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.