Case Summary (G.R. No. 226443)
Procedural Posture and Relief Sought
NASECORE filed a petition for review on certiorari assailing the Court of Appeals’ affirmation of ERC Orders dated 21 June 2011 and 4 February 2013, which had affirmed ERC decisions to declare MERALCO’s unbundled rates final. NASECORE challenged, among other things, the ERC’s treatment of the COA audit findings, the recoverability of certain operating expenses (notably pension and benefits), the inclusion in rate base of specified properties and facilities, and the characterization of amounts recovered in excess of lawful limits as over‑recovery refundable to consumers. The Supreme Court partly granted the petition.
Core Facts and Origin of COA Audit
Following this Court’s direction in MERALCO v. Lualhati, the ERC requested COA to undertake a complete audit of MERALCO’s books, records and accounts to determine whether the implemented distribution rates yielded a fair return and whether recovery of generation costs was revenue‑neutral to MERALCO. COA conducted a special audit covering test years 2004 and 2007 and transmitted its Special Audits Office Report No. 2009‑01, a rate audit of unbundled charges. The audit accounted for revenues from approved rates, reviewed property and equipment for rate base inclusion, inspected selected facilities, reviewed operating expenses for recoverability, and accounted for generation costs and revenues. COA used a cost‑based Return on Rate Base (RORB) methodology.
COA’s Principal Findings
COA’s audit disclosed excess or deficiency in MERALCO’s revenue under three alternative rates of return: the ERC‑approved 15.50% (based on MERALCO’s WACC for 2000), MERALCO’s actual WACC figures for 2004 and 2007 (12.80% and 11.70%), and a 12% reasonable rate of return established in jurisprudence. COA also disallowed certain operating expenses—principally increased pension and other benefits—and excluded certain property and equipment from the rate base as not used and useful during the test periods. COA recommended that its audit results be considered by the ERC in deciding the MERALCO cases.
ERC’s Orders and Reasoning
In its 21 June 2011 Order, the ERC affirmed its original findings and declared MERALCO’s unbundled rates final. The ERC declined to adopt COA’s conclusion of “over‑recovery” or excess revenue, explaining that COA had: (1) improperly applied disallowances derived under MERALCO’s Performance Based Regulation (PBR) application to the RORB application, contravening principles against retroactive rate‑making; (2) relied on historical costs and a 12% return contrary to law and jurisprudence permitting present market value and use of WACC for prospective ratemaking; and (3) failed to account for incrementals and differences in billing determinants (kWh sales) across years, rendering comparisons improper. The ERC denied NASECORE’s motion for reconsideration on 4 February 2013.
Court of Appeals’ Disposition
The Court of Appeals affirmed the ERC, holding that (a) while ERC had been directed to request COA assistance in Lualhati, a COA audit is not a prerequisite for ERC’s rate‑setting and the ERC is not compelled to adopt COA’s findings; (b) COA used different test years and accounting methodologies, and it was unlikely that COA would reach the same conclusion as ERC; and (c) ERC did not err in declining to adopt the COA Report in its entirety because the COA employed accounting methodologies different from that used by MERALCO in its rate application.
Issues Raised on Appeal to the Supreme Court
NASECORE framed the following principal issues: (1) whether ERC gave proper weight and credence to COA’s findings; (2) whether MERALCO’s operating expenses—specifically employees’ pension and other benefits—are recoverable from consumers for 2004 and 2007; (3) whether certain properties and facilities (e.g., Meralco Theater, Museum, Wellness Center, shooting range, sports/recreational facilities) should be included in the rate base; and (4) whether costs recovered by MERALCO in excess of lawful limits constitute “over‑recovery” subject to refund to consumers.
Legal Authority of COA and ERC’s Statutory Duties
The Court reiterated that Section 38 of the Government Auditing Code and Section 22 of the Administrative Code specifically authorize COA to examine and audit public utilities’ books and records in connection with fixing rates. Lualhati had required ERC to seek COA’s assistance in conducting a complete audit while allowing ERC to exercise its rate‑making authority. The Court stressed that COA’s audit was properly conducted as a post‑audit to inform ERC’s decision‑making and that COA “recommended” consideration of its results by ERC.
Rate‑Setting Principles and the Regulatory Balance
The Court restated established principles: regulation of public utility rates is a valid exercise of the State’s police power to protect the public from arbitrary or excessive charges while ensuring efficient service and a fair return to investors. Ratemaking considers three major elements: rate of return, rate base, and operating expenses, which combine in the traditional formula R = O + (V − D) r. Determinations on rates are technical and generally accorded deference when supported by substantial evidence, but judicial review remains available to assess whether rates are reasonable and just.
Methodologies: RORB, PBR, WACC, ODRC and Their Distinctions
The Court described the methodologies involved in the proceedings: RORB (historical cost base, benchmark rate of return, and present or market value for rate base), and PBR (performance‑based forecasting of costs and capital expenditures with incentives/penalties and use of reappraised asset bases optimized to lower of replacement cost or modern equivalent asset). The ERC had signaled a regulatory shift toward PBR for wheeling rates; MERALCO was an early entrant under PBR. The Court noted distinctions between RORB and PBR (treatment of corporate income tax, cost base type, valuation of rate base, method of determining allowed return, and regulatory approach – rate‑of‑return vs price/revenue cap). The Court also discussed Optimized Depreciated Replacement Cost (ODRC) and documented criticisms of ODRC/ODRC‑style revaluation methods, including risks of estimation error, potential to produce tariffs at odds with competitive outcomes, and wealth transfers from consumers to shareholders.
Supreme Court’s Assessment of ERC’s Consideration of COA Findings
The Court found that ERC failed adequately to consider COA’s findings and to discharge its statutory mandate to ensure electricity is provided “in the least cost manner” under EPIRA. On operating expenses, the Court observed that COA did not contest pension costs as necessary per se but disallowed amounts MERALCO failed to justify, given insufficient documentation (e.g., lack of detailed salary scales and benefits for comparative analysis). The Court agreed that consumers should not bear expenses not necessary or incidental to distribution utility operations and directed ERC to formulate parameters to determine when such expenses may
...continue readingCase Syllabus (G.R. No. 226443)
The Case
- Petition for review on certiorari filed by National Association of Electricity Consumers for Reforms, Inc. (NASECORE) under Rule 45 of the Rules of Court, assailing:
- The Court of Appeals (CA) Decision dated 29 February 2016 in CA-G.R. SP No. 129052 and its Resolution dated 18 August 2016;
- The CA’s affirmance of the Energy Regulatory Commission (ERC) Orders dated 21 June 2011 and 4 February 2013 in ERC Case Nos. 2001-646 and 2001-900.
- Relief sought: review of ERC’s non-adoption in full of the Commission on Audit (COA) Special Audits Office Report No. 2009-01 (Rate Audit of Unbundled Charges of MERALCO) and related determinations on recoverability of operating expenses, asset inclusion in rate base, and alleged over-recovery/refund obligations of Manila Electric Company, Inc. (MERALCO).
- Decision authored by Justice Carpio; Supreme Court PARTIALLY GRANTED the petition and issued specific remedial directives.
Factual Background and Origin of Audit
- In MERALCO v. Genaro Lualhati (Lualhati), this Court (6 December 2006) directed the ERC to request the COA to undertake a complete audit of MERALCO’s books, records and accounts relative to provisionally-approved rate increases and unbundled rates.
- Pursuant to that directive, the ERC on 12 January 2007 requested the COA to determine:
- (a) whether the implementation of approved distribution rates resulted in a fair return; and
- (b) whether recovery of generation costs had been revenue-neutral to MERALCO.
- COA conducted the audit pursuant to MS/TS Office Order No. 2008-015 dated 8 September 2008.
- COA transmitted Special Audits Office Report No. 2009-01 (Rate Audit of Unbundled Charges of MERALCO) to the ERC on 12 November 2009.
Scope and Methodology of COA Audit (as stated in COA Report)
- Audit covered the test years 2004 and 2007, because unbundled rates were implemented in June 2003.
- The audit team’s work included:
- Accounting for revenues generated from approved rates and those earned from related activities;
- Reviewing property and equipment accounts to ascertain propriety and values to be considered in rate base;
- Conducting ocular inspection of selected transmission substations and branches to determine existence, condition and usage;
- Reviewing operating expense accounts to determine expenses recoverable from consumers;
- Accounting for generation costs and related revenues.
- Rate-setting methodology employed by COA in the audit: a cost-based method known as Return on Rate Base (RORB).
COA’s Audit Findings — Excess/Deficiency Revenue (as reported)
COA disclosed impacts on MERALCO’s revenue structure using three different rates of return and two valuation bases (historical cost and appraised value). COA’s tabulation (excess/(deficiency) revenue) is reported as follows:
Using the ERC-approved rate of return of 15.50% based on MERALCO’s WACC for 2000:
- 2004, Historical Cost: P6,756,940,879
- 2004, Appraised Value: P2,590,667,993
- 2007, Historical Cost: P2,207,598,653
- 2007, Appraised Value: P(1,272,322,123)
Using MERALCO’s actual WACC (12.80% for CY 2004; 11.70% for CY 2007):
- 2004, Historical Cost: P8,142,009,602
- 2004, Appraised Value: P4,701,474,573
- 2007, Historical Cost: P4,561,646,651
- 2007, Appraised Value: P1,934,867,743
Using a “reasonable rate of return” of 12% established in jurisprudence:
- 2004, Historical Cost: P8,552,400,334
- 2004, Appraised Value: P5,326,898,745
- 2007, Historical Cost: P4,375,800,757
- 2007, Appraised Value: P1,681,668,543
COA further reported that the excess/deficiency in distribution revenues was determined after considering COA’s disallowances, specifically:
- Certain operating expenses (including employee pension and other benefits) amounting to P3.479 billion (2004) and P2.916 billion (2007) were not considered recoverable from consumers because they were not reasonable and necessary in distribution services; and
- Certain property and equipment amounting to P3.701 billion (2004) and P3.586 billion (2007) were not considered part of the rate base because they were not used and useful in the distribution operation during the test period.
Parties’ Contentions and Comments to the ERC
- NASECORE’s Comment (5 April 2010) alleged, inter alia:
- The 2003 rate of return granted to MERALCO was 15.50%, which is 3.5% higher than the 12% established and adopted by administrative and judicial bodies;
- Based on alleged excessive revenue, MERALCO should not be entitled to the 2003 rate increase and should be directed to refund excess profits;
- ERC should hold in abeyance any further MERALCO rate increases until a complete audit of MERALCO’s books and accounts from 1987 to present is conducted;
- The COA report confirmed that MERALCO’s provisionally approved unbundled rates were “oppressive and exorbitant.”
- MERALCO’s Comment alleged, inter alia:
- ERC has the final decision on matters involving rates;
- Pension and benefits are reasonable costs of a utility and are recoverable expenses;
- Certain assets disallowed by COA have been consistently upheld by ERC as used and useful; and
- The proper basis for determining whether MERALCO exceeded its return is the 15.5% WACC and ERC is not bound to maintain rate of return at 12%.
ERC’s Orders and Reasoning
- ERC Order dated 21 June 2011:
- Affirmed findings and conclusions in ERC Decision dated 20 March 2003 and Order dated 30 May 2003, and declared MERALCO’s approved unbundled rates final.
- Rejected COA’s findings of “excess revenues”/“over-recovery” on MERALCO for reasons including:
- COA applied disallowances derived under MERALCO’s Performance-Based Regulation (PBR) application to MERALCO’s Return-on-Rate-Base (RORB) application — a misapplication not supported by established rate-making rules;
- COA calculated revenues using historical cost and a 12% RORB which ERC found contrary to existing laws and jurisprudence that allow present market value and WACC in appropriate circumstances;
- COA failed to account for incrementals (i.e., increases in costs/assets/sales over time) and compared non-comparable years (e.g., 2000 to 2004/2007) when assessing “over-recovery.”
- ERC concluded COA’s approach violated the principle against retroactive rate-making and was therefore improper for denying recoverability or adjusting rates previously fixed by the regulatory body.
- ERC Order dated 4 February 2013:
- Denied NASECORE’s motion for reconsideration for lack of merit.
Court of Appeals Ruling
- CA Decision dated 29 February 2016:
- Found ERC dutifully complied with the Supreme Court’s directive in Lualhati.
- Held that a COA audit is not a prerequisite for ERC’s exercise of rate-fixing powers and ERC is not bound to accept COA audit findings.
- Observed that COA and ERC used different factors (test years, accounting methodologies) and thus COA’s conclusions would likely differ from ERC’s.
- Found no reason for COA to depart from the accounting methodology MERALCO used in its rate application; concluded ERC acted correctly in not adopting COA Report in its entirety because CA could not determine whether the rate increase granted to MERALCO was justified.
- DISMISSED the petition and AFFIRMED ERC Orders dated 21 June 2011 and 4 February 2013.
- CA Resolution dated 18 August 2016 denied NASECORE’s motion for reconsideration.
Issues Framed in the Petition to the Supreme Court
- NASECORE presented these issues for resolution:
I. Whether or not the Energy Regulatory Commission gave proper weight and credence to the findings of the Commission on Audit;
II. Whether or not MERALCO’s operating expenses (OPEX) such as employees’ pension and other benefits amounting to PHP3.148 billion in 2004 and PHP3.228 billion in 2007 are recoverable from the consumers;
III. Whether or not certain properties and facilities amounting to PHP3.848 billion in 2004 and PHP3.069 billion in 2007 should be considered as part of the rate base — e.g., MERALCO Theater, MERALCO Museum, MERALCO Wellness Center, MERALCO Shooting Range, MERALCO Tennis Court/Fitness Center/Oval/Open Space;
IV. Whether or not all costs recovered by MERALCO from the consumers in excess of limits allowed by law should be treated as “over-recovery” and refunded to the consumers accordingly.
Statutory and Regulatory Authorities Considered
- Section 38 of the Government Auditing Code of the Philippines:
- Authorizes COA to examine and audit the books, records and accounts of public utilities in connection with fixing rates of every nature or in relation to regulatory proceedings; requires production of records; empowers COA to examine under oath any official or employee; provides penalties for refusal or obstruction.
- Administrative Code of 1987, Book V, Title I, Subtitle B, Chapter 4, Section 22:
- Similarly authorizes the Commission to examine and audit public utilities in connection with rate-fixing and regulatory proceedings; mandates cooperation and production of records during examination and audit.
- Republic Act No. 9136 (EPIRA):
- Section 23 (as c