It grieves me that there is a lack of a comprehensive documentation on electricity pricing and people rant in the dark. I have written several blogs on electricity pricing before. Here I shall cover some of the same grounds, but as brief and as simple as possible. In addition, I shall explain some additional aspects never covered before, as well as a brief on SP Ltd's financials.
There is a laziness syndrome worldwide, a propensity to rant but unwillingness to read beyond 144 characters of a twitter comment. It behoves one to make an attempt to understand SPL financials and electricity pricing before criticising or run the risk of being the subject of criticism by IBs in whites.
For the last time, let's be clear -- SP Services makes no profit from it's electricity sales !
Financials of SP Ltd (SPL):
SP owns 100% of the following which are it's main profit centres:
- SP Services (SPS) -- It sells electricity, and as Market Support Licencee, is responsible for metering and billing for utilities (electricity, water, gas), manages transfer of accounts of retailers, consumer utility account opening and activation, seller of last resort for electricity, and others.
- SP PowerAssets (SPPA) -- As Transmission Licencee it is responsible for transmission & distribution of electricity (It owns the Grid infrastructure and engages SP PowerGrid Ltd to manage the Grid)
- PowerGas Ltd (PGL) -- As Transmission Licencee for gas, it delivers gas from the gas terminal to consumers.
- Spore District Cooling (SDC) -- manages the district cooling system (supplies cold water for HVAC)
The above forms the core financials we are interested in. It previously had 100% of SP Telecommunications Ltd (this owns the telecommunication network infrastructure) but it has been parred down to 49%. The financials of SPTL are not consolidated but booked in SPL as investments. There are some other minor subsidiaries.4.8%)
Group financials above show business segment report. SPS profits accounted for only 10% of the S$1 billion. Very cleary, SPS never make any monstrous profits from electricity sales as most people think. It fact, it makes ZERO money from electricity sales which is explained below. Its profit is from its market support licencee functions, mainly metering business.
Transmission and distribution of electricity and gas is based on similar 'use-of-system' billing model, so they grouped SPPA and PGL together. I was able to see only SPPA's financials which showed its net profit was S$498.0m, with the balance of S$201.5 obviously coming from PGL. Thus 48.4% of SPL's profits of S$1 billion came from transmission and distribution of electricity. In other words, almost half of SPL's S$1 billion earnings come from the electricity grid!
Transmission & Distribution :
To gripe about SPS making money out of excessive tariff is barking up the wrong tree. Clearly it is in the transmission & distribution of electricity and gas that needs to be scrutinised. I have no data on SPG so I shall limit my comment on SPPA.
There are 2 major points on SPPA.
- The electricity tariff for 2019 Q3 is S$0.2422/kwh before GST. Of this, the network cost (grid or transmission/ distribution) is S$0.0544/kwh. The question is, is this rate high or not? Well the current annual aggregate load of Singapore is about 54 tetrawatts which gives SPPA a gross revenue of S$2.938 billion a year. With a capex of S$15.3 billion, this represents an gross margin of about 0.19% pa. This will be a good basis to benchmark against other utilities, but I don't have the data. Offhandedly, it does appear excessive to most people I would think.
- This is infra heavy business so it obviously tend to have high capital cost. The capex recovery cost is thus a main cost driver that determines its pricing structure. With this type of operation, the fear is always that revenue collection formula remains unchanged long after fixed cost have been fully depreciated.
SPPA's plant and machinery are in leasehold land & buildings, switch gears, transformers, other plants & machinery etc. As at 2019 its carrying cost was $15.3 billion and it made a provision for depreciation of S$510 m which means a recovery rate of about 3.3%pa. This works out just about right since its transmission licence is for a 25 year term.
On PGL, the company levies a 'use of system' rate that consumers of gas pay. The main consumers are the gas power generation plants. The cost of which gets into the power generation company's production and impacts the wholesale price of electricity. Whether the rate applied is excessive or not, I have no idea. But obviously S$201.5m seems a hefty profit.
Transmission & distribution rates are high for both electricity and gas because the system milks consumers to fund the never ending pursuit of investment in the latest technology, infrastructures and products and planning for a massive population and economy.
Transmission/Distribution & Market Support Licence Regulatory rates :
How much SPPA, PGL and SPS are allowed to earn are based on complex formulae spelt out in their respective licence. The rates are regulated by the Electricity Market Authority and established for a 5-year time frame. Each year, what the Licencees actually billed their customers and what they are legally allowed to recover, will differ. This is due to volume variance and other factors.
Licencees are allowed to report a cash P&L (actual billed revenue) and adjust for the variance with regulatory rates to arrive at a regulatory P&L. This adjustment represents a deferred income or expense which they will collect or refund customers by way of future rate adjustments. The net profit of S$1,019 for 2019 shown above is before the regulatory adjustment. In 2019 for example, they under-billed, so there was a regulatory adjustment of additional sum of S$152.1m (of which SPPA portion is S$103.2m) to their profits. The amount of this regulatory adjustment which has not been refunded or recovered is reflected in a Regulatory Deferred Accounts in the balance sheet. As at 31 Mar 2019 there is about S$110.2m to be refunded, and S$264.7m to be collected of which S$197.5 relates to SPPA.
In a previous blog I wrote "Unknown to most people, they upped the use-of-system rate by another $0.0013/kWh to $0.0544 in Q2". There you go, SPPA was quick on the collection. With that small adjustment in rates and aggregate load of 54 tetrawatts, SPPA collected additional S$70.2 million from consumers in 2019.
Sale of electricity by SPS :
How come SPS makes no profit form sales of electricity?
SPS determines a tariff quarterly. The tariff comprises a fixed portion (transmission. market support services & administrative costs) and a variable portion which is the energy cost. It makes a forecast of the cost of electricity generation for the next quarter. In this forecast it takes into consideration many parameters such as spot price of oil (because gas price is indexed to oil prices), US$/S$ exchange rates (because oil is priced in US$), and the capex cost, reasonable ROI, etc. It computes just like a new entrant coming into the market who needs to figure out the plant and machinery cost and their amortisation. SPS uses the most efficient model of gas plant currently employed in Singapore at latest market cost. This is known as the long run marginal cost model where in the long run, all cost are held to be variable, including capex.
Unlike SPS, the power generators' cost of fuel (gas) does not depend on forecast or spot prices of gas. It depends on their management of inventory, such as long term supply contract, hedging strategy, etc. If they had locked in their prices at low rates, they benefit. If their supply is locked in at a high rate, they suffer (which was the probable cause of Hyflux's problem). Generators compute on the short run marginal cost model. They don't bother with the capex cost because it is a sunk cost. In the short run, as long as their price is higher than their variable cost, they have cashflow to cover variable cost and some fixed cost. As long as variable cost can be covered, they can survive. Of course, to be profitable, their price needs to cover all cost and provide a decent margin. Power generators' production are auctioned in the electricity market every 30 minutes. Thus their pricing is based on the next 30 minutes time frame. With a market that is very much over capacity, a very important factor in their pricing is market competition. If they are not priced right, their plants don't get despatched.
All market participants, including SPS, purchase electricity at the same wholesale price at the Singapore Electricity Wholesale Market (SWEM). The wholesale electricity price changes every 30 minutes and sometimes, it can be very volatile.
SPS sells electricity to their customers at tariff which is fixed for 3 months. Since SPS purchase at SWEM every 30 minutes at wholesale prices, it is exposed to price volatility. To overcome this risk, it adopts a policy of fully hedging itself. Having computed the energy cost, SPS enters into vesting contracts with power generators. These are hedge arrangements. In these vesting contracts, a strike price is agreed (which is SPS computed energy cost for the qtr). If wholesale electricity price is higher than strike price, generator compensates SPS. If it is lower, SPS compensates generator. In other words, SPS is assured that the cost of their electricity purchase will always be the energy cost they computed, which is in the tariff.
Each time SPS makes a purchase, it settles periodically with power generators the vesting contract differences. Sometimes it gains, sometimes it looses. However, for the past few years, power generators' short term marginal cost curve has consistently been lower than SPS' long term marginal cost curve. A good reason is market over capacity is forcing power generators to price themselves low. This has resulted in SPS being a net payer under the hedging arrangement almost every year. It has paid out S$ billions to power generators over the years.
Is the SPS worried about all these S$ billions of hedging cost paid out? Not the least. SPS hedges on behalf of their customers. All these cost are charged to their customers by adjusting the tariff. There is actually a time lag. One quarter's hedging cost is adjusted in the following quarter's tariff. Now all hedging transactions can go one way or the other. So there are times when power generators pay SPS who then refunds the credits to customers, again via an adjustment in the tariff. However, the trend has basically been one way, with power generators benefiting at the expense of customers.
So in reality, the regulated tariff comprises of one portion of fixed fees (transmission, distribution, metering, admin costs), a variable cost of forecasted energy cost for next quarter, and an adjustment for last quarter's hedging cost or refund. All consumers who have not switched to retailers bear the full effects of this vesting contract adjustments because their supply for electricity from SPS is at regulated tariff..
The objective of vesting contracts started off as a mechanism to control market power of power generators. By today, no power generator controls the market by capacity, so vesting is really not required. However, it has mopped into a mechanism to ensure the success of the LPG terminal project. Today it is known as the LPG vesting contracts. SPS hedges a certain volume of aggregate electricity load with power generators who purchase their gas from the LPG operator. With the vesting contract strike price consistently higher than wholesale market price, power generators who buy LPG from the terminal operator use the vesting account as a way to compensate their earnings. This vesting volume is enough to cover all SPS customers, any excess not covered,SPS passes the hedging cost or refund to electricity retailers who build this into their rates for their customers.
It can be see quite clearly that SPS makes ZERO profits from their electricity sales.
Why electricity retailers can charge lower than SPS:
The market dynamics at the moment is one where power generators' short run marginal cost is much lower than SPS long run marginal cost (the basis for tariff computation). In other words, generators price themselves much lower than SPS' forecast. This state of affairs is due mainly to market over capacity in the power generation sector. The consequence is a much lower wholesale price than the energy cost component in the tariff.
At the moment, the gap between the wholesale price and energy cost component in the tariff (SPS' forecast), is wide. Retailers and SPS buy at the same wholesale price. Retailers sell at wholesale price +++ (to cover hedging cost, admin cost, profit margin) which is at a level that is 20-30% lower then tariff. Retailers hedge with electricity futures. SPS buys at wholesale price and sells at tariff (based on their forecast) and fully hedges in vesting contracts.
Why retailer pricing model may not be workable in a perfect market:
With a capacity of 13,350 MW and peak demand of 7,000MW, there is massive overcapacity of 48%. Supply over capacity is driving wholesale prices down. In other words, consumers who have switched to retailers must thank their lucky stars ELECTRICITY IS CURRENTLY ACTUALLY LOWER THAN IT SHOULD HAVE BEEN.
This state of affairs is not sustainable for the industry because power generation companies are bleeding. The auction system of National Electricity Market of Singapore works best in a market with a slight over capacity. What happens when that optimum capacity scenario is reached? In a near perfect market, the power generators' short run marginal cost curve and SPS' long run marginal cost curve will be closer together, some times one is higher, sometimes the other.
Herein lies the paradox. When over capacity is resolved, the wide gap between the short run and long run marginal cost curves disappear. With that, the wide gap between wholesale prices and the energy cost component in the tariff disappear. Then the business model of retailers come crashing down because their wholesale+++ retail rates will be higher than the tariff.
The non-equity in the vesting contracts :
The vesting contracts are no longer for the initial purpose of preventing power generators exercising market power. It is now a mechanism to encourage the use of the LNG terminals. When the government interferes in the market, it distorts price discovery. The irony is that price discovery is the holy grail the government tries to achieve with the liberalisation of the electricity industry.
Customers who have not switched to retailers suffer a double whammy. Firstly, they lock themselves into a tariff where the energy cost is much higher than wholesale market prices. Secondly, 100% of aggregate load of SPS customers (except those that buys from the pool) are fully hedged. The hedging cost of the vesting contracts are applied to them.
Where the vesting volume is in access of SPS customer aggregate load, the proportion of hedging cost are apportioned to retailers' customers.
*********************
No comments:
Post a Comment
Appreciate comments that add knowledge to the subject. Please participate within bounds of civility. Admin reserves the right to moderate comments. In any exchange, seek WHAT is right, not WHO is right.