Home / Markets / Mark To Market /  For govt’s electricity auction to succeed, producers must relent on prices

Weak demand and non-committal power distribution companies (discoms) are undermining the central government’s efforts to revive the thermal power sector.

The government is set to conduct an auction to procure 2,500 MW of electricity for three years and sell it to power distribution companies this month. A similar attempt in 2019 received a tepid response from buyers, leading to the cancellation of the auction.

The fate of this month’s auction remains uncertain as well. With demand weakening, discoms have no reason to commit to long-term purchases in a hurry.

Indications are that electricity prices will remain muted in the near term. Fuel (coal) prices, the key determinant of electricity tariffs, are subdued.

With fuel inventories at thermal power plants at comfortable levels, India may even have to temper coal imports this year. “If the economy doesn’t pick up in early 2020, and power, cement, and steel demand remain slow, we see a downside risk to our coal imports forecast," says Pralabh Bhargava, principal analyst at Wood Mackenzie.

The subdued expectations are reflected in the spot electricity markets. Power prices remain below 3 per unit. In December, average prices on the India Energy Exchange (IEX) dropped 11.2% from the year ago to 2.9 per unit. Average market clearing price for the full year (2019) stood at 3.1 per unit. Last year’s failed auction saw the producers offering electricity at 4.41 per unit. No wonder discoms shied away.

Source: India Energy Exchange
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Source: India Energy Exchange

The tariff differential can be partly explained by the duration of the contracts. Spot electricity prices are for next day delivery and reflect present demand-supply dynamics. Producers here often sell at marginal cost. In three-year contracts, producers have to price-in long term fuel prices, the direction of which is uncertain.

Even so, given the weak demand conditions and low tariffs in spot electricity, market producers would do well to align their tariff expectations with market conditions. “For the scheme to work this time around, either a) the IPPs have to take a more benign view of the short-term market in the light of the recent power demand weakness and be ready to offer lower prices more acceptable to discoms, or the near-term short term market led by demand recovery should see some tightening, resulting in a rise in spot rates, which may then force the discoms to relent and sign up for PPAs at higher prices," analysts at SBICAP Securities Ltd said in a note. IPP is independent power producers and PPA is power purchase agreement.

The other option, of course, is that producers and discoms find a middle ground. It will be interesting to see producers and discoms agree to some give and take.

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