Detailed Glossary of Energy Trading terms

A Megawatt is a measure of energy per unit time

• in this case one million joules per second
• one watt being one joule per second

Abbreviation is MW

Not to be confused with MWh

Detail

In energy trading we usually refer to electricity as power

In physics power is energy per unit time

• so a Megawatt is a measure of power
• It is easier though to think of a Megawatt as a flow rate of energy
• that is so much energy flowing per second, or per hour
• think of MW being like the speed of a car (MWh are the distance the car has travelled)

Gas and power trades are often specified in Megawatts because they have a continuous flow rate

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

For clarity:

1 Watt = 1 joule per second; 1 W = 1 j/s

1 kilowatt = 1,000 Watts; 1 kW = 1,000 W

1 Megawatt = 1,000 kilowatts; 1 MW = 1,000 kW

1 Gigawatt = 1,000 Megawatts; 1 GW = 1,000 MW

1 Terawatt = 1,000 Gigawatts; 1 TW = 1,000 GW

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:

• Payment Date
• Currency
• Commodity (some times)

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

The Business Process or Capability covering the payments relating to trading activities. It includes agreeing payments, making them, and ensuring that payments are received at the correct times

Detail

Settlement includes:

• Invoicing
• Netting
• Making payments
• Receiving payments
• Margining
• Collateral Management
• Clearing

We also referred to the concept of financial and physical settlement of trades

• Physical settlement involves the delivery of a physical commodity, with a cash payment
• Financial settlement does not involve the delivery of a physical commodity, there is just a cash payment

We need to be careful to recognize the legal definition of settlement of a physical trade:

• The physical part of the trade settles on the delivery date(s)
• The cash part of the trade settles on the Due Date

Most other parts of energy trading businesses identify the term settlement with cash settlement (or payment)

Weighted Average Price (WAP) is the average price over a series of individually priced volumes

Detail

The quickest way to calculate WAP is to calculate the total value over all the individually priced volumes, sum them and then divide by the total volume

A type of contract in which the delivery period is the remainder of the current month

Detail

Widely used in gas trading a Balance of Month contract (BoM) can vary from 30 days down to a few days depending on the day traded

Balance of Month contracts often have separate contract codes and settlement prices for each day of the month that they are traded

A clean spark spread is the spread between the value of power (electricity) on the one hand and the value of the gas needed to generate that power, and any associated carbon costs of generation

Detail

The term clean spark spread may refer to

• the cash value of the spread itself
• a trade executed that has three physical legs
• a trade that has at least one physical leg and up to two financial legs
• a trade that is settled financially based on a fixed ratio of power to gas and carbon

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

 

A financial side or leg of a trade that is not fixed in advance, but is dependent on the value of some observable (usually an index) at a pre-agreed time related to the delivery date

Detail

Most trades involve at least two legs or sides, in a straightforward physical Forward contract one side is the physical delivery of the commodity, the other is the cash payment in settlement of the commodity delivered

In an indexed forward, or floating forward, the cash side is not fixed in advance, but related to an index (usually published daily), and generally fixed in daily or monthly either at the daily price or the average of the daily-published monthly price

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

 

A Futures Contract is an agreement to buy or sell a commodity at a fixed time in the future executed on or with an Exchange

Detail

Note the similarity in description to a Forward Contract

We will focus mainly on the differences

Exchanges list standardized products that may be traded. A product describes a standardized commodity, delivery period and delivery location that may be traded

Exchanges list a buy and a sell price for every different product they list. These buy and sell prices are provided by Market Makers

Futures Contracts are always cleared

Futures Contracts may be physically or financially settled

A financially settled futures contract may be taken into the delivery period, and is settled by daily margining at the daily fixed in price

If you're wondering how that is different to an exchange-traded swap - then the difference is a swap is very like a financially settled futures contract, but the swap is generally not daily margined