Wednesday, June 19, 2002 05:19:23 AM

Asia Energy Watch: Little Future For Asian Elec Futures

By Lucy Hornby 

SINGAPORE, June 14(Dow Jones)--These days, energy trading has gotten a bad name, and even wash trades have turned out to be dirty. 

Asia-Pacific countries are stepping carefully into this brave new world. As electricity trading loses its luster in the West, countries here are cautiously implementing wholesale power trading. 

They hope transparent markets will bring competitive power rates and attract investment. But the very diversity of Asia's restructuring plans augers against a regional futures exchange that could smooth price volatility. 

For the forerunners - Australia, New Zealand and Singapore - wholesale electricity trading is well underway. But isolation and illiquidity hampers the development of a futures contract, making it unlikely these countries alone can achieve the critical mass necessary for viable futures trading. 

In Japan, discussions are underway for a power exchange market that would pry open local monopolies to competition. Bilateral exchanges of excess power by generators could evolve into a system like the PJM Interconnection, regarded as one of the most successful electricity markets in the U.S. 

Other Asian countries have different - and often deferred - timetables for launching a power pool. Each have idiosyncrasies, including Thailand's scheme for bundling existing, long-term power purchase agreements into tradable "portfolios", that will make cross-border trading hard to synchronize. 

For countries like the Philippines and Indonesia - where frequent blackouts deter industrial investors - officials hope price signals from liberalized electricity markets will encourage new power plant investments the state cannot afford. 

But many countries - including Thailand and the Philippines - will continue to try to offset higher electricity prices in rural areas, for political reasons. 

Even prosperous Singapore has proposed vesting contracts to cushion consumers' exposure to pool volatility, and other countries will likely face public pressure to keep retail prices under control. 

Down Under 

Australia is a good example of how neighboring markets don't necessarily foster liquidity, even if the physical connection is present. 

The interconnection between Australia's main population centers was recently upgraded, but only Victoria has fully privatized generation, transmission, distribution and retail, while New South Wales boasts full retail competition. 

Initial trading excitement faded as state governments tried to dampen speculation, while Enron Corp.'s (ENRNQ) withdrawal reduced liquidity, discouraging other market makers. Less liquidity in turn lowered generators' trading book value, and consolidation among retailers accompanied a shift to bilateral contracts. 

"It's gone from a high-performance sports vehicle to a Toyota Corolla," said a former trader with a Victoria retailer. 

Market players say they want a standard, liquid instrument to mitigate risk and smooth volatility, but it's not clear that the Australian Stock Exchange's futures contract will be any more successful than its infrequently-traded predecessor on the Sydney exchange. 

In New Zealand, a nodal pricing system helps compensate for a long, thin shape, single grid connection between its two main islands, and heavy reliance on hydropower, which concentrates generation capacity in the South. 

Nodal pricing allows generators to bid different prices at different nodes and thus divert supply to where it's needed. 

But New Zealand hasn't developed active electricity futures either, in part because vertical integration of power companies doesn't encourage the necessary liquidity. That lack of liquidity, coupled with a drought, caused prices to soar in mid-2001. 

A few, large, integrated companies are also less likely than a fragmented market to require a transparent futures benchmark, a former trader with a New Zealand generator said. Instead, generators use their retail arm as a natural hedge. 

Islands 

Singapore's market is similar to the New Zealand model, complete with nodal pricing. Generators and retailers compete for market share, while transmission remains a regulated monopoly. 

But vertical integration of generators and retailers and the market's small size will work against developing tradable futures in the next few years, even after real-time pool trading begins later this year. 

Singapore will likely set the pace for Asian-wide trading. Its stability and financial expertise has turned it into a trading hub for petroleum and petrochemicals, despite its tiny domestic market, and brokers and investment bankers hope the same will be true for an electricity contract. 

The proposed Asian power grid would provide the necessary physical connections. So far, Thailand has been the most active in promoting cross-border electricity sales - for the most part through government-to-government or power purchase agreements, hardly the stuff of trader's dreams. 

But Singapore is still physically and figuratively an island. Its only grid connection to Malaysia is for emergency use, not trading, and the Singapore government has so far dismissed Malaysian proposals to sell to the Singapore pool from lower-cost Malaysia-based plants. 

Even if there were the political desire to integrate Singapore and Malaysian electricity markets, it won't happen for several years due to Malaysia's decision to indefinitely defer setting up its own power pool, in the wake of the California crisis. 

-By Lucy Hornby, Dow Jones Newswires; 65 6415-4065; lucy.hornby@dowjones.com