Ensuring security of supply in the Indian power system

Status 

As of September 2021, India’s non-fossil fuel power generating capacity of 154,825 megawatts (MW) was about 39.8 percent of the total installed power generating capacity of about 388,848 MW. New renewable energy (RE) capacity (excluding nuclear and hydro power) accounted for over 26 percent of total power generation capacity, the second largest share after coal.  Solar, wind, small hydropower, biomass and others accounted for over 65 percent of non-fossil fuel-based capacity while large hydropower 30 percent and nuclear just over 4 percent.

Stand-by Capacity

Though RE with 101,532 MW of capacity is the second largest in terms of capacity share, it accounted for less than 10 percent of power generation in 2020-21, equalling hydro-power generation that has only half the capacity as RE. Coal that accounted for 54 percent of capacity contributed over 79 percent of generation in 2020-21. In terms of specific generation or power generated per unit of capacity that represents economic efficiency, nuclear power was the most efficient with a score of over 6 while RE power was the least efficient with a score less than 1 in 2020-21.  This is because of low-capacity factors for RE which are in the range of 15-20 percent at best. Without stand-by capacity, a high RE power system can lead to compromise on security of supply as the recent events of power outages across the country illustrates. As RE cannot be relied upon to provide needed electricity at any moment, other tools such as making payments for maintaining stand-by capacity (either in the form of batteries or in terms of gas or coal-based generation) or compensating consumers to reduce demand, when necessary, must be employed. India often uses the latter option of reducing demand through forced outages for rural consumers (or industrial consumers during elections when people are temporarily more valuable) who receive neither electricity nor payments for outages. They are in fact India’s back-up system which is perverse and should be eliminated. The other credible options for supply security include creating vibrant markets for electricity, capacity, and ancillary services. India is technically an energy-only market but using the term market to describe India’s power sector is a stretch as the electricity tariff does not respond to market signals.   

Energy only and Capacity Markets

Capacity markets aim to ensure grid reliability by paying participants to commit generation for delivery years into the future. Energy-only markets, by contrast, pay generators only when they provide power on a day-to-day basis. Capacity markets prevent generating capacity that only supplies excess energy at high prices being squeezed out of the wholesale electricity market in such quantities and at such speed that it may affect system reliability. The opportunity to secure revenue years in advance gives generators added incentive to build new plants. But the model could be wasteful, since the concerned utility will pay out the capacity costs for load events that may not materialise years down the line. Capacity markets also remain vulnerable to price depression as a result of out-of-market subsidies. If these resources also enter as price takers without any checks and balances into the capacity market, the regulator can end up compromising the ability of the capacity market to balance the revenues. Payments for capacity may also blur price signals on traded markets, preventing scarcity markets from functioning. Capacity remuneration also risks double payments to the generator—for energy and for capacity. In mature energy only markets, regulators ensure reliability through a mechanism called scarcity pricing, which allows real-time electricity prices to increase on days of peak demand. Instead of guaranteeing generation revenue through a capacity market, the promise of high prices is supposed to incentivise generators to build new plants and keep them ready to operate. In an energy only market, the grid’s reserve margin is maintained at sufficiently high levels allowing for enough instances of scarcity that increase prices to such an extent that generators can recover their capital costs.  The worry is that energy-only markets could become increasingly unstable because low electricity prices—on account of subsidies for certain energy forms or on account of depressed demand—could discourage generators from building new power plants without the guaranteed revenue of a capacity market.  Essentially, securing sufficient flexibility in the system is a separate issue to stimulating investment in future capacity.

In mature energy only markets, regulators ensure reliability through a mechanism called scarcity pricing, which allows real-time electricity prices to increase on days of peak demand. Instead of guaranteeing generation revenue through a capacity market, the promise of high prices is supposed to incentivise generators to build new plants and keep them ready to operate

The critical difference is that in an energy-only market, generators must wait and hope for the day when real-time prices increase substantially. With a capacity market, some of that revenue is guaranteed. The capacity market is designed to provide a solution by balancing lower energy market prices with higher revenues for generators in the capacity market. Capacity remuneration mechanisms can remove investment incentives for demand-side response activity in the wholesale market and energy storage. They also impede cross-border electricity trade by reducing the peak-prices that make trade profitable. Over the long term, the energy-only and capacity market constructs could end up delivering similar cost results to consumers. The third alternative, often confused with capacity markets, is to use ancillary service markets, which procure short-term reserve generation and grid support products for everyday system stability. As the proportion of RE continues to increase the demand for ancillary services to ensure daily operational stability is likely to increase. Ancillary services are traded in months, weeks, days and hours, not years like capacity. Ancillary service markets are for securing the right combination of resources for generation quality and not for generation adequacy.  Competitive trading of these services is part of some, but not all, wholesale electricity markets. If generators can generate revenue from selling ancillary services, the need for capacity payments to keep plants online can be reduced. A properly functioning energy and services market can deliver all the capacity that the Indian grid requires. India is quite far away from this situation not only because it is an imperfect energy only market but also because India’s energy supply serves non-energy goals such as delivering development subsidies.  However, keeping the future in mind, India’s central electricity authority (CEA) has studied the prospect of developing an ancillary services market.  But it is too early to say whether a well-designed market that makes it profitable for generators to provide ancillary services (short term reserves and grid support products) would also stimulate investment in future capacity in India. The worry is that continued policy supported RE additions may keep electricity prices low, thereby, reducing the incentive for generators to build new plants.  Most of the RE is “aspirational capacity,” capacity directly contracted for to meet climate commitments not necessarily capacity needs. Reconciling environmental goals that demand more RE additions with the need to preserve market incentives for new generation is a critical challenge. If India’s electricity sector matures into a vibrant open market, it can at least in theory, of value reliability and compensate investors for supplying fixed resources. A well-functioning wholesale electricity market should dynamically value energy, support services and capacity in response to the changing forces of supply and demand. An ancillary services market that responds to scarcity of flexible reserves by pushing up their price will make it profitable to operate peaking plant that can rapidly ramp up and down, giving generators a reason to keep plants online and invest in future capacity.

Creating a new system of benefits or an entire new market, to stimulate investment in enough future capacity without interfering with the ancillary market's valuation and procurement of reserve capacity is complicated even in the most mature market and much more so in India.

Another alternative is keeping strategic reserves of power generating capacity where the capacity mechanism is procured completely outside the wholesale market so that it does not compromise the move towards developing an energy market in India. As in the case of strategic oil reserves, it should be owned and operated by the government to provide a national security (energy security), a public good. Strategic reserve for power generation is a pragmatic and relatively simple solution to meet demand for the short periods of extreme system stress. But the risk with a peak strategic reserve is that over time it can become just as expensive as a capacity market. Creating a new system of benefits or an entire new market, to stimulate investment in enough future capacity without interfering with the ancillary market's valuation and procurement of reserve capacity is complicated even in the most mature market and much more so in India. Source: Ministry of Finance, Government of India, “Report of the Sub-Committee for the Assessment of the Financial Requirement s for Implementing India’s Nationally Determined Contribution (NDC)” June 2020.

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• Energy
• India
• Energy Monitor
• Power Sector

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