Is Capping Electricity Prices Justified?

On April 2, the Central Energy Regulatory Commission capped the spot prices of electricity on power trading exchanges, citing the high volatility in prices on the power exchanges.

With the demand for electricity peaking out during summers, and the current shortage in coal, distribution companies and open-access customers have begun buying power from these power exchanges.

The two main exchanges in India are the Indian Energy Exchange and the NSE-promoted Power Exchange of India Limited. These exchanges facilitate electricity trading between producers and consumers. Given India’s size and geographical diversity, some areas have excess production of electricity, while others suffer from a lack of electricity. Energy exchanges help in facilitating power trading between these surplus and deficit areas.

“This has widened the gap between demand and supply, with average buy to sell bid ratio reaching more than 2 and MCP frequently touching Rs 20/kWh. Needless to say, such abnormally high prices, even for a short period, without any significant increase in supply is not only against consumer interest but also erodes the buyer’s confidence in the market’s credibility,” the CERC report said.

The market-clearing prices on these platforms are usually low at around Rs 1 to Rs 3 per kilowatt-hour (kWh), on normal days. But, recently, power prices have even moved up to Rs 20 per kWh on some days.

With the economy coming back on track, and the heatwave aggravating the need for electricity, demand has begun outstripping supply. The supply side faces issues from a coal shortage as well. After bottoming out at around USD 50 a ton in September 2021, prices have risen up to USD 285 per tonne.

As a result, consumers that have been unable to procure power through existing bilateral contacts or power traders, or are looking to address peak power demand, are now turning to the power exchanges to procure power.

On the exchanges, supply continues to outstrip demand by around two times. But according to the CERC, with buyers becoming desperate to secure uninterrupted electricity supply, they are submitting bids at the upper cap of Rs 20 per kWh. Some plants have been importing coal to run their operations, resulting in higher and more volatile costs. A price cap, in such a scenario, could lower the profitability of such players, while potentially disincentivising higher sales.

This isn’t the first time CERC has attempted to intervene in the market. Previously, in 2013, CERC had suggested a Rs 5 price cap for electricity trading on power exchanges. While such actions do help the buyers, they do have a negative effect on the market as well. Markets such as the power exchanges help to connect buyers and sellers and send out the right price signal for market participants. Often price controls are implemented with a short-term view. Implementing these controls is often akin to treating the symptom (the price) but not the actual disease (supply-demand issues).

In addition, the heavy regulation over the power sector could hamper the development of power exchanges in India. In Europe, 60 per cent of power is procured through power exchanges, while in India only 5-6 per cent of power requirement is procured through these exchanges. While the share of power exchanges has continued growing, such caps could cause sellers to assure power to buyers at higher rates through off-market transactions. Bilateral contracts and power traders could replace the power exchange as the intermediary, and allow generators to sell power at higher rates to eager buyers.

Nevertheless, the CERC believes that the price cap is in line with market realities, and would safeguard customers, while not significantly affecting volumes. It has been argued that 99 per cent of the bids come from the Rs 0.01/kWh to Rs 12/kWh, while only one per cent of the bids come above the Rs 12/kWh cap. In addition, the CERC has said that supply hasn’t increased commensurately with the increase in prices, as supply has remained constrained. Hence, according to the CERC, it is in the public interest for the prices to be capped. While one can argue both for and against teh CERC report, whether the move would result in lower volumes being traded on the exchange, or the volumes would remain unaffected as the CERC says, remains to be seen.