## Detailed Glossary

A Detailed Glossary of Energy Trading terms for registered users

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### I

#### Instrument

At its most abstract an Instrument is a category of trade types

Detail

It is difficult to define Instrument further than this, because the term is used differently between organizations, functions within organizations, and trading systems

A typical instrument may have dimensional attributes of:

So, examples of Instruments may be

Note the similarity and differences to a Product

Note that some proprietary systems make a very specific use of the term Instrument

 Keyword(s): instruments

#### Interconnector

A gas or power connection between two different locations

Usually used to flow gas or power from a lower priced location to a higher priced location

Detail

Interconnectors consist of either a pipe, or cable connecting two hubs or grids

For a trading company the process of flowing gas or power from one location to another goes as follows:

Procure capacity on the interconnector

This may be through an auction, mainly annual and day ahead, or in some cases through a secondary market (i.e. buying or selling capacity to other organizations)

Capacity is usually bought in flow rate units (e.g. Nm3/hour for gas, MW for power) over a period of days, a month, quarter, years etc.

Capacity on an interconnector is much like an option on a location spread

Capacity gives the right, but not the obligation, to flow gas or power from one location to another

Transmission

In order to use the capacity the trading organization needs to nominate transmission of gas or power to the TSO

Let's say we have a long term capacity contract to flow power from the France to the UK through the IFA

Noticing the price of power is less in France than in the UK so we nominate to the TSO that we will flow power (up to the capacity flow rate), using the capacity

We normally book this as a trade in our ETRM, but there is no change of title - this is an internal trade

We usually book this trade at a fair market price to keep P&L shifting between locations

Obviously we need to hedge this with an appropriate long position in France (we buy the power in France) and a short position in UK (we sell the power in UK)

#### Invoicing

Like most businesses, we sell something, we deliver it, we raise an invoice, we send it to our buyer, we get paid - we hope.

The Master Agreement between us and our counterparty will specify if we raise an invoice for a specific delivery (of oil for example), or for a continuously delivered commodity (gas or power for example) over a period (usually a day, week or month)

Detail

The two main invoicing schedules are:

• Monthly - all of the commodity that has delivered to a counterparty at a location in the last month is invoiced shortly after the end of the month. The invoice will include all trades that have delivered during the calendar month. Trades delivering over multiple months will appear on successive invoices. Each invoice will only relate to the delivery of each trade within that month
• Delivery - typically oil is invoiced a few days after a physical shipment has occurred

Invoices usually have the following granularity:

We may therefore raise a number of invoices for a counterparty, with different combinations of the above

Once we generate, or raise, an invoice, and are satisfied that it is correct, we transmit the invoice(s) to our counterparty, and we post the invoice(s) into an Account in our General Ledger

We expect our counterparty to be doing the same for commodities that we have bought from them, and expect to receive invoice(s) that we will check against our own records

To help this we raise a set of shadow invoices, or purchase orders, so that we can compare these to the invoices received from our counterparty. Once agreed we post these purchase orders into an Account in our General Ledger

 Keyword(s): invoiceinvoicesinvoiced

### L

#### Line Loss

When transmitting Electricity via Interconnector, some  of the power is lost and thats called Line Loss. For UK-FR interconnector line loss factor is 1.17%

Detail

Why?

The linearity refers to the delta - that is the variation of the value of the trade with the main underlier

Trades with no optionality have a value that is directly proportional to the value of the underlier - if we plot the value against the value of the underlier it will be a straight line - hence linear trade

Trades with optionality do not have a linear relationship between value and underlier. As the value of the underlier becomes less and less favourable the value of the trade becomes nearer and nearer to zero

Unsurprisingly these trades are known as non-linear

 Keyword(s): non-linear

#### LNG

Liquefied Natural Gas

Natural Gas is difficult to liquefy by compression alone, it is usually liquefied, stored and transported at very low temperature

LNG acts like oil and coal for transportation, like natural gas once it is returned to its gaseous form

Detail

Unlike propane gas it is not practical to liquefy natural gas (which is mostly methane gas) by compression alone, and it is normally liquefied by refrigeration to -160 oC and stored and transported at moderate pressures

LNG needs to be transported in specialist ships (LNG vessels) that can maintain the low temperature required, so are quite different to other commodity carriers

On arrival at a destination port the LNG needs to be returned to its gaseous state in a plant which is attached to a gas terminal

Other than the ships themselves the logistics of LNG transport involve the same complexities as oil and coal

LNG is big business for two main reasons:

A vast quantity of natural gas is already available from oil rich countries - but there are no pipelines to flow it long distances (Russian gas into Europe being the main exception)

The process of extracting natural gas from unconventional sources (typically shale) by hydraulic fracturing ("fracking") is likely to yield even more gas - but usually not where it's needed

 Keyword(s): Liquefied Natural Gas

#### Location

Location is one of the key dimensional attributes of all physically settled, and many financially settled, trades

Detail

Location is usually a description of where the delivery a of a trade will take place

Although this sounds fairly straightforward, in practice location means different things for different commodities.

This is because the delivery location simply defines the lowest level of distinguishable information about the delivery, and this lowest level varies with the commodity

So let's look at some commodity locations to see what this means:

Natural Gas

The location of the majority of gas trades in the UK is the NBP

The NBP isn't even a real location, it describes the UK-wide gas pipeline network called the National Balancing Point

On the day of delivery, a seller of gas has an obligation to deliver gas at the NBP

The seller may deliver it from any other location that is physically connected to the NBP, it doesn't matter where that is.

The buyer may take delivery to any other location that is physically connected to the NBP

Gas traded locations such as the NBP are called hubs.

Some hubs require the buyer and seller to identify the physical connection point of delivery - these are physical hubs

Other hubs, like the NBP do not require the buyer and seller to identify the connection point - these are virtual hubs

 Keyword(s): locations

### M

#### Margining

Margining is a form of Settlement, whereby exposure to Credit Risk between two parties is limited by keeping the overall Credit Exposure below a certain threshold by means of Margin payments between the parties whenever the threshold is breached

Detail

Let's take a simple example

I buy a delivery of 200 tonnes of coal from you at a fixed price of $60 per tonne, to be delivered in Antwerp in December 2018 Let's also assume the day we do the deal the forward price of coal for that delivery month and location (and quality) is also$60 per tonne (we agree on a daily published price to value the coal, in this case the Argus/McCloskey API 2 INDEX)

https://www.argusmedia.com/Methodology-and-Reference/Key-Prices/API-2

At the end of the first day the contract calls for me to pay you $12,000 at the time of delivery, and for you to deliver to me, what we both currently agree is,$12,000 with of coal at about the same time

We are even - we'll call this day one

If either of us goes out of business, or defaults in any way, then the other party will not lose out

Every day up until the delivery takes place we will recalculate the value of the coal and determine if one side would lose out if there were a default

At the end of day two we both note that the API 2 index is now set at $59 for November 2018 delivery At this point I will still have to pay you the$12,000 cash, but you will only need to deliver to me $11,800 worth of coal If you go out of business or default on the deal I won't lose out But if I default then you will lose$200

I need to arrange for that $200 available to you in case I do default we'll look at how that is arranged in a moment On day three we both note that the price has risen to$62 per tonne - that's good for me, bad for you

Now if I default you won't need to deliver $12,400 worth of coal in exchange for$12,000 cash

But if you default then I'll be $400 worse off You need to arrange for$400 to be available to me in case of default

Let's say on day eight the price rises to $66 per tonne You now need to arrange for$1,200 to be available to me in case of default

We talked about making the cash available in case of default - how does that work?

There are actually a few different schemes:

###### Clearing

in a clearing arrangement each if us has a margining account with a central clearing house

Before we even start trading we need to deposit some money into the account, and each time we execute a trade we need to make sure there is sufficient in the account to cover a certain amount of loss

Let's say we both deposit $1,500 initially and then an additional$1,000 as a result of doing the single trade - we can see that on typical price movement, for the volume of the trade this, then it would take quite a large movement in the price to change the value of the trade by $1,000 We both now have$2,500 deposited

The initial $1,000 deposit against this specific trade is called the Initial Margin At the end of day two the clearing house would remove$200 from my account and put it into your account - this is the Daily Variation Margin

I now have $2,300 and you have$2,700

At the end of day three the clearing house would remove $600 from your account and put it into my account - this is the Variation Margin That's$600 not $400 because it includes a refund of the$200 already taken out (the price swung by $3 per tonne - that's$600)
I now have $2,900 and you have$2,100
At the end of day eight I would have $3,700 and you have$1,300

At this stage you would need to make a payment into your account to top it back up to a minimum level - this may be $200, or it might be more depending on the agreement ###### Collateral We might agree to post$2,000 collateral with each other to cover any initial movement either way

We agree to margin limits of a minimum of $1,500 and a maximum of$2,500, if the margin falls below $1,500 we will post a minimum of$500 to get the collateral back up to $1,500, and likewise, if the collateral goes above$2,500 we will be able to withdraw cash to bring it below $2,500 At the end of day two my collateral stands at$1,800 - the cash in the collateral account minus the $200 current liability on the deal at that point - we're both OK, I have more than the minimum$1,500

At the end of day three I have $2,400 collateral and you have$1,600 (your original $2,000 less your current liability of$400 on the deal)

At the end of day eight I have $3,200 collateral, and you have just$800 (your original $2,000 less your current liability of$1,200 on the deal)
you need to transfer $700 into your collateral account held by me, I can withdraw$700

A requirement to top up a clearing account or collateral account is known as a margin call

#### Mark to Market

A way of valuing the unrealized P&L of a simple linear Forward, Futures contract or Swap

Detail

Most businesses that own assets or hold inventory routinely value those assets and inventory, the change in value between two points in time is the profit or loss

Some assets, like computers, simply depreciate, and a simple depreciation percentage is used each year

Other assets, like buildings, vary in value with the market conditions, and are generally valued using a mark to market principle (that is we simply look and see what the building is worth at the end of the accounting period)

It's important to realize that each trade is an asset (or a liability) - it's a firm contract and must be valued like any other asset

The current value of a single trade is the difference between the price paid, and the value of the delivered commodity when it is delivered (which may be a cargo, a day of gas delivery, or a half hour of power delivery)

We can find the value of the commodity once it has delivered by looking up the spot trading price on the day of delivery

But to value the deal before delivery we must mark the value of the delivered commodity to the market; that is we set the value of the commodity to the price that is currently being paid for the delivery period

For example:

We have bought 10,000 therms of gas for delivery in March next year at 25p per therm

Each day we can look at the average traded price for that month, and mark the value of the 10,000 therms to that price

After two days we note that March is trading at 27p a therm, so we mark the physical value to the market price of 27p, and subtract the price we will pay, 25p. The unrealized P&L is therefore £200 ((27p - 25p) * 10,000). Each day we will need to repeat this calculation until the delivery is complete

 Keyword(s): MtMMTMmarking to market

#### Market

In Energy Trading a Market describes a standardized trading environment for a commodity and a geographic zone

The geographic zone is not necessarily the delivery location, but usually determines the valuation of the traded commodity

For example API#2 is a market based on the published index for coal in the Amsterdam, Rotterdam and Antwerp (ARA) location; a trade may deliver coal to a port in France but still be part of the API#2 market

Detail

A market combines attributes of commodity and location and may have an associated calendar and business rules, which provide defaults for any trade associated with the market

Some delivery locations are also markets, so far example NBP is a gas location and also market

Note the similarity and difference to a Master Agreement which has similar attributes

 Keyword(s): Markets

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