Opinion

Coming, forward trading in energy exchanges

| Updated on: Dec 01, 2021
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The apex court has settled the issue between CERC and SEBI. A well-regulated derivatives market will help improve price discovery

The purchase and sale of power in India has long been dominated by power purchase agreements (PPAs) that state-owned distribution companies (Discoms) enter into with power generators. The term of these PPAs is usually 20-25 years. Such long-term contracts are needed given the high capital and operational expenditure requirements of these projects. At the same time, many state Discoms have also begun to purchase power from energy exchanges to meet their short-term needs.

On October 8, 2021, the Ministry of Power announced a plan to move to a market based economic dispatch model by April 2022 on a pilot basis. This implies that more power would be purchased from electricity exchanges. As electricity is a commodity that is difficult to store, it is at first glance hard to imagine the trading of electricity via a stock exchange. The challenges of scheduling and dispatch of electricity traded on energy exchanges have gradually been solved through complex co-ordination with load dispatch centres at various levels. Thus, it is now possible for grid connected entities to purchase physical electricity from power exchanges.

With regard to the electricity market there are three different types of electricity contracts that are traded on these energy exchanges: real-time contracts, day-ahead contracts and term-ahead contracts (presently up to 11 days in duration). The resolution of a long pending jurisdictional dispute between the Central Electricity Regulatory Commission (CERC) and the SEBI has the potential of adding new types of contracts to India’s energy exchanges and commodity exchange — that is, forward contracts (of more than 11 days duration) and derivatives.

A forward contract in electricity is one where electricity is delivered at a future date at a price agreed to in the present. Forward contracts are referred to as term-ahead contracts under the CERC Power Regulations, 2021 and as non-transferable specific delivery contract (NTSD) under the Securities Contract Regulation Act, 1956 (SCRA). When forward contracts are traded in the secondary market, they are referred to as derivatives. A futures contract is a type of derivative. A well-regulated derivative market helps in transferring price risk from the buyer to seller or vice a versa and improves price discovery.

For over a decade, term-ahead contracts beyond 11 days were not permitted in the electricity sector due to a decision of the Bombay High Court in the Multi Commodity Exchange vs CERC (decided on February 7, 2011) case. The Court, in this case, did not taken into account the fact that NTSDs were outside the regulatory purview of the Forward Markets Commission (now merged with SEBI) under Section 18 of the Forward Contracts Regulation Act, 1956 [FCRA] (now repealed, and found in Section 30A of the amended SCRA).

The Court instead relied on the definition of ‘ready delivery contracts’ which are defined as contracts where the price settlement and delivery of electricity occurs within 11 days under Section 2(i) of the FCRA [currently found under Section 2(ea) of the SCRA]. The Court thus held that the CERC had the power to regulate only ready delivery contracts and stated that regulation of contracts beyond 11 days required greater legislative clarity.

Anomaly corrected

It took the Ministry of Power eight years to correct this anomaly. Only in October 2019 did the ministry- constituted committee on ‘Efficient Functioning of Electricity Derivatives’ recommend that physical delivery based forward contracts be regulated by the CERC and derivative contracts be regulated by SEBI.

It took another two years for the Supreme Court, in the case of Power Exchange of India vs SEBI (decided on October 6, 2021), to approve of this settlement. The Supreme Court, which was hearing an appeal from the Bombay High Court decision, vide an order asked the CERC and the SEBI to abide by the terms and conditions suggested by the Ministry of Power-constituted committee, thus putting an end to this long saga.

However, certain challenges arising from the creation of a financially settled derivative market in electricity futures to be regulated by SEBI as a commodity derivative will need consideration. There continues to be a risk of regulatory collision between the CERC and SEBI as prices of electricity derivatives are derived from spot or term-ahead physical delivery-based electricity contracts. Therefore, price fixation could be an area of concern.

On July 27, 2021, the CERC had passed an order in relation to a petition filed by the India Energy Exchange and the Power Exchange of India Ltd for approval of introducing term-ahead contracts beyond 11 days. The CERC had stated that the petitioners should approach the CERC once the Supreme Court disposes of the matter. As the matter was disposed of by the Supreme Court on October 6, 2021, the introduction of ‘term ahead’ and ‘green term ahead’ electricity contracts seems only a short while away.

Aakanksha is Partner, and Pranaav is an Associate, with Economic Laws Practice. Views are personal

Published on December 01, 2021

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