Radical implications of FDI up to 49% in power exchanges

Written by Pramod Deo | Updated: Oct 3 2012, 08:11am hrs
Considering that FDI up to 100%, under the automatic route, is permitted in the power sector (except atomic energy) for generation, transmission, distribution of electricity and power trading, is the recent decision to permit foreign investment up to 49% in power exchanges a forward-looking step Or, as the present policy does not provide any specific dispensation for foreign investment in power exchanges, is it only a weak attempt to plug this gap

To answer these questions, we need to take a quick look at what is happening in electricity markets. Development of the market in electricity remains at the heart of power sector reforms, especially after the enactment of the Electricity Act, 2003. The electricity regulators are called upon to play a pivotal role in this endeavour.

The CERC, as a frontrunner in this venture, has shaped the market, especially the short-term market, by licensing more than 40 electricity traders and creating two power exchanges. The Over the Counter (OTC) market consisting of electricity traders, direct bilateral transactions between distribution companies and power exchanges, providing a neutral platform for buyers and sellers to meet their short-term needs of electricity, have helped optimise the utilisation of generation and transmission resources in the country. The size of this market is today more than $4 billion or R22,000 crore.

We have come a long way from the traditional arrangements where generators had long-term power purchase agreements with state electricity boards (now distribution companies) backed by government guarantees, and no third party sale was possible which inherently increased the business risk for producers. The power exchanges as part of the short-term market, including inter alia the traders, now provide the generators an alternative avenue for risk mitigation in case of default by long-term buyers. This has certainly helped in attracting private investment in power generation which has crossed 27%.

Power exchanges along with the traders have also helped bring in captive generation into the market. Power exchanges have launched several products like day-ahead contracts, week-ahead contracts, intra-day contracts, contingency contracts and renewable energy certificate contracts. Day-ahead power prices are benchmark prices for short-term transactions and are very closely watched by all stakeholders in the industry. Day-ahead prices are indicators of transmission network expansion requirement and to some extent generator sitting signals. The average power price on the exchanges has shown a declining trend over the last three years. The liquidity in the power exchanges has been growing, which makes the price discovery more robust. The annual turnover of power exchanges in 2011-12 was approximately R5,000 crore.

The initiatives of the central commission led to the setting up of two power exchanges: the Indian Energy Exchange Ltd (IEX) commenced its operations in June 2008 and the Power Exchange of India Ltd (PXIL) in October 2008. The commission subsequently issued Power Market Regulations to inter alia regulate power exchanges. The power exchange is a market infrastructure with a multiple buyer and seller model and promotes a competitive marketplace for generators and utilities.

Both the power exchanges have been promoted by commodity/stock exchanges in partnership with power sector companies including generating companies, distribution utilities and power traders. This collaborative arrangement has helped to bring the best of both the worlds to power exchanges: exchange-related promoters have brought best practices in price discovery methodology and risk management, while power sector promoters have brought an understanding of power sector the appropriate products required in the Indian power market.

As the concept of power market was in its initial stages, CERC allowed a shareholding structure with anchor investor allowed to have 25% equity to take the lead role and to keep the exchange demutualised, while individual members of the exchange were allowed 5% equity and all members put together could hold up to 49% of the equity.

It is in this context that GoIs recent reform initiative to allow FDI in power exchanges is a welcome move. It will help in further the development of Indias power market. Investment in the power exchange business needs to be attractive and remunerative, in the context of globally acceptable best practices, modern management skills and latest technologies. Though FDI was not banned in the power exchanges, there was no stated policy on FDI in power exchanges.

Since power exchanges constitute a critical market infrastructure as a large number of participants procure power regularly through this platform, it is prudent that the management control remains with Indian shareholders from a strategic interest perspective. Hence the balanced approach: allowing 49% FDI and FII together with 26% FDI and 23% FII bifurcation as an appropriate way forward. FII investments would be permitted under the automatic route and FDI would be permitted under the government approval route. No non-resident investor/entity, including persons acting in concert, will hold more than 5% of the equity in these companies.

The foreign investment would be in compliance with Sebi Regulations, other applicable laws/regulations, security and other conditions. The implication of 23% FII investment and investment only through the stock exchange route is that the power exchanges will have to come out with an IPO and list themselves on the stock exchanges for FII investment to fructify. This will again have a positive impact from the corporate governance point of view.

The author is chairperson, Central Electricity Regulatory Commission