Lessons to learn from REC Trade in April-2011

India witnessed first ever trade of REC in March 2011 where 424 Non-Solar RECs got traded collectively through Indian Energy Exchange (IEX) and Power Exchange India Limited (PXIL) at Market Clearing Price (MCP) of Rs. 3900/REC and Rs. 2225/REC respectively. Market got super excited seeing REC prices touching forbearance price at IEX.
However, the market got little surprise as well as shock in the very next trade session that got executed in April-2011, in which buyers were hard to find at both the Power Exchanges (PXs). Based on its existing strong hold in the market, IEX managed to get 260 Non-Solar RECs from buy side whereas their counterpart – PXIL could not get a single bid from REC buyers!
This came as a little surprise to us (REConnect) as well as the market. We were expecting that the market would see a strong dip in the price due to following factors:

1. Most of the distribution companies & obligated entities might still be busy settling their financial accounts
2. As this trade session was a just beginning of the new compliance year, most of the obligated entities might not be prepared with their estimated requirements for RECs for this compliance year
3. As the RPO compliance is expected to be enforced on an Annual basis (in most states), all the obligated entities actually had no strong incentive to actively participate in April trade of REC

These reasons are sufficient to justify low buy side participation in REC trade session this month. But, does this also indicate something else which could be more alarming for stakeholders – especially investors? The first two reasons mentioned above may not be that significant. However, the third one may prove itself a crucial one for the investors as well as for the market. The reasons being are:

1. Buyers of REC may not have any incentive (except possible price advantage) to buy RECs in a planned manner. Hence, obligated entities may not participate into REC trades till fag end of the compliance year
2. This could result in low trade volumes during almost all the trade sessions at PXs except last quarter of the compliance year
3. Ultra low volumes during first three quarters and very high volumes during last quarter may result into an inefficient price discovery as at the end of the compliance year the market may witness either panic buying (in case of shortage of RECs) or panic selling (in case of excessive supply)
4. The other issue associated with this could be: lack of consistent cash-flow for generators. Today, many generators have opted for REC route just to ensure that they will get immediate payment form PXs on the sale of REC and with regular trades of RECs, they would get consistent cash-flow which they sometimes do not get by selling power to distribution companies.
5. This lack of consistent cash-flow from REC route and uncertainty on payment from distribution licensees may make REC project proposition difficult for investors to convince banks and hence get project financed

The way-out ??
The possible way out for this could be:

1. Strong enforcement of RPO across all the states in India: A crystal clear clarity on legislation about who are the obligated entities and what are the penalties for non-compliance. There are states in which such clarity is missing.
2. Quarterly compliance of RPO for obligated entities rather than annual compliance: There are few RPO regulations which have recommended to submit planning for RPO compliance by obligated entities to State Regulatory Commissions (SERCs) on a quarterly basis. This should be extended further by making quarterly compliance (and not planning) mandatory.

Comments and thoughts are welcome.