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Articles Archive
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November 2003
Tech For Gas Turmoil
An adaptable straight-through processing system is crucial if natural gas market participants are to stay profitable despite continuing price volatility, says OpenLink International's JEAN-CLAUDE RISS.
Turmoil in the European natural gas markets in
recent years has caused a sharp decrease and subsequent slow rebound in the
number of firms actively trading. As a result, there has been a major change in
the definition of a typical trading organization. As the markets regain momentum
and trading volume increases, so trading firms increasingly need a technology
infrastructure that can keep pace.
Since the 2002 exodus of US trading companies from European natural gas and power, smaller industry-veteran gas firms and new financial institution entrants, such as Barclays Capital and Deutsche Bank, have begun to trade actively in the wounded gas markets.
The move by these firms into the physical market and the growth in hedging activity by smaller producers, operators and distributors was fueled by the pool of skilled employees created by the downturn and a new-found ability to acquire assets cheaply. And since these barriers to market entry are falling, companies can actively participate in natural gas trading on the shortest time scale possible.
Before the Enron debacle triggered shifts in the market, transaction volume was strong and the trading climate was warming to new ways of doing business. And despite slower-than-expected European liberalization, it was these pre-Enron signs and a forecast continuing increase in gas demand - led by demand growth in power generation - that made it clear that the markets would never be left for dead.
Poor internal controls
While the start of the natural gas market's recent wild ride can be traced back to one company's illegitimate hiding of business losses, the subsequent close examination of the energy markets revealed flaws throughout the sector. Supervisors and regulators uncovered a widespread lack of internal checks and balances and found that neither market nor credit risk were being managed adequately.
Since October 2001, steps in the right direction have been taken, such as the introduction of International Accounting Standard 39 financial reporting standards. But it is still up to most companies to assess whether they are adequately prepared to maintain long-term profitability within the volatile natural gas markets.
Yet most of these organizations still rely on proprietary and/or antiquated trading and risk management IT solutions, regardless of whether they are a financial institution, the trading arm of a recently expanded multinational or a surviving physical trader.
And, with the gold rush over, the ability to leverage a straight-through-processing (STP) software infrastructure - a strategy that financial institutions in the capital markets have embraced, but which has so far eluded most energy market participants - is critical.
The issues involved in implementing an STP transaction and risk management solution vary depending on a firm's size and complexity. A multinational, cross-market company might need to replace and/or integrate disparate solutions. A financial organization might need to address logistical concerns. And a veteran trading firm might need to update a spreadsheet-based, homegrown system that cannot meet the complex demands of today's fast-evolving gas markets.
Yet common to all is the need for a solution that includes modern facilities such as highly configurable deal-capture functionality with a multi-step validation process; robust micro- and macro-level risk management (covering market, credit and operational risk); integrated settlement processing and accounting; full audit capabilities; detailed user security privileges; and secured database control. And this is to mention just a few standard requirements.
Anchoring the system
Certainly, most companies will find this a complex wholesale upgrade project, and some will decide it is too costly and risky to perform all at once. In that case, the weakest link in the IT mix should be replaced with a new 'anchoring' system. The best way to do this is to select a new solution that can replace the most vulnerable point today, while offering additional capabilities that can be substituted for other aging functionality later. The identification and implementation of a new anchor solution that is comprehensive and flexible will allow easy mapping of the remaining upgrade based on available budgets.
Despite the recent bumps in the road, consumer consumption will drive natural gas demand higher, liberalization will spread and the European markets will continue to evolve. Firms must realize that to thrive - given the recent operational pressures and scrutiny - they must focus on improving business processes throughout their front-, middle- and back-office operations.
Jean-Claude Riss is the managing director of London-based OpenLink International, the European arm of software vendor OpenLink.
Copyright © 2003 Incisive Financial Publishing. All rights reserved.
Used by permission. First published in Energy Risk - November 2003
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