Competitive Power Markets

Knowledge Series

Competitive Power
Markets
Growth Imperatives and Critical Success Factors

Table of Contents

OVERVIEW .................................................................................................................................. 1
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POWER EXCHANGE MECHANISM ........................................................................................... 2
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POWER EXCHANGE BENEFITS ................................................................................................. 2
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POWER EXCHANGES IN INDIA ................................................................................................ 2
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SHORT TERM TRANSACTION OF ELECTRICITY IN INDIA .................................................. 2
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ISSUES CONFRONTING THE DEVELOPMENT OF POWER MARKETS ................................ 3
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CONCLUSION ............................................................................................................................. 6
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ABOUT INFRALINEENERGY ...................................................................................................... 7
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August 2009 Page 2 of 8
Competitive Power Markets: Growth Imperatives and Critical Success Factors

Overview
As the Indian economy continues to surge ahead, its suggested the development of power markets,
power sector is also expanding concurrently to governed by appropriate regulations. It created a
support the growth rate. The demand for power is liberal and transparent framework for power
growing exponentially and the scope of growth in this development. Power trading through exchange is at a
sector is immense. India's total installed capacity of nascent stage and the volumes of exchange are small.
electricity generation has expanded from 105,045.96 The power market in India comprises mainly of long-
MW at the end of 2001–02 to 150323.41MW at the term power purchase agreements (PPAs) with a small
end of June 2009. The government has targeted a proportion of short-term (up to 1 year) bilateral
capacity addition of 78577MW in the 11 th Plan.
P P contracts.

Prior to 2003 the market was characterized by vertical Power is mostly traded between power surplus
integration with the state electricity boards forming a packets in Eastern Region (ER) and Northeastern
monopoly and excessive price regulation. Each state’s Region (NER) on one-hand and deficit areas in
electricity board was responsible for generation, Northern Region (NR) and Western Region (WR)
transmission and distribution within its own on the other.
jurisdiction. But the SEBs turned loss making and
inefficient. In the wake of the growing power needs The Electricity Act 2003 paved the way for new
and the continuous surplus-shortage situations faced trends like Open Access, power trading, etc. This has
in various parts of the country, the government helped in streamlining power flow from surplus
introduced Electricity Act 2003 for restructuring of regions to deficit regions and thus attempts to strike a
the power sector and to introduce competition and balance. Power Exchanges envisioned to bridge the
increase efficiency. It delicensed generation, demand and supply gap by introducing a common
recognized trading as a separate licensed activity and bidding platform that brings together various power
introduced open access in T&D. sector participants to buy and sell electricity through
an auction based system.
EVOLUTION OF THE POWER MARKET
The demand for power has continually outstripped
India being a predominantly agrarian economy, some supply. India currently faces an energy deficit of 9-
states experience seasonal surpluses of power while 10%. The power demand, which varies from region
some face deficit. Thus inter-state transmission of to region, creates an ideal situation for the trading of
electricity became the need of the hour. RLDCs were power, thus enabling better capacity utilization.
formed to facilitate such transfer of electricity. The Following conditions are necessary for competition
Central Government set up Central Generating
Stations to assist the state governments in • Multi buyer and seller model
overcoming shortages, and also promoted private • Responsiveness of demand and supply to
participation. However, the contracts were mostly price
long term for duration of twenty five years or more. • Equal access to essential facilities like
To meet short-term demand the states resorted to transmission and distribution
trading of power through bilateral trading agreements • Efficient marketplaces
on the basis of mutually negotiated prices. States
resorted to energy banking where in a surplus state CERC issued the Guidelines for setting up and
would supply energy to a deficit state and in deficit operation of the power exchange in February 2007.
situation, it would claim back that amount of energy The general approach of CERC was to allow
.But at times, when both states faced deficit and operational freedom to the exchange within an
there was no excess electricity to return to the state overall regulatory framework and deliberately kept a
that banked electricity, lead to complications. distance from its governance. The participation in the
power exchanges was voluntary and no existing
The Electricity Act, 2003, an astutely drafted Power Purchase Agreements and bilateral contracts
legislation, ushered in and formalized the concept of were to be disturbed. Issues like allocation of
trading of electricity within the country and also Transmission Capacity for power exchange and


application of Open Access charges & trading margin and information to plan their bidding strategy. It
are to be decided by CERC. Performs activities of schedule coordination,
settlement handling and physical delivery, under a
Power exchanges emerged as a market based single roof and further assists in creating deep and
institution for providing price-discovery and price liquid market on hourly basis for any size of bid.
risk management to the generators, distribution They also eliminate credit risk by performing the role
licensees, traders and consumers. of a counter party to all trade.

POWER EXCHANGE MECHANISM POWER EXCHANGES IN INDIA

Currently CERC permits the purchase and sale of Particulars IEX PXIL National
electricity on a day ahead market basis through Power
exchanges. The Indian markets are based on the Exchange
auction trade mechanism where bids for the purchase (proposed)
and sale of contracts of one hour duration that cover Date of August 31, September July 3, 2009
all 24 hours for the next day are collected by between approval by 2007 30, 2008
CERC
10am and 12am.
Date of June 27, October Yet to take off
commencement 2008 22, 2008
The model adopted by the power exchanges in India of operations
is based on that of the Nordpool market. The Indian Promoters Financial National NTPC,
power market is divided into 10 separate bid areas Technologi Stock NHPC, PFC,
which have different prices incase the unconstrained es (India) Exchange and Tata
electricity flow between biding areas exceeds the Ltd, PTC of India Consultancy
available transfer capacity. India Ltd (NSE) Services
Financial & National
Services Commodit
Flow Chart of Power Exchange Mechanism
Limited ies &
(PFS) Derivatives
Exchange
Ltd
(NCDEX).
Share in volume 93% 7% -
traded

A new trend that is emerging is that the existing
generation companies have reduced their long term
power sale commitments from 90-100% to 75-80%
and sell the remaining 20-25% through the open
market which provides them better returns thus
improving their financial position. Power exchanges
act as a catalyst for efficient transfer of power at fair
and transparent prices using open access. In FY2006-
07, short term market size was worth Rs.7200 cr and
it is expected to increase about Rs. 40000 cr in
coming five years.

POWER EXCHANGE BENEFITS SHORT TERM TRANSACTION OF
ELECTRICITY IN INDIA

The power exchanges provide a fair and transparent
According to the Monthly monitoring Report by
mechanism for efficient price discovery of the power
CERC on Short-Term Transactions of Electricity for
traded. The trading system is based on an auction
the month of April 2009, total electricity generation
mechanism and is divided into multiple sessions
excluding generation from renewable and captive
meant for sell, buy, trade matching and price
power plants in India was 62486.24 MUs .Of the
revision, which provides bidders with sufficient time
total electricity generation, 4432.07 MUs (7.09%)


transacted through short term i.e. 2210.34 MUs
(3.54%) through Bilateral (through traders and direct
between distribution companies), followed by
1815.66 MUs (2.91%) through Unscheduled
Interchange (UI) and 406.07 MUs (0.65%) through
Power Exchanges (IEX and PXIL). Of the total short-
term transactions, Bilateral constitute 49.87%
(40.50% through traders and 9.38% direct between
distribution companies) followed by 40.97% through
UI and 9.16% through Power Exchanges. There are
42 trading licensees as on April 30, 2009, of which
14 licensees undertook trading during April 2009.
Top 5 trading licenses had a share of 88.80% in the
total volume traded by all the licensees.
Figure 1: Share of various kind of electricity trading as a percentage of total
electricity generated and percentage of short –term electricity trade in
The volume of electricity transacted through IEX and April’09
PXIL was 376.72 MUs and 29.35 MUs respectively.
The volume of total Buy bids and Sale bids was
821.30 MUs and 485.48 MUs respectively in IEX ISSUES CONFRONTING THE DEVELOPMENT
and 52.18 MUs and 59.30 MUs respectively in OF POWER MARKETS
PXIL. The weighted average price of electricity
transacted through Trading Licensees and Power
1. Lack of Participation in Electricity Trading
Exchanges was Rs.7.21/KWh and around
on Power Exchanges: One of the most
Rs.10.00/KWh, respectively. The price of electricity
important objectives of setting up power
for UI transactions was around Rs.6.00/KWh.The
exchanges in India was to introduce
gap between the volume of buy bids and sale bids
competition. The very concept of competition
placed through power exchange shows that there was
lies on the premise of presence of a large number
more demand (1.69 times) when compared with the
of buyers and sellers, so that no single player can
supply offered through IEX and it was less demand
exert undue influence on the entire market.
(0.88 times) when compared with the supply offered
The multi-buyer and multi-seller model as
through PXIL.
envisioned by the Electricity Act 2003 is yet to
materialize in a concrete manner. The current
These observations point out that the total quantity
power exchanges in India IEX and PXIL suffer
of electricity traded via the power exchanges was a
on both the accounts:
meager 0.65% of the total electricity generated in the
• Lack of sufficient participation especially on
month of April and 9.16% of the total short term
the seller side
trade in the same month. These statistics don’t
highlight good performance of power markets. The • Strong influence of the top five trading
power markets in India initiated by the setting up of licensees. Amongst themselves they share
IEX on June 9, 2008 and subsequently PXIL, vide 88.80% of the total market
the Electricity Act 2003, still have a long way to go.
The composite development of power trading in Even six years after the Act, all of the state utilities
India currently faces a lot of challenges. haven’t unbundled and even the unbundling states
continue to procure power in a joint manner, thus
reducing the number of active participants. Power
markets are yet to see the light of the day when every
eligible player is active in the market. As a first step in
this direction, the technical hassles related to power
exchanges need to be resolved at the earliest. The
preparedness of the participating entities is a big
question therefore the participants as well as the
employees of the power exchanges need to be well
versed with the operations and technology in use. In
case of shortage situation, power utilities purchase
power from other utilities or captives and sell it to the


purchasers. This kind of trading activity must be participation and liquidity to power markets is to
brought under the ambit of the Power Exchanges. introduce various kinds of products to suit
There are some other positive outcomes in the different consumer needs. There is a need to
pipeline such as the introduction of Open Access differentiate between markets for physical
contracts up to three years and provisions to enable delivery and market for financial products.
large buyers such as NTPC and SAIL to connect Currently 100% of the Indian power exchange
directly to the CTU. Both these proposals are market operates in the delivery mode and trades
awaiting approval by CERC. Besides, appropriate in derivatives/ futures are yet to evolve.
regulatory framework to encourage developments of Power markets should enable both; trade of
power markets, Financial Institutions need to play an power as a commodity and the trade of
active role in the deepening and expansion of Indian derivative instruments with power as an
power markets. underlying commodity. In due course of time as
the market develops, ancillary and related
2. Definition of Appropriate Market place and products such as energy efficiency certificates,
its Forces: In order to ensure the success of renewable energy certificates and transmission
Power Markets, it is imperative to ensure the rights can also start getting traded in the power
working of a free, fair and transparent market markets. Provisions such as easy down selling of
place and its various participants. This existing delivery contracts by the consumers and
necessitates the step to first define market place standardization of new contracts should be
appropriately. Power Markets are typically enabled. The need to induce liquidity and
defined on the basis of tenure and geographical stability in the initial physical phase calls for
limits. In terms of tenure the transmission timely introduction of standard, risk
contracts are available either in short term period management products such as electricity futures
of less than three months or long term period of options and swaps. It goes without saying that
up to twenty five years. This huge gap needs to proper regulatory environment would be
be bridged and calls for the introduction of required to ensure smooth roll-out of these
medium term contracts of one to five years. In products. In the pipeline: PXIL has applied to
addition to this, real time/ balancing contracts the CERC for approval of following three new
also need to be developed. These contracts are categories of products:
typically based on random events and
contingencies and give rise to intra-day demand • Long tenure products: week-ahead, 1st month
and supply need of power. These kinds of ahead, 2nd month ahead and 3rd month ahead
contracts enable a participant to enter the market contracts.
on a real time basis and trade power. • Intra-state products: The intra-state products
In the geographical context, the biggest challenge involve 2-day-ahead transactions wherein a
is that Indian power exchanges operate on a market participant can buy/sell power from/to
“multiple control points”, as a result of which other market participant within the same state.
there are transmission constraints on a single • However, the unmatched trades would be
line. One of the solutions suggested to deal with brought to the national day-ahead market on
this problem is to develop the infrastructure for a next day.
super capacity highway to assist fast and • Day-Ahead-Contingency (DAC) product: It has
decongested transmission of electricity. The been designed by PXIL to provide buyers and
process to connect regional and national markets sellers with additional opportunity to clear their
to each other via the national grid must be volume at the end of the day after trading is over
quickened. The regulatory commission must for the day-ahead market. According to PXIL
make it mandatory for states to foretell their authorities, given the perishable nature of
procurement requirement and assist them in the electricity, surplus electricity which could not be
construction of enabling transmission traded during the earlier session can still be
infrastructure at their respective boundaries. cleared if the sellers reduce their price bids and
buyers requiring electricity match such prices
3. Introduction of Innovative Market Products:
The Indian Power Markets are characterized by • Lack of liquidity: The bulk of trade in Indian is
lack of innovative financial products and through PPAs leaving little or no surplus
liquidity. One of the best ways to attract greater available for short term trading. Also, it causes


price volatility and sends distorted price signals. time for the regulator to step in? The market
The PPAs should be freely down-sold by the matching mechanism being used now in the day-
consumers, who are large scale participants in the ahead market, needs to be suitably evolved to
exchange markets. Secondly, lack of liquidity suit the needs of products of longer tenure.
provides a great learning and experimentation There are various market matching mechanisms
opportunity. It can be harnessed to introduce which can be utilized for the power markets such
products in a relatively shallow and less as pay-as-bid auctions and Vickrey Auctions, to
impactful market. name a few.

4. Deficit Market: An important point to 6. Regulation: Though the Indian exchanges
highlight here is that India is perhaps the only currently operate under CERC’s supervision,
country to have a growing power market in an broader market defining regulations delineating
overall deficit condition. In such a scenario, the the role of each participant in the power market
benefits of trading cannot be sufficiently passed value chain are yet to be developed. The concept
on to the consumers. Therefore, it goes without of power trading is still in its nascent stage and
saying that generation capacity addition to appropriate regulatory framework to guide its
bridge the demand supply gap is a pre-condition success is critical. Regulators should work in
to ensure efficiency of power markets. Besides, in collaboration with the power exchange
a deficit market the participants face quantity authorities to keep in mind participants and
risk in addition to price risk. Deficit market also consumer interests and at the same time ensure a
poses a hindrance to the introduction futures vibrant and smooth functioning of the
trading, as their delivery on maturity cannot be exchanges. Particularly, the regulator should look
guaranteed. into the following issues:
• Consumer Interest:
5. Pricing Mechanism: While introducing o Prevent speculative trades
exchange-traded collective transactions, a form o Prevent predatory pricing
of point-of-connection tariff on MW usage basis o Ensure Price stability
was conceptualized. This mechanism though o Ensure justified proportion of volumes
suitable to the day-ahead market, isn’t amenable in short, balancing and real-time
to long term contracts. In fact the pricing markets
mechanism varies across the various categories of o Encourage growth in diversity of
trading contracts. Below are mentioned some participation over time
characteristics of the pricing of different term o Keep a check on abuse of opportunities
contracts. for transfer pricing
This varied inherent nature of different term • Regulatory perspective on
contracts makes the entire process of pricing o Level of trading margins
complex. In such a scenario, it is essential to o Capital requirements
define the extent of regulatory jurisdiction over o Norms for cross-border trade
pricing. The prices determined by market forces o Assessment of long-term costs and
have been an up hill task, therefore it becomes all recovery
the more important to deliberate over the fact
that should exchange prices be completely left to
demand and supply forces. When is the right

Near Term Contracts Short Term Contracts Long Term Contracts
- Prices determined by demand - Based on seasonal and diurnal - Based on long term demand supply
supply interaction demand-supply patterns trends
- Electricity almost commoditized - Prices characterized by underlying - Pricing of generation asset, fuel,
- Pricing on the basis of risk-reward asset delivery, specific asset characteristics-
matrix for quality of planning and - Implicit pricing of transmission such as location, fee, duty
flexibility in supply options and congestion - Pricing on the basis of fit with long-
- Pricing on the basis of utility of term demand growth projections,
end-use, bargaining power of quality of power supply (economies of
counterparties, enforceability of scale, peaking capability, technology
reliability guarantees used, risk-sharing formulae)


7. Open Competitive bidding (short- term): CONCLUSION
In the short term trade, market participants and The Indian Markets are substantially different
intermediaries are invited for discovery of best levels from power markets elsewhere in the world. Its
of sale and purchase prices. But, this works well only very nature poses unique challenges in the
in an unconstrained and efficient market. In a development of the market and the product as
constrained market, characterized by limited well. In consideration of the issues highlighted
evacuation paths, lack of participation and overall above, a lot remains to be done on the part of
shortage situation, it leads to price spikes. Thus, in regulators and power exchange authorities to
order to tackle such a situation, the exchanges should ensure smooth functioning of the power
adopt a method based on a combination of markets. Some of the important matters
highlighted in this paper are summarized below
• Adequate leeway to participants to deploy sound • The markets lack participation and liquidity.
commercial practices in entering short-term Appropriate steps, such as introduction of
arrangements; and innovative products, must be taken up and
financial assistance should be provided to
• Evolving, over a long term, a bidding encourage wider participation.
methodology that allows generators and utilities • The operating staff and participants need to be
in an unconstrained system to discover a system- adequately trained
Marginal-Price • The Power Markets needs to be defined clearly
and appropriately, keeping in mind the aspects
9. Information Asymmetry: There are a varied of tenure and geography.
group of entities involved in trading through the • Besides, medium term contracts its high time to
Power Exchanges, each having its own set of introduce financial products in the markets with
valid information. Valuable information thus power as the underlying asset.
gets distributed in different form, structure and
• The products and trading methods need to keep
places. Also, the timeline for this information is
price volatility in check and an open auction
not laid down. Thus, there is an urgent need to
methodology is perhaps more apt in the context.
streamline all relevant data and develop a
• In view of the varied inherent characteristics of
comprehensive data to cater to the needs of
different term contracts, pricing mechanism
power trading and help in making the entire
needs to be developed accordingly. Also, the
process more efficient.
regulatory jurisdiction over pricing norms needs
to be clearly defined
• Appropriate Regulation must protect consumer’s
“Indian Markets are Substantially interest and lay down norms regarding capital
Different than the Markets requirements and monitoring. A comprehensive
Worldover” database of power markets information must be
developed at the earliest.


ContactUs
Rishi Baid
Email: rishibaid@ymail.com UTH


Competitive Power Markets

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