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.