We reported previously that the Loss-making Power Generation Sector in Singapore requires Bold Steps to improve its gross profit margin (i.e. Spark Spread) and profitability. Investments in new power plants during 2011-2013, partly incentivised by the LNG Vesting Scheme, resulted in a structural over-capacity of efficient CCGT generation.
This over-capacity combined with Singapore’s Market Model which determines the prices for electricity leaves little room for the power generating companies (the Gencos) to recover their fixed costs. It is a feature of these markets that they clear at the marginal cost of production. And the marginal cost of production of a CCGT power plant does not recover its fixed costs.
The Vesting Contracts introduced by the Energy Market Authority (EMA) to curb the exercise of market power by the Gencos reveal the extent of the issue. Numbers derived from the Vesting Contracts show that the gross profit margin (VC Adjusted Spark Spread) of CCGT power plants is not sufficient to cover costs like fixed and other non-fuel related costs, financing costs and a return on equity.1
As Vesting Contract prices are set at the start of each calendar quarter, the fuel costs projected in these prices are not necessarily representative for the actual fuel cost. Fuel costs changes are passed on to the Vesting Contract prices, but with a delay of a quarter. This clarifies why in some periods the Adjusted Spark Spread as calculated from the Vesting Contracts is negative. It suggests that during these periods the Gencos would run at a gross margin loss. This is however not the case. The Vesting Contracts projected cost of fuel (natural gas) has been larger than the actual cost of fuel during these periods as a result of the delay.
This is illustrated by figure 1 in which the Adjusted Spark Spread is calculated using our estimates of the realised costs of Natural Gas in Singapore.
Figure 1: Adjusted Spark Spread vs Non-Fuel Costs
The periods with a negative VC Adjusted Spark Spread (based on the the Vesting Contract implied cost of Natural Gas) are now showing positive when based on the realised cost. This is most profound during Q3-Q4 2008 when commodity prices drop rapidly following the global financial crisis. And likewise during the decline during the period Q3-Q4 2014 and Q3-Q4 2015.
Figure 2: Brent Oil Price
It follows that the realised Adjusted Spark Spreads are larger during periods with falling fuel costs than the VC Adjusted Spark Spreads as implied by the Vesting Contract prices. Nevertheless, the conclusion we made before1 is the same. The current electricity prices are not sufficient to cover all costs (with one exception in Jul 2015)2 and take away the ability of the power industry to be profitable.
2. In July 2015, some coincidental events resulted in an unexplained price spike. Although investigated by the EMA and Market Surveillance & Compliance Panel, no prove of market rigging or irregularity was found.