Dark Energy Consulting
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Detailed Glossary
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Netting | ||
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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:
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 | ||
Master Agreement | ||
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When two parties execute a trade between themselves they specify the terms of the trade: Price, Volume, Location, timing etc. But in order to successfully manage the trade's delivery and settlement a lot more information needs to be available than is captured in the trade details, such as when payment is due, who needs to notify a TSO etc. This additional detail is held in a Master Agreement Each trade that is executed is regulated by a Master Agreement Detail Master Agreements exist to cover various sorts of trade, for example the UK standard gas and power Master Agreements : GTMA (Grid Trading Master Agreement) covers UK power trading, complete with all the details of notification NBP97 (Short Term Flat NBP Trading Terms and Conditions Ref. NBP 1997) covers natural gas trading at the NBP complete with details of nomination Master Agreements may reference other Master Agreements - ISDA for example is an organization that is aiming to offer master agreements that unify trading, for example at the NBP and at TTF Master Agreements are themselves referenced by bilateral trading agreements, which are agreements set up by pairs of potential trading partners to specify which Master Agreements will be used for different products and instruments, and usually cover other arrangements such as netting, collateral etc. Master Agreements may have schedules or annexes that define additional terms, or override terms in the main agreement Bilateral Master Agreements may have additional schedules that define variations to the standardized master agreements A Confirmation, as well as confirming the trade details, also confirms the master agreements that regulate the trade, and may itself contain exceptions or variations from the general bilateral terms
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Virtual | ||
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Something that behaves like something else but is not really that thing Detail We've all heard of virtual reality - it appears (or tries to appear) real but is not, but it does have many of the characteristics of real So what does that mean for us? Well let's take a real(!) example Virtual Storage - Storage allows organizations to inject gas at one point in time and withdraw it later An organization (the seller) may sell another organization (the buyer) virtual storage the buyer of the product sells gas at no cost to the seller at some point later in time the buyer of the product requests the seller of the product to sell the gas back at no cost the seller tracks the level of virtual gas, and tracks this against the virtual capacity of the storage product sold | ||
Take or Pay | ||
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A type of supply contract in which the buyer commits to buying a minimum quantity of some product, or to make an alternative payment for the amount below the minimum quantity Take or Pay contracts are widely used in the Gas and Oil markets Detail The minimum quantity, the price of purchase, and the price paid for any amount below the minimum are all defined in the contract Typically the buyer nominates a delivery volume each day from the supplier, the minimum quantity applies over a year | ||
Maturity | ||
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Generally a financial trading term used sometimes in the commodities trading market to mean the expiry or expiration date - particularly futures contracts Detail A classic energy futures contract has a single date that represents: The last date it may be traded The date it is cascaded to shorter contracts The date it is completely settled (if a financial futures contract) This date is usually called the expiry date, and therefore it is also the maturity date However it is possible that the contract may continue to be financially settled after the last date it may be traded - in this case the maturity date is usually the completion of financial settlement Be careful when looking at contract details - the terms are used inconsistently between exchanges and brokers... | ||
Invoicing | ||
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Like most businesses, we sell something, we deliver it, we raise an invoice, we send it to our buyer, we get paid - we hope. The Master Agreement between us and our counterparty will specify if we raise an invoice for a specific delivery (of oil for example), or for a continuously delivered commodity (gas or power for example) over a period (usually a day, week or month) Detail The two main invoicing schedules are:
Invoices usually have the following granularity:
We may therefore raise a number of invoices for a counterparty, with different combinations of the above Once we generate, or raise, an invoice, and are satisfied that it is correct, we transmit the invoice(s) to our counterparty, and we post the invoice(s) into an Account in our General Ledger We expect our counterparty to be doing the same for commodities that we have bought from them, and expect to receive invoice(s) that we will check against our own records To help this we raise a set of shadow invoices, or purchase orders, so that we can compare these to the invoices received from our counterparty. Once agreed we post these purchase orders into an Account in our General Ledger | ||
Interconnector | ||
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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) | ||
Instrument | ||
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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:
So, examples of Instruments may be Note the similarity and differences to a Product Note that some proprietary systems make a very specific use of the term Instrument | ||
Index | ||
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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.
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Hedge | ||
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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) | ||