Spotlight on the WESM - The Lantau Group · Spotlight on the WESM Four points I will make today 1....

Spotlight on the WESM

Spotlight on the WESM Mike Thomas 26 March 2014


The WESM has recently been in the news

1

Most of the attention has been negative – is it deserved?


Four points I will make today

1. The WESM is not the cause of high electricity prices in the Philippines

2. The WESM produces signals essential to reducing mistakes and driving down costs, and

should be respected more, not less

3. The November / December price spikes highlight problems with contracting and regulation, not

the WESM per se (though improvement is possible!)

4. Going forward, more focus needs to be put on how to ensure timely capacity investment,

especially giving rising perceptions of regulatory and policy risk

2

We step back and put some perspective on the WESM’s role and on recent developments and risks


What the consumer sees

Why are the retail tariffs in the Philippines so much higher than

Asian neighbours?

(But….is this a problem with the WESM?)

3


0

2

4

6

8

10

12

14

16

18

20

Ku

ala

Lu

mpu

r

Be

ijin

g

Ta

ipe

i

Sh

ang

hai

Va

nco

uve

r

Se

oul

Sh

enzh

en

Ja

ka

rta

Ho

ng K

ong

(H

EC

)

Ho

ng K

ong

(C

LP

)

Sa

n F

ran

cis

co

Mia

mi

Wa

sh

ingto

n,

D.C

.

Da

va

o

Ma

ca

u

Ho

usto

n

Pa

ris

He

lsin

ki

Sin

gap

ore

Ce

bu

Lis

bon

Am

ste

rdam

Ma

nila

To

kyo

Bru

sse

ls

Lon

don

We

llin

gto

n

Luxe

mb

ourg

Ne

w Y

ork

Sydn

ey

Ma

drid

Ro

me

Be

rlin

Other Cities

Asia Cities

Philippines

Electricity tariffs in the Philippines are high compared to most other Asian

countries (as they have been for many years)

4

Source: TLG research

PhP/kWh

Residential retail tariffs for customers using 200kWh per month (Nov 2013)

Major utility in each Philippine

grid

Australia / New

Zealand


Same story for commercial customers

5


PhP/kWh

Commercial tariffs for customers using 1,923MWh per month (Nov 2013)

Major utility in each Philippine grid

0

2

4

6

8

10

12

Ho

usto

n

Se

oul

Ku

ala

Lu

mpu

r

Au

ckla

nd

Ma

drid

Ta

ipe

i

Am

ste

rdam

Me

lbo

urn

e

Ro

tterd

am

Ho

ng K

ong

Ja

ka

rta

Los A

ng

ele

s

Ba

nga

lore

Ha

noi

Ba

ngko

k

Sh

ang

hai

Ad

ela

ide

Be

ijin

g

Da

va

o

Co

pen

hag

en

Zu

rich

Sto

ckh

olm

Sydn

ey

Mu

mb

ai

Ne

w D

elh

i

Du

blin

Bru

sse

ls

Ne

w Y

ork

Lon

don

Ce

bu

Pe

rth

Sin

gap

ore

Ma

nila

Vie

nna

To

kyo

Yo

ko

ham

a

Mu

nic

h

Fra

nkfu

rt

Ro

me

Other Cities

Asia Cities

Philippines


0

2

4

6

8

10

12

Ho

usto

n

Ha

noi

Se

oul

Sto

ckh

olm

Ba

nga

lore

Ja

ka

rta

Ku

ala

Lu

mpu

r

Au

ckla

nd

Ma

drid

Ho

ng K

ong

Ta

ipe

i

Am

ste

rdam

Me

lbo

urn

e

Ro

tterd

am

Los A

ng

ele

s

Ba

ngko

k

Mu

mb

ai

Sh

ang

hai

Be

ijin

g

Ne

w D

elh

i

Ad

ela

ide

Co

pen

hag

en

Da

va

o

Zu

rich

Sydn

ey

Bru

sse

ls

Du

blin

Lon

don

Ne

w Y

ork

Ce

bu

Pe

rth

Ma

nila

Sin

gap

ore

Vie

nna

To

kyo

Yo

ko

ham

a

Mu

nic

h

Fra

nkfu

rt

Ro

me

Other Cities

Asia Cities

Philippines

And for industrial customers, too

6


PhP/kWh

Industrial tariffs for customers using 2,188MWh per month (Nov 2013)

Major utility in each Philippine grid


Smaller users are somewhat protected from the higher prices, however

7

Manila residential tariff structure

0

5

10

15PhP/kWh

kWh consumption per month

50kWh per month (PhP/kWh)

0

4

8

12

16

5.6

About a million Meralco residential

customers (21-70kWh pm)

29% 18%

3% 14%

7% 13%

Customer number distribution


Other Asian countries face rising tariffs – slowly catching up to the Philippines,

as they reduce subsidies, invest, and absorb rising fuel costs

8

Energy costs are increasing throughout the Asia Pacific region

• Government policy shift to reduce fuel

and other subsidies Kuala Lumpur Tariffs in KL went up by more

than 10% in Dec 2013

Price Trend

• Proposing significant shift to gas-fired

generation to meet emissions targets

Hong Kong (CLP) CLP estimates a potential

c.40% rise over next few

years

• Reduce subsidies and restore

Taipower’s financial viability Taiwan (Taipower)

Tariffs in Taiwan went up by 7-10%

for residential users and 10.4-

12.2% for commercial and

industrial users in October 2013

• Cover rising costs due to increased

reliance on imported gas and new

emission reduction requirements

China (Beijing, Shanghai) Tariffs in Beijing and Shanghai

recently increased by an average

of 8% and 5% despite falling coal

costs


Compare Manila to Hong Kong or Singapore – two other non-subsidised power

systems dependent on natural gas or imported fuels…

9

Note: * Meralco’s WESM purchases assigned to fuel type according to WESM monthly generation mix. This may underestimate proportion of oil and other

peaking supplies; ** Generation charge plus adjustments to previous months and system loss.; ^ 2012 exc. CEDC; ^^ 2013 local

Source: Meralco; PEMC; FirstGas; CLP; EMA (2012); TLG analysis

3.7

1.5

0

2

4

6

8

10

12

14

16

18

20

Hong Kong

(CLP)

5.6

Manila

11.1

6.3

1.0

4.1

PhP/kWh

Breakdown of Residential retail rates for

200kWh per month (Nov 2013)

Electricity

sales (TWh):

32.5^ 31.8^^

Manila vs. Singapore Manila vs. Hong Kong

Energy cost**

T&D / Other

Taxes

PhP/kWh

Breakdown of Residential retail rates for

200kWh per month (Nov 2013)

3.7 1.7

0

2

4

6

8

10

12

14

16

18

20

9.3

7.0

Manila

11.1

6.3

1.0

Singapore

Taxes

T&D / Other

Energy cost**

Electricity

sales (TWh):

42.6 31.8^^

2.0 network/metering/

retail/other

-0.7 energy

2.2 network/metering/

retail/other

2.2 energy


Gas and coal costs are about the same

10

Philippines CLP Singapore

Gas marginal cost (US$/MWh)

~89 ~93 ~119

Coal marginal cost (US$/MWh)

~39-43 ~37 n/a

GEN COSTS BY

FUEL TYPE

The challenge lies in a combination of fuel mix and the cost of legacy investments


The fuel mix (gas intensity) is an obvious difference

11

0

10

20

30

40

50

60

70

80

90

100

Meralco HK (CLP) Singapore

Oil/Other

Nuclear

Coal

Gas

More gas than Hong Kong, less than Singapore – but these largely reflect historical commitments

Percent

(higher cost than

In WESM)

(lower cost than

In WESM)

Generation fuel mix (2013)


0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

The fuel mix has been challenging because the amount of Malampaya gas

exceeded the ability of the system to efficiently absorb it….

12

Take-or-pay gas c. 2,700 MW

Hydro ‘must-take’ c.400 MW

Geothermal ‘must-take’ c.400 MW

Total ‘non-coal’ c.3,500 MW

Coal pmin (2013 exc. GNP) 1,325 MW

Total ‘must-take’ c.4,800 MW

In 2007, many coal plants could barely run due to insufficient opportunity; by 2013 things had changed

MW

Load-Duration Curves (2007-13)

Percentage of hours

Only 50-60% of hours

where coal can run

above PMIN –

inefficient and costly

Most coal can

finally run at

PMIN all year

2007

2013

Source: PEMC; TLG analysis

4,800


The Philippines (like other Asian countries) committed to gas when gas was

expected to be cheaper but, later, oil-linked gas prices increased materially

13

COAL WINDOW COAL WINDOW

1991 Discovery of

Malampaya gas

field

1997 NPC/FirstGen sign GSPAs

with SPEX/OXY

2001 Commission of

Malampaya

2006 Singapore

commits to

LNG imports

1995 Hong Kong

first gas unit

commissioned

As the price of oil increased, gas prices also increased (due to oil-price linkages in gas pricing formulae)

1992 Singapore first

gas unit

commissioned


Different systems (HK and Philippines) are in different places in their overall

investment cycle – making direct tariff comparisons misleading

14

TYPICAL RATE BASE CAPITAL

RECOVERY PROFILE

TYPICAL PPA CAPITAL

RECOVERY PROFILE

Two “LRMC” Profiles with the Same Value (Across three investment cycles of 20 years each )

Hong Kong has older depreciated coal fired capacity (replacement of which would drive up prices in the future)

(Philippines still has a number of PPA obligations – but many of these will expire in the next several years)

MANILA

PPAs

HONG

KONG

(older capacity more depreciation)

YEARS

PHP/KWH

20 Years 20 Years 20 Years

BUILD FIRST POWER STATION BUILD SECOND POWER

STATION

BUILD THIRD POWER STATION


Summary: tariff differences reflect many factors – none relate to the WESM

• Subsidies and cross subsidies

– Most Asian countries use fuel or other subsidies to support their electricity sectors, at significant expense

• Treatment of legacy versus new costs (historical PPAs, PSAs, Stranded Costs, etc.)

– When an industry is “restructured” what do you do with the cost of past decisions/investments?

• Fuel contracts and supply mix

– Fuel costs vary widely depending on when contracts were signed. Some countries are lucky, others not

• Reliability of supply

– More reliable systems cost more, but also deliver more value

• Outlook for growth and age/condition of existing system

– Some systems have excess capacity or older/newer network systems

– Costs vary widely depending on age of system and overall supply/demand balance

15


The WESM produces signals essential to avoiding past mistakes, and should

be respected more, not less

16

What is the essential challenge of the Philippine power

sector: dealing with uncertainty and variability!


The Philippines has an “event-driven” electricity sector – much uncertainty and

variability for both natural and technical reasons

Note: * Buying price (with 100% surplus)


0

2

4

6

8

10

12

14

16

18

20

22

24

26

Jan-14 Jul-13 Jan-13 Jul-12 Jan-12 Jul-11 Jan-11 Jul-10 Jan-10 Jul-09 Jan-09 Jul-08 Jan-08 Jul-07 Jan-07

PhP/kWh

Low

hydro

Gas curtailments

and low hydro

Plant forced maintenance

outages and HVDC link

maintenance

Transformer breakdown and San

Jose substation congestion

Plant outages and

coal limitations

Plant outages

Gas curtailments

and plant outages

Average monthly WESM spot settlement price* (2007-14)

17

Gas scheduled outage

and plant outages

ERC-

regulated

price

reduction


Weather effects vary widely each year – the system must have the capability to

deal with strong swings between El Nino and La Nina

18

Deg. C

NOAA Oceanic Niño Index (ONI)

Source: NOAA

(2.5)

(2.0)

(1.5)

(1.0)

(0.5)

0.0

0.5

1.0

1.5

2.0

2.5

3.0

Jan-5

0

Oct-

51

Jul-5

3

Apr-

55

Jan-5

7

Oct-

58

Jul-6

0

Apr-

62

Jan-6

4

Oct-

65

Jul-6

7

Apr-

69

Jan-7

1

Oct-

72

Jul-7

4

Apr-

76

Jan-7

8

Oct-

79

Jul-8

1

Apr-

83

Jan-8

5

Oct-

86

Jul-8

8

Apr-

90

Jan-9

2

Oct-

93

Jul-9

5

Apr-

97

Jan-9

9

Oct-

00

Jul-0

2

Apr-

04

Jan-0

6

Oct-

07

Jul-0

9

Apr-

11

Jan-1

3

ONI measures average surface sea temperatures and it is used by the US

National Oceanic and Atmospheric Administration (NOAA) for their

operational definition of El Nino and La Nina

El-Nino

La Nina


Temperature variations have profound impacts on hourly demand

19

Relationship between hourly GDP-normalised*

demand and temperature in Luzon by time of day

(2006-13)

0

1

2

3

4

5

6

7

8

9

15 20 25 30 35 40

Shoulder

Peak

Off-peak

GW

Air temperature (oC)

Note: * Demand across the different years can be adjusted for levels of economic activity in order to elucidate the impact of other factors (e.g., temperature).

Assumes 0.73 GDP-demand elasticity (maximises R-sq); Off-peak defined as 10pm-7am and Peak from 9am to 5pm and 6pm to 8pm

Source: PEMC; NSCB; Wunderground.com; TLG analysis

R-sq = 0.443

Dec Nov Oct Sep Aug Jul Jun May Apr Mar Feb Jan

32

31

30

29

28

27

26

0

oC

27.0

27.5

28.0

28.5

13 12 11 10 09 08 2007

Annual average oC

Monthly average temperatures

(Manila)

2013

2012

2011

2010


And of course hydro is not the same each day, week, month, season, or year

20

13

2

1

0

5.3

12

5.3

11

5.5

08

4.4

10

4.0

09

5.5

05

4.3

04

4.3

03

5.4

07

4.6

06

4

3 2.9

2002

3.8

6

5

Source: DOE Power Statistics (2002-12); PEMC (2013); TLG analysis; NOAA

Annual hydro generation in Luzon

(2002-13)

0

5

10

15

20

25

30

0

5

10

15

20

25

30

600

400

200

0

D N O S M F J A J J M A

800

Monthly hydro generation in Luzon and

2011 precipitation (2006-2012)

Hydro generation is

low in Q2 when

demand is at its

peak

Low inflows in severe El-

Nino years reduce ability

of hydro plants to

generate

TWh (bars) GWh (lines) mm (bars)

2008

2007

2006

2011 precipitation

(RHS)

2012

2011

2010

2009

Generation peaks

when there is

plentiful inflows


Hydro unpredictability is greatest during peak demand hours…

(which is kind of a bummer!)

21

Hydro scheduled generation profile (ordered by total Luzon load) GW

Difference between a dry and wet year depends on fuel and capacity availability

0

200

400

600

800

1,000

1,200

0 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

2009

2010

2011

2012

2013

Note: Illustrated data points represent aggregation of 80 hours


High Luzon load Low Luzon load


As a consequence of all these things – timely, flexible, capacity is needed

22

0

100

200

300

400

500

600

700

2/3/14 2/2/14 2/1/14 1/31/14 1/30/14 1/29/14 1/28/14 1/27/14

Sual G1

Mariveles G2

Pagbilao G1

Typical weekly generation schedule (w/c January 27, 2014)

MW

Source: PEMC (ex-post schedules)

However -- the plants currently providing most of this capacity are not well suited to do so

COAL PLANTS


Coal plants are optimally operated as baseload plants – with other

technologies being better suited for flexible / responsive operations

23

Oil Gas Coal Oil Gas Coal

0

50

100

150

200

250

300

Fixed costs - $/kW per year Variable costs - $/MWh

0

20

40

60

80

100

120

140

160

180

Capital

Fixed O&M

Fuel

Variable O&M

No single technology or fuel is “best” or “cheapest” – the mix of fixed (capital) and variable (fuel) costs is what matters

IT’S BECAUSE

YOU WANT TO RUN IT A LOT

IF YOU SPEND ALL THIS

MONEY TO BUILD IT


Furthermore, excess coal-fired capacity is being absorbed as a result of

Philippine economic growth

24

2013

Source: PEMC (ex-post schedules); TLG analysis

Percent of max

Percentage of hours

0

20

40

60

80

100

0 20 40 60 80 100

Pagbilao G1

Pagbilao G2

Sual G1

Sual G2

QPPL

Masinloc G1

Masinloc G2

2009 Percent of max

0

20

40

60

80

100

0 20 40 60 80 100

Pagbilao G1

Pagbilao G2

Sual G1

Sual G2

QPPL

Masinloc G1

Masinloc G2

Percentage of hours

Generating unit dispatch-duration curves – Coal units

But as the Philippines grows, economically, the available “spare” coal capacity is being absorbed


Improving fundamentals of supply and demand for coal lead to both greater

offered and more scheduled capacity!

25

No surprises here. Fundamentals matter.

2011 2010 2009

+24% +67%

+49%

+34% +25% +18%

2008

30

25

20

15

10

5

0

2013 2012

Excludes GNPower

Mariveles for

comparability

"Theoretical"

85% gross CF

Offered

Scheduled

TWh

Luzon coal capacity offered and scheduled



If we could wave our magic wand, a raft of flexible gas-fired CCGT capacity

would enter the WESM, reducing costs and enhancing reliability

26

Note: EWC plant assumed to not be committed

Source: DOE (committed plants as of Aug 2013); TLG analysis

Least-cost capacity expansion plan for Luzon under expected assumptions

0

200

400

600

800

1,000

1,200

29 27 25 23 21 19 17 15 2013

Net MW

Economic least-cost entry

Natural Gas

Biofuel

Wind

Geothermal

Hydro

Oil

Coal

Uncertainty over how

further supplies from

Malampaya could be

used?

Other types of capacity (coal, geothermal, renewables) also all have bright prospects…but today I focus on flexibility

Displacing older oil-fired

capacity

Providing cover for

Malampaya

outages

Responding to varying loads

Allowing baseload plant to

operate

consistently and efficiently


(10)

0

10

20

30

40

50

0 1 2 3 4 5 6 7 8 9

5/7/2013 2pm

1/8/2013 2pm

As the system gets tighter, offers increase, which is the logical and normal

situation how else to signal the need for new capacity?

27

Offered quantity (GW)

Price (PhP/kWh)


Luzon generator offers for two illustrative peak hours

DEMAND?

DEMAND?


Some capacity is always on outage, and other capacity is uneconomic to

operate in normal market conditions

28


Average capacity on outage in Luzon (2011-14) MW

0

500

1,000

1,500

2,000

2,500

3,000

No

v

Oct

Se

p

Au

g

Ju

l

Ju

n

Ma

y

Ap

r

Ma

r

Fe

b

20

12 J

an

De

c

No

v

Oct

Se

p

Au

g

Ju

l

Ju

n

Ma

y

Ap

r

Ma

r

20

11 F

eb

20

14 J

an

De

c

Geothermal

Nat Gas

Coal

Hydro

Oil

De

c

No

v

Oct

Se

p

Au

g

Ju

l

Ju

n

Ma

y

Ap

r

Ma

r

Fe

b

20

13 J

an

Total

2013 average

(MW)

303

359

659

283

446

2,051

Proportion of

registered capacity

35%

13%

15%

12%

25%

17%

Fire at San

Lorenzo 2

Gas plant maintenance

to coincide with

Malampaya outage

Sta. Rita/Ilijan

maintenance

Sual1 and GNP2

on maintenance

It is not economic or technically possible for a lot of capacity in the Philippines to be operational all of the time – need to focus

on sharpening incentives so that this capacity can be counted on when needed (and can be ignored when it is not)


Normally the highest offers are found in the off-peak period on older, less

flexible, capacity – a sign of trouble….

29

Capacity offered ≥PhP60/kWh

The probability of being required is low – the ability to respond economically is low – the value expected is low

Or perhaps there is just not enough risk in the market to reward more responsive behaviors and investment!

Normally the highest prices would be here

(which suggests that the price cap is too low)

than in the peak hours….

More capacity offered

near the price cap

during the off-peak…


However – the WESM rules include provisions designed to “force” uneconomic

behavior, an approach that almost always backfires

Consider the “Must Offer” rule in combination with the PMIN requirement….

• It costs money to keep a plant at its minimum output level (PMIN) just in case it might be called –

and there is little if any compensation for this

– If a unit cannot be started quickly and is not needed often, it loses money waiting around

– If the price cap is too low, it cannot be sure of making enough money back

• Not all units can even perform consistently at their PMIN

– Fuel-limited operations (hydro, some oil)

• If the price cap is too low, a new unit that might be faster in response may not be economic

– The WESM won’t reward an investor and prices won’t support contracting

– So the Philippines is stuck using expensive older plants on must-run or special direction

30

A better WESM would not “force” good behaviour, but would use more effective incentives

(as is done in energy-only wholesale spot markets in other countries)


(5)

0

5

10

15

20

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Percentage of hours*

2013

2012

2011

2010

2009

2008

2007

Note: * Excludes administered prices; Graph clipped at PhP(5)/kWh and PhP20/kWh

Source: PEMC (RTX); TLG analysis

Luzon WESM price-duration curves (2007-13)

PhP/kWh

As a result there is very significant risk for anyone who purchases from the

WESM in the top 30% of hours over the year

31

Graph clipped at PhP20/kWh

Variation in fuel prices

(not nearly so material)

Variation in supply

availability & peak demand

(enormous risk)

Far fewer zero or

negative prices after 2009

The harder we try to “protect” consumers from these higher prices, the less likely investors will be able to respond with

prudent, viable and effective investments to solve the problem


WESM fundamentals are telling us two things

• The supply situation is tightening – new capacity

is needed

• But even more urgently and important: some of

that capacity needs to be flexible and responsive

• (Incidentally: this has been a focus of our work

on a Gas Masterplan for the Philippines, the

reports for which may be found at

www.lantaugroup.com)

32

The WESM is pointing the way towards a solution – but will we listen and respond?

Philippines Natural Gas Master Plan – Recap of Key Findings of Phase 1

Phase Two Public Consultation

20th March 2014

Prepared for:

Supported by:

Prepared by:

http://www.lantaugroup.com


Unfortunately, the ERC does not consider the

WESM is fully competitive

33

ERC Order, case no. 2014-021MC (dated 3 March 2014)

ERC Order, case no. 2012-118RC (dated 28 January 2013)


Despite the fact that the concentration of capacity in the largest players is

similar to other markets

0%

20%

40%

60%

80%

100%

Other

NEM-QSL

CS

Energy

Stanwell

Intergen

Other

NEM-NSW

Macquarie

Origin

Other

WESM

Power

Seraya

SMC

PSALM

Aboitiz

Alinta

Tuas

Other

WEM

NewGen

Verve

NEM-SA

Other

Senoko

Snowy

Hydro

NEMS

Int’l

Power

Alinta

AGL

Energy

Other

Energy

Australia

First

Gen

Source: PEMC (2012 Annual Report); EMC (2012 Annual Report); AER (State of the Energy Market 2013); ERA (2013/14 capacity credits)

NEM

Generation company market share

Oligopoly market power exists in some degree in all energy markets, but so too does significant confusion between “bad”

market power (gaming) and the high prices that arise during periods of true economic scarcity

34


Or the fact that vast majority of WESM outcomes are readily understood and

modelled

35

0

1

2

3

4

5

6

7

8

9

10

Q12009

Q2 Q3 Q4 Q12010

Q2 Q3 Q4 Q12011

Q2 Q3 Q4 Q12012

Q2 Q3 Q4 Q12013

Q2 Q3

Actual

Estimated

PhP/kWh

Source: PEMC (2012 Annual Report); EMC (2012 Annual Report); AER (State of the Energy Market 2013); ERA (2013/14 capacity credits)

Comparison of actual vs. estimated quarterly average LWAP

That which can be modeled can be understood and explained


0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

LWAP / SRMC

Load / Available Capacity

1.2 1.1 1.0 0.9 0.8 0.7 0.6 0.0

Some WESM outcomes rely on capacity “above” the level that is

“available”….a clear indication of a problem of incentives

36

2012

“Strong economy”

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

LWAP / SRMC


1.2 1.1 1.0 0.9 0.8 0.7 0.6 0.5 0.0

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

LWAP / SRMC


1.1 1.0 0.9 0.8 0.7 0.6 0.0

2011

“Cool year”

2013

“Major Events”

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

LWAP / SRMC


1.2 1.1 1.0 0.9 0.8 0.7 0.6 0.0

2010

“Hot dry year”

Gradient: 12 Gradient: 11

Gradient: 5.6 Gradient: 11

Capacity forced to run (must run)


In similar markets, prices spike to much higher levels during the same types of

events that happen in the WESM – these price spikes support investment

37

New Zealand historical monthly average final prices

2000-Current at 3 major nodes

Eastern Australia historical monthly average final prices

2000-Current at 3 major nodes

Without investment, price spikes get worse, the market fails, and huge value is destroyed


We think that a key problem is the WESM price cap – it is too low

38

Comparison of the Market Price Caps

0

100

200

300

400

500

600

Singapore

NEMS

159

US

ERCOT

IMEM

226

32

Australian

NEM

WESM

(2013)

538

62

PhP/kWh

Due to increase

in 2015

Low price caps penalise responsive capacity and can both exacerbate market power and promote insufficient peaking

capacity – trapping the Philippines in a cycle of dependence on older unreliable and very expensive “must run” units

With a higher price cap:

The highest offers would more sensibly be found during

the peak periods, not the off-peak periods

More attention would be paid to effective contracting

strategies – especially contracts to cover disruptions

outages and peak demand

Flexible and responsive capacity would become

more commercially attractive, leading to earlier

replacement of older, expensive, and less responsive

capacity

The WESM would mature faster, provided it is allowed

to develop

On the other hand:

The diversity of contracts and pricing terms would

seriously challenge the current approach to

contract approvals by the ERC

Risk to retailers would increase, as they would be

more exposed to uncovered (spot) price risk


The lower the price cap, the greater the risk of future unserved load

39

7,000

7,200

7,400

7,600

7,800

8,000

8,200

8,400

0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 7.0% 8.0% 9.1%

Unserved

Served

Fuel consumption (l/kWh) 0.34

Fuel cost (PhP/l) 42.05

VOM (PhP/kWh) 0.32

Host DU wheeling (PhP/kWh) 1.9424

Capital cost (PhP/kW) 22,000

WACC 15%

Lifetime (years) 25

FOM (PhP/kW/yr) 150

Price cap (PhP/kWh) 32

Lowest capacity factor 2.6%

229 unsupported

hours

“normal year”

Proportion of hours

MW demand

Disastrous hot / dry El Nino year

(1 in 3 El Nino year: 3x229 = 687 hours)

(1 in 5 El Nino year: 5x229 = 1,145 hours)

May be fine in a “wet / cool” year

Minimum running time needed at price cap

before reaching commercial viability of annual hours

At

Risk

A price cap of 32 will, in time, guarantee shortage

Source: DOE; PEMC; TLG analysis


The other clear symptom of a problem is that stakeholders appear unable to

contract efficiently

40

Average power cost vs. load factor for Luzon grid ECs (2012)

Despite the ERC’s diligent approvals process, contract prices outcomes make no sense!


Contracting behaviour seems influenced mainly by historical price experience

(not current expectations) – a bit like driving through the rear-view mirror!

41

0 2 4 6 8 10 12 14 16 18 20 22 24

LWAP (PhP/kWh)

18

16

14

12

10

8

6

4

2

0

Spot load (%)

0 2 4 6 8 10 12 14 16 18 20 22 24

LWAP (PhP/kWh)

7

6

5

4

3

2

1

0

Spot load (%)

In Month Price 12-mo Trailing Average Price

Note: Monthly averages are time-weighted, as reported by PEMC

Source: PEMC; World Bank; BSP; TLG analysis

R-sq = (0.47)

R-sq = 0.08

Average monthly market price vs. proportion of load transacted on spot market


Summary

1. The WESM is not the cause of high electricity prices in the Philippines

2. The WESM produces signals essential to avoiding past mistakes, and should be trusted more,

not less

3. The November / December price spikes highlight problems with contracting and regulation, not

the WESM per se (though some improvement is possible!)

4. Going forward, more focus needs to be put on how to ensure timely capacity investment,

especially giving rising perceptions of regulatory and policy risk

42

There are problems, but they are fixable


Fix simple, basic, and long-standing WESM issues

• Stop distorting economic outcomes

– Eliminate Pmin

– Eliminate the must offer rule

• Provide proper signals with offer caps that align with desired reliability of supply targets

– Raise the price caps

– Don’t use price caps for consumer protection unless you also plan to hand out flashlights when the power

does not come on

• Introduce trading of Ancillary Services in the WESM

– Price signals for the value of flexible capacity

– Potentially not fully compensated under current regulatory regime

• Invest in market software / processes to minimise pricing errors

43

If necessary to manage consumer / transitional exposure, temporary value management mechanisms are available


Improve economic regulation of purchases for regulated (captive) consumers

• Trust competition

– The perfect is the serious enemy of the good

– Move away from regulatory review of every contract

– Make it easier for DUs to secure a range of different contracts to cover entire demand curve

• Focus on economic fundamentals

– Financial contracts not physical delivery

– Prices vary by time of use and level of responsiveness required

• Expose stakeholders to WESM risk so they support prudent contracting

– Do not cover all mistakes with regulatory sledgehammers and pass-through

44

Economic regulation is about achieving reasonable value not adhering to precedent


There is considerable scope for improvement in DUs’ contracting processes

• Trading is a 24 hour activity – the WESM is a risky environment

• Time of use and different types of financial contracts are imperative

• Target efficient portfolios, not specific contracts

• Avoid “cliffs” where many contracts expire at once

• Actively educate respect to portfolio analysis and risk management

45

Actively educate respect to portfolio analysis and risk management


Rigour

Value

Insight

Energy Power Utilities For more information please contact us:

Mike Thomas

[email protected]

+852 2521 5501 (office)

www.lantaugroup.com

The Lantau Group (HK) Limited

4602-4606 Tower 1, Metroplaza

223 Hing Fong Road

Kwai Fong, Hong Kong

Tel: +852 2521 5501

www.lantaugroup.com

Thanks

46

mailto:[email protected]

http://www.lantaugroup.com/

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