The Dumbing Down of CTRM
A CommodityPoint CommodityAlert
By: Gary Vasey and Patrick Reames
Commodity trading, transaction and risk management, as a practice, is complex, very complex and for a variety of reasons. Traders in this industry can, and many do, transact in multiple commodities, multiple markets, multiple instruments, multiple assets, multiple currencies, and utilize multiple transportation methods; making their buying and selling decisions by constantly tracking and analyzing price trends, price correlations, supply/demand imbalances, physical system constraints, weather forecasts, and a plethora of other factors, both internal and external to their company. Even the most “simple” commodity trading activities (such as buying/selling a single commodity in a specific market or region) usually involve complex deal structures and specific and highly detailed logistical requirements.
CTRM Software
As a result of all of that complexity, the systems that are utilized to capture, track, analyze and account for trading activities, the CTRM software systems, tend to be built to be highly configurable. They have to be built that way or else a commercially packaged software model couldn’t work in this space, as the size of this software market will never be large enough to justify the investment in developing a true “one size fits all”
shrink-wrapped software solution. In fact, the CTRM software market simply isn’t a classical commercial software market at all. Any software package in the CTRM space, at best, may meet 80% of the requirements after configuration (and more commonly less than 70%) with the remaining requirements being met via other packages, home grown software, the ubiquitous Excel spreadsheets or manual process. That’s why integration is such a pervasive (and often massive) issue for the trading and risk departments of almost every trading firm on the planet.
The successful larger CTRM vendors have found ways to develop broadly functional software that is highly configurable usually using a modular approach to deliver specific functionality for specific areas - either for a particular commodity, market, geography or function. Their success in developing these modular solutions is evidenced by at least two vendors boasting of greater than $100m annual revenues and several more are between $30 and $100million; but, there are more than 80 vendors with multiple products still serving this market, with many of those serving a small geographic or functional niche and doing so profitably.
However, given that the energy trading industry (not even the larger commodity trading industry), is often quoted as having a turnover of hundreds of billions, if not trillions of dollars a year, the fact that the largest of these CTRM solutions vendors generates around $200 million/year should speak to the difficulty of creating a singular solution that can meet the needs of that broadly defined market place.
Underestimating Complexity
Periodically, CommodityPoint receives inquires from Venture Capital or Private Equity firms looking at this software class and thinking about making an investment in one of the vendors. In most cases, they tend to view CTRM as a homogenous software class just like ERP or CRM and even will sometimes argue our views regarding its complexity. You see at a certain level it is simply deal capture, position keeping, risk management, back office and logistics, right? In other asset classes this is all fairly standard and mundane stuff so how can it possibly be so complex and fragmented as we say it is in commodities? The more they chose to dig and learn, the more they begin to see and understand the reality - it really is that complex and requires a lot of expertise to understand.
Often, potential buyers of software have the same problem. “It’s just vanilla stuff we do,” they say. “Surely the software can do that?” It might, but it has to do all the other things that all the other trading firms do too in order to have a market large enough to sustain it; but, more importantly, what is normal stuff at one firm often isn’t at all usual at another. In part, it’s the industry lexicon that’s at fault. “Price risk management” is a common term and it means broadly the same thing across the industry; but, at the detailed level of practice, procedures and so on, it can prove to hide a number of remarkable differences and the same goes with many of the other terms we all use so loosely.
Models Versus Tools
After more than a combined 30 plus-years in the industry being involved in nothing other than ETRM and CTRM software, we can tell you categorically that this is a complex software category that defies the use of simple models to classify it, or the products or vendors that serve it. The use of such models does a disservice to everyone in the industry by dumbing it down to a nonsense level and it reveals the promoters of such models to be naive about CTRM software.
Because of this, CommodityPoint has always adopted a different approach and that is to provide tools to help prospective buyers navigate the complexity and risks successfully, to gauge the size and maturity of the industry and to follow market perceptions around vendors and products that reveal much about what is going on at a basic and detailed level. Our aim is not to dumb down the complexity but to acknowledge that complexity and assist those that operate in this industry understand and navigate through it, with the ultimate goal of reducing costs, risks and timescales for those seeking a solution that best fits their particular piece of the market.