One of the significant objectives set out under the Electricity Act, 2003 was to enable a market for efficient power trading in India – an initiative which has spanned a period of more than a decade to be realized. In wake of the controversial Draft Electricity (Amendment) Bill, 2020, the Government has realigned its aim for a policy enumerated long ago via the Draft Power Market Regulations, 2020. This blog analyses the proposed changes for the power markets, whilst also examining whether the current scenario of India’s energy regime is favourable for a shift in policy.
The Central Electricity Regulatory Commission (“CERC”), invoking its powers under Section 178(2)(y) of the Electricity Act, 2003 read with Section 66 and Para. 5.7.1 of the National Electricity Policy, released the Draft Central Electricity Regulatory Commission (Power Market) Regulations, 2020 (“Draft Regulations”) on 18th July, 2020.
The provisions enumerated in the Draft Regulations elaborately deal with the structure of regulatory oversight and mechanism to facilitate real-time trade in electricity futures contracts. Among other features such as contingency contracts, day-ahead contracts and intra-day contracts, the draft proposes to regulate the procedures for various aspects like market participants, over-the-counter (“OTC”) platforms, trading licensees, and market coupling operator. This is quite similar to the 2010 Regulations. The Draft Regulations resolve the loopholes possessed in earlier regulation through separate procedures that have been mentioned in order to regulate different contracts for aspects like price discovery, scheduling and delivery.
Pre-Existing Concerns in the Indian Power Market
Firstly, the power market is dominated by public-owned power generation companies. Despite the fundamental objective of enticing private sector participation, as set out under the preamble of Electricity Act, 2003 and exemptions granted in licensing of these entities, there has been a limited increase in the number of independent power producers in the country and only a few UTs/States have been able to access the benefits of open access mechanism. The overwhelming presence of public sector undertakings in power generation causes an uneven distribution of power generation facilities and adversely impacts the insufficient government regulated transmission networks. Therefore, relying on a market that is concentrated with conservative generation entities to vanguard the power trading reforms may not yield the best results, especially at a time where the sector is beset by a pandemic.
Secondly, the Distribution Companies (“DISCOMS”) are already plagued with mismanagement and bureaucratic interventions in price regulation, which has culminated in unpaid dues of Rs. 90,655 crores to the power generation companies. Moreover, Covid-19 has resulted in a dismal demand for power from major industries which has critically affected their revenue options, resulting in stonewalling of the current repayment plans. Thus, it is possible that the generating companies might express their reluctance to partake in these untested waters of power trading so long as they remain doubtful about the massive debt which is already owed to them by state distribution entities.
Thirdly, there is an imperative need to ensure that no regulatory overlaps occur. For instance, in the case of Securities and Exchange Board of India v. Central Electricity Regulatory Commission, theCERC exerted sole regulatory jurisdiction over trading in futures contracts, arguing that it is empowered by the provisions of Electricity Act, 2003, thus preventing the Multi Commodity Exchange of India Limited (“MCX”) from initiating trading of power futures. However, the Forwards Market Commission was adjudged as the appropriate authority to regulate future contracts by virtue of electricity having been identified as a commodity.
As a result of the 2020 Draft Regulations, introducing real-time-contracts and the subsequent authorization for SEBI to trade derivative contracts, there is a sense of uneasiness regarding any congestion which may subsequently cause a setback to the indispensably unruffled flow of trades in real-time trading of electricity futures.
Key modifications introduced by the Draft Regulations –
1. The net worth has been increased from 25 crores to 50 crores for power exchanges. Provisions have been added for the shareholders in equity holding where, shareholders other than a client/member cannot hold more than 25% stake in power exchanges. Entities, on the other hand, cannot hold more than 49% stake.
2. The Draft Regulations have introduced OTC platforms with permit innovation-driven price dissemination for the buyers and sellers in the OTC market. The settlement of agreements executed in the OTC market will be by the physical conveyance of electricity only.
3. The regulations have emphasized on ‘demutualization’ – a concept the CERC has borrowed from Section 4A of The Securities Contracts (Regulation) Act, 1956 to ensure that the operations and maintenance of entities listed for trading are segregated from their trading rights. Demutualization provides for severability of these rights, and in essence, allows the instruments of an entity to be traded as an issuance of a publicly listed company as the respective interests of members, under a mutual co-op are converted into shareholdings.
4. Electricity would now be able to be exchanged like some other item with derivatives and forwarding contracts on exchanges as the government provided an order allowing this. Forward contracts are private agreements between two parties such that trade does not take place on an exchange. It is an agreement between a buyer and seller to exchange an asset sometime not too far off. The cost of the asset is determined when the agreement is set up. Forward contracts settle towards the finish of the contract. These contracts are comparatively flexible in their terms and conditions. With this introduction, companies will have the option to develop and implement a design for long-duration contracts and go ahead with procedure for approval in CERC.
5. The concept of market coupling has been introduced to achieve uniform market clearing price and optimal transmission in infrastructure use by gathering bids from all the relevant power markets and matching them. It aims to connect power markets, simplify cross-border power trade and accords the determination of cross-border transmission limit as per the requirements in the corresponding markets. It further reduces avoidable risks of trading short-term capacity energy separately, promotes robust spot markets, and enables all participants of the spot market to avail from cross-border access. Market coupling has been introduced to connect market and areas so as to fit various frameworks of electricity exchanges and, specifically to mitigate any differences in price, which was a legitimate concern underlining the 2010 Regulations. Consequently, the electricity market observes smooth electricity flows as electricity grids are interconnected. Since grids are interconnected, electricity takes the shortest transmission network from producer to buyer. The same concept has been borrowed from the European Electricity Market.
Thus, market coupling increases transparency, diminishes the time and administrative encumbrances, and subsequently minimizes the transaction costs. However, although market coupling promotes optimum transmission infrastructure it is pertinent to note that transmission infrastructure in the country is primarily limited to 400 KV which was introduced in 1977.
Energy-saving regulations have also been linked with the Draft Regulations with the introduction of ‘energy savings certificates. Essentially, energy savings certificates are tradable certificates representing one megawatt-hour of energy savings from ventures. These certificates are used by regulators to diminish greenhouse gasses effect on the environment. The Draft Regulations mention work in consonance with the CERC (Terms and Conditions for recognition and issuance of Renewable Energy Certificate for Renewable Energy Generation) Regulations, 2010, CERC (Indian Electricity Grid Code) Regulations, 2010, Companies Act, 2013, CERC (Grant of Connectivity, Long-term Access and Medium-term Open Access in inter-State Transmission and related matters) Regulations, 2009 and the CERC (Terms and Conditions for Dealing in Energy Savings Certificates) Regulations, 2016.
A limitation was set on the Market Regulation of 2010 in the case of Multi Commodity Exchange of India Ltd. v. CERC, wherein it was stated that with respect to future or forward contracts, the provisions are inoperative under CERC (Power Market) Regulations, 2010.
Although the regulations are a positive measure in reinvigorating the under-performing power sector, in addition to the aforementioned concerns, there are various other issues which exist within both the macro and micro frame of reference and need to be addressed succinctly to realize the potential of trading futures in the power sector.
Notwithstanding that the CERC Draft Regulations are still in their infancy and will be subject to multiple revisions prior to the enactment and supposing that the Government aims to achieve the desirable infrastructure critical to the functioning of the power trading market, it seems to have envisioned on the likes of its global counterparts and for cross-border trade of electricity. The Indian power market has evolved over the years since the inception of power exchanges and many products such as day-ahead market, total addressable market, interest during construction, renewable energy certificates, e-certs, security constrained economic dispatch & real-time electricity market have achieved stability with market dynamics.
These Draft Regulations come at a perfect time when derivatives and future contracts can lead the foray of the power markets and facilitate enhanced trading opportunities for individuals concerned. Electricity futures and different derivatives help market members to oversee, or fence, price dangers in electricity market given that futures contracts are legitimately authoritative and negotiable contracts that require the future conveyance of a product. Introduction of derivatives and day-ahead/intra-day exchange of electricity may also aid the DISCOMS in (i) raising liquidity; (ii) restructuring their repayment mechanism, and (iii) subsequently reducing significant losses that occur due to the limited transmission and distribution networks. Furthermore, the futures market will give signs of impending distress in power trading ahead of time as when future exchanging commences, the power exchanges would be in a situation to offer derivative instruments to members. These instruments could be electricity futures with an unmistakable conveyance-based calendar and other derivative instruments, for example, call and put alternatives that will support the generators and consumers to moderate dangers by supporting their situations through derivative instruments.
This article has been authored by Aadarsh Anand and Varun Pandey, students at School of Law, University of Petroleum and Energy Studies, Dehradun.