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