WHITE PAPER CAN BLOCKCHAIN DISRUPT ENERGY AND COMMODITY TRADING?

Transcription

1 WHITE PAPER CAN BLOCKCHAIN DISRUPT ENERGY AND COMMODITY TRADING?

2 Introduction As Roy Amara the American Scientist once said - We tend to overestimate the effect of a technology in the short run and underestimate the effect in the long run, Blockchain is the new technology trigger that every other industry is pursuing to eliminate transactional inefficiencies. Energy and Commodity trading sector is looking at using blockchain to reduce operational risks and costs, bring in efficiencies in back office processes by eliminating intermediaries. Major Energy producers, consumers, trading firms and Banks such as BP, Shell, Statoil, Mercuria, Koch, ING are running pilots to develop Blockchain based trading solutions. Consortiums like the Energy Web foundation, Enerchain has been formed to accelerate adoption of Blockchain technology in energy trading. This paper aims to analyze the impact Blockchain technology has on the Commodity and Energy Trading landscape and look at possible use cases in this space.

3 Current Inefficiencies in Energy and Commodity Trading Energy and commodity trading involves cumbersome processes and multiple intermediaries at various points of the lifecycle which makes it inefficient, error prone and expensive. Multiple applications are used for processes such as Confirmations, Reconciliation, Trade Finance, Settlement, Operations and Delivery especially for Physical and OTC trading which slows down the exchange of information between parties. Transaction costs and collateral requirements are quite high in the industry due to counterparty risk involved. Below is the list of indicative inefficiencies in the energy and commodities trading space. Confirmation required from both counterparties in OTC trading to agree to the terms of the deal Physical trading requires letter of credits and bank gaurantees from third party trade finance firms Inefficient Backoffice Processes Multiple reconciliations are required with intermediary systems Brokerage fees, Clearing fees adds to the cost of executing a transaction High Collateral and capital requirements for margining has increased transaction costs High Transaction costs Supply chain bottlenecks and lack of Contract standardisation across counterparties leading to overhead costs Slow Delivery & Settlement cycles Stakeholders use different information systems which makes it difficult to effectively track shipments for delivery due to interoperability challenges Transfer of ownership involves paperwork and is slow Financial intermediaries involved in payments and settlements slowing down the process Intermediaries Intermediaries like Clearing houses, Clearing brokers, Execution brokers, Banks, Operators involved at various stages of the life cycle Multiple interventions required in intermediary systems to progress deals Figure 1: Inefficiencies in Energy and Commodities Trading

4 How Blockchain can help? If all the stakeholders to an OTC transaction are available in the same interoperable network and have access to the same verified transaction at real time, this eliminates the need for intermediaries and processes currently required to execute various deal lifecycle events. Trader A Trader based on terms agreed with the counterparty enters the transaction against a Smart Contract Smart Contract Trader B Transaction is verified based on consensus algorithm and is combined with other transactions in a block Buyer Transaction Verified Block of data created Bank Shipping Agency Distributed Ledger Blockchain Operator Inspector Transac on is transmi ed to the decentralised database and is available for verifica on to all par es Seller Smart Contract is programmed to execute automa cally based on trigger condi ons. Contract is auto se led based on the terms New Block is added to the blockchain and is recorded in the distributed ledger Figure 2: High Level Blockchain based trading workflow Faster exchange of information enabled by the distributed ledger technology can reduce the settlement timescale significantly leading to faster movement of commodities reducing counterparty risk. Reduction in settlement cycle will lead to low capital and margin requirements in order for the counterparties to enter into a deal thereby increasing the market liquidity. Improved trade finance availability as Banks are on boarded on to the same distributed ecosystem which enables banks to verify the firm s credit worthiness. Digitisation of commodity assets will enable the recipients to transfer assets as collateral against payment. Traceability of commodities across the supply chain can be improved. Intermediary costs such as Broker, Clearing and Settlement fees will no longer be applicable bringing down the cost per transaction Digitisation of commodity assets will enable the recipients to transfer assets as collateral against recipients

5 Leading energy and commodity trading houses believe that 30% of the operational costs can be saved Banks have found that trade nance availability (which supported 2 trillion $ worth of commodity trade last year) will improve due to blockchain adoption Banks spend around 100 Billion $ per year on IT and Operational costs for post trade operations which can be antly reduced post blockchain adoption Figure 3: Key Bene Figure 3: Key Benefits s Con rmation Transaction with the agreed terms of the deal is available in real time to both the counterparties for veri cation eliminating the need for paper based or electronic con rmation. Transactions are veri Trade Finance d in real time by the nodes and a treacable block of data is created. Enables quick transfer of collateral and payment to nance the deals if the trade nance provider and the counterparty to the deal are in the same distributed ledger. The trade nance provider can also track the deal in real time and settlement will be triggered based on Smart Contract condition and cash s initiated. Reconciliation Veri ed Transactional data will be available across all the nodes of the distributed ledger and any updates to the transactions will be made available real time. Multiple rounds of data reconciliation across systems will not be required. Smart ontract Preprogrammed Smart Contracts are automatically triggered based on conditions enabling auto execution of life cycle events without any manual interventions. Maintaining Contract reference data will not be required as Smart Contract can compute exposures, generate payment instruction and delivery instructions, settle the deals based on the code it holds. Settlement Settlement of contracts will be quick as centralized clearing and involvement of depositiories will not be required. The data is available to every stakeholder and the Smart Contract can generate payment and delivery instruction. Movement of commodity can be tracked real time and the title transfer done and recorded in the Blockchain post completion of delivery rather than working with physical documents such as bill of lading, Letter of credits, inventory and inspection receipts. Figure 4: Key Industry Use Cases

6 Key Industry Initiatives Market participants and key industry leaders are running pilots and forming consortiums to trial and accelerate the adoption of Blockchain in energy and commodity trading. Some of the key initiatives are listed below Enerchain consortium formed by a group of market participants has developed a platform for peer to peer wholesale energy trading using blockchain technology Energy Web Foundation funded by Energy and Commodity Trading majors is in the forefront of analysis and research around ne tuning blockchain technology for use in trading Tra gura, a leading trading house in collaboration with IBM and Natixis have developed a Block chain based trading platform Major European Oil producers - BP, Shell and Statoil with other market participants are leading an initiative to develop a blockchain based energy trading platform HSBC and Mercuria piloting a Block chain based commodity trade application which will facilitate nancing of cross border deals in separate initiatives Figure 5: Key Initiatives Challenges in Adoption of Blockchain Blockchain technology is yet to be rolled out at an industrial scale which will require addressing some of the technical, legal and regulatory challenges before its adoption picks further pace. Scalability of the technology is a concern. Bitcoin platform powered by a public Blockchain can process just a few transactions per second. Fintech firms are trying to solve the scalability issue which is critical for trading firms to adopt the technology Performance is hindered due to the complexity of the consensus algorithm required for verification of the peer to peer transactions. Alternate algorithms such as Proof of Stake are being developed to fasten the verification and increase throughput. Anonymity of the transactional data is a concern as all the market participants in the distributed network will hold a localized copy of the data. Cryptography is yet to evolve to selectively reveal data to some of the nodes. Private permissioned distributed ledger technology administered by a central operator with customized set of rules which is currently evolving should address some of these issues Legal framework customized for this technology and a distributed system needs to be formulated as the market participants involve in peer to peer trading without a central authority. Scalability Anonymity Scalability issues needs to be sorted out for adoption by trading firms Cryptography to selectively reveal data to nodes is yet to evolve Regulatory and Compliance requirements around trading, Figure 6: Challenges in Blockchain adoption mandatory clearing and reporting has to evolve based on the technology advancement. In its current form, market participants using Blockchain will not be able to comply with the regulation Algorithm used for verification of transactions needs to be fine tuned Legal framework with lack of a central authority yet to evolve Performance Legal and Compliance External Document Infosys Limited

7 Conclusion Market participants are not expected to adopt the technology across their transaction pipe. Blockchain based pilots will be run on specific functionalities such as Confirmation, Smart Contracts, Trade finance, Settlement to verify feasibility and potential savings. In the short term, firms will look to streamline operational processes using Blockchain and in the long term the Blockchain technology is expected to disrupt entire market structure removing Clearing, Settlement and Financial intermediaries making it a peer to peer trading network. Market participants are relying on Fintech firms and consortiums formed by major industry players to solve various technical limitations for an industry scale roll out of Blockchain based applications. Overcoming legal and regulatory hurdles and technical advancements enabled by fintech firms and consortiums are key to the rate at which firms adopt blockchain technology.

8 About the author Prasanna Sekar - Senior Consultant, FSDCG- Capital Markets Practice Prasanna Sekar has over 11 years of experience in IT and Domain Consulting with expertise in Energy Trading, Derivatives Clearing and Settlement, Regulatory Reporting and Treasury Management. Prasanna has worked with major European clients in Energy Trading, Regulatory reporting and Clearing implementation projects and has developed solution accelerators in the area of Regulatory reporting. He holds a Bachelor of Engineering degree. He can be reached at prasanna.sekar01@infosys.com and over Linkedin at References 1. Oliver Wyman, 2016: Blockchain in Capital Markets. London: Oliver Wyman. 2. Deloitte, 2016: Blockchain applications in energy trading. London : Deloitte Publication 3. Gunther Dutsch & Neon Steinecke, 2016: User Cases for blockchain technology in Energy and Commodity Trading.London: PwC. 4. PwC, 2016: Blockchain an opportunity for energy producers and consumers. London: PwC. 5. Arnaud Stevens, 2017: Blockchain Technology Represents a New Frontier of Innovation in the Commodity Trading Industry. California : CIOReview 6. John Kingston, 2017: Blockchain was hyped for a long time, now they re getting down to business. London: Platts Publication platts.com/2017/11/21/blockchain-getting-down-to-business/?utm_source=feedburner&utm_medium=feed&utm_campaign=feed%3a+ TheBarrelBlogPlatts+%28The+Barrel+Blog+-+Platts%29 7. Michael Merz, 2016: Potential of the Blockchain technology in Energy Trading. Hamburg: Ponton Publication. For more information, contact askus@infosys.com 2019 Infosys Limited, Bengaluru, India. All Rights Reserved. Infosys believes the information in this document is accurate as of its publication date; such information is subject to change without notice. Infosys acknowledges the proprietary rights of other companies to the trademarks, product names and such other intellectual property rights mentioned in this document. Except as expressly permitted, neither this documentation nor any part of it may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, printing, photocopying, recording or otherwise, without the prior permission of Infosys Limited and/ or any named intellectual property rights holders under this document. Infosys.com NYSE: INFY Stay Connected