Coming soon, futures trading on energy exchanges
The buying and selling of electricity in India has long been dominated by the Power Purchase Agreements (PPAs) that state-owned distribution companies (Discoms) enter into with power producers. The duration of these PPAs is generally 20 to 25 years. Such long-term contracts are necessary given the high demands on capital expenditure and operation of these projects. At the same time, many State Discoms have also started purchasing electricity from energy exchanges to meet their short-term needs.
On October 8, 2021, the Department of Energy announced a plan to move to a market-based economic allocation model by April 2022 on a pilot basis. This implies that more electricity would be purchased from the electricity exchanges. Electricity being a commodity difficult to store, it is at first glance difficult to imagine the trade of electricity via an exchange. The challenges of scheduling and delivering electricity traded on energy exchanges have been gradually resolved through complex coordination with load balancing centers at different levels. Thus, it is now possible for entities connected to the network to purchase physical electricity from electricity exchanges.
With regard to the electricity market, there are three different types of electricity contracts that are traded on these energy exchanges: real-time contracts, day-ahead contracts and term-ahead contracts ( currently up to 11 days). The resolution of a long-standing jurisdictional dispute between the Central Electricity Regulatory Commission (CERC) and SEBI has the potential to add new types of contracts to Indian energy and commodity exchanges , that is, futures contracts (with a term of more than 11 days) and derivatives.
An electricity futures contract is a contract in which electricity is delivered at a future date at a price agreed upon in the present. Futures contracts are referred to as futures contracts under the CERC Power Regulations, 2021 and as a specific non-transferable delivery contract (NTSD) under the Securities Contract Regulation Act, 1956 (SCRA). When futures contracts are traded in the secondary market, they are called derivatives. A futures contract is a type of derivative product. A well-regulated derivatives market helps transfer price risk from buyer to seller or vice versa and improves price discovery.
For more than a decade, futures contracts beyond 11 days were not allowed in the electricity sector due to a Bombay High Court ruling in the Multi-product exchange vs CERC (decided on February 7, 2011) Case. The Court in this case did not take into account the fact that the NTSD did not fall under the regulatory competence of the Futures Markets Commission (now merged with SEBI) under Article 18 of the Law of 1956 on the regulation of futures contracts. [FCRA] (now repealed and included in section 30A of the amended SCRA).
Rather, the Court relied on the definition of “plug-and-play delivery contracts”, which are defined as contracts for which the price settlement and delivery of electricity takes place within 11 days under section 2 (i) of the FCRA. [currently found under Section 2(ea) of the SCRA]. The Court thus ruled that the CERC had the power to regulate only immediate delivery contracts and said that regulating contracts beyond 11 days required greater legislative clarity.
It took eight years for the Ministry of Power to correct this anomaly. It was not until October 2019 that the committee formed by the ministry on the “Efficient Operation of Electricity Derivatives” recommended that futures contracts based on physical delivery be regulated by the CERC and derivative contracts. by SEBI.
It took another two years for the Supreme Court, in the case of India Electricity Exchange vs SEBI (decided on October 6, 2021), to approve this regulation. The Supreme Court, which was hearing an appeal from the Bombay High Court decision, issued an order asking the CERC and SEBI to comply with the terms and conditions suggested by the committee set up by the Ministry of Energy. , thus putting an end to this long saga. .
However, certain challenges arising from the creation of a financially regulated derivative market for electricity futures contracts to be regulated by SEBI as a commodity derivative will need to be considered. There is always a risk of regulatory collision between CERC and SEBI, as the prices of electricity derivatives are derived from electricity contracts based on physical cash or forward delivery. Therefore, pricing could be a concern.
On July 27, 2021, the CERC issued an order regarding a petition filed by the India Energy Exchange and the Power Exchange of India Ltd for approval of the introduction of futures contracts beyond 11 days. The CERC had said that petitioners should apply to the CERC once the Supreme Court has ruled on the case. The case having been decided by the Supreme Court on October 6, 2021, the introduction of electricity contracts “forward” and “green forward” does not seem far away.
Aakanksha is associated and Pranaav is associated, with the practice of economic laws. Views are personal