Formation of Electricity Prices
Outlook for Third Quarter 2018
On 19 March 2018, marketing commenced for the soft launch of the Open Electricity Market (OEM) in Jurong. Interest from consumers has been higher than expected and many have gone to great lengths to understand how electricity prices are determined; both by SP Services when setting the quarterly regulated tariff and by the many retailers for their various products. In this review, we intend to explain how the electricity prices are impacted by outside factors (mainly oil prices) and how the factors that underpin both the regulated tariff and the prices offered by retailers have changed since the soft launch of OEM.
There are three different but related issues to consider when trying to understand how the electricity price may change over time, they are:
- The difference between the wholesale electricity price and the all-in retail price paid by the consumer – The regulated tariff is an example of an all-in retail price.
- Fuel cost to the generators – This determines the regulated tariff and thereby contracts that are a discount to the regulated tariff.
- Electricity futures market pricing – This affects various fixed price contracts that retailers are offering.
The difference between wholesale electricity price and all-in retail price
The wholesale price is the energy-only price. This is the price used when electricity generators sell electricity into the wholesale market and retailers buy electricity from the wholesale market. Prices are quoted and traded in S$/MWh (dollars per megawatt-hours) in the wholesale market, and the market is operated by Energy Market Company (EMC).
Singapore has a “gross pool” model, meaning all electricity generated in Singapore must be sold into; and collective consumption has to be bought from (through retailers); the same wholesale market. A company that is both a generator and a retailer, must still sell all generation into the wholesale market and then buy it back via their retail arm at an amount equivalent to what they have sold to consumers, through the same wholesale market.
There are several elements that make up the all-in retail price. Energy accounts for the bulk (approximately 60%) of this price (“energy-only” price) and this is the price quoted on the wholesale market. Other elements include, but are not limited to:
- Electricity volume losses arising from transmission inefficiencies;
- Cost of transporting electricity to the consumer (grid operation and distribution cost);
- Wholesale market operation cost;
- Market development fees
A very rough estimate of the all-in retail cost price can be obtained by multiplying the energy-only price (the wholesale price) with 1.67 (Calculate (60+40)/60 = 1.67). This does not take into account the retailer’s margin. All-in retail prices are frequently quoted in ¢/kWh (cents per kilowatt-hour), a price $100/MWh is the same as 10¢/kWh. As such, if the wholesale price is $100/MWh, the all-in cost to the retailer is roughly estimated at 16.7c/kWh. In this document we primarily use cents/kWh and have converted from S$/MWh.
What drives the Regulated Tariff?
During the first few months of OEM, retailers are able to offer contracts to consumers that are at a discount (around 20%) to the regulated tariff. This may have led to the misconception that SP Services has enjoyed very large margins over the years, which is not the case.
When the Singapore wholesale electricity market in opened in 2003, there was concern that generation companies could push up wholesale prices by exercising their market power through withholding capacity. To protect consumers from such instances, the regulator introduced Vesting Contracts in 2004. These contracts require the generators to sell a fixed amount of electricity to SP Services (as the supplier to all non-contestable consumers) at a specified price. This price is based on a pre-determined formula which aims to set the energy-only element of the price for (non-contestable) consumers at the long-run marginal cost of the most efficient generation in Singapore. This calculation is done quarterly, with oil price of the previous quarter as the main driver of price changes. (Figure 1, below, illustrates this)
Vesting Contracts have served to protect the consumers in some years where the wholesale prices were higher than the energy component of the tariff. However, in recent years, the spot price (since 2013) and the futures price (since inception) have nearly always been lower than the vesting price, thus enabling retailers to source and sell electricity cheaper than SP Services. Fuel Costs – Impact on discount on tariff (Ohm Discount)
Almost all (~ 95%) of the electricity in Singapore is produced using natural gas. The price paid for the natural gas is pegged to oil prices, either High Sulfur Fuel Oil (HSFO) or crude oil quoted in London (Brent). Simply put, the oil prices in one quarter determines the gas (fuel) price for generation in the next quarter. By following and analyzing the changes in oil price in one quarter, we can make an educated guess of how the electricity spot price is going to move in the following quarter.
Figure 1: The Effect of Oil-price on Energy Component of the Regulated Tariff
When the oil price is used in calculating the regulated tariff, the change in exchange rate between the Singapore dollar and the US dollar is also taken into account. We did not account for exchange rate adjustments in these examples to keep it simple. All numbers are used to for illustration to indicate how oil affects the electricity price.
Electricity Futures – Impact on price plans with a fixed price (Fixed Ohm)
Since April 2015, the Singapore Exchange (SGX) has listed electricity contracts two years into the future (herewith referred to as the “electricity futures market”). Today, both monthly contracts (commodity code EE on SGX) and quarterly contracts (commodity code EF) are traded in the market.
Electricity futures contracts do not result in a physical delivery of electricity, but rather, they are a contract for difference. When the contract has ended, the average electricity spot price (for the period of the contract) is measured against the previously agreed contract price. If the average spot price is higher than the agreed contract prices, the seller of the contract has to pay the buyer the difference. If the average spot price is lower than the agreed contract price, the buyer pays the seller the difference.
Generators, retailers and traders use this electricity futures market to hedge the future electricity price. As a retailer, we use this market so that we can offer longer-term contracts; such as our 12-month fixed priced contract (Fixed Ohm). Without this ability to hedge, retailers would take a lot of risk if they sold electricity at a fixed price for 12 months and higher oil prices resulted in the spot price going up over the 12-month contract period.
Consumers can also benefit from the information this market provides. If a consumer compares the electricity futures price when he signed up for a fixed price plan, against the electricity futures price when his plan is up for renewal, he will be able to gauge whether the price on his new upcoming plan will increase or decrease.
Figure 2: Change in Brent (oil) and electricity futures prices this year
The chart above shows the development in the electricity futures market since the launch of OEM. It displays prices from 1 January to 15 May this year for three different futures contracts, namely, contracts that cover the second, third and fourth quarter of 2018. The blue curve shows the change in Brent oil price for the same period. The chart indicates that prices for fixed term price plans should increase.
Expectations for Electricity Prices for Q3-18
Since we started marketing in March 2018 for OEM, the average electricity spot price has moved from around 9.5 cents/kWh to 10.9 cents/kWh (first half of May); futures price (Q3-18) has increased from 9.3 cents/kWh to 12.1 cents/kWh; and oil (Brent) has moved up from around US$ 65/barrel to approximately US$ 79/barrel.
The oil price (Brent) that was used to set the regulated tariff for Q2-18 was approximately US$ 67/barrel. So far (1 April to 15 May), the oil price that will affect Q3-18, the average Brent price has been approximately US$ 73/barrel. While it is uncertain how the oil price will move over the next month and what the basis for calculating Q3-18’s regulated tariff will be; current oil price increases and electricity futures suggest an expected an increase in electricity prices in Q3-18.
We expect that a 6 or 12-month fixed contract priced today would be between 1.1 cents/kWh and 2.6 cents/kWh higher than it was 2 months ago.
Further information on topics discussed in this article:
Vesting contracts: https://www.openelectricitymarket.sg/about/vesting-contracts
SGX’S Electricity Futures: http://www.sgx.com/wps/portal/sgxweb/home/products/derivatives/commodities/electricity/electricity_futures
SGX Electricity Future Prices: http://www.sgx.com/wps/portal/sgxweb/home/marketinfo/derivatives/delayed_prices/futures
EMC’ Electricity Spot Prices: https://www.emcsg.com/marketdata/priceinformation
Disclaimer: Information in this article is only to illustrate how the electricity market in Singapore works and how various elements and markets affects the electricity price. Nothing in this document can be construed to be an offer of services or goods. Ohm Energy does not guarantee the accuracy of any numbers.
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Posted: 22nd May 2018