Asia Report: Reformation
Consequently, lenders to Singapore's electricity sector will need to start afresh when assessing the risks facing individual companies. As is the case with other restructured energy markets, the risks are now more exposed. In particular, lenders will need to assess the risks in a newly competitive generation and retail sector and calculate which companies are most exposed to, and best placed to deal with, such risks. This will not be an easy process. Moody's experience from other similarly restructured markets indicates that it is difficult to perfectly predict all the risks ? and those likely to have the most exposure to them. Nevertheless, lessons from around the world can provide some guidance.
Moody's expects the credit of Singapore Power (unrated) to remain the strongest in the sector over the medium term. Its regulated network business (both electricity and gas) will have much lower business risk and therefore much more predictable revenue streams than those operating in the more competitive sectors. As a result, such network companies typically obtain significantly higher ratings than those companies operating in the competitive energy sector. However there are a number of challenges facing Singapore Power in the coming years that will need to be carefully addressed by management. These include dealing with a new regulator in a new environment; meeting new shareholder expectations if the planned IPO proceeds; and successfully growing its international investment portfolio through Singapore Power International (unrated).
It is still too early to tell who will emerge as successful players in the competitive sector of the Singapore electricity market, as the structure is still not complete and the generation companies have not yet been sold. However enough is known of the planned structure to draw some general conclusions, based on overseas experience. The market structure adopted does not contain the flaws of the Californian model and thus the extreme problems encountered in California are unlikely to be replicated in Singapore. Nonetheless, experience from elsewhere would suggest that only the brave would expect no surprises when the market becomes fully competitive in 2002. For example, it remains to be seen how the high reserve margin evident in Singapore will affect market dynamics. Commodity market basics (and lessons from elsewhere) would indicate the likelihood of soft pricing in the early stages of the market until some plant is mothballed. Such considerations will no doubt impact the prices paid for the generation companies during the sale process.
In addition, overseas experience suggests that participants need to plan for unpredictable pricing, particularly in the early stages of the new market. However, it may be that the Singapore market will exhibit more stable pricing patterns over the medium term, given that it will be dominated by three generation companies; have a high capacity reserve margin; and be implementing a market for reserve generation capacity.
Structural changes will result in loss of Singapore Power's dominant market position in generation
At the beginning of 2001 Singapore Power was a vertically integrated utility with a monopoly in transmission and distribution, and a dominant position in generation (68% market share). In the restructured electricity industry being put in place, the contestable parts of the industry (generation and retailing) will be separated from the non-contestable parts (transmission and distribution) at the ownership level. To this end, Singapore Power has divested its two generation companies, Senoko Power and PowerSeraya to Temasek Holdings for onsale in the near future1.
Unlike Australia (but similar to New Zealand) generators will be allowed to own retail companies. In addition, Singapore Power's retail arm, Power Supply, will restrict its involvement in electricity retailing to non-contestable retail customers (primarily households and small non-domestic consumers) and will exit this market as it becomes gradually contestable over time. Power Supply will not be allowed to compete for customers and its role is expected to transition to that of a market support services provider; it will offer services to the electricity market, such as meter reading, customer billing, etc. Also, in its new role, Power Supply will provide default access to the wholesale market for those customers who decide not to switch retailers. In performing this function, Power Supply is not likely to be exposed to fluctuation in pool price risk as it is expected it will be allowed to pass on the pool prices to customers.
As part of the restructuring, responsibility for planning for the electricity system and market pool operations has been transferred from PowerGrid to the Energy Market Authority of Singapore (EMA) and EMA's partly owned associate company, Energy Market Company Pte Ltd (EMC) respectively. This move is intended to make the system and market operations more transparent to industry players. The EMC will oversee the operation of the new electricity wholesale market when it is put in place in the second half of 2001. In addition EMA will become the regulator for PowerGrid's and Power Gas' tariff charges for operating the electricity and gas network, respectively. Such regulation is expected to be performance based, i.e. allowing the licencee to earn excess returns if certain performance standards are achieved. The exact regulations are currently being negotiated between the parties and therefore details remain sketchy.
New wholesale electricity market will partly resemble that of Australia
The new wholesale electricity market will comprise a spot market for electricity. However while the dispatch of generation through the market will be mandatory, the settlement of transactions through the market will be voluntary. Market participants will have the choice of buying or selling electricity at the spot price, or through bilateral contracts. Any injection and offtake of electricity not covered by bilateral contracts will be settled at the relevant spot market price. In this way the market resembles, inter alia, that of Australia. In addition, the market rules provide for bids to be made by generators to provide standby reserve power in the event of an unexpected outage, or extraordinary demand. This is different from both the Australian and New Zealand markets.
Vesting contracts planned
Although details are unclear, it seems that vesting contracts for (at least) non-contestable customer loads will be put in place between generators and retailers. However it remains uncertain as to what will be the terms of such contracts, and whether any other form of vesting contracts will be implemented.
Singapore model does not exhibit the flaws of the Californian model
The market model proposed by Singapore does not contain the flaws that proved so disastrous in California. Although Power Supply will have ongoing supply obligations at fixed prices, it is expected that it will be able to enter into vesting contracts to hedge this risk. Furthermore, unlike California, there is no shortage of supply in Singapore ? indeed the opposite is true with a current reserve margin estimated at approximately 37%. Thus retailers can hedge their supply risks, plus there is excess capacity available to meet demand for the foreseeable future. In the table below we set out a comparison of some of the key characteristics of the Australian, Singaporean and Californian markets.
Singapore Power will remain the strongest credit in the market but faces its own future challenges
Singapore Power will remain the strongest credit in the Singapore electricity industry after the market restructuring has been fully implemented. Such strength will reflect its lower business risk and more predictable revenue streams compared with those operating in the contestable parts of the energy market, as well as its strong balance sheet and ongoing financial flexibility. However, exactly just how strong a credit Singapore Power will be in 3 to 5 years' time will likely depend on the following key factors:
The predictability of regulatory revenue streams
Singapore Power faces a new regulator in a new market environment. Experience in Australia and the UK demonstrates that initial expectations of ?light-handed' regulation in such circumstances can often be proved wrong. Regulators can be more aggressive in requiring rate reductions than originally anticipated.
As Singapore strives to remain competitive in the Asia Pacific region there is always the danger that ongoing pressure to reduce key input costs, such as electricity and gas, may result in increasing pressure to reduce both regulated electricity network charges and wholesale electricity costs. Any analysis of Singapore Power must, therefore, begin with a clear understanding of the regulation under which it will operate in the new market, the degree of discretion such regulation will leave to the regulator, and the philosophy of the regulator itself.
The ultimate level of ownership retained by the Government of Singapore
Plans have been announced for an initial public offering of shares in Singapore Power that will dilute the level of government ownership. Weighing the value of government ownership in assessing the credit of a company is often difficult and, invariably, a qualitative exercise. Nevertheless, Moody's believes that in a key industry such as electricity, a government commitment to maintain a majority ownership (or ?golden share') in Singapore Power would have positive credit implications for the company.
Conversely, this could also have negative implications. Singapore Power may continue to have duties imposed on it by government ? such as the rate rebates (totalling S$647 million) it gave to business customers in 1998/99, 1999/2000, and 2000/01 to help them weather the ongoing impact of the economic downturn in Singapore. However, a public listing may restrict the ability of the government to impose such obligations on Singapore Power in the future.
Management strategy
As with most companies a key determinant of future creditworthiness is the strategy adopted by management. In turn, this strategy is likely to be determined by shareholders' expectations ? especially if the planned IPO proceeds. If management were to position Singapore Power as a growth stock, it would most likely focus on Singapore Power International. (The domestic regulated business will probably provide Singapore Power with steady low to medium growth earnings potential, but not much more). If this were to be the case, then a key question would be how aggressively SPI plans to pursue opportunities, how successful the strategy will ultimately be, and how acquisitions will be funded.
To date SPI investments include just under 3000MW in generation assets in China, the Philippines, Indonesia, Korea and Taiwan. With the exception of Taiwan, these represent investments in some of the more volatile power markets in the region ? although the purchase of Powernet, the transmission network in Victoria, clearly adds more stable revenue streams to the portfolio.
Potential for retailer of last resort obligations
The potential for Singapore Power to retain residual exposure to the retail market (through ?retailer of last resort' obligations imposed on Power Supply) remains an open question. It is not clear whether Power Supply will be expected to take on this role in the long run, although the expectation is that it will not have to do so. In the interim period, when it has this role, it is expected to be able to pass pool price risk directly onto its customers.
There are a number of other issues that could impact Singapore Power's creditworthiness but these are not peculiar to Singapore; rather they are generic to the industry. These include significant issues such as the ability to accurately predict and control operating and capital expenditures in a way that makes them recoverable through regulation.2
Generation sector faces challenges, particularly with high reserve margin
On current indications Singapore faces a number of years of electricity oversupply. This would suggest that those considering investment in the (soon to be privatised) generation plants will need to carefully consider the potential for this to depress power price paths over the next few years. Like all commodity markets in which there is oversupply, there is potential for low prices if some plant is not closed down. Germany is a good example of a system that had a high reserve margin when it was deregulated on the supply side in 1998. Wholesale prices fell significantly (up to 50%) because of the oversupply and competitive pricing by market incumbents attempting to protect their market share. Prices still remain significantly below the estimated new entrant price for new baseload plant.
The reserve margin in the first quarter of 2001 was approximately 37%3. If all planned capacity is brought on line Moody's estimates this reserve margin will actually grow to approximately 42% by 2010, assuming annual peak demand growth of 5% per annum. Even if peak demand growth were to average 7% per annum, this would still leave a reserve margin of approximately 30% in 2010. With a large portion of the planned new capacity already committed, the oversupply suggests that some of the older oil-fired plants will inevitably be mothballed. In turn, this is likely to have an impact on the price that will be paid for the three generation companies expected to be privatised.
Linked to the issue of oversupply are the new supplies of gas being brought into Singapore from Indonesia.4 Oil plants currently make up over 60% of the generation capacity in Singapore, but new gas-fired plants are planned to take advantage of the new gas supplies. As a consequence Sembcorp Cogen, Senoko Power, Tuas Power and PowerSeraya have either built, or have commenced building, new combined cycle gas-fired plants. In addition Senoko Power has begun construction to repower part of its existing oil-fired plants.
The proposed pool system also plans to promote the maintenance of a certain amount of generation reserve by actively encouraging the development of a market for buying or selling generation (or load reduction) capacity. This could be made available at short notice if there were unexpected surges in demand, or forced outages of dispatched plant. While this may result in a small amount of ?peaking' capacity being retained (that otherwise might have been mothballed), it is difficult to see how such a mechanism will encourage the maintenance of the currently very high reserve margins. It is also relevant to note that the UK also used to have a system of capacity payments to generators to encourage the maintenance of a suitable reserve margin. However this system proved to be very volatile and inadequate for planning purposes, and became somewhat discredited. Ultimately it was abandoned when the UK changed from the pool system to the New Electricity Trading Arrangements.
Past experience elsewhere indicates possible turbulence in the competitive part of the market, especially in its early days
Moody's will draw on its experience of rating power companies in other markets around the world when analysing the risks facing participants in the restructured Singapore wholesale power market. Some particular lessons include:
Competitive pools often go through an unpredictable period of pricing in their early stages of full competition
This was true of Australia where spot prices were initially much lower than many anticipated when the National Electricity Market commenced operations in December 1998. As Figure 1 highlights, prices for 1999 were below A$20 MW/H for many parts of that year which, in turn, placed financial strain on a number of the newly privatised Victorian generators.
Even after the initial period electricity prices can be volatile on a seasonal basis and even on an intra-day basis.
Whilst violent swings in pricing are much more likely in periods when reserve margins are low (as is increasingly the case in Australia in both Victoria and South Australia), unforeseen events such as extended unplanned outages can result in rapid changes in pool prices. This happened in Victoria from May to September 2000 when an unplanned outage at the Loy Yang B power plant resulted in a rapid increase in average monthly pool prices. (Again, see Figure 1). In addition, as Figure 2 highlights, the price for electricity can be extremely volatile from one day to the next. Prices in Victoria on 8 February 2001 increased to over A$4,100 dollars per MW/H, yet on the same day one week earlier prices had not gone above A$75 per MW/H.
Moody's acknowledges that the proposed reserve market for Singapore may mitigate against some of this volatility since it is, in part, designed to make capacity available at a fixed price if demand surges or forced outages occur. In this way it may operate as a market ?cap' on such prices in most such circumstances.
In a market with a small number of generators pricing stability is more likely
Most commentators would describe the UK market in its early years as a ?managed market' where competition between generators was not intense and prices therefore remained relatively stable. On privatisation, Powergen and National Power had approximately 75% market share, which reduced progressively as new entrants appeared and the incumbents withdrew capacity. It may be that Singapore, with three generators dominating the market may also exhibit similar ?managed market' characteristics over the medium term. However, much will depend on the attitude of the companies themselves and that of the regulator.
Lessons from Australia indicate that vesting contracts can have unintended consequences
Whilst vesting contracts protect retailers who have mandatory customer franchises at fixed prices, they can have unintended impact on the wholesale spot market. Generators can be tempted to aggressively compete for contestable customers in the knowledge that a large part of their capacity is contracted at set rates under the vesting contracts. This can result in low prices for contestable customers at the expense of non-contestable customers. It can also distort the spot market and the future contracts market since, with low spot prices, retailers or end-users may be unwilling to sign up to future, higher-priced, bilateral contracts. This can result in generators suffering material reduction in revenue as the vesting contracts roll off. n
Footnotes
1 Temasek will divest Senoko Power, PowerSeraya and Tuas Power either in late 2001 or early 2002. It is expected that foreign ownership limits in these companies will also be lifted.
2 For a more detailed discussion of such issues see Moody's rating methodology on Australian and New Zealand Utilities published in February 2001
3 Source ? Energy Market of Singapore
4 Supplies from the West Natuna gas field commenced in 2001; further supplies are expected to commence from Sumatra in 2003
Moody's contacts:
Sydney Brian Cahill 612.9270.8100
Hong Kong Clara Lau; Julia Turner 852.2916.1120
New York Susan Abbott 1.212.553.1653
London Stuart Lawton 44.20.7772.5454
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