Event Highlights

Electricity Forward Markets: Physical Contracts

FSR Global

Regulatory Insights

Feb 06, 2024

Our #RegulatoryInsights debate brought together eminent speakers from India and Europe to discuss on the topic of #ForwardMarkets. The speakers were Khem Gautam, Long-term Sector Expert, Indo-Danish Energy Partnership, Rohit Bajaj, Head of Business Development, IEX, Kapil Dev, Managing Director, New Age Markets in Electricity, Sanjeev Shukla, CE (Planning), UP Power Corporation Limited with PK Pujari & RP Singh, Distinguished Fellows, FSR Global and Morten Pindstrup, International Chief Engineer, Danish transmission system operator as discussants to illuminate upon the topic. 

With the Indian power market growing, many explorations are being made to enhance the sector’s performance. Of such, forward electricity markets is a topic of interest which is being looked at with the following points to be considered and examined in this debate: duration & design of such contracts, role played by power exchanges and OTC platforms to realize the same, impact on spot market, tandem relationship with capacity markets, price discovery and examination of the role of portals like DEEP, PUSHP in facilitating forward markets.

Lessons learnt from Norway 

In Norway in 1990, bilateral physical contracts were used for buying and selling electricity between vertically integrated utilities. With electricity prices being high, there was overcapacity leading to inefficiencies in the system. This led to the market being liberalized leading to the introduction of the day ahead marketplace which on one hand, reduced the inefficiencies and sought more market participants, and on the other hand, eventually brought in volatility in the system in the form of differential price risks. Need for hedging was understood as a result which led to the introduction of physical bi-lateral forwards contracts which was adopted by Nordpool in the short-term market with their reliable price signals. Physical trade seemed difficult due to zonal pricing in Norway which was divided into 5 zones, indicating 5 different trade footprints. So they shifted to system prices (virtual price for entire region) in the Nordic Zones which turned trade from physical forwards (1994) to a financial transaction.  

By 2022, the Nordpool market was flourishing with very high liquidity (with trading upto 8 times) but it created price differences in different zones which necessitated in the need for another hedging product: electrical price area differential (EPAD) which are essentially futures contracts reflecting the difference between an area price and an index (such as the Nordic system price) and allows members to hedge against the price risk. Currently, both system prices and EPADs are available to trade in Nordpool and participants can choose and hedge against the product they wish depending upon their risk appetite. Denmark has two synchronous bidding zones without a system price but long-term transmission rights (LTTRs) that must be acquired through auctions. The Nordic experience is different than the rest of the European experience due to the presence of system prices and LTTRs.  

In the Nordics, market participants were encouraged to move to the short-term market due to reliable price signals which helped in the flourishing of forward markets in the region. This is unlike the current Indian situation where most of the volume is tied up in long term PPAs with very few market participants. Furthermore, with the market price caps being touched frequently, it hinders true price discovery, leading to unreliable price signals, which is not the conducive environment for a forward market.  

Forward Markets: Duration & Design  

In the Indian context, forward contracts are allowed upto 11 days to 3 months which gives a certain leeway on the spot market. In the previous financial year, with all three power exchanges combined there were roughly 3 billion units in the forward contracts. This volume has more than doubled upto 7 billion in current financial year (upto 3 quarters). With a growing appetite among the market participants for forward contracts and there is also a growing demand to increase the duration of these contracts from upto 11 months (as already provisioned in the General Network Access Regulations) and beyond. 

Market interaction: Exchanges and OTC Platform 

For the market to perform well, there needs to be a complimentary relationship between power exchanges and the OTC platform since they both offer flexibility in terms of contracting and delivery of electricity.  

The power exchanges today provide a better price discovery than DEEP, PUSHP portal where reverse e-auction is done to obtain the best electricity price. Due to the increasing volatility in the power market, utilities are facing uncertain pricing issues, which also highlights the need for short term capacity markets (upto 3 months). To combat such uncertainties and offer flexibility to utilities for choice and procurement, forward markets are touted as an acceptable provision complemented by capacity markets.  

To build liquidity and ensure the robustness of the price discovery process, customization of products become essential which is a prime feature of the OTC market, providing services beyond the capacities of the power exchanges. For risk transfer between buyers and sellers, contracts need to be benchmarked which OTC markets provide for. This is unlike the PPA where risk was built into the system, the new products such as forwards require bank guarantees against risks. The impact of this on Day-Ahead Market and Real-Time Market needs to be investigated into.  

Looking into the future of forward markets 

As per the expected projections of increase in energy consumption in India for the next decade, approximately 900 billion units of additional energy will enter the market every year. This indicates a strong case for the market volume to expand. Furthermore, the design of the products itself shall be under surveillance and consideration to create a balance between the RE supply and demand profile of the states.  

To keep in mind 

The Indian power sector is gradually transforming from a traditional peak load based to a flexible generation and flexible load, fueled by the increasing grid integration of renewable energy, demand from e-mobility and industrial decarbonization. However, in absence of a robust resource adequacy framework, demand forecasting and decrease in cost of renewables, they are amplifying the risk associated with long term PPAs of the DISCOMs. As a result, the latter are preferring to go towards short-term contracts which provides them with greater flexibility, eliminating the obligation to pay fixed charges of the contract for an extended duration. Keeping such developments in mind, role of forward contracts to be utilized in the Indian power markets is becoming clear. For a better utilization of this opportunity where hitherto the DISCOMs rely on portals like DEEP, PUSHP to meet their diverse short term power requirements, forwards need to be integrated to a long-term product like upto 11 months (and beyond) which power exchanges are exploring into.  

It is an opportune moment for the Indian power sector to be benefitted by the forward market products in the long term which shall enable larger participation, increase in liquidity, price convergence among different market segments and provide the right signals for evaluating investment decisions.

#ForwardMarkets #PhysicalContracts #SpotMarket #DayAheadMarket