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Power Exchange To Promote Power Market: Cautions Required, Shri R V Shahi, Former Secretary, Ministry Of Power

Power Exchange To Promote Power Market: Cautions Required
[R V Shahi's Weekly Column for Infraline, October 8, 2007]

Electricity Act 2003 has provided a number of features which are aimed at not only bringing about transformation of the electricity industry and market but also for introducing a competitive environment. The focal point of the Act, and of the changes stipulated, is the consumer interest. A number of instruments that have been envisaged in this legislation aim at bringing about the required structural changes so that the sector shifts from limited options or no option to multiple options. One such change is through Power Trading. This has been recognized as a distinct licensed activity. As we are aware, prior to this Act, it is only the Electricity Boards, as provided in the Electricity Supply Act 1948, which could supply power to consumers or which could engage in purchase of power and distribution. By way of implementation of Electricity Act 2003, today we have almost two dozen electricity trading licensees. This has already resulted in the distribution companies throughout the country making use of this instrument and trying to get the best possible advantage for procuring power. It is not only facilitating such procurement of power but is also helping in better utilization of generation capacities available in the country. Therefore, while trading has helped in mitigating shortages to some extent, it has also assisted in bringing about overall improvement by better utilization of power plants. Inspite of these enabling provisions in the Act, and despite a large number of trading licenses having been granted by the Regulatory Commissions, the trading volume continues to be abysmally low at around 3% of the total power generated in the country (out of more than 600 billion units, only about 20 billion units are being traded).

While the subject of Power Trading, its existing status, the constraints, the remedies etc. are by themselves issues of examination analysis and discussion, we are for the present focusing on Power Exchange as an initiative to promote this process. In India we are familiar with stock market exchange for a number of years. Bombay Stock Exchange and similar exchanges in different towns existed about ten years ago. National Stock Exchange with some fresh ideas and new approaches emerged on the scene. Obviously faced with the competition, working of Bombay Stock Exchange has also improved as was expected and definitely National Stock Exchange which started on a clean slate and from the scratch brought in innovative freshness while dealing with this issue. In the recent years there have been good examples of commodity exchanges facilitating and bringing about transparency in the process of trading of commodities. Experience has shown that input and contribution of these exchanges in the whole process have proved to be positive and useful for all the stake holders.

About three years back, MCX which was already in the commodity exchange business came up with an idea of promoting Power Exchange to facilitate power trading. They made a presentation to me and senior officers of CEA, NTPC etc. in the Ministry of Power. In principle it was agreed that Power Exchange could definitely be a useful instrument and would contribute in bringing about a competitive environment in the sector through enhancement of more convenient, faster, transparent and more efficient transactions. In fact, the Ministry of Power set up a group to study the working of Power Exchanges in some other countries where these exchange have demonstratively established success. A lot of data and information was collected. Subsequently two groups started working on this namely MCX and NCDX. Recently, the Central Electricity Regulatory Commission has already cleared the Power Exchange promoted by the MCX Group in association with Power Trading Corporation, TATA Power, Reliance Energy, IDFC etc. The other group which is working on this and is in the process of securing the license consists of NCDX, NSE, NTPC, Power Grid and Power Finance Corporation etc.

To really appreciate the mechanics of Power Exchange and to understand the implications of various issues involved, it would be necessary to establish the need for Power Trading. On 3rd October, 2007, the Monthly Round Table organized by Infraline Energy and IDFC deliberated on the issue of Power Exchange for promoting development of power market in India.

Why power exchange?

  • To create a transparent, national-level platform for trading electricity in India. In order to create a vibrant power market, a transparent platform for trading of electricity is a pre-requisite.

  • To access a diversified portfolio. Power exchange offers a broader choice to generators and distribution licensees at the national-level who can trade for smaller quantities and smaller number of hours without additional overheads.

  • For payment security. The exchange will be the counter-party for all trades. Participants need not be concerned about the risk-profile of other party.

  • For minimal transaction overheads/charge. All charges are displayed on the trading terminal; so there would be no need to negotiate. The cost of transactions through the power exchange is much less than any other mode of bilaterally traded transactions.

  • To precisely adjust portfolio as a function of consumption or generation profile. Participants in the power exchange, especially distribution licensees, shall be able to precisely manage their consumption and generation pattern.

  • Hedging UI risks. The real-time prices of electricity fluctuates and licensees need to mitigate risks. The power exchange shall provide a tool to minimise price risks.

  • For market development: The exchange can be expected to launch a range of products to facilitate development of power markets in India.

Source: MCX Brochure

The process of sale and purchase of power and the nature of commercial arrangements over last 15 years were discussed in detail. As we are aware, after the economic liberalization of 1991, the change in the power sector that happened led to long term commercial arrangement between generator of power and electricity distribution utilities through Power Purchase Agreements. When Electricity Boards at the state level used to deal with generation, transmission and distribution, all of them were under one umbrella, even this commercial arrangement did not exist. When during mid 80's Central Public Sector Undertakings such as NTPC started with commercial approach, the instrument of Power Purchase Agreements, though not very comprehensive, commenced the commercial orientation of such transactions in the sector. Subsequently with Independent Power Producers, in the private sector, getting into the generation, long term Power Purchase Agreements became the main modality of commercial arrangement. Thus, most of power capacity today is locked through such long term contracts. Even the so called 15% unallocated capacity of central power companies, viz. namely NTPC, NHPC etc. are really not getting into traded commodity but they are reallocated to states like the normal allocation category. Therefore, the room for power trading in the electricity sector is extremely restricted. Unless the system enables reasonably good proportion of the total capacity to get out of the long term locked-up arrangement, power trading, in true sense, would not emerge as a meaningful contributor to competitive environment in the sector. I recall that when the instrument of E-Auction for coal was being examined, many of us belonged to the school of thought which suggested that unless about 10 to 15% of coal was allowed to be traded through this method, it might lead to excessive rise in the price and might even lead to manipulations by vested interests. It is now history that a small percentage of trading volume through the auction of coal did lead to many problems. Even in power sector 3% of power being traded leads to excessively high price in the situation of overall shortage in the country. Therefore the idea of enlarging the size of trading by way of facilitating captive plants supplying to the grid, development of merchant power plants or merchant capacity in large power plants or aligning a small percentage of Ultra Mega Project capacity to be kept out of the long term Power Purchase Agreements are the instruments through which this process can be enlarged and encouraged.

Unfortunately, the Power Exchange which is being developed would not capture the inputs from captive plants linked to state level grids at lower voltages, nor would it accommodate the small merchant plants which are not linked to Extra High Voltage National Grid. The issue which needs to be seriously considered is how best they could be brought into the ambit of exchange operation. The national grid developed and maintained by Power Grid has the necessary infrastructure including modern hardware and software to lend themselves to any sophisticated treatment including online transactions. Therefore, in the first instance, it is but natural that the first Power Exchange is being asked to restrict its activities to the transfer and trading of power through Extra High Voltage Transmission System. However, it is also a fact that for enlarging the volume of trading we can't leave out merchant plants and captive plants most of which could be connected to the local and state grids. The problem of updating of the hardware to accommodate the requirement of trading and modernization of the grid operation at these voltages will need to be taken up on priority so that this potential of power is brought on to trading through power exchange at the earliest.

Power Exchange as a concept is not new to the power industry. For India it no doubt new. For India even power trading is relatively a new development - a development of last five to six years and it is at a nascent stage. It needs to mature and larger volume will obviously yield that type of growth and maturity. In U.K., Australia, Ontario and Alberta the trading happens through bilateral/forwards, through day-ahead transaction as also through real time operations. Similarly, these three types of trading are prevalent also in New Zealand and NordPool. In India, however, as of now real time trading is not happening. The closest that we can interprete the real time purchase/sale in Indian Power sector is through the mechanism of Unscheduled Interchange (U.I). This is not a planned transaction or trading. This is a forced event. Quite often states, having shortages of power, particularly during peak hours, tend to over draw power from the grid, thus depriving other states of the power to which they are entitled. This type of frequent overdraws from the grid create imbalances in system operations and sometimes this can lead to major grid collapse thus disrupting power supply in a large number of states. Therefore, the mechanism of Unscheduled Interchange has been put in place to penalize such states at very high rate of tariff, may be four to five times of the usual tariff, to discourage them and prevent them from doing so. In a way this transaction happens without any planned arrangement. Therefore, it is not trading but it is very near a commercial arrangement which automatically is like an online transaction.

When the normal trading itself picks up to a larger volumes, the concerned utilities will find considerable merit in dealing with this arrangement rather than indulging in grid indiscipline warranting penal tariff under the above dispensation of Unscheduled Interchange.

Long term Power Purchase Agreements and medium and short term trading have to co-exist. Entire investment in highly capital intensive power sector cannot be expected to happen unless there is proper contractual arrangement for long term off-take of power, at least for larger portion of the capacity which is being planned. A marginal capacity may be of the order of 20 to 25% in such project, is kept untagged and is allowed for the purpose of medium and short term trading. It would result in a highly harmonious blend to ensure payment security with major portion on long term contract and also to promote market development. Besides, it would lead to a spin-off benefit by way of an upside or return on investments derived from market oriented trading of power. It is precisely for this reason when Ultra Mega Projects were conceived, about 15 to 20% of capacity in the subsequent power projects was being considered to be kept outside the preview of long term Power Purchase Agreements. This should be pursued.

An interesting issue that emerges in the context of Power Exchange is whether such exchanges could lead to dilution of activities and therefore to a truncated role for Power Trading Companies. One school of thought seems to suggest that when Power Exchange itself could arrange the agencies which can supply power with agencies which need power to come together, finalize the commercial aspects through well structured and computerized transactions, the role obviously of the power traders will drastically reduce. Another school of thought, however, opines that these Power Exchanges may lead to great degree of awareness about an appreciation for power trading as an established and streamlined mode of power purchase and sale. Therefore, the volume itself will increase so substantially that the likely dilution on account of exchange might be more than offset, and hence power traders need not have any insecure feeling.

Another issue which has been discussed over last few months is whether the time is right to have two Power Exchanges, particularly when the trading value is so small (hardly 3% of total). Those who support at least two exchanges argue that when the idea of National Exchange was being mooted some ten years ago similar apprehensions were expressed. Operations of Bombay Stock Exchange by that time had already come under critical evaluation with certain deficiencies and therefore it was felt that another exchange might not only provide an option but the very competition will help even the Bombay Stock Exchange improve its efficiency of operations. The event of last ten years have vindicated the wisdom of having a second Stock Exchange. This line of argument attempts to justify that two exchanges would be in the overall interest of all stakeholders.

The authorization given by the Regulatory Commission to the MCX Power Exchange is, for the present, for day ahead operations. This means that the power available will need to be declared a day in advance. This could be available on computer screens in a transparent manner and those who need to buy will have to declare their requirements. Buyers will need to deposit the money in advance or an arrangement will have to be put in place so that payment is ensured before the transactions take place. A number of issues arise around this architecture of the transaction. They relate to the empowerment for decision making both in the group of sellers as also in the group of buying utilities. Most of these on either side are government agencies. How well they would be empowered at working levels and more importantly how well they would be equipped to respond to a daily transaction, and on time, could be really a matter of concern. At this point of time what appears clear is that we are on the right direction, the tentative structure seems to be in order. But, necessary refinement will obviously be required when we implement the whole scheme. There might be difficulties on logistic, procedures, transparency etc. All these could be addressed as we go along.

Another important issue which might make or mar the outcome of this initiative is in relation to allocation of transmission capacity in an objective and credible manner. An independent system operator may be an answer.

Ring fencing of the roles of various players is also an important dimension. Since the partners in the equity of the Power Exchange Company are also the active players in trading or generation or in transmission, conflict of interest may be an issue. An unbiased approach and action will require clear distancing and arms-length operation in the decision making as also in day-to-day activities. It may perhaps desirable that none of the stakeholders are represented on the Boards or in senior positions of the Power Exchange Companies.

This is a new concept. Capacity building at various levels and in all concerned organizations will be an important requirement for the success of this scheme. Even now the power sector, after 6 to 7 years of Regulatory Commissions, is still to learn and equip itself on the rules of regulatory process. There is also a challenge of change of mindset. These will also be the issues to make Power Exchange initiative a success.

Copyright: R.V. SHAHI