We invested in Indian Energy Exchange (IEX) during March 2020 crash at a very opportunistic price of Rs 144 per share i.e. at a market capitalization of Rs 4,300 Cr.

In simple terms, our investment thesis in IEX revolved around the fact that this disruptive business has been leveraging technology to bring operating and financial efficiency in one of the most inefficiently run large sectors - power. The price discovery and operating ease offered by a power exchange stand to benefit the entire value chain - power generators, power distributors as well as power consumers. IEX has over 95% share in the exchange-traded power, which is 40% of short-term power which in turn is just 10% of overall traded power in the country. Rest 90% is still sourced via long-term (25-year) power purchase agreements (PPA).

Since IEX is practically a monopoly, the incremental market share opportunity is negligible. Hence the two key drivers to take the company forward are naturally the rising share of exchange-traded power within short-term power, as well as rising share of short-term power within overall traded power. Both these need massive regulatory overhaul across the ecosystem.

Our 18-month journey with IEX has been surreal because the regulations which have been in the workings for years have all been pushed in this period. In the last couple of years, a series of new products have been launched by IEX, out of which real-time is the most noteworthy. Recently, regulations have further paved the way for the introduction of long-term power contracts (beyond 11 days) to be traded on the exchange. The regulator has also announced the implementation of Market-Based Economic Despatch (MBED) Phase-1 with effect from 1st April 2022, under which all of NTPC’s volumes will be traded via exchange which alone will increase the total volumes by 300%. In the subsequent phase, as long-term PPAs expire, non-NTPC power will also be routed through exchanges.

In a blue sky scenario, the annual profitability can move to Rs 1,500-2,000 Cr over the next 5-7 years vs Rs 250 Cr currently. Such positive developments have resulted in a massive jump in its stock price; compared to our entry at Rs 144, the current price is Rs 710 implying a market cap of Rs 21,300 Cr, a 400% jump in just 18 months.

While these are landmark reforms and have the potential to change the very orbit for the company, we also need to keep in mind the risks, the biggest being that power is an extremely regulated business:
1). The regulator (CERC), as well as Government, wants to bring efficiency and ultimately reduce power costs for the consumers. In this regard, another policy that is in the working is - Market coupling, where all exchange bids will be collated to arrive at a single market-clearing price, and effectively IEX losing its moat - volumes and price discovery.
2). While the competing exchange PXIL is trying to revamp, a third exchange co-promoted by BSE, PTC India & ICICI Bank recently got approved by CERC.
3). The biggest risk though lies in the fee cap - currently, the maximum fee an exchange can charge is 4 paisa/unit which is almost 1% of the power cost. In a scenario in which regulations bring down the permissible fee or demand preferential treatment to the likes of NTPC, the positive financial impact of higher volumes could be nullified to that extent.

To summarize, there are certainly a lot of positives as well as potential negatives (risks) waiting to play out in this story. If a series of positives play out first, the market could continue to reward whereas if certain negatives play out first or in parallel, the value of the company may erode or stay range-bound. It is impossible to predict the sequence of events increasing the role of luck from here on.

At this stage, we don’t prefer to carry full exposure, neither do we intend to exit completely given runway as well as certain optionalities around Gas Exchange too. Accordingly, we suggest rebalancing the position in the following manner: We had initially allocated medium (5%) to this position, which has today risen to almost 9% due to the stock’s outperformance. We are downgrading the suggested allocation to low (3%).

This implies we have to bring the current weight down to 3% by chopping the excess above it.
For instance, if your current allocation is 9%, you would sell 6% (two-third) while holding the remaining 3%.