All you need to know: The electricity futures market in Singapore
The electricity futures market in Singapore is a financial exchange where parties trade contracts to buy or sell energy at future dates. The futures contract price is based on the underlying asset, which is electricity.
The aim of participating in this market is for hedging and risk management purposes. With frequent power outages in developing countries like Singapore, it becomes crucial that organizations have the means to manage their business continuity even when there are technical difficulties faced by our power grid provider, SP Group.
Many derivative products are available in the market, but I will focus on two types of products, namely:
- Single Stock Futures (SSF)
- Power Index Future (PIF)
Singapore retail consumers who want to hedge against their physical consumption can use SSF contracts. These contracts are traded on the Singapore Exchange (SGX) and represent 1MW hour of energy. The underlying asset is Singtel, SP Group’s largest customer.
On the other hand, PIF is a contract that is based on a basket of electricity futures. It allows investors to gain exposure to multiple electricity prices in one trade. This contract is also listed on SGX and represents 1MW hour of energy.
The market for electricity futures has been around for more than ten years now, and it has become more popular with time as we face increasing power demands coupled with ageing infrastructure.
There have been five successful PIF auctions, with the latest one being held on Dec 8 2017. The total traded volume for PIF was about 2,700MW hours with an average price of S$48.24/MWh.
What about trading futures in Singapore?
All derivatives trading in Singapore will go through one clearinghouse for the first time.
The Monetary Authority of Singapore (MAS) has mandated that all securities and commodities derivatives trades be cleared through the Singapore Exchange (SGX), subject to certain exemptions. The change came into effect on Nov 17, 2013.
If you are new to options trading, this development will give you a false sense of security because it’s pretty likely that your broker will not offer them to retail clients. This is explained below, along with other facts you should know before even thinking about trading futures or options in SGX or elsewhere in Asia.
1) Why trade futures/options?
Futures and options contracts are financial derivatives that derive value from an underlying asset.
For example, a futures contract might give you the right to purchase a certain amount of gold at a predetermined price on a specific date in the future. The price you pay for that contract is called the premium.
If the price of gold increases to above the price set in your contract by the time it expires, you can choose to buy the gold at the lower price or sell your contract at the higher price and pocket the difference.
Conversely, if the price falls below the set price, you would have to purchase the gold at that higher price or sell your contract at the lower price.
In this way, futures contracts offer investors a way to hedge their bets against price movements in the underlying asset.
2) Why is SGX mandating all derivative trading go through one clearinghouse?
The main reason is to reduce systemic risk and promote financial stability. Having all derivatives cleared through one central counterparty (CCP) reduces the chances that a failure at any one clearinghouse will cause a domino effect across the financial system.
3) What are the exemptions?
The following derivatives instruments are exempt from the mandate:
- swaps between affiliates of the same group of companies
- foreign exchange forwards and swaps
- gold and silver forwards and swaps
- physically settled commodity futures contracts- contracts that derive their value from USD interest rates.
4) How will I know which markets SGX is clearing?
You can visit the SGX website and click on Markets, Marketplace and Product Directory, and you’ll be able to see your options.
5) What does it mean for me as a retail trader?
It means that you now have one less option for trading futures or options in Singapore. You cannot trade those instruments through any broker except those clearing members of SGX. For example, Phillip Futures is not listed as a clearing member.
However, you can still trade CFDs on Indices/Stocks/Commodities with them, but it’s just like forex trading where you are simply betting on the direction of the price movement.
Looking ahead, I believe the electricity futures market will continue to grow as it provides a viable hedging tool for businesses and consumers alike. In addition, this market is also liquid, which gives investors the flexibility to enter and exit positions quickly.
If you want to hedge your risk against power outages or want to gain exposure to the electricity market, consider investing in the electricity futures contracts!