Power trading exchange

Don’t trade in power

If power is traded, it could be the next big bubble to burst

One of the most critical shortcomings of Indian economy has been its inability to push through drastic reforms in some of the key sectors that have severe ramifications on its long term well being. And it’s needless to say that such a list would always have the power sector way up in the ranks. Come this time of the year, with the rising mercury, it’s only a matter of time before power cuts would again become more of a norm than an exception and inverter manufacturers would again make a fortune out of it.

With an installed capacity of around 1,50,000 MW, India is in no way a minnow in terms of power production, but the real problem, as has always been, is the distribution of the power produced. With the distribution of electricity still being a near monopoly of the State Electricity Boards (SEB), inefficiency in the distribution of the same continues till date, in spite of the substantial efforts being made to unbundle the SEBs into separate companies involved in production, distribution and transmission of electricity. Not only does a substantial part of rural India remain unlit, but even in some of the better cities of India, including manufacturing hubs, it is considered a naivety not to have power backups. To counter and address all these shortcomings, regulators have suggested the introduction of competitive wholesale electricity markets.

In order to materialise the concept of competitive market, the Central Electricity Regulatory Authority (CERC) is embarking on the task of initiating a Power Trading Exchange (PTE), which many believe is long overdue. For the uninitiated, it will be in the pattern of other exchanges viz. stock exchanges or multi-commodity exchanges. The whole aim of this model is to provide electricity to the consumer at the cheapest rate, without revealing the source of power generation. In retrospect, there’s nothing wrong per se in putting electricity into a perishable commodity category and then trading it accordingly. Since power produced cannot be stored, it becomes all the more important for the power producers to instantly transmit it to the end consumer, albeit through the transmission & distribution companies.

For an economy as big as India’s, a certain place would always have a high demand and shortage of supply at any point of time, while another place might have less demand and more supply of power. An efficient power trading exchange might just help in bridging the gap efficiently with the aid of technology. Every time there is a supply and demand gap in the power sector, the SEBs do indulge in irrational power transactions. The hourly rates fetch states an average price of Rs.7.50 per KW. Contrast this with the amount they receive from domestic electricity consumption, which is just Rs.2.10 per KW. Even when the state is not self-sufficient in power, they do not hesitate in back-door sale of power. SEBs get huge subsides from the government in order to bridge their cash deficit and update their set up. Subsidies are fundamentally given to SEBs so that it can eventually flow down to the end consumer, but then it takes an altogether different route and reaches back to SEBs. Even then, most of them are ironically bankrupt with assets totally wiped out.

Yet, trading in power nationally is no child’s play and would require a grid capable of handling all kinds of fluctuations. Take for instance a national power grid (with a capacity of 30,000 mw of power), which requires nothing less than a whopping Rs.800 billion. This amount is obviously beyond the ability of the state or central power distribution companies to garner. Therefore, call it by default or by design, the private sector has to intervene. Power subsidies, most of the time, are extended and revised in spite of being revoked. This is luring many private companies to enter this sector. Out of a Rs.6.34 trillion of total corporate announcements (of investment) made in the first six months of 2008, power sector attracted the maximum number of investments totalling Rs.1.96 trillion. Videocon, TVS, NBCC, Ansals, Jindal and Logica and even companies like Reliance Energy, Essar Power, Tata Power and Adani Export, are trying to tap the advantage of this to-be power exchange in the next couple of years. In hindsight, the PTE may seem to be very rational and balanced initiative. But as the saying goes - the devil is in the details. Talking about PTE, since the trader in the PTE will have bilateral contracts i.e. with the power generator (SEBs) and with the distributors (BSES and Yamuna in case of Delhi), it will lead to huge price speculation – as it happens in traditional stock exchanges. With the help of speculation and lobbying, the market can superficially alter the price as it is happening in real estate. There is no clear-cut framework, which forces the regulators or SEBs to reduce and eliminate cross-subsidies. Being bilateral, trading in power at present leaves virtually no scope for fair trade. Commenting on the same, Subir Gokarn, Chief Economist, Standard & Poor’s Asia Pacific said, “In order to make the whole system more effective, open access needs to be provided. Presently, national grids are open but state grids are not. There is a possibility of speculation.” The physical power supply system in India is still influenced largely by the British legacy and has many complex aspects viz. delivery, non-storability, and severe price instability. This complexity leads to lack price transparency.

If the potential chaos of the power trading exchanges and the bankruptcy of the SEBs were not enough, the incredible leverage that most of the power producers and especially the Independent Power Producers (IPP) in the private sector have been resorting to is also a matter of big concern. The debt to equity ratio (DER) of most IPPs is nothing less than 3:1, while conventional business models generally presume that it should never be more than 1:2. Most of the funding is done through the bank and equity intervention is at its minimum. So it should not be surprising if it turns out to be the next big bubble and the reason for a recession in India; given the apocalyptic exposure that Indian banks have in this sector. The leverage rate is following the footsteps of the realty sector.

Coming back to the PTEs, there are no specific frameworks to set up any monitoring body that will be made responsible for PTEs. So eventually, price will be controlled by market forces rather than by the marginal costs of production, which may again lead to superficial price hike.

The power sector does need several doses of reforms but the power trading exchange should ideally be the last bead in the string. To presume that the malaise of unavailability of power can be sorted this way would be a little far fetched. A far better option would always be to allow at least the industrial consumers to directly purchase power from the producers. This would take care of much of the inefficiencies in the sector due to state run distribution companies. Moreover, until power remains a poll sop and an indispensable carrot for freebies during election times, no amount of trading of the same would help. The real change would start with bringing it out of the holy cow tag.