Don’t ask what has changed in energy: the answer is almost everything. First, fundamentals are changing as we transition to a low-carbon economy. With renewable energy the volume is inherently unstable: wind power is not like a nuclear power station, where the output is constant. Instead, you are constantly trying to understand how much power you will get and when. This volume uncertainty has driven a move to more short-term trading and a shift from longer-term hedging strategies to short-term optimisation of highly flexible assets. At the same time, the market as a whole is more volatile. That’s just the first two problems that you are trying to solve.
Meanwhile, traders have lost access to some hedging options because of the high cost of credit.
This is the new normal and it has driven up the volume and variety of trades. Even looking simply at basic transaction costs it is cumbersome and expensive if you try to manage this with out of date IT, but bigger risks loom behind. For example, a couple of years ago, when oil markets went negative unexpectedly, it was not supported by the option models used to value option contracts. Exchanges swapped out their option models – and providers had to support the change immediately, to understand their exposure.
Of course, oil prices are not negative now. Far from it. February’s invasion of Ukraine by Russia is causing both short-term and structural change in energy markets. In the gas markets we have seen prices that nobody expected to see – and hedging and risk management practices that are built around £50/MW are not the same as they are at £200/MW.
Energy flows are changing and the instruments you need to hedge with are almost certainly different today than they were six months ago. You have to have the flexibility of being able to trade different instruments, whether that is LNG instead of piped gas (because the gas that was coming in from Russia is now coming in shipbound), new locations or new transport routes – in fact, any new options that allow you to manage your risk better. Alongside the new options we have also seen the re-emergence of some commodities that have been out of favour for some time, such as coal.
But the Ukraine invasion is just the latest shock that has hit the industry and that should be a lesson. No hedging practices are going to be static in future, instead flexibility and responsiveness will be the watchwords for traders.
That has to be reflected in the technology that supports them. It’s okay being able to come up with a new strategy, but if you can’t enable it in the IT, it’s meaningless.
The system has to be able to react fast. The days of traditional implementation projects where trading a new energy commodity or entering a new region takes months to go live, is no longer acceptable. You need to be able to respond directly and have a flexible system with a return time of hours sometimes, not days or weeks.
We see the problems of dealing with out of date IT when we replace systems. Old IT, based on spreadsheets, can take a day just to get to the point where you can say, “I have a good set of records here that represents what I am doing.” It limits the amount of trading that the business can do, because of the operational risk.
Now you need to have those records reconciled in real time, and see deals appearing instantaneously, so you have confidence that the position is right. With more confidence in your hedging and risk exposure you can do more trades – and also have more freedom to take calculated risks.
Managing a high volume of trading, a short-term market, high volatility, volume uncertainty and price shocks is the new normal. It is a complex technology problem, but it is fundamental to what we offer our clients.
We think any system has to offer at minimum a modern high performant technological architecture that modifies quickly and can provide real-time positions and real-time P&L. We’ve added to that high levels of connectivity to all the major European exchanges and ‘straight through’ processing with high levels of automation in front middle and back office to support the necessary flexibility so if you ask for it tomorrow – you get it.
Your IT shouldn’t be a constraint on determining what you can and can’t do.