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Megawatt hour | ||
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A measure of energy - abbreviated to MWh Equivalent to one Megawatt of power flowing for one hour Detail In physics Power = Energy per unit time, e.g. joules per second this can be thought of as an energy flow rate it follows that Energy = Power * time think of energy (MWh) as the equivalent of distance (miles or kilometres), and power (MW) as the equivalent of speed (mph or kph) Electricity (confusingly also normally called power) and gas trades are often described in terms of a rate of energy, e.g. Megawatts, or therms per hour However energy trades are priced in terms of energy (e.g. €45.3/MWh) so we need to be able to calculate the number of MWh of the trade or delivery period This is easy if we use the equation: 1 MWh = 1 MW flowing for one hour and simply remember this Megawatt.hours = Megawatts x hours or MWh = MW x hours Just like the speed of a car: you can't meaningfully add two values in Megawatts at different times - what does it mean to add two speeds together at different points on the Motorway? If I drive 60 mph for 10 minutes, then 72 mph for the next 5 minutes, does the number 132 mph mean anything? (No!) If I flow 10 MW one day and 20 MW the next day, the value 30 MW has no meaning you can meaningfully add two values in Megawatt hours at different times If I drive 10 miles in the first ten minutes, then 6 miles in the next five minutes, then I have driven 16 miles in total If I flow 240 MWh one day and 480 MWh the next day, then I have flowed 720 MWh over the two days you can't normally price something in Megawatts - a toll road makes you pay per mile, it doesn't matter how fast you went | ||
Netting | ||
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Netting is the aggregating and offsetting of multiple cash flows between counterparties to arrive at one, or a limited set of physical payments Detail There are two distinct sorts of netting: Settlement Netting - which might also be described as payment netting All cash flows between two parties are summed (receipts are positive, debits negative) to arrive at one physical payment due Settlement Netting granularity aggregates cash flows to a single legal entity over one or more cash flow attributes including:
The exact terms of Settlement Netting are described in the bilateral Master Agreement that we have in place with the counterparty Close-out netting - The set of outstanding cash flows that will be netted if our counterparty goes into receivership or liquidation If we are expecting a payment of £999,999 from our counterparty, and they are expecting £1,000,000 from us, and they go into liquidation - we want to be owing them £1, not £1,000,000. The liquidator will do his best for all creditors to try and get us to pay the £1,000,000, and have us wait in line with other creditors for the £999,999. Indeed without a legally sound close out netting agreement in place the liquidator would be favouring us as a creditor were they to let us net the outstanding payments | ||
Nomination | ||
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An electronic message sent to a third party detailing a transaction or requirement as part of a pre-existing agreement Typically gas and power transactions are nominated to system and market operators Detail Examples of nominations:
Nominations are sent typically some time in advance, and then updated as any changes occur (new trades are executed, new forecasts are made etc.) For power and gas there are deadlines for the last nominations for a delivery period - if nominations are missed then the trading organization may face large imbalance costs so: Nominations are one of the most time-critical processes or capabilities of any trading organization In the UK nominations are officially known as Notifications - but the general term, nomination, is more usually used | ||
Novation | ||
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A generic legal term for transferring existing contracts from one legal entity to another Detail A legal entity may agree with another legal entity to transfer all, or a subset of, its contracts to another legal entity Each company that the original legal entity has contracts is notified, and a novation is agreed: that is our organization agrees to novate our contracts from the first legal entity to to the other on a particular, mutually agreed, date amongst the contracts novated will be any long term contracts, master agreements and any trades Trade novation has to be reflected in our ETRMs, and the following convention is usually followed:
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Offer | ||
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An Offer is a type of Order; a trader offers to sell a product or commodity at the Offer price Detail The trader offers a product for sale at a particular price Offers are normally submitted to a Broker or an Exchange If an offer is matched by a subsequent bid by another party, then a trade is executed If the offer matches an already quoted bid then a match is made and a trade is executed See also Bid | ||
Option | ||
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At its simplest an energy option is an instrument that gives the buyer the right, but not the obligation, to buy, or to sell, a commodity at a specified price at some point in the future.
More complex options may be financially settled, the payout being dependent on some condition(s) being met, and varying with some observable value(s) at the time of exercise
There is usually a single non-refundable payment made by the buyer of the option (the holder) to the seller of the option (the writer) - this is the option premium
Detail
First, let's try and categorize the different types of options we'll come across, and then describe each in detail, starting with the simplest:
1. Vanilla options - so called because they are a standard "flavour", which may themselves be divided into:
a) Simple physical options - already briefly described above, these include European and American options
b) Financially settled options - these pay out if some measurable, usually a published index, meets some specified criteria. The payout varies with this or other measurables. This category includes Asian options
c) Simple combination options - not strictly different types of options, but traders frequently combine simple options to tailor risk and payout to their circumstances
2. Exotic options - in contrast to vanilla options, exotic options are non-standard, usually complex and are designed to offer, or conceal, a combination of characteristics
Let's look at the simpler types in more detail
Simple physical options
Simple physical options may be thought of as an option to execute a Forward Contract. Indeed, if the option is exercised it effectively becomes a Forward Contract
When the option is traded the following terms are agreed:
Financial options Financial options pay out a cash amount if they are in the money - the cash payout usually being the difference between a fixed strike price, and some variable observable, usually the published price of a energy commodity or product Spread options and options on swaps (swaptions) are types of financial options Asian options are financial options which pay out on the average price of an underlier over the delivery period - assuming they are in the money | ||
Order | ||
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An Order is an instruction sent to an Exchange or a Broker to execute a trade unconditionally, or when or if specific criteria are met Detail A Market Order is the simplest, unconditional, type of Order. It is a simple instruction to buy or sell a specific volume of a product or commodity to be executed immediately at the best price available A Limit Order is an instruction to buy or sell a specific volume of a product or commodity if the price of execution is at or better than the Limit Price specified with the Order An Order may combine, in a single instruction, a number of transactions that are required A Fill or Kill Order requires all transactions to be carried out, or none. Partial execution is not permitted Exchanges handle all types of Order internally Other organizations or parts of organizations may accept combination Orders, and then route different parts of the Order to different Exchanges, Brokers or other parts of the organization For example a large trading organization may have several desks issuing Orders that overlap. An internal order routing capability matches internal orders as far as possible before routing the unmatched orders to external organizations (brokers or exchanges) Bids and Offers are types of Order
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Origination | ||
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Origination - the negotiation and conclusion of bespoke contracts, and structuring of non-standard products to offer for sale Detail Origination teams and originators in energy trading organizations are about putting together large integrated contracts, outside standard master agreements. These might involve: Structured long-term procurement deals particularly for oil and gas Virtual Assets - Virtual storage, virtual power plants, virtual refining | ||
OTC | ||
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OTC - Over-The-Counter Generally used to refer to any trade not executed with an Exchange Detail Over-The-Counter trades may be executed by a broker, or directly bilaterally between two parties. The resultant trade, whether brokered or not has the following characteristics: The trade details may be anything the parties agree - compared to the standardized contracts offered on an Exchange The agreed trade price is private to the parties - although either may report it to a market data service to increase price transparency Delivery, settlement, and all credit risk is entirely between the two parties | ||
P&L | ||
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Profit and Loss (P&L) is a finance and risk reporting term to describe the profitability of an individual trade, a book, a desk, or a company. Whilst the P&L of a company includes all activity, and costs (offices, staff etc.) the trading P&L is a measure of the profitability of a single, or a set of, trade(s) Detail P&L is a change in the value of something, or a set of things between two points in time You will often hear people refer to the P&L of the trade in terms of its value - the value at any point in time is effectively the difference between the value at that point in time, and the value before the trade was executed. We usually refer to this as the Lifetime to Date P&L or LTD P&L Often we are interested in the change in value, the P&L, from the start of the year, from the start of the month, or from the last valuation. These are respectively known as:
As an example, let's say we bought some shares in a company for £60, and a year later we sold them for £100, then it seems obvious that we made £40 profit, assuming there were no cost of buying the shares, or selling them, nor indeed any other costs directly associated with the buying or selling
Before continuing we will align our example with a more normal energy trading example.
In general traders don't buy a commodity, and then sell it later because of the difficulty and cost of storing energy commodities - see Storage
In general traders enter into a Forward contract, that is to buy the shares at fixed time in the future, at a fixed price
The other advantage of Forward contracts is that the trader can enter a Forward contract to sell, as well as buy, at some time in the future. This is known as taking a short - i.e. negative - position
In March 2018 we will give £60 to the seller of the shares. This is called the financial side or leg of the trade. It has a known cash value: £60
We call this the physical side or leg (it's physical because it's not cash, even though the share certificates are electronic, we still call this physical)
In general the first method is preferred because it is simpler, we may have to use the second method when we are not sure the position is entirely closed out, or we know some is, and some isn't.
if the first method sounds odd, think about buying and selling a house, once you've bought a house you're very interested in how much you paid for it, and how much it's currently worth. Once you sell it however, you're only really interested in the price you paid and the price you sold it. You have little real interest in the current price
P&L that may result in a cash flow in the future is often discounted back to present day value
We may refer to undiscounted, and discounted P&L
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