Will ‘Price Cap’ For Power Work? : Daily Current Affairs

Date: 31/10/2022

Relevance: GS-3: Infrastructure: Energy, Ports, Roads, Airports, Railways Etc.

Key Phrases: Central Electricity Regulatory Commission, Pricing Methodology In The Power Trading Market, Day Ahead Market, Real Time Market

Why in News?

The Central Electricity Regulatory Commission (CERC), has recently issued a discussion paper and has invited suggestions from all the stakeholders on pricing methodology in the power trading market in the wake of price spikes and unprecedented demand in the last year.

Key Highlights:

In March 2022, an unprecedented demand was observed without the increase in supply and the prices in both the DAM (day ahead market) and RTM (real time market) remained significantly higher for a significant period.

What Is The Day-ahead Energy Market?

The day-ahead energy market is a financial market where individuals and companies can sell and purchase electric energy at financially binding, or day-ahead, prices for the next day.
The day-ahead energy market has a financially binding schedule of commitments for both the sale and purchase of energy.
The day-ahead market ensures both buyers and sellers can hedge against price changes and volatility in the real-time energy market as energy prices are locked in before the next operating day.

What Is The Real-time Energy Market?

Real-time energy markets enable consumers, companies, and energy distribution businesses to buy and sell energy in real-time, usually, an hour before delivery.
Auctions on the real-time market take place every 30 minutes, and the pricing of energy can change throughout the operating day.

Day-ahead Vs. Real-time Energy Markets

The day-ahead energy market lets individuals and companies buy or sell wholesale electricity 24 hours before the operating day, ensuring they avoid being negatively affected by market volatility.
On the other hand, the real-time energy market lets market users sell and buy wholesale electricity throughout the course of an operating day with no set or previously agreed prices.
As the real-time energy market calculates its prices based on day-ahead commitments and the real-time demand for energy, it creates prices that reflect market demand.

Short-term power market:

According to the discussion paper, power supply in India is predominantly tied up in long-term contracts.
With 87%, long-term transactions dominate the share of total electricity transactions in the country.
Of the total short-term transactions, the volume transacted through the power exchanges was the highest at 54%, followed by bilateral transactions through traders at 21%, transactions through DSM at 14%, and bilateral transactions between distribution companies (DISCOMs) at 11%.
Most of the volume transacted through the exchanges is being transacted in the DAM (including G-DAM), followed by RTM and Term-Ahead Market (TAM).

Pricing principles at power exchanges:

Based on the pricing principle, the contracts are broadly categorized into two types:
1. Collective Transactions: The price is discovered through anonymous and simultaneous competitive bidding by the buyers and sellers.
2. Continuous Transactions: The buy and sell bids are matched continuously with price-time priority. For a specific contract, the seller with the minimum quote and the buyer with the maximum quote are considered the best seller and best buyer.

Over-the-counter market:

The discussion paper refers to the over-the-counter (OTC) market as a key avenue for electricity trading.
The Commission made provisions for an OTC platform in the CERC Power Market Regulations 2021.

The objectives of the OTC platform are to:

Provide a platform with the information on potential buyers and sellers of electricity.
Maintain a repository of data of buyers and sellers and provide such data to participants
Provide such services as advanced data analysis tools to market participants.

Pricing Methodology:

The mechanism for collective transactions leads to the discovery of a uniform market clearing price (UMCP).
However, due to a uniform price for all market participants who are cleared, all sellers who bid lower prices get an extra profit (difference between the UMCP and the bid price).
Owing to the recent events in the electricity market, with prices reaching alarming levels, concerns have been raised that some sellers are making huge gains due to this market auction design.

Uniform Pricing versus Pay as Bid: The difference between the two lies in the final price paid to the cleared sellers.

Uniform Pricing: All the cleared sellers receive the same price, which is the market clearing price. As observed, the market cleared price is the bid price of the most expensive seller cleared to meet demand.
Pay as Bid: Prices paid to the cleared sellers are based on the sell bid offered by the respective seller. Each seller is paid a different price tied to the bid offered. These prices do not depend on the price of the most expensive seller.

Supply shortage and uniform pricing:

UMCP is the most commonly adopted pricing methodology globally, but concerns have been raised regarding the efficacy of this market design.
In March 2022, India witnessed a period of demand surge coupled with a supply shortage.
On the other hand, the increase in the supply has been limited. The situation has been further aggravated due to geo-political factors affecting the fuel supply and certain domestic supply constraints.
The increased prices of fuel, particularly imported coal, led to a significant increase in the marginal costs of the margin-setting generators of the market. This, along with a surge in demand, led to an abnormally high market clearing price, touching ~20/kWh.

Regulatory intervention:

The Commission directed the power exchanges to re-design, with immediate effect, the bidding software so that members can submit their bids in the price range of Rs0/kWh to Rs.12/kWh for DAM and RTM.
As a result of setting the ceiling price at Rs.12/kWh for DAM and RTM, the market clearing price in DAM and RTM was frequently hitting the ceiling price with the volume of buy bids greater than the volume of sell bids.
The Commission felt the need for a uniform price ceiling in all segments so that there was no shift in supply volume from one segment of the power exchanges to another segment induced by differential ceiling prices in the market segments.
On May 6, 2022, the Commission directed the power exchanges to revise the ceiling price of all segments to RS12.

Will price cap work in India where power is generated through various sources — coal, gas, renewables?

As per the experts, it will work if done with due diligence, which will depend on the method being adopted to derive the price as well as the threshold price.
In India, the uniform price concept is relatively at a nascent stage, so challenges may not be many in the short-term but for the long-term, if this system has to be adopted then the framework has to be properly structured with enough flexibility.
1. Identification of parameters: Identifying the parameters responsible for a trigger in the price rise i.e., the price rise is speculative or because of fuel supply uncertainty or demand-driven.
2. Fixing the cap: Once the trigger is identified, then, based on it a mechanism for fixing the cap can be worked out.
3. Fixing the floor price: It is important to have a floor price in case a cap is being set to ensure that the market is not distorted.

Conclusion:

Most of the volume transacted through the exchanges is being transacted in the DAM (including G-DAM), followed by RTM and Term-Ahead Market (TAM).
While the imposition of a price cap ensures that the market prices remain reasonable and within bounds, the generators with variable costs higher than the price cap tend to go out of the market.
A price cap is put mostly in an abnormal situation, so before deriving any formula this needs to be considered.
While the debate and discussion are happening, there is also a need to ensure that there is an inbuilt mechanism of passthrough so that generators and distributors do not take a hit when viewed in terms of their market sale/purchases on annualised basis.

Source: The Hindu BL

Mains Question:

Q. What do you understand by the Day-ahead Energy Market and the Real-time Energy Market? Discuss the various pricing methodologies in the power trading market. (250 words).