40%, a dra- matic improvement over the 50-60% it might have become in the absence of sound energy policies, vigorously pursued. Commercial Energy Consumption 1.04 Total Energy consumption is usually divided into commercial and non-commercial forms. The former includes electricity, petroleum products and coal; noncommercial energy includes everything else, e.g. firewood, charcoal, bagasse, animal power, and all other forms whose use is not  -3 determined primarily by exchanges in the cash economy. A large but minority share of firewood is regularly bought and sold throughout the country: it is nevertheless classified as a "noncommercial" energy. In the Philippines nearly a third of total energy consumption comes from noncommercial sources; for millions of people, especially in the rural areas, this form of energy dominates their experience of energy problems. The Survey has paid little attention to noncommercial energy, partly because the problem has only a weak and indirect relation to the central balance of payments problem, and partly because this aspect of the energy sector has not yet been given much attention; consequently few data exist. 1.05 Despite the rapid growth in commercial energy consumption over the past two decades, per capita energy consumption in the Philippines is still only about 40% that of other countries at similar income levels and only about 5% of the average for industrialized countries. These figures show the high "demand" potential for growth in energy consumption; but with over 90% of such energy coming from imported oil, the country cannot afford inten- sified energy use unless a large part of it can come from domestic resources. 1.06 The rapid rise in commercial energy consumption in the past two decades can be traced directly to the rate and structure of the country's economic growth. Gross domestic product (GDP) grew at over 5% a year in the 1960s and, unlike many other developing countries, at an even higher rate (6.3%) during the 1970s. Moreover, much of this growth was spearheaded by the energy-intensive manufacturing sector which, as in most middle-income countries, has grown at above-average rates for the past two decades, lifting its share in GDP from 28% in 1960 to 35% in 1978. Finally, the growth in household real incomes -- about 2.6% a year since 1960 -- has increased the demand for commercial energy and energy-using appliances. Reduced access to traditional, noncommercial fuels brought about by increased urbanization has been an added reason for the growth of commercial energy./l 1.07 The growth of commercial energy was much faster before the first "oil shock" of 1973 than it has been since, however. Prior to 1973, total commercial energy consumption was rising at rates well above the growth rate of GDP; as noted, the average growth elasticity was above 1.5./2 Since 1973 this situation has changed radically. Energy consumption has grown at 3.7% p.a., about half the rate of previous years even though GDP has con- tinued to grow at about 6%. The elasticity of energy growth has conse- quently declined to about 0.6. Much of this change is directly attributable /1 The share of the population living in urban areas has increased from 30% in 1960 to 36% in 1980; recent growth rates for the urban (and particularly Metro Manila) areas continue to be well above the national figure of 2.7% per annum. /2 The elasticity of (commercial) energy growth is the ratio of two growth rates, i.e., the rate of energy growth over the rate of growth of the economy (GDP). It is a useful measure of energy intensity and efficiency as measured at the margin of growth (it reflects, however, changes in energy use and output throughout the economy, not only in new activities).  -4- to the Government's pricing policy for energy products which has, by and large, passed on the increased costs of energy to the final consumers (see Chapter IV). However, part of the low recent value reflects the once-and- for-all adjustment to sharply higher energy prices in 1973/74, when total commercial energy consumption actually declined by 4.8%. A more accurate picture of recent trends can be obtained from the data relating to the period 1975-79, when commercial energy consumption and GDP grew at 4.8% and 6.2%, respectively, resulting in an energy-output elasticity estimate of nearly 0.8. Even this reduction represents a highly favorable development, telling us that recent growth in GDP has been achieved with roughly half as much growth in commercial energy as in the previous decade. The strength of this adjustment (in the absence of any major structural change in the country's growth) can only mean that the price elasticity of energy has been higher than often assumed. 1.08 These favorable changes in the elasticity of commercial energy con- sumption have been accompanied by equally important changes in the sectoral pattern of energy use. As the following table shows, energy consumption in the transport sector has grown at below-average rates in recent years, while the industrial sector has continued to exhibit above-average growth in energy consumption, producing an increase in its share. The changing sectoral pattern of commercial energy consumption has been reflected in the demand pattern for the major commercial fuels -- petroleum and electricity. These are dealt with in turn below./1 /1 The consumption of coal in the Philippines has so far been both relatively small (less than 300,000 tons in 1980) and concentrated entirely in the industrial sector. However, there are good prospects for increasing coal consumption; these and the Government's program for coal development are discussed in Chapters 5 and 6 below. Table 1.1: SECTORAL DISTRIBUTION OF COMMERCIAL ENERGY CONSUMPTION Percentage share Sector /a 1975 1979 Industry 47 49 Transport 33 30 Commercial/Residential 19 20 Others 1 1 Total 100 100 /a Energy losses in electric power generation are allocated to end-use sectors on a pro- rata basis. Source: Staff estimates based on data from Ministry of Energy.  Table 1.2: PETROLEUM PRODUCT CONSUMPTION BY PRODUCT TYPE (Million Barrels) Ave. Growth rate '73-80 Product type 1973 1974 1975 1976 1977 1978 1979 1980 % Premium gasoline 4.2 4.2 5.1 5.5 6.1 6.8 6.7 5.9 5.0 Regular gasoline 12.3 10.4 10.1 9.3 8.8 8.4 7.8 5.3 (-12.8) Diesel 12.8 12.2 13.2 14.0 14.8 15.6 17.0 17.4 4.5 Fuel oil 28.3 27.1 30.5 32.0 36.6 37.6 38.6 40.0 5.0 Kerosene 3.3 2.9 3.2 3.2 3.4 3.7 3.5 3.2 (- 0.5) LPG 1.8 1.8 2.1 2.2 2.4 2.6 2.7 2.4 4.2 AVGAS 0.2 0.2 0.2 0.2 0.2 0.1 0.1 0.1 (-10.4) AVTURBO 2.0 2.0 2.2 2.1 2.3 2.6 2.7 2.6 3.9 Non-energy products 2.1 2.1 2.7 2.7 2.7 2.8 3.0 2.4 1.9 Total product sales 67.0 62.9 69.3 71.2 77.3 80.2 82.1 79.6 2.5 Total petroleum consumption /a 71.0 66.5 72.1 73.9 80.1 83.0 84.8 82.7 2.1 Daily average consumption /b 194.6 182.2 197.6 202.5 219.5 227.3 232.2 226.5 2.1 La Including refinery fuel and losses (typically around 4%). /b In thousand barrels/calendar day. Source: Ministry of Energy. Consumption of Petroleum Products 1.09 Between 1973 and 1980 the final consumption of petroleum products for energy (i.e., excluding the small non-energy products) increased from 64.9 mmboe to 77.2 mmboe, an annual rate of growth of approximately 2.5% (see Table 1.2). At the same time there was a reallocation of petroleum consump- tion across sectors. In the transport and commercial/residential sectors higher petroleum prices restrained consumption growth well below the average. This has not been the case for the industrial or power generation sectors where, despite a moderation of past trends, energy consumption has continued to grow at fairly rapid rates.  - 6 - Table 1.3: SECTORAL DISTRIBUTION OF PETROLEUM PRODUCT CONSUMPTION Percentage share Annual average Sector 1973 1975 1979 growth rate C73-79) Industry 29 34.8 35.9 7.1 Power Generation 19 21.0 23.0 6.8 Transport 41 36.5 34.3 0,4 Commercial/Residential 11 7.7 6.8 -5.0 Total 100 100 100 Total Energy (million barrels) 64.9 66.6 79.1 3.4 1.10 The other point to emerge from these figures is the high proportion of petroleum product consumption in the industrial and power generation sec- tors where the potential for energy conservation and interfuel substitution is large, at least over the medium-term. The Government of the Philippines has recognized this potential and launched major programs for conservation and the substitution of oil by other indigenous fuels; these are discussed in Chapter 6 below. 1.11 An important feature of the post-'74 changes in demand has been major shifts in the growth of demand for different petroleum products. The consumption of kerosene, used mainly by households for cooking and lighting, has registered only a moderate increase, for example, even though its price has not been allowed to rise as fast as most other product prices. Gasoline consumption has actually declined in absolute terms. On the other hand, diesel demand has grown significantly because of the Government's pricing policy, which has encouraged the substitution of diesel for gasoline in the transport sector. Fuel oil consumption, limited to industry and power genera- tion, has also continued to grow at a rapid rate. These differential growth rates have led to product imbalances (mainly an excess of gasoline) that cannot easily be remedied by changes in refinery runs, changing the types of crude imported, or by changing refinery configurations (often very expensive, if feasible). Thus surplus naphtha and its main derivative, gasoline, is largely unavoidable and must be dealt with by other means. We do not know enough about the specifics of the problem in the Philippines (which is not alone in having a gasoline surplus problem) to make any useful suggestions as to how it might be solved. We would only warn against over-reliance on high gasoline prices alone as a tool for achieving transport energy objec- tives, i.e., getting the desired "mix" of public/private transport, of fuel- efficient vehicle types and sizes, and of fuels (gasoline, diesel, LPG, charcoal, alcohol, alcogas). In addition to relative fuel prices, other policy instruments have a legitimate role to play in achieving these objec- tives, e.g. import bans, tariffs, licensing fees, and manufacturing regula- tions. While the gasoline surplus might be eased slightly by a less  - 7 - punitive price for gasoline, the main solution will have to come from trading strategies, finding non-transport uses for naphtha, and reducing the overall demand for oil. Consumption of Electricity 1.12 Electricity consumption has been growing at about 9% a year since 1975, somewhat slower than in the previous seven years but at a rate still well above that characterizing overall commercial energy growth, Over half of the 1979 level of electricity sales, estimated at about 15.1 billion kilowatt-hours, was accounted for by industrial users; the commercial and residential sectors each took roughly a fifth of the total. Table 1.4: SECTORAL DISTRIBUTION OF ELECTRICITY CONSUMPTION Percentage share Annual average Sector 1975 1979 growth rate Industry 53 54 9.2 Commercial 23 23 8,7 Residential 19 19 8.7 Others 5 4 2.8 Total (GWh) 10,778 15,056 8.7 Source: Staff estimates based on data from MOE/NPC/NEA. 1.13 As the figures show, there has been little change in the sectoral consumption pattern in recent years with the three major sectors growing at much the same annual rate of about 9%. However, there have been changes in the regional pattern of electricity consumption, with consumption growing at higher rates in the Visajas and Mindanao grids, albeit from a much smaller base. Two-thirds of total consumption was on Luzon, and within Luzon, 85% of its consumption (over 50% of national use) occurred in Metro Manila.  - 8 - Table 1.5: REGIONAL DISTRIBUTION OF ELECTRICITY CONSUMPTION Percentage share Annual average Region 1975 1979 growth rate Luzon 74 70 7.5 Visajas 14 16 10.8 Mindanao 12 14 12.8 Total 100 100 8,7 Source: Staff estimates based on data from MOE/NPC/NEA. Noncommercial Energy Consumption 1.14 It is estimated that noncommercial energy sources account for nearly a third of total heat-energy supply /1 and meet about 65% of the nation's household energy needs; data on their consumption by type of fuel or sector of use are extremely sparse, however. The most recent statistics come from a sample survey of household energy use done in 1979 by the MOE; they are summarized in Table 1.6. The preliminary data confirm the important role played by noncommercial energy sources -- primarily firewood and bagasse -- in meeting national energy needs. They also reinforce the need to fill in the big gaps that still remain in knowledge about the sources and patterns of noncommercial energy use as a first step towards the formulation and imple- mentation of programs for their more efficient utilization (see para. 6.14 fft below). Table 1.6 summarizes the relative importance of the noncommercial energy sources now in use and of their end uses. Two points can be made about the above table: first, the only significant source of noncommercial energy now in use is biomass (i.e., vegetable) sources; there is as yet no significant contribution from solar, wind, biogas, or other source, in contrast to the considerable attention being given these potential sources in R&D work. Among the present sources, firewood is dominant, as in many other developing coun- tries; it supplies more than half the total by weight, slightly less by heat value. The 1979 firewood consumption level implies a rate of extraction of over 6.0 million tons of wood per year; this has an important bearing on the overall prospects for the natural renewal of the country's forest re- sources. Over the past decade, the amount of land under forests has fallen from 55% in 1968 to 43% in 1978; some of this decrease is the result of logging operations, but it also reflects the effect of the burning of cut- over forest areas for shifting cultivation and grazing which prevents natural regeneration. In many areas of the Philippines -- Negros and parts of Ilocos /1 Human and animal energy for motive power is excluded from this analysis.  - 9 - Norte, for example -- deforestation has already become a critical problem and its spread will grow if past trends continue unchecked, Strengthening the institutional framework of the forestry sector will be an essential prerequisite to reversing these trends. 1.15 The second point that emerges from Table 1.6 relates to the high proportion of noncommercial fuels consumed outside the household sector. Firewood is used extensively for tobacco curing, and woodwastes for steam and power generation in the lumber industry. These examples serve to illus- trate not only that programs aimed at increasing the supply and improving the efficiency of noncommercial energy use have a wider range of benefici- aries than is sometimes assumed, but also that households are facing in- creasing competition from other sources of demand for noncommercial fuels partly as a result of the increased cost of commercial energy. Data on regional variations in household consumption of different forms of commer- cial and noncommercial energy are presented in Annex 7, Appendix 4,  - 10 - Table 1.6: NONCONMERCIAL ENERGY CONSUMPTION (1979) (Based on consumption Consumption of in original units and original units assumed heat values) /a ('000 m tons) ('000 BOE) I. Household Consumption Firewood 8,003 12,452 Woodwastes 64 100 Charcoal 1,137 5,310 Coconut shells 788 2,454 Rice hulls 236 367 2,225 8,231 Subtotal 10,228 20,683 II. Nonhousehold Consumption Bagasse in industrial use 4,160 8,091 Woodwastes in industrial use 3,250 5,057 Firewood used in tobacco flue-curing 2,600 4,045 Firewood and coconut shells for miscellaneous industrial uses 1,460 3,408 Subtotal 11,470 20,601 Total 21,698 41,284 /a Assumed heat values for each biomass source: BTU/lb. Firewood 4,000 Woodwastes 4,000 Charcoal 12,000 Coconut shells 8,000 Rice hulls 4,000 Bagasse 5,000 Source: Ministry of Energy.  2. COMMERCIAL ENERGY SUPPLY Overview 2.01 Since World War II commercial energy supply in the Philippines has been characterized by a heavy and growing dependence on imported petro- leum on the one hand, and the presence of substantial, but as yet largely undeveloped, indigenous energy sources on the other. Efforts to harness. the country's hydroelectric potential predate the 1973 oil crisis but, not surprisingly, it is only since that year that the development of indigenous energy resources to replace imported oil has assumed a central role in the Government's energy policy. The impact of this policy on national energy supply has already started to be felt: the country's first commercial oil discovery has been made and brought on stream; coal production, although still very small, has recovered production losses of the 'sixties and appears ready for a major expansion; and the first large-scale electric power plants to be fueled by geothermal steam have recently been commis- sioned, making the Philippines the world's second largest user of this re- source; finally, in the field of hydroelectric power, the completion of projects started in the 1960s has resulted in a doubling of capacity since 1972 and an increase in the share of hydro energy in commercial energy supply. In spite of these developments, the country's reliance on imported oil remains high, as the following figures show: Table 2.1: COMMERCIAL ENERGY SUPPLY BY SOURCE Percentage share Source 1975 1979 Petroleum products /a 94.2 91.0 Hydroelectricity /b 5.3 6.6 Geothermal lb - 1.5 Coal 0.5 1.0 Total 100 100 /a Excluding non-energy petroleum products. |b Hydro and geothermal energy converted at fossil fuel equivalence for Theiral Electric Power generation. Source: Staff estimates based on data from MOE.  - 12 - The Supply of Petroleum Products 2.02 Crude Oil. Prior to 1979, the country's crude oil requirements were met entirely from imports. With the bringing into production of the country's first commercial field (Nido) domestic production now accounts for a modest 5-10% /1 of the total crude oil supply of 75 million barrels. An important element of the Government's petroleum supply policy since 1973 has been to encourage the geographical diversification of oil imports and to increase its control over them by transferring responsibility for the bulk of this trade from the private refining companies to the public sector Philippine National Oil Company (PNOC). The other important supply policy has, of course, been to encourage domestic oil exploration and production by both the public and private sectors. Oil exploration in the Philippines has a long but sporadic history which can be divided into three phases. The first phase, which concentrated on drilling where seepages occurred, began in the 1890s; it tapered off soon thereafter, without much success. The second surge in exploration activity took place in the late 1950s and early 'sixties when the major international oil companies explored the onshore sedimentary basins, again without success. The current phase of activity, which commenced in 1970, has been the most intensive and the most successful. Exploration has concentrated offshore, particularly on the reefs near Palawan, where the first commercial discoveries were made. /1 A precise figure is impossible, since initial domestic production has been erratic. Table 2.2: CRUDE OIL SUPPLY BY SOURCE Supply (million barrels) Source 1973 1975 1977 1979 Domestic - - - 7.7 Middle East 65.6 54.5 51.3 47.0 Indonesia - 5.4 10.4 8.0 Malaysia 3.1 4.3 3.0 3.1 China - 3.3 6.1 7.1 Brunei - - - 1.9 Total 68.7 67.5 70.8 74.8 Source: PNOC.  - 13 - 2.03 The present resurgence in domestic exploration activity can be attributed partly, of course, to the tenfold increase in international oil prices and the consequent surge in exploration activity worldwide. However, two other factors have also been at work here. The first of these was the replacement, in 1972, of the traditional concession agreement for oil ex- ploration by the production-sharing or service contract system, The new system set out more explicitly the work obligations of the contractor and increased the Governments share of oil revenues. The second factor has been the growing realization by international and domestic companies alike, that the prospects for commercial oil discovery in the Philippines had been underestimated in the past. Modern seismic analysis and drilling techniques have cast doubt on the validity of conclusions drawn from years of disappoint- ing drilling results, most based on the less promising onshore areas. Of the total of 377 wells drilled to date for hydrocarbons, less than 150 are reason- ably valid evaluations -- the rest were too shallow, prematurely abandoned or offstructure. Thus the possibly prospective sedimentary area of the country has been tested only at the low rate of one valid exploratory well per 2,800 square kilometers. 2.04 Since 1973, the number of exploratory wells drilled has increased dramatically -- from 4 in 1974 to 33 in 1979 -- and it is these 84 wells which provide much of the evidence for estimating the country's oil pro- duction potential, The latter is still inadequately evaluated, however. Recent evidence suggests that the country has relatively certain remaining recoverable reserves of between 100-500 million barrels in addition to the approximately 30 million barrels of discovered but still unproduced reserves in three offshore fields -- Nido, Matinloc and Cadlao. The undiscovered but likely reserves are not large by international standards but, if discovered, they would meet around 20% of the country's petroleum requirements for the next decade. In addition, there is the small chance that one or more of the many gigantic offshore reefs would turn out to be oil-bearing and add 1 billion barrels or more to reserves. While this would be a handsome bonus for the country, the chances of it happening are too small (less than 1%, on the basis of current information) to take it into account in drawing up national energy plans. Refined Products 2.05 About 85% of the country's refined product requirements are met from three domestic refineries. However, net imports of refined products have more than doubled since 1975, partly because domestic refinery output has not increased as fast as product demand, but more importantly, because the structure of demand has increasingly diverged from the mix which the refineries are capable of producing.  - 14- Table 2.3: RECENT SUPPLY OF REFINED PETROLEUM PRODUCTS (million barrels) 1975 1977 1979 Domestic production 62.22 66.07 69.68 Imports 6.05 9.85 14.07 Exports 1.13 .92 .57 Domestic supply 67.14 75.00 83.18 Ratio of domestic production to domestic supply 0.93 0.88 0.84 Source: MOE/PNOC data. 2.06 The bulk of refined product imports is accounted for by fuel oil, over 9 million barrels of which were imported in 1979 to meet local demand. Other products which were imported in large quantities in that year were diesel and LPG -- whose consumption has also been growing rapidly in recent years -- and, somewhat paradoxically, gasoline. Gasoline consumption in 1979 was actually lower than it had been in any year since 1973, and large quantities of it were being stockpiled by local refining/marketing companies who were unable to sell it at the recently-increased prices. The reason be- hind this apparent paradox is that under the government-to-government contract for crude oil purchases from China, the Philippines was also obliged to import a certain volume of gasoline. The Government hopes to resolve this problem in the near future by entering into swap agreements with neighboring countries which would import this gasoline for fuel oil or diesel.  - 15 - Table 2.4: STRUCTURE OF PETROLEUM PRODUCT SUPPLY (1979) (million bbls.) Domestic % Net Domestic % Product output share imports supply share Gasoline-premium 6.42 9.2 .76 7.18 8.6 -regular 8.18 11.7 - 8.18 9.8 Aviation fuels 2.21 3.2 .14 2.35 2.8 Diesel 16.53 23.7 .95 17.48 21.0 Kerosene 4.06 5.8 .05 4.11 4.9 Fuel oil 29.28 42.0 9.29 38.57 46.4 LPG 1.96 2.8 1.06 3.02 3.6 Other nonenergy 1.06 1.5 1.24 2.30 2.8 Total 69.70 100.0 13.49 83.19 100.0 Source: MOE/PNOC. Coal: Present Levels of Production and Consumption 2.07 Coal deposits of reasonably good steam-raising quality are found on several islands of the archipelago. Because the coals were deposited on the edge of an unstable shelf, the strata have been folded and faulted, lead- ing to wide variations in the thickness, lateral extent, and rank (combustion characteristics) of many of the deposits. The outcrops have been worked by individual miners since the middle of the 19th century but organized under- ground mining did not begin until about 1900. A small coal mining industry developed during the interwar and post-World War II years, with production fluctuating erratically between 50,000 and 150,000 tons per year. In the early 'seventies, annual production was between 105-125,000 tons. The sharp increase in oil prices in 1974 stimulated increased interest in coal among industries and private utilities, and in 1977 the industry reached its historical peak output of 284,000 tons. 1979 output was 263,000 tons; the MOE's Ten-Year Energy Program has set a domestic production target of 6.0 million tons for 1989 -- a figure that now seems far too high (see below, paras. 6.09-6.13). The industry is small, highly fragmented, and uses relatively primitive technology. 2.08 There are some 33 coal mining companies, all domestically owned; these operate 36 small underground mines, plus a large opencast mine under development on Semirara Island. No underground mine produces more than 100 tons per day; the average is 26 tons per day or 8,000 tons per year of 300 working days. Total employment in the industry is around 4,000; output per man-shift (OMS) is about 0.25 tons, a quarter of the underground mines of Europe. Despite the widespread occurrence of coal deposits, 80% of  - 16 - production comes from the island of Cebu, where 32 of the country's 37 mines are located. In addition to the organized companies, there is a long tradition of very small-scale operations along the outcrops by indi- vidual "camote" miners; the Government is now trying to phase out camote mining, however. 2.09 Historically, the market for coal has been extremely limited and has been met entirely from domestic production. For example, almost all of 1979 production went to 11 customers: five private power plants, four cement companies, one sugar mill, and one chemical company (see Annex 2, page 9). The National Power Corporation (NPC) has not had any coal-fired generating capacity: the first such plant, a 55 MW station at Naga near Cebu City, will be commissioned in 1981; a large -- 300 MW -- dockside plant, at Batangas 100 km southwest of Manila, is scheduled for construction 1981-84; a second 300 MW coal-fired station is scheduled for commissioning in 1986 (it will be built either alongside the first unit at Batangas or as a new mine-mouth plant in the Cagayan Valley). Table 2.5: COAL PRODUCTION, 1973-79 1973 1975 1977 1979 Production ('000 tons) 39.0 105.1 284.6 263.0 Source: MOE. 2.10 A major increase in the scale of coal production is almost certain to occur in the 1980s. The country's coal reserves have been variously estimated at between 150 million and 1,000 million tons. This wide range reflects both the lack of adequate technical data and the variety of defi- nitions used for the classification of 'reserves'. While further improve- ment in definition and measurements are clearly desirable, there is no doubt that from a purely geological viewpoint, coal production could be expanded tenfold and sustained at that rate for half a century with no increase in the present minimum estimate of proven workable reserves. 2.11 However, the pace at which this expansion could be achieved is less certain. It is unlikely that domestic coal production, coming about equally from open-cast and underground mines, can increase, by 1989, to more than 2.0 to 2.5 million tpa from the 1980 level of almost 330,000 tpa. This projection compares with a Ministry of Energy (MOE) target of over 6.5 mil- lion tpa by 1989./1 Even to expand production tenfold over the next decade will require, in addition to doubling the labor force, a tripling of present /1 The 1981 Six-Year Program projects 1986 output between 3.7-5.1 mn. tons ("firm" and "probable" targets). The Bank is assiting the Government to prepare a coal exploration project, with emphasis on finding open-pit deposits. One major such deposit has already been proven up, by a private Filipino-Canadian-British joint venture, in Central Luzon.  - 17 - productivity. The reasons for mission projections so far below the Ministry's are the limited opportunities for strip mining; the small size and faulted deposits that must be worked as underground mines; the absence of any insti- tution to train skilled technicians and supervisors; the need to shift over from room-and-pillar to longwall working; the need to re-equip mines with higher-capacity haulage and lifting equipment; expected difficulties in or- ganizing an adequate pit-prop supply; the difficulty of rapidly increasing the present labor force of about 3,000 men; and the improbability that an industry whose largest present mine produces less than 100 tpd can develop 10 mines producing 200-300 tpd within 10 years. A large investment in access roads will also be necessary at many sites. In view of the foregoing con- straints, a successful substitution of coal for oil in power and industrial uses will therefore require substantial coal imports. The Government has recently negotiated an initial 15-year supply contract with Australia. Gov- ernment policy is to distribute its overseas procurement over a number of countries. The Supply of Electricity 2.12 Electric power supply in the Philippines has been characterized by a fairly rapid growth of installed capacity and generation; declining but still very heavy reliance on oil-fired thermal generation; a complex and fragmented institutional structure; and marked interregional contrasts in the structure and growth of power supply. Historical data for electric power generation, particularly by the small private utilities and self-generating industries which together have been responsible for about a fifth of total supply, are sparse and unreliable. On the basis of available information, the annual growth rate for electric power generation has been estimated at about 10% since 1970, somewhat higher than the rate of growth for commercial energy as a whole but about a third slower than Thailand or Korea. Nor has there been the same slowing down in the growth of electricity generation in the last five years that has characterized the other energy forms. Between 1975 and 1979, electricity generation continued to grow at just under 9% per annum when the supply of commercial energy as a whole was growing at half that rate. Table 2.6: ELECTRICITY SUPPLY BY PRIMARY ENERGY SOURCE Generation in 1975 1979 Annual Average Source GWh % share GWh % share Growth Rate (%) Thermal oil 9,947 81 12,601 74 6.1 Thermal coal 24 - 177 1 64.8 Hydro 2,250 19 3,500 21 11.7 Geothermal - - 800 4 - Total 12,221 100 17,078 100 8.7 Source: MOE, staff estimates.  - 18 - 2.13 Over the same period, there was a significant shift in the source of electricity supply. Electricity from indigenous sources such as hydro- electricity and coal grew at above average rates and they were supplemented by the bringing on steam of the first large geothermal electricity gener- ating plant in 1979. Despite this shift, the absolute level of electricity generated in oil-fired thermal plants rose by 25%, requiring 18 million barrels of oil in 1979, about 22% of the country's total oil consumption. 2.14 These national statistics hide important regional differences. The industry presently consists of eight non-interconnected subsystems. The main Luzon grid accounts for 72% of the country's installed capacity; it interconnects virtually all generating plant on the island. Six systems on the six largest Visayas islands are in an early stage of development; together they account for only 13% of national capacity. Mindanao, with 15% of capacity, is not well interconnected among its own components and has no connections with other regions. As the following figures show, these three regions rely in varying proportions on different primary sources. Table 2.7: INSTALLED GENERATING CAPACITY BY REGION (1979) (MW) Source Luzon Visayas Mindanao Total Oil thermal 2,230 - 2,230 Coal thermal - - - - Diesel 33 516 253 802 Hydro 544 2 380 926 Geothermal 220 - - 220 Total /a 3,027 518 633 4,178 Percentage 72.4 12.4 15.2 100.0 /a Generating capacity of captive plants is based on dependable capacity rather than on installed capacity. This helps explain minor dif- ferences from Table 2, Annex 4. Source: MOE/NPC data. Hydroelectricity 2.15 The country's many mountains and high average rainfall give it a theoretically large hydroelectric potential currently estimated at over 7,000 MW (over seven times today's hydro capacity and much more than today's total installed power capacity). Only 926 MW of hydro capacity has yet been built, so the potential for expansion seems enormous. The big problem is  - 19 - cost: very few hydro sites permit continuous electricity production to meet base-load demand. Most hydro power can be used only to meet daily or sea- sonal peaking demand, meaning that expensive dams have to lie idle much of the time. This loads heavy costs on low output, making each kWh generated relatively expensive. Run-of-river hydro plants do not suffer these dis- advantages but, except for Mindanao, there are few opportunities for large- scale run-of-river projects. Most large-capacity sites require dams and storage reservoirs, which are very expensive. Sometimes the share of costs which has to be borne by power can be reduced, if other benefits (e.g. irriga- tion or flood protection) will be produced. For all these reasons the eco- nomically useable hydro capacity is likely to fall far short of the 7,000 MW engineering estimate. 2.16 Recently, the Government has compiled, with the assistance of con- sultants, an inventory of 30 potential hydro sites and is preparing detailed prefeasibility studies for 10 of these./! Although the ranking of these sites and the appropriate timing for their development must await the completion of these studies, it is clear that there is considerable potential for further development of this source, particularly on the island of Mindanao. Here most of the hydroelectric sites are of the run-of-river type with a low unit cost (average $700/kW), relatively short construction times, and a high utilization factor. Unfortunately, this is not the case for Luzon where the bulk of the power market lies. Most of the hydroelectric projects here are multipurpose in nature -- with important other objectives in flood control, irrigation, and water supply -- have high capital costs for the electricity component (about $2,000 kW) and require long construction periods of up to eight years. In general, most of these projects have low utilization factors (about 30%) and electricity production is often limited by irrigation requirements. Thus, most large hydroelectric projects in Luzon would qualify only as peaking plants; while their attractiveness is generally enhanced by the rising price of alter- native fuels, each candidate site will need testing by careful economic justi- fication. Geothermal Electricity 2.17 The Philippines' location in the so-called Pacific Fire Ring pro- vides it with a rich source of geothermal energy with an estimated ultimate production potential which would be adequate for about 2,000-4,000 MW of electricity capacity. Proven reserves are much smaller -- about 1,000 MW -- but this mainly reflects the relatively early stage of the exploration and development effort. Firmly identified resources are concentrated in four areas (two in Luzon and two in the Visayas) where about 140 exploration and production wells have been drilled to date. The first large-scale units to become operational were at Tiwi and Mak-ban in southern Luzon; both are /1 The World Bank has assisted in the financing of a number of these studies through the loans for the Fifth and Sixth Power Projects (Ref. 809-PH and 1034-PH). Technical assistance has also been pro- vided by the Asian Development Bank.  - 20 - operated by a private company /1 under a contract with the NPC. Installed generating capacity in these fields was 220 MW in 1979 with an additional 220 MW due to come on stream in 1980-81 and a further 110 MW in 1982. 2.18 The areas with the largest geothermal resources in the Visayas are located on the islands of Leyte and Negros. Responsibility for their exploration and development lies with the PNOC subsidiary, the Energy Development Corporation (EDC), again under a service contract with NPC. Although both these fields have a high production potential (at least 900 MW in the case of Tongonan and 200 MW for Palinpinon), the early development of their full potential is hampered by their distance from existing load centers. The Tongonan field, where NPC is now installing 112 MW of generating capacity for commissioning in 1982-83, will supply a copper smelter, now under con- struction, with a final electricity demand of some 60 MW. The remaining capacity will be needed to meet other industrial demand only if the Govern- ment's policy for industrial decentralization -- inducing industries to locate outside Metro Manila -- is successful or if an early interconnection between Leyte and Luzon can be justified. 2.19 The Palinpinon project is located in the southeastern part of the island of Negros and has a production capacity of about 200 MW. Although this region offers an important potential electricity market because of the presence of a number of mines which generate their own electricity largely from oil-fired units,/2 the rapid development of the Palinpinon project is hampered by the difficult terrain in which it is located and the delays in- volved in securing firm purchase commitments from industries that now produce their own (diesel) power. Transmission and Distribution 2.20 The electricity transmission system in the Philippines belongs to NPC, with the exception of the few lines owned by the private electricity enterprises and those that the electricity cooperatives have built in the areas where NPC is not yet providing power. In 1979, NPC had about 5,200 km of transmission lines, nearly three-quarters of which were located on Luzon. A further 3,700 km (between 69 KV and 230 KV) is under construction and ex- pected to enter into service during 1980 and 1981. 2.21 Electric power distribution is primarily the responsibility of (a) the hundred or so electric cooperatives (affiliated to the National Electrification Administration [NEA]) which distribute power in the rural areas and (b) the private utilities which cover urban areas, the largest of which is the Manila Electric Company (MECO). About 2.5 million house- holds or 43% of potential connections are connected to the electricity network. However, the extent of coverage varies considerably across the different islands and between rural and urban areas. As the following /1 Philippine Geothermal, Inc., a subsidiary of Union Oil of California. The contract, drawn up in 1971, is for 25 years and renewable for a similar term at the company's option. /2 The largest of these, Marinduque Mining Corporation, generates about 130 GWh a year, mainly from oil-fired units.  - 21 - figures show, the percentage of households with access to electricity in Luzon is twice as high as in the Visayas or Mindanao. Rural electrification is still relatively low, but a large and vigorous program aims at 100% coverage by 1990 (see Annex 7). Table 2.8: STATUS OF HOUSEHOLD ELECTRIFICATION 1979 Potential Connections Connections Electrified Percentage Coverage (000) (000) Elec. Elec. Elec. Region co-ops Private Total co-ops Private Total co-ops Private Total Luzon 2,400 1,400 3,800 720 1,360 2,080 30 97 55 Visayas 800 200 1,000 167 18 185 21 9 19 Mindanao 900 150 1,050 157 70 227 17 47 22 Total 4,100 1,750 5,850 1,044 1,448 2,492 25 83 43  - 22 - 3. ENERGY PRICING, TAXES AND SUBSIDIES Introduction 3.01 As an oil-importing country, the Philippines has not only adjusted the domestic prices of petroleum products quickly to cover changing world prices; it has gone further and imposed selective taxes to further discourage consumption. Since 1973, the weighted average of petroleum product prices has registered a sevenfold increase and despite some important anomalies in relative product prices, the structure of prices is broadly satisfactory. This is unfortunately not the case for the power sector where the level and structure of both wholesale and retail tariffs urgently need revision. In coal, the new National Coal Authority (NCA) has not yet decided what pricing policy it will follow -- if, indeed, it decides that some or all coal prices ought to be brought under Government control. Petroleum Products 3.02 Between January 1973 and May 1980 product prices were increased ten times.]L Because of increased taxation, prices have risen well above import parity (see Table 3.1 below). In February 1980, the retail price of a reconstituted barrel was just over $50, of which 20% was accounted for by sales taxes. These taxes are levied in varying proportions on the different refined products, with the bulk of the burden being placed on gasoline (see Table 3.2). The intent has been to discourage private car transport and to collect revenue from those better able to pay (car owners). Taxes have been left low on products widely used by the poorer classes (kerosene, LPG and diesel for public transport) and important to the viability of industry (fuel oil, whether used directly or as electricity). One important result of price evolution has been a widening gap between prices, with diesel prices now amounting to about half of gasoline. This differential is the result of the Government's explicit objective of shielding public transport users from the full impact of higher international prices. Although the differ- ential can arguably be justified on grounds of the Government's social pric- ing objectives, its impact on relative product demand growth needs to be closely monitored. There is already some evidence that the absolute decline in gasoline consumption of recent years and the emergence of surplus gasoline stocks in the country, was due not only to less discretionary driving by car owners but also to a large-scale shift from petrol to diesel powered vehicles in the public transport sector. This would not be a problem if refinery runs or the crude feedstocks could be adjusted further to yield more diesel and less gasoline; but this is technically impossible for any of the country's three refineries without very large new investments. An alternative policy would be to impose tariff duties and licensing fees in a way that would encourage the use of fuel-efficient vehicles without regard for what fuel they use (i.e., light vehicles with small engines, for their type); gasoline and diesel fuels could then be priced more flexibly so as to prevent the /1 There have been two additional increases since May 1980 -- in August 1980 and March 1981.  - 23 - development of chronic surpluses of particular fuels. The present policy reflects an undue bias against gasoline and puts the whole burden of fuel economy on relative fuel prices instead of sharing it (through differential taxes and licensing fees) with the other costs of owning and operating different vehicle types. Table 3.1: RETAIL PRICES FOR SELECTED PETROLEUM PRODUCTS (MAY 1980)11 Percentage Comparative Prices Retail increase Import parity Retail Prices price since (ex Singapore) Thailand Pakistan Product US$ gal. Oct. 1973 $/US Gallon Aviation fuel 1.96 900 1.04 - Gasoline regular 2.18 1,200 0.99 1.79 1.63 premium 2.28 1,060 - 1.89 2.33 Diesel 1.22 725 0.97 1.43 0.96 Kerosene 1.22 775 1.04 1.30 0.76 Fuel oil 0.85 735 0.65 0.70 0.40 LPG 1.14 580 - 1.15 - Source: PNOC/MOE data; staff estimates. Fiscal Contribution of the Sector 3.03 Sales of petroleum products have traditionally been an important source of revenue for the national exchequer; today, they contribute nearly 20% of total tax revenues. Since 1975 these revenues have risen dramatically both because of the increase in the price of these products and because of the rising proportion of taxes in the final sales price (28%, on average). The application of these taxes has also been broadened. The traditional 'specific tax' whose proceeds augment the general revenues of the Government has been supplemented since 1974 by a 'special fund' levy. The revenues from this fund, which are again generated primarily through gasoline sales, have in fact been used for other energy-related projects although they are not earmarked for such. /1 By March 1981 Philippine product prices had increased another 17-37%, depending on the product (industrial fuel oil and diesel were increased about 30%, regular gasoline 17%). Thus some of the "undue bias against gasoline" has now been removed. In 1981, the Board of Investments re- vised its policy of encouraging diesel-car manufacture (begun in 1979) and decided not to permit further expansion.  - 24 - Table 3,2: STRUCTURE OF PETROLEUM PRODUCT PRICES (MAY 1980) Pesos per liter Oil Taxes as a company /a Specific Special L Wholesale % of whole- Product take taxes fund price sale price Gasoline regular 2.803 0.91 0.438 4.15 32.5 premium 2.860 1.000 0.483 4.34 34.1 Diesel 2.040 0.185 0.035 2.25 9,3 Kerosene 2.165 0.070 0.035 2.27 4.6 Fuel oil 1.448 0.045 0.038 1.53 5t4 LPG 2.005 0.078 0.038 2,121 5.5 Average 1.952 0.278 0.160 2.39 18.3 /a Includes crude equalization differential. lb Includes "energy development impost" of P 0.19/liter on regular and premium gasoline. Source: MOE/PNOC. 3.04 The special fund has provided the Government with a valuable and growing source of revenues for its energy development program./l Since its inception in 1974, the fund has disbursed over P 1.6 billion ($215 million) for a wide variety of energy-related projects. It has been used to provide equity capital for PNOC and its subsidiaries and to finance specific projects undertaken by them; it has helped finance the purchase by the NPC of power plants previously owned by the private MECO; and it has provided equity and project finance for the NEA. Because of recent increases in product prices and tax rates, the fund's revenues are rapidly growing. Collections in 1979 were over P 1.4 billion ($185 million); in 1980 they were expected to rise to approximately P 2.0 billion ($265 million)./2 /1 Disbursements from the fund can only be made on the basis of a letter of instruction from the President of the Philippines to the Commissioner of the Budget, the Treasurer of the Philippines and the President of the PNOC. /2 Additional revenues generated through the specific tax on petroleum product sales amounted to P 2.3 billion ($300 million) in 1979 and were estimated to rise to P 3.2 billion ($425 million) in 1980.  - 25 - The Power Sector 3.05 Electric power pricing in the Philippines has historically been governed by social and political objectives which have limited the ability of power generating utilities to earn a reasonable return on their assets or adequately finance their investment programs from internal cash genera- tion. The result has been a retail tariff structure which is complex, dis- torted and often inconsistent with the Government's stated objectives of equity and efficiency. The problem has been exacerbated by the multiplicity of regulatory authorities and distribution agencies, and the archipelagic nature of the country, which results in a fragmented power market and wide differences in the cost of electric power supply. 3.06 Electricity tariffs are set at two levels. Wholesale rates for the NPC, which generates 90% of national supply, are set by its Board with the approval of the National Economic Development Agency (NEDA) and the President. Retail tariffs for the electricity cooperatives are approved by the NEA. Tariffs for the private utilities are set by the Board of Energy (BOE), originally an independent three-man Board that was incorporated into the MOE in 1979. This wholesale/retail distinction is by and large valid with the exception of direct NPC sales to large industrial consumers outside the Metro Manila area, a practice not always welcomed by the cooperatives in those areas, who usually feel that they should be allowed to serve local in- dustries. Such conflicts, although not yet common, are a source of some inter-agency friction which needs to be resolved by a policy decision in the near future./l NPC Wholesale Rates 3.07 The deficiencies characterizing the existing tariff framework can also be analyzed at these two levels. At the wholesale or NPC level the main problem has been financial. Despite a five-fold increase in its overall rates since 1974, NPC still receives an average price for its power which is too low to enable it to earn a reasonable return on its capital. Since 1968, NPC's rate of return on average net fixed assets in operation has ranged from 3% to 6.4%, well below the 8% minimum target it has set for itself. As with all rate covenants, this target serves the purpose of assuring sufficient internal cash generation so that the entity is able not only to service its debt but to make a reasonable contribution to the financing of its ongoing investment pro- gram. In recent years, NPC has had difficulty covering its debt service out of its internally-generated cash flow; any surpluses have had to be used to cover growth in needed working capital leaving substantially no funds avail- able to finance investment. Consequently, the Government has had to make substantial injections of equity (on the order of P 1.3 to 2.3 billion a year) to cover the peso component of the investment program. The foreign exchange component has been covered entirely by foreign borrowing. NPC has estimated that if it can reach an 8% return on its asset base during the years 1982-85, this would be sufficient to relieve the Government of any need to inject equity to cover the peso component of its investment program. There is room for doubt, however, that the modest tariff increases proposed by NPC for introduction over six consecutive quarters starting in November, 1981, would be sufficient to achieve this objective, even if adjusted upward for inflation. /1 See also paras. 5.13 ff.  - 26 - 3.08 Partly as a recognition of its increasingly unsatisfactory finan- cial situation, NPC established a special unit in 1977 to prepare a revised tariff based on the long-run marginal costs of supplying electricity to the various consumer categories. This study was completed in 1979 but no com- prehensive set of conclusions or recommendations for their implemuentation has yet been drafted./l The results of the study also need to be updated in the light of the sharp 1979 increases in fuel prices and revisions in the power expansion program. Nevertheless, certain basic conclusions can already be drawn from this analysis and appropriate tariff revisions initiated. These conclusions fall into four particular areas. Firstly, despite the substantial increases in NPC tariffs in February 1980, these tariffs are on average still 30% below the long run marginal cost (LRMC) of power supply.12 Secondly, the principal component which needs to be changed is the capacity rather than the energy charge./3 Currently MECO does not pay any capacity charge, and the charge for other NPC customers is too nominal to influence capacity require- ments. One manifestation of this is the fact that capacity charges constitute only 15% of the current NPC tariff when their contribution to LRMC is of the order of 60%. Thirdly, the wide difference in NPC's existing rates for Luzon and Mindanao (Luzon rates are about double the rates for Mindanao) is not justified by differential costs of power supply (as reflected in LRMC). Finally, average rates for the Visayas should continue to be higher than in the other areas so long as the region's heavy reliance on oil continues; when and if the region is interconnectea to lower-cost sources, tariffs can be adjusted down- ward. /1 Marginal Cost Analysis for NPC, Power Sector Tariff Study, NPC Corporate Planning Department, January 1979. /2 This concept can refer either to capital or operating costs, or both. Capital LRMC refers to the investment cost of meeting an increase in kW requirements of a system. This cost is best measured by reference to peaking plants in process of being added to the system. The LRMC of supplying energy would be the variable cost of operating the same plants. Total LRMC per kWh would be the sum of capital LRMC (annualized and divided by estimated kWh output) and the LRMC of energy production (see Table 3.3). 13 A capacity charge is each customer's share of the capital cost of the generating, transmission and distribution capacity needed to provide him with energy during the period of maximum system demand. An energy charge covers the variable-cost element of supplying kWhs actually used. A capacity charge geared to peak-hour use encourages customers to arrange their power requirements so as to minimize their maximum demand; if every- one does this, system peaking requirements are minimized.  - 27 - Table 3.3: NPC WHOLESALE RATES AND MARGINAL COSTS OF POWER SUPPLY (in centavos/kWh at 1980 prices) Marginal costs / Rates as a Wholesale Capacity Energy % of marg. Grid rates cost cost Total costs Luzon 35.32 28 18 46 77 Visayas 39.15 23 34 57 69 Cebu & Panay 42.00 Bohol & Negros 30.00 Mindanao 17.00 lb 30 16 46 37 Mindanao 17.00 General Santos 40.00 Overall 33.81 28 20 48 70 /a NPC estimates for 1978 prices updated to reflect higher fuel costs of 1980. Energy costs increased by 100% and capacity costs by 8% per annum. lb Excludes General Santos subgrid. Source: Staff estimates based on data from NPC and NPC tariff study, op cit. Retail Power Rates 3.09 Retail tariffs in the power sector reflect the Government's "isocialized pricing" policy which aims at cross-subsidizing the electricity consumption of poorer households through the imposition of progressively higher charges for the consumption of electricity by richer households and by commercial and industrial users. Although such a principle implies some misallocation at the margin between electricity and other fuels, it can be justified within the context of the Government's broader economic and social objectives; variants of the policy are in force in many other developing countries. Having said that, there remain important and serious inequities in the existing retail electricity tariff structure. 3.10 These distortions fall into two groups. First, the extent of sub- sidies within the Metro Manila area is excessive, both in regard to those extended to consumers in other parts of the country and in relation to the generally accepted definition of "lower-income" households. Residential  - 28 - consumers in the Manila area with a monthly consumption level below 200 kWh pay rates varying from 2-14