The basics of energy trading. Edgar Wilton

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1 The basics of energy trading Edgar Wilton

2 Overview I. Liberalized electricity markets II. OTC and exchange trading III. Pricing analysis IV. Risk management V. Trading strategies 2

3 About me MSc in Risk Engineering MSc in Energy Science BSc in Economics At Priogen Trainee Trader (CWE short-term power futures, EUA ETS) Data Scientist/Trading Analyst 3

for the best possible price and reduce hedging and imbalance costs Traders, Analysts, R&D,

4 About Priogen Proprietary trading house In-depth scientific approach to price forecasting Focussed on short- and medium-term power trading Generation optimization Selling capacity for the best possible price and reduce hedging and imbalance costs Traders, Analysts, R&D, Meteorologists, Finance, IT, HR, Business Development Young, eager and inquisitive 40+ people 4

5 I. European Wholesale Power Markets 5

6 Overview The European wholesale power market is a conglomerate of regional markets (exchanges), which are physically connected. Exchanges usually provide a day-ahead market where the orders are submitted and the market is cleared on the day before actual delivery. Due to the long time span between the settling of contracts on the day-ahead market and physical delivery, most exchanges offer an intraday market. 6

coordinated calculation of prices and flows between

7 Market Coupling Market coupling Exchanges optimize the allocation of cross-border capacities by means of coordinated calculation of prices and flows between countries. CWE (2010) ATC vs. Flow-based NWE (2014) SWE CSE (2015) 7

Flow-Based Market Coupling Transmission capacity allocation is a trade-off between offering crossborder transmission capacity to the market and ensuring reliable power system operation.

8 Flow-Based Market Coupling Transmission capacity allocation is a trade-off between offering crossborder transmission capacity to the market and ensuring reliable power system operation. Since 20 May 2015 the CWE flows are no longer set by the TSO s based on security constraints, but by the physical laws governing the flow of electricity. Under FBMC, the external flows of the CWE countries are governed by codependent constaints reflecting the the physical limits of the grid. 8

9 Price coupling of regions Orders Network topology Network data (e.g. constraints) EUPHEMIA (Branch-and-cut) (Hourly) price per bidding area Net position per bidding area Flows per interconnection Input Output 9

10 II. OTC and Exchange Trading 10

11 Overview The main goal of exchange-based markets lies in the facilitating trading of standardized products, promoting participation and liquidity and providing clearing and settlement services. In addition, there is also an over-the-counter (OTC) market where contracts are traded that are not listed on exchanges (although OTC deals can be cleared here). Every OTC deal involves two counterparties, the buyer and the seller, who come to an agreement on a digital marketplace or over the telephone through a network of middlemen called brokers 11

12 Trading What is the purpose of a trade floor? A. To generate P&L B. To hedge generation assets C. To liaise between the clients dealing desk and the market place 12

13 Types of trading A. Speculative (spec) traders take positions based on where they believe the market is headed to make a profit for themselves. B. Asset-backed trading revolves around maximizing the value of a portfolio of various types of production assets. C. Sales traders are informed about the market, they ensure the smooth flow of information and trade requests and may execute trades as well. 13

14 Order Book Bid and Offer (Ask) Price-Time Priority Code shows at which broker (middleman) the order is available Terminology: Hit the bid and lift the offer or yours and mine What was the highest selling price in the market at the time? 14

Passive vs. Aggressive Order types Market order any price for a specific size Limit order a specific price for a specific size The Bid-Ask Spread The market is 39.75 at 40.

15 Passive vs. Aggressive Order types Market order any price for a specific size Limit order a specific price for a specific size The Bid-Ask Spread The market is at Passive vs. Aggressive: Mine in 25! Aggressive, when you need to get into a position quickly Bid for 25 MW When time is less of an issue and you want better execution 15

16 III. Pricing Analysis 16

17 Overview The hourly settlement price is governed by supply and demand variables, such as load demand, the availability of renewable energy sources and thermal generators and cross-border flows. Different groupings of hours exist such as Base (1-24), Peak (9-20), Offpeak (1-8, 21-24) In a deterministic model, each of these variables is a source of uncertainty given that an actionable price forecast requires forecasted input variables The load demand may deviate due to fluctuations in temperature The renewable power production depends on the future state of wind, solar and hydrological variables The cross-border flows depends on the future state of the grid Each combination of input variables represents a different storyline with an associated price effect. How do traders translate these various price effects into an expected value?

18 Merit Order Why do prices vary that much? Source: AGORA Energiewende 18

19 Setting up a trade Calculate expected value, e.g.: 1) We forecast a day-ahead price of for Thursday with our current inputs 2) However, we think that the clouds might clear up over southern Germany giving 2000 MW of extra solar power 3) We forecast a price of if that happens 4) If we pay we can make 1.75 and lose 1.00, almost a 2:1 risk-reward 5) Let s say that we estimate the Solar risk will materialize in 33% of the cases. 6) What is our expected value? 1.75 * (100% - 33%) 1.00 * 33% = 0.84 Look for opportunities with positive expected value. Size your position, i.e. how much am I willing to risk? 19

20 Dark and Spark Spreads Definition: the gross profit of coal-fired and gas-fired power plants after fuel costs. When the prefix clean is added the carbon costs are also included. Essential for assetbacked traders, useful for speculative traders. 20

21 IV. Risk Management 21

22 Overview Power trading acitivities attract various types of risk, including market risk (e.g. price), counterparty risk, regulatory risk, environmental risk, etc. A typical price print in the order book is a composition of various scenarios (storylines) for your power system. That is, more often than not, the scenarios that you concocted during the pricing analysis stage are already priced-in As you move closer towards settlement, the risk premium (positive or negative) slowly degrades. Indeed, the time-value (uncertainly) diminishes as you move closer to your settlement date Now how volatile is the day-ahead market? 22

23 Day-ahead OTC to Spot Germany Belgium 23

24 Value-at-Risk A popular way to measure portfolio exposure is the Value-at-Risk (VaR). Assuming we re interested in day-ahead, it computes the most we can expect to lose - with a 95% or 99% level of confidence by bringing our OTC position to settlement. In order to create a VaR model you need: A correlation matrix showing the dependence between the products your trading The probability distribution A VaR model typically assumes that the data underlying it is normally distributed. This, however is not always the case 24

25 V. Trading Strategies An inside look 25

26 Overview Trading strategies revolve around find a way to trade profitably, i.e. finding an edge over other market participants. Being quick e.g. being the first in the market to spot outages Superior fundamental analysis i.e. knowing what the value is of the product you are trading at a certain point in time Superior meteo forecasts and analysis Superior technical analysis e.g. chart patterns, algorithms resulting from data analysis Can you think of other ways to create an edge? 26

27 Being quick JUST OUT! 2 nuclear power plants in France not returning on 30 November, but on 18 December. We want to buy 15 MW of December in France, this is the order book: Qty Price Price Qty How to approach this: Should we place a bid? Should we lift the offer? 27

Fundamental analysis What the world will look like 1-120 days in the future?

28 Fundamental analysis What the world will look like days in the future? Plant maintenance Fuel prices Interconnector flows (Major) weather systems 28

29 Meteorological analysis 29

30 Technical analysis While fundamental analysis may give you a decent bottom-up price forecast, it doesn t cover market sentiment. According to the believers market sentiment can be read by interpreting patterns of candlesticks. They are often accompanied by indicators such as moving averages, RSI and Stochastics....and analysis tools like Fibonacci retracements. 30

31 Questions?

ICIS Energy Forum. Power and Carbon Markets. 1

ICIS Energy Forum. Power and Carbon Markets. 1 ICIS Energy Forum Power and Carbon Markets www.icis.com 1 Germany-Austria bidding zone split market impact? Irina Peltegova Editor EDEM +44 207 911 1975 irina.peltegova@icis.com Germany-Austria bidding