IEX: Too many moving parts make it a wait-and-watch

Indian Energy Exchange (IEX) has been in the news ever since the Power Ministry sent a letter to the Central Electricity Regulatory Commission (CERC) on the use of market coupling. It is believed that the ministry’s move can hurt the monopoly status of IEX in the power exchange market.

Though market coupling might prove a dampener for IEX, the sharp reaction to the stock by the street came as a surprise as discussions on market coupling have been on for some time now, including its implications for IEX.

What is market coupling?

Indian power sector regulator CERC had, in its draft Power Market Regulations 2020, proposed a market coupling operation (MCO) to determine the trading price of electricity on all power exchanges. The MCO will club buying and selling bids on all power exchanges to facilitate better price discovery and an opportunity to serve more customers. The ministry has now approved it and directed CERC to implement it in consultation with stakeholders, followed by finalisation of the construct.

Currently, around 87 per cent of electricity volume is transacted through the long-term power purchase agreement of around 25 years, while 7-8 per cent is through power exchanges, as per CERC. There are three power exchanges in India: IEX, Power Exchange India Limited (PXIL), and Hindustan Power Exchange Limited (HPX). The prices at which electricity is traded on these exchanges are different as each collects bids on its own and comes up with its own market clearing prices and two-way brokerage per trade.

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Under market coupling, an independent entity will aggregate all the buy/sell bids at the different exchanges to discover a uniform price. As per a report by financial services company Nuvama, it remains to be seen whether the market coupler would be theNational Load Dispatch Centre (NLDC) or some other entity.

How will IEX be affected?

In the power exchange market, IEX commands a monopoly with nearly 90 per cent of market share as on FY23. The volume traded on the exchange has witnessed a five-year CAGR of about 12 per cent while doubling the number of participants from around 3,000 to more than 7,200 in the last 10 years, as per a Keynote Capitals report. IEX has been able to do this through the timely and consistent launch of products (Real Time Market, Term Ahead Market, Green Term Ahead Market, Green Day Ahead Market, and so on) tailored to customer needs, which is reflected in its market share.

However, with increasing competition, IEX’s market share fell from around 95 per cent to 90 per cent year-on-year. Further, with market coupling, liquidity will no longer be an advantage for IEX, as the matching of orders will occur at a common liquidity pool on the platform of the market coupling operator, regardless of where the buyer or seller places their order. Hence, a buyer from IEX can purchase electricity from a seller on PXIL. As per the Nuvama report, market coupling potentially negates IEX’s moat, as other exchanges can eat into its market share over time.

Chairman and MD SN Goel expressed apprehension over the ministry’s move by likening market coupling in the power market to the coupling of BSE and NSE or Ola and Uber. He believes that market coupling can kill competition and innovation in the sector. At the same time, as per Naveen Singh, Head of Policy Advocacy and VP of Business Development, there has been a lot of discussion on the matter in the past and, hence, the market is prepared for the change and is merely in need of a proper framework. Further, he beileves that with market coupling, other exchanges like HPX stand to gain market share as implementation can take at least 4-5 months.

MBED mechanism

Another side of the argument is that market coupling is a step towards introducing the market-based economic dispatch (MBED) mechanism, which was not mentioned in the letter sent to CERC recently. In December 2018, the CERC released a draft proposal for the MBED system, which outlined that all power transactions shall be conducted through power exchanges, including those tied up in PPAs. If implemented, this can further increase the opportunity size and volumes traded on the exchanges, which can be beneficial for IEX. Such an approach is in line with developed economies, where 30-80 per cent of power is transacted through exchanges.

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Ultimately, there is no clarity on the framework and implementation timeline for market coupling. However, it seems clear that IEX stands to lose market share. Further, one needs to keep an eye on developments as the CERC begins consultations with stakeholders.

IEX currently trades at a trailing P/E of around 36 times while its peers are not listed for comparison. Typically, EBITDA margin for the company hovers around 85 per cent. While the market coupling news proved a dampener on the stock, it was under pressure earlier too. Since its all-time high in December 2020, the stock was down 48 per cent even before the market coupling news broke. This was due to competition from other exchanges and reports of Dalmia Bharat group’s planned sale of more stake in IEX after trimming it to the tune of 5.2 per cent to touch 14.8 per cent during FY22. Further, with valuation running way ahead of fundamentals during the market euphoria phase in 2021, there was significant stock underperformance even before the recent news on market coupling.

Given the numerous moving parts discussed above, the stock remains a wait-and-watch for now.

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