The recent surge in electricity demand globally due to the increased level of economic activity after the lifting of pandemic restrictions and unprecedented climatic events have put pressure on electricity prices discovered in the power market. Against this backdrop, the Central Electricity Regulatory Commission (CERC) has prepared a staff paper on power market pricing to curb the abnormal market trends and protect consumer interests.
The volumes of electricity transacted through the power exchanges has increased manyfold over the years at a compound annual growth rate (CAGR) of about 25 per cent from 2009-10 to 2021-22. The overall demand-supply situation generally gets reflected in the prices discovered through the exchanges, and some price hikes were witnessed in October 2021. The situation, however, was short-lived and improved with increased supplies and the fall in temperature, which lowered demand pressures. In late March 2022, a similar phenomenon was observed due to unprecedented demand without a commensurate increase in supply and prices in both the day-ahead market (DAM) and the real-time market (RTM) remained significantly high for a consistent period, which led to regulatory intervention in terms of imposition of a price ceiling in the DAM and RTM, which was later extended to all other market segments. A look at the key details of the staff paper on power market pricing…
Key highlights
In March 2022, the prices discovered on the power exchanges were significantly high. This was due to factors such as a rise in temperature with the early onset of summer, increase in economic activity with the lifting of Covid-19 restrictions, domestic fuel supply constraints, geopolitical factors affecting fuel supply and prices, and supply limitations until May 2022 when wind- and hydro-based generation come onstream. On April 1, 2022, the CERC directed the power exchanges, until further orders, to redesign the bidding software with immediate effect in such a way that members can submit their bids in the price range of Re 0-Rs 12 per kWh for DAM and RTM. Since the ceiling price was fixed at Rs 12 per kWh for the DAM and RTM, the market clearing price (MCP) in the DAM and RTM frequently hit the ceiling price with the volume of buy bids being much more than the volume of sell bids. Hence, the cleared volume was getting prorated among buyers quoting the ceiling price in proportion to their bid volumes. Due to apprehensions of such prorating, it was observed that buyers substantially increased their bid volumes at the ceiling price. However, they were still not able to meet their electricity demand in the collective transaction segment of the power exchanges, namely, DAM and RTM. Therefore, to fulfil their supply obligations, the buyers shifted to other market segments of the power exchanges, such as the term-ahead market (TAM). The difference in the ceiling price between DAM/RTM and TAM led to a shift in the supply volume from DAM/RTM to TAM.
In view of this, the commission realised the need for a uniform price ceiling in all segments of the power exchanges so that there is no shift in supply volume from one segment of the power exchanges to another, induced by a differential ceiling price between different market segments of the power exchanges. Sellers could not make any profit in the backdrop of increased demand and reduced supply. Thus, on May 6, 2022, the CERC directed the power exchanges to revise the ceiling price of all segments to Rs 12 per kWh. Based on the assessment of the demand-supply position in the power sector, the high demand for electricity is likely to continue over the next few months. Accordingly, the capping of the ceiling price at Rs 12 per kWh on all segments of the power exchanges has been extended by the commission till December 31, 2022.
Current market scenario: At present, the bulk electric power supply in India is predominantly tied up in long-term contracts. For meeting their daily power needs, discoms that have the obligation to provide electricity to their consumers mainly rely on supplies from long-term contracts and the remaining is procured through bilateral transactions with other discoms, through power exchanges or traders. Long-term transactions dominate the share of total electricity transactions in the country by 87 per cent.
During 2021-22, power procurement through short-term transactions grew significantly, particularly through the power exchanges. The share of short-term transactions was about 13 per cent. Of the total short-term transactions, 54 per cent was transacted through power exchanges, followed by 21 per cent through bilateral transactions by traders, 14 per cent through the deviation settlement mechanism and the remaining 11 per cent through bilateral transactions between discoms. In addition, of the total volume transacted through the power exchanges, a majority is being transacted in DAM (including G-DAM), followed by RTM and TAM (including intra-day, DAC and G-TAM).
Pricing principle: Based on the pricing principle, contracts are broadly categorised into two types – collective transactions and continuous transactions. In collective transactions, the price is discovered through anonymous and simultaneous competitive bidding by the buyers and sellers, while in continuous transactions the buy and sell bids are matched on a continuous basis with price-time priority. For a specific contract, the seller with the minimum quote and the buyer with the maximum quote are considered as the best seller and best buyer. In case the best buy order is better than or same as the best sale order, they are matched, resulting in a contract.
Issues in pricing methodology: At present, the mechanism utilised in India for collective transactions leads to the discovery of a uniform market clearing price (UMCP). All leading power exchanges across the world have adopted the UMCP mechanism in the DAM. However, due to a uniform price for all types of market participants that are cleared all sellers who bid lower prices get an extra profit (difference of the UMCP and the bid price), which constitutes the seller’s surplus. Owing to recent events in the electricity market with prices reaching alarming levels, concerns have been raised that some sellers are making huge gains in the market due to this market auction design. This has prompted the regulators and policymakers to analyse different possible pricing methodologies.
Uniform pricing and pay as bid: The difference between this two-pricing methodology lies in the final price paid to the cleared sellers. In uniform pricing, all the cleared sellers receive the same price, that is, the MCP. As observed, the MCP is the bid price of the most expensive seller cleared to meet the demand, whereas pay-as-bid prices are paid to the cleared sellers based on the sell bid offered by the respective seller. Thus, each seller is paid a different price tied to the bid offered by them and these pay-as-bid prices are not dependent on the price of the most expensive seller cleared to meet demand.
Supply shortage and uniform pricing: As per the discussion paper, the UMCP is the most commonly adopted pricing methodology globally but with the recent events in the electricity sector, concerns have been raised regarding the efficacy of this market design. As in March 2022, India witnessed a period of demand surge coupled with supply shortage. On the other hand, the increase in supply has been limited. The situation has been further aggravated due to geopolitical factors affecting fuel supply and certain domestic supply constraints. The increased prices of fuel, particularly imported coal, have led to a significant increase in the marginal costs of the margin setting generators of the market. This, along with the surge in demand, led to an abnormally high MCP, frequently touching Rs 20 per kWh, which is the maximum quotable price.
Points for discussion
Need for change in pricing methodology: In a competitive market, any difference in cost due to the pricing methodologies becomes a function of the bidding behaviour of the sellers. Thus, it is imperative to mitigate the concern of supernormal profits which may apparently be achieved through a pay-as-bid auction. While participating in the market, generators quote a price to receive their marginal costs and also recover part of their fixed cost. The pay-as-bid auction may encourage sellers to offer a high bid price (higher than the marginal cost) to earn a profit and also recover fixed costs (business rationale). The CERC’s discussion paper questions whether it would make sense to switch to pay-as-bid pricing methodology and whether the methodology will address the concerns regarding supernormal profits for inframarginal generators under the UMCP?
Criteria for regulatory interventions: As per the discussion paper, market intervention is justified when the price spike is a result of market power or misuse of market position by suppliers. One school of thought if the price rise is caused by demand behaviour is that there is a need to correct the demand side and not further burden the supply side. The other school of thought believes that India cannot afford very high price caps or the standard scarcity pricing framework. Given these realities, the CERC discusses whether it would be advisable to define a tolerance level beyond which intervention is justified. What should be the basis for such intervention and the tolerance level in the Indian context?
Addressing negative impact of price caps: The imposition of price caps ensures that market prices remain reasonable and within bounds. However, the generators with variable cost higher than the price cap tend to go out of the market. In order to attract more supply volume, India has floated a proposal for introducing a separate high price market segment within the existing DAM. In its discussion paper, the CERC highlighted the issues pertaining to the basis for defining supramarginal or high-cost generators (technology or fuel). Would there be enough liquidity in this small segment for collective transactions (demand and supply curve intersection) to take place? Would it lead to market power by these small sets of generators? If the high- cost/marginal generator setting the market clearing price is a concern and a cause for market intervention, would the TAM be a better option for such transactions to take place without affecting the rest of the buyers? Further, the commission has asked for suggestions on mitigating the negative price impact.
Market design for incentivising demand response and ESS: As prices are driven high due to high demand coupled with low supply, demand-side response in such crisis situations would help lower prices. In view of this, the CERC commented on what should be the appropriate market structure/design to encourage flexible resources like demand response and energy storage system (ESS)? Also, apart from time-of-day or dynamic tariff for varied consumer categories, what are the mechanisms that can be considered for encouraging such resources? Can we think of bringing aggregators to pool together such resources and participate in the market? If yes, what should be the bidding criteria or the cost recovery mechanism for such resources given that their usage is going to be limited to a very small duration during the year?
Conclusion
That said, the commission seeks to review the regulatory framework, especially the pricing methodology used in the power market, and to explore possible options to deal with such situations in a predictable manner.