The Securities & Exchange Board of India (SEBI) has approved the launch of electricity derivatives on the MCX, a development that will help deepen and mature the power markets, besides hedging against price volatility.

What are electricity derivatives?

Electricity derivatives are a financial instrument that aids Gencos, Discoms and large customers such as commercial and industrial (C&I) players to hedge electricity price related risks. A derivative exchange basically trades on future output of electricity.

The new contract will offer participants a reliable, transparent and regulated platform to manage electricity price risks that have become more dynamic on account of addition of renewable energy. As India adds more RE to its grid and the focus on open access markets, a derivatives market can help bridge the gap between the physical and financial markets in power trading.

Why are they critical?

Derivatives offer a critical risk management tool allowing market participants with exposure to an asset (electricity) to hedge it across various time periods.

To understand the criticality of electricity derivatives we need to understand the limitations of the current power procurement system in the country. The balance is traded through power exchanges.

Majority of the power, more than 90 per cent, is traded through long term (25 year) power purchase agreements (PPAs), which in general does not reflect the evolving market and price dynamics. This impacts forward planning.

Besides, Discoms are shying away from signing long term PPAs due to their stretched financial capacity. Almost 40 gigawatt (GW) of RE capacities are idle due to states shying away from inking PPAs. This can impact India’s ambitious target of adding 500 GW of non-fossil fuel capacity by 2030.

A futures market for electricity derivatives can aid in hedging off-taker risks, while offering flexibility and certainty of supply. It will also offer Gencos and Discoms better visibility of future demand and projections, particularly during peak demand and weather related surges, a step that can help develop projections for installing energy storage systems (ESS) and better demand response management.

Power exchanges or short term power markets have evolved with several segments such as DAM, RTM, G-DAM, etc. However, they are not mature enough and off late have become slightly unpredictable with respect to price surges and crashes during high demand and low demand periods.

For instance, recently prices on power exchange (Indian Energy Exchange) plummeted to record lows due to high generation of solar power, which adversely impacted generators with revenue loss. Rising unpredictability in weather events coupled with price spikes is also a concerning issue.

Lastly, derivatives will provide a forward price curve that will help in making better investment decisions. With an increasing share of renewable energy, derivatives will provide avenues for sale with price certainty, a step that will attract more investments.

How do electricity derivatives work?

Electricity derivatives can be in the form of futures contracts, which mandates a buyer or seller to buy or sell electricity at a specific price and time in the future. Options and swaps are other forms.

While options are used to hedge or speculate on the future price movements of electricity, swaps are leveraged by businesses to manage fluctuating power prices over time

Options allows the holder to buy or sell electricity at a set price within a specific time frame. Swap involves exchanging cash flows based on electricity prices, such as fixed price payments.

How can electricity derivatives help deepen India’s power sector in terms of players and service offerings?

In a June 2021 commentary, Vibhuti Garg, who is currently Director for South Asia at the Institute for Energy Economics and Financial Analysis (IEEFA), noted that derivatives can deepen the short term power market.

The derivatives market will provide vibrancy by increasing trade volumes and encourage more participants by separating the physical delivery of electricity from the financial settlement. This will allow hedgers, speculators and a host of other participants to trade in the electricity market, she explained.

Besides, Garg added that it will provide diversified avenues for supply, higher visibility of a more reliable forward price curve and transparency in power pricing.

It will enable the transfer of risk from entities that have it but may not want it to those with an appetite for it, which further enables market participants to expand their volume of activity. Moreover, prices in the derivatives market will reflect the collective perception of market participants about the future.

Published on June 11, 2025