The case for coupling of power exchanges

A single market-clearing price will not kill competition

Electricity is provided to consumers by distribution companies (discoms). The discoms usually buy electricity from power generating companies under long-term power purchase agreements. However, the demand for electricity varies from moment to moment, and there is significant variability in this demand. Also, the supply of electricity has a certain variability and uncertainty. It is, therefore, necessary for discoms to buy electricity from generating companies who may have at that moment certain surplus generating capacity.

Considering the inadequacies of such information asymmetry where discoms and generating units do not know who needs power and who has surplus, power exchanges were set up around a decade ago for trading electronically on a day-ahead and more recently on a real-time basis. Here, those who have electricity to sell or want to buy, put their bids consisting of the quantity they want to trade and the price at which they want to trade. The exchange balances demand and supply and determines the price. If the total supply is larger than demand, then some of it remains unsold. Similarly, if the demand is larger than supply, then some of the demand remains unmet. The price at which the last unit of supply or demand is cleared is considered the market clearing price.

Today around 5 per cent of the electricity generated is traded on the two operating electricity exchanges —  the Indian Energy Exchange (IEX) and Power Exchange India Limited (PXIL). IEX, registered in 2006, signed up many members, imported software and started functioning in June 2008. PXIL, on the other hand, was registered in February 2008 and started operating in late 2008 with indigenous software. With its head start, IEX dominates the market.

There are different types of products available on these exchanges. In the Day-Ahead Market , participants transact electricity for 15 minute blocks for the next day. The bids by both buyers and sellers are put on one of the two exchanges with quantum and price specified. These are closed bids and are not revealed to any other bidder. After the window for submitting bids closes for all, each exchange collects all the supply and demand bids received by it and works out a market clearing price. The prices discovered on the two exchanges differ as these are two separate markets.

The Central Electricity Regulatory Commission (CERC) has proposed in its Draft Power Market Regulation (PMR), 2020, to couple the bids of the two markets and determine a single market-clearing price. This has the advantage that it will maximise the sum of producer and consumer welfare as it is more efficient and also will lead to better utilisation of the transmission infrastructure. With two separate markets, some lines may remain unused and some others overloaded.

This proposed market coupling is opposed by some columnists, notable among these is the distinguished economist S L Rao, the first chairman of CERC. His argument is that two separate markets lead to competition and such market coupling is not required in other exchanges such as the NSE and BSE or on Amazon and Flipkart.

Before I argue in favour of market coupling, I want to disclose that I am an independent director on the PXIL board.

First of all, the proposal for market coupling is meant only for the collective transaction segment — which comprises the Day-Ahead Market and the Real-Time Market.

Illustration: Binay Sinha

It is only in the collective transaction market that closed-type batch auctions are conducted. In such auctions, participants place their orders blindly without being aware of what other participants (buyers or sellers) are placing. The price discovery takes place only after the auction window has closed. Therefore, there is no recourse for a participant to alter their orders once the auction window is closed and the price discovery takes place.

In contrast to the above, on NSE and BSE where continuous matching takes place, participants know the prevailing price and can modify their orders based on it in real-time and thus get the benefit of true competition. In fact, entities many a times spot price differences for the same stock in two exchanges and arbitrage betweenthe two to narrow the price difference substantially. Due to this, for the same scrip there is barely any difference.

This is also the case on Flipkart and Amazon where the prices at which products are offered is known to the buyer before it decides what to purchase from which platform. CERC does not propose market coupling for the term-ahead market where buyer and seller are matched through open auctions or continuous matching.

Would market coupling reduce the benefits of competition that two exchanges provide? Exchanges compete on various fronts — on the basis of the number and diversity of contracts listed on the exchanges, on the basis of ease of transaction and the technology solutions provided to customers, on information dissemination and analytical tools made available, on ensuring low-cost access and high quality of service for participants and so on. This will continue even after market coupling.

In the absence of market coupling the fear of different prices has led market participants to flock to only one platform, which has higher liquidity to start with and therefore created a monopoly. This reduces the benefit of competition.

The development of competition in accordance with the precepts of the Electricity Act, 2003, is a necessary condition to achieve a vibrant power market in the country. Competition delivers the best solutions and the policy / regulatory framework needs to provide a stable level playing field.

The implementation of market coupling as proposed by Hon’ble CERC in the Draft CERC (Power Market) Regulations, 2020, would ensure a truly competitive Pareto efficient multiple Power Exchange model and will lead to benefits in terms of innovation and better services.

The writer is chairman, integrated research and action for development, IRADe, and a former member, Planning Commission