SINGAPORE ELECTRICITY LIBERALISATION - A GREAT ACHIEVEMENT OR A HULLABALOO?

"Knowledge speaks. Wisdom listens"

This quote is often wrongly attributed to the guitarist Jimi Hendrix. It was actually the American poet Oliver Wendell Holmes who wrote in 1858  “It is the province of knowledge to speak, and it is the privilege of wisdom to listen.”

Many moons have passed and we are still hearingg the same narratives as regards the retail electricity fiasco after the tornado of rising oil prices swept through the NEMS (National Electricity Market of Singapore). Inside or outside parliament, media, and academia, there has been no new illumination. Example, this piece on 10 Mar 2022 "What went wrong with Singapore’s energy market liberalisation" by Energy Research Institute from Nanyang Technological University. We learn nothing new. I was expecting some academic brilliance but saw a run of the mill typical media narrative.

I am throwing out here snippets that have not been broached into public consciousness. As is the case with most of my blogs, I vouchsafe out-of-the-box views hoping for some public discussion and a learning opportunity. Frankly, it has been most disappointing, but national concerns are worthy causes.

What is the purpose of liberalisation and have we achieved it?

The whole purpose of liberalisation of the electricity market is to provide competition at power generation and retail marketing to bring economic efficiencies and lower cost for consumers. Liberalisation to attain market efficiency is sacrificing regulated or public managed cost-based pricing which is more stable, for market-driven pricing which is highly volatile.

Have we achieved the objective? Only power generation and retail marketing is liberalised. Transmission, distribution and metering are still regulated. In generation and retailing, the framework in place is well organised.

Are we having cheaper electricity after liberalisation?

So how does Singapore cost of electricity compare to other countries? Country cost comparative is fraught with difficulties due to wild differences in energy source (coal, oil, gas, thermal, nuclear, solar, hydro etc), taxes, subsidies, purchasing power disparities. Nevertheless, the table below on Household Electricity Prices As At June 2022 provides a general idea.

Singapore ranked 144 at S$0.299/kwh is above world average of S$0.212/kwh and the most expensive in Asean. A good comparison to Singapore is Hong Kong which has cheaper electricity at S$0.215/kwh.

Could our electricity have been cheaper if it were publicly run? One thing is for sure. We would have benefitted from better synergies and avoided massive duplication in production, marketing and operation, which translates to huge savings.

What is the social cost for liberalisation?

The working of NEMS is predicated on an auction system to feed the load into the wholesale market, and a electricity futures market to bring down the cost for new entrant retailers. What is the cost for maintaining these two predicates? 

Is there a ball park figure to judge? Yes there is. Total consumption of Singapore is now about 54 twh. The tariff component cost for Power System Operation & Market Admin Fee is $0.0006/kwh. Thus the cost of maintaining NEMS is currently about S$32.4m per year. Is it all worth it getting what we have at this cost?

Could our electricity have been cheaper or higher without liberalisation?

Yes and No. Let me explain with this chart.

The red line is the energy component of the tariff. This cost is computed by SP on a 3 month ahead projection. This is known as the long run marginal cost (LRMC) and is a projection by SP based on various parameters such as forecasted price of oil. This is a projection based on what a new entrant to the market will cost their production using the most efficient plant in the market. Thus the projection takes into consideration capital cost.

The blue line is USEP (uniform Singapore electricity price) or the power generation cost. In order to get despatch in the auction market, generators will price themselves on the basis of production cost plus a margin. The production cost is primarily fuel (predominantly gas for Singapore). As long as they can cover fuel, power generators will try to get despatch. This is called the short run marginal cost (SRMC) where capital cost is not considered. How much margin they add is a matter of market competition, ie demand and supply dynamics.  

Both the USEP and the tariff have a positive co-relation to the price of oil. The USEP is very positively related as the oil spot price is a factor in their cost computation for the wholesale auction every 30 mins. The tariff is less co-related since it is a quarterly projection and actual oil spot prices may not have performed according to forecast. The tariff curve is more normalised as fuel cost is based on a 3 month forecast, with backward adjustment for vested contracts which is priced on the USEP.

In a perfect system (where no power generator has market power, and capacity is slightly higher than demand) the USEP and tariff curve should have a fairly close relationship somewhat like 2005-2012 in the chart, moving up and down each other, often converging.

The USEP-Tariff relationship changed from 2012. The Tariff (LRMC) is now consistently higher than the USEP (SRMC). A long period where LRMC is higher than SRMC is not sustainable because it means power generators are making losses. It will lead to the collapse of the power generation industry. What that can mean to the whole economy is unthinkable, and yet from 2012 to 2021, we see no discussion about this existential issue by the regulator EMA (Electricity Market Authority). In fact, recall in the collapse of Tuas Spring, there was some criticism of the government for allowing a new power generator to enter the market in 2016 at a time of already high over capacity, EMA distanced themselves that it was purely a commercial decision (but they provided the approval). 

The next chart explains clearly, why for one whole decade, a danger lurked, while the authorities pat themselves on the back for a liberalisation job well done.

This chart shows why from 2012 the LRMC (Tariff)  has been running higher than the SRMC (USEP). Due to government incentives in 2012 to replace old plants with more efficient new model combined-cycle plants, there was a stepped-up jump of capacity.. The industry was then plagued with a massive over-capacity for years. During this period, gencos priced themselves low at the auction in order to obtain despatch and suffered losses. 

Contestable customers (those not buying from SP) were allowed since 2001. The market was fully opened by 2017. The huge gap between USEP and tariff allowed electricity retailers to buy from wholesale market cheap and sell to consumers at huge discounts compared to tariff, at times of about 30%. Singaporeans were sold the narrative that liberalisation and open market competition brings cheaper electricity. That is misinformation. It was the massive over capacity, not the fact the market was liberalised, that brought electricity lower than tariff from 2012 to 2021 which allowed retailers to sell cheaper than SP.
 
Hyflux's Tuas Spring plant was commissioned in 2016 right smack into a huge loss making industry. Tuas Spring collapsed within two years. I have been blogging for 3 years about the unsustainability of the situation, both for power generation losses and the pricing structure of retail electricity.

What happened in the oil price hikes in 2022?

We were told the narrative of Russian invasion of Ukraine, increased pent-up demand after pandemic lockdown, and the cold winter, all conspired to a perfect storm of massive oil price hike. The Singapore situation was worsened by projected piped gas supply decrease from Indonesian sources and their upstream problems. This led to a decrease of LNG supply in the Singapore market and blew power generation cost skyhigh.

Singaporeans have not been told the full and real narrative. Firstly, oil price started to move north on the very first day Joe Biden came into office, long before Russian invasion of Ukraine. Biden's energy policy took US from net oil and gas exporter to importer, thus pushing up the price of oil worldwide. Russian incursion of Ukraine Feb 2022 exacerbated the situation, but it was not direct causation because Russian oil was still on the market. It was Western sanction of Russia, not the war itself, that pushed oil prices higher. Singapore's unilateral sanction of Russia denied us the chance to buy cheaper gas from them. The decrease from piped gas supply was long known and Singapore had planned well with our own LNG terminal and infra. With combined-cycle plants, gencos were able to switch to alternative oil fuel with slight increase in production cost.

The fact that supply still managed to meet demand during the crunch time 2020 Q1 to 2022 Q3 meant gencos were able to obtain their fuel one way or another. Electricity cost went sky high because Singapore had no national LNG stockpile to smoothen out short term price crisis. We have sand stockpiles, rice stockpiles, sugar stockpiles, etc, but no LNG stockpiles.

The key metric in a liberalised market - capacity:

By 2021, before the oil price began its climb, the gap between tariff-USEP was already closing. Since 2021 Q3 the SRMC is now higher than the LRMC. This could mean either the tariff projection of oil prices had been too conservative, or the gencos are now making massive profits. As I mentioned in my previous blogs, watch out for massive profits by gencos for 2022. Look at the capacity chart above to see what has changed. The massive over-capacity had tapered off in 2019. 

The first chart showed the oil price hikes of 2008 and 2011-2014 did not cause a huge divergence between USEP and tariff as compared to 2021-2022. Quite clearly it shows it was not the oil price hike per se, but the decrease in over capacity, that forced generation cost up. This is the behaviour of the liberalised beast, market-driven and responsive to supply-demand dynamics, totally volatile.

It seems the gas supply crisis is over and the market has normalised. With massive over-capacity no longer an issue, we can expect to see a paradigm shift in USEP-Tariff relationship back to pre-2012 days. That means the 2 curves will tend to converge and criss-crossing each other. That also means the huge gap between USEP-tariff disappearing and the retailers working in much more challenging environment.

Too much excess capacity, prices will be depressed which jeopardises the generation industry. Too little capacity, gencos will maximise profits with higher prices. In a fully regulated public run system, this problem does not arise.

The government is awake. They know optimum capacity is key to stability and fair pricing. In Nov 2021, legislation was amended to enable the regulator EMA to acquire, build, own and operate power infrastructure when it deems necessary and private investments are not responding. 

New regulation to tighten on retailers:

Impending new regulation by EMA seems like a scapegoating move, putting the blame squarely on retailers to appease consumers. The proposed compensation for customers is a positive move. It is righting an oversight in the vendor of last resort arrangement which did not safeguard consumers' loss when their accounts are transferred back to the MSSL ie SP Services. (By the way where was CASE, the consumer protectors, all these years).

The proposed increase in retailer capitalisation and increase in their load portfolio to be hedged (from 50% to 80% ) has serious risk returns ramifications. Instead of leaving hedging to commercial decisions, it becomes highly regulated. Retailer margins in other liberalised electricity markets are razor thin and I assume it is similar in Singapore. Any increase in regulation-imposed cost will invariably be passed on to consumers.

On safe-guarding the interest of consumers, the matter of security of deposit monies have not been addressed. In the recent exit of several retailers, consumers have been most fortunate that their deposit monies were fully recovered. This does not necessarily warrant future similar outcomes.

Why independent retailers crashed:

The spoon fed explanation is wholesale prices have gone up and retailers who have not hedged their positions cannot sustain their operation since they will be buying at higher prices in the spot market and selling to customers at previously committed lower prices. By regulation, retailers have to hedge at least 50% of their load. I do not have the data, but I find retailers not hedging their positions difficult to accept. This is because retailers live on very fine margins. It is sheer madness not to fully hedge. 

Assuming they are fully hedged, why then did they collapse? This was because valuation of futures had skyrocketed and margin calls became their undoing. If this were the reason, and I believe it to be so, then the solution was just a matter of short term credit lines. Since none of the retailers were names too big to fail, no rescue was attempted, ala Singapore Press Holdings. Let retailers fall, and let consumers bear the losses as they get transferred back to SP at much higher current prices.

Do retailers and futures market make sense in Singapore?

A liberalised market is predicated on a pool of retailers selling competitively but they need to be supported by a futures market where they can hedge their risks. A large pool of players is needed to provide liquidity to the futures market. The participants comprise of gencos, retailers and financial derivative speculators. The EMA would have wanted to have as many retailers as possible so the bar for entry was very low. 

Retailers are basically always short and gencos are naturally always long and both need to hedge away their positions. However, gencos which have their own retailing arm, have a natural hedge to the extent of their aggregate production. Which is why in the oil price hike crisis, gencos-owned retailers refuse to commit beyond what they produce. The gencos and their retailing arm can sort out their long-short positions internally without having to go to the futures market and incur transaction costs.

In NEMS, gencos-owned retailers have the giant share and the small number of independent retailers' share is minuscule.  I believe there are only 2 independent retailers left standing. Given this situation, does a futures market make sense?

Are there subsidies in the liberalised market?

The word subsidy is anathema to the government. Subsidy of course means supporting the consumers. However the government is big on incentives to promote the various market development schemes they have, not just in the electricity market, but in many other industries. Business persons please step forward. Consumers step back.

The liberalised electricity market has its share of incentives. Vesting contracts by SP, originally meant as a mechanism to prevent market power by gencos, later on to promote the new LNG terminals, have been used to booster revenue by power generators especially when SMRC is lower than LRMC. As SP's loads are fully vested, the vesting costs are fully absorbed by non-contestable consumers.

In the electricity futures market there is a Future Investments Scheme. Participants tender for MMO (market maker obligation) under which they receive certain fee income from the MSSL (SP). Under the scheme, the tender winners must make a certain number of bid-offer quotes in the futures market. In the case of gencos and their retailers, MMO is a zero-sum gain risk wise, so the MMO fees is a pure bonus.

Incentive schemes, if not designed well, may and do end up as windfalls for participants and socialised costs to consumers. During the period when LRMC is higher than SMRC (2012-2021) due to massive over-capacity and a shrinking pool price, led to windfalls for those tender winners of vesting contracts and MMOs. I have no data on these cost figures, but judging by the big gap between USEP and tariff, the difference between the strike price and contract price must have been significant and payouts substantial for vesting contracts. For the MMOs, I read somewhere (forgotten the source) SP once paid out S$204m, so large that they had to re-design the incentive scheme. These payouts end up in the tariff as social costs to consumers.

There was an interesting case in the Appeals Court recently regarding MMO. It involves Sun Electric, a retailer, and a company called RCMA Asia Pte Ltd. (RCMA is a huge Aussie group strong in energy and commodities trading. It owned ISwitch, the first retailer to collapse). Sun had tendered and won a MMO spot but contracted the MMO operations out to RCMA for a share of the fee income. Sun paid out a partial sum of the MMO fees. RCMA sued for the balance. The MMO fees seem to be substantial enough for RCMA to sue all the way to the Appeals Court.

(This RCMA v Sun case is interesting for eagle beavers. It is a precedent setting case that established directors of companies under liquidation that sue, will be held personally liable for costs and damages if they loose the case. The details are here.)

The outsourcing of the market making operation by Sun to RCMA defeats the EMA's objective of growing local expertise. This is just one example of the many instances where policy driven incentive schemes of the government are not properly tracked and outcomes measured.

To the above question of what is the social cost of liberalisation surely must be added the cost of vesting contracts and MMO incentive payouts.

Grid or network cost is still regulated and it is the government's cash cow

At each increase in tariffs, Singaporeans show their displeasure at the S$ billion profits that SP makes annually. I have often educated complainants that SP Services makes no profits on tariff increases since their uncontested load is fully hedged in vested contracts. The profits are from SP PowerAssets which owns the grid whose earnings are from operating the transmission network. Their contributions came from 50% Singapore and 50% overseas operation.

I have also often advised energy subsidy is a bad move, even during inflation, but tariff reduction is possible at the network cost component. This can be done by scaling back, or withholding development work. A big chunk of network cost is sunk cost recovery which can be deferred during a financial crisis. 

Instead, whilst you were not watching, the government increased the network cost component in Q3 last year from $0.0577//kwh to $0.0594/kwh. Assuming aggregate consumption of 54 twh, SP PowerAssets revenue just went up by $91.8m per year during this high inflation.

Conclusion

To conclude for yourself whether it makes sense for a liberalised electricity market that offer good economic payoffs, you need to understand the macro perspective. Singapore is a very small market, of approximately 54 TWh consumption per year. There are only 7 major power generators. The distribution is within a small dense urban area. There is very little seasonal variation and a high proportion of industrial demand  which means the daily load is basically flat. That translates to very low volume risks.  Power generation is 95% natural gas and majority of plants are combined-cycle models. Penetration by renewables such as solar and waste recycles are insignificant. In other words, a very homogenous market. Easy-peasy to regulate.

Let more knowledge speak out, please.

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