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India’s power sector may finally allow derivative trading after years of delay

India’s power sector may finally allow derivative trading after years of delay

After years of delays, India may soon open a derivatives market for the power sector allowing both power generators and consumers to enter into futures contracts and use it as a new hedging tool to mitigate price volatility and other associated risks.

Introduction of pure play futures and options as products on power trading platforms would be a major reform initiative that would help in developing a robust and vibrant energy market. The introduction of the derivative products has got delayed over jurisdictional issues between market regulator Securities and Exchange Board of India (SEBI) and power regulator Central Electricity Regulatory Commission (CERC).

Sources privy to the development said that SEBI and CERC have now reached an understanding to allow futures trading in electricity.

The former is expected to oversee the functioning of all financially traded electricity forwards while the latter would regulate physically settled forward where electricity is delivered on future date at the contracted price.

“Decks have been cleared for the start of the electricity futures market in India with regulators reaching broad understanding on how to go about while allowing derivative instruments for market participants. They will still have to get concurrence of the Supreme Court that was overseeing the issue of electricity futures jurisdiction between SEBI and CERC,” said an official source.

“The order on ending the case based on applications given by the two regulators got delayed due to Covid-19 related disruptions. It is expected anytime this month now. So the futures market could become reality this year itself,” the source added.

Even after clarity on regulations, there may be further delays on account of the lockdown and economic slowdown that has also impacted power demand. Futures and options work best in a rising market where players need to hedge their positions to minimize losses.

While India presents a large power market with installed generation capacity of close to 370 GW and large number of participants from both private and public sector, it is yet to offer futures trading option that is the hallmark of all mature markets.

Though electricity is available in surplus now, its trading is limited and only through spot contracts (up to 11 days) on exchanges. Forward trading in electricity started in 2009, but the matter soon ended in court over jurisdictional issues.

“With clarity on regulations, electricity futures may soon start in the country. For any mature market, future and options are a must. This should not be seen as instruments facilitating speculation but the one that promotes hedging and allows price discovery in medium term markets with mitigation of counterparty risk,” said Rohit Bajaj, head (business development) of IEX. IEX is the largest power trader in the country.

Once future trading is started, power exchanges such India Energy Exchange (IEX) would be in a position to offer derivative instruments to participants. This could be electricity futures with a clear delivery based schedule (delivery at a price on future date) and other derivative instruments such as call and put options. This will help both generators and consumers to mitigate risks by hedging their positions through derivative instruments.

Start of derivative instruments would also be helpful for the sector at a time when spot power prices have fallen on exchanges due to slowdown and the demand for electricity has also come down. Futures market will provide such indications in advance.

Power producers can sell their perceived surplus in futures and consumers, who foresee higher consumption and a price rise, can buy power on the same platform.

Trading in electricity futures will also be helpful as power prices are volatile. Those who buy or sell power in the spot market will benefit directly from this. That apart, dealings via an exchange would be safe as its clearing house provides a system of guarantee that mitigates counterparty credit risk..