Detailed Glossary of Energy Trading terms

An organization that manages the clearing for an Exchange

Detail

Every Exchange appoints a Clearing House to manage the clearing of trades executed on the Exchange

Bigger Exchanges may own their own Clearing House - others may appoint a large Clearing House to act for them

For most settlement and financial purposes the Clearing House (or a Clearing Broker acting for us) is the settlement and financial counterparty to futures, swaps and spot trades executed on the Exchange

In Energy Trading a commodity is generally either a form of energy itself, or a physical material that may be used to easily provide energy, or a related commodity or service. The most common commodities are oil, gas, electricity (power) and coal

Detail

Standard energy commodities are:

Electricity - almost always referred to as Power in Energy Trading environments

Gas - almost always meaning Natural Gas

Sourced from underground Natural Gas fields, and increasingly from shale

Transported in gaseous form transported through pipelines, or liquid form (LNG) in pressurized vessels and purpose built ships

Used in power stations, and directly burned for heating

Oil

Probably the most heavily traded energy commodity

Sourced as Crude Oil from underground oil fields, and increasingly, shale

Mostly refined in refineries to produce fuels for heating, transportation and use in power stations

Transported mostly by ship (tankers)

Coal

Sourced from underground coal deposits

Transported by ship, barge and truck

Biomatter

Fuels that are grown, or made from plants

Parts of plants may be directly burned in power station

Liquid equivalents of gasoline and diesel (biofuels) may be synthesized from plants

Related commodities and services include:

Freight - for moving solid and liquid commodities

Environmental certificates, including carbon

Foreign Exchange, FX

Storage

Capacity

Trading and pricing for delivery the next day

Detail

Day Ahead and Within Day trading is responsible for the vast majority of gas and power trades executed

The Day Ahead Market (DAM) is used by

Operations/logistics teams to balance supply to demand

Speculative traders to make money out of the massive liquidity in Day Ahead trading

Day Ahead trading may be executed in the normal ways:

Bilaterally with a counterparty

OTC through a broker platform

In addition there are specialist Spot Exchanges that offer a wide range of within day and day ahead products, traded in two main ways:

Continuous spot trading much like any other OTC or Exchange trading

Day Ahead Auctions - with a fixed close 

At the close of Day Ahead trading many Spot Exchanges publish Day Ahead Settlement prices based on the auctions and/or a particular trading period in the current day, or provide these prices to a third party who publish a Day Ahead settlement price

Day Ahead settlement prices are often used as tradable indexes for indexed or floating forwards. 

These Day Ahead settlement prices are often referred to as Day Ahead indexes

Physically settled trades have a delivery time or period specified in the terms (details) of the trade

Delivery is the physical act of delivery of the traded commodity at the location and time specified in the trade details

Detail

The act of physical delivery is made in different ways according to the commodity:

Gas:

Location is some specified point on the gas pipeline network

Time is usually specified at daily granularity, a trade may cover one or more days, months, quarters or seasons

Power (electricity):

Location is some specified point on the electricity grids

Time may be specified at quarter hour or above granularity

Oil & Coal:

Location is specified as a port, or group of ports in the trade details - the specific port or docking location is specified later by mutual agreement within the terms of the trade.

Time is usually specified at monthly granularity - the specific dates being agreed later as shipments become clear 

In general:

Gas and power delivery continuously throughout the delivery period, and the delivery volume is often specified as a rate of delivery

Megawatt (MW) for power - remember one MW flowing for one hour is a Megawatt.Hour (MWh)

Therms per day (therms/day) for gas

Oil, coal, LNG and most other commodities are delivered in discrete consignments at mutually agreed points in time during the delivery period

To offset the delta of an option or other non-linear trade, usually with a linear derivatives position

Detail

If we buy a simple call option, or sell a simple put option, then we may or may not have a long position when the delivery date of the (potentially exercised) contract is made

In reality the option will either get exercised or not - let's say the option is for the delivery of 1,000 MT of coal in January 2016 at ARA (Amsterdam Rotterdam Antwerp location) - we will either have a position of 1,000 MT at that time, or not

On any particular day the option will have a calculable delta, which roughly translates into a probability of the option being exercised:

An option with a delta of 0.01 has a 1% chance of being exercised

An option with a delta of 0.5 has about a 50% chance of being exercised

Traders generally hedge the exposure of the option (which is the delta times the volume), so if the delta is 0.5 they will hedge 500 MT of coal

In general as the option exercise time approaches the delta of the option will swing quite rapidly toward 0 or 1 (or -1) so that the hedge swings toward 1,000 Mt or 0 MT

If you're wondering why an option with a delta of 0.5 (meaning the value of each MT changes by €0.5 for each change in €1 per MT in the value of coal) has a 50% chance of being exercised then think the other way round - if the option was certain to be exercised then its value would change by €1 per MT per change of €1 per MT in the price of coal, so its delta would be one - the delta is effectively the probability of being exercised

Energy Trading and Risk Management - usually referring to a computer system that allows trades to be electronically recorded, and risk measures to be calculated

An Exchange is a trading organization which matches bids and offers on standardized contracts to form trades. Unlike a Broker the Exchange acts as the counterparty for the trades, and trading is anonymous

Detail

An Exchange offers standardized contracts, normally

• Spots - Forward trades for Prompt delivery (today, tomorrow - day ahead, and sometimes for the forthcoming weekend
• Futures - Contracts for future delivery, usually weeks, months, quarters, seasons and years, in standardized volumes or rates (e.g. therms per day, Megawatts, Tonnes)
• Swaps - Financially settled Contracts in the future, usually between a fixed price and an index, or between two indexes
• Options - Options on standardized contracts for future delivery, offered at a trade price or premium, with a range of strike prices, puts and calls, expiry dates and delivery dates

Spots are delivered and settled in a matter of days - settlement occurring through movement of funds held in a cash account

Futures may be physically or financially settled - credit risk is reduced through daily margining. Physically settled Futures are either converted to equivalent Spots at expiry, or alternative physical delivery is agreed between partners

Swaps are always financially settled through margining

Options, like OTC options, have a defined expiry date, at which time they or may not be exercised, usually into the corresponding exchange traded Futures

Convert an Exchange Futures position to a physical position either with an OTC counterparty, or with the Exchange itself

Detail

Classic Futures contracts are settled physically: if you are long 2,000 pork bellies for delivery in May 2018 then, when the contract expires, the Exchange will arrange for one or more parties that are short those pork bellies to make delivery to you at the location, time and price specified in the Futures contract

we don't usually call this Exchange for Physical, since it is the contracted outcome of the Futures contract. The Exchange usually just calls this "Delivery", it is is also known as "Take to Physical" or "Cascade to physical"

Other Futures contracts do not necessarily contractually go physical, or you may want to exchange your regular Futures position for physical before the expiry date, or under different terms

in these cases you may contact the exchange and request an Exchange for Physical - the Exchange will attempt to match you up with another party who wishes to take their opposite position to physical

alternatively you may arrange off the Exchange to Exchange for Physical with another party, and then both contact the Exchange to  notify them

In general, Exchange for Physical is an expensive process, it is usually simpler to close out the Futures position on the Exchange and open an equivalent OTC position on a broker platform

In trading terms execution is the act that makes a trade a legally binding contract between the trading parties

Detail

A trade may get executed in a number of different ways:

• Two parties agree a trade directly between themselves. Trades executed this way are described as bilateral, or Over the Counter (OTC)
• One party makes a bid or an offer and another party accepts it, usually through a broker
• One party makes a buy or sell on an Exchange

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