Thursday, December 3, 2009

Ban OTC trades in electricity markets

Though exchange based trading of power has been in vogue in India for slightly more than a year, they constitute just 0.3% of the total consumed power in the country. Two power trading exchanges - Indian Energy Exchange (IEX) and Power Exchange of India (PXI) - are presently operational. Further, of the total short term power trade, exchanges (which trade only day-ahead contracts) form just 9%, while bilateral forward contracts (upto one year) form 50% and Unscheduled Interchange (UI) (spot market with frequency-based pricing to settle real time inter-state unscheduled imbalances) forms 41% (figures from April, 2009).

Currently, of the total power traded, exchanges form just 9%, while bilateral trades form 50% and Unscheduled Interchanges (UI) forms 41% (figures from April, 2009). This multiplicity of platforms for traded power has resulted in the fragmentation of the nascent power trading market, and rendered all of them inefficient and distorted. The bilateral trades are conducted Over the Counter (OTC) by registered traders who sell day-ahead and longer term contracts to mainly state utilities at negotiated prices. Sensing the importance of increasing liquidity in the exchanges, the Government have also taken several steps including obligating all new generators to sell a part of their produce through the exchanges, and a proposal to slowly shift UI trades into the power exchanges.

Markets in electricity trading are qualitatively different from those in other products, including commodities. Since electricity is not storable and transportation a major constraint, the markets trading in electricity contracts are inherently inefficient, liquidity strapped and have limited fungibility. The constraints in transmission capacity means that prices for delivery at one place at any time will have no relation to that for delivery at another place at the same time. This limits the forward market for each time and place to only a few buyers and sellers. In other words, the absence of a country-wide market in forward contracts seriously limits the market liquidity and efficiency. It is therefore important to have markets that trade the full spectrum of products - spot, forwards and futures; have considerable liquidity; and have enough transmission capacity to increase the fungibility of contracts.

In the context of a market with substantial power deficit, limited number of sellers, and relatively inelastic demand (buyers cannot afford not to meet the demand due to political compulsions), sellers will always be the market makers. All the aforementioned conditions are likely to persist for some time to come. This market power of the seller's gets amplified in inverse proportion to the volumes traded in the exchange. In the circumstances, it is imperative to take all possible measures to increase trading liquidity in the exchanges so as to mitigate market conditions favoring the sellers.

In the circumstances, it would appear natural for the government to encourage the shifting of OTC trades into the transparent of platform of power exchanges. It will do more than any other intervention to considerably enhance the market liquidity and promote efficient price discovery in exchange transactions. This assumes importance especially in view of the proposal by both IEX and PXI to introduce term ahead contracts in its portfolio of offerings. Contracts not covered by the exchanges can continue through OTC route, while those offered by the exchanges can be immediately brought under the exchanges.

The presence of OTC traders inhibits the development of efficient power exchanges in the country. The non-transparent nature of its price discovery and the demand-supply imbalances makes OTC trades attractive for traders who enjoy a superior bargaining power. These bilateral contracts "crowds in" all types of trades and drains liquidity from the exchanges. Despite its high prices, desperate state utilities too prefer the longer term bilateral contracts which lowers the uncertainty associated with procuring power in an illiquid and deficit market. In the final analysis, the day-ahead and term-ahead markets should converge towards the same efficiency and transparency that has been the mark of the CERC managed UI market.

The State and Regional Load Despatch Centers consolidate the requirements of each utility on a day-ahead basis and then schedules the transmission corridors to match the generating station and the purchasing utility or open access customer. Any demand by a utility, over and above that scheduled is called unscheduled inerchange (UI) demand. The UI rates are fixed based on the marginal cost of production of the costliest scheduled generator supplying at that point in time and is capped by a ceiling rate. Since the UI rate are known in advance, these trades are done without any contracts and involve real time balancing and settlement.


arjun said...

Hello Gulzar,

I've been following trades on IEX for the last few months. Last month, prices have dipped as low as Rs 2.5. During this period the no. of buy bids are extremely low- prices have recovered in the northern region over the last week due to increase in purchases by Discoms in Rajasthan and UP. Sell bids are uniformly high through the period. This is indicative of a buyer driven market. That only a fraction of the sell bids are currently cleared, might be a deterrent for new entrants on the exchange.

gulzar said...

the 2.5 rate is an off-peak price... even the UI prices are low when the frequency is high. daily peak prices, when there is demand from the state utilities, still remain high - above Rs 6-7.

one reason for the relative dip from the April-July prices of Rs 11-15 per unit has been the fact that many states like Andhra Pradesh, constrained by budgetary issues, have been staying away from the markets. since the elections in maharashtra got over, the forced purchases by its utilities too would have come down.

the seasonal trend and the variations in agriculture consumption may also partially explain the relative decline in prices. the market is so tight (illiquid) that even small purchases from some of the biggest players - Maharashtra, AP, TN etc - would be enough to tip the scales in favor of the sellers.

also how much impact has the CEA's recent 45-day price cap on exchange traded power has had on market discipline (the propensity to indulge in price gouging!)?