Retail electricity sales persons face these questions everyday. These are questions of a public wary of PAP trickery when it comes to things money. The packaged response is 'deregulation brings benefits to consumers with choices and competition in prices'. No one has ever explained the real reasons.
Here I will show the current retail pricing model and reasons why it is not sustainable. You need to first understand some basic background information :
SP customers:
- Non-contestable consumers (domestic consumers + commercial consumers with < 2,000 kWh monthly consumption in the districts which are still not yet open).
- Consumers who are contestable but chose to remain with SP
- Consumers who buy from the pool through SP
SP makes a forecast for the next quarter's power generation cost. This forecast is based on many assumptions such as oil prices, exchange rates, gencos ROI. etc. This is known as the long run marginal cost LRMC model. LRMC is on the basis of a new entrant into the market, so capital cost is on brand new CCGT gas plant.
Gencos price themselves based on the short run marginal cost SRMC for the next 30 minutes supply. SRMC is based on gencos existing plants and their immediate cost of operation.
Assuming no vast difference in plant cost structures (of old and new) and no wild swings in oil prices in the quarter, then the LRMC and the SRMC should fairly be close, sometimes one could be higher or lower than the other slightly. However, due to current huge overcapacity in the industry, gencos bid below their own SRMC at the wholesale market in order to get despatch for their plants. This auction is conducted every 30 minutes.
That's the current status of NEMS. Gencos' have consistently bidded below their SRMC thus resulting USEP significantly below LRMC. They have been making huge losses in the last 10 years.
Auction clearing price. nodal price, USEP, wholesale spot prices:
Clearing price - Gencos bid at the wholesale market every 30 minutes. This is on auction basis where the gencos' bids are stacked according to price. When the quantity required is met, the price that was the highest is the clearing price. All bids higher than that are rejected, and all accepted bids are based on the clearing price.
Nodal price - Gencos deliver their electricity into the nodes near their plants for which they pay a certain charge to get into the grid. The cost at each geographical locations differs slightly. The clearing price plus the nodal cost is the genco's nodal price. Gencos are paid at their nodal prices.
USEP - Uniform Spore electricity price is the weighted average of all nodal prices for a particular 30 minute period.
Wholesale spot price - Market participants (retailers/SP/certain big consumers) buy at the wholesale market every 30 minutes at the wholesale spot price, which is the USEP plus a small transaction (market admin) charge.
Vesting contracts and Regulated tariff:
When SP computes the LRMC, that is the tariff for the quarter ahead.
Vesting contracts complicate the matter. SP hedges a certain quantity of total load with gencos at the LRMC price (strike price of the vesting contracts). Where the nodal price is lower than the vesting price. SP pays gencos. Where nodal price is higher, gencos pay SP. Due to the over capacity in the industry, gencos' nodal prices have been consistently lower than the vesting price, thus SP has been paying out to gencos all the time.
In order not to take any risks, SP fully hedge their customers (1) and (2). Thus SP customers (1) + (2) are charged at the LRMC plus the vesting contract difference. For practical purposes, the vesting contract adjustment is on a lagged time basis. The vesting contract difference of the last half month in the previous quarter + the first 2-1/2 months of current quarter forms the adjustment to the next quarter's LRMC to arrive at the regulated tariff.
When the total vesting contract load is higher than total load of SP customers (1) and (2), the proportion of vesting contract adjustment is computed. SP bills retailers with their share of this amount. Retailers add this into the rate they charge their customers.
Retail pricing model under 70-80% overcapacity in power generation :
Current model is characterised by a USEP that is much lower than the forecasted LRMC (due to overcapacity and gencos bid lower) and a tariff that is higher than the LRMC (due to adjusting for the vesting contract difference of previous quarter).
This results in a wide gap between wholesale spot price and tariff that allows retailers a lot of room to price themselves lower than tariff. Retailers buy at the wholesale spot price and add a margin to cover risks and a rate of return.
Question of concerned consumers are answered -- the model explains why retailers can offer hefty discounts off the tariff, there is no catch, SP does not profit from electricity sales, the government did'nt forgo anything (at least since deregulation).
Singaporeans who complain that electricity rates are high have got it wrong. When consumers switch to a retailer, they currently enjoy lower electricity cost at the expense of gencos.
Retail pricing model with no huge overcapacity in power generation :
Retailers buy at wholesale spot price and add in their margins. When the wholesale spot price moves above the tariff, the retail price collapses because consumers have no reason to buy electricity above tariff. (The only reason may be in expectation of longer term oil price increases, the customer wish to lock in a long term fixed rate contract).
Current retail pricing model is unsustainable :
The power generation overcapacity of 70-80% has a downward pressure on wholesale prices resulting in gencos incurring losses in the last 10 years. The industry is in jeopardy and Hyflux is the first casualty. Come what may, the wholesale price has to stabilise at a level that brings some profitability to the gencos. That can only happen by reducing over capacity down to about 30% level, just enough to cover reserves. Paradoxically, that spells doom for the retailers and higher prices for consumers.
The power generation industry is the underbelly of the whole economy and the government needs to address the overcapacity problem sooner or later.
Additional reason why retail pricing model is not sustainable - buying at pool :
Buying at the pool means buying directly at the wholesale spot price or pool price. This occurs in 3 ways. High usage consumers buy at pool by joining as direct market participants. Some retailers buy on behalf of customers and charge a small management fee. When retailers close down, their customers are transferred back to SP who manage these accounts on pool price basis.
Pool prices are cheaper than retail rates because they are without retailer margins. As more consumers realise the benefits of cheaper pool rates, especially those from a failed retailer who get transferred back to SP, they will be reluctant to switch to another retailer.
Pool prices change every 30 minutes, moving up and down according to how the wholesale auction moves. A fixed term rate offers some protection to consumers from oil price volatility. But the term is only mostly for 2 years, some 3, since there are no contracts longer than this. In the long term, there is no escaping oil price increases.
The real reason consumers avoid buying from the pool is because spot prices can spike at anytime during the day. There have been times when it hit above S$1.00/kWh. Spot prices spike due to planned and unplanned plant outages that cut short term supply. Events like a plant failure, power line failure, weather-related problems. natural disasters, terrorists destroying cable towers, etc.
In the context of Singapore, unplanned outages are very rare. The risk of buying from pool is comparatively low. When consumers are educated on this, more will be likely to switch to buying from the pool through SP. Take market risk and cut out retailer cost.
Abolish regulated tariff under no overcapacity generation :
Should there be no generation overcapacity, doing away with regulated tariff ensures the viability of retailers. Retailers purchase at wholesale spot price and offer to customers competitively.
The purpose of vesting contracts was primarily to curtail market power of gencos. This no longer applies since no single genco now has more than 20% share of aggregate generation. The purpose switched in 2013 to LNG vesting in order to ensure the LNG Terminal storage project kicks off with some levels of guaranteed business. New CCGT plants buying certain quantity of LNG feom the LNG Terminal is allowed a level of their power generation vested. Gencos welcome this as vesting guarantees a reasonable ROI. LNG vesting ends in 2023.
Doing away with regulated tariff means also no more vesting contracts. This imposes a problem to SP. They now carry a risk for the prices they quote to their customers.
Who's in charge anyway?
The electricity deregulation of Singapore which started in 2001, is into its final stage as domestic consumers in the last few districts become contestable. Systems and process wise, the National Electric Market of Singapore (NEMS) is a glowing success. Unfortunately, it is marked by a serious failing in capacity planning which has resulted in a huge overhang of generation capacity.
Generation capacity shot up in 2013 as investors read opportunities in the LNG vesting contract arrangements to promote the planned LNG storage terminal. Two new entrants and an incumbent genco added a new gas plant.
Electricity Market Authority, the regulatory body, has said investments in power generation plants are commercial decisions. This is the standard refrain we get from a government that has been distancing themselves from each and every administrative shortcoming. When things go wrong - deny responsibility. This is unacceptable because capacity planning is one of the most important aspect of EMA's mission, and while commercial investment decisions are not made by them, they issue the licences.
The power generation overcapacity and the impact on retail pricing model need to be addressed, if not by EMA, then who?