UtiliPoint International IssueAlert
Patrick Reames- VP – Trading and Risk Management
As I noted recently in the ETRMCommunity blog, it’s been interesting monitoring the 2008 results from the various ETRM software houses. Many of the large vendors are indicating that license revenue numbers for the year were up significantly over 2007, even as new customer signings were down, in some cases 20% or more.
The results are indicative of two factors: 1) Increased sales of add-on-modules, incremental functionality, and additional user licenses which are generally accounted for as license revenue but do not increase new client company counts and 2) an increase in the average sales price for new systems, which, based upon conversations with many of the vendors, is the single largest contributing factor to 2008 results. A few of the ETRM system vendors signed deals that were of very significant size in 2008, such as Triple Point landing Cargill and expanding their presence in ConocoPhillips. Allegro also reported several large transactions during the year, and indications are that Open Link closed several very significant deals; however, until the company publically releases their results through an updated SEC filing or via a press release, it will be difficult to know the full scope of their year as they are necessarily careful in discussing results and forecasts due to SEC restrictions as the company looks toward an IPO.
In terms of incremental license revenue, our research indicates that many companies, in the face of an uncertain global financial situation, have chosen to make the best of what they have in place - spending to improve their systems’ capabilities, while limiting their overall expenditures. Given the economic conditions and the costs associated with a new ETRM license and implementation, many trading companies have made the decision to delay purchasing or replacing their existing systems, instead upgrading what they have in place and putting off the replacement decision until economic conditions improve.
2008 was a Year of Mixed Results
The first half of 2008 was a continuation of 2007, with virtually all markets segments showing strong growth. However, after the commodities crash in July, the lower to mid tiers of the market – the small regional to mid-sized national companies showed a significant slowing of activity, with new system purchases put on hold as companies scrambled to cut costs. However, on the high end of the market, including the multinational producers and trading companies, there appeared to be less slowing of activity. Many of these very large companies have had system replacement or expansion programs in the works for a year or more. These companies tend to take a longer view of the markets, so unless they are caught up in the financial turmoil engulfing the financial sectors, they’ve generally been following through on those plans despite the currently unfavorable economic conditions. This long view has resulted in several large and, in a couple of cases, record-setting sales for a few of the ETRM providers as noted above.
Given the turmoil in the financial sector, the banks and other financials are obviously not beating down the doors for ETRM system suppliers; in fact, many aren’t even returning calls. They have bigger problems right now, like trying to stay alive. While a few financial institutions bought new systems in 2008, these were deals primarily consummated in the first half of the year, with only a tiny handful closing in the latter half.
Crude centric buyers have become few and far between these days. While the results from last year do indicate several crude driven ETRM deals closed, with the global crude markets being pounded by the more than 70% drop in crude prices in the last eight months, few refiners or traders are currently focused on adding or replacing a system. In fact, the crude markets seem to be without any real equilibrium. Conflicting price signals abound in the global markets - futures seem locked in a permanent contango; domestic crude inventory reports have only within the last week started to show any lessening of inventory builds; and reports are emerging out of China of increased petroleum product exports (though currently modest, with increases up to 12,000bpd, this volume could go much higher as an additional 1 million barrels of Chinese refining capacity will come on line this year alone. Should China’s economy continue to slump, this capacity would most likely be turned to the open market, putting significant additional downward pressure on prices). Meanwhile, some reports do indicate that OPEC has been moderately successful at cutting production, achieving about 75% of their stated 4.5 million bpd cut.
The bottom line for crude is that there is an untold millions of barrels of crude in stock tanks, tankers and bunkers around the globe. Until the excess is absorbed by a freshening global economy, the outlook for crude producers, traders and refiners remains murky at best. Given the state of the crude markets, and despite some recent mixed indicators of futures prices, it’s difficult to see much improvement until the 4th quarter at the earliest. And until the underlying market improves, ETRM system sales to the segment will continue to be depressed.
The end user, or commercial scale commodity consumers, markets have also all but disappeared for most ETRM vendors. Commodity prices have fallen across the board as demand has weakened and many industrial facilities have been dialed back or shuttered entirely. Most commodity futures markets are in contango, leaving few hedging opportunities and, at least in the near term, reducing this group’s attention on risk management and commodity management systems. The one remaining bright spot in this market group is the agricultural centric buyers. This group as a whole, with some notable exceptions, appears to have not been impacted as much as chemical producers, industrial manufacturing or transportation companies. Even in poor economic times, “people gotta eat” (as Houston Astros outfielder Hunter Pence noted to a reporter after hammering a home run that hit the Chick-Fil-A sign attached to the right field foul pole, providing free chicken sandwiches for the fans) and agricultural producers continue to be a viable, if not robust, market for a few of the ETRM vendors.
Buyers for gas functionality are also still active in the markets. The LDC market, while relatively small and somewhat specialized, continues without much interruption, and many (but certainly not all) gas producers don’t appear to have radically altered their system acquisition plans. Natural gas, despite having fallen significantly off of the highs of 2008, is still a relatively healthy segment. Though today’s $4 gas pales in comparison to the $14 gas the producers enjoyed in the middle of last year, that price provides most a fairly nice return on investment and solid cash flow. However, indicators are pointing to toward lower prices in the coming months - despite record cold in the north and north east recently, prices actually fell in those regions as reduced industrial demand more than offset increased heating demand. If prices do fall significantly in the coming months, ETRM system sales in the natural gas market could start to slacken as market participants across the board rein in spending.
Utilities, particularly the regulated utilities, are by their nature, somewhat less exposed to the immediacy of wholesale price movements. While they rarely get to share in really good times alongside the traders and producers, they also rarely get pounded when the markets tank. For many, in fact, today’s lower fuel prices are providing short term benefit. The biggest issue for this group is their capital intensive structure - with the financial markets in turmoil, their access to capital has been constrained. However, small scale projects, such as new systems purchases, while having been somewhat delayed, are moving forward, providing a continuing market for power capable ETRM solutions.
Again, while sales of full scale systems have slowed, the market for ETRM components and add-on modules continues to be relatively strong. As pointed out in our recent report “Changes in Energy Commodity Markets – Impacts on Traders and Software“, risk management and credit risk are, not surprisingly, top priorities for the companies that responded to our survey. Many existing users of ETRM systems are seeking additional functionality in these areas and have been purchasing new modules or replacing risk management systems in order to address infrastructure weaknesses in these areas.
Looking at the markets globally, the North American market appears to have slowed more than has the European market. Sales of gas and power ETRM systems are down somewhat in Europe compared to the peak of the market in early 2008; however, the growth and maturation of the continent’s wholesale energy markets continue to provide opportunities for many vendors.
The Big Picture
The sale of an ETRM system can be driven by one or more factors:
1. New market participants entering an expanding energy market place
2. Company growth or expansion of activities forcing a move to a more capable system
3. New regulations or industry driven business practices requiring additional system functionality
4. Technology advances attracting buyers to the latest and greatest system
5. Normal software replacement cycles (on average about every 5 to 6 years for ETRM systems)
6. A failure by an incumbent vendor that drives an company to seek a new ETRM supplier
Unfortunately, only a few of the factors listed above actually create real growth in the ETRM markets. Several, like system replacement driven by depreciated software assets or service failures, are a zero sum gain for the market as a whole as one vendor’s gain of a client is another’s loss. The only clear expansion of the ETRM solutions market will come from the emergence of new market participants or niches (like end users emerged as a significant market in 2006 - 2008) or from increased functionality requirements to meet changes in regulation, such as new hedge accounting pronouncements, or new business practices like the development of new trading products and instruments.
Without a dynamic and expanding energy market driven by a robust economy, the overall market for ETRM systems will become moribund, with vendors cannibalizing each other’s client base at an ever increasing cost and with lower margins. It becomes a market of clear winners and losers, not a market, as we’ve had over the last several years, of big winners and not-so-big winners. In a depressed global economy, there is no rising tide to lift all ships.
An Uncertain Outlook for 2009
Market growth for ETRM systems is directly linked to a healthy energy commodity market, which is in turn directly dependent upon a healthy global economy. Unfortunately, until the global economy, or at a minimum the US economy starts to recover, some ETRM vendors will be facing difficult times. We are now in a market where the strong will survive, however the outlook for the weaker companies is uncertain.
Until the economic pulse quickens, the energy markets and those that rely on them for their livelihood are going to be facing an uncertain future. Until our political leaders start concentrating on calculating and applying the proper amount of defibrillative voltage to the heart of our economy (instead of dressing the body in a new suit and styling its hair, in addition to adding a whole lot of junk debt and severely burdening the economic body, if and when it can get up off the ground), the recovery this market needs may be a while in coming.
Tradeshows are alive and well in Europe and while they present an opportunity to ”image make” and message spin about ”green energy” the truth is some real business was being done between traders and that is what these events are really about. It is still a people business which requires relationship building and networking and based on what I saw—it is thriving.