Electricity prices are shaped not only by how much power is produced but also by what buyers expect prices will be tomorrow. In India’s wholesale electricity markets, utilities and large consumers routinely secure power in advance through short-term exchanges rather than rely on uncertain real-time prices.
This behaviour reflects a basic feature of electricity systems: electricity cannot be stored easily and demand fluctuates sharply. To avoid sudden price spikes, buyers often purchase electricity ahead of delivery. The gap between the advance price and the price at delivery – known as a risk premium – is the cost of that insurance.
These premiums are not trivial. They average about 4 percent on weekdays and can rise to nearly 13 percent on weekends. More importantly, when they rise persistently, they reveal deeper pressures within the power system – from fuel costs to supply constraints. How these pressures translate into electricity prices depends on how short-term power markets are organised.
A Market Built on Day-Ahead Decisions
India’s short-term electricity markets operate largely through advance trading. In the day-ahead market, buyers and sellers agree on electricity deliveries for the following day, with prices set through competitive bidding on power exchanges.
Because much of this power is secured in advance, day-ahead prices incorporate expectations about fuel costs, demand conditions and supply risks. Distribution companies secure most of their short-term power through these contracts, using real-time trading mainly to correct imbalances as actual demand and supply unfold.
Risk premiums therefore emerge most clearly in this market, where buyers weigh the cost of securing electricity in advance against the uncertainty of real-time prices.
Coal Dependence and the Cost of Volatility
In India’s power system, the fuel that most strongly shapes electricity costs is coal. Despite the rapid expansion of renewable energy, around 70 percent of India’s electricity generation still comes from coal-fired power plants. When coal becomes more expensive or supply becomes uncertain, the cost of generating power rises and is quickly reflected in electricity market prices. In a system where buyers frequently secure power through day-ahead contracts, this can translate into higher prices and larger risk premiums.
The sharp rise in coal prices in early 2021 illustrates the link clearly. Risk premiums in India’s electricity market increased significantly – by more than ₹200 per megawatt-hour in the day-ahead market before prices later stabilised.
When Global Shocks Reach the Power Grid
Fuel price movements in India’s electricity markets are shaped not only by domestic supply conditions but also by developments in global energy markets. The Russia–Ukraine war offers a stark example of how geopolitical events can influence electricity prices far beyond their immediate geography.
In the weeks following the invasion, global energy prices surged sharply. Oil prices increased by about 40 percent, coal prices by roughly 130 percent, and natural gas prices by nearly 180 percent.
These shocks quickly filtered into electricity markets worldwide. For India, which imports large quantities of energy commodities, the impact was particularly visible. Higher international coal and gas prices altered import costs, and amplified uncertainty in energy markets. For power producers and electricity buyers alike, these shifts translated into greater price volatility in short-term electricity markets, particularly during periods of tight supply and peak demand.
But how exactly do these global and fuel-market pressures translate into electricity prices in India’s power markets? The answer lies in how short-term electricity trading is organised.
Designing a More Resilient Power Market
Risk premiums are not inherently problematic. In well-functioning electricity markets they reflect rational behaviour: buyers pay a premium to secure supply and reduce exposure to sudden price spikes. But persistently high or volatile premiums can signal structural pressures within the power system.
Addressing those pressures requires two complementary responses: stronger financial instruments that allow participants to hedge risk over time, and greater physical flexibility within the power system itself.
India’s electricity markets still offer limited options for managing price risk. Compared with mature electricity markets in Europe and North America, forward and futures markets remain underdeveloped, leaving much of the sector’s risk management concentrated in short-term trading.
Expanding these financial instruments could distribute risk more efficiently across time and market participants, reducing the pressure on short-term markets where risk premiums currently concentrate.
At the same time, strengthening the system’s physical flexibility can reduce the price volatility that drives risk premiums in the first place. Expanding renewable generation and energy storage can reduce exposure to fuel price shocks originating in global energy markets.
Technologies such as battery storage, demand-response systems, and flexible generation can help balance sudden shifts in supply and demand, reducing the price spikes that drive risk premiums.
The Next Phase of Market Reform
India’s electricity demand will continue to grow as industrialisation, urbanisation and electrification expand. Managing that growth will require not only additional generation capacity but also more resilient electricity markets capable of absorbing global energy shocks.
Ultimately, market design determines how those shocks reach consumers. In markets where risk premiums already average between roughly 4 and 13 percent, those design choices matter.
Markets with deeper hedging instruments and greater system flexibility can absorb volatility. Where such buffers are weak, it passes directly into electricity prices.