ENERGY & TRADING
Complex and compelling
Energy is the foundation of modern life, and energy trading plays a crucial role
in keeping energy supplies secure, affordable and carbon-efficient.
THE MAKING OF THE MODERN WORLD
The increased use of energy over the last century or so has significantly improved our standard of living.
We rely on energy for just about everything in our homes, in our places of work, and for the transportation of people and goods. In fact, we couldn’t perform most of our daily tasks without energy.
Modern society depends upon a safe, consistent and abundant supply of energy to function: without it, bills become unaffordable, homes freeze and businesses stall.
Energy supply has become the most important aspect of modern living and convenience, and energy trading has become key to ensuring sufficient supply.
Across Europe before the 1990s, energy supply was a state-run vertically integrated monopoly comprising production, distribution and trading.
By the early 2000s, several European countries began to deregulate their creaky energy industries by separating these components. This trend was eventually transformed into actual EU policy, triggering the creation of energy markets within the EU.
Since 2008, the EU energy market for electricity and natural gas has been liberalised in most countries, creating more competitive structures in which prices are set by the markets.
The successful coupling of the power markets in Europe (the allocation of cross-border capacities to enable fast and efficient trading of power) currently comprises over 20 countries.
FROM FOSSIL FUELS TO RENEWABLES
Most energy has traditionally been obtained by burning fossil fuels, finite resources which, when burnt, release by-products harmful to the surface biosphere.
To mitigate harm to the environment, the EU aims to eliminate net EU emissions by 2050 by encouraging the development of renewable energy sources – including solar thermal, photovoltaics, wind, hydro, tidal and bioenergy.
Renewable energy is any source of energy that doesn’t consume the finite resources of the Earth and can be easily and quickly replenished.
To help meet the 2050 goal, the EU has set an ambitious interim target to raise the share of renewable energy to 40% of final consumption by 2030.
Progress in the green energy transition has been made. As recently as 2015, Europe generated twice as much electricity from coal as it did from wind and solar. Today, coal makes up just 12% of the EU’s electricity generation, while wind and solar provide over 20%.
Energy markets, however, remain vulnerable to disruption and have yet to master the new reality: the decline of fossil-fuel output, and a rising share of intermittent solar and wind power – neither of which can be controlled by the flick of a switch.
POWER AND GAS TRADING MARKETS
Power and gas trading are similar in many ways, yet they differ in one obvious characteristic: gas can easily be stored and transferred at a later date, whereas power – with the exception of hydro-electric dams – is difficult to store in large quantities and demands that power generation is closely aligned with power consumption.
In Europe, power trading is conducted via 30 or so power exchanges, via brokers, or over-the-counter (trades that take place outside of power exchanges without intermediaries or clearing houses).
Power exchanges operate in a similar way to regular stock exchanges.
For power traders, power exchanges offer Intraday trading (the continuous buying and selling of power on the same day as the power delivery) and Day-ahead auctions (power for the next day is traded for a dedicated hour or quarter-hour interval).
Gas trading in Europe is conducted on a dozen or active gas trading exchanges (known as gas trading hubs), via brokers, or over-the-counter.
Gas trading hubs operate in a similar way to regular stock exchanges, and offer short-term traders Intraday and Day-ahead options similar to those in the power marketplace.
ENERGY TRADING IN TRANSFORMATION
In tandem with the transition to intermittent renewables from fossil fuels, trading itself is undergoing a radical change as digitalisation, access to data, advanced analytics and innovative IT capabilities transform the trading landscape.
Today, traders enjoy increasing accessibility to market and weather data, talent skilled in machine learning and statistical algorithms, and computing power capable of predictive analytics fast enough to identify market signals and trigger trades.
Big data and predictive algorithms enhance the accuracy of fundamental analysis, meaning that IT specialists now play a pivotal role in providing structured data directly to trading systems.
By enabling faster and more accurate decision making and cost reduction, automated digital technologies have become indispensable to traders for retaining a competitive edge and protecting trading margins.
DATA-DRIVEN APPROACH TO BUSINESS
To fully leverage digitalisation, energy trading houses must now take a data-driven approach by digitising their data, workflows and – most challenging of all – mindsets.
Intelligent trading systems now demand anticipation and response to changes and challenges on an ongoing basis.
To remain competitive, energy trading house leaders must adopt a disruptive vision and create a culture that encourages continual experimentation.
THE ENERGY TRADING SETUP
While most people visualise a room full of traders doing deals and making money, the reality is a little more complex. For every trader, there are a number of people needed to help to make it all work seamlessly. Generally, there are three departments in a trading organisation:
The front office
Where traders map out and execute trading strategies, supported by analysts looking into all the factors that drive energy prices – e.g. pricing, weather, consumption and capacity data. To minimise delivery costs, scheduling and dispatching are also managed here.
The middle office
Where the risk inherent in the company’s portfolio and the exposure of the business is managed on a day-to-day basis. This includes managing trader limits, credit and market risk, compliance and profit and loss reporting.
The back office
Where settlements and accounting are processed, collateral is supervised to ensure sufficient funds to clear deals, and where regulatory reporting and tax are managed.