Biting the bullet

The whole world is paying the price.

The conflict may just be between Russia and Ukraine and their backers, but almost every country is feeling the impact.

In its World Economic Report last July, the International Monetary Fund (IMF) revealed that global output contracted in the second quarter of this year as several shocks hit the world economy already weakened by the pandemic – higher than expected inflation worldwide especially in the US and major European economies triggering tighter financial conditions, a worse than anticipated slowdown in China reflected COVID 19 outbreaks and lockdowns, and further negative spillover from the war in Ukraine.

The IMF said that growth is forecasted to decline from 6.1 percent last year to 3.2 percent in 2022, or 0.4 percentage point lower than what was projected in its April report.

Meanwhile, global inflation has been revised up due to food and energy prices as well as lingering supply-demand imbalance and is anticipated to reach 6.6 percent in advanced economies and 9.5 percent in emerging market and developing economies this year. In 2023, IMF expects disinflationary monetary policies to bite, with global output growing by only 2.9 percent.

However, for the ASEAN 5 which includes Indonesia, Malaysia, the Philippines, Singapore and Thailand, IMF projects growth (in terms of real GDP) to increase from 3.4 percent in 2021 to 5.3 percent this year and then to slow down to 5.1 percent next year.

IMF also noted that the risks to the outlook are overwhelmingly tilted to the downside. “The war in Ukraine could lead to a sudden stop of European gas imports from Russia; inflation could be harder to bring down than anticipated either if labor markets are tighter than expected or inflation expectations unanchor; tighter global financial conditions could induce debt distress in emerging market and developing economies; renewed outbreaks and lockdowns as well as a further escalation of the property sector crisis might further suppress Chinese growth; and geopolitical fragmentation could impede global trade and cooperation,” it said.

IMF adds: “A plausible alternative scenario in which risks materialize, inflation rises further, and global growth declines to about 2.6 percent and two percent in 2022 and 2023, respectively, would put growth in the bottom 10 percent of outcomes since 1970.”

In the Philippines, the Philippine Statistics Authority just reported that the country’s inflation rate continued to accelerate, reaching 6.4 percent in July which is the highest level in four years, due to faster increase in prices of food and non-alcoholic beverages. Meanwhile, the purchasing power of the peso declined to 86 centavos.

Not only will this war yield no winners, but virtually the whole world loses.

A critical pain point for us, apart from food, is energy. For months now, many countries all over the world have seen record energy cost increases, such as in Europe, where countries like the United Kingdom, Germany, and Spain have seen electricity rates increase by 300-400 percent.

In the Philippines, electricity rates have increased by about 50 percent since 2021. A major reason for this is because about 80 percent of the power supplied by generators to Meralco comes from traditional fuel imported from various countries, including coal, whose prices have soared by 128 percent during the first half of this year compared to 2020.

A report from the World Bank last July noted that the recent surge in coal and natural gas prices has been so swift that the main benchmarks were roughly three times higher in the second quarter of 2022 compared to a year earlier. The surge in prices, it said, partly reflects the impact of the Russian invasion of Ukraine and robust demand. Russia in 2020 accounted for a quarter of global exports of natural gas and one-fifth of coal exports.

The International Energy Agency has warned that global coal consumption is set to rise by 0.7 percent in 2022 assuming the Chinese economy recovers. In the European Union, demand for coal has increased as coal is increasingly being used to replace gas which is in short supply. It added that boycotts of Russian coal add further upward pressures on coal prices.

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Ultimately, consumers have to bear the brunt in terms of higher electricity charges since most power generators have no choice but to sell at higher prices to Meralco.

Two of the Philippine’s major power facilities, the Sual coal plant and Ilijan gas plant, are on the verge of tapping out, in large part because they have been the power consumers’ silent saviors through the past year and a half.

However, unlike Meralco’s other power supply contracts, the power supply agreements (PSA) with these facilities, which comprise 1,000 megawatts or around 30 percent of total Meralco supply, do not allow for passing-on of costs to consumers.

In short, these two power plants have been cushioning the impact on consumers of skyrocketing global fuel prices, unlike other generators who have the luxury of passing on their cost increases to consumers.

San Miguel Corp. president Ramon Ang himself admitted recently that the facilities have lost over P15 billion on the supply contract between SMC Global Power and Meralco to date, adding that the company has absorbed the P10 billion it lost in 2021. Unfortunately, no business can operate at a loss for so long.

With the Russia-Ukraine conflict further driving up global coal prices to unprecedented heights, it could only be a matter of time before SMCGP may be left with no recourse but to opt out of the PSA, rather than continue bleeding money and ending up in dire financial straits. Among the grounds of termination listed in the PSA is a “change in circumstances” which could include external factors beyond its control like skyrocketing fuel prices brought about by war, coal export bans, among others.

The Ilijan gas plant situation is essentially the same. Because the Malampaya gas field unilaterally stopped supplying gas to the Ilijan plant, it has been forced to source additional capacity from the Wholesale Electricity Spot Market (WESM).

Its WESM purchases have triggered spikes in WESM prices, thereby further compromising its cost to supply Meralco, and the cost of electricity for others, to boot.

Both Meralco and SMC have asked the Energy Regulatory Commission that they be allowed to charge higher, citing increases in coal and natural gas used to produce electricity.

If SMC’s plants are not allowed to raise their prices, worst case scenario is that they will stop producing and supplying power due to mounting losses. Where then will Meralco get the 1,000 MW that will be lost? If Meralco buys from the WESM, this will expose consumers not just to much higher prices and price volatility, but also to uncertainty of supply.

The consequences of intermittent power supply, if not outright outages in the event there is no sufficient capacity, will have disastrous consequences on our economy already battered by the effects of the Russia-Ukraine conflict and the pandemic.

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