Policy key to unlock Indian Energy Exchange’s full potential

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One question that long-term investors may ask about Indian Energy Exchange Ltd’s (IEX) initial public offering (IPO) is to what extent the company can achieve its full potential. IEX’s fortunes are intertwined with the evolution of policy and power transmission infrastructure in the country.

The price band for the IEX IPO, which is currently open for subscription, has been set at Rs1,645- 1,650 per share.

To be sure, IEX has done well. It has emerged as the undisputed leader in the day- ahead or the spot electricity market. IEX is a profit-making entity and thanks to its asset-light business model it generates good returns. Further, given the excess capacities in the Indian electricity generation sector, diversifying generation base, competitive rates and expanding customer base, the company should be able to maintain the growth tempo. The scalable exchange platform also holds much promise, which should add heft to the current share offering.

But for IEX to get into the big league, several factors should fall in line. For perspective, the company till now has made tremendous strides in exchange-traded volume, which is garnering a larger share of the short-term power market. The share of power exchanges in the short-term power market has risen from 11% in FY10 to 34% in FY17, points out a report from Bank of America Merrill Lynch (BoFA ML).

While this aided IEX, given its dominant position in the segment, the larger pie in which the exchange is seeing growth—the short-term power market—has not seen much of an expansion (as a percentage of total power generation and demand) in recent years, says BoFA ML (see chart). Further the report adds that the compound annual growth rate in India’s short-term power market volume has stagnated since FY11, despite a sharp decline in prices.

This is due to a combination of reasons, including infrastructure constraints. One is the continued preference by state electricity boards (SEBs), the largest buyers of power in India, for long- and medium-duration contracts. These types of contracts are not available on exchanges.

The second is poor implementation of the open access policy. SEBs are wary of losing their large consumers, who are allowed to buy electricity directly on exchanges. They impose huge transmission charges on purchases from power exchanges, making such transactions uneconomical.

The third reason is the prevalence of bilateral trades, even though rates in such contracts are higher than in spot markets. One reason why SEBs prefer bilateral and longer-duration contracts is credit duration which they do not get on the exchanges, points out BoFA ML.

True, there is no denying that power exchanges have gained a foothold despite the impediments. But for them to see a quantum leap, the policy environment should become more market-friendly. “Going forward we believe market share gains for exchanges will be contingent on (1) improving health of SEBs/success of UDAY reform (this will improve their ability to pay upfront for exchange contracts); (2) some form of regulatory interjection by the government that forces SEBs to minimize cross-subsidy/additional surcharges (for open access users); and (3) introduction of new long-term products on exchanges,” adds the BoFA ML report.