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Is the spot market mechanism the panacaea for the slack in energy sector?

Topics electricity | Coal  | gas

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In the span of less than a month, India has brought trade in gas and electricity under the spot market mechanism. It wants to do the same for coal. The coal ministry has this month announced auctions for coal mines and wants to set up a coal exchange soon. 

Allowing pricing freedom as an exchange is a big deal in the Indian energy policy. Gas is under an administered pricing system, electricity prices in no state reflect demand-and-supply forces and lack of transparency in coal pricing was one of the reasons foreign investors have been reluctant to invest in Coal India. Both the bureaucrats in energy ministries and politicians in states have tried to block these reforms. 

Last week, West Bengal chief minister Mamata Banerjee made her objections clear to some of these reforms. 

Even for oil, the rapid ramp up in prices in the past few weeks has made it clear that it is not fully market-linked. The International Energy Agency at most times Indian consumers still pay more for petrol than global crude prices warrant. 

The establishment of trading exchanges for gas and coal and its expansion for electricity markets is therefore a harbinger of significant changes for the consumers. At the very least there would be options for the consumers of not having to buy the fuel when the suppliers want them to. It will be a demand driven market for each of the fuels, something that manufacturing industry will love and domestic consumers of cooking gas to those planing electric vehicles could certainly be pleased with.

As the prices for all these commodities for long administered by the ministries become market determined, the benefits should accrued to the renewable electricity sector too, which has increasingly replicated the ills of coal based power. India plans to move 40 per cent of its power to renewable by 2030.

Pricing freedom: 

A domestic market mechanism for pricing the energy commodities and their derivatives makes sense even though India has a shortage of gas and oil. It imports over 80 per cent of those and even of coal despite holding the world’s fourth largest reserve.

According to Enerdata statistics India’s total energy consumption is a third of USA and even less at 30 per cent of China for the year 2018. The change in the relative pricing of the key fuels could help quite a bit to bridge the gap.

To understand why one has to compare how gas is currently supplied within India and what a market can do instead. Suppose there is a cement plant in Rajasthan (there are quite a few of them). This plant runs on gas as a fuel and has a varying demand for its product. But it cannot tailor its demand for gas since it has to buy it at an administratively set price with a set quality standard. A spot market is however like a bazaar where our cement maker can on a given day of the week to buy gas at an advantageous price and offset it against a lean market for cement. On other days when the market for cement is buoyant it will be willing to buy at a higher price too, or settle for a compromise of a lower rated gas like an unprocessed gas if it wants to. At another time it may opt for a variety with a higher heating value. A spot market for gas can offer to sell all varieties of the product offering advantage to the buyers even when the country is dependent on imports, in other words ensuring what industry calls a stronger price discovery. 

The Indian Gas Exchange (IGX) which began operations last week will hope to reach there as a nationwide online delivery based gas trading platform. As of now it will allow participants to trade in standardized gas contracts. It will take a few years though, to reach maturity. A Morgan Stanley report estimates the domestic gas market could be as high as $15 billion by 2025. The same report notes India has become the second fastest growing gas market in the world (China is the first) with LNG demand set to reach 31 million tonnes by 2025. 

“There can be industry wise value discovery with a gas exchange, something which wasn’t possible without a gas market. Of course it will not be positive for everyone but that is what a market mechanism is for”, said Shuvendu Bose, senior energy expert at IFC. The domestic gas currently sold under the administered price mechanism cannot be sold in the exchange. The market is available only for fresh capacity coming up under the New Exploration Licensing Policy. 

The other challenge is infrastructure for gas pipelines. Unlike the power sector where there is a national grid, India has less than 12,000 kms of existing gas pipeline. Another 14,239 kms of network of about 12 pipelines has got approval last year. It would also need hiving of state run Gail into two companies with one only responsible solely as a pipeline operator.  

The same concerns for price discovery should propel the coal market too, where government run Coal India and Singareni Collieries Company Limited suffocatingly dominate the supply chain. This is peculiar because India is the lowest cost producer of coal among the key producers of the world. India’s coal demand is expected to reach close to 1500 million tonnes by 2025 but this could have been larger. A large percentage of manufacturing companies that used to depend on coal have shifted out meanwhile. Some did due to environment concerns but more have done it because of the uncertain state of supply of coal that has encouraged them to switch. 

Even giant downstream companies like NTPC have wrestled with quality and price issues of the coal they purchase for their power plants. There has been some improvements though. Since 2018 the coal prices are set by the two state run suppliers based on the gross calorific value (heat content) of each coal consignment it sends out. It is a more realistic price and certainly an improvement over an averaging mechanism it was using earlier. Coal was earlier sorted into grades and for each grade their average heat content was used as yardstick. But CIL complains that the new mechanism makes the prices adverse for it because it has to account for every dip in the quality but cannot take the same advantage for an improvement. All of these concerns can be sorted in an open market which can judge the quality far better than a company set mechanism even if one assumes that it has been set transparently. 

M Nagaraju, notified authority in the union ministry of coal is hopeful. He is in charge of the auctions of the mines. “The auctions of coal blocks for commercial coal mining will need a mechanism for price discovery in the markets. We expect to roll out the coal exchange soon”, he said. Unlike gas, more of CIL’s production is expected to come under the exchange, which will also subsume the e-auction mechanism of the company. 

Rationalisation of coal prices would basically help the power sector, big time. Of all the exchanges in fuel, the power business has enjoyed the longest spell in the spot market. But it is also the sector grappling with the highest legacy issues. 

Cutting fixed costs for power:

Because of these legacy issues, whenever a company buys electricity it has to pay for both the fixed costs demanded by the power producers in addition to the variable cost of production. Some of the higher fixed costs flow from the high price of coal. To compensate for this price and uncertainty of supply, the generation companies prefer to enter long term power purchase agreements with the electricity distribution companies. These agreements account for more than 90 per cent of the market. The latter too is happy with the buffer for they are not sure about the ability of the different generators to meet their commitments. In Maharashtra for instance, the installed capacity is 38GW but the average load drawn by the state has never exceeded 17GW. It is the same story for other states too. The cost of this additional capacity has to be apportioned among the stake holders. It also makes renewable capacity costlier as the discoms have to make allowance for this legacy fixed costs when bidding for new capacity. 

The spectre of losing the arrangement and being forced to work realistic prices for power has annoyed some of the states. West Bengal chief minister Mamata Banerjee has ticked off the centre for plans to amend the Electricity Act. Her grouse is that electricity is a concurrent subject for legislation and so the centre should not have moved in. The expansion of the role of the power exchanges does not come under those amendments but by asking the states to stick to the narrow in the act, it certainly gives more room for play to the exchanges. 

At a pan-India level, costs of this nature have ballooned to more than Rs 90,000 crore. Another evidence of this is that India is sitting on 370 Gw of capacity with a peak load of 180 Gw. It is an infrastructure build up which has added to costs in the sector and is deadweight for the economy. 

If instead the prices can be sorted through spot exchanges, it will bring sanity to the eventual price of electricity. It will also force the distribution companies, mostly state run and so reluctant to cut losses by charging efficient prices to pull themselves up. If electricity flows through exchanges, there shall be no option for the states to offer free power sops and will be perforce forced to reform their pricing. The generation companies most of all will have no option but to finance their own fixed costs and either become efficient or shutter their plants. Actually unlike what the West Bengal chief minister feels the exchanges can raise the efficiency of current investments in power generation and distribution and so reduce the drag on state finances. As Somit Dasgupta, former member Central Electricity Authority notes this can be a win-win situation for both the consumer and the states

The two electricity exchanges had, for some time, been offering day-ahead market, i.e. a market where anybody who needs power can book a slice of supply at a 24-hour notice. This month, the exchanges have extended the market to what is known as real time market. In this market consumers, including discoms and captive users or anybody else can buy power on exchanges just an hour before delivery. The next phase is the development of an ancillary market for power. “The day ahead market has begun to get traction. Prices at real time market should be higher than day ahead, but I suppose that will eventually happen”, adds Dasgupta. Overdraw from the grids by the discoms to meet sudden surges should also smoothen out now, he said. 
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