Republic Act No. 12120 or the “Philippine Downstream Natural Gas Industry Development Act” sets a legal framework to develop the domestic gas industry and increase natural gas in the energy mix. The law has two key provisions: (i) to grant priority dispatch to power generated from indigenous gas (“Priority Dispatch”); and (ii) to set a mandated minimum share of electricity using indigenous natural gas (“Mandated Gas Share”).
The Priority Dispatch and Mandated Gas Share provisions represent a significant intervention in what is otherwise a liberalized power market. The Philippine electricity sector, under the Electric Power Industry Reform Act (“EPIRA”), is supposed to operate on least-cost procurement and competitive dispatch in the Wholesale Electricity Spot Market (“WESM”). The new gas mandate, while well-intentioned, departs from the principle of least-cost generation, potentially forcing higher-cost power into the system.
We analyze the economic inefficiencies introduced by this policy, including distortion of merit-order dispatch and increased generation costs.
In a competitive electricity market, generators are dispatched according to their short-run marginal cost (“SRMC”), with the cheapest units running first to meet demand to ensure overall least-cost pricing (“Merit Order”). The Merit Order ranks power plants based on the SRMC, from lowest to highest, and WESM dispatches plants starting from the cheapest (lowest SRMC) until demand is met. The last plant dispatched (the most expensive needed to meet demand) sets the Market Clearing Price (“MCP”). All dispatched plants get paid this price.
RA 12120’s mandate upends this merit-order principle by giving preferential treatment to domestic gas-fired plants regardless of cost. Priority Dispatch creates a market distortion by not reflecting true production costs in dispatch decisions, as illustrated in comparative tables below.
Table 1. Merit Order without Priority Dispatch
If demand is 5,000 MW, then demand is met at Rank 4 (Geothermal); hence, MCP = ₱4.50/kWh. Gas and LNG only ****run if demand spikes higher.
Meanwhile, a Merit Order with Priority Dispatch looks like this:
Table 2. Merit Order with Priority Dispatch
Now MCP = ₱6.50/kWh, because Malampaya gas is now the marginal plant, even though cheaper plants were available.
WESM is now forced to dispatch higher-cost gas even when gas is not needed (e.g., renewables and coal are enough). Priority Dispatch sets an artificial demand floor for gas. Plants that could have set a lower MCP are sidelined. Price paid to all dispatched plants rises: everyone gets paid ₱6.50 instead of ₱4.50.
What is the price impact of Priority Dispatch and Merit Order distortion?
If demand is 5,000 MW, then under a merit-based dispatch (without distortion), the total system cost is ₱22.5 million (MCP of ₱4.50 × 5,000 MW energy dispatched). However, with Priority Dispatch: if 5,000 MW of demand is met, and 1,000 MW of that must be from Malampaya gas at ₱6.50, MCP becomes ₱6.50/kWh. Even solar and hydro plants (with ₱0 and ₱1 SRMC) get paid ₱6.50. Under a distorted Merit Order, the total system cost is ₱32.5 million. This results in a net inefficiency of ₱10 million per hour of overpayment. (Note: these figures are just illustrative examples.)
New gas generators know their power is mandated and prioritized, thus there is no pressure to be cost-efficient. Lower-cost competitors (e.g. coal) are penalized by being withheld from dispatch.
If the Mandated Gas Share is enforced rigidly, the system operator might have to curtail or back down other low-cost plants to ensure gas output reaches the quota. During periods of low demand (e.g. off-peak hours or high renewable output), a must-run gas allocation could force lower-cost plants offline, even if their energy is cheaper. This interference with optimal dispatch can raise the MCP in the spot market. The marginal unit setting the price could more often be an expensive gas unit rather than a cheaper alternative, leading to consistently higher spot prices.
This forced reordering of the dispatch stack elevates the likelihood that higher-cost gas-fired units will become the marginal price-setter in the WESM.
The EPIRA obligates distribution utilities to procure power in a least-cost manner to protect consumers. The gas mandate of RA 12120 conflicts with this principle.
Got questions or comments? E-mail us at attorney@geronimo.law.
Disclaimer: this article simplifies the dispatch framework for illustrative purposes. Actual market operations under WESM involve multiple dispatch layers, including Preferential Dispatch and MDGU treatment.
