Infra DraftPowMktReg Dec09

8/3/2019 Infra DraftPowMktReg Dec09

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InfralineEnergy Thought Leadership Serie

Draft Power Market

RegulationsExamining the Efficacy

December 2009


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Table of Content

Power Markets in India .........................................................................................1

Regulatory and Support Environment for Power Markets .....................................1

Draft Regulations on Power Market Development- 2009 ......................................4

Background .......................................................................................................4

Scope of the regulations....................................................................................4

Key Features.....................................................................................................5

Issues................................................................................................................6

Other Issues......................................................................................................8

Conclusion ........................................................................................................8

Contact Us............................................................................................................9


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CERC Draft Regulations: An Impetus to Power Market Development

December 2009 Page 1 of 9

OverviewIn the last few years Indias power sectorhas grown many folds with the installedcapacity reaching 153694.09 MW at the endof October 31, 2009. The Indian powermarket has gone through many changes in

the recent decade. The structure of thismarket has been tilted towards thegovernment in the past with the powersector utilities, vertically integrated beingowned by it. But this structure did notprovide any great help in satisfying theincreasing needs of the Indian economy.The state electricity boards (SEBs) for amajor part of their life functioned as lossmaking entities. In the era of liberalization itwas felt that if these SEBs were to work inconcurrence with the private sector, thepower sector shall be able to achieve its

target of growth. The failure of the projectsbeing developed by private sectororganizations made the government rethinkits policy and the power sector underwentserious restructuring in the last decade.

The main step in this restructuring was theintroduction of the Electricity Act 2003. TheAct was passed with the objective of leadingthe Indian power markets to the path ofdevelopment through competition but withsome amount of regulatory control on thesame. It delicensed generation, recognizedtrading as a separate licensed activity and

introduced open access in T&D.

Power Markets in IndiaThe demand for power has continuallyoutstripped supply. India currently faces anenergy deficit of 9-10%. India is divided into5 main regions and the level of variationbetween inter regional demand is very high.Traditionally long term PPAs have been themain mode of buying and selling power. Tomeet short-term demand the states resortedto trading of power through bilateral tradingagreements on the basis of mutuallynegotiated prices.

The situation in terms of trading of powerwas changed with the introduction of the EAin 2003. It formalized the concept of tradingof power by making it a separate licensedactivity and also introduced open access intransmission and distribution.

Power is mostly traded between powersurplus packets in Eastern Region (ER) andNortheastern Region (NER) on one-handand deficit areas in Northern Region (NR)and Western Region (WR) on the other.

To further develop the market powerexchanges were also introduced. Thesehave now emerged as a market basedinstitution for providing price-discovery andprice risk management to the generators,distribution licensees, traders andconsumers.

Regulatory and SupportEnvironment for PowerMarketsThe Indian economy as a whole is stillwidely governed by regulations and thesame applies to the power sector. TheIndian power markets are at a nascent stageof development when put in a comparativepicture with markets across the world.Regulatory support had been the backboneof their functioning.

In the initial years the development of thepower sector was centered on the verticallyintegrated utilities and so were theregulations, policies, guidelines, etc. but as

the power sector reeled under the lossmaking entities it was felt that there was aneed to gradually move towards a holisticdevelopment of the sector and the CERCwas formed keeping this in mind. One of itsobjectives was to promote competition,efficiency and economy in the activities ofthe electricity industry. This helped inidentifying the need to develop a competitivepower market in India.

Electricity Act 2003 was set up with themotto of competition with regulatory

oversight and suggested the development ofpower markets, governed by appropriateregulations.

CERC in 2004 came out with guidelines forinter state trading in the backdrop of EA2003 distinguishing trading as a separatelicensed activity. These guidelines specifiedthe procedure for obtaining a trading license.


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Draft powerMarket

Regulations-2009

PowerExchangescommence

operations-2008

CERCguidelines on

PowerExchanges-

2007

NationalElectricity

Policy-2005

Guidelines forinterstate

trading-2004

Electricity Act-2003

Formation ofCERC-1998

Power MarketDevelopment

The National Electricity Policy 2005 wasprepared keeping in mind the developmentof power markets. It envisages that in thecoming years, a significant portion of theinstalled capacity of new generating stationscould participate in competitive powermarkets. This will increase the depth of thepower markets and provide alternatives forboth generators and licensees/consumersand in long run would lead to reduction intariff.

CERC issued the Guidelines for setting upand operation of the power exchange inFebruary 2007. The general approach ofCERC was to allow operational freedom tothe exchange within an overall regulatoryframework and deliberately kept a distancefrom its governance. The participation in thepower exchanges was voluntary and noexisting Power Purchase Agreements and

bilateral contracts were to be disturbed.Issues like allocation of TransmissionCapacity for power exchange andapplication of Open Access charges &trading margin are to be decided by CERC.

Power exchanges were finally launched in2008. At present there are two functionalpower exchanges in the country- PXIL andIEX. In principle approval has been grantedby CERC to a third power exchange-

National Power Exchange (NPX). They havebeen playing a crucial role in helping in pricediscovery of electricity in the day aheadmarkets. The price is gradually gettingaccepted as a reference price by all powermarket players. The share of theseexchanges in the total electricity generatedin the year is very low as can be seen fromthe following diagram:


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There are still some issues that arehampering the growth of these exchanges inthe country such as lack of participation,liquidity, low level of trained staff available,etc.

Draft regulations on power markets werereleased in September 2009 with the aim ofstreamlining the functioning of the Indianpower market.


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Draft Regulations on Power Market Development- 2009

BackgroundTrading as we see was made brought intothe main foray with its separation as alicensed activity in 2003. Over the years

apart from that a new trend has emergedwith only 80-90% of power being tied up inlong term PPAs and the remaining power issold freely in the market on competitivebasis. The power exchanges further providea platform for this power to be traded in thecountry and satisfy the power needs in thedeficit regions.

A need was felt to regularize the practicesfollowed in the power market. These draftregulations have been introduced with theaim of bringing an over all sense of

uniformity in the market and to develop amarket where this power not tied up in longterm PPAs can be efficiently traded and alsothe short term needs can be balanced.

As seen globally the highly developedmarkets have a separate spot and financialmarket. CERC also envisages the Indianpower markets to grow on similar lines and

has thus with these regulations tried toprovide a roadmap for the development ofvarious products including derivatives in themarket. The Commission aims at building a

robust market place. These regulations arebrought under section 66 of the EA 2003.

Scope of the regulationsThese regulations shall cover the marketfrom three perspectives:

Markets

Contracts

ParticipantsThe markets shall include both over thecounter or OTC and exchange tradedmarkets. In terms of contracts they aredesigned to cover both physical or delivery

based, financial or derivative, real timebalancing, capacity, ancillary market andrenewable energy contracts. The variousparticipants or stakeholders include all grid

connected entities, traders, power exchangemembers, clearing corporation, commodityexchanges, etc.


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Key FeaturesThe regulations are divided into eight mainparts:

Preliminary

Scope of Regulation and Extent ofApplication

Approval of the Contracts by theCommission

Principles of Market

Power Exchange

Clearing Corporation

Market Oversight

Miscellaneous

Some of the key features of theseregulations are entailed below.

Licensed traders are not required toobtain any approval under theseregulations

Power exchanges should functionon the basis of the followingprinciples:

o Ensure fair, neutral, efficientand robust price discovery

o Provide extensive and quickprice dissemination

o Design standardizedcontracts and work towardsincreasing liquidity in suchcontracts

They shall also provide price signalfor efficiently allocating resources inpower sector

Similarly the principles for OTC

markets have been defined:o OTC market shall provide

customized solution tosector participants and bringinnovation in the marketplace.

o Contracts to be sold toclient shall be based on thesuitability, appropriatenessand full material disclosure.

o Endeavour shall be made toprovide complete materialinformation about the

contract pricing, its risksand implications to theparties entering into thecontract.

The regulations provide that noperson shall operate a powerexchange without obtainingregistration under these regulations

and follows the eligibility criterialisted in them.

The prudential norms for powerexchanges are specified. MinimumNetworth should be Rs. 25 Crores. IfPX has separated its clearingoperations the minimum Networthshall be Rs. 5crores. Current ratio of

1:1 and a liquidity ratio of 1:1. It also proposed the formation of a

Settlement Guarantee Fund (SGF)to pool in the initial security depositpaid by all members.

A non member of the PX shall havea maximum of 25% and a membershall have 5% shareholding.

The regulations further specify thatpower exchanges shall beregistered for a period of 25 yearsand shall pay an annual registrationfee of Rs. 30 lakhs.

The Member Service Charge forproviding services to clients in dayahead and term ahead marketsshall not be more than 0.75% oftransaction value.

The Risk management Committee(RMC) shall review the riskmanagement framework andprocess of the Power exchange ona six monthly basis in January andJuly each year.

These exchanges shall hive offclearing and settlement function

within 1 year from the date ofnotification of the regulations.

A 3 tiered default mechanism is tobe followed.

Power exchange which has lessthan 20 % market share ( turnovervalue of all contracts traded in allthe Power Exchanges) for twocontinuous financial years fallingafter a period of two years ofcommencement of its operationsshall close operations or merge withan existing Power exchange with in

a period of next six months. Clearing Corporation shall have a

minimum net worth of Rs 25 Croresand shall perform the function ofperiodical clearing and settlement ofany transaction or contract ofelectricity in spot, term ahead andderivatives traded on the exchange.

The Commission may maintainmarket oversight and surveillance to


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check market integrity in suchmanner as it deems fit

IssuesThe draft regulations though a welcome stephas some gaps which need to beaddressed. This section discusses a few ofthem.

Minimum Networth of Rs. 25 croresIt has been stated in the regulations that theminimum net worth of a power exchangeshould be Rs. 25 crores and incase it hashived off its clearing and settlementoperations the same should come down toRs. 5 crores. If we see power exchanges asa concept is new to the Indian market andthe current exchanges are yet to flourish.The development of these exchangesrequires more investment on building

technical support and capability. To facilitatethis minimum net worth should be kept at ahigher level so as to strengthen the powerexchanges. Also it has been argued thatkeeping a low net worth can induce manynon serious parties to start a powerexchange. Stricter norms should be followedfor it. Another important point to keep inmind is that there is a clause in theregulations which states that in case thepower exchanges are not able to garner amarket share of 20% for a period of twocontinuous years, within two years of

commencement of operations then theconcerned exchange shall either wind up itsoperations or merge itself with anotherexchange. To meet this task the exchangesrequire higher investment so as to augmenttheir market holding. The minimum Networthshould be such that it is able to account forthe changes that will be there in both theexternal and the internal environment facedby an exchange such as inflation, requiringmore funds on part of developing thetechnical capability, etc. This can be doneby linking it to the volume and risk of thetransactions done wither in a day or bytaking the moving average of some months.

Shareholding PatternShareholding pattern of the powerexchanges as stated in these regulationshas given rise to a serious concern from theconcerned stakeholders. A member ofpower exchange can hold a maximum of 5%

of shares whereas a non member can hold amaximum of 25%. It has been argued thatthese exchanges are currently at a nascentstage of development and need strongvisionary and leadership support. By limitingthe shareholding to 25% for non members,the Commission has decided to stop justbefore the threshold limit of 26%. Any

shareholder holding 26% or more in acompany has the decision making power inthe company. Thus the maximumshareholding level can be increased toaccommodate serious investors at this earlystage of operations of the exchange whichwould help the exchanges working through aunited and concentrated approach. Also anyconflicting interests of shareholders will beminimized. A timeline can be set for thedilution of this stakeholding in the comingfuture.

Time constraintThe Commission has given the powerexchanges to hive off the clearing andsettlement functions from its main oneswithin two years of notification of theseregulations. Similarly as mentioned abovethe exchanges are required to achieveatleast 20% market share for two continuousyears, within two years of their operations soas to avoid merger with another existingexchange or closure of its operations. Theexchanges are also required to realign theirshareholding pattern to the one specified inthese regulations within two years.

Looking at the current scenario hiving offwithin two years is a premature attempt. Themarkets are currently faced with insufficientvolumes and liquidity. By doing so theincreased cost of operations shall be passedon to the participants. Development of theexchanges, strengthening of operations,shedding off excess shareholding, etc shalltake time. The exchanges need to be givenmore time to accommodate these changesstep by step. Being a deficit market, theclearing and settlement operations can be

hived off when there is sufficient liquidity inthe market. As suggested above theshareholding can be diluted in the next 5-7years when the power exchanges havereached a certain level of maturity.

Registration Period and annualregistration fees


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The exchanges as specified would beregistered for a period of 25 years unless itis revoked. It has been felt that thisregistration instead of being limited to 25years should go on till perpetuity unlessrevoked. Such a step will help theseexchanges to introduce more products intheir portfolio without any time constraint.Securities Contracts (Regulation) Act, 1956.(SCRA) also has prescribed thatRegistration of Exchanges shall be tillperpetuity and can be revoked if found not tobe in the public interest. The same logicshould be followed for these as well as theCommission has plans to evolve the powerexchanges on the lines of the stockexchanges already operating in the country.

The regulations list down that exchangeshall pay an annual registration fee of Rs. 30lakhs. With the current level of operations of

the power exchanges being highly capitalintensive, this high amount of annualregistration fee would be a strain on thefinancials of the exchange.

Member Service ChargeThe regulations stipulate that members ofpower exchanges will charge 0.75% of thetransaction value from their clients forproviding services to their clients. This shallalso include the service charge of anysubordinate service provider as well. Thereis a mixed view on this clause. Themembers of the exchange are concernedwith the fact that along with the concernedservices being provided by them, additionalservices like filling into the role of an advisor,etc is also covered by them. Thus thisservice charge should be mutually decidedby the concerned parties and no cap shouldbe put on it.

Other stakeholders like the consumers putforth that both the power exchanges andtraders should be treated at the sameplatform and should reduce this charge. Ifwe see a broker can technically earn as high

as 26 P/kWh margin (2 X 0.75% ofRs.18/kWh) whereas even the new drafttrading margin regulations cap tradersmargin to maximum 7 P/kWh. There wouldbe instances when the margin earned bymember is more than the Trader which may

jeopardize basic Trading Regulations itselfand lead to malpractices.

Three tiered default mechanismA three tier default mechanism has beensuggested in the regulations where in caseof default the funds will be utilized in thefollowing manner:

Security Deposit of the member

The remaining default amount shall bemade good by 50 % from Networth of

power exchange and 50% from the SGFof the Power exchange

Any remaining amount to be paid 100 %from SGF of the Power exchange.

The three-tiered structure as proposed hasno precedents worldwide, and ifimplemented will in itself create systemicrisk to the Market as a whole. It is arguedthat exchanges are voluntary marketinfrastructure, available for all to trade in afair, efficient, transparent and mostimportantly, risk-free manner. They are also

required to have robust margin system, astable and adequate settlement guaranteefund and appropriate prudential norms formembership. Thus if in case of a default thefunds thus used for settlement shall put inpressure on the non defaulting members aswell which should be reduced.

50% Exchange BalanceSheet & 50% SGF-Tier2

100% SGF-Tier3

100%memberssecuritydeposit-

Tier1


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Congestion Revenue FundA new concept of congestion managementhas been included in the regulations whichstate that the exchange shall carry outmanagement of congestion in variousregions through market splitting. Congestionrevenue shall arise from the difference inmarket prices as a result of market splitting

and this shall be maintained in a separateaccount transferable to NLDC, the nextworking day.

When it comes to utilization of the fund,power exchanges have no say in it. Thefund should be used in concurrence of theexchanges. Globally this revenue iscollected and used by the market operator.Looking at the priority level powerexchanges are scheduled last and for thesame the exchanges are being chargedhighly as compared to others. It has been

argued that the proceeds of the fundsshould reach back to the people who havepaid for it.

Other IssuesSome of the other important issues arelisted below:

The SGF should not be linked to theturnover of the exchange or the clearingcorporation. It can be linked to theoutstanding positions of the members withreference to the type of contract traded.Also additional security deposits can be a

part of the SGF as against initial depositsonly.

Renewable energy certificates (REC)should be allowed to trade in theOTC/bilateral markets along with thepower exchanges.

Ancillary Services have not been defined.

In case of closure or merger of operationsfor not achieving a 20% market share, thesaid share is calculated based on theturnover value of all the contracts traded inall power exchanges. This does not give aclear picture of the actual share as theprices and other parameters may vary. Asan alternative it can be linked to number ofunits traded in all the exchanges.

ConclusionDevelopment of power markets thoughfaced by many strong issues is anevolutionary process. The draft regulationswere brought about with the aim of providing

the markets a set of guidelines for thecomplex functioning of the market in thenear future. They define the extent andboundary of the market. But for most of thepart these focus on power exchanges onlydespite defining the other components.Bilateral markets, power traders, powerexchanges, etc all co-exist together in the

market and equal focus should be made oneach component. Globally power exchangesform the most critical infrastructure in powermarkets. India is also following the sametrend. The regulations provide a welldesigned structure for the exchanges butwhat is lacking is a similar approach for theremaining part of the market.

As the markets become more and moreintegrated, new complex products areintroduced, the risks associated with it alsoincreases. Thus hedging becomes an

important tool to remove any deviation indemand and supply. It has thus becomeimportant for the issues listed above to beaddressed before the markets are floodedwith various new products.


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Contact Us

ADITI TANDONPower PracticeInfraline Energy Research14th Floor, Atmaram Towers1, Tolstoy RoadNew Delhi - 110 001. India.

Tel: +91 11 6625 0088 (Direct)Facsimile: +91 11 6625 0099

Email: [email protected]

Infra DraftPowMktReg Dec09

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