Mint Explainer: Why NSE, MCX are powering up with electricity derivatives

Mint

2 days ago

The National Stock Exchange (NSE) and the Multi-Commodity Exchange (MCX) recently secured approvals from the equity market regulator to launch electricity derivatives. Not only would this minimise financial uncertainty for power distribution companies but they can also use electricity derivatives or futures contracts to lock in electricity prices in advance. Mint takes a look at what this means and why there is a sudden interest in electricity derivatives.
What are electricity derivatives?
Electricity derivatives are financial contracts that help power companies and other electricity buyers protect themselves from sudden price changes in the electricity market. Think of it like this: electricity prices can rise or fall sharply due to factors like demand spikes, fuel costs, or weather changes. For power distribution companies, or discoms, this kind of volatility can cause financial uncertainty. To avoid this, discoms can use electricity derivatives or futures contracts to lock in electricity prices in advance.
Why is this important?
In electricity delivery in the unlisted space, there's always a counterparty risk—a fear that the other party may default. But in the listed space, the risk is significantly reduced, said Trivesh D., chief operating officer at trading platform Tradejini.
He added that electricity derivatives contracts also offer discoms a reliable way for price discovery. 'Once electricity is listed as a derivative, its pricing becomes market-driven, based on actual demand and supply, rather than manipulated practices," he said.
How will electricity derivatives work?
Rajesh Palviya, head of technical & derivative research at Axis Securities, said derivative contracts will allow buyers and sellers to trade based on their anticipated electricity needs without involving physical delivery of power.
'Companies and manufacturers can purchase electricity contracts for specific durations—ranging from a month to a year—locking in prices to hedge against future price fluctuations. Instead of physically receiving or supplying electricity, participants settle the contracts financially. At the contract's expiration, the difference between the contracted price and the market price is credited or debited to the respective parties' accounts," Palaviya added.
What do NSE and MCX have to say?
India's transition to net-zero emissions requires substantial investment of over $250 billion year-on-year till 2047, according to government think tank Niti Aayog. India announced its net-zero target for 2070 at the 26th session of the United Nations Framework Convention on Climate Change (COP26) in November 2021.
A robust and dynamic electricity derivatives market is essential to attract this scale of climate finance from both domestic and global investors, NSE said on Wednesday.
MCX said electricity contracts will allow participants to manage power price risks, which are becoming more dynamic due to renewables and market-based reforms.
What is the Indian Energy Exchange's (IEX) role?
IEX is the dominant platform providing spot electricity trading. But it does not offer an electricity derivative contract. However, with MCX and NSE now allowed to launch electricity futures contracts, discoms, power producers, and retail investors can participate through new platforms.
'This means IEX no longer holds a monopoly," said Kranthi Bathini, director of equity strategy at Wealthmills Securities.
'Also, with both NSE and MCX joining the segment, the market is expected to become deeper, more liquid, and capable of delivering better price discovery and broader participation," said Trivesh of Tradejini.
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Who will regulate electricity derivatives?
Under current rules, if electricity derivatives are cash-settled, they fall solely under the purview of the Securities and Exchange Board of India (Sebi). If the contracts are compulsorily deliverable, regulatory oversight will be shared between Sebi and the Central Electricity Regulatory Commission (CERC).