Electricity Retailers - things you don't hear about

Deregulation of the electricity industry allows consumers the right to choose the retailer they wish to buy from, or to remain with the government-owned SP Services. The open market roll out is in stages which started in 2001 with higher load industrial/commercial consumers. The residential market was only opened recently and retailers are suddenly thrust into public prominence. With door-to-door canvassing disallowed, they are very noticeable at promotional spaces in MRT stations, markets and malls. 

NEMS (National Electricity Market of Singapore) is designed to provide 2 levels of market driven competition -- at power generation and retailing. Gencos bid at WEMS (Wholesale Electricity Market of Singapore) every 30 minutes, the auction mechanism makes sure electricity is supplied at competitive costs. Retailers compete in the open market and provide good rates to secure customers. Retailers purchase at the same wholesale electricity prices, and with 30 retailers in a small market, they work at razor-thin margins. The only way retailers can try to improve the bottom line is build market share or carry trading positions. Running an unhedged book is however, deadly risky for them.

As competition for residential market heats up, retailers try to differentiate themselves.  Electricity is  just negative electrons moving in the copper wires. To be technically correct, there is high and low tension, there is brown and clean electricity. But it is essentially a commodity, there is no branding. In the 4 P's of marketing - Product, Pricing, Promotion , and Place, it is only in pricing that retailers work on out-distancing the competition. However they name their plans, it falls into 3 basic types - fixed rate plan, a discount off regulated tariff plan, and a peak/non-peak plan. Some retailers offer cash or gift vouchers etc. With the new entrant Singnet comes bundled products - electricity and telephony services. Some price gimmicky and bundled rates make it more difficult for consumers to decide. The pricing on bundled rates is confusing and adds unknown risks, as seen in the Hyflux mix of desalination and energy.

Retailers offer consumers price certainty.  For a fixed rate contract, the rate remains unchanged throughout the term.  For a discount off tariff, the rate is re-fixed every 3 months. Consumers do not need to worry or bother with the volatility in the spot rates which fluctuate every 30 minutes. Basically, consumers pay a small premium to buy the price certainty from retailers. The premium represents the retailers gross margin.

Obviously it's cheaper to buy at the wholesale market. Consumers are free to buy directly at SWEM thus bypassing the retailers and make some savings cutting out the middleman. To buy at SWEM is what is known as buying from the 'pool'. The term derived from the metaphor of all electricity flowing into the SWEM and then distributed to consumers. To buy from the pool, consumers need to be a direct market participant, and that requires some registration and understanding of market operation and reporting obligations. Consumers still need to pay all the various pass-through costs - MSSL/ transmission/ distribution/ admin. The only saving is consumer does not pay any retailer's profits. Some retailers offer the service of buying from the pool for consumers so there is no need to be a direct market participant. However, this comes with a management fee. Is this all worth the bother? Perhaps so for the high load consumers.

Consumers who buy from the pool need to manage their exposure to volatility of spot prices which changes every 30 minutes. There are various  reasons  for  spot prices to spike, such as planned and unplanned plant outages, nodal congestions, excessive peak demands, fuel spot price variations, etc. There have been occasions where wholesale prices spiked to above S$1.00/kWh. Consumers who buy at the pool can hedge their exposure by buying options in the Electricity Futures Market. This is something not for the small consumers for reasons of lack of knowledge of industry sophistication, the fact hedging instruments come in certain lot sizes that may not fit consumer load patterns, and there are transactional costs.  .

In comparison to some other countries, the risk of exposure to spot price volatility is very low in Singapore. Two main reasons are weather and energy-mix. Singapore is not in a natural disaster-prone zone and 95% of power generation is from gas-fired plants. Power generation is not exposed to the vissisitudes of weather like the typhoons in Philippines. We have no hydrology risks that hydro-plants face in times of drought. There are no militarised successionist groups that threaten power assets. Or poorly managed gas plants that has problems with a steady supply of piped gas.

So there is a fine trade-off between spot price exposure risks and retailer margins. A high retail margin may drive consumers to buy from the pool and take the low spot price exposure risk.  In other words, Singapore retail rates are challenged by competition and the possibility of consumers switching to buy from the pool. This puts a downward pressure on retailer margins.

There are currently 30 retailers and they can be distinguished in two ways. Firstly they are either owned by gencos or independent operators. All the gencos have their own retailer subsidiary, let's call these gentailers. Secondly, are they direct market participants. Most retailers are, meaning they purchase directly at SWEMS. Some retailers are not, in which case they purchase through SP Services, which makes them essentially resellers.

At the moment, gentailers have the major market share. This is not due to gentailers providing better service or cheaper rates, but purely because they were first off the block. There were no independent retailers when the market opened in 2001. Proof of the fact that competition brings prices down can be seen in the discounts offered by gentailers in the earlier years compared to now. Gentailers have advantage of name recognition. There is a disquiet that consumers fear the viability of independent retailers and tend to gravitate towards gentailers, leading eventually to cartel-like situation similar to the petrol pump industry. Today, the 5 major gentailers has 70% of the market. The problem of a market monopolised by gentailers is that it promotes a vertical integration of power generation and retailing which goes against the very objective of industry liberalisation. This is further exacerbated by the fact gencos who have their own gentailers, have a natural hedge. A genco is naturally 'long' in its position, whilst a retailer (without bilateral purchasing arrangements but buys only at the wholesale market, such as in Singapore) is naturally 'short'. If a genco's dispatch is fully covered by their natural hedge, there is no need for it to hedge, thus hindering the development of the industry. 

It is in the interest of consumers to ensure the survivor of as many independent retailers as possible. With 70% of market share in the hands of 5 gentailers, 25% under SP Services, the remaining 25 and counting retailers are chasing a very small market, the odds are not encouraging.

Consumers have no supplier risk.  Only one retailer, Red Dot Energy, has exited the market. On the failure of a retailer, SP Services steps in automatically as the supplier of last resort. The consumers of the failed retailer will simply be transferred over to SP Services who will buy from the pool on the consumers behalf.  Consumers can then switch to another retailer if they so wish to, There is no interruption to electricity supply. 

Singapore wants to be in the forefront of the technology and innovation curve in the national electricity system, at least in this part of the world. So we can now boast of an Electricity Futures Market, run by the STX. It's still early days for the market which has several challenges to overcome -- market size (51 tetrawatt) is small, few market makers, limited participants, limited liquidity. There is lack of local knowledge and skills sophistication so we won't see any of our local banks stepping in as traders to promote energy-driven financial derivatives and inject liquidity into the market. One key element that EMA encourages at the moment is to have as many retailers as possible to keep the futures market moving. 

I foresee a problem on the horizon with the vesting contracts. (To know more about vesting contracts, click here for a past blog). Vesting contracts are 'contracts for difference' between SP Services and gencos. If the cost of the power generation is lower than the strike price of the vesting contracts, SP Services pay gencos the difference, and vice versa. Excess capacity are forcing gencos to price their generation cost low and making losses since 2013. So SP Services have been paying gencos since 2013 for the vesting contracts. These sums paid out are factored into the following quarter's regulated tariff. If the VCL (vesting contract level) ie the load quantity vested, is lower than the non-contestable load, then the hedging cost is fully absorbed by non-contestable consumers. However, if VCL is higher than the non-contestable load, the excess is charged to retailers who will of course pass-through the cost to their contestable consumers. The VCL started off at 65% of total load and has been rolled back gradually to current level of 25%. It has been the case so far that VCL has been lower than non-contestable load, so all vesting contract differences paid out have been borne by non-contestable customers. In other words, retailers have not been faced with the prospect of passing the hedging cost to their customers.

The issue is with the market now in its final phase of opening up, more consumers will be switching to retail electricity leaving only a small % remaining with SP Services as non-contestable. If the VCL is rolled back accordingly and below the % of non-contestable load, then the status quo remains - the cost of vesting contracts will still be fully borne by non-contestable consumers. But if the VCL remains at 25% and non-contestable load reduces to say 10%, then 15% of the cost of vesting contracts will have to be charged to retailers for their customers. So here lies the problem which is not talked about. How are retailers going to pass the vesting contract cost to customers whose current supply contracts are still running. Of the few retailer terms & conditions I have seen, none has any clause to handle this contingency.

The burning question is, will the VCL be rolled back further? Vesting contracts are supposed to be temporary in nature. It is a mechanism to mitigate market power of gencos. However, the supply mix is now different from a decade ago. The 3 major gencos no longer have a significant major market share so market power is no longer a concern. The problem is, because of price weakness due to excess capacity, gencos look to revenue support from the vesting contracts. Any reduction of the VCL is going to increase their losses. There is a planned reduction of VCL right down to the level of LNG vesting levels and remain at that level till 2023. (I have no idea what the LNG vesting quantity is at the moment).

Tough decision for EMA - do nothing and hurt retailers; reduce VCL and hurt gencos.

Singapore Carbon Tax - Much Ado About Nothing

The era of carbon tax is upon us, The French will have none of this and Parisians are taking to the streets to denounce it, telling their government their preference for wine women and songs. The US is fighting over a tax bill in Congress. The Canadians are planning on its implementation amidst much negative public sentiments. Nordic countries meanwhile, have long implemented it, and at very high rates (Swedish rate is US$126/m tonne of CO2 emissions).  A servile Singapore simply accepts what the smart government decides. There are no success metrics to go by. How do we even know exactly what we hope to achieve and quantify the outcome.

For starters, I am not a climate change denialist. I just want a clearer picture of what is hoped to be achieved with carbon tax in Singapore and whether it makes any sense.

The Paris Agreement is an agreement within the United Nations Framework for Climate Change Control. All signatory countries made certain commitments to implement actions to help mitigate global warming.  These commitments are voluntary in nature, of which carbon tax is one. Countries go about their carbon emission reduction programmes in one of two, or both ways - (a) cap and trade, or (b) carbon tax.

Cap and trade is known as a compliance regime. Emitters have their CO2 emissions capped at a certain quantity each year. If they needed more, they have to change technology to be more energy efficient, use green energy, or purchase carbon credits (thus trade in the carbon credits market). Failing which they are subject to heavy taxes on the excess CO2 emissions.

The carbon tax is known as a voluntary regime. The government imposes a carbon tax, leaving emitters to voluntarily seek ways to reduce green house gases. The carbon tax is collected to fund various projects or schemes aimed at CO2 emission reduction.

All of us are emitters, whether directly or indirectly. Scope 1 emitters are those who cause green house gas emissions directly by the use of their assets - eg power generators, a farmer doing a slash and burn cultivation method. Scope 2 emitters are indirect emission from consumption of goods -- an airline passenger is partly responsible for the fuel burnt by the plane.Scope 3 emitters are all users of electricity.

Carbon tax comes into effect in Singapore 1 Jan 2019. The government has imposed a carbon tax of S$5 per tonne of green house gas emitted. This will be further raised in 2023. For the electricity industry, the tax is applied on the gencos. Gencos in turn pass it on as a cost to consumers who ultimately foot the bill. The carbon tax in Singapore is thus a tax on consumers. I'm guessing that carbon tax is not tax-allowed for consumers, so the electricity bill will likely disclose the tax amount.

Now let's see how much a consumer has to pay each month. It is based on the actual meter reading for the month, ie on actual load consumed without including the transmission losses.  You would think simply take this quantity and multiply by a rate, simple as ABC, right? Wrong! Why of course such great systems must come with great mystical formulation. There is a word for this, it's called a Rube Golberg machine. It is a strange device, contraption or system intentionally designed to make a simple application terribly complicated.

To compute the tax amount the consumption in kWh has to be converted into CO2 equivalent tonnage. This requires a conversion factor called GEK-AOM (Grid Emission Factor - Average Operating Margin). No idea what this mumbo jumbo means but it is based on UNFCCC guidelines and published by EMA. For example, the GEK-EOM for 2018 was 0.4192 CO2 tonne/MmWh. So for a consumer with a consumption of 10,000 kWh in the month, the carbon tax is :

10,000 kWh x  0.4192/1,000 x S$5.00 = S$20.96

Per consumer, the carbon tax is negligible. But what about the national level, how much carbon tax will the government collect?. The aggregate consumption of electricity in Singapore is about 51 tetrawatts per annum currently. The carbon tax collected per year is about :

51,000,000,000 kWh x 0,4192/1,000 x S$5.00 = S$106,896,000.

S$107 million into the state coffers a year is no small change.  Courtesy of consumers. So then the question, what is all this for?

The carbon tax is meant to incentivise emitters to move into non-fossil fuel technologies and be more energy efficient. How will this be achieved in Singapore with the carbon tax and will it?

For gencos, this will be absolutely meaningless. Firstly, they are scope 1 emitters but don't bear the carbon tax cost which is passed through to consumers. Why should they be bothered?  Secondly, 95% of power generation is already from gas-fired turbines. Singapore has moved out of coal plants long ago.

For consumers, the tax quantum is so inconsequential, user inertia is guaranteed. Hardly anyone is going to go change lower energy bulbs, increase the aircon temperatures 2 degrees, change lifestyles, etc.

Solar energy uses no fuel so carbon tax does not apply. Those who install embeded solar pv systems are driven by environmental sustainability goals rather than seeking cost reductions. The risk-returns on solar pv is still some way off. For the grid-sourced solar energy, ie generators whose solar pv power is for the grid, the retail rates at the moment is quite close to grid-parity, meaning it is almost on par with the normal brown eletricity prices. The low carbon tax is insufficient to tip the scale in favour of solar. At the moment solar constitutes less than 4% of our electricity mix. A quantum leap in investments is required to achieve our goal of 25%. A more realistic way to achieve this is to solve the excess capacity at the moment which is pushing USEP (Uniform Singapore Energy Price) below the LRMC (long range merginal cost). Gencos have been operating at great losses in the past few years due to the huge excess capacity. Without the huge excess capacity, gencos will price themselves higher to be profitable, thus pushing the USEP up. At today's prices, my rough estimate of USEP moving closer to LRMC by $0.015 would have made grid-sourced solar on grid-parity with the other gencos at the retail level. This will drive more investments into solar pv power generation.

For the heavy emitters other than the gencos, there are only a handful in Singapore. This is the petrochemical industries and it is here that the impact will be greatest. This is a very price sensitive and critical export industry, a tiny increase in cost will hurt their competitiveness in the international market. When it comes to that, will the authorities bend to protect the very powerful and critical players. It will bear in mind neighbouring countries are trying to challenge local petrochemical industry and the fact that Singapore is the lone Asean country to implement carbon tax.

Finance Minister Heng Swee Keat said in his Budget speech last year that the tax will create a "price signal" to incentivise industries to reduce emissions.as well as create "new opportunities" in green growth industries such as clean energy. We can see that his statements are off the mark. It will have no such desired effects other than to make the petrochemical industries less competitive. 

Many companies have taken initiatives to implement various programmes to improve energy efficiency and in aggregate has made significant reductions to CO2 emission reductions. But these were not driven by 'price signals' of any kind. They were simply taking advantage of a whole host of subsidies or grants offered by various government agencies. Adding to these grants, we now have the revenue from this carbon tax of $107m per year to be used to fund future decarbonisation initiatives. There has been no clear indication of how the fund is to be managed, where it will go. We are talking of billions of $ at the disposal of businesses to avail of. In other words, Singapore's decarbonisation path is not driven by penalising the emitters, but by tax payers money. It is in reality, a massive massive transfer of wealth from taxpayers to investors.

This is not a dampener on Singapore's effort at decarbonisation, nor a suggestion to take to the streets like the French. It's to put the Rube Goldberg machine aside and face the reality that taxpayers are funding a substantial part of the cost of climate change mitigation.  

Q2 Tariff In A Perfect Storm

Sans any quantitative data, and solely on intuition alone, I'm going to predict a perfect storm is brewing to jack up the electricity tariff for Q2. Watch out, you have been warned.

The first part of the tariff computation is a forecast of what power generation cost will be for the 3 months April, May and June. This is based on the LRMC (long run marginal cost) of a hypothetical efficient CCGT plant. Parameters that are factored in include an ROI rate, plant recovery (over 30 years), fuel cost, and other non-fuel costs. For a CCGT plant, fuel is the biggest cost component. In the LRMC computation for each quarter, fuel cost is variable as it is affected by oil price and US$ exchange rate projections. The short term view is oil prices will increase due to problems in Venezuela, renewed sanction of Iranian oil, Saudi Arabia cut-back on production, US shale production appearing to be over-optimistic, and a surprising recent increase in global demand. Market expectation is oil hitting US$70/barrel anytime this year. All these make for a higher LRMC for Q2.

Next, the difference of the vesting contracts of the previous Q1 is computed. (To be exact, it relates to the period 15 Dec 2018 to 15 Mar 2019). Vesting contracts are contracts for difference that SP Services take up with gencos. The strike price of the vesting contracts is based on the LRMC of Q1. If the strike price is higher than the gencos' nodal prices, SP Services pays the gencos the difference. The USEP (Uniform Singapore Energy Price) is the weighted average of nodal prices. Since 2013, the USEP has been lower than the LRMC, which means SP services has been paying out to gencos on those vesting contracts. The quantity of load vested in these contracts is currently 25% of aggregate demand load, which is immense. As mentioned in previous blog, since 2013, more than S$3B in the contract of difference has been paid out by SP. Who is paying for all these -- the non-contestable consumers. They don't see it because this adjustment in respect of one quarter is added into the tariff of the next quarter.

The Q2 tariff will be based on the LRMC computed for Q2 plus the adjustment for vesting contracts of  Q1. Because oil prices dropped significantly sometime mid Dec 2018 and through Jan 2019, it depressed USEP further. Thus I'm suspecting the adjustment that will be added into Q2 tariff will tend to be higher. Non-contestable consumers who were 'too busy' to switch in Dec last year lost an opportunity to lock in at very low rates in the region of $0.15/kWh and continue to pay for the vesting contract differences..

The third punch is the long expected carbon tax which comes into effect 1st April. The government is imposing a carbon tax of  S$5./m tonne of CO2 emission. The Singapore carbon tax is a tax on consumers. The tax is applied on the big emitters, gencos being one of them. However, gencos will pass on this as a cost, so it's consumers who ultimately pay the bill. The add on cost to domestic consumers is expected to be just a few $ more, but industrial and commercial consumers may feel the pinch.

For those who bitch at each increase in the tariff - stop it. It's not the government's fault. It is what it is.

Singapore democracy through the looking glass

Should Singaporean pride swell at the architectural marvel of Jewel Changi Airport or are we seeing the latest altar to pure consumerism, one that is of Babellian proportion. The shinning skyscrappers being built one a day, the spanking malls that never stop popping up in the neighbourhood, the ever glorious exhortation of technology in a seemingly ego trip to secure a gold cup for the smart city race, ultra-dense over-capacity infrastructures that seem to be pursued simply for GDP numbers, all these to incite public exaltation. In the 2017 PISA test on problem solving capabilities, Singapore kids came out on top over their peers from 50 other developed countries. Surely we have enough critical thinking capabilities to see all that glitters in Singapore is not gold. Yet, should Alice step through her looking glass, she will see frogs basking in slowly boiling water, blissfully oblivious to the way a ruling elite is chipping away what we have painfully built up over the past 53 years. 

The chisel left its scars in the tweaking of voting process in both the General and Presidential Elections, the shifting goalposts of the CPF, conflict of interest and accountability lapses in elite circles that is condemning governmental agencies to deteriorating service quality, weaponising certain administration mechanisms against perceived political threats, employment policies that disadvantaged local citizens, fiscal policies that disregard the less privileged but benefit the rich, the shrinking space for political opinions and criticism of government, and many other ways.  

Is Singapore even a democracy at all? Democracy is a political system where there is universal suffrage, i.e., everyone has a right to vote. In the western democracy sense, it's a system that has it's ideals in the protection of human rights and freedom to live our lives the way we want so long as we do not trample on the rights of others. We elect our leaders to represent us, so ours is a representative democracy. Our rights, and the limitations of the powers of those we choose as leaders, are enshrined in the Constitution. So our government form is a parliamentary constitutional democracy.

How democratic a country are we is measured in the equality in political representation. It depends on how well the respondent perceives he/she is being politically represented. Patrick Flavin, an assistant professor at Baylor, did some pioneering work on policy representation at state level. Flavin said there is a big divide between those with higher and those with lower income. Political representation is skewed in favour of the rich. Well we don't really need the good professor to tell us what is evident. The rich has the attention of the government and policies are crafted in ways that certain interests are supported. If the government is really interested in addressing income inequality, let's stop the bullshit $300 future medical benefit that one many never really enjoy at all. Instead let there be capital gains tax and an inheritance tax.

Faux political representation has never been seen in its raw naked form than the famous 'Ah Gong and Ah Seng' story of the member of Parliament M/s Lee Bee Hua. Incidentally, M/s Lee's story is a big blatant lie. According to her, 'Ah Gong' is her neighbour. It's testing credibility that an 'Ah Gong' who scrimps and saves by cents can live next door to a millionaire politician. Is she trying to fake street cred as a HDB dweller for that's where 'Ah Gong' really lives. An MP who calls us 'Si Gui Kia' represents no one from the HDB hinterland. 'Si Gui Kia' which means little devil in Hokkien, is a chastisement in a sort of dismissive manner. I'm guessing members of parliament must surely hate their weekly meet-the-people sessions. It's their night out to meet the 'mediocres' and the 'Si Gui Kias'. 

We pick our representative based on strength of character and competency and from a political party that has certain ideology that aligns with our interest. Ideology simply put, is a cohesive set of ideas, ideals and belief values such as socialism, liberalism, conservatism, etc. And we trust that the party will pursue policies in our interests, crafted from their moral stand on their ideological beliefs. Many of us rooted for the People's Action Party for such was the endearing strength of the legacies of the founding fathers. It is this legacy that has carried the PAP to election victories in the past. But the premium on the brand is eroding fast under the current 3rd generation leadership. It is now seen by many as a party of elites who has lost the moral high ground to craft policies that can benefit a major population segment to whom they have completely lost touch, the disenfranchised who are struggling in a country with one of the highest reserves in the world. 

We should ponder what is the ideology the PAP subscribes to. Well the strong ideology of the founding fathers, one based on a dedicated pursuit of building better lives and uplifting the population from the clutches of poverty, is no longer vogue. The 3 Gen PAP has metamorphosed into self-preserving ideologists where elite clan ship is protected. Any mishap, mis-management, and we see members circling the wagons in Parliament. There is no ownership of mistakes. Singaporeans are not demanding hara-kiri, but it would be nice to see a show of honours like David Cameroon who resigned as Prime Minister of UK on loosing the Brexit vote.   

The PAP has actually learnt well the Marxist view of ideology and twisted it round to better suit their circumstances. Marxists thought that if the proletariat could see their place in a capitalist society and how they are being exploited and manipulated, there will be a revolution. To hide the truth from the people, to show them a false world view, an illusion is needed. And so, the right ideology is created and propagated -- that there is no exploitation, everyone is equal, those with capability has upward mobility, the rich worked hard and took risks and deserves their rewards. Ideology to the Marxists, is a set of ideas, propagated till it is a dominating ethos in the land, to justify the power and privilege of the ruling elite. And so PAP imprints on young minds in school, the familiar bogeyman of racial riots and no natural resources, non-PAP government that will lay to waste the accumulated national savings, and a well-intended meritocracy policy which has now been hijacked as exclusive to the elites. The PAP ideology to breed tunnel-vision Singaporeans that will profess the belief that this is the only party that can govern Singapore.

In the past few elections, as the days for the polls to open arrive, there were much expectation of a landmark event in the making. No one is expecting an opposition win, but many were and still are, hoping for a decreased PAP lead to punish and jolt them to re-evaluate their values. Instead, they often surprise us with 70% winning margins in efficient and clean elections. PAP hatters turn their vehemence on the majority voters in social media with a dressing down on the 70% as Singaporeans who don't have their own minds, people who are indoctrinated by PAP propaganda. This is a lazy and convenient reasoning for people lacking a strong argument that the opposition is a better alternative. The actual reason probably lies in a big pool of middle class voters who believes in their own capability for upward mobility and prefers not to meddle with a system which they see as imperfect, but at least working. 

The danger to the PAP is, increasing arrogance has blinded them to the reality on the ground that this 'upward mobility' has been eroded by an impaired foreign worker policy that sees cheaper employment pass holders taking over many jobs once held by locals. Local PMETs all over the island are loosing their jobs. Alice would have wondered why in a land of highly educated people, there are so many MBA Grab drivers. Unemployment and a weakening economy is explosive. So once again, we look forward to another possible landmark event with polls round the corner. Except this time, I'm not taking bets.

Hyflux is still a proud Singapore brand

The predicament of Hyflux is a great disappointment for those of us who are watching for a home grown conglomerate to carry the Singapore flag into the global market. They seem to be doing well on the technology side. It is finance that sinks the ship. A cursory review of their short history shows heady expansion, not from organic growth, but high leverage. The era of cheap money tempts many corporations on a borrowing spree. Many took on debts just to buy back shares so their earnings ratio can look better and dividends higher, but which adds nothing to the business. Hyflux is no exception.

Tuaspring Energy and Desalination Integrated Plant is an innovative concept that tries to incorporate an embedded power generation plant at a desalination complex. The main play is the desalination plant. Power generation is secondary. A CCGT (combined cycle gas turbine) plant has a gas turbine and a steam turbine. Gas is used to fire the gas turbine to generate electricity. The waste heat from gas turbine is captured and used to produce steam which powers a steam turbine to generate additional electricity. This enables a CCGT plant to have a high efficiency of 60%. The innovative idea here is to use the same steam to warm the sea water feed , and power generated, for the desalination plant. Excess power generated is exported into the grid.

The desalination plant has the advantage of using heated sea water feed which reduces energy consumption in portable water production. Having an embedded power generation capability also means lower electricity cost since there is no transmission and other pass through costs. All-in, it means a lower cost of water production. Great idea.

What went wrong with Tuaspring has never been adequately explained.  Company officials have pinned their financial problem on the power generation part due to decrease in oil prices. The fact that the 'drop in oil price' line has been mentioned a few times the suggestion that Tuaspring got locked into a long term purchase contract at a time when oil prices were much higher.  The government moved to set up an LNG Terminal for fuel security reasons. To promote the viability of this project, EMA implemented a LNG Vesting Scheme. Under this scheme, new gas plants must purchase a certain quantity of degassified LNG from the LNG Terminal. This scheme runs from 2013 to 2023.  As early as 2011, Tuaspring seem to have entered into Purchase Agreements with LNG Terminal. But the idea about locking into a fixed price is incorrect.  It is a supply contract but prices will be at prevailing market rates. 

The actual reason is Tuaspring opened for business in 2016 and ran smack into an industry facing massive over capacity since 2013. This over capacity has depressed generation prices from 2013 to current times. The spark spread has been negative the last 6 years. This spark spread is basically the generation price (USEP) less fuel cost, a negative spread shows inability to cover non-fuel costs. Profitability is impossible under current conditions.

The burning question is whether Tuaspring is cognisant of the power generation market situation when it came onstream.  If it did'nt, then it's fair to assume it has moved out of it's core competency of water technology into a commodity market and at the start of a learning curve. Did it's confidence of the desalination play blind it to the complexities of the power generation play? If it indeed it was aware of the market situation, why was'nt the weakness in the power generation sector mentioned in the Offer Information Statement of the 2016 perpetual bond issue? It was not in compliance with the requirement to release all critical information relating to the bond issue. There was bad faith.

The Tuaspring project is a 25 year build and operate concession from PUB which has indicated it may exercise its right to take over the plants if Hyflux is unable to resolve its financial problems. If PUB takes over only the desalination plant, it will have to negotiate with the operator of the power plant for the steam generation and electricity supply which may make the cost of the water produced more expensive.  Given the over capacity of the market, it is impossible for Hyflux to dispose of the CCGT plant. The new owner may have to accept a CCGT plant with a slightly lower efficiency rate since some of the heat is used for heating the sea water feed of the desalination plant. If PUB is to take over the CCGT plant, then it runs into legislative obstacles as the mandate of the utility as specified in the PUB Act does not include power generation.

PUB action is simply a contractual consequence. It has nothing to do with water being of national security importance. Electricity is also a critical national resource but generation plants have since been divested to some foreign owners.

It seems Indonesia's Salim Group and Medco Group will end up acquiring 60% of Hyflux for S$400m.  Tuaspring is a huge problem and requires a big picture approach, or as our highly salaried ministers like to say, a helicopter view, to solve the problem. The Hyflux brand is still a very attractive name with good technology, and is slowly conquering the world. It is a crying shame that the many powerful men and women of Singapore do not see the long term value in the Hyflux brand. For that we will loose the one brand that has been carrying the Singapore flag overseas proudly. This is a game straight out of the books for Temasek to play, but the most powerful woman is nowhere in sight. While they are sleeping, Indonesian vulture capitalists are taking over Hyflux for peanuts. 

Gencos getting fried

The EMA (Electricity Market Authority) has distanced itself from the Hyflux debacle. It takes the position that the failed Tuas Spring power plant is a commercial decision which has nothing to do with them. That is only partially correct. Of course, a private investment decision is not the concern nor responsibility of EMA. In a deregulated industry, investors enter the market based on price signals and other metrics. Nevertheless, it is EMA that provides the final green light.  An application for a new plant would be reviewed on the basis of a host of criteria, such as investor credibility, technology, whether it fits into the overall plan of the national electricity system, etc. 

In the electricity industry, over and under capacity is undesirable. Given that power plant construction is investment heavy and a very long process, it is the reason why one of the most important functions of a regulatory authority in the industry is capacity planning. Over capacity has been there for a long time, but in 2013 Keppel and Pacific Light added on 1,200 MW of CCGT capacity, and Tuas Spring another 395 MW in 2015. That exacerbated the system and brought it to crisis proportion. With generation capacity at 13,600 MW in 2018 and output of 52,000 Gwh, there is roughly 50% over capacity in the system.

Over capacity means price war. Low power generation prices are bringing gencos to the brink of financial disaster. While consumers may enjoy lower prices from competition, made fiercely lower by over capacity, the state of the industry is untenable. The electricity industry is the underbelly of the economy. Disruption, instability, or collapse of the power generation sector is unthinkable. 

What we have here is yet another government agency that has been inflicted with the disease of accountability-phobia. EMA has a lot of explanation to do on the failure of capacity planning. Whilst the underbelly of the economy is getting fried, parliament is treated to  Oxley 38 soap operas and histrionics of 'Ah Gong and his grandson' that bordered on the juvenile and imbecile. No one has thought it fit to grill the Minister of MTI.

Should you be concerned? Certainly. Power generation needs to be sustainable in the long run. It has to, and will, be resolved. Any solution to prevent a collapse of the industry will most invariably fall on the shoulders of consumers by way of higher tariffs. 


SRMC Vs LRMC  (Short Run Marginal Cost Vs Long Run Marginal Cost):

A quick economics 101 for those without this background. SRMC vs LRMC is something that often confuses even economics students. Most books explain this with geometric models that can go pretty deep. I'll try to explain this in a more intuitive way,

First of all, MC (marginal cost) is the cost of producing one more unit of the product.  Initially MC decreases as more and more units are produced, due to economies of scale.  Up to a point, the Law of Diminishing Utility sets in, and MC rises. A manufacturer will not produce anything beyond the point where the MC is more than the MR (marginal revenue, or sales price) because it will mean a net cash outflow for each additional widget produced.

Under SRMC, the plants are already in operation. All fixed cost have been expended. The only costs to produce the next unit are variable costs -- direct labour, fuel, direct overheads. As long as the price for the product is higher than the MC, production can continue as the product will have net revenue to help recover setup costs or fixed overheads. In other words, SRMC focus is on the cash flow. 

For LRMC, it is forward looking. The plants have not been set-up. So production cost for the project takes into consideration all costs including the plant setup costs. This is the financial information the investors need to decide if the project is viable.


USEP (Uniform Spore Energy Price) vs Vesting Price :

Brief note on vesting contracts : It is a hedging instrument, a contract for difference. Certain quantities of gencos' output are tied up in vesting contracts with SP Services. The parties settle the difference between vesting prices and actual power generation prices.
For detailed explanation of vesting contracts, refer to the previous blog here

The USEP is based on the clearing price of each 30 minute auction in the SWEM (Spore Wholesale Electricity Market). As the gencos offer price is based on SRMC, we can assume the USEP as representative of the market SRMC.

The Vesting Price for the LNG Vesting Contracts and the Balance Vesting Contracts are computed on the basis of LRMC of a hyphotetical efficient CCGT plant. So we can use the vesting prices as the market LRMC.

The chart above shows a very clear picture. Before 2013, the USEP and Vesting Price evens out more or less, as it should be in a real efficiently functioning market. From 2013 up to current time, USEP has been significantly lower than the Vesting Price. This means the gencos SRMC are running below the LRMC. Gencos are not earning enough to cover their fixed cost, and of course, no ROI.


Spark spread:

A cool way to assess genco profitability is by a metric called the spark spread. Energy investment analysts compute this to gauge the financial viability of power generators. A negative spark spread means the genco is definitely loosing big time. The spark spread is basically a theoretical gross margin. It looks at a genco's electricity price and deducts the fuel cost from it. The residue is the spark spread to cover all other non-fuel cost. It's a ball-park figure but rather useful.  The actual computation is difficult as internal data are required. It involves info like fuel hedge ratio, cost of fuel, output load (peak hours distribution), plant efficiency or heat rate, and others. 

Since genco data is not available, we can look at SP computed vesting prices to get an idea of the status. This chart is an estimated spark spread of the LRMC of vesting contracts computed by energy consultant Martin J. van der Lugt. To simplify the explanation, just focus on the blue and orange lines. The blue line is the spark spread. Before 2013 it was sometimes negative and sometimes positive over the orange line for Non-fuel cost. After 2013 it has been consistently running negative. Gencos are running at a loss - the gross margin is insufficient to pay for all other non-fuel costs. (Vesting prices are computed a quarter in advance based on projections. The black line is the spark spread as computed from vesting contract data. The blue line is to sync the projected fuel cost data to realised costs).

Gencos' productions can be split into two parts. One parted is vested, that is, committed to a vesting contract with Singapore Power at a pre-determined price. The above spark spread chart looks at this vested portion and it's showing losses for gencos.   

Balance of the production that is not vested is in worse situation since the electricity generation price, the USEP, is lower than the LRMC. 


Vesting contracts offer gencos some protection:

Vesting contracts as a hedge, may or may not be beneficial to gencos, depending on how the generation prices will be. Because vesting prices are higher than USEP since 2013, gencos gain in the price difference of the strike price of the vesting contracts and the USEP. The higher the proportion of their production that has been committed under the vesting contracts, the better for the gencos as they can look to the hedge for some compensation. The interesting question is -- who has the higher production vested? Well, in order to push the LNG storage project, EMA implemented the LNG Vesting Scheme which binds the new CCGT plants coming onstream in 2013.  Under this scheme, the relevant gencos are bound to purchase certain quantities of their fuel from the LNG terminal. So surprise, Hyflux's Tuas Spring plants, together with Pacificlight and a new plant of Tuas Power, they have LNG vesting contracts. So they actually have some advantage in the market.

LNG Vesting Scheme is here to stay until 2023. So if the authorities want to tweak the system to assist Hyflux in its predicament, this is one area where they can do it. Simply tweak the LRMC model used to set higher vesting prices. If LIBOR can be tweaked, this is a piece of cake. I'm not saying they will do it, but technically this is one way out. If this is done, who is paying the bill? Well the regulated tariff is computed on the basis of the vesting prices plus the adjustment from contract differences.  So non-contestable consumers foot the bills. This is pure speculation, folks. 


Gencos are really bleeding:

The over-capacity is an albatross round the necks of the gencos for years.  Almost all gencos are in the red for the past few years. The industry as a whole is loosing close to a S$1B a year now. It is a crisis situation.










Hey, the SWEM actually works:

The Singapore Wholesale Electricity Market is designed as a free market system where prices will be determined by demand and supply forces. Gencos make their offers every 30 minutes in the SWEM and the supply is auctioned off based on prices. The lowest priced will be accepted first and it goes up the price list until the demand load is satisfied. The higher priced offers are rejected. With over capacity, gencos price themselves low.

The way the SWEM is set up, it will never work in an under capacity environment. The system works well with some over capacity. But with serious over capacity, which is where Singapore is right now, it works extremely well. In an over supply market, gencos are forced to offer low resulting in low USEP. As long as their offered price is still above their marginal cost, gencos will bid in the wholesale auction to try to get the dispatch to keep the plants going. They cover marginal costs, but do not earn enough to cover fixed and other admin costs. Gencos with less efficient plants are forced off the market first. Plants using steam turbine technologies with higher SRMC will drop off the chart. This has already happened.  The bump up in capacity in 2013 caused USEP to drop significantly. 


What is the solution:

Actually, the solution is absolutely simple. Price is a function of demand and supply. It's of course impossible to ramp up massive demand overnight. But supply can be dropped immediately.  Simply retire one or more of the existing plants. The question is, who wants to do national service.

Export the excess capacity, so said some. That means generate the full capacity and export the excess. Unfortunately, the idea of exporting electricity is a piped dream for the moment. The Asean Grid is being discussed at ministerial levels but it will be decades before it can be realised. Cross border sale of electricity is not new but requires lots of protocols, infrastructure, legislation, and treaties. 

In Asean, corruption is high in many countries. Power generation is one great opportunity for greased money. Why should politicians forgo this opportunity to develop themselves and resort to buying from Singapore. Even, or unless, Singapore electricity is extremely low.  Though luck, within Asean, Singapore and Philippines have the highest tariff, due in part both countries carry no subsidies. The other countries have tariffs that are significantly subsidised. Difficult to explain to their citizens why they import high from Singapore and sell low in their country.  

There are lots of political consideration for exporting electricity. Example Germany has excess production which they export via the European Grid. Germany heavily incentivised green energy with feed-in tariff, so consumers pay high electricity at home and the government exports cheap to other countries. So let's say Singapore has the opportunity and exports electricity. What it will be doing, under present circumstances, is to export and reduce supply in Singapore, thereby enabling gencos to push up the USEP. A moral anomaly to export in order to increase electricity prices for local consumers. 

One way or another, EMA will have to resolve the over capacity mess.  It is absolutely unacceptable for those entrusted with the system to say it's not their fault. 

Non-contestable consumers suffered $3b hedging losses

The previous blog "Demystifying electricity cost" covered a description of the vesting contracts and its purpose. There are very serious ramifications of these vesting contracts, one of which is its impact on consumers which I shall elaborate in this blog.First, a revisit on how tariff is determined and how vesting contract differences are embeded in the computation. 

1. The regulated tariff is for SP to bill non-contestable consumers (consumers who are not yet qualified to switch to retailers AND those who qualify but still purchase through SP).

2. EMA (Electricity Market Authority) determines the quantity of demand load to be vested quarterly. The VCL (Vesting Quantity Level) is the % of aggregate demand load to be vested. This comprises the LNG Vested Qty, the Balance Allocated Qty, and the Tender Vesting Quantity. The TDQ is a % of non-contestable load within the VCL. Finally, the MSSL Unvested Quantity is the balance of  non-contestable load not covered within the VCL. 

3. For illustration, the Q3 tariff is being prepared. The tendered price for the Tender Vesting Contracts and MSSL Unvested Tender Contracts of Q3 are obtained. These vesting quantities are in respect of non-contestable loads.

4. SP computes the price of the vesting contracts for the LNG Vesting Qty and Balance Allocated Qty  using the LRMC (Long Run Marginal Cost) model of a hypothetical efficient CCGT plant. The portion that is applicable to non-contestable load is obtained.

5. The tendered price and the computed price in (3) and (4) are weighted in respect of non-contestable load. This is the average vesting price for Q3 which is, for example 27.00 cts/kWh.

6. Vesting contracts are 'contracts for difference' between gencos (as sellers) and SP (as buyer). The parties settle with each other half-hourly for loads dispatched based on the difference between the strike price of the vesting contracts and the relevant gencos' nodal prices. If vesting price is lower, gencos pay SP the difference, and vice-versa. SP recovers from or distributes to non-contestable consumers, this difference. To do this, the adjusting debits/credits are worked into the tariff by adjusting the weighted average vesting price of 27.00 cts/kWh for Q3. However, since Q3 data are not yet available, this adjustment is done on a stagatime basis. The Q3 adjustment is based on the lasf 1/2 month of Q1 + the first 2-1/2 month of Q2 (mid-Mar to mid-June). 

7. The USEP or Uniform Singapore Electricity Price is the weighted average of all nodal prices.  SP buys from the Wholesale Electricity Market at spot prices, which is the USEP + some admin fees.  For the adjustment period from mid-Mar to mid-June, the USEP is higher than the vesting price. It means SP has been a net payor to gencos in respect of the vesting contracts. The amount that SP has paid out that is attributable to the non-contestable load needs to be recovered from the non-contestable consumers in Q3 in the tariff. Hence from the Q3 vesting price of 27.00 cts/kWh, the tariff is adjusted upwards to, for example, 28.50 cts/kWh.

8. Note that the adjusting debits/credits attributable to contestable loads is settled between SP and retailers, other direct market participants, and contestable consumers who buy at pool with SP, via monthly invoicing.


The benefits and cost of hedging:

The purpose of vesting contracts is to mitigate the capability of gencos to exercise market power.  They are in effect, financial hedging instruments. As such, there are benefits and cost for the hedge depending on how the actual cost of electricity turns out. 

From 2004 up to about 2012, the vesting price and the USEP were roughly evening out. Then from 2013 onwards, vesting price has been way above USEP every quarter. This means from 2013 onwards, it has been a one way ticket with SP paying out huge sums of cash to gencos for the vesting contract differences. Industry experts estimate that for the 5 years 2013-2018, more than S$3 billion has been paid out. 

So who's footing the bill:

As the MSSL, SP is the sole counter-party to all gencos for these vesting contracts. SP does not assume any risk, and all benefits and costs of the vesting contracts are passed on to consumers.

The benefits and cost of vesting contracts are split between the contestable and non-contestable loads. The non-contestable load is fully vested, so the vesting contract difference is first fully apportioned to it. The balance is attributable to the contestable load. 

The total demand load is split into :-

(a) Non-contestable load - comprising of those consumers who are not qualified to switch to retail AND consumers who are qualified to switch but remain as SP customers.
(b) Contestable load - comprising of consumers who have switched to retailers, other direct market participants (big consumers who buy direct from the wholesale market) , and consumers who buy at the pool through SP. 

Which group of consumers then, are bearing the major part of the S$3 billion+ hedging cost from 2013-2018? This depends on the Vesting Contract Level (VCL). In 2004 when Vesting Contract mechanism was introduced, the 3 biggest gencos controlled 87% of generation market, the VCL was set at 65%. The VCL was gradually rolled back as genco market composition changes. The 3 big gencos market share is now only 57% and VCL is now 25%. The gradual reduction of the VCL also coincides with the rolling out of the open market which reduces the non-contestable load as more consumers switch to retail market. The overall effect is that between 2013-2018 the hedging cost is practically almost fully attributable to the non-contestable load.

So the many consumers that I have come across who did not wish to switch to the retail market because they are too busy, their bill is too small to bother, it is not their priority, they are happy with current services, etc, etc, and the others who are not yet qualified to switch, these are the consumers who are footing the S$3 billion+ hedging cost. To add insult to injury, they have also paid out more than S$210 million GST in respect of these hedging cost.

The morality and equity of hedging cost:

A regulated pricing mechanism in the electricity business  with a bias or faulty methodology, has the capability to make massive transfer of wealth from consumers to investors. The estimated hedging cost of S$3 billion+ from 2013-2018 is massive. This is certainly not sustainable, nor equitable to non-contestable consumers.

With the domestic (residential) market opening up by stages, non-contestable load is expected to get smaller. Assuming the trend of vesting prices being higher than USEP continues, and assuming the VCL  remains at 25% of total demand load, there will need  to be an equitable redistribution of the huge hedging cost to all consumers, both non-contestable and contestable. It is not clear how retailers can negotiate this looming problem in respect of their existing consumers with contracts locked up. 

Where hedging is done with financial instruments that are market driven, transparency is ascertained. You win some, you loose some, but in the long run, it probably evens out. But if you have a loosing streak for 5 years, it perhaps point to some weakness in the methodology. In the case of these LNG Vesting and Balance Vesting contracts, the strike price is a regulated one, derived from very complicated formulation and parameters set subjectively. When the vesting price relationship to the USEP make a pronounced change as in 2013-2018, an explanation is in order. Something has changed significantly and we need to know what it is. So what happened in 2013? Were there some changes to the parameter settings for the LRMC model, or has there been some structural change in the market?

This is a politically hot potato best kept under wraps for the average moms and pops will have difficulty understanding it, except walking away with a sense that they have been short-changed. However, it is not a situation brought about by incompetency. Market driven electricity systems are highly complex, fluid and dynamic, and the NEMS (National Electricity Market of Singapore), like most other countries', is continually evolving. The electricity crisis in California in 2000 showed ill-planned concepts in the system can have a devastating effect. We are nowhere like California, but there currently exists in NEMS serious problems that require policy or regulatory intervention. This S$3 billion+ vesting cost is one of them. Next few blogs will explore more.

Coming up next :
Ramifications of vesting contracts - continued

Demystifying Singapore electricity prices

Is there a big fat margin embeded in the tariff that ensures Singapore Power Services huge profits at the expense of consumers? And is that the reason why electricity retailers are able to sell at much lower rates than the tariff? Such public disquiet has never been adequately addressed.

Each quarter when electricity tariff is revised, the social media clamour for a better understanding goes into rehash mode.  The public understands oil price movements have something to do with tariff revisions, but questions why they do not seem to move in proportion. 

The official explanation is - "Tariff computation is based on the average of oil prices in the 2-1/2 months of the preceeding quarter, thus there is a time lag difference." In an environment where trust with officialdom is at an all time low, the credibility of this explanation tethers on a spinning coin -- heads it's false, tails it's not true. 

Tariffs are revised quarterly for the quarter ahead. It is obvious that the tariff is forward looking, so the rationale that historical fuel price cost is a factor is at best a white lie, at worst, a dumping down on the public. The real reason is, a full explanation is too laborious.
95% of Singapore's electricity comes from gas-fired plants which use natural gas (NG) as fuel. With NG accounting for easily 50-70% of generation cost, changes in fuel cost impacts electricity prices significantly. NG is indexed to the price of oil, thus movements of oil prices affect electricity tariff. Although the relationship is clear, the impact of changes in oil prices on electricity price is not apparent on a day to day basis, and even in the short term. This is due to gencos' long term supply contracts and hedging strategies as well as vesting contracts between SP and Gencos.

The purpose of this write up is an attempt to bring some clarity to how electricity is priced at the wholesale, retail and regulated tariff levels. It then becomes clear that the impact of oil prices on tariff is not so straight forward.

First, more important than oil prices, you need to understand something called vesting contracts.


VESTING CONTRACTS:

A vesting contract is a price control mechanism imposed by an energy regulator.  A genco is viewed to have market power if, due to it's market share or other advantages, it has the ability to dictate the price by with-holding supply.  A genco may with-hold supply or quote at a price above their SRMC. It manipulates the market price to seek seek better profits, or frustrate new entrants into the market. Different regimes use different ways to constraint gencos from exercising market power, such as price caps, or capacity caps. EMA uses vesting contracts. Gencos are forced to commit certain levels of their capacity to a vested contract at pre-determined price, thus reducing their capability to exercise market power.

What is a vesting contract: 

It is a 'contract for difference' (CfD) between a seller and a buyer where a pre-determined vesting price (strike price) is agreed in advance. Seller and buyer settle with each other the difference between the strike price and the eventual actual price of the product. If price of product is higher than the strike price, seller pays buyer the difference, and vice-versa. It is basically a hedging instrument. 

Vesting contracts were first introduced on 1.1.2004 and there have been further developments since. There are now different categories :

1. Allocated vesting contract -- w.e.f. 1.1.2004. This is the original vesting contract. Binding on all plants in operation, and those planned, as at 1.1.2001.
2. Tender vesting contract -- w.e.f. 1.5.2010.
3. LNG vesting scheme -- w.e.f. 1.1.2013. Binding on all plants in operation, and those planned, as at 1.1.2013.
4. Unvested MSSL tender

EMA decides on a certain quantity of demand load to be vested. Gencos take up vested contracts with MSSL (aka SP) as their only counter-party. The contract runs quarterly and the vesting price, or the strike price of the contracts, depends on the vesting type (see below). MSSL settles with EMC the settlement sum based on load dispatched 1/2 hourly with the difference between the strike price and a reference price, which is the weighted average of USEP. EMC in turn settles with the gencos. MSSL transfers the debits/credits to consumers.

1. Allocated Vesting Contract:
Of the total electricity demand load, EMA decides the level (Allocated Vesting Contract Level) to be regulated. In 2004 it was set at 65% to be lowered gradually. In 2017 it was 25%. ( In 2004, the 3 big gencos Tuas Power, Senoko and YTL had 87 % market share. Their share is now about 57% in 2017.) Gencos are allocated their share based on capacity (Allocated vesting quantity) which they have to commit at the vesting price. 

2. LNG vesting scheme:
By 2000s, Singapore gencos were mostly gas-fired plants using PNG (piped natural gas). In 2010 EMA made a strategic switch to LNG (liquified natural gas) for security and economic reasons (going into trans-shipment and trading hub business).

With LNG, Singapore now purchases in the international market where new gas fields were also coming onstream, putting a downward pressure on prices.  Natural gas is liquified and transported by LNG tankers to Singapore where it is stored in LNG Terminal (construction completed in 2013). The LNG is degassified and the gas is transported to gencos via a Gas Pipe Grid.

In order to ensure there is a ready market for LNG, the LNG Vesting Scheme was introduced in 2013 and ending 2023. This binds new plants after 2010 (Pacific Light & Tuas Spring and some new plants of existing gencos). Gencos take up Gas Supply Agreements (GSA) with the LNG Aggregator with quantity as determined by EMA. Gencos must purchase the vested LNG quantity from the LNG Terminal operator, the balance of their fuel requirements they purchase freely in the gas market, whether it's piped NG or LNG in open market.

With LNG vesting scheme, the Allocated Vesting Contract quantity is now split into 2 groups :
- LNG vesting quantity
- Balance vesting quantity

The LRMC model : 

The strike price for the allocated vesting contract (allocated vesting price) is determined by EMA. The EMA reviews and sets the vesting price parameters biennially, and recalculates vesting prices quarterly.

The allocated vesting price is based on the long run marginal cost (LRMC) of the most efficient new generation technology in operation in Singapore that contributes at least 25 per cent of the total electricity demand, currently identified as an F-class combined-cycle gas turbine (CCGT). The computation is based on complicated parameter settings that takes a lot of externalities into consideration, such as fuel price and US$/S$ exchange rate forecasts, ROI on equity, plant life, return on capex, etc.

In the LRMC model, the only difference in computation of the strike price between LNG vesting quantity and Balance vesting quantity is the use of LNG price S$/GJ for the former and  Gas price S$/GJ for the latter. 

3. Tender vesting contract:
The tender vesting price is based on open tender. EMA determines the tenure and quantity which is between 3-12% of total demand load. The purpose of this is to introduce competitive pricing to the electricity tariff for non-contestable consumers.  In this case, SP is only hedging on behalf of Non-contestable customers.

4. Unvested MSSL Tender Contract:
Unvested MSSL load tenders have been used in the case where the Total Vesting Quantity (i.e. the VCL) is less than the level of non-contestable load. Similar to the Tender Vesting Quantities, contract volumes and prices are determined on a competitive basis. 

Settlement of contract difference between MSSL & gencos:

Vesting contract difference is based on comparing the vesting price, or contract strike price, to a Vesting Contract Reference Price (VCRP). The VCRP is the weighted Nodal Prices of the genco' dispatch. MSSL and gencos settle via Electricity Market Co. Settlement is done with the half-hourly billing for gencos' dispatch.  

Where strike price is higher than the VCRP - MSSL pays gencos.
Where strike price is lower than the VCRP -  Gencos pay MSSL

Settlement of contract difference between MSSL and consumers:

MSSL's hedging is done on behalf of consumers. All credit/debit adjustments are passed on to the following group of customers :-
- Non-contestable customers (including contestable customers who remain with SP)
- Contestable customers who buy at the pool through SP
- Other market participants (contestable consumers who buy directly at SWEM)
- Retailers (on behalf of their contestable customers).

MSSL settles with contestable consumers through the monthly invoices. For non-contestable consumers, there is no settlement. The adjusting debits/credits are embeded in the tariff that SP bills the non-contestable customers.

EMA current policy is to have non-contestable consumers fully vested. The Tender vesting contracts are fully applied to non-contestable consumers. Where the non-contestable consumer load is greater than the Tender Vesting Quantities, the shortfall will be deducted from the balance of the Allocated Vesting Quantity. Whatever vesting quantity that is not applied to non-contestable consumers will be apportioned to contestable consumers.

Settlement of contract difference between Retailers and contestable consumers:

Retailers would have adjusting debits/credits embeded in their rates, so there are no settlements for differences. For those who buy at the pool through them, retailers invoive the adjusting debits/credits monthly. In any case, with current Vesting Contract Level down to 25%, it may not be exceeding non-contestable loads. Chances are the full vested quantity is applied to non-contestable consumers.

Impact of vesting contract:

1. On gencos - 
The Vesting Quantities to gencos means part of their output is hedged. Vesting contracts offer gencos certainty to revenue stream. The higher the quantity vested, the less exposed they are to spot prices, thus less motivated to withholding tactics to increase spot prices.

2. On MSSL (i.e., SP) - 
There is no impact on SP. As counterparty to vesting contracts, SP is only acting on behalf of consumers. All vesting contract gains/losses are passed on to consumers.

3. On retailers -
Vesting contract debits/credits are bundled in retailer rates. Retailers rate-fixing therefore needs to take into consideration the effects of vesting contracts.

4. On consumers -  
They are the ultimate gainers or loosers of vesting contracts. 


THIRD PARTY PASS-THROUGH COST :

Other than gencos, retailers and SP, other parties involved in the National Electricity Market of Singapore (NEMS) are :

1. EMC    - Electricity Market Company (owned by SGX) runs the NEMS
2. PSO    - Power System Operator (a division of EMA) runs the power system
3. MSSL  - Market Support Services Licencee (currently SP is the licencee) provides metering, support services to consumers and other services.
4. SPPG - SP PowerGrid (subsidiary of SP PowerAssets - govt agency that owns the Grid infrastructure) runs the transmission and distribution network.

The costs of these parties are regulated by EMA. They don't change in the short term, hence they are viewed as fixed. These parties recover their cost by passing through the retailers/SP who collect on their behalf. If you ask for your electricity bill to be unbundled, the detailed dreakdown can be seen. 


GENERATION COST:

Electricity is a unique product in that it cannot be inventoried. Once it is produced, it has to be consumed. Or viewed another way, it has to be readily available whenever demanded. Too little in the system, blackout occurs. Too much and brown out occurs. Supply must equal demand and this must be balanced at all times in order to maintain systems stability at the frequency of 50 Hz.

To ensure an economic dispatch of power generation, Singapore uses an auction system. 'Dispatching' is the management of electricity flows. The system is monitored closely to ensure supply balances demand. In Singapore, this is done every 30 minutes at the Singapore Wholesale Electricity Market (SWEMS) 24/7.

Demand loads are forecasted in 30 minute periods. The Power System Operator (PSO) notifies gencos to submit bids for the next 30 minute period. Gencos submit their offer price for each plant they have. PSO stacks the offers in a merit order from the lowest to the highest. The price level which cuts the total demand is the Clearing Price. All offers above this price are not accepted. For the marginal unit, i.e. the unit which determines the marginal price, only partial quantities are accepted. The plants below the Clearing Price are dispatched.

Price terminology:

1. Clearing Price - this is the price determined by the algorithm of the Market Clearing Equipment (MCE) for an economic dispatch.
2. Nodal price - Each plant of a genco feeds their output into the Grid at a specific gateway known as the nodal point. Each nodal point may affect prices slightly due to various reasons such as congestion. Gencos are paid at their nodal prices, which is the Clearing Price + relevant nodal charges. 
3. Uniform Singapore Electricity Price (USEP) - this is the weighted average of all the nodal prices of the successful bids in respect of each 30 minute period. 
4. Wholesale Market Price --  This includes USEP plus some other administrative fees and charges. It is referred to as the electricity spot price. The spot price changes every 30 minutes and buyers pay at the same spot price to SWEM. 

Components of power generation cost:

1. Fixed overheads (depreciation or capital cost)
2. Variable cost - (a) Fuel cost + (b) Variable overheads
3. Administration cost|
4. %  Return on capital (gross margins)

For gas-fired plants, the fuel cost is very high, making easily 50%-70% of total generation cost. In the long term, fuel prices critically affect generation costs although day to day fuel price movements do not affect the plants which have long term purchase agreements or hedged supplies.

Factors affecting genco prices:

Gencos bid at the SWEM based on their Short Run Marginal Cost (SRMC). There are various factors they take into consideration when bidding.  USEP tend to be moderated by market capacity. In the current situation in Singapore, the big excess in capacity is the over-riding force that has kept USEP down in the past several years. 

Genco bidding prices are driven by factors that include:

- competitors' strategies (scheduled outtages)
- supply and demand balances (capacity, unscheduled outtages)
- their take-or-pay fuel contract (hedging costs)
- vesting contracts (see below)
- natural hedges (from portfolios of genco-owned retailers)

Products in SWEM:

Actually, supply of electricity is a little more complicated than described above. Gencos quote for 3 classes of electricity namely :-

1. Energy - the supply necessary to meet the projected demand (other coutries may call this 'baseload')
2. Reserves - Stand-by generation capacity or interruptible load that can be drawn upon (within seconds) when there is an unforeseen disruption of supply. Currently this is about 30% level of (1).
3. Regulatory - This is a frequency-following service. Singapore electricity frequency is 50 Hz. The system must at all times run very close to this frequency. To maintain this, the system must have genco output = demand. Due to various reasons, during the course of the day, output may fluctuate slghtly. Gencos fine-tune the match between demand and supply.


ELECTRICITY RETAILER PRICES :

Retailer rates comprise of several items. The top three are self-explanatory.
Hedging costs - When a  retailer signs up a consumer, it is taking a short position on spot prices for the tenure of the contract (1,2 or 3 years for fixed term; 3 months for discount off tariff with price refix quarterly).The retailer will most likely hedge in the electricity futures market. A retailer which is owned by a genco may not need to hedge if the genco assumes the retail consumers as their natural hedge.

Risk spread - The wholesale electricity spot prices is volatile and changes every 30 minutes. Retailers post their rates which are revised periodically, mostly weekly. For the days their rates remain open, they are exposed to spot rate price changes. Retailers will add in some points to assume this risk. Decision on the risk spread requires retailers to take a view on day to day price movements in the crude oil market.

Vesting contracts - Retailer rates are mostly on bundled basis. They need to take into account the impact of SP-gencos vesting contracts and debit/credit adjustments attributable to their contestable customers' load. 


REGULATED TARIFF :

The tariff is computed by SP and regulated by EMA. It is refixed quarterly. The regulated tariff is the rate that SP charges non-contestable customers (ie customers who have not yet met the criteria to switch to retailers, and consumers who are qualified but choose to remain buying electricity through SP).

2019 Q1, the cost mix of the SP tariff (for low tension)

It comprises of a fixed portion and a variable portion. The fixed portion is the pass-through costs of third parties. The variable portion has consistently been called 'generation cost' which is incorrect. It is much more than that. Let's call this the 'power cost'. This component is variable and revised quarterly.

The formula for the Variable Power Cost looks like this :

It's some rocket science, but basically, because non-contestable loads are fully vested, SP considers the following  in computing the tariff :

(1) The vesting contracts of non-contestable loads for the relevant quarter.
(2) The debit/credit adjustments for the vesting contracts relating to non-contestable loads in the previous quarter.

The forward looking part in the formula -
For the tender vesting quantities, SP relies on tendered prices of gencos. For the LBG vesting quantity and the Balance allocated quantity, they rely on the LRMC model, which amongst other factors, requires projections of fuel prices like gas, degassified LNG prices, HSFO 180 CST Oil, Brent Index Price, and US$/S$ exchange rates, as well as a host of other parameters requiring lots of assumptions and opinions of panel of experts. 

The backward looking part of the formula -
SP has already settled with gencos the vesting contract differences of the prior quarter and this debt/credit adjustment is applied to non-contestable customers for the next quarter in respect of the shares attributable to their loads. The vesting contract difference is the strike price vs the reference price which is the gencos' nodal prices for loads dispatched. 

There is a staggered matching of prior quarter's vesting debit/credit adjustments to next quarters tariff for the practical reason that it takes some time to compute. For example, the tariff for Q3 would be computed towards the end of Q2. It is thus not possible to take adjusting debits/credits of the full Q2. Instead, the adjustments are based on the last 1/2 month of Q1 + the first 2-1/2 months of Q2.


CONCLUSION :

Since gencos' prices are influenced significantly by fuel prices, officialdom has loosely explained that oil prices in the first 2-1/2 months of the previous quarter is the cause of tariff changes. Whilst this is technically correct, it is not a complete picture. 

It is obvious that oil price movements impact generation cost and thus the tariff, but there is no perfect co-relationship. The relationship is not straight forward due to long term supply contracts and hedging strategies of gencos. Gencos' bids in SWEM are influenced by many other factors, not least of which are market generation capacity and vesting contracts.

The regulated tariff is the price SP charges non-contestable consumers. EMA current policy is for non-contestable consumer load to be fully vested, or hedged. The tariff is derived from computing the power variable cost from both public tendered vesting prices and the regulated price determined from the LRMC model of a hypothethical CCGT plant and adjusting for the vesting contract price difference of the previous quarter. THERE IS NO FAT MARGINS in the tariff for SP to profit at the expense of consumers. 


Reference :
EMA Procedures for computing vesting contracts ver 2.4

Coming up next :
The ramifications of vesting contracts