UtiliPoint IssueAlert
Patrick Reames

The phrase “Energy Trading and Risk Management” (ETRM) would seem pretty self explanatory. It means, well, the trading of energy and managing the risk associated with the trade or trades. Right? Well, yeah, but not really.

ETRM has been adopted as a label by software vendors in order to readily identify themselves and their products to a marketplace comprised of a very diverse group of companies that transact in energy commodity products. The term first appeared more than a decade ago and was actually intended to be ETTRM - Energy Trading, Transaction, and Risk Management - implying an even broader set of capabilities beyond the trading environment, reaching out to include those systems that tracked and managed transactions that were not based upon the sale or purchase of a commodity, but rather focused on the logistics involved in managing the commodity, such as pipeline nomination systems.

As an analyst covering energy and commodity trading, including the systems and technologies employed to support the trading business, I find myself struggling with term. Because “ETRM” has achieved fairly ubiquitous usage, it’s become the default identifier utilized by many different software development houses that field systems that touch anywhere along the wholesale (and at times, even the retail) energy supply chain. Given the wide variety and complexity of processes involved in the commercial exchange of energy commodities, it’s exceedingly difficult to effectively capture in a single bucket the breadth of tools and applications that are required to meet the needs of today’s market players.

On one end of the ETRM product spectrum, you’ll find specialist systems, such as a web delivered solution that calculates Value at Risk (VaR) for wholesale energy trading books. On the opposite end of the spectrum are systems that are very broad in functionality and encompass capabilities that attempt to cover virtually every aspect of the extremely complex process of energy delivery from “source to sink”, including production management, wholesale trading, commercial marketing, contract management, position management, risk analytics, logistics, operational optimization, financial accounting, and credit and credit risk management.

Some vendors have, appropriately, narrowed the term down to more accurately reflect their competencies by using the term “risk management” system. Even within this category however, you’ll find a wide variety of capabilities. At CommodityPoint, we see the term “risk management system” applied to solutions whose capabilities involve contract management and deal capture for physical and financial products, the ability to consolidate the value of those deals to a single screen or report (position management), and finally, be able to produce fairly complex analytic metrics such as VaR or PaR (Profit at Risk). Then again, on the other extreme, we see software packages that pull in transactions from other systems (instead of direct deal entry), produce a simple position management view or report (but only for financial transactions), and provide little in the way of analytics beyond the financial position management capability and a VaR or Mark to Market (MtM) calculation related to those positions.
Beyond being able to identify a system by its functional footprint, one also needs to understand the complexities poised by commodity coverage. There a several systems available today that can capture a purchase or sales deal for virtually any commodity (either physical or financial), and can, with a fair amount of functional competency, address the unique logistics requirements of those commodities, whether they travel by barge, ship, wire, pipe, truck, plane, or train. Still other systems are available that provide the same types of broad functionality (deal capture, scheduling, position management, accounting, etc), but are more focused on managing the unique needs of a single commodity. These single commodity systems shouldn’t be viewed as less capable; in fact, it could be argued that for their specific coverage, many provide a greater depth of capability, particularly in the area of logistics, than do those systems that cover a wide range of commodities.

So what’s the point of all this? It really boils down to this - it’s very difficult for any potential buyer of “ETRM” software to understand and stay abreast with the ever changing capabilities of all the various vendors that serve this space. Despite what their marketing materials and sales staff may indicate, an ETRM system from Vendor “A” does not equal an ETRM system from Vendor “B”. Each system has evolved in a unique manner, having been developed to meet the needs of the individual vendor’s clients and potential clients in their target market, both of which will change over time. For example, Vendor “A” may have started in the wholesale power markets a number of years ago, supplying tools that allowed wholesale power traders to transact in various ISO’s and RTO’s, and only later built out natural gas capabilities in response to their market’s demands for a system that could also manage fuel procurement; and from there, it was on to wholesale gas trading and risk management. Vendor “B” may have evolved in the opposite direction, initially serving natural gas trading organizations and moving into the wholesale power markets much later. So they both currently serve the same markets, however, it’s likely that the relative strengths of their products will be significantly different, with varying degrees of “maturity” for specific functions or commodities. If you’re a buyer looking for a system to help you manage your business around, for example, the NYISO, which system would be the optimal solution? The answer may be Vendor “C”. Unless you have a gas portfolio, or plan on developing one in the next five years, you might be better off with a system that is focused only on the regional power markets.

If you haven’t had experience with those products and understand their relative strengths, it could be very difficult to discern any differences amongst the multitude of ETRM vendors based upon their sales and marketing materials. Painting the market with a broad “ETRM” brush can produce a lot of confusion for companies seeking software solutions to fit their specific functional needs. As such, it’s certainly in every buyer’s best interest to seek out expert advice and guidance as to which vendors are capable of addressing that buyer’s specific needs, and have done so successfully with similar companies. Unfortunately, many times companies seeking out software solutions will fall back to what they know and have had experience with. While that limited view may produce a “best fit”, the odds are that there is a better solution available for that particular buyer, one that provides either a better functional fit with their assets and strategies, or one that provides higher value in terms of cost vs. functional coverage.

Think of it this way - you need a motor vehicle to take you from point A to point B - on one hand you can hire a cab, on the other extreme you can buy a bus and drive yourself; both will get you there in about the same amount of time, but one is going to be a heck of a lot more expensive; unless of course you travel that route every day, and always travel with thirty of your best friends; or you may only travel the route once a week, but you may be able to pick up a couple of dozen high paying riders along the way; or you might need to carry a lot of cargo with you, or...never mind, its complicated.

CommodityPoint maintains a number of free resources to assist companies as they seek out new “ETRM” systems, including the online TRM Directory (www.trmdirectory.com) which lists all the providers of software in and around the energy and commodity trading, transaction and risk management software space along with service providers and other resources. The ETRM Community website (www.etrmcommunity.com) and blog provides additional information and news on ETRM software. The UtiliPoint Europe Blog (www.utilipointeuropeblog.com) also provides similar information, more focused on European markets.

Apparently it came from France…

I recently caught up with Michael Muse, who many in this space will remember as one of the founders of Woodlands Technology, an ETRM provider that was purchased by Siemens in 2004 and was rolled up into New Energy Associates, which in turn was bought about a year ago by Ventyx. After the acquisition by Siemens, Michael headed up the ETRM products groups with NEA and later Ventyx.

Michael left Ventyx late last year, and along with Steven Wall (serving as the new company’s CTO), started a new venture, Woodlands Solutions. In the short time since the company’s inception, they have completed build-out of their flagship product, Phoenix (which the company describes as a “full-featured, front-to-back office energy trading and risk management solution used by energy companies to manage their trading and marketing operations at a fraction of the cost of other ETRM systems”) and have just announced the signing of their first customer, Coast to Coast Partners, LLC, a Dallas based gas marketer.

I haven’t had a chance to look at their new product yet, but it certainly sounds intriguing and early success speaks for itself. I’m scheduled to meet up with Michael again soon and get a demo - when I do, I’ll let you know what it looks like. Their website is www.woodlandssolutions.com.

Kiodex just announced that Ameren Energy Marketing (AEM), the nonreg marketing and trading arm of St. Louis-based Ameren Corporation, has implemented SunGard's Kiodex Real Time, the recently acquired product formerly known as ICE Risk, a real-time, integrated trade capture, mark-to-market and risk management solution for commodity trading.

According to the press release, “AEM uses Kiodex Real Time, integrated with SunGard's Aligne (formerly Zainet) end-of-day books and records solution, to track intraday positions and profit and loss (P&L), and provide support for traders responsible for executing daily and strategic hedging strategies.”

A good start for Kiodex. Given the company’s proven ability to deliver SaaS solutions, combined with ICE’s ubiquitous reach in the energy markets and the ability for the product to consolidate and manage real-time exchange trades, there’s likely to be more such announcements in the near future.

Despite a rather challenging market environment, Triple Point continues to knock down new business, with a couple of new deals recently announced.

Bruce Power, a Canadian-based nuclear generation company involved in the wholesale and retail power markets in the Ontario region, has licensed Commodity XL(TM) to support the entirety of their generation and marketing operations. In addition to Commodity XL(TM) for Power, they also picked up Hedge Accounting, Fair Value Disclosure, Credit Risk and Credit Analytics, Commodity XL(TM) Xchange, Management Dashboard and Power Scheduling ‘Visual Cockpit’(TM).

A nice win across for the entirety of Triple Point’s product family.

The company also announced that Tullow, one of the largest independent oil and gas exploration companies in Europe, has selected Commodity XL for Hedge Accounting(TM) to ensure compliance with IAS 39 disclosure and reporting for crude oil and natural gas. According to the press release, “Tullow has operations in Africa, Europe, South Asia and South America with current production of 60,000 barrels of oil equivalent per day (boepd). Founded in 1985, Tullow is headquartered in London and employs over 540 people worldwide.”

Even though a significant portion of the global economy is in the dumps, things have been amazingly busy around here the last couple of months. I have a couple of large projects going, been doing quite a lot of traveling and speaking at events, and then there’s the usual trying to keep up with the industry type things. So, as usual, the blog tends to suffer during these periods. I’m going to try to get caught up with some new thoughts/topics in the coming weeks, but unfortunately, this is one of those days that isn’t giving me a lot of time in the margins to do a lot of “deep thoughts” type blogging.

Since that’s the case, I’ll just throw out a few random thoughts and you can discuss amongst yourselves…

1) LNG is going to hit the US gas markets in a few months in a pretty big way (from Qatar, Russia, and others), and could very well establish the price ceiling for a long time. Even if crude runs up to $200/bbl, gas is going to languish below $8 for the foreseeable future.

2) The hedge funds are back. Our CommodityPoint hedge fund expert, Gary Vasey, indicates that more than a dozen commodity hedge funds have appeared in the last few weeks. This is a reversal of a trend that started with the financial meltdown and saw the erosion of that group of market players. Also noted this morning, Bloomberg is reporting that hedge funds had their best month last month, providing larger returns than any time since February of 2000.

3) Arthur Laffer wrote an article in the Wall Street Journal yesterday that should make your hair stand on end. Be sure to check out the graphic. For us grown-ups that remember the Nixon wage and price freeze of the seventies, its not a particularly happy story. You can see it here.

4) Question: If you have a choice, which you do now, of buying either a GM product, designed by members of congress and being put together by what are essentially becoming civil servants, or a Toyota or Ford or BMW or whatever, what would you buy?

Cue the film…

5) I’ve got a bachelor party this weekend for some guy named Andrew. As best man, I’ve decided the theme of the evening will be “Hammer Pants”. Here’s a sneak preview of what the party will entail…

So, there you go. More “deep thoughts” soon.

Patrick Reames
An UtiliPoint IssueAlert

About 10 years ago, vendors of middleware solutions, such as Tibco, gained much attention in the energy trading and risk management (ETRM) space with the promise of allowing companies to seamlessly tie together complex transaction management products from multiple vendors, enabling what could be called the “Best of Breed Phase” in ETRM solutions history. The promise was that through the use of “simple to build adapters” and the magic of the middleware bus, you could take a physical gas transaction system from one vendor, a physical power system from another, a financial transaction and risk management system from yet a third vendor, and a dozen or so on-line exchanges and price feeds and ultimately create the Real-Time Enterprise powered by straight thru processing and providing up-to-the-second, consolidated views of the entirety of your trading operations.

Unfortunately, the promise and expectation did not match up well with experience. Many of the larger commodity trading organizations invested tens of millions of dollars each into the strategy and few could demonstrate much success and certainly little tangible ROI for their efforts. Many mid-sized trading shops started down the road and were forced to turn back, having run out of funds and patience for what turned out to be, in many ways, giant data reconciliation projects.

What was left behind for many of these failed projects were disparate systems, nominally integrated via point-to-point links, providing after the fact and somewhat awkward reports that fell far short of the desired global portfolio management solution capable of providing real-time intelligence. Even these hard fought minor victories were short-lived, for when the various vendors pushed out the dreaded upgrades for the individual systems, the links in the tenuous integration chain broke, requiring additional effort and funds to keep the technology strings attached to the proper tie downs.

Given the large investment in the various commodity or functionally specific systems that comprised the initial best of breed vision, few could, or were willing to make a quick move to the emerging multi-commodity, physical and financial solutions that had begun to appear on the market from a few vendors. Still, even as recently as a couple of years ago, with their investments fully depreciated, many companies were still reluctant to take advantage of the broadening capabilities provided by systems from the cadre of vendors that have made the investment in creating truly multi-commodity, physical and financial solutions.

Compelling Movement toward the Single Vendor Solution
Despite the availability of systems providing the entirety of the functionality required by the multi-commodity shops, it has taken time for many energy trading shops to start to realize the true benefits of a single vendor solution. However, there is little doubt that the movement is clearly away from the days of the costly to maintain and difficult to manage Best of Breed strategy. Somewhat surprisingly, cost may not necessarily be the primary driver; rather it could be the nature of today’s evolving energy commodity markets that are catalyzing many companies to make the move toward the consolidated, single vendor solution.

I recently meet up with Mark Jackson, Solarc’s Director of Risk Management, who offered some interesting insights into the growing willingness of these companies to move toward the single-vendor solution and the advantages of doing so. Solarc is one of the solutions providers that have been evolving their products from being highly capable systems serving the specific needs of discrete industry segments or commodities, to now providing greater breadth of capabilities across a much wider spectrum of physical, financial, functional and industry requirements.

As Mr. Jackson succinctly put it, “More and more companies are really beginning to comprehend not only the cost savings but also the value of faster and more precise risk reporting, streamlined back-office operations and more timely and accurate financial data offered a comprehensive, single vendor solution.”

Market Risks make a Single Vendor Solution more Attractive
Mr. Jackson noted the advent of electronically traded and centrally cleared commodity contract products has created a demand for robust ETRM systems that can handle both physical and financial transactions. “Commercial and trading operations are finding new ways to use these standardized products to procure their raw materials. And, firms are using a combination of cleared products and over-the-counter trades to deliver the commodities they produce.”

“All these new products are quoted, traded and risk-managed like traditional financial derivatives, but they are being used to exchange physical possession of commodities. Managing them requires an ETRM system that not only can meld financial risk reporting and physical/operational reporting but that also can handle all of the logistical, operational and accounting tasks that result from using these instruments.”

While cleared products in the form of futures contracts with their attendant clearinghouse guarantees have existed for many years, the movement toward the wider acceptance of cleared physical products took off first with Enron-On-Line and, after that company’s implosion, the Intercontinental Exchange (ICE) and ClearPort. With the recent credit crisis, however, their use has grown exponentially.

The protection from the collapse of individual trading partners is really starting to reshape the nature of trading in this business. As Mr. Jackson notes, “The collapses of Long-Term Capital Management (LTCM) and the threat of systemic implosion made the headlines for weeks. Yet when Amaranth Energy failed in 2006, it was largely ignored in the mainstream media because its use of ClearPort and NYMEX-cleared trades had prevented any spectacular counterparty collapses. The commodity trading community was quick to recognize the benefits of centralized clearing.”

As Mr. Jackson observes, “In addition to reducing credit risk, electronic trading has increased market transparency, transaction speed and the volume of market data generated. As a result, ETRM systems must be able to interface with exchanges electronically and to handle the increased data loads resulting from multiple fills on different platforms. They must be able to reconcile with brokers, confirm trades and handle all of the traditional clearing functions at a much higher pace than in the past.”

“Cleared products are forcing a redefinition of a trade and are changing the way traders interact with their systems. In the past, traders operated in one or two trading venues with rigidly designed contracts. The characteristics of those contracts drove interface and functional designs of ETRM systems. In the future, traders will decide what to trade and how to clear. The ETRM system will have to be intelligent and abstract enough to choose the appropriate system for execution, handle all the external reporting and verification, and clear and maintain the resulting transactions.”

“Finally, these products are blurring the line between the traditional physical trading world and the financial world, forcing the view of ETRM systems' risk and reporting to be revised. In the past, physical traders concerned themselves with operational and logistical risks peculiar to their markets. Depending on the market, price risk was either ignored or passed on to financial traders.”
“Now, physical traders are being constrained by shrinking credit lines, and they are turning to cleared products as a way of procuring the physical products they need. More liquid markets mean that players who would not traditionally trade physical contracts will do so secure in the knowledge that they can liquidate their positions. The bifurcation of reporting between physical risk and financial risk is being replaced by reporting on price risk and on detailed operational risk.”

The Role of Risk Management
Being on the wrong side of a volatile market has proven to be fatal for a few companies, and near fatal for more. These high profile failures and near-misses have elevated the risk management function in virtually all firms that trade in the energy commodity markets. As Mr. Jackson notes, “Risk management has changed from a part-time accounting function to a full-time specialty with visibility at the highest levels of the firm. An influx of talented risk managers is creating demand for tools that are closer to traditional trading tools than accounting reports.”

“The halo surrounding Value-at-Risk (VaR) as a standalone measure of risk has lost much of its luster. The electric power market’s enormous price moves led to questions about the ability of the underlying pricing models to accurately depict real-world markets. The collapse of Enron pointed to other risks, such as credit risk, that hadn’t been closely monitored at many firms.”

Indeed, in CommodityPoint’s recent study and report, Changes in Commodity Markets, Impacts on Traders and Systems, we observed the growing sophistication of analytics, especially in those shops affiliated with banks, hedge funds and other financially oriented organizations. While VaR continues to be used by virtually every one of these trading concerns, portfolio stress testing and pre-trade, or what-if analysis are increasingly being brought to bear.
According to Mr. Jackson, “Today's risk managers typically use VaR as an early warning indicator of risk rather than a risk number that, by itself, constrains a firm's behavior. These managers back up VaR with detailed reporting on interest rate risk, currency risk, volatility and skew risk, as well as price risk.”

“Risk managers are attuned to the risks that surround them. Risk tools are now expected to be able to quantify and manage risks throughout the enterprise. Implicit options in transportation, storage or purchase agreements are just one example of real options that managers must report on and incorporate into their calculations.”

“The growth in general knowledge about and awareness of risk at the executive level means that risk managers now have a much more diverse audience. With this diversity come differing information needs and understandings of risk. ETRM systems must have highly flexible reporting tools, including data visualization capabilities that allow for quick, customizable information extraction.”

Conclusion
While the best-of-breed approach did provide companies operating in the commodity trading space the opportunity to pick and choose those systems they felt were a best fit for a single commodity or business function, ultimately the strategy has shown its weaknesses - cost, complexity and an inability to provide the actionable information necessary to keep up in a very volatile and evolving marketplace. Still, until recently, many companies have proven reluctant to put all their eggs in one vendor’s basket, feeling that the best of breed approach kept them from being exposed to a potential failure of single vendor system.

However, recent experience has shown that the greater risk in this market is not vendor failure, but failing to keep up with the market itself - relying on incomplete or out dated data in a market that can, and will, run over those companies that don’t stay abreast or ahead by employing the best fully integrated ETRM solutions available.

Allegro has announced the release of their new Allegro Credit 8.1 component. While the name may be somewhat underwhelming, the new functionality appears to be able to match just about anything on the market. I talked with Gary Craze, who headed up the design of the module, and he said that they had purposely set out to ensure that they were able to match any product currently available in terms of features and functionality. He also said that as part of their new development methodology, they ensured that anyone running Allegro 8 could take-on the new capabilities offered within this new set of functionality without impacting their current implementation of version 8.

One of the key features that Gary felt was most important, besides the new analytics, was the ability to integrate with the various credit rating agencies, ensuring the users of Credit 8.1 that they would always be up to date the latest developments from those agencies.

On the credit analytics side, Gary pointed out they now have the following capabilities:
- Market and Credit Event Liquidity Adequacy stress testing
- Credit Value at Risk analysis
- Potential Future Exposure analysis
- Walk Forward analysis

They also built out a lot of collateral analysis and monitoring capabilities:
- Comprehensive collateral status
- Monitoring of collateral obligations
- Documentation of collateral / margin disputes
- Default Risk and Recovery Factor functionality

While I haven’t yet had a demo of the new system, it seems apparent that Allegro took stock of what has been in the market for credit risk and intends to compete heads-up this particular piece of the market.

Even in what almost all consider to be a “challenging” market for ETRM products, OATI is making a major investment in expansion. They recently announced the acquisition and development of what they are calling their OATI Campus.

It’s the site of the former Honeywell Camden Facility in Minniapolis. The facility covers 22 acres and will be the site of their new data center, as the company has reached max capacity on their current facility. The new campus will also house an Executive Briefing Center, Conference Center, Customer Care Center, Training Center, and will have room for up to 500 staff members.

I talked with Jerry Dempsey, OATI’s VP of Sales about the investment in the new facility. He indicates while they, like all vendors, have seen some softening of the market for new systems, their current client base and business model helps to isolate them in from the periodic ups and downs in the market, even one that is mostly down like this current one. Paraphrasing Jerry, he said that if they didn’t sell a single new system for two years (which of course “ain’t gonna happen” as they have closed several new deals recently and are close to several others), their business is diversified enough across the energy markets and structured such that they would have little or no problem sustaining all that they have in place now. Their investment in this new facility (which from what I can tell is the single largest dedicated facility in the energy software space) is certainly proof of that.

Kiodex announced on Monday that they had acquired ICE’s risk management product, ICE Risk. The product, launched in the middle of last year, is a web delivered solution providing real-time integration with ICE and other exchanges, which, in turn, enables real-time position managment and valuation capabilities.

Kiodex, a long time provider of web delivered risk management systems and risk tools, intends to integrate the real-time capabilities of ICE Risk, now rebranded as Kiodex Real Time, into their Risk Workbench product and expand its capabilities to provide real-time calculation of VaR (both historical and Monte Carlo), positions, and valuation across multiple asset classes. Ben Jackson, Kiodex’s President told me yesterday that they also intend to incorporate additional capabilities provided by SunGard’s GL Stream product, expanding the universe of exchanges which can be integrated into the product. He indicated that the initial integration efforts between the newly acquired product and their Risk Workbench is well underway, with new functionality currently being deployed at a couple of customer sites - customers that have been using both products prior to the acquisition.

The combination of Kiodex’s sophisticated analytics and newly acquired real-time position management capabilities and exchange connectivity are going to create a very formidable offering in the risk management side of the CTRM markets.