The energy trading landscape continues to be reshaped by the green transition, the proliferation of battery storage options and the advent of algorithmic trading. As a result, the demands on ETRM systems have intensified. In this blog we discuss the evolution of energy trading desks and how technological shifts have fundamentally altered the approach to software implementation, internal resource allocation, and the purchasing lifecycle, presenting both opportunities and challenges for market participants.
Functional strengths
The extent to which the system is designed to best service the front, middle, or back office is a key differentiating factor in the marketplace of vendors and products.
Legacy ETRM systems were heavily back office-focused, reflecting the composition of the energy markets in years gone by, where larger assets and generators with fleets of large assets represented the vast majority of trading volumes. These systems were geared more towards contract management, accounting, and other back office functions, and less towards the needs of the traders.
Today, with the growing prominence of renewables, the advent of batteries, and the technological progress which has allowed for algorithmic trading, traders are relying much more on their ETRM systems. Consequently, some of the more modern ETRM systems have adapted over recent years to offer the front office a wider set of features such as live position and P&L, which were not possible with the older technology stacks used in the past.
Geographical locations
Different markets can have quite different rules, processes, and regulatory conditions that energy traders need to adhere to. Thus, the system which services them needs to adapt to these differences in various ways. One example is the need to facilitate the user not being in imbalance in one market due to regulatory constraints (e.g. in Germany), while this could be a perfectly acceptable P&L decision in another market (e.g. in GB).
Another example is the need for the ETRM system to connect to different exchanges in one geography than in another, or to different transmission system operators in order to facilitate the scheduling of physical flows of power based on the user’s position going into delivery.
Complexity of implementation
A successful implementation of a traditional ETRM system typically involves teams of commodity subject matter experts from the front, middle and back office, as well as associated functional areas. On-premise installations require deployment of infrastructure teams to get these systems up and running and to integrate these systems with other platforms used by the organisation. In the era before cloud-native systems offering robust security protocols were available, it made sense for large trading organisations to keep all their tools ‘in-house’ as much as possible.
Today, energy market participants are diverse, from utilities to ten-person propriety shop trading houses, For many of them, a cloud-native ETRM system allows them to focus on their strengths in trading-related intellectual property, without the need for dedicated in-house IT resources to run and maintain on-premise software installations.
The evolving nature of commodity trading organisations
The fallout of the 2008 financial crisis resulted in an increase in scrutiny of any business engaged in trading, including commodity traders. A review of trading practices and assets held on the balance sheet of the banks which had become heavily involved in commodity trading followed, with many deciding to refocus their commodity trading operations on customer flow, or simply to divest them.
Hedge funds and energy merchants ‘absorbed’ the speculative trading operations of these banks – and teams which had previously worked at the banks raised their own capital to be able to keep generating P&L in their areas of focus. An era of lean trading operations had begun – where many participants now sought to access the markets through direct market access providers, to make use of more agile systems, and to focus more on their trading operations. There was less desire to keep the IT infrastructure needed to trade in-house, with all the associated complexities to manage.
Today, we see a large range of energy market participants coexisting – including large utilities, multinational energy merchants, vertically integrated asset owner-operators, asset optimisers who monetise assets for a fee, and large and small prop shops. With lower barriers to entry and increased competition, everyone is looking for a competitive edge, and this is driving increased deployment of newer technologies such as machine learning and algorithms into various aspects of commodity trading, from running the fastest and most accurate weather prediction models to the automated execution of trading strategies. Real-time systems are a must in this new era.
Challenges in modern energy trading: impact on the front, mid and back office
Energy markets today are more competitive than ever before. Direct/sponsored market access providers allow funds to access over-the-counter energy markets quickly, without the operational and capital requirements that traditionally acted as barriers to entry, increasing the number of market participants in the energy space. In the power trading space specifically, the advent of renewables has dramatically increased liquidity in the prompt day-ahead and intraday markets.
Statistical trading techniques honed in the equity markets have been applied to energy trading as liquidity has increased, bringing a range of new market participants into the sector who formerly specialised in other asset classes. Even the prompt markets in some of the more liquid geographies, such as Germany have been affected by this change, and traders are now automatically scalping P&L and arbitrage opportunities across various markets, time horizons, and commodity types.
Impact on the front office: traders
These trends have affected both financial and physical market participants. Proprietary traders seeking to extract P&L from market volatility find that they need access to the latest market intelligence, including their own position and P&L as soon as possible, lest they lose out on opportunities to their competitors.
Physical traders find that they require a live single source of truth about not only the market and their positions, but also the forecasted outputs of their assets. No trader of a renewable energy portfolio wants to be the last to know how to re-hedge their forecasted output, when they’re competing with other traders who would be taking positions in the same direction as them on the back of more up-to-date information.
Modern ETRM systems cater for traders specifically, providing real-time trade processing straight from the exchanges and venues that the traders are active on, and displaying comprehensive views of their positions, hedges, and even providing a live percentage-hedged view of their assets.
Impact on the middle office: risk managers.
The increased liquidity in modern energy markets creates a challenge for risk managers too – who seek live, intraday information to ensure that traders aren’t surpassing their trading limits within the span of the trading day, and then unwinding positions later on in the day so that the overnight reports show them to be compliant. The higher the number of trades, the more important it is to ensure that you have a system which can report a live risk view, as well as flexibly and quickly report on the back of your official marks to present your exposure the way you want to see it, and within a timespan that allows you to act on the information.
Impact on the middle office: operators
Higher trading volumes, power being moved across more markets, and all the accompanying scheduling requirements, from day-ahead nominations to within-day nominations and tracking of volumes to be allocated to interconnectors and more, mean that the potential for human error is higher than ever. Incorrect nominations can result in hefty imbalance costs to the company, if they end up with resulting imbalance exposure that happens to be on the wrong side of the imbalance calculation.
Impact on the back office: confirmations and settlements teams
Increased trade volumes place more demands on back office teams, and the process of manually confirming and settling large numbers of trades can become overwhelming. This is where ready-made solutions can be integrated into your trading workflows, and third party confirmation and settlement matching can be of great benefit. Rather than re-invent the wheel, deploying a modern ETRM system that natively integrates with these industry-standard tools allows your data to flow into them automatically, straight from the ETRM system itself, bringing significant efficiencies to your back office function.
The importance of modern ETRM systems
All the above means that trading companies today require ETRM systems that can parse all the information that is relevant to them, display it in an intuitive format, and display it in real-time. They need to be characterised by high levels of automation, all the way from automated deal capture, to the scheduling of physical power flows, to the reconciliation of various important data sources such as clearer files to ensure agreement. This is exactly the use case with which traditional, legacy ETRM systems struggle, and where more flexible, modern systems excel.
The purchasing model for an ETRM system
A perpetual licencing agreement used to be the standard model for purchasing an ETRM system in the era when they were all delivered as on-premise solutions, whereby the customer was entitled to use the software that they had purchased indefinitely. This would typically involve a large up-front charge for the purchase of the licence (similar to how the suite of Microsoft Office products used to be purchasable for a one-off fee as opposed to the monthly subscription model of today), as well as for the implementation of the system, during which it would be configured according to the client’s needs by the vendor. An ever- daunting “upgrade project” would have to be undertaken every 3-5 years – which in effect meant a brand new implementation project with all its associated costs.
This model has changed over time, as the spin-up and wind-down of trading operations to mirror the increase and decrease of volatility and resultant opportunities in different markets has become a more dynamic and fast-occurring process. ETRM software users now seek a lot more flexibility in pricing models. Vendors have responded by offering subscription-based options, which replace the traditional perpetual licence model, comprising an up-front fee and implementation costs.
Modern systems tend to give greater clarity and predictability with respect to what you pay. You sign up for a given configuration, and the price is then locked in for the term of your contract. Older on-premise solutions often included a number of hidden costs – your IT infrastructure, the maintenance costs associated with your particular implementation, the internal attention that would be required to manage associated projects, and so on.
Reliance on product specific experts
Traditional ETRM systems can be thought of as frameworks which rely on large teams of specialists for configuration and customisation. An entire labour market of consultants who specialise in specific legacy systems exist, and larger companies deploy them in-house to maintain and configure their ETRM system. Each change to the system becomes increasingly embedded in the trading entity’s operations and the sunk costs related to it increase, making it ever-harder for the business to decouple from it.
Business agility challenge
The above means that any changes to your trading operations, or market changes, require costly projects and project management to be undertaken, often with a significant risk of failure or delays. Being an on- premise installation does not help in this respect, as scaling of system resources requires its own planning and successful execution. This can often mean that the market opportunity which you were seeking to capture has long gone, or that your new team of traders are held back by not having access to the information they need to trade profitably for an extended period of time.
Business expansion challenge
The lifeblood of a trading company should be its trading IP – the personnel, analytical processes, and models it has developed to accurately predict how long or short the market will be on a given day, or whether the summer-winter gas spreads are looking cheap or expensive, and so on. As markets change, this IP can signal to you that P&L opportunities exist in adjacent geographies where they didn’t before, or that a new commodity class has become interesting to trade.
Beyond the challenges already inherent to business expansion of identifying, attracting, and onboarding the best talent to capture these expansion opportunities, traditional ETRM systems add several more barriers. If you want to trade a range of new instruments and a new market, the project becomes an IT issue as much as a trading one, with its own project management and associated resourcing considerations. Often, trading companies are not focused on maintaining a competitive IT edge, which then hinders their ability to do what they do best – trade where there is potential for profit.
Whether you are a new entrant to energy trading, an existing player expanding into new markets, or just looking to improve the overall performance of your trading operations, there are clear benefits of deploying a quick-to-implement, agile SaaS ETRM solution. Let us help you transform the way you trade and the results you achieve.
Download our white paper here:
The Future of Energy Trading & Risk Management: Looking towards 2030
Authors
Shubham Kumar
Product Manager
Mohammed Alanizi
Commercial Director
