Chempost : Going down the rabbit hole: December 2021

Tuesday, December 21, 2021

ENERGY PRICE SHOCK (PT II) - IS SHRINKING SUPPLY CUSHION AND PRICE FIXING THE REAL PROBLEM?

The Ministry of Trade and Industry explained the unprecendented surge in spot prices in the Wholesale Electricity Market (WEM) in October which led to the closure of 5 retailers, is strictly exogenous. These external causes are beyond our control and the government is working its best to mitigate the hardship for consumers. Let's unpack the official explanation and try to make sense of a complicated industry.

Second Minister of MTI Tan See Leng. explained in Parliament Nov 1 that it was a perfect storm of surge in demand as economies begin to recover following the easing of restrictions of the pandemic, lower generation of wind and solar power in Europe due to unusual weather events and lower coal production, gas production outages in the world, countries building up fuel inventories for the winter.

Mr Tan explained everything except the elephant in the room. Joe Biden's kamikaze energy policy that pulled the rug on the fracking industry caused the US from being a net exporter of natural gas to an importer of gas and oil. Energy commodity prices immediately began to rise from the day he took office. The recent meeting of oil ministers from OPEC and non-OPEC countries ended Oct 4 with these oil producers rebuffing Biden's plea for increased output. This sent a strong signal to the energy market and oil/gas spot prices spiked immediately. The upward pressure was exacerbated by diminished inventories which has been almost fully drawn. Remember all those idle and fully-loaded tankers lying idle off Singapore waters and many other ports 2 years ago? They are all gone.

Natural gas (NG) are priced differently depending on the region. In our part of the world, gas is indexed to the price of oil. A rise in crude oil price causes NG prices to rise. This has immediate impact on Singapore electricity prices because 95% of supply comes from gas-fired plants. So was the October rise in oil prices the cause for the spike in USEP?

Chart 1

USEP is the Uniform Singapore Electric Price. This is the average price for a 30 minute supply of electricity that power generation companies (gencos) feed into the grid. The Wholesale Electricity Price (WEP) is the USEP + a small admin fee. The chart shows the USEP is very closely and positively related to the price of crude oil except in Oct 2021 where the relationship was markedly different in terms of degrees. USEP spiked by more than 400% compared to a 20% increase in oil prices. Thus demand and supply factors for crude oil was not the main reason for the spike in wholesale electricity spot prices.

Singapore power plants are 95% gas-fired. The fuel is 70% Piped Natural Gas (PNG) and 30% Liquified Natural Gas (LNG). PNG is on long term contracts with operators of Malaysian and Indonesian NG fields in the Natuna Seas. PNG supply is expected to decrease due to reduced deposits in the Natuna gas fields and part of the Indonesian contract runs out in 2023. LNG are shipped in by tankers and de-gassified at Singapore LNG Terminal. However, our energy supply is not at immediate risk. Security of supply and gas storage levels will be met with increased capacity at the SLNG Terminal and planned offshore LNG Terminal.

Whilst long term supply security is monitored and addressed by EMA, hiccups in NG supply can happen at anytime. For example, outages at Indonesian gas fields caused a supply shortage in July, and currently, low pressure of the Indonesian piped gas is causing supply hiccups. Short term NG supply hiccups are met by the CCGT plants switching to alternative liquid fuels such as diesel. These periods are usually accompanied by spikes in the USEP. The NG pricing mechanism is indexed to oil prices, its supply is not a direct determinant factor to increases in gencos' production cost.

The huge surge in electricity price in October is felt everywhere such as the UK which MTI pointed out in poor consolation. UK electricity prices increased a mere 21% compared to Singapore which spiked close to 200%. In Singapore 5 retailers have been forced to exit. In many other countries having basically similar open electricity market structures like Singapore and facing same price and supply pressures, no marketer or utility has been forced out. Clearly, something else apart from the exogenous forces is responsible for the unprecedented upsurge in the WEM spot prices in Singapore.

Chart 2

Wholesale electricity spot prices is characterised by its volatility as gencos compete to auction their production every 30 minutes. After the OPEC meeting Oct 4, the extreme volatility of USEP can be seen in chart 2. On Dec 2, the USEP came within whiskers of the EMA regulation cap for USEP of S4,500/mWh.

In the electricity business, demand is more or less predictable in the short term and it is inelastic to price. Supply, on the other hand, has immediate short term challenges in terms of planned and unplanned plant outages, fuel supply, and network reliability. This supply environment is dynamic throughout the day and night which causes volatility in the 30 minute supply cycle.Pricing is extremely elastic in response to supply cushion.

Fig 1

Fig 1 illustrates the supply cushion. A capacity of 1,000 mW means at 100% efficiency, the plants can generate 1,000 mWh of electricity in an hour. In a 30 mins period, it can supply 500 mWh. Due to outages, whether planned maintenance or unplanned, it can offer only 480 mWh for the next 30 mins. Only 450 mWh is accepted to meet demand and reserves. 30 mWh is rejected which is the surplus to needs. This is the supply cushion which is 6% which is dynamic throughout the 24x7 cycle.

Chart 3

Chart 3 shows USEP has a reverse relationship to the supply cushion. In 2021 the decrease in supply cushion has seen an increase in USEP. Given demand remains more or less level, supply cushion is affected by capacity and outages. Whilst fuel plays a big part in production cost, gencos' price themselves according to the competition. A big factor in their pricing strategy is how they view the level of supply cushion.

Massive over-capacity in the past caused huge supply cushion situation in the industry. This in turn forced gencos to price themselves low. The situation was exacerbated in 2012-2015. To reduce dependency on PNG, Electricity Market Authority (EMA) established the LNG Terminal so tankers can ship in LNG and degassification done locally. To promote the use of LNG, new CCGT plants were offered LNG vesting contracts. This attracted 2 new plants into the market, one of which was Hyflux's Tuas Spring plant. Market capacity expanded massively. The over supply resulted in under-priced energy enjoyed by unappreciative consumers ignorant of the situation.

The over-capacity is not sustainable in the long run for the industry as gencos are not profitable and insolvency is unavoidable. Hyflux is in deep financial trouble from the git go. The government has taken the stand capital investments are commercial decisions. It seems gencos are bidding time and letting natural attrition play out as older plants are retired.

Chart 4

Chart 4 shows the over-capacity situation. By 2018 older plants were getting retired. There was a 1.1 mW reduction of capacity in 2019 and a further 0.5 mW in 2020. A further retirement of another 0.5 mW was planned in 2021. All this capacity reduction significantly lowered the supply cushion. As at Q3 of 2021, the planned reduction of 0.5 mW did not seem to have taken place. Either this reduction occured in Q4, or expectation of this plant retirement played a crucial role in the pricing strategy of the gencos.

Fuel prices of course impact production cost. But it is the supply cushion that cause volatility. The bigger the supply cushion, the more competitive the offered prices. The lower the supply cushion the more tendency for collective market power to be exercised. Apparently, the fuel price surge on Oct 4 coupled with the expected reduction of 0.5 mW capacity, caused the massive spike in spot prices in the WEM. By December, the gas price surge phenomenon has more or less stabilised, but the WEM spot prices remain erratic with record high spikes. This is yet another proof that supply cushion is the underlying causation.

Is what we are seeing purely the nature of open competition in a new era of normalised supply environment or did collusion and price fixing take place? Going forward, is this the new normal where gencos can wield their new found market power? As long ago as 2018, looking at the supply forecast, Mr Tan had warned of future electricity price increases due to the normalisation of capacity. By that, he meant when the industry has a power capacity that is just right to supply the needs of the economy at a level slightly above the reserves level. That's when the Short Run Marginal Cost of power generation will be close to the Long Run Marginal Cost. (Explanation of LRMC v SRMC is in an earlier blog here.) In that scenario, as I pointed out in earlier blog, the retail electricity price model of discounts on tariff will no longer be viable. As is also the case in the current Q4.

Saturday, December 11, 2021

ENERGY PRICE SHOCK (PT I) - WHO WINS, WHO LOOSES

Losses to consumers

Someone by the name of Vivi recently posted on Facebook lamenting on the huge jump in her October/November electricity bill from Singapore Power. This is apparently an account on a pool plan, ie buying at wholesale prices, which are ordinarily very volatile with prices changing every 30 minutes. With the current upswing in prices, Vivi was shocked at the S$0.5153/ kWh SP has billed her. All those who are buying from the pool, whether through SP like Vivi, or through other retailers, or as direct participants in the Wholesale Electricity Market, have been hit with a jump of 200% in energy cost.

Retailers exit, consumers get cancelled

Many have asked - Do retailers have the right to cancel their contracts? Unfortunately, YES. Retailer contracts carry a Retailer Of Last Resort (ROLR) event clause under which when they exit the business, they can cancel their contracts with consumers who either re-contract with another retailer, or transfer to SP. The ROLR procedure seeks to ensure consumers do not experience supply disruption.

Under retailers' term of contract, how customers will be charged by SP depends on whether they will be classified as contestable or non-contestable. SP charges non-contestable consumers at the applicable tariff rate, and contestable consumers at wholesale price. This matters a lot as the energy cost in the Q4 tariff is currently way below prevailing wholesale spot prices.

The eligibility to be classified as non-contestable is defined in The Electricity Act (Cap 89A) Electricity (Contestable Consumers) Regulations 2018.

Consumers loose out under the October ROLR event

When consumers re-contract due to ROLR event, they may benefit or get disadvantaged. It all depends on whether they are transferring from a higher to a lower rate or the other way round. In the current ROLR event, consumers loose out since their retailer contracts were all signed in earlier months when rates were much lower. This is especially so for those who had signed up for low fixed term plans previously.

In this ROLR transfer, SP put household consumers on regulated tariff. Commercial and industrial consumers are based on a capped load - those below monthly average of 4,000 kWh are put on tariff plans and those above 4,000 kWh at pool plan (wholesale prices). This appears to be in accordance with EMA market practice code amended in 2018/2019. However, it seems to be a shift of goalposts and at odds with retailer contract terms.

Those transferred consumers on pool plans are grappling with the same price shock as Vivi when they received SP invoices in November. Those on tariff plan have a short reprieve as the Q4 tariff is still on a low energy cost of S$0.1788 /kWh. Like everyone else on tariff plans, whether with SP or retailers, they will see a huge increase in their bills for January with a higher Q1 tariff.

Does SP profit from such big increase in electricity prices

ABSOLUTELY NOT. I have explained in numerous blogs (check the archieve) that SP makes no profits on electricity sales. It is simply purchasing electricity from wholesale market ON BEHALF of their customers. These purchases are fully hedged. Whether the wholesale spot prices go up or down makes no difference to SP. As MSSL licencee SP makes some profits on the metering services. The billion $ profits that SP Group makes come from Transmission Services and overseas operations.

Potential Q4 losses for generators with Vesting Contracts (VC)

VCs are hedge contracts between SP and power generation companies (gencos). SP uses the VC to hedge their purchases. When the wholesale price is lower than the VC price, SP pays to the counterparty gencos the difference. Gencos pay SP if wholesale price is higher. (The wholesale spot price is the Uniform Singapore Electricity Price or USEP + a small admin fee).

Since 2011/2012, the Singapore Electricity Market has been one where the Long Run Marginal Cost (LRMC) curve has been constantly higher than the Short Run Marginal Cost (SRMC) curve. This is due to substantial excess capacity where generators price themselves low in order to win despatch for their plants. In this scenario, gencos are making losses and this is not sustainable for the industry in the long run because it leads to insolvency for power generators.

VC price approximates the energy cost component of the tariff and commonly referred as LRMC for the Singapore electricity market. The USEP in economic parlance is the SRMC. With the massive excess capacity since 2011/2012, VC tends higher than USEP. This has meant that SP has been a payer for all the VC that cumulatively totals billions of $ all these years. All these are borne by SP's non-contestable customers in the pricing mechanism embeded in the tariff. It also meant that gencos who had VC were able to recoup some of their losses in the wholesale spot market.

This all changed in Q4. With the massive spike in wholesale spot prices, the SRMC curve is now higher than the LRMC. The average USEP for October was S$491.24 /mWh compared to VC of S$170.50 /mWh. Under the VC, gencos now pay SP the price difference between the higher USEP and the VC price. Based on October figures, I estimate the cash payment by gencos for the vesting contracts in Q4 is about S$491.23-S$170.50 = S$320.74 /mWh x 2,200,000 mWh = S$706m. Does this represent actual losses to gencos? We don't know since we have no idea how they hedge their exposures.

Does SP make money under the VC

VC are hedging instruments that SP contracts with gencos to cover the load of their non-contestable customers. The gains or losses of these hedges are borne by SP customers which are embeded in the tariff.

SP non-contestable customers are under tariff plan. The load is fully hedged so either way the wholesale spot prices move has no impact on SP. All gains or losses arising from the VC are for account of their non-contestable customers which are embeded in the tariff.

For the years since 2011/2012, the SRMC curve has been below the LRMC curve (USEP below the tariff), it means SP has been a payer to gencos for the VC which cumulatively have amounted to billion $ payouts. Did SP loose money here? NO. Because they bought at lower wholesale prices and sold to their customers at higher tariff prices. The hedging losses they pay to gencos is compensated by their cash transactions at higher tariff rates their customers pay. In effect, SP's non-contestable customers have been paying for this billion $ hedging costs. This partly answers the question frequently asked "why retailers can charge lower then SP?".

So for Q4, with the hedge in favour of SP and gencos having to pay up for the VC losses, does SP get to keep the profits? YES. Recall SP is now purchasing at very high wholesale prices but billing their customers at lower tariff of S$0.1788 /kWhr. The profits on the VC cancels out the losses on their cash transactions. SP's hedging gains in effect flow to their customers because whilst the wholesale market is boiling hot, these customers are enjoying low energy price of S$0.1788 /kWh.

Potential Q4 losses for SP

Under normal circumstances, the volatility of the wholesale spot market has no impact on SP since the load pertaining to their non-contestable customers are fully hedged by VC. This is not the case for Q4.

VCs are arranged for the quarter ahead. Thus essentially in Q4, SP has 2 sets of customers on the tariff plan. (A) are customers on their books before Q4, and (B) customers transferred from failed retailers. SP purchases at wholesale S$0.5153/kWh (average) and sells to (A) and (B) customers at tariff S$0.1788/kWh. The loads for (A) are hedged in the VC contracts, thus the higher cost of purchases are offset by gains in the VC contracts. (B) is not hedged as they were onboarded during the quarter. Thus SP will be out of cash by S$0.5153 - S$0.1788 (S$$0.3365) for every kWh purchased.

Suppose all the 140,000 affected households revert to SP, which I think most likely is the case. Average household consumption is 400 kWh per month making a total of 56,000,000 kWh. I estimate SP will be hit by a possible loss of S$ 57m for Q4 arising from the ROLR event (56,000,000 x S$0.3365 x 3 months).

Losses to electricity retailers

EMA regulations require retailers to hedge at least 50% of their contracts with electricity futures. With such high jumps of prices in the wholesale electricity spot market, retailers with even 50% of hedged positions will suffer massive losses. Retailers that remain standing are obviously substantially, if not 100%, hedged. The 5 retailers that exit, which includes a seasoned player like iSwitch, have obviously left a huge cash position unhedged. By exiting and transferring their customers to SP under ROLR event, they cut the lost making short cash positions. If they retain the hedge contracts, they make huge profits on the long futures position. I'm not too sure how this works out under the EMA market practice in ROLR event.

Going forward, this ROLR event most definitely has dented consumer confidence with independent retailers that are not owned by gencos. These retailers have a very small market share of less that 10%. It has been difficult for these small independent retailers to build market share. With the lost of confidence, it will be considerably more difficult to acquire new accounts. It is unlikely they can ever gain scale to improve efficiency and innovate.

Conclusion

SP customers on tariff plans and retailer customers on discount-to-tariff plans have still not yet personally felt the impact of the energy price shock. Come January when the Q1 tariff is announced, the discontent will be loud. By February when people have their January bills, internet and coffee shop conversations will be iron hot that need to be well managed.

One thing is for sure. If the significantly higher energy prices are here to stay, as it most likely will be the case, then everybody losses as inflationary pressure will trigger down to consumer prices by January.

Note: I blog on topics with viewpoints not commonly seen in the public domain. If you enjoy this, please re-visit in a few days time for Part II where I'll discuss Second Minister of Trade and Industry Mr Tan See Leng's Nov 1 speech in parliament on 'unprecedented storm' in the energy market. It's basically me trying to place the finger on where the problem lies.

Monday, December 6, 2021

IT'S SO DIFFICULT TO SAY I'M NOT VACCINATED

When asked a simple question "Have you been vaccinated?", Mr Ugur Sahin, CEO of bioNtech, the company that developed the Pfizer Covid-19 vaccine, he squirmed, obfuscated, befuddled, diverted, deflected, circumbulated, anything but answer a kindergarden question.

Obviously he has no confidence in his own vaccine. Three, four jabs for Thee but none for Me.

Actually, he has mentioned why he is not taking the vaccine. Did you miss it? At about 3.05 mark, he said German law makes it illegal for him and employees to take part in clinical trials. Verzeihung, excuse me. You don't need to be in the experimental or control group can't you? Or are we all guinea pigs in an international clinical trial involving billions of people?

What about his company? What is the corporate position for the vaccine that they developed? Well, in their 2019 annual filing with the SEC (Securities Exchange Commission), the company made some startling self-flagellation.

"To date, there has never been a Phase 3 trial for an mRNA-based product or a commercialized mRNA-based product. Our product candidates that appear promising in the early phases of development may fail to advance, experience delays in the clinic or clinical holds, or fail to reach the market for many reasons, including:
• discovery efforts aimed at identifying potential immunotherapies may not be successful;
• nonclinical or preclinical study results may show product candidates to be less effective than desired or have harmful or problematic side effects;
• clinical trial results may show the product candidates to be less effective than expected, including a failure to meet one or more endpoints or have unacceptable side effects or toxicities;"

That's not much of confidence there I would say.

"Currently, mRNA is considered a gene therapy product by the FDA. Unlike certain gene therapies that irreversibly alter cell DNA and may cause certain side effects, mRNA-based medicines are designed not to irreversibly change cell DNA."

I like to slap the next fact-checker that tells me the mRNA is not gene therapy. "Are designed" not to change cell DNA is not the same as saying our vaccine "does not" change cell DNA. It's designed not to, but they don't really know if it will, affect the DNA.

"As a result, we cannot be assured that adverse effects of our product candidates will not be uncovered when a significantly larger number of patients are exposed to the product candidate. Further, any clinical trials may not be sufficient to determine the effect and safety consequences of taking our product candidates over a multi-year period."

What does it mean here? They are not sure of adverse effects and long term effects of the vaccines. So are the vaccines safe or not? The right way to answer this, having learnt from the CEO, and to ensure not receiving a POFMA from MOH, is to say that the vaccines are safe since the whole world knows it better than bioNtech.