How to recover from a 3000% shock When prices of virtually all commodities were on the boil and gave our policymakers sleepless nights last year, there was one commodity that bucked the trend. It was electricity! While the WPI of 'all commodities' was witnessing a yoy surge of over 9% during January-September 2008, that of electricity was crawling at less than 1.5%. Thanks to regulated markets. Irrespective of the change in cost of production, demand, and supply, the prices of electricity at users' end remain, by and large, unchanged.
While regulation has served to protect the power users from exposure to market volatility, it has also resulted in widening the gap between demand and supply, with peak-hour shortages sometimes reaching as high as 15%. Despite liberalisation of policies over the last many years, private investment in the power sector has remained low due the unattractiveness of the returns caused by flexibility in prices of raw materials but rigidity in the prices of electricity. Fixity of the price has also resulted in inefficient use of electricity. Heavy cross-subsidisation within the agricultural, residential, commercial and industrial classes has further aggravated the problem of inefficiency, a logical outcome of the regulation of the sector. Realising the constraints of regulatory policies on power markets and the need for introducing reforms to help meet the growing demand for electricity, the government is gradually clipping the scale of regulation as per the Electricity Act, 2003. Competition is now allowed at various levels, vertically integrated State Electricity Boards (SEBs) are being unbundled, generation and trading monopolies are being abolished, and efforts are on to reduce cross-subsidisation by narrowing down the gap in tariff charged from different user categories. Deregulation is also being done to make the process of price discovery of electricity more efficient, albeit for a small segment of the market. The government has permitted spot and futures trading of electricity at the electronically operated exchanges. While the spot market came in to operation last year, futures trading made its debut early this year. Price-setting on such a platform takes place in a transparent and efficient manner. This is in sharp contrast with deals negotiated between two parties at high transaction costs, with no third party to absorb the risk of default in honouring the contract obligations. Spot trading is also expected to fine tune the existing process of price discovery by transferring electricity from the surplus region to the deficit region, besides attracting captive power generators to produce electricity during the peak period. Studies in developed economies reveal that prices have the tendency to become highly volatile as the process of deregulation picks up. A few cities of Europe in recent years, for instance, have witnessed 3000% volatility in hourly prices of electricity. Price of electricity, once left to the market forces, tends to be much more volatile than other commodities, due to its non-storability. Further, demand for electricity is heavily dependent upon weather conditions. But electricity is too sensitive a commodity socially, economically and politically to leave its price volatility unattended. The futures market provides a tool to hedge risk against price volatility and attempts to reduce it through periodical convergence of information by increased participation. If it is forecast in February that June may be exceptionally hot, many electricity buyers would hedge by locking in their June purchase in February itself. With large markets participants doing so, power-generating firms would mobilise their efforts to supply more power in June when prices are higher, and prices would start moving up gradually from February itself. Further, in view of the information available in advance, the power supply in June would also be augmented and, hence, the rise in the price would be less than what it would have been in the absence of the advance signals provided by the futures markets. With reforms being increasingly unleashed in the power sector to strengthen energy security, parallel development of vibrant spot and futures markets would ensure that the economy adjusts to policy changes effortlessly. After all, addressing the issue of price volatility, resulting from deregulation of the power sector, is as important as the process of deregulation itself. --~--~---------~--~----~------------~-------~--~----~ You received this message because you are subscribed to the Google Groups ""GLOBAL SPECULATORS"" group. To post to this group, send email to [email protected] To unsubscribe from this group, send email to [email protected] For more options, visit this group at http://groups.google.com/group/globalspeculators?hl=en -~----------~----~----~----~------~----~------~--~---
