Trading & Risk Management Technology
the fact that price fluctuations cannot be passed on to customers in today’s competitive environment. Even if such fluctuations can be passed on, the effect will be reduced consumption, at least in the short-term. This means that the impact of unfavourable commodity prices has to be absorbed by the corporation, so there is a definite downside to not protecting commodity price levels. Therefore, in the absence of a clear objective, many
corporations forget (more often than not) that the purpose of hedging using various instruments is to protect against the market risk of commodity prices going against them and not for profiting from the hedges. In almost all instances after the hedges are executed there is further need to dynamically manage these hedge positions. For example, a power generation company with several
power plants might need to secure the availability of physical coal for running plant at budgeted prices over a period of time to ensure their operating margins and growth. Recent market volatility has created a growing demand for ETRM/CTRM systems – the category of software applications, architectures and tools that support the business processes associated with managing and trading commodity exposures. Not surprisingly, these software suites tend to be composed of a very complex set of functionalities that vary considerably depending on which commodities are traded, what assets are employed in the business, where those assets are located, and what the company’s business strategy and associated business processes might be and how they alter in real-time. The market for ETRM/CTRM software
has become more buoyant. It has rebounded significantly as hedge funds, proprietary traders and investment banks have entered the market. UtiliPoint International research indicates growth rates for software in North America and Europe at 15% in recent years. After the recent lull in activity, more and more companies are directing their attention to T&RM systems once again. Additionally, the development of new and maturing of
existing electronic marketplaces (such as CME Group and ICE) has reduced many of the barriers to entry for those wishing to trade commodities, with the expansion of the number and type of traded instruments fuelling this growth. Another aspect of this growth is that the requirements have
changed and, particularly in North America, replacements of older solutions has taken place. In fact, the changes that Utilipoint have observed in commodity markets in general are helping to drive fundamental changes in both trading and risk management practice and in the requirements for T&RM software – particularly with credit and regulatory risk becoming
worldPower 2010
paramount in today’s trading environment. Notwithstanding the temporary decline in trading for a number of energy commodities last year, overall there has been an increase in traded volumes through an increase in the number of instruments, exchanges and traders – a growing financial aspect to commodity trading, with larger and more erratic price swings. Increasingly, commodity price movements have had veteran traders fooled and looking for rhyme or reason to explain market events. And one characteristic of today’s commodity markets that must not be overlooked is the fact that they are now a fully-fledged asset class in their own right.
Impacts on Energy Trading & Traders At the highest level, there are three major impacts of all
this in terms of trading and risk management. The first major change is that, unlike a few years ago multi-commodity trading is increasingly the norm. A second significant change is that simple directional trading
... these software suites tend to be composed of a very complex set of functionalities
strategies that profited earlier in the commodities cycle are increasingly being replaced by more sophisticated trading strategies including spreads, options and ‘black box’ trading. Some trading strategies conducted by financial players in these markets would not make much sense to traditional physical energy traders. What often gets forgotten is that hedge funds and investment banks make money in both up and down markets and (as discussed above) are not limited to a fundamental view of the commodity world, seeing opportunities that play across different asset classes. Furthermore, there are a wider variety of instruments to trade.
The final change worthy of note is that with these new
instruments, trading strategies, factors influencing price formation and changing commodity inter-relationships, there is an impact on risk management – and the systems required to manage trading, risk and reporting. The Gartner Group recently identified a number of factors
that have continued to influence the T&RM platform market in its ‘Magic Quadrant’ series (Figure 1). As Gartner note, the global energy and utility market continues to be driven by a confluence of forces: energy sustainability and environmental concerns, shifting regulations, and the quest for improved performance and profitable business models. Consequently, energy and utility companies are forced to modify their IT and operational technology application portfolios and architectures, and to closely review their investments in T&RM platforms. A further concern for market professionals, as volatilities and other parameters have changed is, “Are the risk measures
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