Ahead of the Curve? Parsing your Energy Portfolio for Profitability
- Dec 1, 2022 7:49 am GMT
In the low-margin business of a retail energy supplier, the timely procurement of sufficient wholesale supply at the best possible price and risk level is critical to profitability. This is no easy task during “normal” times, but with today’s economic and geopolitical factors wreaking havoc on energy markets the task has become exponentially more difficult. While these conditions may offer traders opportunities, they present others, like retail energy suppliers, with tremendous challenges. Portfolio management, risk analytics, near-real time reporting and automation are critical tools to help answer fundamental questions about supply & demand, portfolio performance, valuations, and profit & loss. An integrated system that handles the business processes from supply contracts to settlement, and where the retail sales book is linked to the wholesale sourcing book to facilitate in-depth monitoring and assessment of positions and exposures is a necessity. Are you ahead of the curve? Parse your Portfolio for Profitability
As we have witnessed in the past year, the wholesale price of electricity and gas can fluctuate significantly due to a number of factors, including the weather, economic conditions, plant or transportation availability, geopolitical landscape and the competitive environment. The wholesale price of natural gas worldwide surged due to a global rise in demand as countries emerged from the economic recession caused by the Covid-19 pandemic. Cold spells in Asia and North America contributed to further demand increases, while a perfect storm of weather-related factors, low storage levels, and regional conflicts in Europe have affected supply. Gas remains an important tool for balancing electricity markets in many regions today, and the links between electricity and gas markets are not going to go away anytime soon. A retail energy supplier will closely watch the opportunities and threats that may affect their current and future customer deliveries. At the same time, their customer-base may increase or decrease or perform differently than was forecasted.
This is all familiar territory for the portfolio manager, who needs to manage this process to secure reasonable margins within the company risk limits, but he or she is often left with systems that rely on end-of-day reporting, require manual effort to consolidate data and are incapable of performing risk analytics. To successfully navigate today’s volatile market conditions, the portfolio manager has to place more emphasis on portfolio management, risk analytics, near-real time reporting and automation to get the insights and answers on positions and performance.
A state-of-the-art integrated Energy Trading and Risk Management (ETRM) system is crucial to allow for effective portfolio and risk management. This starts with a flexible multi-level book structure where your portfolio strategy can be captured and which enables the level of reporting granularity required to assess and analyse volume and price exposures, for example, by wholesale or retail book, commodity, customer and contract type. Furthermore, production assets, sourcing agreements as well as large customer contracts can be configured, each with their own commercial parameters, pricing rules and settlement terms.
To enable valuation of contracts and perform risk reporting, multiple market price feeds (not just end-of-day closing prices but also intraday price data in model analysis and calibration) can be set up, as well as company specific custom curves. Time-series functionality will accommodate the import of historical and actual consumption data to support the tightly integrated and crucial load forecasting function for aggregated and individual customers, project production outputs, feed the invoicing and settlement, and crucially allow comparison and contract performance analysis.
Being organized with all the data in a single integrated system, workflow management allows for the implementation of company policies for limits, risk, credit and associated approvals and notifications. As such, the system provides centralized control and decentralized execution, allowing the portfolio manager the autonomy to achieve cost savings or increase revenues, while enabling management control and regulatory compliance.
With retail sales and wholesale supply contracts in place, the retail energy supplier is exposed to several risks, including market price risk, volumetric risk, and shaping risk. A next-generation ETRM system, or a specialized add-on module for advanced risk management, provides the portfolio manager with several tools to assess exposures, including a position threshold alert, mark-to-market, value-at-risk and earning-at-risk reports.
Yet with the extreme market conditions, these risk measures may be impacted by correlation and calibration challenges because realized prices and volatility are much higher than those in the historical data set, resulting in underestimated exposure.
In these conditions, the ETRM system offers other approaches that support decision making, including ‘what-if’ analysis which allows viewing such exposures under different scenarios, and testing the impact of ‘what if’ scenarios from current market conditions, what market conditions could cause a particular adverse outcome (limit breach, P&L deviation), or testing and better understanding portfolio exposures. Additionally, linking the sales and sourcing books allows one to see the underlying performance and profitability between retail and wholesale positions against particular price curves and set cost. Moreover, the system can provide volumetric comparison analysis between forecasted values and actual values allowing the monitoring of customer groups or specific large customers’ consumption behavior against a contract.
In addition to market risk, high price levels and volatility, we have also seen rising credit exposures. This includes credit risk of counterparties as well as mark-to-market values of contracts. Smaller energy retail suppliers have experienced this due to inadequate hedging, while larger, more protected market participants are often exposed to less credit worthy counterparties. Margin requirements from trading venues as well as bilateral contracts have increased demand for margin management functionality in ETRM systems.. Managing credit risk is critical as the ability to manage risk through hedging is affected by credit constraints and as a result may increase the cost of trading.
Retail energy suppliers must be on top of their game when it comes to sourcing energy supply and serving load to achieve reasonable margins during extreme market volatility in an already highly competitive market. Deploying next-generation technology with a state-of-the-art ETRM system provides the ability to measure, hedge and manage portfolio risk. This means when managing a power and gas portfolio, the portfolio manager must be able to ‘parse’ it, i.e. to closely analyse and discover implications, by slicing and dicing the data until arriving at the right level of detail for analysis. This includes accurate mark-to-market reporting, risk limits, daily profit & loss attribution, credit exposure and cashflows. A single fully integrated ETRM system will help achieve this and enables him to improve buy and sell decisions thereby increasing profitability.
Are your energy risk management systems, controls and reporting fit for purpose?
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