Powering a Nation : A Look at India’s Electricity Sector and Recent Announcements
Real-Time Markets, Market-based Economic Dispatch for Day-Ahead Markets, power derivatives…a lot of announcements have been made with regards to India’s energy markets!
The power sector is of very high importance. Most of us cannot imagine life without electricity. The ability to read this article via this channel is itself a product of electricity. There have been some interesting updates in India’s power sector recently, and they offer electrifying potential opportunities for growth. Now, as a student of physics, this article was a little tough for me to write because of two words…energy and power. To put it simply, power is energy per unit time. However, for this piece, I’ve utilized the two terms interchangeably. After conveying my apologies to Joule and Watt, I’ll dive straight into my main piece.
India’s power sector value chain can be divided into three broad sectors — generation, transmission and distribution. Generators like NTPC, Adani Power, NHPC and NLC India are responsible for the generation of power and electricity. This power is then transmitted via the transmission network. Finally, the distribution sector comprised of distribution companies (discoms) handles supply and distribution of energy to domestic, commercial, agricultural and industrial consumers. Now, discoms have been facing numerous headwinds and are suffering from high debt. They rely on payments from consumers in order to settle bills for power purchased from generators. Yet with delayed payments, transmission losses and cash collection shortfalls, discoms have had to borrow considerably to pay their bills. Massive amounts of unpaid dues still linger. Their high debt further increases the cost of borrowing which gets transmitted to end consumers. Overall, the situation isn’t rosy. While there have been multiple rescue packages deployed by the Government, some recent announcements regarding the electricity exchange market seem to offer a glimmer of hope.
Electricity trading refers to the buying and selling of electricity between market participants in a manner similar to other commodities. Market participants include distribution companies, electricity generators and open access consumers. The idea is to utilize market forces to ensure efficient production, distribution and consumption of power. In contrast to other tangible products like gold, oil etc, electricity is a flow product. Storage of electricity is quite expensive and supply must meet demand in order to ensure efficient and optimal functioning of power systems. In addition, energy is also completely interchangeable, as the energy contained in 1MWh of electricity produced from coal or natural gas are equivalent.
Electricity trading involves long-term and short-term agreements, over-the-counter (OTC) and exchange-traded products. In India, OTC long-term contracts have been the primary product utilized by the market participants, and only around 10% of electricity trading happens via short-term agreements. Futures and derivatives have not been offered so far and spot contracts on exchanges are restricted to 11 days of trading. While forward trading did start in 2009, legal issues around jurisdictional control clouded the matter.
The primary instrument of electricity trading hence has been long-term power purchase agreements (PPAs). A PPA is a bilateral agreement between a producer and consumer stipulating the amount of electricity that would be supplied, the payment rate, delivery timeline and schedule. They are long-term agreements, with lock-in periods ranging from 7 to 25 years. And most importantly, they are OTC products. OTC stands for Over-the-Counter. Unlike exchange-traded products which, as the name suggests, are listed on exchanges, OTC products are handled bilaterally. While this allows for immense customization, price transparency takes a hit and counterparty risks are higher.
Discoms enter PPAs with power suppliers, via contracts usually of 25 years’ duration. In order to meet their daily needs, discoms employ a practice known as self-scheduling, wherein they requisition power from their portfolio of suppliers (suppliers with whom they have PPAs) on a daily basis. In addition, bilateral contracts with other discoms, trading on power exchanges are also carried out, but this forms a relatively smaller chunk of the pie. Now, because they are restricted to their portfolio of generators, they cannot requisition power from other low-cost generators. Nor can discoms easily identify such generators as while carrying out the self-scheduling process, as it is not mandatory for discoms to reveal the cost. Thus they have limited options to procure power in an economically favourable manner while some low-cost generator companies (gencos) may face issues of under-utilization.
In India, we currently face an issue of over-capacity with respect to power, a result of coal-based capacity addition coupled with lesser than projected demand growth. Installed electricity supply capacity exceeds peak demand and coronavirus-induced lockdowns have widened this supply-demand gap further, though the situation is slowly moving to pre-pandemic levels. And PPAs have caught discoms in a bind. These long-term agreements are usually pretty rigid, with minimal to nil provisions to alter contract terms, renegotiate pricing and account for extreme fluctuations in demand. While it is fair for investors and power suppliers to expect contractual terms to be honoured, discoms are also tied up when it comes to ways of tiding over the issue of excess capacity as they cannot re-trade their contracted supplies, and given their financial health, this adds to their burden. Most PPAs are signed for 25 years and, more often than not, provide no contingencies for situations of massive demand fluctuations.
While discoms do have the option of selling energy bilaterally or through power exchanges, participation in these markets remains dismal. The exchange markets for power are highly under-utilized. India has two power exchanges — the Indian Energy Exchange (IEX) and Power Exchange India Limited (PXIL), both of which fall under the aegis of the Central Electricity Regulatory Commission (CERC).
However, there are some shifts occurring in the power sector prompting more reforms and changes. Discoms are showing greater interest in short-term agreements, renewable energy generation costs are declining, greater focus is being laid on greener and cleaner energy, coal block auctions are being opened up and the government is deploying efforts to improve discoms’ financial health. And multiple announcements have been made recently to address the shifting contours.
Market-Based Economic Dispatch (MBED) Model
In late 2018, the CERC published a discussion paper where they propose a market-based economic dispatch (MBED) model for the Day-ahead market in India. A Day-ahead market refers to the system where sales and purchases of electricity are made at today’s prices for tomorrow’s requirement and dispatch. In the regular model, as depicted in the previous figure, discoms partake in self-scheduling within silos of portfolio generators. In the MBED model, however, a market operator receives sell and buy bids for different time blocks from generator companies (gencos) and discoms. After identifying a market-clearing price (MCP), buyers will be supplied electricity as per their requirements and gencos will get dispatched in merit order up to the point where total system load is met. This is the Scheduling and Dispatch aspect of MBED. There’s a second aspect as well, the Settlement of Bilateral Contract (BCS), designed to uphold PPA contracts as well. When the MCP is less than the contract price, then the PPA contracted supplier wouldn’t be dispatched and hence, there isn’t any need for BCS. In case a discom’s power dispatch comes from its PPA generator and the MCP is greater than the contract price, then the price agreed to on the contract will be upheld and the difference between the MCP and contract price would be refunded to discoms.
Real-Time Market (RTM)
This June, IEX and PXIL kick-started the Real-Time Market (RTM) for electricity transactions. Functioning as a half-hourly market with 48 auctions sessions of 15 minutes each, RTM allows buyers and sellers to purchase or sell electricity from across the country with just an hour’s notice. This would allow generators and players to sell excess power produced and discoms to access power at economical prices to meet any shortfalls. The RTM is the first exchange contract allowing generators with long-term PPAs to sell their surpluses on the exchange.
Power Derivatives, Market Coupling and More
The Government has also allowed opening up the derivative market in the electricity and power sector, though this is still subject to a Supreme Court verdict scheduled for August 28th. This would mean that electricity can be traded via physically-settled forward contracts on power exchanges (under CERC) and financially-traded forwards and derivatives on commodity exchanges (under SEBI, the Securities and Exchange Board of India). Both exchanges would also look at measures for the introduction of futures and options contracts.
The CERC recently issued the Draft Power Market Regulations 2020 applicable to contracts traded on power exchanges and OTC markets. Key features include ‘market coupling’ for price transparency, stringent rules for the energy market and transaction fee caps for exchanges. Market coupling refers to the process of identifying a uniform market clearing price by matching bids from all power exchanges to maximize price transparency and minimise arbitrage. The CERC also proposed allowance of long-term future contracts on exchanges by removing the 11-day trading restriction.
There are numerous benefits that can be reaped by implementing the above measures.
- Discoms can lower their power procurement costs due to the resulting price transparency, can hedge risks and manage their portfolio better
- Power generating companies would benefit from the certainty of payment in spot markets and can sell their surpluses despite being in PPAs. This would, however, be difficult for discoms currently given their financial situation
- A level of flexibility would ensue and overall power generation and utilization would be more efficient
- With multiple products available under short-term, medium-term and long-term durations, market participants can better manage their portfolios and risks
- The Indian power market can leapfrog to the next level and achieve growth
- The above moves would increase market participation on exchanges
- In addition, there would be better renewable energy integration into the power market and this can help in speeding up the transition to greener power
There are some challenges that need to be handled. This is natural given the scale of the above proposals and announcements, legalities involved, robust infrastructure upgrades and the need to convince market participants. There is also a need to ensure that regulations and interventions by the regulatory commission are not in a manner that would impede the proper functioning of the markets.
The current announcements do seem to indicate that India is looking to balance the global practice of conducting power and energy transactions via spot markets and exchanges with the existing PPA-heavy model and leverage the concept of MBED of electricity. It is also necessary to take a look at some other direct measures to help discoms improve their revenue collection, call for proper metering to understand and record power consumption by end-users and ensure timely payments to discoms. Reforms are indeed necessary to improve discoms’ financial state.
