Detailed Glossary of Energy Trading terms

Flattening an open position to a net zero (or flat) position

Detail

Trading activity in general leads to opening positions, and very often to closing out those positions before the delivery period

For example I may sell 10,000 therms of gas for delivery May 2024 today

I have an open position of 10,000 therms in 2024

Next year the price has dropped and I decide to buy back all 10,000 therms at the lower price, thus locking in a profit

(sell price - buy price) x 10,000

remember when we short a position we make a profit when the price drops!

I have no remaining open position in 2024 gas - so I have closed out my position

I can always re-open it by executing another trade

If my second trade had been to buy 6,000 therms then I would have closed out 6,000 therms, and have 4,000 therms remaining open position

Closing out a Futures position on an Exchange has an additional meaning and consequence

The profit or loss value would immediately be considered as realized P&L for the following reasons:

• There is no valuation uncertainty
• Payment has been made
• There will be no delivery

In Energy Trading a commodity is generally either a form of energy itself, or a physical material that may be used to easily provide energy, or a related commodity or service. The most common commodities are oil, gas, electricity (power) and coal

Detail

Standard energy commodities are:

Electricity - almost always referred to as Power in Energy Trading environments

Gas - almost always meaning Natural Gas

Sourced from underground Natural Gas fields, and increasingly from shale

Transported in gaseous form transported through pipelines, or liquid form (LNG) in pressurized vessels and purpose built ships

Used in power stations, and directly burned for heating

Oil

Probably the most heavily traded energy commodity

Sourced as Crude Oil from underground oil fields, and increasingly, shale

Mostly refined in refineries to produce fuels for heating, transportation and use in power stations

Transported mostly by ship (tankers)

Coal

Sourced from underground coal deposits

Transported by ship, barge and truck

Biomatter

Fuels that are grown, or made from plants

Parts of plants may be directly burned in power station

Liquid equivalents of gasoline and diesel (biofuels) may be synthesized from plants

Related commodities and services include:

Freight - for moving solid and liquid commodities

Environmental certificates, including carbon

Foreign Exchange, FX

Storage

Capacity

A Confirmation is a document describing a trade that has been executed, and is generally sent by the Seller to the Buyer to check the trade details, to be returned by the Buyer confirming that the trade details match the trade as they have recorded it

The Confirmation, or Confirm, process allows both parties to agree the trade details

Detail

The Confirmation process, and the form of the Confirmation document are defined in the Master Agreement, usually as an Appendix

The Confirmation match is the final stage of the contract between the two parties, without it the trade is not legally binding, as well as specifying the trade details the Confirmation also specified the Master Agreement under which the trade was executed

Confirmations are not normally produced for Exchange trades

Some parties produce and send Confirmations for both Buy and Sell trades

Confirmations must be signed by an authorized signatory in the Trading Organization

Confirmations are normally produced and signed electronically

Matching Confirms tends to be a manual process - systems of bar coding have been proposed

There are schemes that electronically confirm trades, generically known as ECM (Electronic Confirmation Matching)

These are generally point to point - but there is no reason not to utilize a centralized matching service 

Curve is a relatively general term  to describe a set of time series data, for example prices, interest rates, foreign exchange rates (FX), volatilities etc.

Detail

In general curve is used as a term to describe time series data that is used to value trades, that is to calculate the unrealized p&l of a trade, or set of trades.

Curve data is usually derived from published data

Curve data is typically published each day - so a curve consists of a set of time series data for each publication date

Publication dates are ususally daily

Point dates may be daily, hourly, monthly, quarter hourly

Because of the separate publication date and point date dimensions there may be a huge amount of data over time for a single curve

A forward curve is usually a set of future price points used to calculate the future value of the physical side of Forwards, Futures, Spreads and Swaps

Curves typically have dimensionality of:

Commodity

Location

Market

Product

Trading and pricing for delivery the next day

Detail

Day Ahead and Within Day trading is responsible for the vast majority of gas and power trades executed

The Day Ahead Market (DAM) is used by

Operations/logistics teams to balance supply to demand

Speculative traders to make money out of the massive liquidity in Day Ahead trading

Day Ahead trading may be executed in the normal ways:

Bilaterally with a counterparty

OTC through a broker platform

In addition there are specialist Spot Exchanges that offer a wide range of within day and day ahead products, traded in two main ways:

Continuous spot trading much like any other OTC or Exchange trading

Day Ahead Auctions - with a fixed close 

At the close of Day Ahead trading many Spot Exchanges publish Day Ahead Settlement prices based on the auctions and/or a particular trading period in the current day, or provide these prices to a third party who publish a Day Ahead settlement price

Day Ahead settlement prices are often used as tradable indexes for indexed or floating forwards. 

These Day Ahead settlement prices are often referred to as Day Ahead indexes

Physically settled trades have a delivery time or period specified in the terms (details) of the trade

Delivery is the physical act of delivery of the traded commodity at the location and time specified in the trade details

Detail

The act of physical delivery is made in different ways according to the commodity:

Gas:

Location is some specified point on the gas pipeline network

Time is usually specified at daily granularity, a trade may cover one or more days, months, quarters or seasons

Power (electricity):

Location is some specified point on the electricity grids

Time may be specified at quarter hour or above granularity

Oil & Coal:

Location is specified as a port, or group of ports in the trade details - the specific port or docking location is specified later by mutual agreement within the terms of the trade.

Time is usually specified at monthly granularity - the specific dates being agreed later as shipments become clear 

In general:

Gas and power delivery continuously throughout the delivery period, and the delivery volume is often specified as a rate of delivery

Megawatt (MW) for power - remember one MW flowing for one hour is a Megawatt.Hour (MWh)

Therms per day (therms/day) for gas

Oil, coal, LNG and most other commodities are delivered in discrete consignments at mutually agreed points in time during the delivery period

At its simplest the delta of a trade or position is the ratio of its change in value to the change in value of its underlier 

Detail

More accurately the delta is the ratio or sensitivity of the change in trade trade value to any variable, market value or observable

For example a simple Physical Forward trade has a sensitivity to:

• The price of the underlier
• The interest rate
• The FX rate of the currency it was executed in to our base reporting currency

So the delta is the ratio of the change in value of the trade per unit volume (e.g. €/MWh) to the change in value of a market value or underlier (e.g. the underlier power price quoted in €/MWh) to give a dimensionless ratio

You may come across a use of Delta as the ratio of the change in total value of the trade (e.g. €) to the change in price of the underlier (e.g. €/MWh) to give a value with units of volume, in this case MWh. This definition of delta is usually referred to as the Exposure, and may also be thought of as the delta above multiplied by the volume

The delta of fixed price Forwards and Futures is about one

The delta of options varies between 0 and 1 (or -1 to +1)

Exposures are additive - they can be summed across a set of trades or portfolios

Deltas are not additive - because they are dimensionless ratios

Delta is one of the Greeks - usually the most important Greek for trades with no optionality 

To offset the delta of an option or other non-linear trade, usually with a linear derivatives position

Detail

If we buy a simple call option, or sell a simple put option, then we may or may not have a long position when the delivery date of the (potentially exercised) contract is made

In reality the option will either get exercised or not - let's say the option is for the delivery of 1,000 MT of coal in January 2016 at ARA (Amsterdam Rotterdam Antwerp location) - we will either have a position of 1,000 MT at that time, or not

On any particular day the option will have a calculable delta, which roughly translates into a probability of the option being exercised:

An option with a delta of 0.01 has a 1% chance of being exercised

An option with a delta of 0.5 has about a 50% chance of being exercised

Traders generally hedge the exposure of the option (which is the delta times the volume), so if the delta is 0.5 they will hedge 500 MT of coal

In general as the option exercise time approaches the delta of the option will swing quite rapidly toward 0 or 1 (or -1) so that the hedge swings toward 1,000 Mt or 0 MT

If you're wondering why an option with a delta of 0.5 (meaning the value of each MT changes by €0.5 for each change in €1 per MT in the value of coal) has a 50% chance of being exercised then think the other way round - if the option was certain to be exercised then its value would change by €1 per MT per change of €1 per MT in the price of coal, so its delta would be one - the delta is effectively the probability of being exercised

A type of trade or instrument which has a value dependent on an observable value, which is usually, but not always, the price of a physical commodity.

The observable value is called the underlier

Detail

Any energy trade type that does not involve immediate delivery is a derivative - because the value of the future delivery varies with the expected price of that commodity at that location at the time of delivery

The only significant exception is a Spot or Prompt trade, which involves immediate, or near immediate delivery

Calculation of the present day value of a cash flow that will or might occur at some time in the future

Detail

Suppose I offered to give you £1,000 right now - you'd be pretty pleased (wouldn't you?! If not imagine it's £10,000,000)

Suppose I guarantee to give you £1,000 in one year's time - you'd also be pleased I guess, but less pleased of course...

Why?

Well, for starters if you got it today you could use right away

Even if you wanted to use it in a year's time you'd rather have it now because you could put it in the bank and earn some interest over the next year

Conversely, if you really needed some money now, you could borrow it from a bank and then repay it when I paid you in a year's time

But if you borrowed £1,000 now you'd have to pay interest over the year, so you'd actually end up owing a bit more than £1,000, let's say £1,050

So if you worked out how much interest you would pay, and borrowed an amount, such that the initial amount plus the interest over the next year came to £1,000, then the £1,000 would exactly pay it off

Let's say you did the calculation and it came out that you could borrow £965, the interest on that over the year coming to £35

We could then say that £1,000 in a year's time is equivalent to £965 right now

We call that £965 the discounted value of the £1,000 in a year's time

You can see that the general principle is the discounted value is worked back from the actual value from the expected payment date to today using the expected interest rates

In order to calculate a discounted cash value we need:

The payment date - usually available from the contract terms, or the master agreement

The interest rate curve (for the payment currency or an alternative hedging currency)