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Needed: a futures market in power

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October 21, 2003 10:57 IST

We have had ten years of reforms in the power sector and little to show for it in terms of the final outcome. Reforms are justified only if they bring power to people, at least cost and uninterrupted power that is of high quality with stable voltage.

We have been beating around the bush as we are unwilling to confront the main problem. By now it is well known that the financial sickness of state electricity boards has been the root cause of our troubles. This sickness has been the outcome of subsidies to some categories of consumers and large-scale pilferage.

No one seems to be willing to bell the cat and reforms have progressed by stealth with hope at each stage that someone will bell the cat and catch the thieves and raise tariff for the agricultural users. We were always passing the buck.

The first step was to permit private power generation. Despite enormous initial enthusiasm, given the financial sickness of state electricity boards, not much success was obtained. If your only customer is bankrupt you would not want to get into that business.

The next step was to set up electricity regulatory commissions at the state and the central levels. These were to set tariffs and were to raise it for the farmers, because the unmetered supply at very low fixed cost was seen as the root cause of financial sickness.

However the politician appointed ERCs could hardly raise tariffs for farmers that the politicians were themselves reluctant to raise. The SEBs however did force transparency and commissioned studies concerning the actual use of electricity by the farmers.

These brought out the enormity of pilferage that was taking place in most SEBs as the estimates of so called T&D losses went up from around 20 per cent to nearly 40 per cent. Then followed privatisation and unbundling as also freedom to set up captive power plants.

The hope was that the private distribution companies would bring down pilferage and reduce tariff for those who were cross subsidising the farmers and the pilferers. This has so far not produced results and tariff for industrial consumers burdened by cross-subsidies has not come down.

It has however seen a rapid growth of captive power as the increasing burden of cross- subsidies made many industries go for captive power plants.

Today we have some 25,000 MW of captive capacity compared to about 100,000 MW of generating capacity with SEBs and central sector organisations. Yet the electricity supply continues to remain of poor quality.

The electricity Act has made some fundamental changes. The new Act has dismantled the monopoly power of SEBs as they are no longer the sole buyers and anyone, you and I, can buy and sell electricity to anyone.

Along with this has come availability based tariff. What this means is that the price at which electricity is bought and sold is determined by the availability of electricity in the system, relative to the demand at the moment.

When much more electricity is generated than is demanded, the frequency of supply goes up and correspondingly when the demand is more than the supply, the frequency goes down. The normal frequency is 50 cycles per second.

This availability-based tariff provides incentives to buyers and sellers to even out their consumption and generation across the hours. A market for electricity i.e. a market for electrons (as lawyer Hemant Sahai who also trades in electricity calls it) has evolved.

Today, power is traded in various regional electricity grids and between regional grids, and the price is determined for every 15-minute slots, depending on the frequency of supply. The price and frequency can be seen on the ticker tape in real time on the website of the Northern Regional Grid's load dispatch centre,

The price is 140 paise at the normal frequency of 50 cycles per second and changes by 140 paise for every change in frequency of 0.5 cycles per second. Thus, when the frequency reaches 50.5 cycles per second the price is zero. At the time of writing the frequency is 49.7 cycles per second and the price is 229.6 paise per unit. As frequency drops, the price increases rapidly.

This is a remarkable development whose significance needs to be highlighted. It will make it possible to integrate the captive power plants into the system in a cost effective way. They will get the price, which is appropriate to the time of the day when they pump in power into the system.

No tariff agreements need to be signed. At the same time, the time of the day varying tariff would provide incentive to the distributors to offer time of day tariffs to their consumers in order to even out their load.

A competitive market is emerging and it will force generators and distributors to be efficient and consumers will get the benefits of lower tariffs.

This is possible because given the 25,000 MW of captive capacity, we are in a situation of surplus capacity, even though it may not seem so from the supply interruptions we suffer. The market for electrons permits and facilitates the integration of captive plants in the system.

Does this market for electrons solve all problems of power supply? Of course it does not. The players in the market generally have short-term perspectives. As long as the situation of excess capacity remains, we will have no difficulty. In a situation of excess supply of a non-storable commodity, the market will function.

From a longer-term perspective, we need to ask the question, who will invest in capacity creation in the sector. A power plant has a long gestation period and involves large investments. The market risk will appear to be too large if there is no assured buyer at a reasonable price.

What is needed for obtaining such assurance is a futures market. To complete the process we need to develop a futures market. The market for electrons as it exists should facilitate establishment and working of a futures market, and would remain incomplete without a futures market.

Buyers and sellers should be able to get into long-term contracts. Long-term contracts entered into voluntarily by players in the market, as long as they are competitive players i.e. they do not have any monopoly or monopsony power, should only improve the market's functioning.

Moreover such contracts are necessary to encourage investment in capacity creation in the sector. A regulator should not object to such long-term contracts. The regulator should concern itself with efficiency of the system. It should not worry about the market risk that individual players take.

The functioning of a market for electrons is an important development from the perspective of attaining 8 per cent growth. Power has been perceived as a major bottleneck in attaining rapid growth. Now we have an opportunity to remove this bottleneck in a very short time, perhaps in a matter of months.

The way by which industry can remove this bottleneck is by setting up a captive plant. This however has been an expensive solution. With the new development, cost of electricity will go down, and our industry can be more competitive. Of course we still need to carry out reforms of railways, labour, judiciary and small-scale reservation. These can put us on a still higher growth path.


The writer is chairman, Integrated Research and Action for Development Professor Emeritus at the Indira Gandhi Institute of Development Research

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