DEVELOPMENT OF

AN ELECTRICITY FUTURES MARKET

IN SINGAPORE

CONSULTATION PAPER

Closing date for submission of comments and feedback:

19 NOV 2012

22 OCT 2012 ENERGY MARKET AUTHORITY 991G ALEXANDRA ROAD #01-29 SINGAPORE 119975 www.ema.gov.sg

Disclaimer:

The information in this Paper is not to be treated by any person as any kind of

advice. The Energy Market Authority shall not be liable for any damage or loss

suffered as a result of the use of or reliance on the information given in this Paper.

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EXECUTIVE SUMMARY

1. The Energy Market Authority (EMA) is reviewing the development of an electricity

futures market in Singapore. This consultation paper puts forth a suggested

implementation roadmap with the objective to seek views from stakeholders on the

proposed approach.

2. The development of a liquid electricity futures market will benefit stakeholders across

the industry by providing them with more options and facilitating a robust price discovery

process. The outcome is a more efficient supply of electricity in the wholesale and retail

markets, which will benefit industry stakeholders and electricity consumers. Given the

size of Singapore‟s market, the key challenge to the development of the electricity

futures market is to ensure sufficient initial liquidity. In this regard, the EMA is

considering , as part of the development of an electricity futures market, the incentives

for generators to enter into market making (MM) agreements with an exchange.

Glide Path or Phased Approach

3. To allow generators to build the necessary competencies for trading in the electricity

futures market, the development of the electricity futures market is proposed to be

staged in terms of both implementation and product type. Under the proposed glide path

or phased approach, the MM volumes and the two-way price making spread will

increase and decrease respectively over three phases.

Forward Sales Contract Regime

4. The proposed incentive is in the form of a commercial arrangement called the Forward

Sales Contract (FSC). To be eligible for the FSC, generators will be required to enter

into MM arrangements with an exchange. The FSC allows generators to have fixed

volume indexed price contracts, pegged to either the prevailing Liquefied Natural Gas

(LNG) Vesting Price or Balance Vesting Price.

5. The volume allocated for the FSC scheme would be a fixed MWh pegged at

approximately 5-6% of the average forecasted annual electricity demand for three years

from 2013 to 2015, as of a specified date to be determined by the EMA. The volume of

FSC will be distributed evenly across all time periods in the quarter during the contract

duration.

6. There will be 2 key stages in the FSC allocation process: the pre-qualification stage and

bidding stage. Companies with a generator class of licence are eligible to participate in

the pre-qualification stage, where interested generators have to sign a Memorandum of

Understanding (MOU) with an exchange of the generator‟s choice, in order to qualify for

the next stage.

7. In the bidding stage, pre-qualified generators would be invited to submit a single bid of

their total MM volume in exchange for the FSC volume to be allocated to them.

8. All generators, regardless of size, can sign up for either of the proposed schemes,

depending on their respective commercial preference. Scheme A has a lower minimum

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MM volume of 1.5MW for an FSC volume equivalent to 0.3% of the total load, while

Scheme B has a higher minimum MM volume of 3.0MW for an FSC volume equivalent

to 0.75% of the total load.

9. Prior to the start of the FSC arrangements, there would be a trial phase of six months,

where participating generators can choose to exit the scheme without any penalty. The

intent of this phase is to allow for generators to be comfortable with MM arrangements

before entering the 3-year commitment of market making tied to the FSC incentives.

After the trial phase, participating generators will be required to complete the 3-year

commitment to MM arrangements, in return for the FSC incentives.

10. Similar to the existing Vesting Contracts, which are Contracts-for-Difference (CfDs), the

counterparties for the FSC are the Market Support Service Licensee (MSSL) on the buy

side and the generators on the sell side. Given that the primary beneficiaries of the

electricity futures market will be the contestable consumers (CCs), the FSC will be

spread across all CCs (i.e. any debits or credits from the FSC would be spread across

all CCs‟ load). Like Vesting Contracts, the FSC do not necessarily mean that the

contestable consumers will pay more – essentially they provide a hedge for consumers

against volatile prices in the wholesale market while ensuring that participating

generators have certainty of revenue stream for their allocated volumes.1

11. There are further trading cost synergies that can be realised through the electricity

futures market, such as allowing the electricity futures contracts to be used to offset the

prudential requirements of market participants in the wholesale electricity market. As an

additional benefit, should the electricity market rules be amended in future to allow this,

only participating generators in the FSC scheme will be allowed to offset their

corresponding prudential arrangements, in recognition for their contribution towards the

establishing a liquid futures market.

Market Information Access

12. The success of the electricity futures market, similar to any typical futures market,

premises on that fact that there is little or no significant information asymmetry between

the physical players and non-physical players. The EMA will be reviewing the existing

wholesale electricity market information disclosure procedures, taking into consideration

best practices from other markets. The objective of the review is to ensure that all

potential participants in the electricity futures market can access the information made

available to market participants in the wholesale electricity market, including outage

plans, forecast demand and prices, and aggregated gas curtailment information.

Consultation Process

13. This paper constitutes part of the EMA‟s consultation process to determine the

development approach for Singapore‟s electricity futures market. After considering the

1 The FSCs are CfDs with a strike price based on the prevailing LNG Vesting Price or Balance Vesting Price. The

CfDs work on the following basis: when wholesale electricity price is above the strike price, the generators pay the contestable consumers through the Market Support Service Licensee (MSSL) the difference between the wholesale electricity price and strike price, and vice versa.

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feedback from key stakeholders on the proposed implementation approach, the EMA

intends to issue a final determination paper to specify and detail our decision.

14. The EMA invites comments and feedback to the consultation paper. Please submit

written feedback to EMA_PPD@ema.gov.sg by 19 Nov 2012 (5pm). Alternatively, you

may send the feedback by post/fax to:

Policy and Planning Department Energy Planning and Development Division Energy Market Authority 991G Alexandra Road, #01-29 Singapore 119975 Fax: (65) 6835 8020

15. Anonymous submissions will not be considered.

16. The EMA will acknowledge receipt of all submissions electronically. Please contact Mr

Eng Zhen-Hui at 6376 7589 or Ms Chua Shen Hwee at 6376 7653 if you have not

received an acknowledgement of your submission within two business days.

17. The EMA can facilitate meeting with the relevant stakeholders on an individual basis to

discuss their feedback to the consultation paper. Please contact EMA via

EMA_PPD@ema.gov.sg if you wish to arrange a meeting with EMA‟s Policy and

Planning Department.

18. The EMA reserves the right to make public all or parts of any written submissions made

in response to this consultation paper and to disclose the identity of the source. Any part

of the submission, which is considered by respondents to be confidential, should be

clearly marked and placed as an annex which the EMA will take into account regarding

the disclosure of the information submitted.

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TABLE OF CONTENT

EXECUTIVE SUMMARY ............................................................................................. i

TABLE OF CONTENT ................................................................................................iv

SECTION 1 BACKGROUND AND INTRODUCTION ................................................. 1

SECTION 2 PROCESS OF ENGAGEMENT ............................................................. 1

SECTION 3 APPROACH AND KEY PRINCIPLES .................................................... 2

SECTION 4 GLIDE PATH OR PHASED APPROACH ............................................... 5

SECTION 5 FORWARD SALES CONTRACT REGIME ............................................ 7

SECTION 6 MARKET INFORMATION DISCLOSURE ............................................ 16

SECTION 7 MARKET INFRASTRUCTURE ............................................................. 17

SECTION 8 SUMMARY ........................................................................................... 18

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SECTION 1 BACKGROUND AND INTRODUCTION

1.1 Objective of the consultation paper

1.2.1 The Energy Market Authority (EMA) is reviewing the development of an electricity

futures market in Singapore. This consultation paper puts forth a suggested

implementation roadmap with the objective to seek views from stakeholders on the

proposed approach.

1.2 Background

1.2.2 The National Electricity Market of Singapore (NEMS) is in operation since 2003 with

the objective of promoting the efficient supply of competitively priced electricity. It

comprises a spot wholesale market for energy, regulation and reserve electricity

products.

1.2.3 The electricity retail market has also been gradually liberalised. Consumers with an

average monthly consumption greater than 10,000kWh per month can be

contestable, which allow them to choose from a range of electricity providers for

their supply of electricity. At present, this comprises about 70% of the total demand

in Singapore.

1.2.4 The development of an electricity futures market, which supports the trading of

“forward” electricity products, will complement both the existing wholesale and retail

electricity markets. It is also a platform for industry players and financial

intermediaries to use electricity and related financial instruments for risk

management and investment activities.

1.2.5 Such a development could also tap on Singapore‟s position as a financial centre

with well-established capital markets, and potentially create spin-offs in the trading

of other energy-related commodities such as liquefied natural gas (LNG) related

products.

SECTION 2 PROCESS OF ENGAGEMENT

2.1 Consultation Process

2.1.1 In January 2012, the EMA embarked on a consultancy study for the development of

an electricity futures market in Singapore. The scope of work for the study includes

identifying the key challenges and critical factors for the development of an

electricity futures market in Singapore, as well as to identify appropriate

development paths and possible policy options to facilitate the necessary

development.

2.1.2 The consultancy study was undertaken by Cybele Capital Limited (thereafter

„Cybele‟), which has been previously involved in similar projects, including advising

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the New Zealand Electricity Authority on the successful launch of the electricity

futures market for New Zealand.

2.1.3 The EMA, with the support of Cybele, has engaged the key stakeholders in the

electricity industry and relevant players in the financial sector to seek inputs on the

proposed development approach for an electricity futures market as part of the

consultancy study. Cybele‟s final report is attached with this consultation paper in

Appendix 1 for reference.

2.1.4 Based on the outcome of the consultancy study and following several rounds of

industry engagement, a proposed development path for an electricity futures market

in Singapore has been identified in this consultation paper, which the EMA would

like to seek further feedback and comments.

SECTION 3 APPROACH AND KEY PRINCIPLES

3.1 Key benefits of an electricity futures market

3.1.1 Based on the feedback from stakeholders, the outcome of the consultancy study

indicated that the development of a liquid electricity futures market will benefit

stakeholders across the spectrum of the industry. A liquid electricity futures market

includes the following features2:

(i) standardised contracts (such as volumes of electricity traded, lengths of

contract or expiration dates, and contract tick size or minimum contract

fluctuation);

(ii) centrally cleared (typically by a financial exchange); and

(iii) anonymous trading (buyers and sellers are not revealed).

3.1.2 For generators, the electricity futures market provides an additional option to

manage risks more efficiently. For example, generators can use the electricity

futures contract to hedge plant outages ahead of time. Instead of relying on bilateral

over-the-counter (OTC) contracts with other generators or running up the more

inefficient generation sets to cater for such events, generators can use the

electricity futures market to hedge their exposure during such outages and reduce

their price exposure. The electricity futures contracts enable price risks to be

efficiently transferred during plant outages, thereby providing an additional platform

for generators to manage their commercial and operational risks and facilitate

greater efficiency in the wholesale market.

3.1.3 For retailers, the electricity futures market provides an additional tool for them to

hedge price risks as part of their risk management strategy, on top of the options

available currently, which are to buy via the wholesale market or to sign OTC

2 More detailed explanation on how an electricity future market operates can be found in Cybele‟s final report in

Appendix 1.

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contracts with generators. Given the exposure to volatile prices when buying from

the wholesale market to on-sell to consumers, the latter option is the prevalent

practice where existing retailers sign OTC contracts with generators (typically the

respective generators owned by the same holding company). As a result, the retail

contract volumes are often constrained by the size of the corresponding generation

assets. A liquid electricity futures market will therefore provide benefits in a two-fold

manner for the retail market: allow incumbent retailers to expand their potential

retail volumes, as well as lower the barrier of entry in the retail market to spur the

entry of new and independent retailers. From what has been observed in

jurisdictions with similar market structures such as New Zealand, the entry of

independent retailers, which can use the electricity futures market as an instrument

to lock in fixed retail prices for consumers, would enhance competition in the

electricity retail market by putting downward pressure on retail prices and facilitate

the development of new retail products.

3.1.4 For electricity consumers, the electricity futures market will bring benefits through

enhanced competition in the wholesale and retail markets and the provision of

greater price transparency through the forward price curves established in the

futures market. For example, contestable consumers can access the forward

reference market prices and use electricity futures as a reference price, amidst

other considerations, before making informed decisions on their electricity retail

contracts.3

3.1.5 Overall, a liquid electricity futures market provides a robust price discovery process

for the supply of electricity, enables the efficient transfer of risk between participants

through the trading, and facilitates the procurement of hedge cover for both

incumbents and new entrants. The outcome is a more efficient supply of electricity

in the wholesale and retail markets, which will benefit stakeholders across the

industry including electricity consumers.

3.2 Key barrier – lack of initial liquidity

3.2.1 From our engagements with various stakeholders in the electricity industry, most

market participants have validated the view that an electricity futures market would

be a useful additional feature in the industry, and would improve the

competitiveness and efficiency of the wholesale and retail markets. However, most

market participants indicated that participation in such a market is conditional on

having access to a liquid market, without which they are unlikely to trade in the

electricity futures market. Given the current market structure where there is

significant vertical integration between generators and retailers (who tend to

manage their risks internally by trading with each other) and the relatively small

domestic market size, this creates a self-perpetuating loop of inactivity. The key

challenge to the development of the electricity futures market is to ensure sufficient

initial liquidity in the market. This initial liquidity is required to provide the confidence

to potential participants, including non-physical players (such as financial

3 Contestable consumers are non-residential electricity consumers whose average monthly consumption over a

12-month period is above 10,000KWh.

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institutions), such that there is sufficient market depth, thereby generating more

liquidity for the market to be sustainable in the long run.

3.3 Commercially driven solution with initial regulatory support

3.3.1 The EMA‟s assessment, following the outcome of the consultancy study and

engagement with stakeholders in the industry, is that this initial lack of liquidity can

be overcome with regulatory support from the EMA in order to facilitate the

development of an electricity futures market.

3.3.2 To kick-start liquidity, generators‟ participation in the electricity futures market as

market makers is a key success factor. Market-making requires the putting up of

two-way pricing (i.e. both buy and sell) within a pre-determined price spread. This is

similar to how liquidity is often created and maintained in the trading of other

commodities in the futures markets, where there are sufficient physical providers

playing this role as market makers. As such, the EMA is considering as part of the

development of an electricity futures market to incentivise generators to enter into

market making (MM) agreements with an exchange. Beyond a number of baseline

requirements for MM obligations and contract specifications required by the EMA as

part of the MM arrangements between the generators and the exchange, the MM

agreements and contract specifications would be negotiated between the

generators and an exchange on a commercial basis.

3.3.3 This approach will help to overcome the initial barrier of the lack of liquidity, while

ensuring that the set-up is commercially-driven. The advantage of this proposal is

that it would empower market participants with greater ownership of the

development of the electricity futures market, thereby encouraging the sustained

growth of the market and further product innovation.

3.4 Broad regulatory principles in facilitating the development of a liquid electricity

futures market

Phased implementation approach of the electricity futures market

3.4.1 For the reasons explained earlier, the EMA recognises that the electricity futures

market would not develop organically. However, the EMA also believes that if the

right conditions are provided for trading to begin, the market would be self-

perpetuating to the point that it would evolve on its own accord as the general

trading culture of the market improves.

3.4.2 In view of the net benefits of a liquid electricity futures market, the EMA intends to

provide the necessary initial conditions to encourage the generators (who are likely

to form the core nucleus of electricity futures market participants) to participate in

the electricity futures market. Once the initial conditions are established, further

development of trading capabilities and culture within the participating generators

can occur organically.

3.4.3 To do so, the EMA intends for the electricity futures market to be a staged

development in terms of both implementation and product type, to reduce the risk

for market participants as they build trading capabilities.

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Voluntary approach for generators to participate in the electricity futures market

3.4.4 The EMA intends to introduce incentives to encourage the participation of

generators as market makers in the electricity futures market. This voluntary

approach brings about greater ownership over the development of the electricity

futures market, and is aligned with the EMA‟s long term objectives for the market to

be commercially-driven and self-sustaining at steady state.

3.4.5 The proposed incentive is in the form of a commercial arrangement, called Forward

Sales Contract (further elaborated in Section 5) between the generators and the

Market Support Service Licensee (MSSL, i.e. SP Services), in exchange for binding

MM arrangements between the generators and an exchange. Figure 3.1 shows the

interaction between MSSL, generators and the exchange in the wholesale, futures

and retail markets.

Figure 3.1 Interaction diagram between wholesale, futures and retail markets

3.4.6 Sections 4 and 5 provide details on the proposed approach for the development of

a liquid electricity futures market in Singapore.

SECTION 4 GLIDE PATH OR PHASED APPROACH

4.1 Features of the Glide Path or Phased Approach

4.1.1 A glide path or phased approach is proposed, where liquidity will be built up over

three phases. In essence, the MM volume and the two-way price making spread will

increase and decrease respectively over the phases, and liquidity will be

established accordingly.

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4.1.2 The glide path approach recognises the skill gaps in futures trading and MM within

the electricity industry that will need to be addressed before trading can sustainably

develop.

4.1.3 Table 4.1 describes the key features of the proposed glide path approach, which is

time graduated, with increasing MM requirements over time. Phase 3 is the

outcome that the EMA seeks to achieve for the development of the electricity

futures market. The suggested approach of Phases 1 and 2, including the length of

the phases, allows generators to build up the necessary skill sets and competencies

for MM, but there may be alternative(s) that the industry may want to propose for

the EMA‟s consideration.4 These alternative proposal(s) would require the

agreement, on a commercial basis, between the generators and the exchange of

the industry‟s choice. In this regard, the actual duration and calibration for each

parameter for Phases 1 and 2 would be subject to review by the EMA, depending

on the actual progress of the electricity futures market.

Table 4.1 Proposed specifications for futures market making obligations

Parameter Phase 1

(3 - 6 months)

Phase 2

(3 - 6 months)

Phase 3

(steady state)

Maximum Two-way

Price Making

Spread

$20/MWh $15/MWh $10/MWh

Minimum Period of

Market Making ½ hour (e.g. 4.30pm to 5.00pm) Singapore Business Days

Refresh

requirements No Yes, once

Yes, once and followed

by best endeavours

Portfolio Stress

Clause Yes Yes Yes

Cumulative

Contract Duration

1 year

(4 contracts5)

2 years

(8 contracts)

3 years

(12 contracts)

4.1.4 Market makers will be required to put up two-way pricing (i.e. both buy and sell

prices) for the required market making quantities within the specified spread in each

phase. For example, the difference between the buy and sell prices offered for each

futures contract by market makers in Phase 3 should not be more than $10/MWh.

The two-way price making spread helps to build liquidity by providing assurance to

participants that there will always be sufficient bids and offers on either side at a

fixed spread for them to enter or exit the futures market.

4.1.5 To help concentrate liquidity and trading at specific time period each day (which is

particularly important at the initial phase of the market), the proposed minimum

period of market making is ½ hour for each trading day. During the market making

period, market makers are required to put up two-way pricing for the required

number of contracts or volumes of trade (e.g. 6 contracts for 3MW of market making

4 For example, based on feedback from stakeholders, part of Phases 1 and 2 can be replaced with a simulation

exercise that will allow the generators to build trading competencies and the relevant skills for futures trading and MM. 5 This is based on calendar quarter contracts.

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obligation for each contract of 0.5MW). In addition to the required market making

quantities, market makers can make additional trades (i.e. single sided trades of

either buy or sell) during the market making period or at other trading times.

4.1.6 The refresh requirement is an important feature in a liquid electricity futures market

to ensure continuous prices are available in the market for participants to enter and

exit trading positions. Market makers are required to reload their two-way pricing

immediately after a trade has been made with respect to their bids (i.e. when

another participant accepts the price offered by the market maker, either on the buy

or the sell side). For example, in Phase 2, market makers will be required to put up

new buy and sell prices for the number of contracts traded once a trade (based on

the initial buy or sell prices) has been conducted. In Phase 2, there will be no

requirement to reload the next time the new buy and sell prices are accepted by

another participant. This will be followed by best endeavours from Phase 3

onwards.

4.1.7 To ensure an orderly market environment for trading, the exchange will typically

have standard portfolio stress clauses that will kick in during times of disorderly or

abnormal market conditions. Similar to other financial and commodity futures

markets, these standard portfolio stress clauses will be in place from the start of

Phase 1 and are determined and administered by the exchange. Examples of these

controls include, but are not limited to, position limits, daily volume limits, daily price

limits and market concentration limits.

4.1.8 The cumulative contract duration indicates the length of the forward curve for the

electricity futures market. In Phase 1, the minimum length of the forward curve is

proposed to be one year, i.e. market makers will be required to put up two-way

prices for contracts one year ahead. For example, a market maker in Q4 2013 will

be required to put up two-way prices for each of the quarters in 2014. At steady

state, the proposed length of the forward curve is three years where participants will

be able to trade electricity products up to three years ahead. The progressive length

of forward curve enables market makers to price electricity more effectively and

efficiently ahead of time, and at the same time ensures a robust price discovery

process in the market.

SECTION 5 FORWARD SALES CONTRACT REGIME

5.1 FSC Scheme

5.1.1 To facilitate generators‟ participation in the electricity futures market as market

makers, the EMA is considering introducing an incentive scheme through a Forward

Sales Contract (FSC) regime, in exchange for MM obligations in the electricity

futures market.6 The EMA recognises that there are risks associated with MM

6 The FSC has similarities with the current vesting contract arrangement (i.e. Contract for Differences between

generators and SPS at vesting price), but would be implemented and treated as a separate scheme, given the different objectives.

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requirements and corresponding costs, particularly in the start-up phase where

generators are building the necessary capabilities. The FSC allows generators to

have fixed volume indexed price contracts, and thereby revenue certainty for the

allocated volumes.

5.2 FSC Documentation

5.2.1 The FSC documentation is proposed to be based upon a standard financial

contract, the International Swaps and Derivatives Association (ISDA) Master

Agreement (Second Edition, 2002), which is typically used between a derivatives

dealer and the counterparty when negotiating derivatives trade.7 The relevant

Singapore provisions will be included in the 2002 ISDA Master Agreement. The

proposed FSC regime to facilitate the initial voluntary participation of generators in

the electricity futures market will be detailed as a Singapore Electricity Addendum to

the 2002 ISDA Master Agreement. As the proposed FSC regime shares many

similarities to the EMA‟s existing Vesting Contracts, the Singapore Electricity

Addendum will be modelled largely after the features of the EMA‟s existing Vesting

Contracts.

5.2.2 The intent of the FSC documentation is to provide a standardised contracting

framework for all electricity financial trading, including OTC transactions. As a

standardised contract, an additional benefit of the FSC documentation is that this

contract can be used by any entities for the trading of electricity related financial

products in Singapore and thereby provide a baseline reference to facilitate greater

OTC trading between entities. While entities are free to continue to use bespoke or

tailored contracts for OTC transactions, having a standardised contracting

framework through the ISDA Master Agreement effectively lowers the transaction

costs for trading and facilitates more OTC transactions, which would be

complementary to the growth of the electricity futures market.

5.3 FSC Volume

5.3.1 The volume allocated for the FSC scheme would be a fixed MWh pegged at

approximately 5-6% of the average forecasted annual electricity demand for three

years from 2013 to 2015 as of a specified date to be determined by the EMA. For

instance, based on the forecasted annual electricity demand for years 2013 to

2015, the corresponding average forecast annual electricity demand figure for the

allocation of FSC volumes can be computed (see Table 5.1 below).

7 The ISDA is a trade organisation of participants in the market for over-the-counter derivatives. It is

headquartered in New York, and has created a standardised contract (the ISDA Master Agreement) to enter into derivatives transactions. The ISDA Master Agreement is usually combined with a Schedule to set out the basic trading terms between the parties; each subsequent trade is then recorded in a Confirmation which references the Master Agreement and Schedule. For a copy of the 2002 ISDA Master Agreement, please see www.isda.org.

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Table 5.1 Computation of FSC Volume based on forecasted annual electricity demand

Forecasted total annual

electricity sales8 Average forecasted

annual electricity

sales (2013-2015)

FSC Volume per year

(based on

approximately 6% of

average forecasted

annual electricity sales) Year 2013 2014 2015

Annual

electricity

sales

(GWh)

44,146 45,690 47,287 45,707 2,700

5.3.2 The volume of FSC (i.e. 675GWh per quarter9) will be allocated evenly across all

time periods in the quarter during the contract duration (further detailed in Section

5.12), mirroring the proposed base-load contract in the electricity futures market.

5.4 FSC Price

5.4.1 In view that regasified LNG will be used by both new and existing generators, the

EMA intends for the FSC price to be pegged to the LNG Vesting Price (LVP). Based

on the feedback from the industry, some generators have expressed a preference

for their FSC prices to be pegged to the Balance Vesting Price (BVP) which is

currently based on Piped Natural Gas (PNG) price.10 Given that it is not necessarily

the case that one price is higher than the other as they vary based on different fuel

indices and price formulae, the EMA will allow participating generators to choose

whether their FSC contracts are to be pegged to the prevailing LVP or BVP.11 The

choice will be binary (i.e. there will be no weighted blend of both LVP and BVP) for

the respective generators, and the generators will not be allowed to switch between

the price references during the tenure of the FSC scheme.12

5.5 FSC Implementation and Interaction with Vesting Contracts

5.5.1 The FSC volumes will be additional and above the existing Vesting Contract level.

To avoid over-contracting the market, the EMA intends to dovetail the

implementation of the FSC with the roll back of the Vesting Contract regime

(starting from the second half of 2013 where vesting level is reduced from 55% to

50%, or from 2014 where vesting level would be further reduced to 40%).

8 The forecasted annual electricity demand is accurate as of February 2012. The forecasts will be revised prior to

the start of the FSC scheme, depending on the start date of the FSC. 9 This is based on approximately 6% of the average forecast demand of 45,707GWh per year, i.e. 2,700GWh*1/4

= 675GWh. 10

The BVP, as used in the EMA‟s Procedures for Calculating the Components of the Vesting Contracts, refers to the price associated with a Balance Vesting Quantity, which is the Allocated Vesting Quantity less the LNG Vesting Quantity for each half hour period. 11

This will follow the prevailing methodology under the current procedures for Vesting Contracts. 12

The vesting price is published by MSSL (i.e. SP Services) prior the start of the quarter. In view that the reference or strike price for the FSC is the prevailing vesting price, the reference prices (both LVP and BVP) will be made available at least 7 days prior the start of the quarter.

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5.6 Pre-qualification Stage

5.6.1 There will be 2 key stages in the FSC scheme: the pre-qualification stage and

bidding stage.

5.6.2 Companies with a generator class of licence are eligible to participate in the pre-

qualification stage. In this stage, interested generators have to provide an indication

of interest to participate as market makers by signing a Memorandum of

Understanding (MOU) with an exchange of the generator‟s choice. While the nature

of the MOUs is non-binding, requiring interested generators to sign MOUs achieves

the following:

(i) Allows the EMA to gauge the interest from generators in the FSC scheme to

ensure that there are sufficient interested players to proceed to the next

stage;

(ii) Allows the generators to select the exchange of their choice, rather than for

the EMA to select the exchange. This is aligned with the EMA‟s policy intent

for the development of the electricity futures market to be commercially driven

as far as possible; and

(iii) Allows the generators to work with the exchange of their choice at an early

stage. Early participation will allow the generators to start negotiating and

discussing with the exchange the setup of the electricity futures market, such

as the details revolving around the development approach, market design, as

well as the product and contract specifications. This brings about greater

ownership to the development of the electricity futures market as generators

would have the opportunity to articulate their preference prior to the start of

the futures market.

5.6.3 Only generators who have entered into an MOU with an exchange will be eligible to

participate in the bidding stage. In the event that more than one exchange is

selected during this stage, the exchange that is selected by the majority of the

generators will be the exchange of choice. In such cases, all the generators with an

MOU (regardless of the exchange they chose) can proceed to the bidding stage.13

5.7 Bidding Stage

5.7.1 In the bidding stage, eligible generators are invited to submit a single bid of their

total MM volume in exchange for the FSC volume to be allocated in the bidding

stage. The MM volume would need to satisfy the baseline requirement set by the

EMA to be eligible for the FSC, detailed in Section 5.9. After the bidding stage, the

EMA would inform the generators the volume of FSC allocated and the expected

MM volume. In the event that the MM volume which has been allocated for the FSC

is lower than what the generators have bid in, the former volume will set the

minimum volume that generators have to enter with the exchange.

13

For example, if Generators A, B, C chose exchange X, while Generators D and E chose exchange Y, exchange X will be the exchange of choice for the industry. Generators A-E can proceed to the bidding stage and will have to work out market making arrangements with exchange X. In the event of a tie, the EMA may choose to request the relevant exchanges to submit proposals for the EMA‟s consideration.

11

5.7.2 For example, if a participating generator bids a total of 5MW MM volume in

exchange for FSC volumes but is only allocated 1.05% of FSC volume for 4MW of

MM volume (based on the FSC allocation rate under Scheme A detailed in Section

5.8), it will only be obligated to fulfil their MM obligations for 4MW with the

exchange. However, there will not be restrictions on the generators having MM

agreement with a volume over and beyond the minimum MM volume used for the

purpose of allocating FSC.

5.8 FSC Allocation

5.8.1 The allocation of the FSC volume will be based upon the MM volumes for Phase 3.

All generators, regardless of size, can sign up for either of the schemes, depending

on the commercial preference of the respective generators.

(i) Scheme A : FSC allocation with a minimum bid of 1.5MW; and

(ii) Scheme B: FSC allocation with a minimum bid of 3MW in Round 1 and

optional tranches of 0.5MW in Round 2.

5.8.2 Scheme A has a lower minimum MM volume of 1.5MW, while Scheme B has a

minimum MM volume twice that of Scheme A. Given the higher minimum MM

volume, Scheme B provides generators a higher FSC volume for the same MM

volume offered, i.e. the allocation rate (% FSC per MW) is preferential in Scheme B.

Through this arrangement, generators can choose either of the two schemes

depending on their respective commercial arrangements and preferences, such as

risk management practices. For instance, generators with more conservative risk

management practices may opt for Scheme A as the corresponding obligated MM

volume is lower. The allocation rates for each scheme are detailed in Table 5.2.

Table 5.2 Proposed FSC allocation schemes and rates

Scheme A Scheme B

MM

Volume

FSC

Volume

(% of total

forecast

demand)

Rate MM

Volume

FSC

Volume

(% of total

forecast

demand)

Rate

Round 1 1.5MW 0.3% 0.2%

per MW 3MW 0.75%

0.25%

per MW

Round 214

- - - 0.5MW 0.15% 0.3%

per MW

5.9 Baseline Requirements for Market Making Obligation and Contract Specifications

5.9.1 The MM volume submitted in exchange for the FSC has to comply with a baseline

requirement to be determined by the EMA. The proposed baseline requirements are

14

Depending on the uptake of the FSC volumes, the EMA shall retain the right to redistribute or withhold any remaining FSC in Round 2 for any additional MM volume offered at a minimum tranche of 0.5MW. Generators that offer MM volume greater than Round 1 would then be allocated the remaining FSC, subject to the maximum FSC volume.

12

detailed in Table 5.3. In the event that any of the requirements is not met as part of

the MM arrangements between the generators and exchange, the FSC will not be

allocated to the generators.

Table 5.3 Proposed baseline requirements for MM arrangements in exchange for FSC

Specifications Proposed baseline requirements

1 MM volume

Phase 1 (6 months but can be shortened): 1/3 of MM volume of

respective generator

Phase 2 (6 months but can be shortened): 2/3 of MM volume of

respective generator

Phase 3 (steady state): MM volume of respective generator

2 MM spread

Phase 1 (6 months but can be shortened): $20/MWh

Phase 2 (6 months but can be shortened): $15/MWh

Phase 3 (steady state): $10/MWh

3 Refresh Yes, at least once for one lot of contract (in Phase 3)

4

Cumulative

contract

duration

Phase 1: 1 year (4 contracts15

)

Phase 2: 2 years (8 contracts)

Phase 3: 3 years (12 contracts)

5 Contract size 0.5MW per half hour per day at the Uniform Singapore Energy

Price over the contract length (not larger than 0.5MW per half hour)

6 MM Obligation

Period At least half an hour per Singapore trading day

7 Contract

length Not longer than quarterly contracts

5.9.2 Beyond the baseline requirements, generators will be free to work and negotiate

with the exchange of the industry‟s choice to refine the other parameters in the MM

arrangement and features under the product specifications.

5.10 Compliance with Baseline Requirements

5.10.1 Given that the MM agreements are commercially sensitive, to ensure compliance

with the baseline requirements, generators who are allocated FSC will be required

to submit declarations to the EMA after signing the MM agreements with the

exchange. The declarations have to be submitted prior to the start of Phase 1 of the

electricity futures market.

5.10.2 The EMA can also during the tenure of the FSC scheme request a report from the

exchange on the compliance of the generators with respect to their MM obligations.

5.10.3 Based on feedback from the financial industry, the typical MM agreements have a

contract length of not more than 6 months. As the proposed length of the FSC

incentive is 3 years, there is a need to ensure the alignment of the incentives with

the corresponding MM obligations, with a buffer of a proposed trial phase during the

first six months of the start of the market. To ensure that MM agreements and the

FSC are back-to-back and aligned, several renewals of the MM agreements are

expected over the course of the FSC scheme. As such, over the course of the FSC

15

This is based on calendar quarter contracts.

13

scheme, any renewal of MM agreement between the generators and exchange will

require new declarations by the generators at least 2 weeks prior to the start of the

new MM agreements.16

5.11 FSC Trial Phase

5.11.1 Some generators have provided feedback that they are unfamiliar with trading

practices in the futures market such as market making and are uncertain about the

associated risks and exposure, which may deter them from committing to the FSC

scheme. To address this, the EMA intends for Phase 1 to be a

trial phase, where generators participate as market markers in accordance to the

MM obligations of Phase 1, with an option to exit the scheme without proceeding to

Phase 2. The intent of this phase is to allow the generators to build up competency

and experience in trading and market making in the electricity futures market, while

limiting their risk and exposure. Furthermore, this initial trial phase will allow

generators to negotiate the usual MM incentives (e.g. reduced trading or transaction

fees) with the exchange, which will be necessary for the long-term commercial

sustainability of MM arrangements in the electricity futures market.

5.11.2 In this trial phase, generators who do not wish to continue market making in Phase

2 can withdraw anytime, but will be required to inform the EMA at least 3 months

prior to the start of Phase 2.17 No FSC volumes will be allocated to such generators.

5.11.3 Generators will not be allowed to exit from the FSC scheme from Phase 2 onwards

till the end of the scheme.

5.11.4 Failure to maintain MM arrangements during the period of the scheme, or failure to

deliver the declared MM volume that are compliant with the baseline requirements

will be considered a breach of the FSC scheme. Generators who breach the FSC

scheme will be subject to a penalty of the FSC mark-to-market in-the-money value

for the entire FSC tenure plus 10% of the face value of the entire FSC.18

5.12 FSC Settlement

5.12.1 The allocated FSC volumes determined by the EMA for each participating generator

will be equally distributed across all day and period types for each of quarter of the

next three years (based on the average total forecasted electricity demand for 2013

– 2015). The intent of the allocation is to reflect the base load specification i.e.

equal fixed volumes in every time period. The allocated FSC volumes will be made

known to MSSL (i.e. SP Services) to compute for each quarter for the duration of

16

There should be no time lapse or discontinuity between the previous and new MM arrangements. 17

The notice period of 3 months is set with the assumption that any changes to the FSC settlement will require a lead time of at least 3 months. This is similar to the lead time stipulated as part of the procedures for vesting contract level review. 18

All mark-to-market in-the-money benefits from the FSC plus 10% of the face value of the entire FSC from the start of the scheme to the end of the FSC tenure are to be returned to the consumers via the wholesale market with immediate effect for the nearest quarter prior to the end of the MM agreement and subsequently every quarterly. There will not be any return of the out-of-the money FSC payouts paid by the generators during the FSC tenure. The FSC will remain on the books of the generators throughout the FSC tenure. The same penalties apply for generators who fail to give the three-month due notice to the EMA for their intention to exit the FSC scheme during the trial phase.

14

three years (i.e. from the start of Phase 2 to the end of the scheme) as of a

specified start date to be determined by the EMA.

5.12.2 Given that the primary beneficiaries of the electricity futures market will be the

contestable consumers (CCs), the FSC will be spread across all CCs (i.e. any

debits or credits from the FSC is to be spread across all CCs‟ load). Taking into

consideration feedback from some electricity retailers in prior engagements that a

new debit/credit component for market participants buying on behalf of contestable

consumers may require the review of existing retail contracts with consumers, the

EMA‟s preference is to avoid the introduction of a new line item in the retail

market.19 As such, it is proposed that the FSC debits/credits to be subsumed under

the existing vesting debits and credits line item.

5.12.3 Like the Vesting Contracts, the FSC do not necessarily mean that the contestable

consumers will pay more – essentially they provide a hedge for consumers against

volatile prices in the wholesale market while ensuring that participating generators

have certainty of revenue stream for their allocated volumes.20

5.13 Chronological Process for FSC implementation

5.13.1 To summarise the FSC process from 5.6 to 5.13, Table 5.4 provides the

chronological process of the FSC process where N represents the start of Phase 1

for the electricity futures market.

Table 5.4 Chronological process for FSC implementation

Time Example of time Process / Event

Prior to N – 6

months

Prior to 1 June

2013

Generators to sign MOUs with an exchange of

their choice.

N – 6 months 1 June 2013 Pre-Qualification Stage: Interested generators to

submit MOUs and choice of exchange to the EMA.

The EMA subsequently announces exchange of

industry‟s choice.

N – 5 months 1 July 2013 Bidding Stage: Qualified generators to be invited to

submit MM volume to the EMA in exchange for

FSC.

N – 4 months 1 August 2013 The EMA to inform the generators of their

respective FSC allocation, and corresponding MM

volume.

N – 3 months 1 October 2013 Generators to sign MM agreements with the

exchange of industry‟s choice and submit

declarations to the EMA that the MM agreements

19

For the purpose of the wholesale market settlement, the Vesting Contract and FSC will be settled independently. 20

The FSCs are CfDs with a strike price based on the prevailing LVP or BVP. The CfDs work on the following basis: when wholesale electricity price is above the strike price, the generators pay the contestable consumers through the MSSL the difference between the wholesale electricity price and strike price, and vice versa.

15

are compliant with the baseline requirements set

by the EMA.21

N 1 January 2014 Electricity futures market launched.

FSC scheme and generators‟ MM arrangements to

begin.

Start of Phase 1 (Trial Phase).

N + 3 months 1 April 2014 Deadline for generators to submit notice to the

EMA for the intention to exit the FSC scheme and

the corresponding MM arrangement. Notice

submitted thereafter will be subject to penalties.

N + 6 months 1 July 2014 End of Trial Phase (Phase 1).

Start of Phase 2.

N + 12 months 1 January 2015 Start of Phase 3.

5.14 Eligibility to Participate for FSC scheme

5.14.1 Similar to the existing Vesting Contracts, the counterparties for the FSC are the

MSSL on the buy side and the generators on the sell side. All companies with a

generation licence from the EMA prior to the start of the pre-qualifying stage will be

eligible to participate on the sell side of the FSC.

5.14.2 Existing generation licensees with no generation capacity (i.e. the new power

station is yet to be in commercial operation) are eligible to participate in the FSC

scheme, subject to the commencement of their MM agreement and FSC on or prior

to the start of the next quarter from the commercial operational date of the new

power station. For example, if the commercial operational date is 1 December 2014,

the MM agreement and FSC will have to commence by 1 January 2015. The end

date of the FSC for this group of generators will be aligned with those of the other

generators (i.e. the FSC will conclude at the same time for all generators). Such

generation licensees can choose to commence their MM agreement and FSC

together with the other generators at the start of the FSC scheme, as long as a

generation licence is obtained prior to the pre-qualification stage described in

Section 5.6.

5.14.3 The FSC would be open to any subsequent new generator(s) with a generation

licence from the EMA within the tenure of the FSC scheme. To participate, the new

generator will have to commence the MM agreement and FSC on or prior to the

start of the next quarter from the commercial operation date of the new power

station. The new generator is free to commence their MM agreement and FSC

before commercial operation date of the new power station as long as a generation

licence is obtained prior to the confirmation of its MM volume in exchange for FSC

allocation.22

21

To ensure compliance, the EMA may also require the exchange of the industry‟s choice to submit periodic reports to ensure that the respective MM arrangements with the generators are compliant with the baseline requirements set by the EMA. 22

This assumes that the pre-qualification stage has already passed or that the FSC scheme has already commenced.

16

5.14.4 To be eligible for the FSC scheme, both the existing generation licensees with no

generation capacity and the new generators will have to comply with the same rules

as the existing generators.

5.14.5 The new generators will be able to participate in Scheme A or Round 1 of Scheme

B only. While the rates of allocation will be the same, the EMA reserves the right

and discretion to allocate the FSC up to the maximum volume to be determined by

the EMA under the FSC scheme. To ensure alignment with the proposed length of

the FSC (i.e. 3 years) and the subsequent review of the FSC scheme, the new

generators will only be allocated the FSC volumes for the balance of the FSC. For

example, if the FSC incentive has already been in place for 1 year prior to the date

of commission of the new power station, the new generator will only be allocated a

maximum of the remaining 2 years of the FSC incentive.

5.15 Prudential Arrangements

5.15.1 There are further trading cost synergies that can be realised through the electricity

futures market, such as allowing the electricity futures contracts to be used to offset

the prudential requirements of market participants in the wholesale electricity

market. As an additional benefit, should the electricity market rules be amended in

future to allow this, only generators who participate in at least Phase 1 of the FSC

scheme will be allowed to offset their corresponding prudential arrangements, in

recognition for their contribution towards the establishing a liquid futures market.

This will reduce the cash flow upfront that market makers have to put up in both the

futures and wholesale markets. For generators who do not participate in the FSC

scheme, there will be no change to the existing prudential requirements in the

wholesale electricity market, but they will not enjoy the offsetting of any prudential

requirements.

5.16 Variation of Electricity related Financial Products

5.16.1 The EMA is of the view that further development of other electricity related financial

products after the launch of the market should ideally be achieved without

regulatory mechanisms. Instead, the EMA prefers that such products be developed

organically on a commercial basis between the exchange and the related

stakeholders for the long term sustainability of the electricity financial market.

SECTION 6 MARKET INFORMATION DISCLOSURE

6.1 Importance of Information Disclosure

6.1.1 The success of the electricity futures market, similar to any futures market, is

premised on the fact that there is little or no significant information asymmetry

between the physical players (e.g. generators) and non-physical players (e.g.

independent retailers and financial institutions). This is critical in ensuring that the

17

participants in the futures market trade on a level playing field and building

confidence in the electricity futures market.

6.1.2 To support the development of a conducive trading environment, the EMA intends

to review and bridge existing gaps in the physical market information disclosure to

ensure fair access to information access to participants in both the wholesale and

futures markets.

6.2 Additional Information Access

6.2.1 Based on a review of the existing physical market information disclosure and a

comparison with best practices from other electricity futures market, the additional

access to information should include, but not limited, to the following:

(i) Outage plans: Outages, scheduled and forced/unplanned, will have a

significant impact on spot and forward prices. The Annual Generation Outage

Plan (AGOP) and advisories in the wholesale market, especially for

unplanned outages, which are already available to all market participants in

the wholesale market, should be made available to participants in the

electricity futures market.

(ii) Forecast demand and prices: The demand and price information is currently

available to market participants in the wholesale market. This should also be

extended to market participants in the electricity futures market.

(iii) Gas curtailment information: Information regarding supply disruption such as

gas curtailment plans (in an aggregate form) is critical to the efficient pricing

of forward electricity prices. This should be made equally available to all

market participants in the wholesale market and in the electricity futures

market.

6.2.2 Operationally, the Energy Market Company (EMC) already has a subscription

service where non-market participants can access the market data available to

market participants for a monthly fee subscription. This mechanism will allow

participants in the electricity futures market to access the relevant market data to

ensure a level playing field.

6.2.3 In addition to the above, the EMA would also like to seek views from the

stakeholders including potential participants in the electricity futures market on

whether any additional information is required to ensure the success of the

electricity futures market.

SECTION 7 MARKET INFRASTRUCTURE

7.1 A Single Industry Preferred Exchange

7.1.1 To concentrate liquidity during the initial stage of the electricity futures market

development, MM should be conducted on a single exchange that is collectively

18

selected by the generators. The EMA‟s preference is for the generators to work with

an exchange of their choice to develop the electricity futures market on a

commercial basis. The selection of the exchange by the generators will be

conducted at the pre-qualifying stage, where each generator interested in

participating in the subsequent bidding stage will be required to sign an MOU with

an exchange of its choice. In the event that collectively the generators choose more

than one exchange, the choice of the majority of the generators will prevail.

7.2 Regulation of the Electricity Futures Market

7.2.1 The electricity futures contract will be regulated by the MAS under the Securities

and Futures Act (SFA), if it is launched on a futures exchange already regulated by

the MAS. Otherwise, regulation of the electricity futures contracts will be determined

upon further discussions between the EMA and MAS.

SECTION 8 SUMMARY

8.1. The development of a liquid electricity futures market will benefit stakeholders

across the spectrum of the industry by providing them with more options and

facilitating a robust price discovery process. The outcome is a more efficient supply

of electricity in the wholesale and retail markets, which will benefit stakeholders

across the industry including electricity consumers.

8.2. Generators‟ participation in the electricity futures market as market makers is a key

success factor to ensure there is sufficient liquidity. In this regard, the EMA is

proposing as part of the graduated pathway for the development of an electricity

futures market to incentivise generators via the FSC regime to enter into MM

agreements with an exchange.

8.3. An overview of the timeline for the proposed implementation approach is shown in

Figure 8.1.

Figure 8.1 Overview of the timeline for the proposed key implementation approach

19

8.4. This consultation paper puts forth a suggested implementation roadmap with the

objective to seek views from stakeholders on the following:

(i) The proposed FSC scheme to overcome the initial lack of liquidity to facilitate

the development of an electricity futures market;

(ii) The proposed glide path or phased implementation approach to provide the

necessary initial conditions for participating generators to build trading

capability and engage in trading;

(iii) The market information required to ensure a fair and conducive trading

environment in the electricity futures market; and

(iv) The generators‟ interest in participating in the FSC scheme (to be provided on

a non-binding and confidential basis) to enable the EMA to assess whether to

proceed with the development of the proposed electricity futures market.

8.5. The indicative timeline for the EMA‟s consultation process for the development of

the electricity futures market is summarised in Table 8.2.

Table 8.2 Indicative timeline for the EMA‟s consultation process

Process Date

1 Issue of the EMA‟s Consultation Paper 22 October 2012

2 Feedback from stakeholders on the Consultation Paper due 19 November 2012

3 Issue of the EMA‟s Final Determination Paper Q1 2013

20

Request for Comments and Feedback

EMA invites comments and feedback to the consultation paper. Please submit written

feedback to EMA_PPD@ema.gov.sg by 19 Nov 2012 (5pm). Alternatively, you may send

the feedback by post/fax to:

Policy and Planning Department

Energy Planning and Development Division

Energy Market Authority

991G Alexandra Road, #01-29

Singapore 119975

Fax: (65) 6835 8020

Anonymous submissions will not be considered.

The EMA will acknowledge receipt of all submissions electronically. Please contact Mr Eng

Zhen-Hui at 6376 7589 or Ms Chua Shen Hwee at 6376 7653 if you have not received an

acknowledgement of your submission within two business days.

The EMA reserves the right to make public all or parts of any written submissions made in

response to this consultation paper and to disclose the identity of the source. Any part of the

submission, which is considered by respondents to be confidential, should be clearly marked

and placed as an annex. The EMA will take this into account regarding the disclosure of the

information submitted.

21

Appendix 1

Please refer to Cybele Capital Limited’s Final Report attached separately.