This may come as a surprise – SP Services Ltd actually makes no money from electricity sales. When we want to critique the government, we must at least know what we are talking about. SP Services (SPS) sells electricity at regulated tariff. When tariff has been consistently about 30% above what retailers charge, it lends credence to a hasty conclusion that the government is extracting massive profits out of consumers from electricity sales, no matter which way the price of oil moves.
Let me explain in brief why SP Services makes no profit from electricity sales.
The electricity tariff comprises of a fixed component (for network cost, market services fees, Admin fees) and a variable portion which is the energy cost. Let’s just focus on the energy cost here.
For next quarter’s tariff, SPS makes a forecast of the energy cost for the next three months. Imagine a new power generator wants to enter the market and it computes how much he the company will charge for its energy production for the next three months in order that he can make a reasonable ROI. That’s exactly what SPS does. There are many parameters to consider, (plant cost, exchange rates, oil prices etc) but let’s avoid the details. So SPS has its energy cost and added the fixed component to arrive at the tariff for the next quarter.
SPS sells to their customers at tariff which is fixed for three months. They purchase electricity in the Wholesale Electricity Market at wholesale prices where rates change every 30 minutes. Thus they are at risk to market volatility. To avoid this, SPS has hedging arrangements with certain power generators under what is termed LNG Vesting Contracts. The strike price in these contracts is the SPS computed energy cost. If wholesale price is higher than the strike price, generators pay SPS the difference. If strike price is lower, SPS pays power generators the difference. SPS fully hedges all their customers’ load. In this way, because all their purchases are fully hedged at the same price as their sales, SPS makes zero profits on the electricity they sell.
SPS purchases every 30 minutes and settles the hedging differences with generators periodically. These hedges are done on behalf of customers, so SPS in turn settles this hedging difference by way of an adjustment in the tariff. However, there is a time lag in this adjustment. One quarter’s hedging difference is adjusted in the following quarter. In other words, when SPS makes a forecast for the energy cost for the next quarter, it makes an adjustment for preceding quarter’s hedging difference.
So in effect, customers of SPS buy electricity at a fully hedged price. They will not pay a single cent more if market prices go above energy cost in the tariff, but they will have to pay up if the market price is lower. Consumers do not see these hedging adjustments because it is computed into the tariff.
As a middle-man running fully-hedged transactions, SPS makes no money on electricity sales. So do criticise SP Group for proper issues, not electricity sales.
Where does the S$1 billion profit come from?
Why SPS customers are paying S$billions for hedging costs?
Why electricity retailers’ rates are much lower than tariff?
Why retail electricity pricing model is not sustainable?
Why our electricity cost should actually be higher?
Nobody has ever explained these issues. Find out the answers in my detailed blog here.
The views expressed here are those of the author/contributor and do not necessarily represent the views of The Independent Singapore.