Relevance: GS-3: Indian Economy and issues relating to planning, mobilization, of resources, growth.
Key Phrases: Central Electricity Authority, International Energy Agency, India 2020 Energy Policy Review, Electricity derivatives
Why in News ?
- Recently, Niti Aayog has said it is necessary to introduce electricity derivatives to make the sector more resilient, transparent and integrated.
Key points
- Currently, India ranks third largest in the world in electricity generation.
- 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 percent 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 the Central Electricity Authority.
- The rate of national access increased from 43 per cent in 2000 to about 95 per cent in 2019, according to the International Energy Agency’s report ‘India 2020 Energy Policy Review’.
What Are Electricity Derivatives?
The buying and selling of power in India has long been defined by power purchase agreements (PPA), distribution companies (DISCOMS) enter into with power generators. PPAs are usually long duration contracts around 20-25 years, 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.
Ministry of Power in Oct 2019 announced a plan to
move to a market based economic dispatch model by April 2022 on a
pilot basis which means 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 has 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.
Electricity derivatives are financial instruments whose underlying asset is based on Electricity products, including solar, wind, thermal Electricity. They can either be traded on a formal exchange or on an over-the-counter (OTC) basis.
Electricity derivatives are an important part of the modern financial system and are widely used for purposes such as speculation, production planning, and risk hedging.
Issues in Electricity Derivatives market
- Fragmented Market: electricity market in the country however remains fragmented both at the retail level as well as in wholesale trading
- Slow opening: With the slow opening of electricity trading, the market is still less competitive and transparent.
- Increasing Volatility: At the same time, the market has witnessed an increase in the volatility in electricity prices, exposing stakeholders to price risks.
- 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.
- Hedging Mechanism not Developed: Key stakeholders including generation companies, power distributors, load serving companies that seek certainty in their costs and revenues from the use/sale of electricity, need effective hedging mechanisms for efficient price risk management, which is yet to fully develop.
- Many Legal and regulatory jurisdictional issues connected to trading of electricity derivatives in India still persisted.
Reform measures in Electricity Derivatives market : Expansion, Transparency, Stability, Quality,Integration
- One nation, one grid: India pursuing a ‘one nation one grid’ policy, making the country the world’s largest national synchronous grid.
- Trading System: Meanwhile, a slew of policy reforms oriented towards creating an efficient and transparent electricity trading system across the country has been in the works.
- Liberalization 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: An open access and the introduction of power trading on spot exchanges, which facilitated transparent price discovery in electricity markets.
- Development of Spot Exchanges: 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.
- Risk Management: As has been witnessed in many developed electricity markets around the world, risk management using Futures and Options on electricity is needed on a large scale.
Way Forward: Hedging, Price Discovery
- Transparency of a well-regulated exchange-traded derivatives market is important and to use hedging instruments traded on exchange markets is vital for risk management.
- This will facilitate and further advance a transparent and competitive electricity market in the country while reducing uncertainties and costs.
- It is necessary that the Indian securities market will soon launch financial derivatives on electricity. This is sure to meet a long-pending demand for a product that addresses risk management associated with electricity.
Mains Question
Q. What do you mean by Electricity Derivatives? Discuss how electricity derivatives can strengthen retail-wholesale linkages, risk management and usher a new change in the fragmented electricity market in the country?( 15 marks)
Source: The Hindu BL
