Energy fuels economic growth and electrical energy is a critical component of every nation’s energy mix. India is no exception. Currently ranked third largest in the world, electricity generation in India has witnessed a remarkable growth, particularly in the last 10 years with overall installed generation capacity increasing at an average annual rate of 8.8 per cent from 2010 to 2020, reaching 370 GW in March 2020.

The national peak demand has grown at an average rate of 4.4 per cent to reach 184 GW during the same period, according to Central Electricity Authority. The rate of national access increased from 43 per cent in 2000 to about 95 per cent in 2019, according to International Energy Agency’s report ‘India 2020 Energy Policy Review’.

Reform measures

To be sure, the Indian electricity market has undergone significant restructuring and reforms during the past three decades. The twin objective was to scale up expansion in generation and distribution as well as make the market transparent, competitive and efficient.

Experiences in India and in many countries suggest that as reforms progress and competitiveness increases with restructuring and unbundling of the electricity sector, costs of procurement of electricity reduces while the quality and stability of power availability improves.

One nation, one grid

The electricity market in the country however remains fragmented both at the retail level as well as in wholesale trading. One of the important steps taken to overcome this problem was synchronisation of regional grids into one national grid at one frequency. India has indeed achieved this by pursuing a ‘one nation one grid’ policy, making the country the world’s largest national synchronous grid.

Meanwhile, a slew of policy reforms oriented towards creating an efficient and transparent electricity trading system across the country has been in the works. The reform process began in the 1990s, with unbundling and liberalisation of the sector. A landmark reform was the enactment of the Electricity Act 2003, which removed licensing for generation and introduced open access for transmission and distribution.

Integration of the market

This development fostered competition and paved the way for integration of the electricity market across the country. An offshoot of open access transmission was the introduction of power trading on spot exchanges, which facilitated transparent price discovery in electricity markets.

Electricity trading on spot exchanges has picked up momentum quickly and the volume of electricity traded on power exchanges increased at an average annual growth rate of about 25 per cent while that transacted through bilateral transactions increased at an annual growth rate of about 7 per cent from 2009-10 to 2018-19, according to the Central Electricity Regulatory Commission.

With gradual opening up, the power markets have become increasingly competitive and transparent. At the same time, the market has witnessed an increase in the volatility in electricity prices, exposing stakeholders to price risks.

Reducing volatility

The average annualised volatility in electricity prices was about 41 per cent on an average during the last five years, enough to adversely affect the margins and economic viability of users and producers of this commodity. Indeed, electricity prices are inherently volatile due to their unique physical attributes manifested in the free market in this commodity.

As such, key stakeholders including generation companies, power distributors, load serving companies and myriad user industries that seek certainty in their costs and revenues from the use/sale of electricity, need effective hedging mechanisms for efficient price risk management.

Under the circumstances, creation of and access to appropriate risk management instruments for hedging of electricity prices becomes essential. As has been witnessed in many developed electricity markets around the world, risk management using Futures and Options on electricity is one of the most effective and popular ways to manage this risk.

Further, given the transparency of well-regulated exchange-traded derivatives market, it is important to use hedging instruments traded on exchange markets. This will facilitate and further advance a transparent and competitive electricity market in the country while reducing uncertainties and costs.

Transparent derivatives markets are also known for providing efficient platforms for price discovery which is one more reason for using exchange-traded electricity derivatives market for the development of this sector.

With the recent legal resolution of the regulatory jurisdictional issues connected to trading of electricity derivatives in India, it is hoped that Indian securities market will soon witness the launch of financial derivatives on electricity. This is sure to meet a long-pending demand for a product that addresses risk management associated with electricity.

Chandrashekhar is a policy commentator and commodities market specialist and Dey is Assistant Vice-President, MCX India. Views expressed are personal

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