2004 IEEE International Conference on Flectic Utility Deregulation, Restructuring and Power Technologies (DRP12004) April 2004 Hong Kong Price Responsiveness in the New Electricity Market: A Singapore Experience ‘Youngho Chang and Tuan Hin Tay” Absiact When electricity prices are allowed to fluctuate Ireely the price valuable market information and send the right signal orate-payers for consumption and. to generation companies for production and investment. This study briefly discusses the deregulation of the Singapore leetricity sector before employing loglinear form for cstimatig the coefficient of price-quantity relationships in the electricity demand. Twostage least squares regression method is used and the estimation would yield the elasticity of demand. The more elastic Is the demand, the more ‘hoote the best package and also to make more efforts 0 respond to price luctuation. The analysis reveal that the tmarket ould bring about some consumptionefficiency ins. However, more research needs to be done to quantify the exten ofthe gains. Index Terms- Consumption Efficiency, Contestable Consumers, Electricity Deregulation, Now-Contestable Consumers, and Price Responsiveness IL Itropucrion hen 2 vertcally-integrated electricity industry is deregulated and market forces allowed greater play, such deregulation would bring efficiency gains in production, consumption, and allocation. Among others, consumption efficiency implies that consumers spend the Fight amount of their budget on the different goods available, I requires that consumers choose wisely among, the goods available and consume inthe least cost manner, ie. buy the good at the cheapest price. Under regulation, pices of electricity are not at their true competitive market levels. As such, consumers are not able to gauge the relative prices with accuracy and this likely result in ‘consumption-inefTiieney. When the prices are artificially low (most likely for political reasons), such as in the Commonwealth of Independent States (CIS), ‘consumption decisions are distorted [1]. For example, regulated low prices prevent fuel costs increases from being passed on to consumers; and as such, consumers have no incentive to modify their consumption behavior. ‘With a tariff system under regulated electricity markets, rate-payers may not respond to changes in the matket ‘. H Ching with Deparment of Economics, National Universiy of Siogapore Smgapre 11757 (ema: esses cs) ‘TH Tay sit SP PowerGrid Li 11 Somat Road, Sapnore 2a (cml tanker coms) 0-7803-8237-404/817.0002004TEEE price of electricity because electricity tariffs do not change with such frequency. When electricity prices are allowed to fluctuate freely like crude oil or natural gas, the price could transmit valuable market information and send the right signal to consumers for consumption and 10 ‘generation companies for production and investment. In this paper, we investigate whether « move from regulated tariffs 10 unregulated prices in the New Electricity Market (NEM) of Singapore would increase consumption efficiency. We briefly review a path to the deregulation of the electricity industry in Singapore before employing a log-linear form for estimating the coefficient of price-quantity relationships in electricity demand. Two-stage least squares regression method is, used and the estimation would yield the elasticity of demand. The more elastic is the demand, the more consumption efficient is the NEM. This is because consumers who are allowed to choose theit retailers oF purchase electricity on their own behalf will be able to choose the best package and also to make more efforts to respond 10 price Muctuations, We do not attempt to quantify such efficiency gains as the approach adopted only allows a dichotomous answer. 1, DEREGULATION IN SINGAPORE ‘The electricity industry in Singapore was a wholly government-owned vertically integrated — monopoly. However, as liberalization goes, power generations were privatized and a new statutory board — the Energy “Market Authority (EMA) was established to regulate the energy industry. At the same time, the Energy Market Company Pte Lid (EMC) was set up as a joint venture between EMA and M-co (the Marketplace Company of New Zealand) Pte Ltd to implement and operate the new wholesale electricity market. However, electrical output is still transmitted via the transmission and. distribution (T&D) network owned and opersied by PowerGrid, a wholly ovned subsidiary of Singapore Power Lid, and ‘TAD prices remain regulated ‘AL this stage of partial deregulation in 2001, consumers tare deemed “contestable” if they have maximum power requirements exceeding 2MW and can purchase power from citer retailers or Power Supply Ltd the retail arm fof Singapore Power. Povwer Supply Lid is also the ‘designated Public Electricity Supplier (PES) and retails electricity fo the non-contesiable customers. Thus, a this stage of deregulation, the generation sector is alreadyfully open to competition while that forthe retail sector is partially so The new electricity market (NEM) of Singapore has started on January 1* 2003, Although NEM is still 2 ‘mandatory pool, itis fundamentally different from its precursor Singapore Electricity Pool (SEP). It isa spot market for electricity and reserves operated by the EMC. ‘Although the independent Power System Operator (PSO) ‘under EMA instead of PowerGrid carries out dispatch, clectrical output continues to be transmitted via the T&D network owned and operated by PowerGirid. As ‘mentioned above, consumers with maximum power requirements exceeding 2MW are able to purchase clecricity from retailers oftheir choice. The retail market will be further opened up in three phases, In Phase J, all, consumers with an average annual consumption exceeding 240MWh targeted to be able to choose the! retailers. In Phase IL, all consumers with an average annual consumption exceeding 120MWh targeted to be able to choose their retilers six months after Phase Tis completed. The rest of the one million consumers would be open to competitive retailing in Phase Il by 2004, About 250 consumers had become contestable since July 2001, which represent about 40 per cent ofthe toal electricity demand. Since June 2003, 5,000 non-domestic consumers with average monthly eletrcity consumption ‘of more than 20MWh have become contestable, Another 5,000 consumers with average monthly consumption of 1OMWh will become contestable atthe end of 2003 and the total contestable market will cover 75 per cent of the total electricity demand (2). Contestable consumers have a choice of purchasing electricity from either the retailers oF from the wholesole market via the Market Support Services Licensee of by tading directly in the wholesale market, Electricity tariffs for non-contestable customers will continue to be regulated until the successful completion of Phase III above. IIL. MeTHoD0LOGY FOR ANALYSIS OF CONSUMPTION= EFFICIENCY IN THE NEM A price that reflects actual cost conditions facilitates decision making by the consumers. A tariff (Such as that faced by non-contestable consumers), which varies only ‘once every few months, does not encourage the consumer to cut back on elecricity use during peak hours (when it is the priced highest). A price that varies throughout the day, however, would persuade the consumer to delay or reduce consumption whea the good is expensive. [As such, a regression exercise can be conducted. The variables of concer are the electricity prices and the quantity consumed. AS the log-linear form is employed, the coefficient inthis regression would yield the elasticity of demand, The more elastic is the demand, the more consumption efficient is the NEM. This is because consumers who are allowed to choose their retailers oF purchase electricity on their own behalf will be able to 45 2004 IEEE Intemational Conference on Blecsic Utiity Deregulation, Restricting and Power Technolgies (DRPT2004) April 2004 Hone Kong ‘choose the best package and also to make more efforts to respond to price fluctuations. ‘The regression is caried out on contestable and non- contestble consumers withthe postulated result of higher price elasticities of demand for the contestables. If the regressions yield the hypothesized resulls, and if the ifferences in values are significant, the NEM yields ‘greater consumptionefficiency. This gain is io be proportional to the difference in the elasticities of demand between the two types of consumers, A. The Data Data comprising of hlhourly price and quantity for contestable consumers is collected fiom SP Services for the period July 2001 ill October 2002. For non= contestable consumers, data on quantity demanded is derived by subtracting contestable demand from total island-wide demand. The number of observations amounted to 23,424. This period is chosen because the beginning coincided with the beginning of contestable consumer participation in the Singapore Electricity Pool The end of the period was a Hobson's choice as the regression methodology employed requires instrumental variables (more on this later), and one of the potential instrumental variables are natural gas prices, which were only available til October 2002, Dats from the NEM is not used as the market has started about a year ago and needs some time to setle down. Another study will be carried out when the data from the NEM is available for analysis. 'As the contestable consumers are free to choose their supplier orto purchase electricity from the market itself consumer accounts data is requested from SP Services (which is the Market Support Services Licensee and therefore the facilitator of access to the market). The average monthly number of contestble and non- contestable consumer accounts is provided for the same time period and the average quantity demanded per half hour for each account is used in the regression instead of the total so as 10 minimize variability due to changes in the numberof contestable consumers inthe marke Before procesding with the regression, unit ro0t tests are carried out on the price and quantity data to ensure that the process is stationary. The tests confirm that the processes are mean reverting (stationary) BL Two-Stage Least Squares Regression’ A fundamental assumption of regression analysis is that the right-hand side variables are uncorrelated with the disturbance term, i. these variables are exogenous. If this assumption” is violated, Ordinary Least Squares regression (OLS) estimates are biased and inconsistent "Tis ccvon and the nowt dw tsi up he Evie Help le ands eeenes, sachs [3] and [a] views vorson D1 i fe ‘eersion and oecastng sofware employed in hs tu).2004 IEEE Interational Conference on Electric Unity Dereglation, Resructring and Power Technologies (DRPT2004) Apit 2004 Hong Kong. Such 2 situation occurs here, as price and quantity are jointly determined. The data used to estimate the function are past observations of price and output determined by the points of intersection between the demand and supply curves. It is very likely that there is some movement of both the demand and supply curves in between observations, yielding a pattem of price, “quantity intersection points from which normal OLS will be unable to estimate the parameters effectively. This is known as the identification problem [5] In order to overcome this problem, the Two-Stage Least Squares regression (TSLS) method is employed. Before employing TSLS, a set of instrumental variables is needed. Instrumental variables are variables that are both correlated with the explanatory variables in the equation, ‘and uncorrelated with the disturbances. These instruments are used to eliminate the correlation between right-hand side variables and the disturbances. 1) First Stage Regressions In the first stage, TSLS finds the portions of the endogenous and exogenous variables that can be atwibuted 10 the instrumental variables. This stage involves estimating an OLS regression ofeach variable in the model on the set of instrumental variables, ‘The TSLS process used in this study has the demand function in terms of average quantity demanded (Q) versus price (Px). A logclinear model is used as the coefficient for price yields the price elasticity directly. lox(Q)- Ailos(P) * Aslog(OC-1)) + Aslog(QD) + Ast +c a ‘A lag of one and two ofthe quantity term is also added, Other lags can also be added, such as lags of 48 periods oF 336 periods, since each day has 48 half-hour periods and. each week has 236 half-hour periods. C is the constant term while 1 is the tend variable that accounts for ‘economic or population growth, which increases Q. ais the error ferm (or disturbance term). In the model, the error term has 2 special formulation, which we will refer tin section C. In our demand function regression, we first estimate an equation for price by regressing price on all of the independent variables inthe demand function, plus one or more other determinants of Px (which do not appear inthe final demand function). These right-hand side variables in, the regression of price are the instrumental variables (also known as instruments), 2) Instruments ‘The instruments utilized for this purpose are 1og(NG), logiCPN, log(Pa(-1)), log(OCH), C and 1. NG is the ‘monthly price of natural gas faced by US utes. NG isa proxy for fuel costs facing local gencos. As mentioned above, NG was only available until October 2002 that is why the period under consideration ended in October 46 2002. CPL is the Singapore consumer price index available as a monthly series. Wherever data is only available as monthly figures, such as for CPY and NG, the same monthly figure was used forall hal-hour periods in that mont, “The lags of price and quantity, which are inthe original specification, are also used as instruments because the Jags are uncorrelated with present disturbance terms. The constant term and time tend are also employed as struments because they are obviously exogenous. 3) Order and Rank Conditions In order to calculate TSLS estimates, the specification ‘ust satisty the order condition for identifieation. The condition requires that there be at least as many instruments as there are coefficients in the equation. This Js a necessary but not sufficient condition There is an additional rank condition that must also be satisfied, Since this is a model in which identification comes ftom the ability to use an instrumental variable for price, it were to turn out that the particular instrumental variable such as the CPY is unrelated to price, it would not bbe a valid instrumental variable” This will violate the rank condition for identification. Thus, @ regression of price on the instruments i attempted, Using the rank condition, it appears that both log(CPD) and log(NG) are not valid instrumental variables and are thus taken out. It appears that the constraint due to availability of natural gas prices is unnecessary. However, ‘sven that the sample size is already more than adequate, ‘no effort is made to lengthen the time period. 4) Second-Stage Regressions The second stage is a regression of the original ‘equation, with all ofthe variables replaced by the fitted values from the first-stage regressions. The regression coefficients obtained from this second stage regression are ‘unbiased, consistent estimators of the parameters of the original demand function. Seasonal Autoregressive (SAR) Errors If the TSLS regression is carried out at this tage, it will result in estimates that are not Best Linear Unbiased Estimators (BLUE) because of autocorrelation among the error terms. ‘As mentioned, the error term © in equation (1) above has a special formulation, It is not the usual identically and independently distributed (iid) errors that_ we encounter in normal regressions. Firstly, there will be some autocorrelation due to autoregressive (AR) effects, and this necessitates the inclusion of AR effects in the Secondly, high frequency price and load data exhibits systematic (daily and weekly) seasonal movements. This implies that SAR error terms must be included as wel, * tres eats conrad (4) fr ana discusion,