Electricity Futures May Be Allowed

The government is proposing to allow derivatives trading in electricity, freight and commodity indices. The Forward Markets Commission (FMC) had sent the proposal to a standing parliamentary committee and it was likely to be tabled in the monsoon session of Parliament, highly placed government officials told Business Standard.

The move to permit futures and options trading in electricity follows the permission to commoditise electricity and bring down the tariff rates in the country. The Electricity Bill--which seeks to free electricity generation from all licensing requirements and provides for an open access option to captive power plants, allowing them to sell surplus power directly to bulk consumers--was introduced in Parliament last year.

 

The Bill allows open access of transmission lines to distribution licencees and generating companies, while also envisaging regional load despatch centres and state load despatch centres operated by independent entities.

According to sources, increased competition in the bulk power and retail electricity markets is likely to lower electricity prices, but will also result in greater price volatility as the industry moves away from administratively determined, cost-based rates and towards market-driven prices. The proposal to introduce electricity derivatives follows the realisation that hedging instruments are required to protect against the emerging risks.

Price volatility introduces new risks for generators, consumers, and marketers. In a competitive environment, some generators will sell their power in potentially volatile spot markets and will be at risk if spot prices are insufficient to cover generation costs. Consumers will face greater seasonal, daily, and hourly price variability and for commercial businesses, this uncertainty could make it more difficult to assess their long-term financial position.

Finally, power companies sell electricity to both wholesale and retail consumers, often at fixed prices. But those who buy electricity in the spot market face the risk that the spot price could substantially exceed the fixed prices specified in sale contracts. Electricity futures and other derivative instruments help electricity generators, consumers, and marketers manage, or hedge, price risks in a competitive market.

Other instruments around the electricity rate include options, price swaps, basis swaps, and forward contracts.