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
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
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
Chart 3
Chart 4
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.
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