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The commodities world is experiencing a rapid evolution. We explore how trading technologies can be the key to unlocking the potential of this changing and exciting market
Changing Geopolitical Landscape:
In recent years, energy has come to the forefront of everybody's mind. Whether this has been from the impact of COVID-19 or from the recent conflicts in the Middle East and Ukraine.
Throughout 2022, the weaponisation of natural gas supplies by Russia as it engages in a proxy war with NATO created concerns regarding the scarcity in the natural gas supply and subsequently sharp increases in the gas price. In turn these significant gas price spikes were the main contributor to the high electricity prices that had a major impact on the EU economy.
Prices have started to stabilise in energy markets from their 2022 peaks but with prices still tenfold of their historical averages, trading volumes have continued to significantly increase year on year for both power and gas.
Uncertainty around the supply of natural resources coupled with the energy transition to fight global warming have both contributed to changing the profile of energy as a tradable asset. This in turn has attracted non-traditional players into the energy market and diversified the trading needs amongst market players which now need to be serviced.
The presence of hedge funds is more common along with the banking sector looking to reignite growth in their commodities businesses in pursuit of alpha. Equities and fixed income markets have been lacking returns and following the price evolution and recent volatility there are attractive returns to be made in energy. Many Hedge funds have procured the services of direct market access providers for their intermediation services which has provided a bolster to clearing businesses in the OTC space.
We have also seen breakaways from large utilities companies to the setting up of smaller speculative trading firms and energy providers, increasing competition within the market with more counterparties to trade with outside of the traditional houses.
Volatility and high interest rates to control global inflation together have created an environment where posting margin has become more difficult with counterparty risk increasing. These factors have impacted OTC trading where we have seen traded volumes move to exchange, representing almost 80% where benchmark products of Dutch TTF and Germany Baseload dominate the gas and power markets respectively.
Spot Power, Net Zero & Algorithmic Trading:
With contracts being traded in real time there has been large growth in the spot power market with a 54% increase in EPEX volumes spot between 2022 and 2023. Demand and supply imbalances, greater investments and drives towards renewable energy that have been put forward by the United Nations and individual governments have stimulated a large growth in the spot power markets. This has been further bolstered by technologies and investments into areas such as battery storage and to both store and optimize renewable assets whilst complying with efforts to minimize increases in global warming.
With around 80 % of the power spot power market being traded via algorithms, this has become one of the most interesting and talked about areas within the energy trading industry. Volumes are now being traded in microseconds and it is vital that trading firms are able to maximize speed to market, efficiency and transact quickly on any open opportunities with the right toolkit.
The new governance around energy and net zero has also seen the Introduction of an increased number of environmental products such as carbon offsets Guarantees of Origin (GOOs) and more bespoke offsetting of emissions with marketplaces such as Voluntary Carbon.
Reporting and Data Processing:
The immense volatility in energy markets and the exponential increase in market sizes over the past two or so years has caused both regional and market regulators to adopt more stringent reporting and request greater disclosure from their members. This in turn has required trading participants to provide up-to-date, complete information showing all order types and venues and to be delivered in a timely fashion each day to meet their regulatory needs.
The increase in trading volumes and order actions created a need for a larger amount of data to be reported and integrated seamlessly with third party surveillance software.
How can execution platforms benefit their clients in these changing times?
With a more robust risk and return profile stability is at the heart of electronic execution, the margin for error has dramatically reduced. Participants require technology that is able to deal with volatile times within the market.
Traders require a reliable and stable execution engine built on contemporary technology to meet the demands of new energy market dynamics. This must maximize speed to market, efficiency and allow smooth transaction quickly to draw on any open opportunities.
When it comes to algorithmic trading this is even more so the case. A sophisticated netting process is required to run simultaneous algorithms, with a clear and simple framework to connect to their own programming along with robust internal controls to satisfy compliance teams within organisations and at the regulatory level.
The increased importance of the spot market and renewables means it is vital to be able to provide access to small and mid-size firms with less complex IT infrastructure compliant algorithmic trading solutions in the form of predesigned algorithms which can be configured quickly and easily in real time by traders. This should include the ability to optimize new assets such as batteries in their role of both feeding into the grid and marketing the flexibility energy on the spot market.
Latency is another issue which must be addressed in order for traders to find and transact on the best prices available in the market and successfully implement their strategies. Slow order actions during busy times in the market create costly losses and confusion whilst servers speak to each other across borders. Solutions such as co-location with exchange and venue servers provide security along with the vital microseconds edge that is required to not miss out on the best price.
A cross a market view with aggregation over a variety of products in the energy ecosystem as we are seeing more spread trading between products, especially from the more speculative players. Aside from this, access should encase the entire universe of energy contracts from crude oil to GOOs and environmental products which will all play a big part in the immediate term and provide a truly holistic view of the entire energy market.
Every company has their own needs and workflows which are optimal to them. COVID-19 caused trading houses to reevaluate their workflows and what works best, and this has been amplified by the recent supply shocks in the market. As trading operations increase in size and become more innovative, the nuances in their workflows are more relevant to maximize their resources and it becomes less of a one size fits all scenario.
Access to dedicated, knowledgeable and on demand consultancy services is a must have to provide the level of customization required by the most prominent trading houses. Individualism within the market is what gives traders their proprietary edge and it is paramount that this is harnessed.