Detailed Glossary of Energy Trading terms

A set of indices used to price a trade

Detail

Generally used in the description of a floating side of a trade, such as a Floating Forward or Swap

The valuation of the floating side is based on an agreed formula based on multiple indices; the set of indices being the basket

A form of settlement where responsibility for payment is passed to a third party: a Clearing House or Clearing Broker

The Clearing House accepts responsibility for settling the deal.

Credit risk for the seller in the trade is reduced to almost zero

The Clearing House minimizes its Credit Risk by daily margining

Detail

An organization may trade on an Exchange either by becoming a member of the Exchange, or trading through an Exchange Broker. The clearing principles are similar in either case

In general a trading organization engages a Clearing Broker to act on its behalf

The trading organization is required to open a margin account with the Clearing Broker, which in turn maintains a margin account with the Exchange's Clearing Bank

As the organization enters into a trading position the Exchange marks the trades to market on a daily basis, and transfers cash into or out of margin accounts based on the change of the value of the trading position since the previous day. The Clearing Broker mirrors this operation to its clients' margin accounts

Every trading organization is required to maintain an amount of cash in the margin account to cover a substantial short term loss in the value of its position. If the trading organization does not maintain this margin then the Exchange closes out the position immediately, using the margin account cash to cover any losses as a result of the close out

Payments into the margin account as a result of new trades that cause an increased open position are called Initial Margin payments

Payments into the margin account as a result of the value of trades falling are called Variation Margin payments

A Forward, or Forward Contract, is an agreement to buy or sell a commodity at a fixed time in the future

Details

A Forward Contract involves two trading parties: a buyer and a seller. Our organization is one party, the other is the counterparty

A Forward Contract can involve almost any terms for quantity (Volume), quality, commodity, delivery period, delivery location, pricing and settlement

A Forward Contract may be executed directly with a counterparty, or through an intermediary (a broker)

Whether brokered or not, responsibility for delivery and settlement of a Forward Contract is usually directly with the counterparty (see Clearing for an exception)

Forward Contracts may be executed at a fixed price, or at a floating price:

• Fixed Price Forwards are settled at a strike price which is agreed as part of the trade
• Floating Price Forwards (Floating Forwards or Indexed Forwards) are settled at a price which is derived from a published index, or a combination of indices according to a pre-agreed formula

Forward contracts may be physically or financially settled:

• A physically settled Forward requires the seller to deliver the physical commodity at the time and place specified in the terms of the trade, the buyer is required to pay for the commodity at the price and time agreed in the terms of the trade
• A financially settled Forward requires the buyer and seller to compare the agreed strike price with an agreed valuation of the commodity at the time of delivery. If the strike price is higher than the valuation price then the buyer pays the seller the difference in price (per unit of the trade volume), otherwise the seller pays the buyer

A financially settled Forward is often referred to as a swap

A Forward is usually settled bilaterally between parties.

Forwards may be included in a netting agreement

Forwards may be included in a margining agreement

A Forward may be given up for clearing

An Energy Swap is generally a swap of two different prices on an identical, or similar, Energy underlier

Detail

While financial market swaps may involve swapping almost any cash flow for any other cash flow, an Energy Swap involves the swap of two different prices on an identical, or similar energy product or underlier.

The two types of Energy Swap are:

• Fixed for Floating - one price is fixed by agreement in the trade terms, the other price is derived from one or more published indices based on a formula agreed in the trade terms
• Floating for floating - both prices are derived from one or more published indices based on a formula agreed in the trade terms. This type of Swap is also known as a Basis Swap

By definition, Energy Swaps are always financially settled

Energy swaps may be traded OTC or on an Exchange

An Energy Swap is very similar to a a financially settled Futures or Forward Contract

Exchange traded swaps are generally settled through non-daily margining - and therefore have credit risk

Financially settled futures, like all futures, are settled through daily margining - and have minimal credit risk

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%

A known future cash flow that has not been invoiced

Detail

This term is a perfectly standard accounting term.

Accruals commence at the time of delivery and continue until an invoice is raised, or an invoice is received

For continuously delivered commodities (gas and power), accruals build up over the delivery month, day by day, and continue until an invoice is generated or received early the next month

Accruals are posted to the General Ledger, and are reversed out when an invoice is posted

Unrealized P&L is not accrued - only delivered (and therefore usually realized) P&L is accrued

Accounts Payable/Accounts Receivable

Anything relating to these two departments, that is:

• receiving, checking and paying invoices (Accounts Payable)
• raising, sending and chasing payment of invoices (Accounts Receivable)

Often used to refer to invoices and invoiced cash flows

Detail

In general the Master Agreement of a trade determines the agreed invoicing cycle and dates

A typical invoicing cycle would be to invoice a month's worth of delivery on the 5th day of the following month

Our organization must raise invoices, and may raise shadow invoices or purchase orders to match against invoices received from our counterparties

Once sent, an invoice cannot be deleted or just ignored, but it can be reversed by issuing a credit note. A credit note reverses part of, or a whole invoice

Equally a debit note may be raised to reverse part of, or all of, a shadow invoice or purchase order. This should match a credit note that our counterparty will send to us

The set of invoices, shadow invoices and purchase orders, credit notes and debit notes, and the cash flows held in them may be collectively referred to as APAR 

The difference in cost of achieving the same outcome through different means

Detail

This is easiest explained as an example:

To buy a particular new car in the UK costs £27,000

The identical UK-spec car costs £22,000 in Belgium

It will cost you about £1,000 to have it shipped to the UK, plus another £1,000 costs for delivery, any inspections, your time to manage all this etc.

Cost of buying the car in the UK = £27,000

Total cost of buying the car in Belgium and having it delivered to your home = £24,000

There is an arbitrage opportunity of £3,000

In general, in a liquid market, with minimal market constraints, traders will exploit any arbitrage, and the arbitrage values should all tend to zero

In our example if everyone chose to buy the car in Belgium:

the price would probably go up in Belgium because of the higher demand

the cost of shipping might go up (because of demand and the realization it's valuable)

the price of the car in the UK would probably fall (because they weren't selling any)

When the market acts to reduce arbitrage to insignificant values then we describe this as arbitrage-free

Arbitrage-free is a powerful method in many valuation tools: it implies we can value an Instrument or trade by looking at alternative ways of achieving the same outcome

For example the value of an oil forward contract in six months time, should not be significantly different to the spot price of oil, plus all of the costs of storing that oil for six months

In energy trading terms an asset is something an organization owns that can physically provide, transform or move an energy commodity, such as a gas field, a power station, or a refinery

Detail

In trading terms many assets that transform or help to move a commodity are in effect an option on a spread:

• A gas fired power station acts as an option on a spark spread; if we choose to run it we provide the gas (and the carbon) and in return we get power
• A refinery acts as an option on a crack spread
• A ship acts as an option on a location spread
• A storage facility acts as an option on a time spread
• a pipeline acts as an option on a location spread

Long term supply contracts are also sometimes referred to as an asset

Auto Trade Capture is a capability in most trading organizations (and many have an application called ATC) that allows trades executed on an electronic trading platform (usually exchange or broker) to be automatically downloaded to our organization's ETRM

Detail

ATC usually works by accessing an Instance of Trayport GlobalVision which is a proprietary product.

Trayport provide broker trading platforms to most common Energy Trading Brokers and some Exchanges, and also acts as an interface to many Exchanges running their own trading platforms

Trades executed on compatible platforms may be accessed as XML and mapped into the local ETRM

It is normal for trades to be entered into the ETRM in a status that requires a trader to "validate" or "approve" the trade as having been executed

Trades may also be received from other platforms, often in the form of FIX format messages

Most ATC systems consist of:

• A set of download adapters
• A maze of mapping tables
• A set of ETRM adapters