Financial derivatives in the power sector came into being after a prolonged battle between two regulatory bodies, the Central Electricity Regulatory Commission (CERC) and the Securities and Exchange Board of India (Sebi). Each of these two institutions claimed that financial derivatives in the power sector falls under their exclusive domain. It took more than 10 years of legal battle to settle the matter. And in short, the final agreement is that CERC will regulate all physical delivery-based forward contracts whereas the financial derivatives will be regulated by Sebi. The National Stock Exchange (NSE) and the Multi Commodity Exchange (MCX) are responsible for trading in electricity derivatives, and the first product was launched in July 2025.
Only one product has been offered till now, which is a cash-settled monthly contract for a period of four months including the month when the contract is entered into. This means that if you sign a contract in August, the maximum period can be till the end of November. Financial derivatives differ from physical trading as we see in an electricity exchange; here, no physical transfer of asset takes place. It is only a cash settlement done throughout the contract period; the reference point is the price determined in the day ahead market (DAM) in the electricity exchange.
Let’s say there are a buyer and a seller of electricity and they sign a contact in August for buying/selling electricity from September 1 to 30. The buyer feels the market determined price in DAM will be around Rs 4.20 per unit in September, and therefore will try to sign a contract for a price below Rs 4.20 per unit. The seller, in the meantime, may think that the DAM price will be only be about Rs 3.80 per unit and would thus sign a contract that envisages a price above Rs 3.80 per unit. Both enter into a contract where the price is Rs 4 per unit. Now, the price in the DAM may actually be Rs 4.10 per unit in which case the seller has to compensate the buyer to the tune of 10 paise per unit. Similarly, if the DAM price turns out to be Rs 3.90 per unit, the buyer has to compensate the seller at 10 paise per unit.
A look at the volume of trading gives the impression that financial derivatives have not lived up to their expectations. While the plausible reasons would be analysed later, one may look at the statistics first. The graphic gives the combined volume traded in NSE and MCX for July 2025 to March 2026. It also gives the quantum of trade in DAM. Trade in derivatives has slumped from 7.5 billion units (BUs) in August 2025 to 3.8 BUs this March. The dashed line gives the ratio of derivatives traded to DAM for the period in question. It shows a decline from 1.29 to 0.50. What may be added, although not depicted in the graph, is that NSE handles the bulk of the trade.
The volume traded in DAM is not strictly comparable with the derivative market for various reasons as they are inherently two different products. The most significant difference is that a derivative can be traded several times over whereas in DAM, it is a one-time physical delivery. So, a 200-megawatt hour (Mwh) figure in the derivative market may mean 50 Mwh traded four times over. In DAM, it would be a single physical delivery of 50 Mwh. Such aberrations, however, would get evened out if one studies the trend rather than the absolute numbers. Looking at the trend, one finds that the derivative market began with a bang but soon petered out.
There are several reasons as to why the derivative market has failed to grow. First, considering that even today 90% of the power is locked in long-term power purchase agreements (PPAs), there is not much scope left for the derivative market or for DAM for that matter. For the derivative market to perform, one needs a buyer and a seller with different perceptions of the future price of power as illustrated in the example above. With long-term PPAs, there is no uncertainty about the price. Second, in India most of the buying is by distribution companies (discoms) which are public sector entities. They are generally averse to speculation lest the assessment goes wrong, causing a financial loss to the discom and potential penalties for the personnel involved. A much safer option for them is to trade in DAM where no questions are asked.
Moreover, the product that is being offered has certain features that are not conducive to the growth of the derivative market. First, it is a round-the-clock product that is not in harmony with the requirements of discoms. They want power during specific hours which the product does not allow. Second, a tenor of four months is far too short for any meaningful hedging. Derivatives in other countries have a tenor ranging from 12 to 24 months or even beyond. Third, the product does not allow the contract to spill over to the next month. It is a monthly contract, valid only for the entire month in question. If one seeks a contract that runs into two months or more, separate contacts have to be made for each month.
If the derivative market is to grow in India, it needs more products that are flexible, matching the need of discoms. This key concern must be addressed, along with others discussed above.
The author is a Visiting Professor at ICRIER.
Views are personal.
Disclaimer: The views expressed are the author’s own and do not reflect the official policy or position of Financial Express.
