The OTC trader-based system does not facilitate efficient price discovery, despite regulatory provisions on the profits that can be made, since the transactions takes place in private with little public disclosure of details. It is all the more unexceptionable given the with limited depth and breadth in the exchanges. Banning all OTC trades and bringing them into the fold of the exchanges would multiply its liquidity and optimize price discovery efficiency of the exchanges.
Currently, the two operational power exchanges in India, IEX and PXI, offer day-ahead and week-ahead contracts. The bilateral OTC trading term ahead contracts vary from hours to many years. Such traded power (less than an year contracts), including the unscheduled interchanges (UI), form about 10% of the power generated in the country.
A test of the logic behind this assumption is the trends in market share distribution between the OTC and exchange markets. If the exchanges were more transparent and efficient, it was natural to expect them to increase their market share at the expense of the traders. And, recent trends point to exactly this happening. The Businessline reports that cheap prices in the exchanges are driving consumers - industrial and distribution utilities - away from traders. It writes,
"In 2010-11, the value of deals on the PXs surged to Rs 5,389 crore, a 51 per cent growth (or Rs 1,826 crore in absolute terms) over the deal values clocked the previous fiscal. Volumes more than doubled on the bourses. Correspondingly, the bilateral trader market, or short-term deals executed through a power trader, was down by almost Rs 800 crore during the year even as volumes remained flat. One of the key reasons for the PXs gaining favour over the traders is the lower electricity prices discovered on the two operational bourses — IEX and PXIL.
At Rs 3.47/unit, the average price on the PXs was a good Rs 1.30 lower than the corresponding price of Rs 4.79/unit for deals involving traders in 2010-11. As a result, the gap between the volumes for deals involving traders and those transacted on the PXs has narrowed sharply last fiscal... Thanks to the surge in business on the bourses, cumulative deal value surged to Rs 18,657 crore in 2010-11."
One way to compare the relative efficiencies of the two markets is to compare their prices. The graphic below of prices in June 2011 reveals that even in case of contracts with duration less than a week, which are also offered in the exchanges, the prices were lower in the exchanges (even with the daily average) than with traders.
The differential in prices (between the exchanges and OTC traders) with contracts that are greater than a week too are disproportionately higher. The case for banning OTC trades could not have been more convincing.
Update 1 (11/9/2011)
In the corruption filled environment, it was only natural before skeletons came out from the cupboard of OTC trades executed by state utilities. Businessline reports that the Uttar Pradesh Power Corporation (UPPCL) signed a one-year deal with a private power generator in Gujarat, routed through a private power trader in the western State, to buy some 600 MW at around Rs 4.70 a unit. The price is well above the average of less than Rs 3 a unit on the power exchanges over the last two months.
In fact, the average electricity price discovered on the two operational bourses — IEX and PXIL – was Rs 3.47 a unit, well below the corresponding price of Rs 4.79 a unit for deals involving traders in 2010-11.