Detailed Glossary of Energy Trading terms

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

The earliest tradable month of a particular contract - normally a Futures contract

Detail

It's easiest to give an example:

A March monthly contract may be tradable up to the 25th of February

On 25th February the Front Month would be March

On the 26th February the Front Month would be April 

Contracts beyond the Front Month are sometimes called Back Months

A give up is an OTC trade - usually a forward - given up to an Exchange for clearing 

Detail

A give up may start life as an OTC bilateral trade which, by mutual agreement, is given up to an Exchange to take advantage of clearing

The give up may also be:

a brokered OTC Forward that is mutually given up for clearing

traded as an Exchange Derivative on a Broker platform, and automatically be given up for clearing

Giving up an OTC trade for clearing combines the flexibility of trading bilaterally or through a broker, with the risk-free credit benefits of cleared trades

To hedge is to offset, mitigate or reduce a risk or risks of an organization or individual by entering into contracts or trades

A hedge is a trade or contract intended at least partly to reduce risk

In Energy Trading the risk is usually market risk associated with other trades or contracts, or the operation of assets

Detail

Let's consider a very simple example

Our organization buys oil for delivery next year, because it believes the price next year will be less than the strike price (the price we will pay for it). We're taking a risk we understand. But the strike price is in US Dollars (USD) so shortly after the delivery takes place we will have to pay for the delivery in USD (or the equivalent in another currency at the delivery time)

We operate in GBP, but we don't know what the GBP price will be until delivery - so there is a risk the USD/GBP FX rate will move against us before delivery

We call this risk FX exposure to US dollars

We're not interested in currency speculation, so we buy the required USD now at the forward FX rate

Now we have no risk associated with FX exposure

We have hedged our FX exposure

Hedging is usually carried out with Derivatives. In our example above we could have bought the dollars immediately, but then we would be exposed to the USD interest rates, so it's more likely we would hedge with a Forward contract or a Futures contract

Hedging is frequently carried out with financially settled instruments: the profit or loss we make on the hedge offsets any additional cost of the physical trade

See also Hedge Accounting and Delta Hedging which are related

Another useful way to think of a hedge is a means of realizing a profit-making strategy (profit-making strategies invariably being associated with risk!). If we think we will make a profit bidding on capacity through a pipeline, then the hedges would be the deals to buy at the cheaper location and sell at the more expensive location

By this extension we can also say that hedging a position is a way of saying flattening the position (for example of a book) by trading the position to somewhere else (for example another book, or externally)

An Index is a set of prices that are published for a commodity or product, usually derived from trading data, using an open and independent method

Detail

An index consists of a set of time periods, with an associated price (or set of prices) for a particular commodity or product for each of the time periods:

The time periods are sometimes called grid points (or gridpoints)

A typical index has daily granularity forward from the date it is published for a number of days, then monthly for some months, then quarterly, seasonal and annual

For each time period there may be a bid price, an offer price, and an average (mean) price

Indexes are usually published at the end of each trading day, and represent some sort of average of the prices that Forward and Futures contracts actually traded at on that day (or for a pre-defined period of the day)

Various organizations publish indexes for different commodities and products:

Exchanges publish indexes for the various products they offer

Independent analysts publish indexes for commodities in markets they specialize

Trading organizations use indexes to:

Derive forward (valuation) curves

Fix in floating prices of floating price trades

Agree forward valuation of trade portfolios with counterparties for netting agreements

There is some similarity between indexes and curves since they are both sets of time-series data. The main differences are:

Indexes are published by independent organizations, and are available to any organization that wishes to subscribe to them

Indexes only relate to prices of commodities and products

Curves are usually created by, and proprietary to, the trading organizations that create them

Curves consist of any time-series data, including valuation, volatility, interest rates etc.

Term used to describe transferring natural gas from a transmission network into a storage facility

Detail

Injection volumes are nominated in the same way as other physical gas movements

Injecting gas into a storage facility requires the organization to have available storage capacity

See also Storage for more details

At its most abstract an Instrument is a category of trade types

Detail

It is difficult to define Instrument further than this, because the term is used differently between organizations, functions within organizations, and trading systems

A typical instrument may have dimensional attributes of:

• Trade type
• Commodity
• Settlement type (physical or financial)
• Maybe tenor (day, week, month etc.)
• Maybe market/location

So, examples of Instruments may be

• Physical Forward 
• UK Power Swap
• API#4 Coal Futures

Note the similarity and differences to a Product

Note that some proprietary systems make a very specific use of the term Instrument

A gas or power connection between two different locations

Usually used to flow gas or power from a lower priced location to a higher priced location

Detail

Interconnectors consist of either a pipe, or cable connecting two hubs or grids

For a trading company the process of flowing gas or power from one location to another goes as follows:

Procure capacity on the interconnector

This may be through an auction, mainly annual and day ahead, or in some cases through a secondary market (i.e. buying or selling capacity to other organizations)

Capacity is usually bought in flow rate units (e.g. Nm³/hour for gas, MW for power) over a period of days, a month, quarter, years etc.

Capacity on an interconnector is much like an option on a location spread

Capacity gives the right, but not the obligation, to flow gas or power from one location to another

Transmission

In order to use the capacity the trading organization needs to nominate transmission of gas or power to the TSO

Let's say we have a long term capacity contract to flow power from the France to the UK through the IFA

Noticing the price of power is less in France than in the UK so we nominate to the TSO that we will flow power (up to the capacity flow rate), using the capacity. 

We normally book this as a trade in our ETRM, but there is no change of title - this is an internal trade

We usually book this trade at a fair market price to keep P&L shifting between locations

Obviously we need to hedge this with an appropriate long position in France (we buy the power in France) and a short position in UK (we sell the power in UK)

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 trade with no optionality

Detail

Why?

The linearity refers to the delta - that is the variation of the value of the trade with the main underlier

Trades with no optionality have a value that is directly proportional to the value of the underlier - if we plot the value against the value of the underlier it will be a straight line - hence linear trade

Trades with optionality do not have a linear relationship between value and underlier. As the value of the underlier becomes less and less favourable the value of the trade becomes nearer and nearer to zero

Unsurprisingly these trades are known as non-linear