WHAT IS THE MATTER WITH SINGAPORE ELECTRICITY MARKET?

This report appeared on Jun 19. Bloomberg is a news aggregator and this article was carried by some other media. As for local media, only Business Times reported this. Bloomberg’s article comes with clickbait bombshell title, BT’s is subdued. Both reports are brief and leave laypersons wondering what’s the matter with SEM (Singapore Electricity Market).

Bloomberg says “Singapore plans to more aggressively regulate electricity markets” and BT says EMA “will introduce a temporary price cap on wholesale electricity prices”.

One may be excused to ponder, has the deregulation of electricity faltered?

SP (Singapore Power) sets a tariff which is fixed for 3 months. For this computation, SP imagines it is a new entrant employing the most efficient plant in the market, which is CCGT (combined cycle gas turbine) plant. It prices itself by computing its production cost and adding a gross margin enough to cover operation cost plus a decent net profit. Its production cost includes cost of capital, ie, plant depreciation. This is called the LRMC (long run marginal cost).

The wholesale market price is set every 30 minutes. Now suppose SP computes the LRMC every 30 mins, all cost will remain basically unchanged in the short term. However, its primary variable cost which is NG (natural gas) fluctuates throughout the day. Thus LRMC will be volatile with a close positive co-relation to the spot price of oil to which NG is pegged. See chart below.

Gencos bid at the wholesale auction every 30 minutes. They do not set their prices the way SP computes the LRMC. Gencos compute their production cost excluding depreciation. They then fix an offer price which they feel will be accepted in the wholesale market auction. As long as the price is above variable cost of production (ie covers fuel cost and plant variable overheads) gencos can continue in business because any sales revenue received in excess of variable production cost helps to pay for other costs which are fixed (including depreciation), whether they sell or not. This is the SRMC (short run marginal cost). Of course over the long term, SRMC that does not cover all costs and provide a profit is not sustainable.

Electricity is a unique market where supply must equal demand and available when needed. Too little supply, the system crashes and we get blackouts. The system must have the capacity to supply the demand needed, and also for reserves to meet increased demand. If capacity is just sufficient to meet demand and reserves, then all gencos’ production will be taken up 100%, which means they can price themselves to the moon. For a deregulated market to be viable, there must be some excess capacity. Excess capacity forces gencos to offer wholesale prices competitively to win dispatch for their plants. Some researchers say about 30% excess capacity seems optimal.

SEM has 100% excess capacity for many years resulting in wholesale prices way below tariff. 

The other factor that influences gencos’ wholesale price is of course, fuel cost. 95% of Singapore's electricity comes from gas turbines. Gencos’ SRMC moves in tandem with the price of oil to which gas prices are indexed. In the financial crisis of 2007, oil prices shot above US$106 in July 2008, and between 2010 to 2014 oil prices hovered at high US$90 to US$104. Tariff and wholesale prices increased accordingly. However, Gencos’ SRMC were still below LRMC. This is because the massive excess power generation kept gencos’ wholesale offer price competitive. That means the system held. The yellow band of SRMC-LRMC price variation remained and retailers could continue to offer discounts off tariff during those years when oil prices were much higher than the spike caused by the pandemic and Russo-Ukraine war in current times.

What is the problem with our current situation? The pandemic and Biden’s energy policy caused oil price to rise from US$50s in Jan 2021 to US$70s in Oct. In Qtr 4, the tension in Ukraine further fueled increases in oil price. The Russian invasion in Feb 2022 added more pressure on prices to peak at US$104 in April.

With fuel prices rising, we expect tariff and electricity wholesale prices to rise. But this time, wholesale prices shot through the roof bearing no co-relation to the quantum of fuel price levels. This time, gencos were dealing with not just the price of fuel but also with supply of gas. The convergence of several factors caused a gas supply squeeze – higher demand in winter, improved economy coming out of the pandemic, sanctions on Russian gas, and locally, decreased delivery of piped natural gas from Indonesia.

But why should gas supply shortage cause wholesale electricity prices to hit the roof? Well, with less fuel, gencos were unable to bid at their full capacity levels. In other words, the massive over-capacity in SEM technically disappeared. The wholesale market on the supply side became non-competitive and gencos had carte blanche to up the ante. This chart explains:

With gas supply shortage, gencos offer less to the wholesale market. This causes the supply cushion to decrease. Wholesale prices are extremely elastic to the level of supply cushion.

Under this scenario, the SRMC will close the gap with LRMC. As the yellow band disappears, retailing became unsustainable and retail market collapsed.

When excess capacity vanishes and greed prevails, gencos bid with SRMC now  way above LRMC, which means, spectacular margins. Did this happen? You can bet it did. (See charts in my previous electricity blog on 'shrinking supply cushion and price fixing'). Businessmen will be businessmen. They thrive in times of high price upheavals. I wrote in my previous blog 20 May 2022 'government did nothing to mitigate high electricity prices' to watch out for excessive gencos profits. So let’s take a look. Sembcorp’s net profits was up from S$279m in 2021 to S$848m in 2022; YTL was S$74m in 2021 up to S$110m in 2022. Others not available online, but rest assured they all laughed all the way to the bank. 

Minister Tan See Lang has explained we are now seeing the normalisation of wholesale prices. Theoretically, at the right level of capacity, SRMC should fairly jive with LRMC. That is a fair interpretation of normalisation. At this level, wholesale auction market remains competitive and gencos make fair profits. But retailing becomes unsustainable because that yellow band of cost differential between SRMC and tariff no longer exist. There was shedding of excess capacity in 2020 and 2021 but is still above the 30% level that is effective for normalised deregulated market.

Deregulated market is stabilised at the normalised level. Is SEM actually at this status? This needs serious data reviews and I do not have time for a deep dive into it at the moment. What is clear is the high oil prices are coming off and supply situation has improved tremendously. Yet we are still seeing extreme swings at the wholesale auctions with SRMC obviously much higher than LRMC. If excess capacity level is still at least 30% then it means gencos are maximising their margins, a kinder way of saying profiteering. How can they do this when 30% excess capacity level assures competitive bidding? It can only mean collusion or because recent events allowed gencos to better understand a higher bidding level will still get them dispatch. Or it could be they hold back supply which reduces the supply cushion thus jacking up prices.

We return to the news article. So what is the new regulation for TPC (temporary price cap) all about. SWEM (Singapore wholesale electricity market) currently has a price cap of S$4,200/mWh. This cap has never been breached in its history. TPC is a formulated price that is set at LRMC x 1.5. USEP (uniform Singapore electricity price) is the price gencos sell to SWEM at each 30 min period. A moving average of USEP is computed. If the marginal cost (ie the highest offered price accepted at auction) exceed this, the USEP for that 30 min period will be capped at the TPC. Gencos who bidded at higher than TPC and received dispatch will be compensated at TPC price. The cap is lifted once USEP returns to below moving average. The mechanism is set to incentivise gencos to commit their full capacity thus bringing excess capacity back into play and enforce competitive pricing like before. TPC compensates gencos at LRMC x 1.5. If their cost is actually higher, market rules exist for them to seek additional refunds.

It is not as unsettling as Bloomberg's article try to suggest. Meanwhile, rest assured EMA is still investigating the reasons for the price behaviour of the gencos. 

Read : Is Singapore electricity liberalisation a great achievement or a hullabaloo

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