Meltdown in the Power Corridors

The year 2024 kicked off on a positive note for the Indian Energy Exchange (IEX), the country’s largest power trading platform. It reported nearly 15% year-on-year increase in overall trading volume in December 2023, thanks to higher electricity trading volume, lower market clearing price and higher sell bids. However, that might not be enough to warrant a celebration in the IEX corridors as policy changes knock at the doors of power trading companies. 

Last year, the government directed the Central Electricity Regulatory Commission (CERC) to hasten the implementation of market coupling, a strategy to introduce uniformity of operations of power exchanges. CERC, in its draft Power Market Regulations proposed in 2020, defined market coupling as “the process whereby collected bids from all the Power Exchanges are matched, after taking into account all bid types, to discover the uniform market clearing price for the Day Ahead Market or Real-time Market or any other market as notified by the Commission, subject to market splitting”. It noted that this process will help make power prices uniform across all exchanges. The draft was approved in August 2021.

The government’s desire to implement market coupling has triggered apprehensions regarding the future of IEX and its dominant position in the power trading space.  

India has three major power exchanges—IEX, Power Exchange of India Limited (PEIL) and Hindustan Power Exchange Limited (HPXL). IEX and the PEIL were launched in 2008—June and October respectively—five years after the ratification of the Indian Electricity Act, 2003, which liberalised the power sector and recognised electricity trading as an activity independent from distribution or transmission. The HPXL began operations in 2022. IEX is currently the market leader, holding approximately 95% of the power exchange market share, according to ICICI Securities. 

All the three exchanges have distinct pricing, thanks to their own price discovery mechanisms. Price discovery is one of the most important features of any exchange, which incentivises investment in diverse technological products. 

The Institute of Energy Economics and Financial Analysis, in its recommendations to the CERC for implementation of market coupling, observes that coupling can help form a bigger connected liquid and efficient marketplace to overcome many of the limitations of the fragmented power trading market. This market currently has only 7% liquidity, multiple segments, very low-price cap and aggressive bidding in the face of unfulfilled demand.

Bright Spots 

The primary objective behind establishing power trading exchanges was to bring transparency and competition in the electricity market. Besides allowing for trading for a balance between deficit or surplus power generation, it also lets entities with a surplus supply opt for cheaper power and save on overall procurement costs.

The idea of a power exchange as a single platform for power transactions gained traction and IEX emerged as a key player, reaching Rs 174 crore in revenue in FY14. The volume growth in its segments, such as day-ahead market where buyers can get electricity in time blocks of 15 minutes which are delivered in the next 24 hours, went from just six billion units in FY10 to 50 billion units in FY20. 

The year 2023 brought optimism for the power sector. The BSE Power Index posted more than 35% returns during the year, while the Nifty Energy Index posted gains of over 27%. Power generation and distribution have seen a dramatic surge in the last few months, owing to high electricity demand across the country. This buoyant atmosphere helped IEX, whose shares had dropped in 2022 due to moderation in trading volume. That was the time when supply had witnessed some stress following rise in power demand due to revival in economic activities. In 2023, IEX shares gained 19% to reach Rs 168. 

With India’s ambition to establish a South Asia power market gaining steam, the importance of energy trade is expected to increase in the years to come. The government is already in talks with Nepal and Bangladesh to set up a power market. Ajay Tewari, additional secretary at the Ministry of Power, articulated this ambition at an industry function in 2022. He said, “In the future, we would like to see the grid connected to neighbouring countries including Myanmar, Sri Lanka and then expand that connection to southeast Asian countries, to emerge as a unified market.” This desire to expand its footprint may be one of the reasons for the push to market coupling.

An Edgy Exchange 

Citing senior officials, The Financial Express recently reported that the plan to implement market coupling can be completed as early as the end of FY24. Once it is implemented, IEX stands to be affected the most as its dominant position will lose some significance since all the markets will be interconnected and prices will depend on rates determined among them. 

The proposal of coupling to streamline the markets has received significant attention from players in the sector. Understandably, IEX came out in opposition to the proposal. It argued that the 2020 draft proposal, if implemented, would “render power exchanges to function as mere bid collectors”. 

“The competition amongst the existing power exchanges & the threat of possible new entrant into the market has pushed the existing power exchanges to operate efficiently in the market and the results are there to  see,” it stated in a response to the CERC on the draft 2020 proposal. PEIL, which has a small share in the overall power trading market, welcomed the move. 

Hitesh Chaniyara, executive director of smart utilities at PwC India, says, “Globally, market coupling has, in general, resulted in positive outcomes by combining distributed markets. However, in the Indian context, it aims at an increase in market liquidity and uniform pricing in the power market.” 

Investors have clearly identified the threat to IEX’s prospects if the market coupling proposal goes ahead as planned. The scrip had delivered strong returns around the time of the pandemic when its business got a boost due to robust demand. It surged from Rs 46.77 on December 6, 2019, to Rs 295.25 on December 10, 2021, giving returns of over 500%. Since FY20, the revenue of IEX surged from Rs 297 crore to Rs 474 crore. Its profit after tax has also shown strong growth, rising from Rs 177 crore in FY20 to Rs 292 crore in FY23. 

While IEX’s share prices had started climbing down since 2022, a big hit to the price came in June last year when the market coupling proposal was circulated by the regulator. The company’s share price fell by over 17% within two days. 

The Deeper Fear 

Brokerage firms and analysts note that the fundamentals of the company remain strong, but the looming threat of market coupling is weighing down on the company significantly. For some, it is not just a dent to the growth prospects of IEX, but also represents an existential threat. 

However, market coupling by itself may not make much of a difference to a mammoth like IEX. The government has announced establishment of Market-Based Economic Despatch (MBED) mechanism to further its vision of One Nation, One Grid, One Frequency, One Price framework. MBED will reduce costs for distribution companies and consumers by making power available at the cheapest rates from a central pool. Going forward, this is what might pose an existential threat to IEX, which acts as a platform for power trading between states and entities and risks redundancy in the face of demand and supply being managed from a common pool. 

Market coupling is the first step towards MBED, and the directions to the CERC to hasten its implementation may be seen as a signal of the government’s eagerness to introduce MBED. 

Consultancy firm Eninrac said in a note on the proposal of market coupling, “With the implementation of market coupling, the traditional role of power exchanges as intermediaries may diminish, possibly leading to their reduced relevance or even obsolescence.” Agreeing with the possibility of a big impact on the company, Dhirender Mishra, senior manager of growth advisory at research and analytics firm Aranca, says, “Regulatory uncertainty has dragged IEX’s stocks down in 2023. In case the CERC announces the implementation of market coupling, the company’s share might get impacted significantly.” 

Time for a New Strategy 

A threat to the prospects of IEX was bound to worry investors. This was evident in the last earnings call of the company. Amid the several questions being raised on the proposal on market coupling and the road ahead, the company leadership attempted to reassure the investors. It cited lack of official clarity on implementation of market coupling to allay some concerns. 

Satyanarayan Goel, chairman and managing director of IEX, said during the Q2 earnings call held recently, “The process of finalisation of regulation itself may take one year’s time.” After that, implementation of coupling would require getting a software, customising the software for Indian conditions and putting in place the clearing and settlement mechanism, he explained, adding that it might take almost two years to implement coupling after that.  

The company believes that there is no certainty that the plan will eventually go through. But irrespective of the coupling, some analysts appear to be confident that IEX will continue to have an edge in the market due to its lead in different products.  

Jay Patel, research head at InvestMentor Securities, suggests that the company holds good potential from a long-term perspective. “At the moment, there is little understanding of how the new regulations will work. What sets IEX apart is the diverse set of products it has and good presence in the renewables segment. Looking at the company from a five-year perspective, I believe its current lead in the market puts it in a position to sustain growth,” he says. 

In the last few financial years, the green energy market has received significant attention from the company. Separate from its day-ahead market, it has introduced green day-ahead market to capitalise on the growing renewables space. IEX has also expanded the renewable certificates business. Its total green market saw a 5% year-on-year growth in FY23, while energy certificates distribution remained stagnant at six billion units. To cater to buyers looking for stability, it has also planned to introduce long-duration contracts which will extend up to 11 months instead of the current 90 days. 

As the large portion of IEX’s revenue still comes from the traditional source of day-ahead market and other real-time markets, its stakes are high in any decision on market coupling. A delay in its implementation can buy IEX some time to rethink its business model and find a way to not only remain relevant but also retain its leadership position. That is where the real challenge lies—readying an alternative to fall back on when it is pushed to a corner in the area of its dominance.