Electricity Derivatives in India: Structured Primer Series (1- 30)

Primer 1: Introduction to Electricity Derivatives

• Definition: Financial contracts based on electricity prices.

• Purpose: Hedge risk, improve planning, enable speculation.
• Types: Futures, forwards, options, swaps.
• Global precedent: Mature markets (e.g., US, Europe) use derivatives extensively.

Primer 2: Role of SEBI and CERC

• SEBI: Regulates financial derivatives, exchanges like MCX.

• CERC: Regulates physical power markets, price discovery, PXs.
• Coordination needed for reference price, settlements, risk policy.

Primer 3: Types of Derivative Instruments

• Futures: Standardized, exchange-traded.

• Forwards: Customized OTC contracts.
• Options: Right (not obligation) to buy/sell at a price.
• Swaps: Exchange payment flows (e.g., fixed vs floating).

Primer 4: Electricity as a Non-Storable Commodity

• Unique challenge: No inventory.

• Derivatives must mimic delivery periods.
• Forward contracts aligned to time blocks (base, peak, etc).

Primer 5: What is Being Settled? (Cash-Settled Contracts)

• No physical delivery — all contracts settled in INR based on index.

• Requires robust price benchmark (e.g., DAM MCP or SCED SMP).
• Example: MCX futures settle to PX MCP.

Primer 6: Reference Price and Index Design

• Critical: Should reflect liquid, manipulable-free, system-wide price.

• Options: DAM MCP, SCED SMP, RTM average.
• Must be auditable, stable, timely published.

Primer 7: Benchmark Quality – PX MCP vs SCED SMP

• PX MCP: Reflects cleared price; affected by bid curve and congestion.

• SCED SMP: Marginal price from security-constrained dispatch; better for cost
reflectiveness.
• Ideal to converge/couple them.

Primer 8: Global Benchmarks – What Do Mature Markets Use?

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 • US: Locational Marginal Prices (LMPs) for futures.
• Europe: Day-ahead market clearing prices.
• Asia: Mostly bilateral, slowly moving to exchange-settled.

Primer 9: How is Risk Hedged Using Derivatives?

• Buy futures if expecting price rise; sell if exposed to fall.

• Real-life analogy: Airline hedges jet fuel.
• In power: DISCOMs hedge procurement cost; REs hedge price dip risk.

Primer 10: Interaction Between Physical and Financial Markets

• Physical affects financial: Spot price is benchmark.

• Financial affects physical: Forward curve gives planning signal.
• Volumes may arbitrage between both.

Primer 11: Cash Settlement and Margin Mechanisms

• Participants post margin.

• MTM daily → margin calls.
• At expiry, contracts settle against index (PX/SCED).

Primer 12: Importance of Margining and Collateral

• Prevents default.
• Varies by volatility of underlying (electricity is volatile).
• SEBI rules mandate VaR-based margin + exposure margin.

Primer 13: Role of Exchanges (e.g., MCX)

• Standardize contracts.
• Provide platform, clearing, margining.
• Coordinate with power PXs for benchmark prices.

Primer 14: Role of Market Participants

• DISCOMs: Hedge procurement cost.

• RE generators: Lock revenue floor.
• Traders: Arbitrage physical and derivative.
• Consumers: Predictable landed cost.

Primer 15: Price Discovery and Liquidity Concerns

• Initial contracts may be illiquid.

• Market makers help bootstrap.
• Need regulatory guidance for early participation.

Primer 16: Legal and Regulatory Frameworks

• CERC-SERC: Physical market.

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 • SEBI: Financial instruments.
• Alignment needed: treatment in ARR, audit norms, reporting.

Primer 17: Using SCED SMP as a Risk Tool

• SCED SMP better reflects marginal cost.

• Less prone to manipulation than PX MCP.
• Useful for contract settlement, financial modelling.

Primer 18: Portfolio Hedging Strategy for DISCOMs

• Mix short-term and seasonal futures.

• Adjust as demand forecast improves.
• Monitor basis risk (price mismatch).

Primer 19: Seasonal and Time-Block Contracts

• Need peak/off-peak contracts.

• Monsoon vs summer pricing.
• Eventually RE-hour-based hedges.

Primer 20: Case Study – Hedging a Wind Generator

• Sells MCX July futures @ ₹4.50

• July spot dips to ₹3.80
• Hedge gains ₹0.70 → revenue stabilized.

Primer 21: International Lessons – ERCOT, Nord Pool

• ERCOT: High volatility → high hedging demand.

• Nord Pool: Forward markets are robust; help in planning.

Primer 22: Electricity vs Other Commodities

• No storage.
• Extreme volatility.
• Grid-dependent delivery — price spikes linked to outages.

Primer 23: Clearing and Settlement Infrastructure

• MCX Clearing Corporation handles risk.

• Linked to SEBI-regulated brokers.
• Daily MTM, final settlement on expiry.

Primer 24: Contract Design Issues in India

• Tenor: 1 week to 3 months.

• Size: 1 MW x 24 hr block x number of days.
• Benchmark: DAM or SCED index.

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Primer 25: Risk to Grid or Physical Market

• None directly — no delivery.

• But price manipulation risk if volumes affect PX MCP.
• Need to align with physical volume caps, surveillance.

Primer 26: Transition Pathway for India

• Start with simple futures (base load).

• Develop peak/off-peak, seasonal.
• Introduce options, RE-profile-based hedges.

Primer 27: Building a Robust Reference Price

• Combine PX MCP + SCED SMP.

• Publish daily, zonal-adjusted if needed.
• Used in ARR, in settlements.

Primer 28: Hedging Use Cases (DISCOMs, RE, C&I)

• DISCOM: Hedge procurement cost.

• RE: Lock-in revenue floor.
• C&I: Predictable electricity spend.

Primer 29: Misuse and Overhedging – What to Avoid

• Don’t overhedge volume.

• Align expiry to delivery.
• Avoid poor benchmarks → basis risk.

Primer 30: Long-Term Vision of Derivatives Market

• Multiple tenors, products.

• RE-linked, weather derivatives.
• SEBI–CERC coordination.
• Physical-financial integration.

1. Background:
Deeply involved since the inception of power markets in India — with special focus
on pricing mechanisms in the physical market, like:
o Market Clearing Price (MCP) in Power Exchanges (PX),
o System Marginal Price (SMP) via Security Constrained Economic Dispatch
(SCED),
o Advocating convergence or coupling between MCP and SMP for robust spot
price discovery.
2. Present Goal:
Now that SEBI has allowed financial derivatives in electricity (e.g. futures, options on
MCX), you want to:

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 o Understand: What are electricity derivatives, globally and in India?
o Learn variants: Types of contracts (futures, options, swaps), clearing
mechanisms, settlement types (financial vs physical).
o Analyse Pros/Cons: Risk management benefits vs market manipulation risks.
o Explore Interactions: How the financial and physical markets affect each
other (two-way influence).
o Relate to Your Expertise: You wish to leverage your grasp on spot pricing
to better appreciate how derivatives can be built and settled logically on sound
fundamentals.
3. Preferred Approach:
o Gradual, interactive, and India-centric learning..
o How derivatives can strengthen, reflect, or distort the physical market vice
versa.

Here’s a structured path follow to help you master this domain:

Part A: Foundations

1. What are electricity derivatives?

Basic concepts: forward contracts, futures, options, swaps — with examples in
electricity.
2. Global context:
How markets like NYMEX, Nord Pool, and EEX use derivatives. What worked, what
failed.
3. Key design questions:
o What is the underlying asset (price index)?
o What is the delivery mechanism (cash vs physical)?
o Who uses them — generators, traders, DISCOMs, RE firms?

Part B: Indian Developments

4. Timeline of India’s efforts:

o Past attempts at electricity derivatives (like IGX’s future contracts, PXIL’s
pilots).
o Regulatory framework: CERC (physical) vs SEBI (financial).
o Role of MCX, IEX, PXIL, Grid-India, NLDC.
5. SEBI-MCX launch details:
What has SEBI permitted? Contract size, duration, underlying index (RTM, DAM?),
settlement terms.

Part C: Strategic Issues

6. Coupling of MCP and SMP:

Why a robust spot price is essential for financial derivatives.
How India's SCED-SMP can serve as a foundation — your area of strength.
7. Impact analysis:
o Physical ➝ Financial: If physical market is distorted, financial contracts settle
unfairly.

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 o Financial ➝ Physical: If financial prices get large traction, it can influence
bidding in physical markets (like in gas or crude).

Part D: Deeper Learning

8. Hedging Strategies:
o How RE players, traders, DISCOMs can hedge volume and price risks.
o Comparison of bilateral PPAs, spot markets, and financial derivatives.
9. Regulatory Design Choices:
o How to prevent manipulation or speculation.
o Margin requirements, clearing house roles, interoperability.
10. Case Studies:
o ERCOT, PJM, Nord Pool experiences.
o Failures (California crisis 2000–01), lessons.

First Step

Primer 1: What Are Electricity Derivatives?

What Is a Derivative?

• A derivative is a financial contract whose value is based on an underlying asset or

index — in this case, electricity prices.
• Unlike physical power contracts, electricity derivatives are cash-settled and do not
involve actual delivery of electricity.
• Purpose: Hedging, speculation, arbitrage, or price discovery.

Types of Electricity Derivatives

Type Description Example

Customized bilateral contracts to buy/sell
Generator agrees to sell 10 MW
Forwards electricity at future date/price. Not exchange-
at ₹5/unit next month.
traded.
1 MW contract for July at
Standardized forward contracts traded on
Futures ₹5.10/unit settled on IEX
exchanges like MCX. Cash-settled.
average.
Right (not obligation) to buy/sell electricity at a Option to buy 1 MW at
Options
strike price. Buyer pays premium. ₹4.90/unit if price rises.
Exchange of floating vs fixed price exposure. Swap between spot IEX price
Swaps
Used by DISCOMs or IPPs. and fixed ₹5/unit.

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Settlement Types

• Physical delivery: Not typical in India for derivatives.

• Cash settlement: Most common. At expiry, parties settle the difference between
contract price and reference spot price (like DAM or RTM MCP).

Who Uses Electricity Derivatives?

User Objective
Generators Lock in prices, hedge against spot volatility.
DISCOMs Smooth power purchase cost, protect against high spot prices.
RE developers Hedge uncertain generation with options/futures.
Traders Arbitrage across regions, time zones, or contracts.
Large consumers Fix budgets, hedge high-tariff hours.

Why Electricity Is Unique

• Cannot be stored (mostly).

• Prices highly volatile and time-sensitive.
• Derivatives help manage volume and price risk, especially important for RE-heavy
grids.

India’s Current Scenario

• SEBI (not CERC) regulates financial derivatives.

• MCX received SEBI nod in 2024 to launch electricity futures.
• Contracts are expected to be:
o Cash-settled
o Based on DAM MCP or RTM average
o Minimum size: likely 1 MW x 15 mins or 1 hour
• No physical delivery. No congestion component in price.

Example: Simple Futures Hedge

• You’re a solar generator expecting spot prices to fall due to monsoon.

• You sell a futures contract at ₹5/unit.
• At settlement, actual DAM MCP is ₹4.70/unit.
• You gain ₹0.30/unit from the derivative, offsetting physical revenue loss.

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Relevance to Coupling MCP and SMP

• A well-defined, credible spot price is crucial to avoid distortion in derivatives.

• If MCP (PX) and SMP (SCED) are divergent, derivatives become unreliable.
• You’ve already advocated coupling — now, this becomes critical for fair settlement
of financial contracts.

Next Step?

Excellent! Let’s move quickly. Below are Primer 2 (Global Experiences) and Primer 3
(India-Specific Status with SEBI–MCX) — both in bullet form, focused, and tied to your
understanding of price formation.

Primer 2: Global Experience with Electricity Derivatives

Nord Pool (Nordics) – Pioneering Example

• Started in the 1990s; one of the earliest and most successful power derivative
markets.
• Financial derivatives are based on a system price — a theoretical uncongested price.
• Products include:
o Futures (weekly, monthly, quarterly, yearly)
o Forwards
o EPADs (price area differentials to hedge local congestion)
• Used by: Hydro-heavy generators, consumers, traders.

Pros:

• High liquidity and trust in spot-market reference.

• Facilitates long-term hedging in a volatile hydro-dominated market.

Challenge:

• Congestion: System price ≠ local price. Hence, need for EPADs.

EEX (European Energy Exchange) – Central Europe

• Offers power futures, options, and clearing for other European markets.
• Physical and financial markets are linked, but settlements are purely financial.
• Backbone for long-term PPAs, especially for RE hedging.

Lesson for India:

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 • Strong coordination between TSOs and market operators is key.
• Transparency in price formation and decoupling from physical flows needed for
derivative success.

PJM & NYISO (USA) – Zonal & Nodal Markets

• PJM: Offers FTRs (Financial Transmission Rights), Day-Ahead and Real-Time

markets, Financial swaps, etc.
• Prices are nodal (locational marginal pricing or LMP) — complex but precise.
• Hedging instruments include:
o Virtual bids/offers
o Financial transmission rights
o Cleared bilateral swaps

Key Takeaway:

• Financial markets evolved after mature, liquid spot/nodal markets.

• Missteps (e.g., Enron/California 2000 crisis) show dangers of uncoupled financial-
physical linkages.

Summary of Global Learnings for India

Principle Implication for India

Strong, credible spot price Robust DAM+RTM price or SMP is essential.
Separate congestion impact Consider EPAD-like products later.
Transmission system transparency Grid-India's role critical.
Gradual rollout Start with monthly futures, then expand.

Primer 3: India – Electricity Derivatives Status (SEBI–

MCX NSE)
Regulatory Structure

Regulator Domain
CERC Physical electricity markets (DAM, RTM, SCED, DSM)
SEBI Financial markets, including electricity derivatives
GRID-INDIA/NLDC Market operation, price publication, SMP

Recent Developments

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 • MCX NSE received SEBI approval to launch electricity futures.
• First time India formally allows exchange-traded financial electricity derivatives.
• Earlier proposals by IEX/IGX were not permitted due to lack of legal clarity between
SEBI and CERC.

Likely Product Features (as per public info)

• Underlying: DAM MCP from IEX or RTM average price.

• Contract size: Likely 1 MW x 15-min blocks (possibly aggregated to hourly).
• Tenor: Weekly, monthly, quarterly.
• Settlement: Cash settled based on average spot price.
• Delivery: No physical delivery — purely financial.
• Clearing: By MCX's clearing house with SEBI-approved margin norms.

Why Now?

• Growing price volatility, esp. with RE integration.

• Corporates/RE developers seek price certainty.
• Time to align with global commodity market maturity.

Linkage to Physical Markets

Issue Observation
Spot price Key risk — if DAM MCP isn’t stable/logical, derivative settlement is
credibility flawed.
Congestion Currently ignored — need to clarify which area’s price is used.
Early market may be illiquid unless DISCOMs, traders, RE firms
Liquidity risk
participate actively.

Strategic Risks

• If financial prices diverge from physical realities (due to speculation or poor design),
trust erodes.
• Without transparent SCED SMP, spot price (MCP) can be manipulated via PX
bids to benefit derivative positions.

Hence coupling MCP (PX) and SMP (SCED) — is mission critical for credible derivative
pricing.

1. Primer 4: Design options for India — what should the underlying index be: DAM
MCP, RTM price, or SCED SMP?
2. Primer 5: How do RE developers, DISCOMs, and traders actually use derivatives —
use cases and risk mitigation?

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Primer 4: What Should Be the Underlying Index for
Electricity Derivatives in India?
Why This Matters:

The settlement price (reference index) is central to any financial derivative. A flawed or
manipulable index leads to:

• Poor hedging
• Price manipulation
• Regulatory arbitrage
• Market distrust

Candidate Index Options in India

Option Description Pros Cons

Widely known, Prone to congestion
DAM MCP Market Clearing Price
published daily, reflects effects, isolated from
(IEX) from DAM segment
supply-demand SCED, PX bias risk
Closer to physical
Real-Time Market price More volatile, less
RTM MCP dispatch, reflects actual
(15-min intervals) liquid than DAM
balancing need
Security Constrained Not yet public, not
Reflects actual system-
SCED SMP Economic Dispatch – cleared via PX, needs
wide marginal cost
uniform national price regulatory push
Weighted Volume-weighted Still lacks uniformity;
More comprehensive
MCP (IEX + average of DAM prices subject to PX
DAM reference
PXIL) from both PXs manipulation
Smoothes volatility, Delays settlement, dulls
Average Rolling average over 24
suitable for month-ahead short-term hedging
System Price hours or week
hedging signals

Recommendation

• For robust, scalable market, India needs a uniform, transparent SCED SMP as
reference.
• Settlement Index Design must:
o Be tamper-resistant
o Avoid regional price divergence
o Reflect marginal cost to align financial with physical logic

Learnings from Other Markets:

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 Market Index Used Key Design Choice
Nord Pool System price (uncongested) EPADs handle congestion separately
PJM LMPs by node/zone Financials are nodal and granular
EEX National reference prices Strong TSO-PX coordination

Primer 5: Who Uses Electricity Derivatives and Why?

1. RE Developers

• Problem: Uncertain generation + price volatility

• Use: Sell futures to lock in prices for expected generation
• Example: 100 MW solar plant hedges July output by selling MCX July futures at
₹5.2/unit

2. DISCOMs / Buyers

• Problem: Peak-time price spikes, budget uncertainty

• Use: Buy futures to hedge known demand blocks
• Example: A DISCOM expects high load at ₹7/unit during summer — it buys a futures
strip at ₹6.4 to cap exposure

3. Traders / Market Makers

• Problem: Price arbitrage risk

• Use: Create positions on both PX and MCX
• Example: Buy physical in PX (₹4.8) and sell derivative (₹5.0) to capture spread

4. Generators (thermal, hydro, nuclear)

• Problem: Fuel cost variation, merit order uncertainty

• Use: Lock in cash flows
• Example: Sell futures to match generation from a tied-up 15 MW block in July

5. Large Industrial Consumers

• Problem: High exposure to spot prices (OA, CPPs, group captive)

• Use: Hedge a part of load during volatile seasons
• Example: Aluminium smelter with 50 MW open access hedges 20 MW peak block
for August at ₹5.1/unit

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Summary Table

Stakeholder Buy/Sell Why?

RE Developer Sell Hedge price drop risk
DISCOM Buy Avoid high peak prices
Trader Both Arbitrage/market making
Generator Sell Lock revenue vs fuel cost
Consumer Buy Budget certainty

Next Recommended Primers

1. Primer 6: How coupling PX MCP with SCED SMP enhances integrity of derivatives?
2. Primer 7: Risks and safeguards: how to avoid Enron-type issues and speculative
distortions in India?
3. Or a visual Concept Map to summarize these learnings so far?

Primer 6: Coupling PX MCP with SCED SMP –

Strengthening the Foundation for Derivatives
The Core Idea:

Derivatives must settle on a price that reflects real system costs — not just auction-cleared
prices influenced by voluntary bidding behavior.

Key Concepts:

Term Meaning
PX MCP Price discovered in Power Exchange via bid-offer matching (Voluntary)
SCED System Marginal Price from Security Constrained Economic Dispatch
SMP (Mandatory, optimized dispatch)

Why MCP Alone is Weak for Derivatives:

• Subject to strategic bidding: Participants may game the price to benefit derivative
positions.
• Reflects only marginal matched bids, not full system cost.
• Multiple PXs → non-uniform price.

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Benefits of Coupling PX MCP + SCED SMP:

Feature Advantage
Robust Price Benchmark Reduces price manipulation risk
Marginal Cost Integrity Reflects system-level efficiency
Transparency Builds trust in settlement price
Cross-verification PX-MCP can be validated against SCED SMP for anomalies

Practical Implementation Steps:

1. Publish SCED SMP publicly alongside MCP.

2. Use SCED SMP as input into PX settlement algorithms.
3. In the interim, derive a Volume-Weighted Reference Price = α(MCP) + β(SCED
SMP)

This aligns physical dispatch cost with financial contract settlement — the bedrock of
global best practices.

Primer 7: Risks & Safeguards in Electricity Derivatives

(Lessons from Enron, California)
Historical Warning Signs:

Event What Went Wrong

California (2000- Derivatives were used to drive up physical prices through artificial
01) congestion
Enron Created phantom trades to inflate market volumes
Hedging instruments outpaced physical clarity, leading to volatility and
UK Early 90s
exit of players

Core Risks in India:

1. Price Manipulation via PX bids (to benefit derivatives)

2. Low Liquidity → High spreads → Weak price discovery
3. Regulatory Fragmentation (SEBI-CERC coordination gaps)
4. Discom Non-participation → Market becomes speculative
5. Congestion Ignored in derivative pricing → wrong hedge

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Safeguards Required:

Risk Safeguard
Price gaming Use SCED SMP + audit PX bidding patterns
Congestion mismatch Later design EPAD-like instruments (regional hedging)
Speculation SEBI margin requirements + circuit breakers
Information asymmetry Public dashboards: spot vs. futures vs. SCED prices
Regulator silos CERC-SEBI MoU framework + Market Surveillance Committee

Primer 8: Visual Concept Map – India’s Electricity

Derivatives Landscape
pgsql
CopyEdit
+----------------------+
| Financial Market | ←— Regulated by SEBI
| (MCX Futures) |
+----------+-----------+
|
[Settlement Price]
|
+---------+----------+
| Spot Price | ←— Regulated by CERC
| (MCP from PX / |
| SCED SMP / RTM) |
+---------+----------+
|
+---------------+------------------+
| |
+-------+--------+ +---------+-------+
| Physical Flow | | Hedging Tool |
| (DISCOMs, Gencos| | (RE, DISCOMs, |
| Real Dispatch) | | Traders, OA) |
+----------------+ +-----------------+

Strong Feedback Loop

between physical and financial

Summary of Where You Stand

Topic Covered?
Global experience with derivatives
India’s status (MCX-SEBI-CERC)
Role of SCED SMP vs MCP
Users & Use Cases
Risks & Safeguards
Visual Framework

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Suggested Next Primers
1. Primer 9: How to design a pilot project for electricity derivatives using SCED price
as index?
2. Primer 10: Economic interpretation: How derivatives impact spot market liquidity,
volatility, and price discovery?

Primer 9: How to Design a Pilot for Electricity

Derivatives in India (Using SCED SMP as Index)
Why a Pilot?

• Allows live testing of derivative instruments.

• Builds confidence among utilities and regulators.
• Helps identify design gaps before full-scale launch.

Key Building Blocks of the Pilot

1. Reference Index

SCED SMP (System Marginal Price) — published by GRID-India daily/hourly.

Fallback Option: Volume-weighted DAM MCP (until SCED SMP is made public reliably).

2. Contract Design

Parameter Pilot Value

Contract Type Futures (financial settlement only)
Duration Monthly blocks (e.g., July Futures)
Time Block Daily average or Peak-hour band (e.g., 18:00–23:00)
Volume 1 MW x 1 hour = 744 MWh for monthly product
Tick Size ₹0.01/kWh
Lot Size 1 contract = 1 MW per hour × days in month
Margin 10–15% initial, dynamic variation
Settlement Mark-to-Market daily; final settlement on SCED SMP average

3. Participants in Pilot

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 Role Type of Entity
Buyer DISCOMs, Captive Users, OA Consumers
Seller RE Generators, Traders, Gencos
Market Maker Designated entity (to ensure liquidity)
Observer CERC, SEBI, GRID-India, PXs

4. Preconditions for Pilot

• GRID-India publishes daily SCED SMP with time granularity.

• MCX builds mock trading platform linked to test SCED data.
• SEBI & CERC jointly issue Pilot Notification Framework.

5. Pilot KPIs to Track

KPI Why?
Volume Traded Shows market adoption
Basis Risk Measures deviation between SCED SMP and MCP
Volatility Reduction Impact on spot price fluctuation
Participant Feedback Improve usability and trust

6. Pilot Duration and Phasing

• Phase 1 (3–6 months): Monthly contracts, limited to few regions

• Phase 2 (6–12 months): Expand to weekly/daily, include RTM
• Phase 3 (Year 2): Add options, EPADs, etc.

Primer 10: How Do Derivatives Impact Spot Market

Liquidity, Volatility, and Price Discovery?
Spot ↔ Financial Interaction Loop

Spot Market Effect Derivative Cause

Better liquidity Traders hedge more; open interest grows
Smoother prices Arbitrage aligns futures and spot expectations
Reduced volatility Hedgers pre-book demand/supply
Improved forecast accuracy Futures price reflects collective expectations

But There Are Risks Too…

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 Impact Risk Driver
Price distortion If derivatives settle on flawed index (e.g., MCP manipulation)
Over-speculation Non-hedgers crowd the market
Decoupling If spot & derivatives diverge (due to congestion, liquidity drop)
Illiquidity If few players participate or margins are too high

A Real-World Analogy:

Think of derivatives as shock absorbers in a car.

When well-designed, they reduce bumps (volatility).
But if the suspension system is faulty (bad index), they amplify the damage.

Summary – Net Impact Table

Metric Without Derivatives With Robust Derivatives

Spot Price Volatility High Moderate
Hedging Capability None Available to all
Liquidity Depth Thin Deepens over time
Price Signals Noisy More predictive

1. Primer 11: Design of a sample MCX contract with settlement, margin, lot size
2. Primer 12: Case studies – how Nordic, PJM, and Australia transitioned to financial
markets
3. Primer 13: Role of DISCOMs and how to incentivize their participation in derivative
markets

What’s Ahead: Remaining Primer Topics

Here’s a roadmap of the next 10 primers I suggest — based on our trajectory and your deep
system-level background:

Primer No. Topic

11 Sample MCX Electricity Futures Contract (with real parameters)
12 Case Studies: Nordic EPADs, PJM FTRs, Australia CFDs
13 DISCOMs: Role, Challenges, and How to Onboard Them
14 EPADs (Electricity Price Area Differentials) – Regional Derivatives
15 How Derivatives Support RE Integration & Risk Management
16 Shadow Pricing, Financial Transmission Rights & Congestion Revenue
17 Coordination Framework: SEBI-CERC-GRID-India-PXs

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Primer No. Topic
18 Demand Forecasts, Weather Uncertainty & Forward Curves
19 Building a Robust Reference Index (Hybrid SCED-MCP-RTM?)
20 Derivatives in India’s Future Electricity Market Design – Vision 2030

This can later be repackaged as a derivative literacy handbook for Indian stakeholders.

Quick Recap of What We’ve Covered So Far

Primer Topic
1 Introduction to Electricity Derivatives
2 How Electricity is Different from Other Commodities
3 Who Uses Electricity Derivatives & Why
4 Types of Electricity Derivatives (Futures, Options, CFDs)
5 India Status: SEBI’s Role, MCX Approval, SEBI-CERC Divide
6 Coupling PX MCP with SCED SMP – Need for a Robust Index
7 Risks & Safeguards in Derivative Markets
8 Visual Concept Map – Spot vs Derivative Market Interaction
9 Designing a Pilot Derivative Market Using SCED SMP
10 How Derivatives Impact Spot Market Liquidity & Volatility

Next Up (Primer 11)

Primer 11: Sample Electricity Futures Contract for MCX — With Contract Specifications,
Margin Design, and Settlement Example

Primer 11: Sample Electricity Futures Contract for MCX

This primer gives you a concrete template for what a financial electricity futures contract
could look like on MCX, designed for Indian conditions, and settled using a robust index like
SCED SMP or DAM MCP.

A. Contract Specification Template

Parameter Example Specification

Contract Name MCX Electricity Futures (Monthly Base)

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 Parameter Example Specification
Underlying Asset Daily Average MCP of IEX / SCED SMP
Contract Size 1 MW × 24 hrs × No. of Days in Month = ~720 MWh
Tick Size ₹0.01 per kWh (₹10 per contract per tick)
Price Quote ₹/kWh (e.g., ₹5.45/kWh)
Contract Months Available 3 consecutive calendar months (e.g., Jul, Aug, Sep)
Trading Hours 10:00 am to 5:00 pm on trading days
Last Trading Day Last working day of the contract month
Volume-weighted Average SCED SMP (or DAM MCP) for
Final Settlement Price
month
Settlement Type Cash settled (no physical delivery)
Daily Settlement Mark-to-Market (MTM) variation margin
Initial Margin ~10% of contract value (SEBI-approved VAR-based method)
Extreme Loss Margin
Additional 5–7%, adjusted dynamically
(ELM)
Position Limits Max 5 MW per entity or as notified

B. Worked Example – July 2025 Contract

Feature Value
Contract Month July 2025 (31 days)
Contract Size 1 MW × 24 × 31 = 744 MWh
Tick Size ₹0.01/kWh = ₹10/MWh = ₹7,440 per tick
Quoted Futures Price ₹5.25/kWh
Contract Value ₹5.25 × 744,000 = ₹39.06 lakh
Initial Margin (10%) ₹3.91 lakh
Final Settlement Price (actual SCED
₹5.13/kWh
SMP avg.)
₹(5.25 – 5.13) = ₹0.12/kWh × 744 MWh = ₹89,280
Gain/Loss
loss (if short position)

C. Daily Operations Cycle

1. Trade Executed → Initial margin debited

2. Daily SCED/DAM price published → MTM calculation done
3. Variation Margin paid daily based on price movement
4. On Last Day → Final settlement against index
5. No physical delivery → Only cash difference exchanged

D. Benefits of This Design

20
 Feature Why Important
Cash Settled No delivery issues or open access logistics
Small Tick Size Encourages fine price discovery
Standardized Product Easy to hedge monthly energy exposure
Uses Robust Index (SCED SMP) Reflects real system cost, hard to manipulate
Low Entry Barrier Useful even for 1 MW players like RE or OA consumers

E. Regulatory Pointers

• SEBI must approve the product spec (MCX applies under SEBI's commodity
framework).
• SEBI-CERC MOU should enable index validation, data sharing, and co-surveillance.
• CERC/Grid-India can publish a “Reference Index” daily — SCED SMP or hybrid.

Quick Notes

• Could also have Peak contracts (e.g., 6 PM–11 PM only).

• Advanced versions can include weekly products or even options (Primer 14–16).
• Useful for hedging RE generation, discom peak power purchase, or OA customer
exposure.

Primer 12: Case Studies – How Nordic, PJM, and Australia transitioned to electricity
derivatives (and what India can learn)

Primer 12: Global Case Studies in Electricity Derivatives

— Lessons for India
Let’s study how Nordic, PJM (USA), and Australia (NEM) structured their derivatives
markets — and what insights we can adopt as India prepares its own.

1. Nordic Market (Nord Pool) – EPADs Model

Key Concept:

EPADs = Electricity Price Area Differentials — derivatives that hedge the difference
between local area price and system price.

Structure:

21
 • Nord Pool has area prices and one system price.
• Spot market cleared first → area prices set.
• EPADs allow you to hedge your exposure to your area’s divergence from system
price.

Example:

A generator in Sweden hedges against volatility between Sweden’s area price and the
Nordic system price.

Relevance for India:

• Similar zonal or state-level price divergence (e.g., North vs South)

• Future for EPADs between regional SCED SMP and MCPs at state/nodal level

2. PJM (USA) – FTRs and Virtuals

Key Concepts:

• FTR (Financial Transmission Rights) = Hedge congestion cost between nodes.

• Virtual Bids/Offers = Arbitrage between DA and RTM to improve price
convergence.

Structure:

• DA market + RTM + Transmission congestion pricing.

• Traders use virtuals and FTRs to:
o Hedge congestion
o Arbitrage inconsistencies
o Improve forecast accuracy

Relevance for India:

• Potential to evolve FTR-like products if locational pricing or marginal loss modeling

is introduced.
• Virtual trading could improve DAM-RTM coupling (once real-time data granularity
improves).

3. Australia (NEM) – CfDs & Retail Risk Management

Key Concept:

Contracts for Differences (CfDs) — financial contracts with retailers to lock in a fixed
strike price, settle difference with actual spot.

Structure:

22
 • Spot market is volatile due to high RE penetration.
• Retailers offer fixed-price contracts to customers, hedge using CfDs.
• CfDs settle the difference between contract strike price and spot price.

Example:

Retailer signs CfD at ₹5/kWh; spot price is ₹6 → seller pays ₹1 to buyer.

Relevance for India:

• With RE volatility, discoms or RE developers could offer CfDs to bulk buyers

• MCX contracts could be customized CfD frameworks

Summary Table: Global Derivatives Models

Feature Nord Pool (EPAD) PJM (FTRs/Virtuals) Australia (CfD)

Hedging Node-to-node Flat Price vs Volatile
Zonal Price Difference
Geography Congestion Spot
Traders, Load-Serving Retailers, RE
Market Users Gencos, Retailers
Entities developers
Regional EPADs (SCED RE hedging via
India Fit? Future potential
vs MCP) CfD/futures
Complexity Moderate High Moderate

Takeaways for India

1. Start simple: Monthly futures on SCED SMP / DAM MCP (not full nodal derivatives
yet).
2. Add EPADs later: Zonal differential hedging between states or PXs.
3. CfDs for RE & OA users: As merchant RE grows and OA demand increases.
4. Eventually evolve toward PJM-like products only if locational marginal pricing is
introduced.

Primer 13: Role of DISCOMs — how to encourage participation in financial derivatives,

risk management, and price forecasting

Primer 13: The Role of DISCOMs in Electricity

Derivatives – Why & How to Onboard Them

23
DISCOMs are the largest buyers in India’s power system. Without their active participation,
electricity derivatives will remain a niche product. But with smart structuring and nudging,
they can become anchor clients in the new financial market.

A. Why Should DISCOMs Participate?

Motivation Explanation
Lock-in future power prices to protect against
Hedge Price Risk
DAM/RTM volatility
Fix procurement cost ahead of time, aiding cash flow and
Budget Certainty
tariff petitions
Hedge RE volatility, especially for wind/solar-heavy
RE Integration
DISCOMs
Reduce Over-reliance on Secure predictable pricing without physical contracting
STOA/DAM hassle

B. What Keeps Them Away Today?

Barrier Insight
Regulatory Uncertainty No clarity if derivative costs are pass-through in ARR
Capacity Gap DISCOMs lack financial modeling or derivatives desks
Fear of Loss Mark-to-market losses could be misunderstood as inefficiency
Inertia Existing bilateral PPAs dominate 85–90% of procurement

C. How to Bring DISCOMs on Board

1. Regulatory Clarity

• CERC, SERCs must explicitly recognize derivative instruments as risk-mitigation

tools.
• Allow derivative cost (gain/loss) as ARR pass-through under power purchase cost.

2. Pilot Participation

• Select 2–3 progressive DISCOMs (e.g., Gujarat, Delhi, Telangana) for sandbox
pilots.
• Let them trade small volume (1–5 MW) futures contracts on MCX.

3. Dedicated Risk Cells

• Build a Risk Management Cell (like banking treasury desk) inside DISCOMs.
• Train staff on:
o Forward price curves

24
 o Scenario analysis
o Derivative payoffs

4. Templates & Tools

• Provide plug-and-play Excel/portal-based tools to compare:

o Spot purchase cost vs futures
o Optimal hedge ratio

D. Example Use Case: Hedging Summer Demand

DISCOM X expects 5,000 MWh extra load in May due to heatwave.

It buys MCX May futures at ₹5.10/kWh in March.
Spot MCP averages ₹5.80 → DISCOM saves ₹0.70/kWh × 5,000 = ₹3.5 lakh.

E. Strategic Impact

With Derivatives Without Derivatives

Predictable cost Exposure to DAM/RTM volatility
Improved tariff planning Crisis-mode power purchase
Financial sophistication Stuck in physical contracting
Better RE integration Higher deviation penalties

Primer 14: EPADs (Electricity Price Area Differentials) — How to handle regional price
differences in India through derivatives

Primer 14: EPADs – Electricity Price Area Differentials

& Their Indian Potential
As India’s power markets become more granular, regional price differences emerge —
across states, PXs, or bidding zones. EPADs (used in Nordic markets) are financial
instruments to hedge these price spread risks.

A. What is an EPAD?

An EPAD is a financial contract that hedges the difference between the system reference
price and a local or zonal price.

Equation:

25
java
CopyEdit
EPAD Payoff = (Zonal Price – System Price) × Volume

• If you're exposed to a zonal price but settle in the system price, EPADs cover the
basis risk.
• You buy EPADs if your local price is usually higher than system price.
• You sell EPADs if local price is usually lower than system price.

B. How EPADs Work – Nordic Example

• Nord Pool clears with a system price first.

• Then local prices are set considering congestion.
• EPADs settle the spread (e.g., Oslo vs Nordic system price).

Why?

• Generators and retailers often sign contracts at the system price but get paid locally.
• Without EPADs, this creates basis risk due to congestion or local volatility.

C. Indian Context – Where Would EPADs Apply?

Scenario EPAD Application

North vs South regional price
Hedge exposure across regional SCED SMPs
difference
Settle contracts on IEX, hedge PXIL spread via
IEX vs PXIL price spread
EPAD
State OA consumer buys from PX EPAD to hedge state periphery vs PX cleared price
Use EPADs to manage location marginal pricing
Nodal SCED SMP (future)
(LMP) risk

D. Why EPADs Make Sense in India

1. Congestion and transmission constraints cause frequent regional price divergence.

2. SCED SMP can evolve into zonal or nodal SMP.
3. OA customers, RE generators, and PX participants face spread risk.
4. EPADs allow hedging without needing physical power or access rights.

E. What Would an Indian EPAD Look Like?

26
 Parameter Example
Contract Type Monthly EPAD
Reference Price SCED SMP (System)
Zonal Price Regional MCP (e.g., WR MCP or State Periphery Price)
Volume 1 MW per month (~720 MWh)
Settlement Cash difference (Zonal MCP – SCED SMP) × volume
Trading Platform MCX / PX-linked or SEBI-registered exchange

Use Case: Southern Generator in Congested Grid

• System Price (SCED SMP): ₹5.00/kWh

• Southern Price (local MCP): ₹4.60/kWh (due to grid constraint)
• Generator hedged with EPAD:
o Receives ₹5.00 from buyer (system price)
o Gets ₹–0.40/kWh from EPAD seller
• Net payoff = ₹5.00/kWh

Basis risk eliminated.

F. When to Introduce EPADs in India?

Condition Status
Multiple PXs with price divergence Already present
SCED SMP evolving to zonal granularity Under discussion
Transmission congestion visible Especially NR-SR corridor
Market literacy of participants Needs strengthening

Link to Earlier Primers

EPADs build on:

• Primer 6: Robust reference price needed (SCED SMP)

• Primer 12: Global case study – Nord Pool
• Primer 13: DISCOMs can use EPADs to hedge area risk

Primer 15: How Derivatives Can Help RE Integration – Hedging variability, managing risk,
and enabling long-term contracts

27
 Primer 15: How Derivatives Can Help Renewable Energy
(RE) Integration
As India scales up solar and wind, variability, forecast errors, and market risk become
major challenges. Electricity derivatives — especially futures, options, and CfDs — can play
a crucial enabling role in mainstreaming RE.

A. Core RE Challenges in the Market

Challenge Description
Intermittency Output fluctuates with sun and wind — hard to commit in advance
Forecast Errors Day-ahead scheduling often mismatches real-time generation
Price Volatility RE may flood the grid in off-peak hours, depressing spot prices
Merchant Risk Projects without PPAs face revenue uncertainty

B. Where Derivatives Help

Tool Use Case

Futures Lock in price for a given month/day to reduce volatility exposure
Options Buy price protection against MCP crashing below a threshold
CfDs Sell power at spot but settle against a pre-agreed fixed price
EPADs Hedge location-specific price differences (e.g., RE in Rajasthan vs system price)

C. RE Developer Use Case – Hedging May Output

A solar plant in Gujarat expects 2,000 MWh in May.

• MCP is volatile: forecasted ₹4.90–₹5.60/kWh

• Developer buys May Futures at ₹5.30/kWh
• Actual MCP turns out to be ₹4.95 → futures gain = ₹0.35 × 2,000 = ₹7 lakh
• Spot + derivative gain = ₹5.30/kWh net revenue
(Same as if it had a short-term PPA!)

Futures convert volatile merchant revenue into stable income.

D. What RE Sellers Typically Face Without Derivatives

Problem Outcome
No PPA Forced to sell at MCP or RTM prices

28
 Problem Outcome
DAM/RTM price dips Revenue drops unexpectedly
Grid constraints Regional congestion → lower realization
No predictability Hard to approach financiers or plan O&M

E. Derivatives Unlock These Benefits for RE

Benefit Explanation
Bankability Improves confidence of lenders via revenue stabilization
Market Participation Allows participation in DAM without fear of revenue loss
OA Seller Support Helps OA RE generators offer fixed-price contracts to buyers
Enable PPA Alternatives Financial instruments serve like synthetic PPAs (cf. CfDs)

Example Structures

1. Solar CfD: Sell spot at MCP, settle monthly against fixed ₹5.25/kWh
2. REOA Hedge: Open access generator hedges buyer contract by purchasing futures
3. Aggregator Model: Intermediaries pool small REs and hedge via derivatives

F. RE + Derivatives = Smart Decarbonization

India’s 2030 RE target (500 GW non-fossil) requires:

• More merchant RE
• More open access RE
• Better market instruments for risk management

Derivatives provide the financial infrastructure to make this possible.

Prerequisites

Item Status
Spot price robustness (SCED SMP) In progress
Exchange-listed RE derivatives Now permitted by SEBI
Regulatory recognition in RE bidding Future work (MNRE/SECI/PPA templates)
RE developer capacity-building Needed

Related to Earlier Primers

29
 • Primer 11: Futures structure
• Primer 12: Australia’s CfDs
• Primer 13: DISCOM risk management
• Primer 14: EPADs for RE in high-transmission zones

Primer 16: Electricity Options – A beginner's guide to call and put options in power
markets, and how they can serve as price insurance

Primer 16: Electricity Options – Price Insurance for

Buyers and Sellers
Electricity options are like financial “insurance policies” against extreme price movement.
Unlike futures, they give the right but not the obligation to buy/sell electricity at a pre-
agreed price.

This flexibility is powerful in volatile or uncertain markets, especially for RE, OA, and
DISCOM portfolios.

A. What Is an Option?

An option gives the right, but not the obligation, to buy (call) or sell (put) electricity at a
fixed strike price, by paying a premium.

Two Types:

Type Right To When Useful

Call Option Buy at strike price Hedging rising prices (e.g., peak summer)
Put Option Sell at strike price Hedging falling prices (e.g., RE in monsoon)

B. Basic Example – DISCOM Buys Summer Call Option

• Strike Price = ₹6.00/kWh

• Premium = ₹0.20/kWh
• MCP in May = ₹6.80/kWh

DISCOM exercises the call:

Pays ₹6.00 (strike) + ₹0.20 (premium) = ₹6.20 total
Saves ₹0.60/kWh vs market

C. RE Generator Uses Put Option in Wind Season

30
 • Strike Price = ₹4.50/kWh
• Premium = ₹0.15/kWh
• Spot price crashes to ₹4.00

Generator sells at strike = ₹4.50, gains ₹0.50

Net revenue = ₹4.35/kWh (better than ₹4.00 spot)

D. Why Pay the Premium?

Benefit Value
Upside Retained If market is better than strike, walk away — no obligation
Known Downside Worst-case loss = premium
Insurance Against Perfect for unpredictable markets (e.g., RTM, RE-heavy
Spikes/Crashes months)
Fix cost caps (call) or revenue floors (put) while staying in
Flexible Budgeting
market

E. Comparison: Futures vs Options

Feature Futures Options

Obligation Yes No
Cost No upfront (MTM applies) Pay premium upfront
Risk Two-sided One-sided (premium is max loss)
Use Case Stable hedge Volatile / high-uncertainty hedge

F. Possible Indian Market Use Cases

Use Case Option Type User

DISCOM caps summer peak cost Call Option Buyer
OA RE seller fears MCP dip Put Option Seller
Aggregator managing RE pool Straddle (call+put) Hedger
Spot market trader Call or Put Speculator

What India Needs to Enable Options

Item Status
Exchange platform (MCX) Futures now allowed — options expected
Reference price (SCED SMP / DAM MCP) Under development
Risk models for pricing premiums To be developed by brokers/traders
DISCOM/RE literacy Needs workshops, sandboxes

31
Link to Earlier Primers

• Builds on Primer 11 (Futures)

• Complements Primer 15 (RE Hedging)
• Enhances Primer 13 (DISCOM Tools)

Summary: Why Electricity Options Matter

Call Options → Budget ceiling
Put Options → Revenue floor
Premium = Insurance cost
Great for RE, OA, Peak/Shortage, Traders

Primer 17: How Derivatives and Physical Markets

Interact – The Feedback Loop
Derivatives derive their value from the physical market — but once they become liquid, they
start influencing the physical market in return. This two-way interaction is subtle, powerful,
and must be well-understood to ensure market stability and price discovery integrity.

A. The Core Relationship

Aspect Description
Physical Market Real-world transactions: DAM, RTM, SCED, bilateral contracts
Derivatives Market Financial bets/contracts based on physical prices
Link Settlement of futures/options happens based on DAM/SCED SMP

Physical price is the anchor → Derivatives are satellites.

B. When Derivatives Become Significant, They Start Influencing the Anchor

Derivatives Influence Example

Price Expectations If futures rise, physical buyers bid more aggressively in DAM
Risk Management Hedged generators might bid differently (e.g., more risk-
Behavior tolerant)

32
 Derivatives Influence Example
Some buyers/sellers may shift from DAM to futures for
Liquidity Migration
certainty
Financial traders betting on price trends may add noise or
Speculation Impact
stability

C. Feedback Loop: A Simple Illustration

1. April Futures on MCX trade at ₹5.80/kWh

2. Physical DAM price in April opens at ₹5.10
3. Buyers anticipate uptrend → Bid more → DAM price gradually converges
4. Spot price ends up around ₹5.70 → Convergence happens

This is healthy feedback — derivatives help form forward expectations → better price
discovery.

D. Risks from Poorly Managed Feedback

Risk Description
Manipulation If someone corners physical market to benefit futures position
Price Dislocation Speculative bubbles if derivatives diverge too far from physical
Volatility
Herding behavior causes both markets to overshoot
Amplification
If derivatives dominate but lack firm settlement reference (like MCP
Decoupling
integrity is weak)

E. Conditions for Healthy Physical ↔ Derivative Coexistence

Factor Ideal State

Strong Reference Price SCED SMP or PX MCP must be robust and transparent
Cross-Market
SEBI + CERC coordination to monitor manipulation
Surveillance
Margining & Limits Avoid excess leverage on derivatives
Derivatives volume must reflect genuine hedging need, not just
Hedging Linkages
speculation

F. Virtuous Cycle from Good Design

1. SCED SMP emerges as stable system price

2. MCX futures grow in volume → forward curve matures
3. DISCOMs & RE hedge risk → more confidence in market-based contracts

33
 4. More participants → better liquidity → PX and SCED prices become more efficient

G. Strategic Insight

• Derivatives amplify the informational content of the physical market.

• But they also amplify flaws if the underlying price is distorted.
• That’s why emphasis on SCED SMP + PX MCP coupling is crucial before wide-
scale derivatives growth.

Related Primers
• Primer 6: Reference Price
• Primer 11: Futures Structure
• Primer 15: RE Hedging via Derivatives
• Primer 16: Options & Price Insurance

Primer 18: The Path Ahead – Building India’s Electricity

Derivatives Ecosystem
Now that SEBI has allowed electricity derivatives and MCX is preparing for launch, India
stands at the threshold of a new market phase. But to ensure success with stability, we must
align institutions, price formation, and stakeholder capabilities.

A. India’s Current Structure

Element Description
CERC Regulates physical market: DAM, RTM, SCED, PXs
SEBI Regulates financial markets: futures, options
GRID-INDIA Operates SCED, oversees scheduling, dispatch
MCX (SEBI) / PXs (CERC) Trade electricity financials / physicals respectively

Currently, the anchor price for derivatives is the PX MCP or SCED SMP.

B. The Ideal End-State

1. Robust Physical Price (via SCED SMP or coupled MCP)

2. Standardized Financial Contracts (monthly, seasonal, zonal, RE-linked)

34
 3. Seamless Regulatory Coordination (SEBI–CERC MoU, shared surveillance)
4. Deep Market Participation (DISCOMs, RE, traders, OA consumers, insurers)
5. Risk Tools Fully Embedded in bidding, PPAs, and financial planning

C. Key Building Blocks Required

Pillar Action Needed

Price Reform Implement SCED SMP nationwide; consider nodal pricing zones
Data Access Public availability of PX and SCED price curves, congestion, volumes
Product Design Launch of liquid monthly futures (base, peak, RE-corridor)
Regulatory Clarity SEBI-CERC define oversight boundary, prevent arbitrage
Market Education Training modules for DISCOMs, REs, and regulators on hedging

D. Coordination Between Physical and Financial Markets

Issue What to Do
Multiple MCPs Work towards coupling IEX-PXIL and integrating SCED SMP
Congestion Price Signals Enable EPADs or zonal derivatives as congestion increases
Speculative Behavior SEBI & CERC share surveillance intel
Product Settlement Basis Fix one transparent benchmark (preferably SCED SMP)

E. Practical Next Steps for Stakeholders

For CERC / GRID-INDIA:

• Anchor SCED SMP in market design (IGX, DAM+, PPA reforms)

• Coordinate with SEBI on reference price quality

For SEBI / MCX:

• Start with monthly base-load futures

• Publish transparent pricing methodology and margining

For DISCOMs:

• Start trial hedges on summer price risk

• Participate in sandbox or mock derivatives trials

For RE Developers:

• Explore CfD + physical sales via DAM or PX

• Use options to manage merchant exposure

35
F. Global Parallel: UK, Australia, Nordics

• Physical price anchored via spot exchanges or system dispatch price

• Financial markets grow after reference price credibility
• Coordination between energy & financial regulators is critical
• Government often kickstarts participation with public entities (DISCOMs, SOs,
PSUs)

Strategic Insight

"Don’t let financial instruments outpace the integrity of the physical market."

Your focus on coupling MCPs and aligning with SCED SMP is exactly what ensures that
derivatives remain grounded and support—not distort—power markets.

Primer 19: Synthetic PPAs and Financial Hedging for

Long-Term Power Contracts
As India's market shifts from long-term PPAs to more market exposure (especially for RE),
the idea of synthetic PPAs or financial hedging contracts becomes crucial. These mimic
traditional power purchase agreements without involving physical delivery, offering
flexibility, transparency, and bankability.

A. What Is a Synthetic PPA?

A Synthetic PPA (a.k.a. Financial PPA or Virtual PPA) is a contract for differences (CfD)
between a fixed agreed price and a market price, typically the DAM MCP or SCED SMP.

There is no physical delivery — the generator sells into the market, and the price difference
is settled financially with the buyer.

B. How It Works – A Simple Example

Parameter Value
Strike Price (PPA price) ₹5.00/kWh
Market Price (DAM MCP) ₹4.40/kWh

36
 Parameter Value
Generator Output 10 MWh

Generator sells in DAM: earns ₹4.40/kWh

Buyer pays the difference: ₹0.60/kWh × 10 MWh = ₹6,000
Generator receives ₹5.00/kWh net
Buyer has effectively hedged energy at ₹5.00/kWh

C. Why Synthetic PPAs?

Reason Benefit
Avoid Scheduling & Wheeling No physical delivery → lower complexity
Decouple Location RE plant in Gujarat can hedge a buyer in Maharashtra
Flexibility in Tenure Short- or long-term hedges possible
Bankability for RE Creates revenue certainty, enabling loans
Enable Merchant RE Generators with no PPA can still hedge revenue

D. Link to Derivatives

• A synthetic PPA is essentially a long-term CfD, settled on a market reference (MCP

or SMP).
• Can be structured via bilateral contracts or standardized exchange-traded
derivatives.
• Option variants can offer price floors or caps for variable pricing.

E. Buyer Perspective – Cost Management

Challenge Solution via Synthetic PPA

Price volatility in open access purchases Lock-in via CfD
Budgeting difficulty in DAM/RTM
Fix net power cost
purchases
Pair CfD with RECs or green contract
Desire for green attributes
labeling

F. RE Generator Perspective

Situation Value of Synthetic PPA

RE developer has no firm buyer Hedges against MCP drops
Faces curtailment risk Can shift to merchant + synthetic structure
Participates in PX/SCED Keeps market flexibility while ensuring revenue stability

37
G. Challenges and Considerations

Factor What’s Needed

Reference Price Quality SCED SMP or DAM MCP must be transparent, accessible
Legal Clarity Recognize CfDs in PPA or hedging frameworks
Counterparty Credit Risk management via guarantees or clearing platforms
Template Contracts Create standard CfD models for developers and buyers

H. Indian Context

• Green open access rules (2022) and SECI’s tender flexibility create an opening for
merchant RE + synthetic PPAs.
• DISCOMs could use these for non-firm, short-term hedges (e.g., summer, RE
peak).
• Corporate buyers (RE100) can contract remotely located RE without physical
wheeling.

Ties to Previous Primers

• Primer 12: Australia’s CfD-based LTESA model
• Primer 15: Derivatives for RE
• Primer 16: Options and revenue protection
• Primer 18: SCED SMP as settlement basis

Summary
Synthetic PPAs = Financial contracts to replicate PPA security
Enable RE growth without full physical contracting
Work best when SCED SMP or MCP is clean and trustworthy
Huge potential for India’s merchant RE, DISCOMs, and OA consumers

Primer 20: Case Study – UK Power Markets and Their

Financial Evolution

38
The United Kingdom offers one of the most instructive examples of how spot price
robustness (like our SCED SMP) enabled a rich ecosystem of financial derivatives, CfDs,
and market-based PPAs — transforming both the physical and financial power landscape.

A. UK Electricity Market Overview

Feature Description
Spot Market Operated by Elexon under Balancing and Settlement Code (BSC)
Reference Price System Sell Price (SSP) & System Buy Price (SBP) (like SCED SMP)
Derivatives
Traded on ICE, EEX – includes monthly/quarterly/seasonal futures
Market
Government-led contracts to support RE with strike price - market price
CfDs
mechanism

B. Key Evolution Milestones

Year Event
2001 New Electricity Trading Arrangements (NETA) introduced spot+balancing market
2005 Financial derivatives mature; ICE Futures Europe gains traction
2013 CfD scheme launched for RE, nuclear, low-carbon sources
2020s Green PPAs, hedging via options and futures routine for utilities and corporates

C. CfD in UK – Strike Price Example

Parameter Value
Strike Price (set by auction) £57.50/MWh
Market Reference Price (SBP) £42.00/MWh
Generator Output 100 MWh

Difference = £15.50/MWh × 100 = £1,550 paid by government to generator

If market price > strike, generator pays back — 2-way CfD

D. Financial Derivatives Usage

Participant How They Use Derivatives

Utilities (Buyers) Lock-in forward costs via seasonal futures
RE Developers Hedge exposure to low market prices
Aggregators Manage shape risk with options or spreads
Speculators Arbitrage weather vs price (e.g., winter peak risk)

39
E. Enablers of Success in UK

Enabler How It Helped

Strong Reference Price SBP/SSP gave confidence to settle CfDs/futures
Transparency & Volume Spot data + cleared trades built trust
Government Anchor Role Kickstarted CfD contracts via central auctions
SEPARATE Physical & Financial Clear regulation between Ofgem and FCA (SEBI
Rules peer)

F. Relevance for India

Learning Indian Application

Robust SMP first, then derivatives SCED SMP is the needed anchor
Market-based CfDs for RE Build on SECI auctions + synthetic PPAs
Separate but coordinated regulators CERC–SEBI coordination essential
Public visibility of price curves SCED & DAM price profiles must be published
Phased evolution Start with seasonal futures → CfDs → options →

G. Indian Policy Levers (Inspired by UK)

• RE CfDs for new plants using SCED SMP as benchmark

• Financial settlement-only hedges for short-term volatility
• Standard futures on MCX or PX-linked products
• Education modules for DISCOMs and RE firms on these instruments

Summary Takeaways
UK shows that financial instruments flourish only when the underlying spot price is
credible, granular, and liquid.
India must first anchor price formation (via SCED SMP / coupled MCP) before scaling
derivatives.
Coordination between physical (CERC) and financial (SEBI) markets must be tight and
anticipatory.
DISCOMs, RE, and open access players can benefit hugely — if trained and supported
early.

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Primer 21: Electricity Forwards, Swaps, and Structured
Products – Beyond Futures and Options
After understanding spot-settled futures and options, it’s time to explore the next tier of
financial instruments in electricity markets: forwards, swaps, and structured contracts.
These are especially relevant for longer horizons, custom hedging, and OTC flexibility.

A. Electricity Forwards – The Custom Counterpart to Futures

Feature Futures (Exchange-Traded) Forwards (OTC)

Standardized? Yes (contract size, tenure) No — fully customizable
Traded on Exchange? Yes (e.g., MCX) No — bilateral OTC deal
Margining? Daily MTM Negotiated terms
Transparency? High Low
Use case Price discovery, liquidity Tailored hedging for specific needs

Forwards are like tailor-made futures. DISCOMs, RE players, or OA consumers use them to
hedge specific volumes, locations, or shapes.

B. Electricity Swaps – Fixed-for-Floating Deals

A swap is a contract where one party pays a fixed price for electricity, while the other pays a
floating price (e.g., DAM MCP or SCED SMP). The net difference is exchanged.

Example:

Term Details
Volume 5 MW x 24 hrs/day for July
Fixed Price ₹5.20/kWh
Market Reference SCED SMP or DAM MCP
Outcome If market avg = ₹4.80, seller receives ₹0.40/kWh difference

This is the foundation for synthetic PPAs and price risk transfer.

C. Structured Electricity Products – Combining Layers

These instruments blend features of options, swaps, and forwards to match complex needs.

41
 Product Structure Use Case
Buy call, sell put → fix price
Price Collar RE generator guarantees ₹4.50–₹6.00
band
Base-load swap + peak-load
Shape Hedge OA buyer protects peak prices only
option
Pegs cost to fuel (e.g., gas Gas generator passes fuel cost risk to
Heat Rate Swap
price index) buyer
Volume Flex
Buyer can vary offtake ±20% DISCOM manages RE uncertainty
Contract
Rolling Hedge Monthly forwards for 12 Corporate buyer ensures price budget
Strip months for FY ahead

D. Infrastructure for These Products

Needed Element Description

Reliable Reference Price SCED SMP or PX MCP essential for settlement
Clearing or Collateral
OTC clearinghouse or bilateral credit arrangements
Mechanism
ISDA-based power annex or SEBI-regulated contract
Standard Legal Templates
format
Price Data Availability Daily and historical SMP/MCP curves must be accessible
DISCOMs, traders, REs need internal financial desk
Sophisticated Counterparties
capability

E. India Relevance & Immediate Possibilities

• Start with monthly or seasonal forwards settled against SCED SMP

• DISCOMs use collars to manage summer price risk
• Open access consumers hedge peak-hour exposure using swap + option
• RE developers sell merchant power + swap to stabilize cashflows

Strategic Insight

The flexibility of structured products allows true financial contracting without physical
entanglements — but only when the anchor price is credible and risk is understood.

Related Primers
• Primer 15: RE + Derivatives
• Primer 19: Synthetic PPAs

42
 • Primer 20: UK CfD model
• Primer 18: Derivatives–Physical Feedback

Summary Takeaways
• Forwards, swaps, and structured deals complete the spectrum of electricity risk
management.
• They help customize hedges beyond standardized futures/options.
• India can phase these in post-SCED SMP stabilization and SEBI–CERC
coordination.
• Ideal for RE developers, DISCOMs, and large OA buyers seeking budget certainty.

Primer 22: Congestion Risk and EPADs – Managing

Locational Risk in Power Markets
As India’s power grid becomes more granular and market-based (SCED, GNA, LTA, Px split
bidding zones), congestion risk — the price difference between two locations — becomes
significant. Financial markets globally handle this via EPADs (Electricity Price Area
Differentials).

A. What Is Congestion Risk?

In a zonal or nodal market, electricity prices differ across locations due to transmission
constraints (congestion). This creates basis risk between:

• Where power is generated (generator node/zone), and

• Where it's consumed (load zone/utility/distribution area)

Example (India):
Gujarat solar plant clears at ₹2.40/kWh
Buyer in UP pays ₹4.80/kWh in the PX
Difference = ₹2.40/kWh congestion risk

B. Enter EPADs – Electricity Price Area Differentials

EPAD = Financial contract that settles the price difference between two zones.

Used in Nord Pool, Australia, US nodal markets, etc.

Example:

43
 Type Contract
Reference price All-India SCED SMP = ₹3.80
Delivery node Telangana zone price = ₹4.50
EPAD Buyer Sells SCED SMP, buys Telangana price
Settles ₹0.70 difference

→ Buyer is hedged for Telangana-specific congestion premium.

C. Why EPADs Are Needed

Context Purpose
Generator in low-price zone Protects against price suppression
Buyer in high-price zone Hedged against congestion premiums
Traders Arbitrage spread risk between zones
Market design shift Enable zonal separation without breaking liquidity

D. Precondition: Clear Zonal or Nodal Pricing

EPADs can only exist where there's:

• Clear locational separation (like GNA + SCED zonal prices),

• Transparent reference prices (e.g., all-India SMP),
• Adequate liquidity in each zone's spot or virtual market.

India is progressing via GNA implementation, SCED expansion, and potentially zonal
MCPs → foundation for EPADs.

E. EPAD vs FTR

Item EPAD (Financial) FTR (Physical Congestion Revenue Right)

What it does Hedges price difference Entitles to congestion rent
Delivery None – financial only Settled by ISO/TSO revenue
How it's used Traded OTC or exchange Allocated via auction
Flexibility High More regulated
Global use Europe, Nordic US nodal ISO markets

F. Indian Context – How EPADs Might Evolve

44
Step Action
1⃣ SCED to publish zonal marginal prices by region/state
2⃣ CERC + SEBI allow EPAD-like bilateral or exchange-traded contracts
3⃣ DISCOMs/REs/traders hedge locational exposure (e.g., RE in TN, buyer in Delhi)
Congestion signals incentivize transmission investments, or financial transmission
4⃣
rights later

G. Link to Coupling and Uniform Pricing

You’ve long advocated for MCP–SMP coupling. But even with a single national spot
price, congestion rents and risks persist.

EPADs let us retain national liquidity while financially accounting for regional
differences.

Summary Takeaways
• EPADs are financial tools that hedge location-based price risk.
• Key for transmission-constrained India as we move toward zonal SCED, GNA-
driven pricing.
• Success depends on transparent zonal prices, SCED rollout, and regulatory
coordination.
• EPADs enable open access growth, merchant RE, and cost-reflective transmission
pricing.

Related Primers
• Primer 17: SCED SMP and locational price
• Primer 20: UK and zonal financial design
• Primer 21: Forwards/swaps that can embed EPAD logic

Primer 23: Clearing and Settlement Mechanisms – The

Backbone of Financial Electricity Markets
In any financial market, trust in settlement is vital. Electricity is no exception. As India
ventures into financial derivatives on power (MCX, SEBI-led), robust clearing and
settlement systems will ensure creditworthiness, transparency, and risk containment.

45
A. What Is Clearing and Why It Matters?

Clearing is the process by which trades are confirmed, margin requirements are set, and
counterparty risk is managed.

Function Role in Electricity Markets

Trade validation Ensures both sides agree on terms (price, volume, duration)
Margining Collects initial & variation margins to cover price risk
Netting Offsets exposures from multiple contracts
Default management Ensures settlement if one party fails
Final settlement Cash or delivery settlement based on index (e.g., SCED SMP)

B. Central Counterparty (CCP): The Risk Absorber

A CCP steps in between the buyer and seller, guaranteeing settlement even if one defaults.

Without CCP With CCP

A sells to B directly A sells to CCP, CCP sells to B
Credit risk borne bilaterally CCP absorbs default risk
Margins hard to monitor Standardized margins across board

MCX Clearing Corporation, NCL (for PXs), and IFSC-IGX models in India may evolve
into electricity CCPs.

C. Margining in Financial Electricity Markets

Margins protect the clearing house against losses due to price volatility.

Type Purpose
Collected upfront to cover potential losses from adverse
Initial Margin
movement
Variation Margin (Mark-to- Daily cash flows reflecting current market value of
Market) positions
Extreme Loss Margin Extra cushion for tail risk events

Electricity prices are volatile, so margins are relatively high compared to other
commodities.

D. Cash Settlement vs Physical Delivery

46
 Mode Use in Electricity Derivatives
Most common — contract closes at index price (e.g., SCED SMP, DAM
Cash Settlement
MCP)
Physical Rare — impractical due to grid scheduling, RE variability, time-of-day
Delivery intricacies

India’s upcoming contracts on MCX are cash-settled only, as per SEBI’s directive.

E. Key Design Elements in Indian Context

Feature Importance
SCED SMP or DAM MCP must be tamper-proof, timely,
Reference price integrity
and audited
Exchange + Clearing Corp
Smooth flow of trade → margin → settlement
integration
Risk management rules Margins, position limits, default fund contributions
CERC for spot; SEBI for derivatives — but joint
Regulatory ring-fencing
oversight needed
Market participants must see price curves, volumes,
Visibility
margin levels daily

F. Global Practice Snapshot

Market Settlement Practice

EEX (Europe) Cleared via ECC – daily variation margin on futures, options
ICE (UK, US) Daily MTM via ICE Clear Europe; CCP guarantees
Nord Pool Separate clearing entity (Nasdaq Clearing) handles EPADs
US ISOs FTRs and virtuals settled via ISO-operated clearing engines

India may draw on these by adapting to our zonal model and SCED architecture.

G. Relationship with Physical Market

• Spot (PX/SCED) provides reference prices for cash-settled derivatives.

• Volume risk and default contagion are reduced via CCPs and margins.
• Physical market stress (e.g., RE shortfall) may create derivative volatility — hence
feedback mechanisms matter.

Summary Takeaways

47
 • Robust clearing and settlement is essential for a trustworthy electricity derivatives
market.
• Cash settlement, central counterparties, and transparent margining are the norms
globally.
• India can build on MCX and PX infrastructure, aligned with SCED SMP or MCP.
• SEBI–CERC coordination is key for price integrity and risk harmonization.

Related Primers
• Primer 7: Role of Reference Price
• Primer 14: SEBI–CERC Regulatory Bridge
• Primer 21: Swaps and Structured Contracts

Primer 24: Role of Financial Intermediaries –

Aggregators, Speculators & Market Makers in Electricity
Derivatives
As financial electricity markets mature, they need more than just generators and buyers.
Intermediaries bring in liquidity, depth, and risk transfer mechanisms, making the
market more robust and efficient. Let’s explore their roles and importance.

A. Types of Financial Participants in Power Derivatives

Participant Type Role

Pools demand/supply (e.g., OA consumers, RE generators) and hedges
Aggregator
on their behalf
Takes directional bets without intent of delivery — profits from
Speculator
volatility
Market Maker Offers both buy/sell quotes continuously to ensure liquidity
Exploits price differences (e.g., between PX and futures) to align
Arbitrageur
markets
Hedge Uses power derivatives for portfolio diversification or thematic
Fund/Investor strategies (e.g., RE transition)

B. Why They Are Crucial

Need What Intermediaries Do

Liquidity Market makers ensure tight spreads and constant trading availability
Volume Speculators and funds contribute to active turnover

48
 Need What Intermediaries Do
Price Discovery More participants → deeper insight into expected future prices
Hedging
Aggregators help small players access financial tools
Support
System Arbitrage aligns different market segments (PX, futures, OTC) and
Stability reduces distortions

C. Aggregators: Bridge Between Physical and Financial

Aggregators are especially valuable in India’s context of fragmented RE, small open access
buyers, and DISCOM portfolio risks.

Examples:

• An aggregator representing 50 rooftop solar plants enters a forward to hedge against

price crashes.
• A firm like PTC or Tata Power Trading acts as interface between RE developer and
MCX futures.

Small players get access to hedging through scale.

D. Speculators: Necessary Risk Absorbers

Though often misunderstood, speculators serve critical functions:

Contribution Description
Absorb hedging
Take the other side of DISCOM or RE hedges
pressure
Provide liquidity Enter/exit rapidly, keeping markets active
Use analytics, weather models, and macro cues to forecast
Predictive pricing
electricity trends
No intent to deliver Their exit before expiry reduces delivery stress

Speculators don’t destabilize if margins and position limits are well-structured.

E. Market Makers: The Oxygen of Derivatives

These are licensed or incentivized entities that continuously quote buy and sell prices.

Feature Role
Tight spreads Reduce trading costs for hedgers
Immediate execution Avoid order book illiquidity
Price reference Help anchor contract valuation during lean periods

49
MCX and exchanges often appoint designated market makers, offering fee rebates or
capital support.

F. Global Reference

Market Notable Intermediary Practice

Nord Pool /
Active hedge funds, structured power desks, clearing banks
EEX
US ISO
Virtual bidders, FTR traders, DR aggregators
markets
Contract market has strong participation from financial players and
Australia
retailers
Market makers in CfD auctions and futures help RE developers hedge
UK
revenue streams

India can adopt a phased strategy, starting with:

• RE aggregators
• Voluntary market makers on MCX
• Public-sector hedging desks for pilot volumes

Summary Takeaways
• Intermediaries are vital enablers of healthy electricity derivatives markets.
• Aggregators allow small buyers/generators to hedge.
• Speculators and arbitrageurs add liquidity and price discovery.
• Market makers reduce spread, improve confidence, and support stable entry.
• CERC–SEBI–Exchanges can structure roles, incentives, and oversight to build
trust.

Related Primers
• Primer 21: Forwards & Structured Products
• Primer 23: Clearing and Settlement
• Primer 17: SCED SMP as Reference for Financial Risk

Primer 25: Risk Metrics and Tools – VaR, Stress Testing,

and Greeks in Electricity Derivatives
As India steps into power derivatives, risk measurement becomes critical — for exchanges,
clearing corporations, regulators, and participants. Electricity, unlike other commodities, is

50
non-storable, volatile, and weather-dependent — making risk metrics even more
essential.

This primer introduces key tools: VaR, Stress Testing, and Greeks (adapted from options
theory) used globally in power markets.

A. Value at Risk (VaR) – How Much Could I Lose?

VaR estimates the maximum loss a portfolio could suffer over a time horizon, with a certain
confidence level.

Component Example
Confidence
95% or 99% (higher = more conservative)
level
Time horizon 1 day, 10 days (e.g., MCX may use 2-day VaR)
₹12 lakhs VaR @ 99% over 2 days = 1% chance of losing more than ₹12
Amount at risk
lakhs

VaR is used to set initial margins.

B. How VaR is Calculated (Simplified)

1. Historical simulation – Use past price movements of power indices (e.g., SCED
SMP, DAM MCP).
2. Monte Carlo – Simulate thousands of price paths based on volatility.
3. Parametric (variance-covariance) – Assumes returns are normally distributed (not
ideal for power!).

Electricity is fat-tailed → stress testing is crucial alongside VaR.

C. Stress Testing – What If the Unthinkable Happens?

VaR doesn’t capture black swan events. Stress testing does.

Type Example
Price shock DAM MCP rises from ₹3 to ₹9 in 2 days due to a coal shortage
RE event Sudden RE drop leads to ₹5/kWh volatility spike
Regulatory New order changes RE priority; spreads collapse
Transmission outage Congestion EPADs widen from ₹0.50 to ₹3.50/kWh

Clearing corporations, like MCX Clearing Corp, must design worst-case scenarios to test
margin adequacy.

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D. “Greeks” in Electricity Options (Coming Soon)

If India allows electricity options in future, traders will use:

Greek Meaning
Delta Change in option price per ₹1 change in underlying (e.g., DAM MCP)
Gamma Change in delta — shows convexity risk
Vega Sensitivity to volatility — high in electricity
Theta Time decay — value falls as expiry nears

In electricity, volatility is high, so Vega and Delta management are critical.

E. Additional Risk Tools Used Globally

Tool Purpose
Mark-to-market
Daily revaluation of contracts to reflect current value
(MTM)
Joint risk across many contracts — key for DISCOM hedging
Portfolio VaR
desks
Cash flow at risk
Used in corporate PPAs – max cash loss over time
(CFaR)
Load forecast variance Useful for RE + weather-based portfolios

F. Relevance for India’s Financial Power Market

Context Application
SEBI & exchanges Use VaR + stress tests to set margins and position limits
RE developers CFaR used for PPA-backed bond ratings
Traders/Arbitrageurs Need daily MTM and VaR to control exposure
Clearing Must publish margin methodologies and stress models (like SPAN for
corporations commodities)

Summary Takeaways
• VaR is foundational for managing daily risk and setting margins.
• Stress testing accounts for India’s high volatility, coal/reliability events, and policy
shocks.
• Greeks apply to future electricity options markets.

52
 • Institutions must develop transparent, back-tested, and scenario-rich risk
frameworks.

Related Primers
• Primer 23: Clearing and Settlement
• Primer 14: SEBI–CERC Coordination
• Primer 7: Reference Price Role

Primer 26: Transition Pathways – How to Phase In

Electricity Derivatives Without Destabilizing the Physical
Market
India stands at a delicate juncture: launching financial electricity derivatives (under SEBI)
without destabilizing the physical spot market governed by CERC (DAM, RTM, SCED).
A careful phased approach is essential to ensure market confidence, price integrity, and
systemic synergy.

A. Why a Phased Rollout?

Reason Risk if Ignored

Price reference not Volatile or manipulated benchmarks can misguide financial
mature contracts
Thin liquidity Derivatives may misrepresent actual demand/supply signals
Disjointed SEBI–CERC oversight may trigger confusion or
Regulatory friction
disputes
Market participants need time to build systems, strategies, risk
Learning curve
tools

Phased approach = safe runway for all stakeholders.

B. Proposed Phasing Model (India-Specific)

Phase Features Key Conditions

Phase 1: Vanilla Monthly, cash-settled futures Price benchmark locked; volume
Futures on PX MCP or SCED SMP >10 GWh/day; reference audited
Phase 2: Location- Zonal contracts (e.g., NEW- Market coupling + congestion index
Specific Futures South, WR-North basis) ready

53
 Phase Features Key Conditions
Phase 3: Options & Monthly call/put options, Hedging tools mature; RE
Exotic Contracts weather-linked products participation scales up
Phase 4: OTC– Swaps traded bilaterally but ISDA-like standardization; clearing
Exchange Interlinking cleared via exchange corpus stabilized

Each phase builds on reference price credibility, participant readiness, and clearing
stability.

C. Safeguards to Protect Physical Market

Mechanism Role
PX MCP / SCED SMP integrity must be shielded from
Reference price firewall
speculative influence
Prevent speculative concentration (e.g., one trader owning 60%
Position limits
of open interest)
Price bands / circuit
Control runaway volatility on illiquid days
filters
Publish large position holders, expiry positions, and volumes
Disclosure norms
traded
Joint SEBI–CERC Periodic review of spillovers (e.g., if derivative leads to real
oversight bidding distortions)

D. Coordination: Physical and Financial Must Talk

“Financial market must derive from physical market — not drive it.”

• Derivative settlement must not incentivize artificial bidding in DAM.

• Price indices (SCED SMP or PX MCP) must be non-manipulable, audited, and
publicly transparent.
• PXs and MCX must share anonymized order books to detect correlation drift.

E. International Templates

Country Transition Pathway Used

Started with Baseload Futures; then introduced options, EPADs, weather
Europe (EEX)
derivatives
US Physical FTRs first; virtual bidding and financial hedges followed; robust
(PJM/NYISO) market surveillance systems
Retailers mandated to hedge via futures – helped mature the market
Australia
gradually

54
 Country Transition Pathway Used
OTC swaps → cleared via ICE → PX reference prices now used in
UK
corporate PPAs

India can adopt a “futures-first, options-later” model tailored to RE-heavy, congestion-

prone grid.

F. Role of Pilot Programs

• Sandboxing approach: Start with small MW limits, few zones, short contracts.
• Govt-supported hedging: NTPC, SECI, or RE developers can hedge part of output.
• Academic back-testing: IITs/IIMs can help assess whether SCED SMP correlates
well with futures prices.

Summary Takeaways
• Phased rollout ensures trust, stability, and adaptation.
• Must begin with cash-settled futures, with tight safeguards on pricing and
speculation.
• Physical market and financial market must be mutually reinforcing.
• International examples show this transition is feasible — but design is everything.

Related Primers
• Primer 7: Reference Price Design
• Primer 23: Clearing and Settlement
• Primer 14: SEBI–CERC Coordination
• Primer 19: Price Manipulation Risks and Controls

Primer 27: Electricity Price Benchmarks – What Makes a

Reference Price “Good Enough” for Settlement?
For any derivative to function credibly, it must settle against a trustworthy price
benchmark. In electricity, this benchmark is usually a spot market index — like the MCP
(Market Clearing Price) from Power Exchanges or the SMP (System Marginal Price)
from SCED.

But what makes a benchmark suitable for financial settlement?

55
A. Key Attributes of a Good Reference Price

Attribute Why It Matters

Transparent Price formation mechanism is public and auditable
Liquid Derived from a market with deep participation
Tamper-resistant Immune to manipulation or cornering
Relevant Reflects actual supply-demand conditions in physical system
Stable methodology Rules don’t change frequently, ensuring predictability
Regulator-backed Has policy or regulatory legitimacy (e.g., by CERC)

B. MCP vs SCED SMP – Two Candidate Benchmarks in India

Parameter PX MCP (DAM) SCED SMP

Source PX auction (multi-unit clearing) Post-dispatch marginal price via SCED
Currently implicit (SCED not yet
Liquidity High (40–80 GWh/day)
visible to public)
Transparency Publicly published every 15 min Needs audit/publication mechanism
Yes (marginal from unconstrained
Congestion-free? No (zonal prices vary)
dispatch)
Manipulation Bids can be gamed in tight
Based on cost stack — harder to game
Risk volume windows
Use in Strong candidate if published
Already adopted by MCX
Derivatives systematically

Coupling PX MCP with SCED SMP (as long advocated) may yield best-of-both-worlds.

C. Examples of Benchmarks Used Globally

Region Benchmark Used Notes

System price (uncongested PX
Nord Pool Basis contracts settle to local prices
MCP)
EEX
Baseload day-ahead PX price Financially settled; physically optional
Germany
PJM (USA) LMP or DA MCP Includes congestion and losses
Australia Spot half-hour average Directly used for futures contracts
Supported by National Grid and
UK N2EX spot
regulators

India must evolve a unified, regulator-accepted benchmark, eventually suitable for RE

PPAs, hedging, and futures.

56
D. Design Challenges for India’s Benchmark

Issue Solution Path

Multiple PXs Market coupling and algorithm harmonization (as CERC is pursuing)
Use a “system price” akin to SCED SMP or volume-weighted
Congestion effects
composite MCP
RE integration Include RE price effects via profile pricing or hybrid indices
Gaming risk Require CERC-certified audit trails and anti-manipulation filters
Low volumes on
Use volume-weighted rolling average or price averaging windows
expiry

E. Enhancements to Make It Robust

1. Publish daily SCED SMP: Transparent, CERC-approved, zone-agnostic.

2. Create an index: Weighted average of DAM MCP, RTM, SCED, with congestion
adjustment.
3. Back-test for correlation: Ensure futures prices track actual physical outcomes.
4. Freeze methodology: Once agreed, don't alter formula for at least 1 year.
5. Joint oversight: SEBI–CERC–PXs–GRID-INDIA to review reference price efficacy
quarterly.

Summary Takeaways

• A strong benchmark is the bedrock of reliable electricity derivatives.

• India must build confidence in SCED SMP and/or harmonized MCP, backed by
data, audit, and regulation.
• The best benchmark is not just technically sound but also trusted, tested, and
tamper-proof.

Related Primers
• Primer 7: Reference Price Role
• Primer 17: SCED SMP for Risk Management
• Primer 26: Transition Pathways

Primer 28: Hedging Use Cases – DISCOMs, RE

Generators, and C&I Consumers in India

57
Electricity derivatives aren’t just for speculators. In fact, their core purpose is hedging —
helping genuine market participants manage price volatility, forecast uncertainty, and
procurement risk.

This primer outlines how different Indian stakeholders can use electricity derivatives to
hedge their physical exposures.

A. Use Case: DISCOMs

Objective:

• Avoid price spikes in DAM/RTM when short on power

• Manage budget stability across seasons

How They Can Hedge:

• Buy monthly futures pegged to DAM MCP or SCED SMP

• When physical prices rise, futures profit offsets high spot costs

Example:

• DISCOM expects to buy 100 MU in June

• Buys 100 contracts on MCX for June @ ₹4.50/kWh
• Actual DAM price in June = ₹6.20
• DISCOM loses ₹1.70/kWh in DAM, but gains ₹1.70/kWh on MCX
• Net: Budget protected

Risk:

• Needs accurate volume estimation

• Regulatory clarity on pass-through in ARR

B. Use Case: Renewable Energy (RE) Generators

Objective:

• Hedge price volatility if selling into DAM

• Create bankable cash flows to raise finance

How They Can Hedge:

• Sell futures to lock in revenue floor

• Explore options (once available) to retain upside but cap downside

Example:

58
 • Solar generator expects 40 MU production in July
• Sells July MCX futures @ ₹5.00/kWh
• Actual DAM price = ₹4.10 → earns ₹4.10 in DAM, ₹0.90 from futures

Benefit:

• Helps in project finance; improves credit rating

C. Use Case: C&I Consumers

Objective:

• Predictable landed cost for 6–12 months

• Avoid exposure to peak-hour volatility

How They Can Hedge:

• Buy quarterly futures pegged to DAM prices

• Use calendar spreads to manage seasonal variation

Example:

• Industrial consumer signs OA contract indexed to DAM

• Buys MCX futures at ₹5.10 for Q3
• If DAM goes to ₹6.00, pays more physically but gains ₹0.90 in derivatives

Additional Tool:

• Later use weather-linked options (e.g., hedge against low wind/solar months)

D. Use Case: Captive + Hybrid Generators

• Captive solar/wind tied to group captive loads

• Use futures to manage mismatch risk (load > generation or vice versa)
• Sell excess generation forward; buy to cover deficits

E. Common Hedging Strategies

Strategy Who Can Use It What It Does

DISCOMs, RE,
Straight futures Locks price in advance
C&I
Cost collar
RE, C&I Defines price band: no gain/loss outside it
(options)

59
 Strategy Who Can Use It What It Does
Delta hedging Advanced users Adjusts position daily vs spot moves
Mix short-term and long-term futures to manage
Stack hedging All
load shapes

F. Regulatory Enablers Needed

Measure Needed For

CERC approval of hedging costs as pass-through DISCOMs
Clarity on treatment of profit/loss from derivatives All
Allow RE-linked market participation Generators
Standard reporting and audit norms Market-wide confidence
Encourage market makers and risk advisors Liquidity and support

Summary Takeaways

• Electricity derivatives offer real economic value to physical participants.

• DISCOMs, RE developers, and industrials can reduce uncertainty, protect margins,
and plan better.
• Success depends on regulatory support, volume liquidity, and reference price
quality.

Related Primers
• Primer 3: Types of Derivatives
• Primer 17: SCED SMP for Risk Management
• Primer 26: Transition Pathways
• Primer 27: Price Benchmark Design

Primer 29: Misuse and Overhedging – Avoiding Pitfalls

When Using Electricity Derivatives
While electricity derivatives offer powerful tools for risk management, they can backfire if
misunderstood or misused. This primer highlights common pitfalls and how to avoid them
— especially relevant as India’s market matures.

A. What Can Go Wrong?

60
 Risk Type Description Who's Affected
Hedging more volume than actual need → DISCOMs, RE
Overhedging
speculative exposure generators
Reference price (e.g., PX MCP) deviates from
Basis risk actual purchase price (e.g., regional congestion All participants
price)
Trying to exit position in an illiquid market leads to
Liquidity trap New participants
heavy slippage
Hedge contract expires before the physical need
Expiry mismatch RE projects, C&I
arises
Improper Poor choice of benchmark leads to large mark-to- Anyone using
settlement linkage market losses unrelated to physical operations derivatives
Using multiple instruments (e.g., RTM + DAM + Advanced users
Layering errors
SCED) without netting exposures correctly only

B. Real-World Examples (Global)

Case What Happened Lesson

Hedge must reflect
Texas Winter Generators hedged low prices, but physical
physical exposure
Storm (2021) prices went to $9000/MWh; massive losses
shape
Ensure cash margin
UK Retailer Bought futures without cash flow buffers →
coverage and credit
Collapses (2022) margin calls during crisis
lines
Sold forward contracts expecting low spot Never assume weather-
Nord Pool
prices; unexpected hydro shortage caused spot normal scenarios
Traders
spike → losses blindly

C. Overhedging: Why It’s Dangerous

Let’s say:

• A DISCOM expects 100 MU demand, buys futures for 120 MU @ ₹4.80

• Actual demand = 90 MU; DAM settles at ₹4.10

→ Outcome:

• Physical loss = (₹4.80 – ₹4.10) × 90 = ₹63 lakh loss

• Futures profit = 30 MU * (₹4.80 – ₹4.10) = ₹21 lakh gain
→ Net = ₹42 lakh loss due to unnecessary 30 MU overhedge

Lesson: Hedge only expected shortfall or surplus, not total load.

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D. Basis Risk: Hidden But Critical

Even if you buy PX MCP futures:

• Your actual cost may be congested zonal price, or hybrid RE PPA rate
• Result: Your hedge doesn’t track your true exposure

Solution:

• Use zone-adjusted hedges, basis spreads, or demand-shape-adjusted contracts

(eventually in India)

E. Operational Pitfalls

Pitfall Mitigation
Draft clear risk limits, hedge ratios, approved
No internal risk policy
counterparties
Relying on single trader or
Use internal oversight + external advisors
consultant
Ignoring mark-to-market Monitor daily value of open positions
Not training finance teams Educate treasury, audit, procurement teams jointly

Summary Takeaways

• Electricity derivatives are not plug-and-play — they require volume estimation,

price linkage, and discipline.
• Overhedging and poor benchmark selection are primary causes of misuse.
• India's regulators and utilities must combine training, protocols, and gradual
exposure to avoid costly errors.

Related Primers
• Primer 7: Reference Price Design
• Primer 23: Clearing and Settlement
• Primer 28: Hedging Use Cases
• Primer 12: Margin and Collateral

Primer 30: Long-Term Vision – What Does a Mature

Electricity Derivatives Ecosystem Look Like?

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As India takes its early steps into electricity financial derivatives, it is helpful to envision
what a mature, liquid, and robust ecosystem might look like in 5–10 years. This vision
draws from global experience and adapts it to India's needs.

A. Key Features of a Mature Electricity Derivatives Market

Feature Description
Liquid futures and For base, peak, off-peak blocks over weekly, monthly, quarterly
options tenors
Multiple benchmarks PX MCP, SCED SMP, congestion-adjusted zonal indices
DISCOMs, RE generators, C&I consumers, traders, financial
Diverse participants
institutions
Clear regulatory Coordinated SEBI–CERC framework on risk limits, accounting,
guidance and settlements
Robust clearing Well-capitalized clearinghouses managing margin and
mechanisms counterparty risk
Forward curve Transparent price discovery for months ahead, aiding budgeting
visibility and investment decisions

B. Policy and Market Milestones Ahead

Milestone Indicative Timeline

Unified reference price (PX + SCED coupling) Near term (2025–2026)
Introduction of electricity options Medium term (2026–2027)
Weather-linked derivatives (monsoon, wind) Medium term
Cross-border derivative linkage (BBIN) 2027–2030
Discom cost pass-through allowed for hedging Critical short-term step
Retail participation via aggregators Long term, if risk-managed well
Regulatory sandbox for innovation Should start soon

C. Integration with Physical Market Evolution

Physical Market Evolution Impact on Derivatives

DAM + RTM + SCED integration Better spot benchmark → stronger derivatives base
Green DAM / RE market maturity RE-linked contracts (solar hours, wind ramp) possible
Ancillary services market growth Price signals for ramping/volatility hedging
Transmission pricing reform Easier zonal-to-system price convergence

In a mature system, physical and financial markets are tightly coupled, with the derivative
curve serving as a forward signal for grid planning, investment, and demand shaping.

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D. Institutional Ecosystem

Institution Role
Joint oversight, benchmark approval, margin
CERC + SEBI
policies
GRID-INDIA Publish SCED SMP, congestion data
PXs Data and clearing coordination
FMCs (Financial Market
Develop standardized contracts, monitor health
Committees)
Academia/Consultants Hedging models, risk toolkits, capacity building

E. Future Use Cases

• DISCOMs: Lock annual price bands, use swing options for load uncertainty
• RE generators: Hedge seasonality; even sell profile-shaped futures
• Consumers: Lock electricity budget as part of energy portfolio management
• Storage/EV operators: Arbitrage high/low prices through future spreads
• Transmission operators: Use forward prices for congestion hedging or investment
signals

Summary Takeaways

• A mature electricity derivative market is a pillar of energy transition: it offers price

signals, risk management tools, and investment support.
• India is well-placed to develop it, provided we:
o Build trust in reference prices (e.g., SCED SMP),
o Ensure regulatory clarity and auditability, and
o Promote measured, risk-aware participation by DISCOMs and RE.

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