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Articles Archive
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July 2003
Keeping Up With The Markets
The power trading sector has changed substantially in the past 12 months. Have trading and risk management software vendors kept pace? KEVIN FOSTER reports.
Trading levels are down in the US, financial liquidity is still well below the highs of 2001 and energy companies are scrambling to recenter their operations around assets. Hence, trading and risk management software vendors — many of whom initially migrated their systems from the financial sector — are faced with the task of adapting their operations to the new market requirements.
Some vendors have had to change more than others. Marty Makulski, a senior manager at consulting firm Accenture in Houston, says: "I would classify trading systems and risk management systems separately. A lot of vendors fall neatly into one category, but few find success in offering both."
He says software companies can be divided roughly into four categories: whether they market trading or risk management software, and whether their systems are highly configurable or more standardized. Firms that focused on providing highly customizable trading systems have struggled the most to adapt to the new market, Makulski adds.
Matthew Frye, managing director of the Houston division of trading and risk management software firm OpenLink, says: "During the heyday of the energy trading industry, large firms took a 'best of breed' approach to trading software selection.
"In many companies, all the different trading desks — for financial products, power, crude oil, natural gas liquids and so on — would have their own vendor and product of choice," he says. "Some of the bigger companies would run four or five software products under one roof."
Not any more, Frye says. "That's all changed. The economics of the industry mean that's no longer feasible," says Frye. "Companies are looking for an integrated solution."
Accenture's Makulski agrees. "We've seen a move away from the 'best of breed' model," he says. "On the client side, companies are trying to rationalize the number of systems they have to maintain. Vendors are looking to provide more integrated systems and become broader in scope in terms of the commodities and risk classes they can cover." This process has resulted in some aggressive pricing of systems, Makulski adds.
Split Market
OpenLink's Frye says one of the biggest recent changes on the demand side of the software business is the development of a split market for trading and risk management applications. On the one hand, there are the big integrated energy companies with operations across North America or worldwide, which incorporate many commodities. Although these companies will continue to seek customized software, their requirements — and corresponding financial capabilities — are no longer the growth area of the market, Frye says.
"Instead, a high proportion of market growth will be with those companies that have a unique focus in terms of the commodity they trade or their geographical base — niche players, not global players" he says. "One consistent theme in this market sector is that such companies tend to be physically orientated and have a strong asset base."
OpenLink will be introducing a new product line for such customers, which Frye defines as mid-tier players that may not have been among the top 10 power or gas marketers by volume when the likes of Enron and El Paso Energy were trading, but are in the top 10 now.
"A lot of buyers will be replacing in-house applications or a disparate group of solutions with a standard solution that covers all their requirements," he says. "But there will still be demand from high-end companies for flexible applications."
And despite the complexities of the physical energy markets, vendors say they can adapt systems that were designed for financial trading to energy. But there are certain obstacles to overcome. Electricity, in particular, poses some challenges. Power is not storable, and trading of it is marked by greater volatility than for most other commodities and financial instruments.
Mike Walker, head of product strategy for New York-based vendor SunGard Energy Systems, says: "Financial contracts are much better behaved than physical energy in terms of underlying risks. In many ways, a system needs more sophisticated modelling analytics to model physical energy risk."
For one thing, electricity trades hourly. "Even if you sign a 10-year deal, you need to model hourly load in order to get an idea of price," Walker says. "The capabilities needed to deal with this hourly granularity can require much more technical data than is required in, say, the interest rate spot market. It's a technical challenge, but one we can deal with."
Walker says the software products previously marketed by software firm Caminus aim to deal with the logistics of the physical market. SunGard completed its purchase of Caminus in April, taking on board a number of systems specifically designed to manage physical energy.
One school of thought has suggested that the electricity and natural gas trading markets in North America may split into two: the smaller, utility-type firms, which will mainly focus on their physical risk management; and the large merchant companies and banks, which will drive financial trading.
However, John Andrus, president of SunGard Energy Systems, does not take this view. He refers to a recent meeting with one of his company's customers, who expressed a desire for more integration between financial and physical risk systems.
"There are a lot of physical options involved in running a power business — such as when to ramp production up or down — that you can put into your risk system and treat as options, but when they're exercized, they're still physical," he says. "We're moving towards a tighter link between physical risk on the one side and market and credit risk on the other."
With regard to the economics of the energy sector, Andrus adds: "I don't believe there's less money out there [for companies to spend on software], although maybe it's spread between fewer players," he says. "There are still a fair number of customers with both the need for, and the money to spend on, tailored systems like ours.
"We offer a strong foundation package and the ability to tailor the system to your needs, without having to make the process of doing so your life's work," Andrus adds.
Scheduling
OpenLink, for its part, has sought to address the physical requirements of the energy markets through the launch this year of two scheduling systems, pMotion and gMotion. Coleman Fung, founder and chief executive of OpenLink, says the firm started designing the products two years ago, and that they were not simply launched in response to the changes in the trading market over the past 12-18 months.
The two systems integrate power and natural gas scheduling into Endur, OpenLink's flagship trading and risk management system. Fung says the company is aiming to provide a full front-to-back-office package including trade capture, position management, scheduling and settlement.
Another growth area for software companies is selling to banks. In the past 12 months, a number of banks have entered or re-entered US power or natural gas trading, including Bank of America and Merrill Lynch. Banks are by their nature more familiar with financial than physical trading, and only the two biggest players, Morgan Stanley and Goldman Sachs, own physical portfolios of power plants.
Nevertheless, some feel banks may look to physical trading to better understand the specifics of the power industry and have the ability to offset their risk. OpenLink's Fung says: "Banks that have made strategic investments in the energy business are willing to tackle the logistical problems that can come with physical trading. They may, for example, have lured traders with experience of this part of the market away from energy companies.
"They're not looking to become big physical houses overnight, but rather to take a measured approach and gradually build-in the physical component of the business," he adds.
Sungard's Walker says banks are entering the energy sector from a more mature market, and are bringing with them some good business practices that the energy industry can adopt. "For example, banks are required by their regulators to do back-testing [applying forecasting models to historical data to test the usefulness of the model]," he says. "This isn't something utilities have historically done, but it's good business practice and something that — with our background in the financial markets — we can easily adapt to energy."
As Accenture's Makulski says, it seems that despite the changes in the industry, software vendors have a chance to consolidate and expand their businesses.
"None of the money-market software providers are making moves into the energy market, and we're not seeing any more migration from European software companies into the US," says Makulski. "There are real opportunities for a well placed software vendor to take advantage of this market."
As seen in EPRM's Technology Special Report supplement - July 2003
Copyright © 2003 Risk Waters Group Ltd. All rights reserved.
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