In an Order dated 15 February 2010, the ERC directed the intervenors to comment on the COA Report. On 2 March 2010, Genaro Lualhati filed his Comment, while NASECORE filed its Comment on 5 April 2010.

In its Comment, NASECORE alleged that: (1) the rate of return granted to MERALCO in 2003 was 15.50%, which was 3.5% higher than the 12% established and adopted by administrative and judicial bodies; (2) based on its excessive revenue, MERALCO should not be entitled to rate increase in 2003 and the ERC should direct it to refund its excess profits; (3) the ERC should hold in abeyance any further rate increase of MERALCO until after conducting a complete audit of its books, accounts and records for the years 1987 to the present; and (4) the COA report confirmed that MERALCO's provisionally approved unbundled rates were oppressive and exorbitant.

In its Comment, MERALCO alleged that: (1) the ERC has the final decision on matters involving rates; (2) the pension and benefits are reasonable costs of a utility and are recoverable expenses; (3) certain assets disallowed by COA have been consistently upheld by the ERC as used and useful in providing utility service; and (4) the basis whether it exceeded its return should be 15.5% and the ERC is not bound to maintain its rate of return at 12%.

The Ruling of the ERC

In its Order^[11] dated 21 June 2011, the ERC affirmed its findings and conclusions in its Decision dated 20 March 2003 and Order dated 20 May 2003, and declared MERALCO's approved unbundled rates final. The ERC held that COA's findings of "excess revenues" or "over-recovery" on the part of the MERALCO were due to the following factors: 1) the application of the disallowances under MERALCO's Performance Based Rate (PBR) application to its RORB application; 2) the calculation of MERALCO's revenues using historical costs of the assets and a 12% RORB; and 3) the calculation of MERALCO's disallowances and revenues without regard to incrementals.

The ERC found that COA's application of the disallowances under MERALCO's PBR application to its RORB application is not supported by established rules on rate-making, and that it is a clear violation of the principle against retroactive rate-making, which prohibits the adjustment of rates previously fixed by the regulatory body following a prescribed procedure. The ERC also found that COA's calculation of MERALCO's revenues using the historical costs of the assets and a 12% rate of return is contrary to existing laws and jurisprudence, which allows the use of present market value in fixing the rates to be applied prospectively and the use of a WACC in determining the reasonable return to which the utility is entitled. The ERC likewise found that COA's calculation cannot be adopted because it failed to take into account the incrementals, and the revenues for 2000 should not be compared to revenues for 2004 and 2007 to determine whether they were reasonable.

The Ruling of the Court of Appeals

In its Decision^[13] dated 29 February 2016, the CA found that the ERC dutifully complied with this Court's Order in Lualhati. The CA explained that the conduct of a COA audit is not a requisite for the ERC's exercise of its rate-fixing powers, and the ERC is not bound to accept and adopt any finding that the COA audit may come up with. Furthermore, the CA held that it would be highly unlikely that the COA will come up with a conclusion similar to that of ERC given COA's use of different factors, i.e. test year and accounting methodology. The CA found that there was no reason for the COA to use an accounting methodology other than that used by MERALCO when it applied for the rate increase. Thus, the CA concluded that the ERC acted correctly when it did not adopt the COA Report in its entirety, because it cannot determine whether the rate increase granted to MERALCO was justified. 

Thus, the dispositive portion of the CA Decision states: 

WHEREFORE, premises considered, the petition is DISMISSED. The Orders dated June 21, 2011 and February 4, 2013, respectively, of the Energy Regulatory Commission in ERC Case Nos. 2001-646 and 2001-900 are AFFIRMED.

SO ORDERED.^[14]

In a Resolution^[15] dated 18 August 2016, the CA denied the motion for reconsideration filed by NASECORE on 22 March 2016. On 3 October 2016, NASECORE filed the present petition before us. Subsequently, MERALCO, COA and the ERC, through the Office of the Solicitor General (OSG), filed their Comment.

On 22 June 2017, movant-intervenors Clark Electric Distribution Corporation, Dagupan Electric Corporation, Angeles Electric Corporation, Cagayan Electric Power & Light Company, Inc., San Fernando Electric Light & Power Company, Inc., Cabanatuan Electric Corporation, Tarlac Electric, Inc., and Olongapo Electricity Distribution Company, Inc., (collectively, intervenors) filed a Motion for Leave to Intervene and Admit Attached Comment-In-Intervention (Motion),^[16] essentially alleging that (1) the instant case involves a matter of transcendental importance, (2) they have a legal standing to intervene as electric distribution utilities, and they will be directly and substantially affected if a ruling is held that a COA audit is a prerequisite in granting rate applications.

The Issues

I. WHETHER OR NOT RESPONDENT ENERGY REGULATORY COMMISSION (ERC) 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 2004AND PHP3.069 BILLION IN 2007 SHOULD BE CONSIDERED AS PART OF THE RATE BASE - E.G. THE 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.^[18]

The Ruling of the Court

Section 38 of the Government Auditing Code of the Philippines and Book V, Title I, Subtitle B, Chapter 4, Section 22^[19] of the Administrative Code of 1987 specifically authorize the COA to examine accounts of public utilities in connection with the fixing of rates of every nature. Section 38 of the Government Auditing Code of the Philippines provides: 

Section 38. Authority to examine accounts of public utilities: 

1. The Commission shall examine and audit the books, records, and accounts of public utilities in connection with the fixing of rates of every nature, or in relation to the proceedings of the proper regulatory agencies, for purposes of determining franchise taxes.
   
        
2. During the examination and audit, the public utility concerned shall produce all the reports, records, books of accounts and such other papers as may be required. The Commission shall have the power to examine under oath any official or employee of the said public utility.     
 
3. Any public utility refusing to allow an examination and audit of its books of accounts and pertinent records, or offering unnecessary obstruction to the examination and audit, or found guilty of concealing any material information concerning its financial status shall be subject to the penalties provided by law. (Boldfacing and italicization supplied) 

Thus, in MERALCO v. Lualhati^[20] (Lualhati), we directed the ERC to seek the assistance of the COA in conducting a complete audit on the books, records and accounts of MERALCO to see to it that the rate increases that MERALCO has asked for are reasonable and justified, to wit:

However, while ruling in said manner, this Court is cognizant that such ruling has far-reaching effects dud is of utmost significance to the public, especially to the poor, who face the threat of deeper wallowing in the quagmire of financial distress once the burden of electricity rate increases is passed on to them. Better judgment, therefore, calls for this Court to temper the rigidity of its decision. 

Although affirming the decision and the order of the ERC approving the rate increases for electricity, this Court is not closing its eyes to the fundamental principle of social justice so emphatically expressed by the late President Magsaysay in his statement: "He who has less in life should have more in law." 

The concern for the poor is recognized as a public duty, and the protection of the rights of those marginalized members of society have always dutifully been pursued by the Court as a sacred mission. Consistent with this duty and mission, the Court deems it proper to approve the rate increases applied for by MERALCO provisionally, i.e., MERALCO to impose provisional rate increases while directing the ERC, at the same time, to seek the assistance of COA in conducting a complete audit on the books, records and accounts of MERALCO to see to it that the rate increases that MERALCO has asked for are reasonable and justified. Stated otherwise, the provisional rate increases will continue to be subject to its being reasonable and just until after the ERC has taken the appropriate action on the COA Report.^[21] (Emphasis supplied)

Consistent with its mandate and our ruling in Lualhati that a prior COA audit is not mandatory in rate-fixing, the COA conducted a post-audit on the books, records and accounts of MERALCO to see if the rates asked for are reasonable and just, and "recommend[ed] that the results of the audit be considered by the ERC in deciding the MERALCO cases."^[22]

The regulation of rates to be charged by public utilities is founded upon the police powers of the State and statutes prescribing rules for the control and regulation of public utilities are a valid exercise thereof.^[23] In regulating rates charged by public utilities, the State protects the public against arbitrary and excessive rates while maintaining the efficiency and quality of services rendered.^[24] The fixing of just and reasonable rates involves a balancing of the investor and the consumer interests.^[25] While the power to fix rates is a legislative function, whether exercised by the legislature itself or delegated through an administrative agency, such as the ERC, a determination of whether the rates so fixed are reasonable and just is a purely judicial question and is subject to the review of the courts.^[26]

Thus, in determining the just and reasonable rates to be charged by a public utility, three major factors are considered by the regulating agency: a) rate of return, that is a judgment percentage which, if multiplied with the rate base, provides a fair return on the public utility for the use of its property for service to the public; b) rate base, that is an evaluation of the property devoted by the utility to the public service or the value of invested capital or property which the utility is entitled to a return; and c) the return itself or the computed revenue to be earned by the public utility based on the rate of return and rate base.^[27] In the most simple terms, the traditional rate formula, designed to produce the utility's revenue requirement, is R = O + (V-D) r, where: R is the public utility's total revenue requirement; O is the public utility's operating expenses; V is the gross value of the public utility's tangible and intangible property; D is the utility's accrued depreciation; combined (V-D) constitute the utility's rate base, also known as its capital investment; and r is the rate of return a utility is allowed to earn on its capital investment.^[28]

At issue here is whether the ERC erred in not adopting the recommendation of the COA, particularly as to: (1) the determination of the kind and the amount of operating expenses that should be allowed to MERALCO and (2) the proper valuation of the rate base or the value of the property entitled to a return.

Operating Expenditures (OPEX) 

MERALCO's OPEX, per its books for CYs 2004 and 2007, were at Php14,851,187,785.00 and Php17,744,879,185.00, respectively. The COA made some disallowances on the OPEX based on the principles laid down under the PBR Methodology. Since the approved OPEX was determined under the RORB Methodology for the test year 2000, there was no mechanism to account for any incremental cost.   

In the unbundling of MERALCO's rates, the items "pensions and other benefits" amounting to Php1.381 Billion was allowed to be recovered based on test year 2000. The COA disallowed pensions and other benefits which increased to Php3.148 Billion in 2004 and Php3.228 Billion in 2007. These amounts are already considered as incremental costs. 

Asset Base

The Commission approved MERALCO's rate base after review and evaluation of its books as of year-end 1998, asset appraisal performed on September 19, 1999 and at cost for year ending December 31, 2000. 

The COA determined MERALCO's assets in service based on historical and appraised book values for the years 2004 and 2007. The Commission believes that the audit conducted disregarded the fact that for purposes of determining the utility's rate base, the present or market value of its properties should be determined. The assessment of the assets changes over time such that some of these assets may have depreciated while the others may have appreciated. Either way, the value of the properties will no longer be the same. It is worth mentioning that MERALCO's assets increased by 10% and 15.54% for CYs 2004 and 2007, respectively. MERALCO's rates had been approved by the Commission but had not been adjusted for any incremental cost/asset after the year 2000 despite the approval of its Capital Expenditure (CAPEX) Projects. 

Kilowatt Hour (kWh) Sales 

The Commission's approved distribution rate for MERALCO made use of an annualized kWh sales of 21,880,741,235 for CY 2000 as billing determinant.    

Based on the Audit Report, MERALCO sold a total of 24,660,000,000 kWh and 26,219,000,000 kWh of electricity for CYs 2004 and 2007, respectively, which translate to an increase in sales of 12.70% and 19.83% for CYs 2004 and 2007, respectively. The yearly increase in kWh sales posted an average of 6.32%. The COA determined MERALCO's distribution revenue based on the approved revenues of PhP25,620,683,446.00 and Php25,886,216,689.00 for CYs 2004 and 2007, respectively. Compared to the approved revenue of Php22,563,244,745.00 for CY 2000, there was an increase of 13.55% and 14.73% for the CYs 2004 and 2007, respectively. Hence, MERALCO's distribution revenue increased by an average of 1.04%. This, however, should not be treated as "over-recovery", as claimed by the COA, being merely a consequence of increased kWh sales.^[30] (Emphasis supplied)

The pension costs as a necessary expenses is not an issue. MERALCO, however, is expected to justify the requirements of the regulator and the public as the distribution sector is regulated business and any related expenses are recoverable from the consumers. 

ERC discussed under its Order dated September 4, 2006 that the information submitted by MERALCO is limited to a description of overall totals and do not contain broken-down details of the actual salary scales and benefits applying to MERALCO employees that would allow ERC to conduct a comparative analysis of these benefits with the norm of other utilities and businesses countrywide and in the Manila Region. In the absence of such analysis, ERC cannot make a ruling on whether the compensation offered by MERALCO to its employees is reasonable and will therefore not allow the additional funding requested by MERALCO. 

The team cannot exclude any disallowance on other employee benefits in the absence of sufficient documentation to prove that the same is reasonable.^[31]  

MERALCO Museum 

MERALCO is not prohibited from maintaining a Museum to preserve its history. However, this should not be charged to the customers as this cannot be considered as a property incidental to electric operation and could be dispensed with. MERALCO could still render adequate, reliable and efficient service without maintaining said property. This is more of a concern of the investors than the customers. 

MERALCO Theater

This asset was already 100% disallowed by COA as early as 1993. Under ERC Case No. 93-118, it was disallowed by COA as this is not necessary in the distribution of power to the customers.
 

The said theater cannot also be considered as a property incidental to electric operation and therefore could be dispensed with as MERALCO could still render adequate, reliable and efficient service without maintaining said property. This property was eventually 100% disallowed by ERC.

Corporate Wellness Center formerly JFC Hospital 

The team applied the 8.7% disallowance for test year 2004. However, for the test year 2007, the team adopted the ERC's position in ERC Case No. 2006-045 that the amount equivalent to 36.43% associated with the use of the facility by affiliates, relatives and the public should be executed in the allowable OPEX.

MERALCO Fitness Center/Tennis Court/Oval/Open Space at the North and East of MERALCO Fitness Center
 

Sports and recreational facilities were already considered by the ERC as unnecessary under ERC Case No. 2006-045 which was duly accepted by MERALCO. Thus, for CY 2007, these facilities were fully disallowed in audit. For CY 2004, the team applied the proportionate value of 9.4% of the total assets.
 

Shooting Range 

The team disallowed the area of 3,600 sq.m. reflected in the survey forwarded to the team by MERALCO.^[32]  

We agree with COA that consumers should not be charged for expenses that are not necessary, proper or even incidental to the operation of a distribution utility. ERC should formulate the parameters whether expenses that are not directly and entirely related to the operations of a distribution utility should be wholly or partially passed on to consumers of MERALCO's electricity.

More importantly, in its assailed Order, the ERC stated that "[t]he COA determined MERALCO's assets in service based on historical and appraised book values for the years 2004 and 2007. The COA believes that the audit conducted disregarded the fact that for purposes of determining the utility's rate base, the present or market value of its properties should be determined."^[33]

The determination of what constitutes the rate base forms the basis for judging whether or not rates are confiscatory,^[34] reasonable or just. Various theories have been proposed to appraise the assets and determine what are fair rates for public utilities: 

Valuation methods vary. In a period of static costs, an original cost valuation may be sufficient. With a period of high inflation, a rate base which values plant and equipment at original cost substantially shrinks the purchasing power of dollar. In these circumstances, utilities argue in favor of reproduction cost valuations. In either case, depreciation on plant and equipment is subtracted from the rate base and carried as an operating expense. The theory behind including depreciation as an expense is that capital may be accumulated for further expansion and growth. With inflationary trends, utilities are seeking to use accelerated depreciation techniques to accumulate capital more quickly in the hope of beating inflation. Accelerated depreciation is the exception rather than the rule, but the trend persists.^[35]  

Thus, of the various valuation methods, three appear to have gained favor at various times: (1) the historical cost or prudent investment formula; (2) that of present cost or market value; and (3) the cost to reproduce theory.^[36]

Under Section 23 of Republic Act No. 9136, or the Electric Power Industry Reform Act of 2001 (EPIRA), "[a] distribution utility shall have the obligation to supply electricity in the least cost manner to its captive market, subject to the collection of retail rate duly approved by the ERC." The 2001 EPIRA law is now the governing law on the rate setting of electricity, and the standards for rate setting prescribed in the EPIRA law have superseded all prior standards inconsistent with the EPIRA law. In this present case, the governing statutory standard on rate setting is the "least cost manner" standard.

The retail rates charged by distribution utilities for the supply of electricity in their captive market are subject to regulation by the ERC based on the principle of full recovery prudent and reasonable economic costs incurred, or such other principles that will promote efficiency as may be determined by the ERC.^[37] MERALCO, presently operating by virtue of a franchise granted under RA 9209,^[38] is one of the distribution utilities operating in the country, and the costs it incurs in delivering electricity to its customers are being recovered through charging of rates duly approved by the ERC.^[39]

In the conduct of its audit, the COA used a Cost Based Method known as Return on Rate Base (RORB) methodology, which simply means that a regulated utility is allowed to set rates that will cover operating costs and provide an opportunity to earn a reasonable return on the rate base or the assets utilized in the business.^[40] Acting in accordance with its rate-setting authority under RA 9136,^[41] the ERC signaled its shift from the RORB methodology to the Performance-Based Regulation (PBR) methodology in fixing the wheeling rates of regulated entities.^[42] MERALCO was among the first entrants to the PBR methodology.^[43] The PBR methodology uses projections of operating and capital expenditures to meet projected demand, thereby enabling the regulated entities to invest in facilities to meet customer requirements and prescribed service levels.^[44] This methodology also features a performance incentive scheme which provides incentives and penalties to the utility to compel it to be more efficient and reliable, while maintaining reasonable rates and improving the quality of service to achieve pre -determined target levels.^[45] In simpler terms, PBR is the setting of rates based on forecast of cost and expenses.^[46]

x x x. The historical cost formula had been proposed by oppositors in the 1965 MERALCO case, and in our 1966 decision (18 SCRA, 668), We noted that -   

x x x. Upon the other hand, Ricardo Rosal urges that the rates should be founded upon the amount of the investment made by MERALCO's stockholders or the "historical cost" formula. The PSC has adopted the present or market value theory, as the basis for the computation of the earnings allowable to and the rate schedule chargeable by the MERALCO, as well as the method of valuation used and the appraisal made by the same, after making therefrom some deductions recommended by GAO.   

Section 19, Article XII of the 1987 Constitution provides: "The State shall regulate or prohibit monopolies when the public interest so requires. No combinations in restraint of trade or unfair competition shall be allowed." 

The State grants electricity distribution utilities, through legislative franchises, a regulated monopoly within their respective franchise areas. Competitors are legally barred within the franchise areas of distribution utilities. Facing no competition, distribution utilities can easily dictate the price of electricity that they charge consumers. To protect the consuming public from exorbitant or unconscionable charges by distribution utilities, the State regulates the acquisition cost of electricity that distribution utilities can pass on to consumers.