The conventional rule of thumb is that geographic market development moves in an easterly direction. Traditionally, the US/North American market is the innovator, followed by Europe and then Asia. Within this cycle each new geographic market model improves on the previous model, and in theory this easterly cycle of development can continue indefinitely if we agree that no market can ever be considered perfect.
This analogy of market development cycles can be applied to the electricity and gas markets. The US took steps to restructure its gas and electricity market before continental Europe (as defined by the EU-15 member states) but the European model has been arguably more successful than that of the US. It is therefore of little surprise that the South East Asian market is now looking to Europe as a form of role model for market restructuring and deregulation. Similarly it is of no surprise that within the South East Asian market it is Singapore that has been the most proactive.
But these are still early days for the emerging electricity markets in South East Asia. The ideal for the region is the development of an electricity ring linking the transmission grids of the South East Asian countries. Currently the only physical linkage of grids is between Singapore, Malaysia and Indonesia and it may be many years before any further progress is made.
The issues facing South East Asia are essentially the same as those faced by Europe in the 1990s, and there are some similarities. Just as the UK was the European innovator in deregulating its market and introducing an electricity pool, Singapore is the South East Asian innovator and has also introduced an electricity pool. We could extend the similarities between the UK and Singapore further. Both are islands, small markets, the financial centres of their respective regions and both countries have a history of innovation and progressive market development. As with Europe one issue for the South East Asian countries is whether they should follow the innovative lead of Singapore in restructuring the regions electricity market into a more competitive market infrastructure.
Central to market restructuring is privatisation. Generation assets in South East Asia are government monopolies and, in many cases, are in need of significant investment. A case in point is Indonesia, which is currently subject to fairly frequent brown-outs due to an aging generation and transmission system being unable to meet increasing demand requirements. Environmental issues will also impact on investment and restructuring. Last month Thailand became the first South East Asian economy to ratify the Kyoto Protocol, with the region apparently divided on the issue of Kyoto ratification. Singapore, for example, is opposed to ratification as it looks to prioritise economic growth before emission reduction.
On the issue of privatisation, an interesting scenario can be found in Thailand. Last month the government confirmed that the gradual privatisation of EGAT, the state-owned Electricity Generating Authority of Thailand, will proceed from 2003 with completion by late 2004 or early 2005. In the debate preceding privatisation the main issue has been domestic electricity prices. In announcing the privatisation process the Thai government has said that overseas investment in EGAT will be limited and priority given to domestic investors. The government's rationale being that this will limit increases in domestic tariffs. Unfortunately this rationale is flawed.
Like many of its South East Asia neighbours, Thailand needs significant investment in its electricity market infrastructure. Similarly those domestic companies interested in investing in EGAT have significantly less resource to invest than overseas companies, particularly those in Europe and North America. But perhaps more importantly, overseas companies in Europe and North America have more experience of developing and managing liberalised market structures than domestic Thai companies. Without outside experience and sizeable investment it is highly questionable that domestic tariffs will reduce in Thailand.
Trading is another issue. Singapore has a power pool in operation but there is little or no trading of electricity. A number of companies in the city-state are keen to develop electricity trading through the Singapore Power Pool. Again, outside assistance can benefit the development of electricity trading which in turn will increase the market efficiencies.
With Europe now being cited as a positive example of electricity market deregulation and restructuring the next major market is that of South East Asia. For the region to optimise the benefits of market restructuring through increased efficiencies and lower electricity prices it has to learn from other market models. The danger for the region is that it will focus on the recent market failures, such as California, and become too insular. However if the region is to realise the full potential of a restructured and liberalised market infrastructure it should open itself up to foreign investment and expertise and in this respect it is probably the European utilities that are best positioned to provide this market value.
Long-term problems - no simple solutions
Uncertainty in European electricity markets, and particularly within the UK, places a question mark against the value of long-term electricity contracts. The latest company to cite problems with long-term contracts is TXU Energi. The contract prices that it locked into are too high, it is losing margin and its share price has suffered.
Those in favour of long-term contracts cite market uncertainty as a rationale for locking into long-term contracts. This uncertainty encompasses generation mix uncertainty, renewable development, regulatory uncertainty and the current issues of credit and counterpart risk uncertainty. They also point to the forward electricity curve, which shows a slight contango in prices over the next two to three years. However these same uncertainties provide a strong rationale not to enter into long-term contracts.
Quite simply there is no simple answer to the issue of long-term contracts. Companies could elect to lock in a proportion of long-term baseload supply and manage their peaks on a short-term basis if they believe that prices will not fall any further. Alternatively they could buy long-term call options to protect their contract price but the economics of such a strategy may be prohibitive due to market volatility ramping up the premiums associated with such a contract. Or companies cam manage business on a short-tem basis to try to extract maximum value from market uncertainties.
What is perhaps more important than the issue of long-term contracts versus short-term contracts is the ability to be proactive in the face of market uncertainty rather than adopt a more reactive market approach. Those companies able to manage and profit through uncertainty and volatility will be the more successful.
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