Your posts show you have a certain level of knowledge of the market and I note you refer to yourself as a regulatory economist. Your posts do provide a good change from the sentiment charged posts.
However, I am surprised that as a regulatory economist you have not given a balanced view. Your posts are extremely narrow in focus and continually miss the broader perspective that should be considered and discussed. Particularly in an industry that is in the midst of change (started with EPIRA 2001 and many subsequent documents some of which I will refer to later). You respond to every post providing a one sided argument which is carefully worded. As an example you point out that supercritical coal has improved efficiency and compare it only to an open cycle gas turbine (OCGT), you don’t state and compare the improvements in efficiency of a CCGT, or mention that the majority of the coal plants in Philippines are not supercritical and worse still you fail to mention the capital costs of these supercritical coal plants, which are significantly more expensive (see my discussion below).
You will be right under the following narrow conditions:
WESM prices remain low (and do not provide signals or incentives for developing the next generation required) and agreements continue to be accepted particularly by Distribution Utilities that encourage high cost generation alternatives,
EWC once operating, will never be able to do a similar deal with a Distribution Utility/Retailer,
EWC’s more efficient and cleaner assets will never be attractive to an existing operator,
That open access will never occur (despite this being the next part of the structural change being implemented),
That the wide gap between WESM and Distribution Utility/retail prices will be ignored by regulators and action will not happen to address this e.g. a breakup of the lines companies,
That the Philippines will ignore the Paris Accord which was again confirmed over the last weekend by 200 countries (the Paris Accord is voluntary but deaths from pollution are not).
Let’s get a balanced discussion.
If you have studied market structures you will know that the electricity market in Philippines is likely to undergo more change to enable more competition. I refer you to the many House Resolutions/Bills that question the operations of Meralco, (approving uneconomic contracts), the ERC (already some internal disruption) and NGCP (more of this in my discussion).
Electricity deregulation is a dance between existing utilities incentive to more than recover cost of past and future investments and consumer advocates’ desire for lower electricity prices for their constituents. Obviously monopolistic power, industry structure, uncompetitive procurement, political connections and lobbying can swing the pendulum. Your arguments point to extreme market power or uncompetitive procurement persisting. This is under scrutiny and tends to be unstable and not in the spirit of EPIRA. Looking across different electricity markets you will see a certain pattern which is the dismantling of the vertically integrated structures because of the monopolistic nature/market power of these assets. This starts to create transparency and better accountability across the different components of the industry, generation, transmission, distribution and retail.
The first step in the Philippines was to recognise the issues. This was done some years ago with EPIRA in 2001 and has been followed by many House orders and other official documents all available on official websites. This was followed by the development of the WESM.
The rationale for this is simple; it is to establish a market clearing mechanism to dispatch generation in real time/hour. The market clearing price serves as a reference point and a measure of the opportunity cost for a generator/seller or input cost for a buyer. In times of excess, generation prices will be below Long Run Marginal Costs (LRMC) and in times of supply shortages the price duration curve will signal for new capacity to be built. Obviously if the WESM price remains low indefinitely then buyers should not hedge and should instead buy on the spot market but bear the volatility price risk. One would expect additional products and services to be developed to enable better risk management over time (hedge products, caps, etc.). This greater transparency will allow the market/regulators/ consumer advocates to measure where the margins are being made along the value chain. The difference between wholesale electricity and retail prices less associated cost then becomes an area of focus.
We have already seen the next leg of development and pressure for industry change such as; rules for Retail Competition and Open Access (RCOA), House bills looking into Power Supply Agreements, Cross ownership, Market Power Abuse and Anti-Competitive Behaviour.
With this as a background let me summarise your case and then test this in the real world.
Your argument does not allow for effective competitive procurement ever. High cost plants get built where they get capital cost recovery through contracts with Meralco/Distribution Utilities and the Philippines people are forced to pay for this through high retail electricity prices (among the highest in the region and the world) and by implication this low wholesale electricity price in the WESM will persist and therefore keep competition out and by implication this will perpetuate forever.
My discussion:
There certainly are high cost plants being afforded preferential treatment (investigations into Meralco signing uneconomic contracts and House Resolution 1034 are examples of this). Here are some economics of incumbent plants. The Team Energy supercritical coal plant is likely to cost $1b USD to build 420 MW or $2.4m per MW on a brown field site. Malampaya gas cost inflation adjusted prices in my view is over $11 USD per MMBTU. Who knows what cost is required to keep the 2700MW of relatively old capacity at Batangas running. The best estimate to date is $US2 bill (see DOE presentation). If they don’t do something then they will need to replace 2700 MW just to keep supply flat. Replacing them with supercritical coal to ensure they are competitive with Energy World’s CCGT (your point) using Team Energy’s brown field site expansion metrics would cost $6.5b (pretty sure solar will cost more but will then also require more resilience in the system).
Energy World certainly has some significant cost advantages over these incumbents. 650 MW at $588m i.e. less than $1m per MW. We’ll have to wait and see what the delivered LNG price for Energy World is, but on current prices I’m confident it’ll be significantly lower than the $11 per MMBTU Malampaya price. The 3 million ton LNG capacity tank is enough to supply 3000 MW of generation capacity but for a cost of $130m (excluding cost of carry) versus a $2b solution at Batangas.
I’m sure you will say the assets are not completed etc. But, it is this cost advantage that gives Energy World a high probability of at least getting book value (50 cents) and massive option value should they cement themselves in the Philippines market. These assets are clearly worth a lot more (i.e. above book value) to the incumbents given the replacement cost these operators are willing to incur/pay. Should Energy World successfully establish themselves in the Philippine’s market then all the arguments currently used by you reverse and become a competitive advantage for Energy World. Once EWC has a proven track record it will be attractive to a new electricity retailer enabling it to set up with a significantly lower cost structure than the incumbents locked into long term high priced contracts.
I’m not sure how else a new entrant should optimise their entry into the market without selling it into the WESM especially when part way through a 650 MW build. You argue to establish in the market you need a contract. But to get a contract you need to be established. This is impossible because there are no risk management tools around WESM. This implies no new entrants. It is also unlikely incumbent generators will offer/provide the new player, Energy World, cover at a reasonable price or reasonable terms.
So where is this likely to leave EWC assets and value?
It appears to me that the only way EWC’s assets won’t work is if the existing players continue to “block” progress. The ownership structure of the current power industry does incentivise this behaviour. However this is against the spirit of EPIRA and the build-up of official support to break this is well underway with EWC likely to be a beneficiary (resolution 1034 and many other House Orders). Reading the ERC ruling posted by quack, NGCP should have connected EWC by now.
A couple of other points:
You state that the price cap of $630 per MWh is too low, but it is the load duration curve that matters (estimating how the shifts in demand and supply and that impact on the load duration curve is the critical factor but the best brains get this wrong). Here are some sensitivities, if EWC’s 650 MW plant got 1%, 2%, or 3% of the annual load clearing at $630 per MWh it would generate an incremental $28m, $57m, $85m respectively of EBITDA/gross profit.
You state that WESM is set only by “short run marginal fuel cost period”. I disagree. It is dependent on a number of variables. Game theory and option pricing models suggest this is not the case. Individual hedge positions of participants involved also have an influence. Your assumption would empirically result in a Bertrand type game/equilibrium in wholesale electricity markets but there are plenty of wholesale electricity markets that suggest Cournot type equilibrium occurs where wholesale prices are consistently above the highest short run marginal cost. Obviously given there is volatility involved option pricing models, spark spreads, dark spreads, etc. are also part of the traders tool kits. Vertically integrated models are very good at exploiting these opportunities!
In summary, your narrow focus, the timing of your recent postings (i.e. just when shorter/index issues are impacting the price), the recent frequency of your postings, the intensity of your postings (i.e. an instant answer to every post often repeating the same issues but without complete information) and narrowness of focus would suggest that you are part of the shorting group whether directly or indirectly.
Posters – Sorry about the long post but to deal with the unbalanced nature of the issues raised, it felt necessary.
EWC Price at posting:
23.0¢ Sentiment: Buy Disclosure: Held
(20min delay)
