The introduction of electricity derivatives marks a significant step in the evolution of India’s power market. By enabling better price discovery and risk mitigation, derivatives are expected to enhance overall market efficiency. Industry experts discuss the potential impact of derivatives, key benefits for stakeholders and the challenges that need to be addressed for successful implementation. Edited excerpts…
How will the introduction of electricity derivatives impact the power market landscape in India? What are the key benefits for industry stakeholders?
Pankaj Batra
Let us understand the power markets in India before we discuss what impact the introduction of electricity derivatives will have on the power market landscape, as the context is very important. India already has a market for long-term, medium-term and short-term contracts. All discoms must procure power through the competitive bidding route, as per the latest Tariff Policy of 2016. Long-term PPAs (from 7-25 years) through bidding are facilitated on the Indian government’s Discovery of Efficient Electricity Price (DEEP) platform or through the calling of bids by states through model standard bidding documents notified by the Indian government, under the supervision of the state regulator. Medium-term contracts (1-5 years) and short-term contracts (one day to one year) can also be facilitated through the DEEP platform. However, even though bidding through the DEEP platform can be done for 1 day, it is impractical if it is done for the next day, given that the process cannot be completed in such a short time. This involves open bidding, then reverse auctions, which would be followed by the process of issuing a letter of intent, acceptance and signing of contract, submission of performance guarantees by the generator, etc. Short-term contracts, ranging from 15 minutes to up to three months, can also be facilitated through the power exchanges. So, most of the contracts are fixed-price contracts, known in advance.
The objectives of electricity derivatives are to have price certainty over some future period, and thereby mitigate the risk of price uncertainty for sellers and buyers of power. The risk can be transferred to speculators who are willing. Derivatives are so called, because the trade is not in the actual commodity, but derived from the price of the commodity. In India, about 85 per cent of power purchased is through long-term PPAs, and about 15 per cent through medium-term and short-term contracts, as per the Market Monitoring Report of April 2025. Only about 7 per cent of power is purchased through collective transactions on the power exchanges, with the day-ahead market (DAM) having the majority share, the price of which is discovered through a double-sided anonymous auction, and therefore, the price of which would not be known to buyers and sellers in advance. By studying how market prices fluctuate over the day and over seasons, both buyers and sellers would have a fair idea, except during events of forced outage of power plants and transmission lines or sudden changes in weather. Since there is certainty in prices for long-term PPAs, as well as in medium-term and bilateral short-term contracts, the only uncertainty in price is for the procurement of power in collective transactions through the power exchanges, that is, in the procurement of 7 per cent of the power. Price fluctuations, taking into account the extremes observed in the power exchanges, would be between Re 0-Rs 10, with Rs 10 being the upper limit set in the power exchanges by the Central Electricity Regulatory Commission (CERC). If there is an inaccuracy in the price forecast on the power exchanges, even to the extent of 50 per cent, the overall impact for the discom would be 50 per cent of 7 per cent (power purchased), which is 3.5 per cent. So, the relevance of derivatives in the electricity market in India would have to be seen in this context. In many foreign countries, where a majority of transactions take place through the power exchanges and not through fixed price long-term contracts, derivatives in the electricity market would have a much bigger impact.
I believe that the industry would benefit to a small extent in mitigating the small risks in price certainty, as mentioned above. However, it depends on how we design the market in the future. Do we want to diminish long-term contracts and depend more and more on the market? If so, it could raise concerns among investors if they do not see a definite revenue stream. This strategy was tried in the US, in California, in the year 2000, where the regulator abolished all long-term contracts, and every generator was forced to sell only through the market. The prices initially went down due to competition. However, market prices are subject to the demand-supply scenario. The scheme failed miserably, since retail prices were capped, whereas wholesale prices were not. In the very next year after the change, in California, which depended on hydro and gas for electricity generation, there was a drought, and the prices of gas shot through the roof. So, electricity was in short supply, which made wholesale prices shoot up. Discoms were forced to buy electricity at high prices and sell to consumers at capped prices (fixed by the Californian regulator), which were lower. Most discoms went bankrupt, and the regulator almost got abolished. Long-term contracts were then restored.
For the above market design to succeed, that is, procurement through the DAM or spot market, there has to be adequate generation capacity planned, or resource adequacy. Now that resource adequacy in generation and transmission is mandated in India through guidelines by the Central Electricity Authority (CEA) and the CERC, this can be tried. Here again, solar, wind and hydro generation, which would form a substantial part of the generation resource by 2030, is subject to the vagaries of weather, and it could result in shortages in a specific year. The market prices would then rise, and if power purchase is largely through the market, electricity prices would rise. Since the prices of derivatives are linked to the market, the derivatives prices would also rise. Some risk could be mitigated through speculators, although it would merely transfer the risk rather than eliminate it. Nonetheless, the power industry could benefit to that extent.
Arun Goyal
The introduction of electricity derivatives is a major development in India’s evolving power market architecture. Their immediate impact on spot market prices or supply is expected to be limited, as the DAM currently constitutes only about 3.3 per cent of the total electricity consumption.
Over time, these derivatives will foster more accurate and transparent price signals by integrating factors like fuel prices, demand trends and seasonal patterns. A key benefit for industry stakeholders, including generators, consumers and discoms, is the ability to effectively hedge against electricity price volatility, which is driven by weather, demand fluctuations and input fuel costs. This hedging capability will provide greater revenue certainty for generators, improved budgeting accuracy for large consumers, and enhanced financial stability for discoms by allowing them to manage procurement costs more effectively. Ultimately, electricity derivatives will contribute to a more robust, efficient and financially stable power market in India, facilitating better risk management and promoting long-term growth and investment.
Harish Saran
The Indian power sector is undergoing a transformative shift with the introduction of electricity derivatives – a financial innovation that promises to deepen market efficiency, enable robust risk management and attract diverse participants. This development is also likely to encourage innovation in risk management solutions, structured products and energy-linked investments.
Traditionally, India’s electricity market has been dominated by long-term PPAs and short-term spot transactions. While these served the purpose of physical delivery, they lacked mechanisms for price risk management. Volatility in spot prices due to reasons like seasonal demand, fuel cost variations or renewable intermittency left generators, discoms and commercial consumers exposed.
Electricity derivatives address this gap by introducing financial contracts that allow market participants to hedge against future price movements, like commodity futures in oil, gas or agriculture. This elevates India’s electricity market closer to mature systems like those in the US or Europe, where derivatives are integral to power trading.
The advantages of electricity derivatives ripple across the entire value chain of the power sector:
- Generators and IPPs: Hedge against demand-side shock and stabilise revenue.
- Discoms and large buyers: Ensure cost certainty and budget control.
- Renewable developers: Mitigate price risk and boost bankability.
- Traders and financial entities: Leverage volatility for profit and arbitrage.
- Investors: Enhanced market depth improves the attractiveness of energy as an investable asset class.
India can fast-track its power market evolution by drawing from global best practices, fostering cross-sector alignment and instilling confidence through education, standardisation and transparency. With effective execution, electricity derivatives will not only hedge risks but also catalyse the next wave of growth in India’s power sector.
What are the key challenges in the adoption of electricity derivatives, and what measures are needed to address them?
Pankaj Batra
Any new system that was created with a particular objective in mind can be misused, if not subject to regulatory oversight. One of the main risks is market manipulation. The Securities and Exchange Board of India (SEBI) has already placed daily price limits to mitigate risk and prevent speculators from making excessive profits. There should be a continuous market monitoring of derivatives prices, as well as provision of investigation if there are complaints from market players or whistle-blowers within or related to the speculator. There have been complaints and concerns about the commodity markets in India, particularly regarding issues like excessive speculation and price volatility, which can affect food prices.
In 2021, trading in certain agricultural commodities was suspended in response to these concerns. Essential commodities affect the common man, and both food and electricity are essential commodities. Therefore, a strict mechanism has to be put in place and enforced. Besides, if the financial derivatives are to play a significant role, discoms – most of which are state-owned – will require greater awareness of financial markets and capacity building to effectively leverage these instruments. They would also need to become more agile to actively participate in such markets.
Arun Goyal
Regulators have taken a cautious approach in introducing electricity derivatives in India. At present, only monthly futures have been introduced, and that too for the next three months. Further, the due date rate (DDR), on which the futures will be settled, is based on the volume weighted average of the DAM-unconstrained market clearing price (UMCP) on the India Energy Exchange across all calendar days of the expiry month. The spot market (DAM) already has a price cap, which limits wide fluctuations in spot market prices, and in turn, reduces the risks associated with the computation of the DDR.
However, there is a need for the CERC’s continued vigilance over the power exchanges, as DAM has limited depth (approximately 3.3 per cent of the total generation). Similarly, SEBI close oversight will be required over market conduct in electricity derivatives. There is also a need for transparency in index computation and its publication. There should be full daily disclosure of the UMCP and its volume weight to enable sellers and buyers of futures to make informed decisions.
Both SEBI and the CERC have a track record of successfully overseeing their respective domains. I believe that their coordinated efforts through the Joint Working Group will result in a stable, transparent and efficient electricity derivatives market in India over time.
Harish Saran
The adoption of electricity derivatives in India, while promising in its potential to deepen the power market and improve risk management, also faces several challenges. These stem from the nascent nature of financial electricity markets in India, regulatory complexities and a lack of institutional readiness. Addressing these issues through well-designed measures will be essential to ensure the successful implementation and sustainable growth of electricity derivatives trading:
Shallow spot market participation and fragmented spot prices: Only 7-10 per cent of India’s electricity consumption is traded through the DAM and the real-time market (RTM). This low volume weakens price discovery and limits the effectiveness of futures contracts, which rely on robust underlying spot markets. In addition, varying prices on three different electricity exchanges hinder the creation of standardised futures products. Therefore, market-based reforms, such as market-based economic despatch and market coupling, need to be implemented on priority for consolidating power procurement, improving liquidity and enabling robust price benchmarking.
Regulatory oversight: Though the Supreme Court settled the CERC-SEBI jurisdiction overlap, recent financial incidents (such as the Jane Street case) highlight the need for real-time regulatory vigilance. A harmonised oversight framework is needed, and the CERC-SEBI Joint Working Group must issue clear guidelines.
Further, the price cap of Rs 10,000 per MWh in the DAM and RTM was a necessary safeguard during early market development. However, as electricity derivatives evolve, unrestricted price discovery becomes essential for effective hedging. Gradually phasing out price caps will foster market depth, enable accurate risk pricing and support a robust derivatives ecosystem.
As power purchase costs are pass-throughs for discoms, state electricity regulatory commissions should frame detailed hedging guidelines and monitor discom participation in derivatives markets.
Speculation and manipulation risk: Electricity markets are susceptible to price spikes due to unforeseen events like fuel shortages, weather changes or transmission outages. In a thinly traded derivatives market, such volatility can be magnified by speculative trading, potentially leading to market manipulation or financial distress for poorly hedged players. SEBI and the CERC, in collaboration with power exchanges, should enforce robust surveillance mechanisms to monitor trading behaviour and identify manipulation.
Building capacity and awareness: A major barrier to adoption is the limited understanding of electricity derivatives among discoms, generators and commercial consumers. These stakeholders often lack the financial expertise to assess, hedge and manage market risks. Targeted capacity-building initiatives, training programmes and regulatory handholding are essential to equip market participants with the skills needed for the responsible and effective use of derivatives.
