Detailed Glossary of Energy Trading terms

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

The attribute, or adjective, physical usually refers to trades and business process that results or involves in the physical delivery of energy or a commodity

Detail

A trade is physically settled when it will result in the delivery of an energy or commodity. This is in contrast to a trade that is financially or cash settled

Physical business process involves the activities around

Scheduling delivery of electricity and gas (Operations)

Logistics of moving and delivering other commodities by ship, barge, train, plane, truck etc. including loading and unloading and inspections

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

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

All physically settled derivatives imply either an obligation to deliver, or take delivery of, a commodity at a location at some time in the future

The obligation to deliver a commodity is called a short position of that commodity at that location and time in the future

The obligation to take delivery of a commodity is called a long position of that commodity at that location and time in the future

Detail

Traders sum the position of a set of trades to know their net position across that group of trades - usually called a portfolio, a book or a strategy. This is known as the traded, or trader, position

Traders take a long position if they believe the value of the commodity at the time of delivery will be greater than the contract, or strike, price

Traders take a short position if they believe the value of the commodity at the time of delivery will be less than the contract, or strike, price. Taking a short position is sometimes known as shorting

Each time a trade is executed the trader's net position changes. Most traders update their net position as each trade is executed 

A group of trades

Detail

Trading organizations group trades in order to simplify position management, risk reporting and settlement.

By grouping trades that have a common or complementary purpose, traders can focus on the performance of the portfolio as a whole, rather than the individual trades that make it up

Note the similarity to a trading book

Speculative trading, also known as proprietary or spec. trading, is the trading of commodities with the intent of making a profit with no intent to make or take delivery of those commodities

Detail

Spec. traders take forward positions, either short or long with the view to closing out those positions at a later date, prior to delivery

Closing out the open position involves trading to flatten the net position, eventually (but before delivery) to zero

Location is one of the key dimensional attributes of all physically settled, and many financially settled, trades

Detail

Location is usually a description of where the delivery a of a trade will take place

Although this sounds fairly straightforward, in practice location means different things for different commodities.

This is because the delivery location simply defines the lowest level of distinguishable information about the delivery, and this lowest level varies with the commodity

So let's look at some commodity locations to see what this means:

Natural Gas

The location of the majority of gas trades in the UK is the NBP

The NBP isn't even a real location, it describes the UK-wide gas pipeline network called the National Balancing Point

On the day of delivery, a seller of gas has an obligation to deliver gas at the NBP

The seller may deliver it from any other location that is physically connected to the NBP, it doesn't matter where that is.

The buyer may take delivery to any other location that is physically connected to the NBP

Gas traded locations such as the NBP are called hubs.

Some hubs require the buyer and seller to identify the physical connection point of delivery - these are physical hubs

Other hubs, like the NBP do not require the buyer and seller to identify the connection point - these are virtual hubs

A market maker quotes prices at which they are prepared to buy or sell a commodity - usually on an Exchange or with a broker

Detail

A price at which a party is prepared to buy is called a Bid (they bid to buy the commodity)

A price at which a party is prepared to sell is called an Offer (they offer to sell the commodity)

By offering continuous bid and offer prices, Exchanges encourage traders to take positions, secure in the knowledge that they can always close them out. This is another way of saying that they improve the liquidity of the market

There are usually benefits to the market makers themselves from offering this service

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