Detailed Glossary of Energy Trading terms

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 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