Efficiency trends in power trading market

I have blogged earlier about the anachronism in continuing the non-transparent OTC trade-based sytem of power sales when there were two functional power exchanges in the country.

The OTC trader-based system does not facilitate efficient price discovery, despite regulatory provisions on the profits that can be made, since the transactions takes place in private with little public disclosure of details. It is all the more unexceptionable given the with limited depth and breadth in the exchanges. Banning all OTC trades and bringing them into the fold of the exchanges would multiply its liquidity and optimize price discovery efficiency of the exchanges.

Currently, the two operational power exchanges in India, IEX and PXI, offer day-ahead and week-ahead contracts. The bilateral OTC trading term ahead contracts vary from hours to many years. Such traded power (less than an year contracts), including the unscheduled interchanges (UI), form about 10% of the power generated in the country.

A test of the logic behind this assumption is the trends in market share distribution between the OTC and exchange markets. If the exchanges were more transparent and efficient, it was natural to expect them to increase their market share at the expense of the traders. And, recent trends point to exactly this happening. The Businessline reports that cheap prices in the exchanges are driving consumers - industrial and distribution utilities - away from traders. It writes,

"In 2010-11, the value of deals on the PXs surged to Rs 5,389 crore, a 51 per cent growth (or Rs 1,826 crore in absolute terms) over the deal values clocked the previous fiscal. Volumes more than doubled on the bourses. Correspondingly, the bilateral trader market, or short-term deals executed through a power trader, was down by almost Rs 800 crore during the year even as volumes remained flat. One of the key reasons for the PXs gaining favour over the traders is the lower electricity prices discovered on the two operational bourses — IEX and PXIL.

At Rs 3.47/unit, the average price on the PXs was a good Rs 1.30 lower than the corresponding price of Rs 4.79/unit for deals involving traders in 2010-11. As a result, the gap between the volumes for deals involving traders and those transacted on the PXs has narrowed sharply last fiscal... Thanks to the surge in business on the bourses, cumulative deal value surged to Rs 18,657 crore in 2010-11."

One way to compare the relative efficiencies of the two markets is to compare their prices. The graphic below of prices in June 2011 reveals that even in case of contracts with duration less than a week, which are also offered in the exchanges, the prices were lower in the exchanges (even with the daily average) than with traders.



The differential in prices (between the exchanges and OTC traders) with contracts that are greater than a week too are disproportionately higher. The case for banning OTC trades could not have been more convincing.

Update 1 (11/9/2011)

In the corruption filled environment, it was only natural before skeletons came out from the cupboard of OTC trades executed by state utilities. Businessline reports that the Uttar Pradesh Power Corporation (UPPCL) signed a one-year deal with a private power generator in Gujarat, routed through a private power trader in the western State, to buy some 600 MW at around Rs 4.70 a unit. The price is well above the average of less than Rs 3 a unit on the power exchanges over the last two months.

In fact, the average electricity price discovered on the two operational bourses — IEX and PXIL – was Rs 3.47 a unit, well below the corresponding price of Rs 4.79 a unit for deals involving traders in 2010-11.

The coming coal crunch

It is now becoming increasingly apparent that fuel scarcity is arguably the biggest constraint facing Indian power sector. The situation is alarming in case of thermal power plants, where a large number of plants are scheduled to become operational over the coming 3-4 years.

The Coal Ministry has forecast coal shortfall to be 104-121 mt by end-2012 and 200 MT by 2016-17. This comes on the back of Planning Commission deciding to reduce the 11th Plan (2007-12) annual production estimates from 680 mt to 630 mt (486 mt from CIL, 81 from captive mines, and rest imports). However, this revised coal production target too appears difficult to achieve, with more realistic estimate being 592 mt.

The capacity addition expected based on coal linkage provided by Coal India Limited (CIL) itself is about 40 GW in the 2011-14 period. Assuming an 85% plant load factor (PLF), this would require about 200 mtpa of additional coal, whereas the incremental coal availability, assuming an 8% production growth, would be just around 73 mpta, leaving a whopping deficit or an average PLF of 40% for these new plants.

This leaves generators of all kinds with no option but to blend large quantities of imported coal. The inevitable cost escalation will adversely affect their profitability. Since NTPC has the largest exposure to CIL, it is naturally among those most likely to be affected by the coming deficits.

Since the contract agreement of standard PPAs, especially the tariff-based bids, excludes fuel supply from force majeure provisions, the entire cost escalation may have to be borne by the generator. Much the same would be the fate of private IPPs who won bids under Case I bids, whose tariffs are already determined. The profitability of merchant power plants, seen no long ago as an extremely profitable business opportunity, too will come under severe strain.

A significant number of generators who won Case I bids in recent years do not have firm coal tie-up for a major share of their coal and rely on spot purchases. This exposes them to severe risks on coal availability and coal pricing. Merchant power plants without coal tie-ups are even more vulnerable, being exposed to both fuel and price volatility.

Further, though the CIL issued Letter of Assurances to generators, many of them have not been converted into firm contractual Fuel Supply Agreements (FSAs). This means that while supplies of coal to these plants are on for now, in the absence of a firm FSA, CIL is not bound to maintain a minimum supply round the year. This has shaken up investors who face the risk of developers defaulting on their debt repayment commitments.

In light of all these developments, it is not surprising that, as the Businessline reports, investor interest in private generation is petering out. In any case, this reduction in investor interest was inevitable since the surge in power sector lending of recent years had left many banks with portfolios excessively exposed to the power sector. In order to re-align themselves to their regulatory commitments, they were already paring down lending to power sector.

All these problems comes even as CIL grapples with its failure to increase production capacity (it produces 80% of the country's coal production). Ading to the woes, the Ministry of Environment and Forests' (MoEF) refusal to accord clearances has left an estimated 203 blocks with combined reserves of 600 mtpa and potential generation capacity of 130 GW in limbo. The MoEF in 2009 had categorised these 203 coal blocks as "no go" mining zone. The Coal Ministry has been demanding permission to mine at least 90% of these 203 blocks to meet the ever widening demand-supply gap of the dry fuel.

None of these include the big risk posed by the worsening finances of State Electricity Boards, whose accumulated losses have crossed Rs 55000 Cr. These losses are certain to rise further when distribution losses are 25-30% and more than 20% of electricity is given free to farmers. Saddled with such huge debts, discoms are not likely to venture into spot market purchases, except when faced with an electoral season. This will add to the woes of an already volatile and deficient spot market.

In recent weeks, the government has also started cracking down on developers who though allocated coal blocks had not started developing them. A panel set up by the Coal Ministry has recommended issuing warnings to 29 coal and three lignite blocks allocatees, apart from the cancellation of 14 coal blocks and one lignite block to six PSUs, including NTPC and three private firms for failing to develop the mines.

Update 1 (26/1/2012)

The Economist writes,

"By the year to March 2017 domestic coal production will meet only 73% of demand, leaving a gap of some 230m tonnes, almost five times the level of 2012. Include other industries that use coal, such as steel, and some analysts calculate that India’s total imports by 2017 could reach some 300m tonnes. That is on a par with the current exports of Australia, or those of Indonesia, South Africa and Canada combined."

Electricity prices and elections

Summer time which coincides with elections is a sure-shot recipe for spot power prices in our power exchanges going over the roof. Two upward demand pressures on electricity consumption are at work - the seasonal cycle associated with higher consumption in summers and the pressure on governments facing elections to cut back on load reliefs.

This trend is playing out now, with Assembly elections due in many states. Businessline reports of day-ahead spot prices in the southern region zooming to over Rs 12 a unit in the last couple of days, over four times the price quotes for the rest of the country on the IEX — the country's largest power exchange (handles 80% of transactions). It writes,

"A key reason for spot electricity prices shooting through the roof in South India is the mad scramble among utilities in the region to arrange power to ensure zero power cuts before the polls in States such as Tamil Nadu, Kerala and Puducherry. Lack of adequate grid interconnection between the southern region and the rest of the country has compounded the problem."

The concern here is about the regulators staying away even in the face of such price volatility. There has been ample evidence of spot market prices inching upwards in anticipation of polls from January.



Being a regulated industry, it is natural that regulators step in whenever required to protect the interests of all stakeholders. It is therefore unfortunate that, depsite clear indications of surging prices and resultant profiteering at the expense of consumers, the regulators have stayed away.

It is all the more surprising since the the Central Electricity Regulatory Commission (CERC) had intervened to regulate prices before the Maharashtra Assembly elections in September-October 2009. The CERC invoked the proviso to Section 62 (1) (a)read with Section 66 of the Electricity Act of 2003 and imposed price ceiling on the purchase of electricity through bi-lateral agreements and power exchanges. In order to curb profiteering opportunities in response to a sudden surge in demand, the CERC announced a price band of 10 paise per unit to Rs 8 per unit to cover all inter-state day-ahead trades for a period of 45 days.

The argument that better grid inter-connectivity of the eastern region with the northern and western regions is responsible for the absence of similar price spikes in the NEW grid is a straw man. Neither Assam nor West Bengal are in the market making purchases similar in magnitude to Tamil Nadu. West Bengal is amongst those with the lowest deficits. In any case, as the example with Maharashtra in 2009 shows, when the bigger states enter the market, the demand pressures show up and forces prices upwards.