With physical deliveries

The Securities and Exchange Commission (SEC) has reportedly given its go-signal on the establishment of a “derivatives market” in the Wholesale Electricity Spot Market (WESM) as long as this is anchored on commodities that will have actual physical deliveries.

“When we sat down with the SEC, their major input to us was: we can start with the derivatives as long as there’s physical delivery of the commodity. But if the derivatives market will just be based on ‘speculations’, they told us that current mechanisms and laws may not allow that,” said Isidro E. Cacho, Jr., chief corporate strategy and communications officer of the Independent Electricity Market Operator of the Philippines (IEMOP), the entity currently operating the WESM.

He qualified though that they would still need additional round of studies and further discussions with SEC before they will kick-start derivatives offer in the spot market.

Cacho said the propounded derivatives market will be ideal for “forward contract” that generation companies (GenCos) can lean on, especially on their need for “replacement power” when their generating facilities will suffer forced outages.

In finance, a “forward contract” is a non-standardized transaction agreed upon by parties to buy or sell an asset or commodity at a specified future time and with agreed price at the conclusion or firming up of the contract.

For derivatives market in particular, these instruments could take the form of “futures contract” or “options contract” - which may be underpinned by a whole range of commodities that could be incorporated into the power spot market.

“What we’re looking at is a ‘forward market’ that can have a tenor of one month or quarterly or even annual…because one aspect that we’re trying to address is the need for power replacement. Since for example, if a generator loses capacity because of forced outage, then there should be a market mechanism in the WESM that would be able to address that,” the IEMOP executive emphasized.

When power plants in the country conk out due to technical glitches, these GenCos would have to guarantee “replacement power” that shall be funneled to their off-takers (capacity buyers) because these are generally required under their power supply agreements.

The replacement power will ensure that brownouts could be avoided, but under current set-up, these capacity-procurements are often exposed to price volatilities that could end up more expensive for consumers.

Cacho indicated they would also need further collaboration with the Philippine Electricity Market Corporation (PEMC) because aside from the derivatives market, there are proposals for the integration of financial transmission rights (FTRs) in the new market management system (NMMS) of the WESM.

FTR is a type of financial instrument that entitles the holder to receive compensation from congestion costs that arise when power transmission grids are congested as a result of the dispatch of power plants.

With FTRs, trading participants in the spot market could steer clear of potential losses relative to price risks inherent in the wheeling of energy capacity into the grid.

As envisioned, such financial instrument “will address the volatility of prices associated with power supply due to transmission congestion costs.”