Detailed Glossary of Energy Trading terms

Capacity is a type of commodity associated with gas and power, and gives a trading organization the option to "move" gas and power through the respective networks (pipelines and grids)

Detail

Capacity may be bought in short or long-term auctions directly from the Transmission System Operators (TSOs), or may be traded bilaterally

Ownership of capacity entitles the owner to transport gas or power from one part of a network (location) to another

A trading organization does not need to buy capacity to buy and sell a commodity at a location, it does if it wants to transport the commodity to a different location 

For example capacity on the Interconnector France-Angleterre (IFA) entitles the owner to transport power from the UK grid to the French grid or vice versa

As capacity may be used to change the location of a commodity, it is somewhat similar to an option on a (physically settled) location spread and is usually valued as such

Gas, oil and coal all contain carbon - when they burn the carbon is oxidized to carbon dioxide.

Carbon dioxide, as we all know, enters the atmosphere, and is generally believed to cause global warming

There are various schemes to reduce the emission of carbon dioxide, called emissions schemes, and these require major emitters of carbon dioxide to provide certificates matching their emission of carbon dioxide. These certificates may be acquired in a number of ways, and there is a market for organizations with surplus certificates to sell, and organizations who need more certificates, to buy

Detail

Naturally wherever a market exists to trade anything, speculators attempt to profit by buying and selling - in this case - carbon (in the form of certificates)

The process of decomposing longer tenor Exchange traded derivatives (futures and swaps) contracts for the equivalent shorter contracts

Detail

Let's start with an example - a trader buys a futures contract for delivery for the whole of 2018, a so-called Cal-18 contract

Every day that contract is available to trade, and the Exchange publishes a settlement price for that contract that determines daily margining

At the time of trading (2014) the Exchange does not offer any other contracts covering 2018 - months or quarters for example

At the end of 2017 the trader wants to keep the position open, but the Exchange can't continue to publish a Settlement price for the 2018 yearly contract because it can't be traded (the delivery period has already started)

By this time the Exchange is offering Quarters contracts covering the whole of 2018, and Month contracts covering at least the first three months of 2018

So the Exchange, the Clearing broker and the trader all cascade the year contract into four quarterly contracts; Q1, Q2, Q3, Q4 2018.

Q2, Q3 and Q4 are all still tradable, but the Q1 position needs to be closed out, or itself cascaded into three months, January, February and March

As you've probably realized the January contract will very soon be untradable, so it needs to be

• Closed out - the trader flattens his position in that contract
• Taken to or exchanged for an equivalent physical contract 
• (for financial futures) taken into financial settlement

By cascading longer contracts into shorter contracts shortly before the longer contracts begin delivery the Exchange can effectively offer a small set of monthly, quarterly and yearly contracts, that have monthly granularity in the short term, but cover a period of years into the future

As an example EEX are quoting the following Phelix Futures contracts at the time of writing (11 November 2014):

• Months - usually current month + next nine months - November 2014 to August 2015
• Quarters - next eleven Quarters - Q1 2015 to Q3 2017
• Years - next six years - 2015 to 2020

(If you're wondering why November 2014 is still being quoted then that's because it is financially settled through the delivery month - the contract is not tradable in November)

A payment that has been, or will need to be paid, on a particular date

Detail

Every trade creates one or more cash flows, which represent the payments that will be made:

For deliveries made - often at periodic intervals (e.g. weekly)

For fees, including broker and execution fees, and fees incurred in transportation, storage and inspection of commodities

In general the payment date of all cash flows should be known in advance, the amount of the payment may be fixed or based on one or more index, or be calculated form a formula based on a set of observables, underliers, or other factors

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 form of settlement where responsibility for payment is passed to a third party: a Clearing House or Clearing Broker

The Clearing House accepts responsibility for settling the deal.

Credit risk for the seller in the trade is reduced to almost zero

The Clearing House minimizes its Credit Risk by daily margining

Detail

An organization may trade on an Exchange either by becoming a member of the Exchange, or trading through an Exchange Broker. The clearing principles are similar in either case

In general a trading organization engages a Clearing Broker to act on its behalf

The trading organization is required to open a margin account with the Clearing Broker, which in turn maintains a margin account with the Exchange's Clearing Bank

As the organization enters into a trading position the Exchange marks the trades to market on a daily basis, and transfers cash into or out of margin accounts based on the change of the value of the trading position since the previous day. The Clearing Broker mirrors this operation to its clients' margin accounts

Every trading organization is required to maintain an amount of cash in the margin account to cover a substantial short term loss in the value of its position. If the trading organization does not maintain this margin then the Exchange closes out the position immediately, using the margin account cash to cover any losses as a result of the close out

Payments into the margin account as a result of new trades that cause an increased open position are called Initial Margin payments

Payments into the margin account as a result of the value of trades falling are called Variation Margin payments

An organization that acts as an intermediary wishing to trade on an Exchange

Detail

A Clearing Broker acts for an organization in two capacities:

Intermediary between a trading organization and the Exchange's Clearing House - trades are executed directly with the Exchange itself

Intermediary between a trading organization and an Exchange to allow trading with that Exchange without being a member

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

Flattening an open position to a net zero (or flat) position

Detail

Trading activity in general leads to opening positions, and very often to closing out those positions before the delivery period

For example I may sell 10,000 therms of gas for delivery May 2024 today

I have an open position of 10,000 therms in 2024

Next year the price has dropped and I decide to buy back all 10,000 therms at the lower price, thus locking in a profit

(sell price - buy price) x 10,000

remember when we short a position we make a profit when the price drops!

I have no remaining open position in 2024 gas - so I have closed out my position

I can always re-open it by executing another trade

If my second trade had been to buy 6,000 therms then I would have closed out 6,000 therms, and have 4,000 therms remaining open position

Closing out a Futures position on an Exchange has an additional meaning and consequence

The profit or loss value would immediately be considered as realized P&L for the following reasons:

• There is no valuation uncertainty
• Payment has been made
• There will be no delivery

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