Why is electricity considered a financial commodity?

Electricity is treated as a financial commodity because it is actively traded on exchanges like NSE and MCX, just like other commodities such as oil or gold. Through instruments like futures and options, electricity trading supports price discovery, hedging, and speculation, in the same way other physical commodities are traded in financial markets.

How do electricity futures benefit power producers and consumers?

Electricity prices in India keep changing because of factors like demand, weather, and fuel costs (especially coal and natural gas). This price volatility creates risks for power companies, industries, and traders, affecting their profits. Electricity futures help manage this risk by allowing participants to lock in prices in advance, giving more financial stability.

What role does SEBI play in electricity derivatives trading in India?

The Securities and Exchange Board of India (SEBI) is responsible for regulating electricity derivatives like futures and options that are traded on platforms such as MCX and NSE. While the actual electricity contracts fall under the control of the Central Electricity Regulatory Commission (CERC), SEBI oversees the financial trading side to ensure smooth and transparent operations in the derivatives market.

How do electricity futures help in managing price volatility?

Electricity futures contracts are an effective tool for power market hedging, as they allow participants to lock in electricity prices in advance. This helps reduce electricity price risk by protecting against sudden changes in the spot market. Power producers, utilities, and large consumers benefit from more stable costs and predictable revenues, making financial planning easier and less vulnerable to price swings.

Where can electricity futures be traded in India?

Electricity futures are standardized financial instruments that let buyers and sellers fix electricity prices for a future date. These contracts are traded on regulated platforms like the MCX and NSE.

What are the key differences between physical and financial electricity contracts?

Physical electricity contracts involve actual delivery of power through the grid and are regulated by CERC. In contrast, financial electricity contracts, like futures, are cash-settled without physical delivery. The former manages supply logistics, while the latter helps hedge electricity price risks.

How do electricity futures impact the Indian power market?

Electricity futures impact the Indian power market by providing important tools for risk management and transparent price discovery. These contracts help market participants hedge against price volatility, leading to more stable and predictable pricing. Additionally, electricity futures attract capital investments and support growth across the entire electricity value chain, thereby playing a major role in transforming the sector .

What risks are involved in trading electricity derivatives?

Trading electricity derivatives carries several risks. First, because these contracts are cash-settled, their prices can sometimes differ significantly from actual spot electricity prices, especially when the contract is far from expiry. This can lead to a mismatch between the derivative’s value and the real market. Second, timing mismatches, where a consumer’s billing cycle doesn’t align with the contract’s expiry can leave certain periods unhedged, exposing them to price swings. Third, regional differences in spot prices mean that the price at the exchange may not reflect the local market price, which can affect hedging effectiveness. Finally, inaccurate estimates of electricity consumption can either leave a participant under-hedged, increasing risk, or over-hedged, increasing costs unnecessarily.

How are electricity futures settled without physical delivery?

Electricity futures are usually settled in cash, so there is no physical delivery of electricity. Instead, gains or losses are determined by the difference between the agreed contract price and the current market price at settlement.

Electricity as a Financial Commodity: Understanding Electricity Futures and Their Role in Indian Power Sector Reform

By – Devank Maheshwari and Tannishtha Chatterjee

Introduction

In the recent past, India’s power sector is witnessing a significant shift towards market-based mechanisms with the objective of ensuring greater flexibility and transparency. Among these tools, Electricity Futures play a critical role in reducing Electricity Price Risk and enabling robust Power Market Hedging, marking a major step in the ongoing Indian Power Sector Reform. Among these, electricity derivatives and virtual power purchase agreements (VPPAs”) are two significant tools that decouple electricity trading from the physical delivery of electricity and enable more sophisticated power market hedging options.

In this two-part article series, we examine these emerging energy market derivatives and their implications for the Indian power market. This first article focuses on electricity futures, discussing how they work, their regulatory framework, and the benefits and challenges they present. In the second article, we will turn to VPPAs, exploring how they can drive risk mitigation strategies in this sector.

What Are Electricity Futures and How Do They Work?

In financial markets, derivatives are contracts whose value is derived from the price of an underlying asset, such as commodities, currencies, or securities. These instruments allow market participants to hedge risks or speculate on price movements without owning the underlying asset itself. Among the most commonly traded derivatives are futures, which are standardized contracts obligating the buyer to purchase, or the seller to sell, an asset at a predetermined price at a specified future date. Futures are widely used in commodity markets to manage price fluctuations.

Power sector is one such sector that is significantly impacted by regular price movements. This fact postulates availability of instruments that can be used to hedge against price volatility. In this context, electricity Futures, a type of Electricity Derivatives in India, are standardized financial contracts that allow participants to lock in a price for future electricity settlement. Electricity futures are traded on exchanges and settled in cash.

Two key features stand out:

Electricity futures are not about the actual movement or physical delivery of electricity through power lines. No physical delivery is required, and all contracts are financially settled.

Unconstrained market prices, seen separately from physical electricity market, are used for settlement purposes.

This helps both buyers and sellers manage the risk of changing electricity prices. For example, if a company expects electricity prices to rise next month, it can use futures to lock in today’s lower price and protect its budget.

Why Electricity Futures Matter for India’s Power Market

Hedge Against Price Fluctuations

Electricity prices can change frequently due to various reasons. For producers, distributors, and large consumers, this makes budgeting and planning difficult. This makes Futures Trading in India an essential mechanism for price security in volatile energy markets. This helps them avoid losses caused by sudden price increases or decreases, offering financial stability.

Protection Against Weather-Driven Changes

Weather has a big impact on electricity use. For example, hot summers raise air conditioning demand, and poor rainfall reduces hydropower supply. Such changes can lead to sudden price spikes. Electricity Futures help reduce the financial impact of weather changes by securing prices in advance.

Balance Demand and Supply Uncertainty

Electricity prices can rise sharply if demand increases suddenly or if supply drops due to technical issues. On the other hand, excess supply can cause prices to fall. These unpredictable shifts make it hard to plan ahead. Futures contracts allow buyers and sellers to protect themselves from such market imbalances.

Reduce Risk from Fuel Price Swings

A large part of India’s electricity comes from coal and natural gas. If fuel prices rise due to global or domestic factors, electricity costs also go up. Distributors and consumers face sudden cost increases. Electricity Futures help reduce this risk by allowing participants to lock in costs in advance.

Support Better Price Discovery

When more buyers and sellers participate in the futures market, it leads to fairer and more competitive pricing. This process of price discovery helps reflect the true market value of electricity. It builds transparency and trust in the power sector, supporting the ongoing Indian Power Sector Reform and encouraging more participation.

Improve Overall Market Efficiency

Electricity derivatives make the market more organized and efficient. With clearer price signals and better planning tools, companies can make smarter decisions. This reduces uncertainty, encourages investment, and helps create a more stable and reliable electricity market.

Electricity Derivatives Trading in India: Process and Features

Electricity derivatives in India, particularly NSE MCX Electricity Futures, are traded on recognized exchanges such as the National Stock Exchange (“NSE”) and the Multi Commodity Exchange (“MCX”). In June 2025, the Securities and Exchange Board of India (“SEBI”) officially approved electricity futures on both exchanges marking a significant step in bringing energy derivatives under SEBI’s regulatory framework. Settlement is based on the average Day-Ahead Market (“DAM”) prices published by the Indian Energy Exchange (“IEX”).

Each futures contract represents 1 MW of electricity supplied over a fixed number of hours in a calendar month. Prices are quoted in Rs. per MWh, and the minimum tradable lot size is 50 MWh. For instance, if the price is Rs. 5 per unit, 1 MWh (equal to 1,000 units) would cost Rs. 5,000, making the value of a 50 MWh lot Rs. 2.5 lakh. Prices move in tick sizes of Rs. 1 (equal to Rs. 50 per lot). These contracts are available up to four months in advance and are traded electronically from 9:00 AM to 11:30/11:55 AM on business days.

To manage financial risks, all participants must maintain margins calculated using the Standard Portfolio Analysis of Risk (SPAN) system, widely used in derivatives markets. Profits or losses are settled daily through mark-to-market adjustments. Eligible participants include independent power producers (“IPPs”), distribution licensees, large open-access consumers, energy traders, mutual funds, banks, and retail investors via brokers, all of whom are not required to have access to the physical electricity grid. These fully cash-settled contracts provide an efficient and transparent way to hedge against electricity price volatility, now within a robust SEBI-regulated structure.

Regulatory Framework: SEBI vs CERC Jurisdiction

The jurisdiction over electricity contracts in India has now been clearly divided between two key regulators, the Central Electricity Regulatory Commission (“CERC”) and SEBI. This clarity comes after a long-standing regulatory dispute, which was finally settled by the Supreme Court on 06.10.2021, in the case of Power Exchange of India Ltd. through Vice President vs. Securities and Exchange Board of India & Others. The resolution was based on a mutual agreement reached between the two regulators, SEBI and CERC. According to this arrangement, CERC will oversee physical delivery-based contracts in the electricity market, while SEBI will regulate Financial Electricity Contracts, including SEBI Electricity Futures for non-physical settlements. This division ensures smooth coordination between the physical and financial aspects of electricity trading.

The CERC continues to regulate the physical power market, including contracts that are settled by the actual delivery of electricity, such as those traded on power exchanges under strict conditions. These contracts must involve real delivery without netting, cannot be transferred or rolled over, and must be free from circular trading. CERC’s role is to maintain transparency, fairness, and market integrity in the spot and forward physical power markets. Power exchanges must also share relevant trading data with CERC as required.

On the other hand, SEBI has full authority over financial electricity contracts, including commodity derivatives that do not involve physical delivery. With this regulatory clarity, exchanges like NSE and MCX are now able to introduce electricity futures and other financial products. This development is expected to deepen the power market, boost participation from generators, discoms, and large consumers, and allow better risk management through hedging tools. It also paves the way for the introduction of longer-duration contracts, supporting more efficient short-term power procurement across the sector.

Risks and Challenges of Electricity Futures in India

Electricity futures, like any financial derivative, involve certain risks, the most prominent being price volatility. Electricity prices can swing sharply due to various factors such as weather changes, fuel supply issues, grid constraints, or sudden shifts in demand. Since electricity cannot be stored easily, even small imbalances between supply and demand can lead to significant price movements. If the market moves against a trader’s position, they could face considerable losses. Moreover, because these contracts are marked to market daily, traders need to maintain adequate margin balances. A sudden price drop could trigger margin calls, requiring them to deposit additional funds quickly or risk having their positions squared off.

Another important risk is the relative complexity and limited liquidity of the electricity futures market. Being a newer segment in Futures Trading India, trading volumes are still growing, which can make it harder to exit positions quickly without affecting the price. Participants must factor in these uncertainties when engaging in Futures Trading in India to avoid exposure to unpredictable regulatory shifts. For retail investors or institutions unfamiliar with the nuances of the power sector, these factors can make electricity futures a high-risk, knowledge-intensive product, requiring strong market awareness and sound risk management practices.

Conclusion: Why Electricity Futures Signal a New Era in Indian Energy Market Derivatives

India’s introduction of electricity futures is a big and timely step towards modernizing its power market. It gives companies and consumers a way to manage electricity price risk, discover fair prices, and plan their electricity use and spending more efficiently. By treating electricity as a tradable financial product, India is following the path of other advanced countries that have built strong, reliable energy markets through innovation..

As electricity demand continues to grow and new energy sources are added, a strong futures market will help support this growth. The launch of these contracts on platforms like MCX marks the beginning of a future where India is not just a large energy consumer, but also a leader in smart and well-regulated power trading.

FAQs

What are electricity futures and how do they work?

Electricity futures are standardized financial contracts traded on NSE and MCX, which allow participants to fix the price of electricity for a future period. These contracts are cash-settled, meaning there is no physical delivery of electricity. At the time of expiry, the contract is settled by paying the difference between the contract price and the prevailing spot market price, helping buyers and sellers manage price risk effectively.
Why is electricity considered a financial commodity?

Electricity is treated as a financial commodity because it is actively traded on exchanges like NSE and MCX, just like other commodities such as oil or gold. Through instruments like futures and options, electricity trading supports price discovery, hedging, and speculation, in the same way other physical commodities are traded in financial markets.
How do electricity futures benefit power producers and consumers?

Electricity prices in India keep changing because of factors like demand, weather, and fuel costs (especially coal and natural gas). This price volatility creates risks for power companies, industries, and traders, affecting their profits. Electricity futures help manage this risk by allowing participants to lock in prices in advance, giving more financial stability.
What role does SEBI play in electricity derivatives trading in India?

The Securities and Exchange Board of India (SEBI) is responsible for regulating electricity derivatives like futures and options that are traded on platforms such as MCX and NSE. While the actual electricity contracts fall under the control of the Central Electricity Regulatory Commission (CERC), SEBI oversees the financial trading side to ensure smooth and transparent operations in the derivatives market.
How do electricity futures help in managing price volatility?

Electricity futures contracts are an effective tool for power market hedging, as they allow participants to lock in electricity prices in advance. This helps reduce electricity price risk by protecting against sudden changes in the spot market. Power producers, utilities, and large consumers benefit from more stable costs and predictable revenues, making financial planning easier and less vulnerable to price swings.
Where can electricity futures be traded in India?

Electricity futures are standardized financial instruments that let buyers and sellers fix electricity prices for a future date. These contracts are traded on regulated platforms like the MCX and NSE.
What are the key differences between physical and financial electricity contracts?

Physical electricity contracts involve actual delivery of power through the grid and are regulated by CERC. In contrast, financial electricity contracts, like futures, are cash-settled without physical delivery. The former manages supply logistics, while the latter helps hedge electricity price risks.
How do electricity futures impact the Indian power market?

Electricity futures impact the Indian power market by providing important tools for risk management and transparent price discovery. These contracts help market participants hedge against price volatility, leading to more stable and predictable pricing. Additionally, electricity futures attract capital investments and support growth across the entire electricity value chain, thereby playing a major role in transforming the sector.
What risks are involved in trading electricity derivatives?

Trading electricity derivatives carries several risks. First, because these contracts are cash-settled, their prices can sometimes differ significantly from actual spot electricity prices, especially when the contract is far from expiry. This can lead to a mismatch between the derivative’s value and the real market. Second, timing mismatches, where a consumer’s billing cycle doesn’t align with the contract’s expiry can leave certain periods unhedged, exposing them to price swings. Third, regional differences in spot prices mean that the price at the exchange may not reflect the local market price, which can affect hedging effectiveness. Finally, inaccurate estimates of electricity consumption can either leave a participant under-hedged, increasing risk, or over-hedged, increasing costs unnecessarily.
How are electricity futures settled without physical delivery?

Electricity futures are usually settled in cash, so there is no physical delivery of electricity. Instead, gains or losses are determined by the difference between the agreed contract price and the current market price at settlement.

References

CIVIL APPEAL Nos.5290-5291 OF 2011