The financial year 2021 (FY21) was a telling year for the Indian power sector. In previous blogs in this series, we have described how power demand rapidly recovered to the previous year’s levels after initially plummeting during a nationwide lockdown, and how renewable energy sources performed under stress. But what impact did volatility in demand and supply have on distribution companies’ (discoms) wholesale power purchase planning?
Discoms traditionally rely on long-term contracts (> 25 years) to buy power from generating stations. However, FY21 saw an uptick in procurement using short-term instruments, particularly from power exchanges (PXs) (Figure 1). In most of the developed world, cost effectiveness in the power sector has been achieved through a reliance on wholesale markets and short term instruments. In this blog, we examine India’s progression in this direction in the last year and what would be needed to sustain market based procurement. Some key terms are explained in the box below.
DAM - The Day-Ahead Market is a trading market in which auctions are held for power to be delivered through a 24-hour period, but broken up into 15-minute time windows. As the name suggests, all bidding is completed by 12 pm on the day preceding the date of power delivery.
MBED - Market-Based Economic Dispatch is the principle of optimising the total cost of servicing power demand by allocating a higher share of required generation to lower-cost plants, and vice versa.
MCP - The Market Clearing Price is the price discovered during auctions conducted by power exchanges, by matching sale offers made by power generators and purchase offers made by discoms and other large consumers.
MCV - The Market Clearing Volume is the total energy sold in a single auction period on the power exchange in a market segment.
REC - Renewable Energy Certificates are provided to generators of renewable energy, who earn 1 REC for every MWh of renewable energy they produce. They can then sell these RECs to obligated entities (see below), who can use them to claim a share of renewables in their power consumption.
RPO - Renewable Purchase Obligations are targets assigned to “obligated entities” (such as discoms and other large power consumers), legally obligating them to consume renewable energy as a share of the total energy they consume in a year.
RTM - The Real-Time Market is a trading market where auctions are held for energy to be delivered in 30-minute time slots. Bidding takes place an hour before power delivery.
SCED - Security-Constrained Economic Dispatch is a pilot scheme in which the total cost of power generation is optimised between inter-state generation stations ( which participate in the scheme voluntarily). After RTM (see above) auctions are cleared, costlier plants are instructed to reduce generation and cheaper ones are instructed to increase it. The optimisation takes place in such a way that secure grid operation is maintained.
Note: 1) Total generation excludes renewable energy and captive generation. 2) Short-term market includes transactions on the day-ahead market (DAM) & real-time market (RTM), bilateral transactions (through traders, term-ahead on PXs, or between discoms) and the deviation settlement mechanism.
Subdued prices attracted buyers to the market
As FY21 began, wholesale power prices on the open markets were already lower than in FY20 (Figure 2). The year started with a crash in power demand, as the lockdown was imposed in late March, and consequently, there was a surplus supply of energy from thermal plants on the PXs.
Note: The chart shows 7-day rolling averages.
As the economic opportunity to buy cheaper power became evident, states such as Maharashtra, Andhra Pradesh, Gujarat, Telangana, Punjab and Uttar Pradesh, substituted their power purchase from contracted costlier power plants with cheaper power on PXs for as low as INR 1.8 per kWh. As a result, Andhra Pradesh reportedly saved INR 132 crore in power purchase costs in the month of April 2020.
Note: The chart shows 7-day rolling averages.
Note: 1) June 2020 data includes both DAM and RTM volumes, though RTM volumes were negligible.
Further, as demand resurfaced with the gradual easing of restrictions, especially in the festive season (August-October), uncertainty about the expected level of demand may have prompted discoms to extend their reliance on the PXs rather and cut back on bilateral purchases (Figure 4). The latter allows discoms to purchase power typically 1-3 months in advance, and are usually preferred over the Day-Ahead-Market (or DAM, in which bids are placed up to 12 hours before power delivery) due to the higher certainty of power availability.
Note: 1) Data includes both DAM and RTM volumes. 2) Bilateral price data unavailable for January and February 2021.
New products helped manage volatility and fulfil renewable purchase obligations
New products such as the real-time market (RTM) launched in June 2020 enabled such volatile demand management in a cost-effective way. Unlike the DAM, RTM allows bidding upto 75 minutes before delivery. Data suggests that states such as Rajasthan, Gujarat, Odisha, Telangana, Jammu & Kashmir and Andhra Pradesh were most active in this segment. Owing to increased participation, wholesale prices on the RTM have risen from INR 2.22 per kWh in June 2020 to INR 3.73 per kWh in March 2021.
RTM tempered the reliance on the security-constrained economic despatch (SCED) pilot scheme, albeit to a small extent. The SCED mechanism optimises cost of generation among voluntarily participating plants by instructing cheaper plants to increase generation and costlier plants to reduce generation, post RTM-clearance and subject to technical constraints. A report by POSOCO observed that some participating capacity went into reserve-shut down in 2020 on account of low demand, and the variable cost diversity of participating plants also reduced, due to which SCED savings in 2020 were lower than in 2019. However, it also indicated that contributions to RTM by participating plants could have reduced SCED savings by about 3%, indicating that RTM facilitates market-based cost minimisation at the margin.
Further, following the suspension of Renewable Energy Certificate (REC) trading in July 2020, the Green term-ahead market (GTAM) acted as an alternative to the REC mechanism for discoms and corporate consumers to meet their renewable purchase obligations (RPOs). Following high activity initially (208 MUs in October 2020), the GTAM subsequently saw a decline (94 MUs in February 2021) due to low solar and wind generation between December 2020 and February 2021. Due to scarce supply and a consistently high buy-side liquidity, the price has seen an upward trajectory, from INR 3.07 per kWh in August 2020 to INR 4.09 in February 2021.
There is money on the table for discoms to grab
Even though increased market-based procurement in FY21 may be an anomaly in the trends, it has revealed that there is money on the table for discoms. While planning for the upcoming summer, when demand is expected to peak, discoms must continue to include PXs in their procurement plans. In the longer term, lower market prices will sustain only if liquidity in the PX remains abundant even as demand grows. One way of ensuring this is to restructure long-term contracts between generators and discoms, allowing scheduling of plants across state boundaries. Continued savings from the SCED pilot shows that optimal scheduling across a larger pool of plants can deliver system-wide cost savings.
Even with the current distortions in fuel pricing and availability, market-based economic dispatch (MBED) can introduce efficiencies, and a transition to such a bulk-power market must be hastened. Further, to ensure socially optimal outcomes, energy efficiency must be at the heart of merit order dispatch and not the distorted metric of variable cost of generation. A well-functioning wholesale market will form an important precursor to the vision of an effective retail power market. It can also help drive financial solvency of stressed but productive assets and improve the outlook for non-performing assets in the banking system.
Nikhil Sharma is an Associate at CEEW-CEF, Dhruvak Aggarwal is a Research Analyst, Prateek Aggarwal is a Programme Associate and Karthik Ganesan is a Fellow at The Council. Send your comments to [email protected].