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Detailed Glossary
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Megawatt | ||
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A Megawatt is a measure of energy per unit time
Abbreviation is MW Not to be confused with MWh Detail In energy trading we usually refer to electricity as power In physics power is energy per unit time
Gas and power trades are often specified in Megawatts because they have a continuous flow rate However energy trades are priced in terms of energy (e.g. €45.3/MWh) so we need to be able to calculate the number of MWh of the trade or delivery period This is easy if we use the equation: 1 MWh = 1 MW flowing for one hour and simply remember this Megawatt.hours = Megawatts x hours or MWh = MW x hours Just like the speed of a car: you can't meaningfully add two values in Megawatts at different times - what does it mean to add two speeds together at different points on the Motorway? If I drive 60 mph for 10 minutes, then 72 mph for the next 5 minutes, does the number 132 mph mean anything? (No!) If I flow 10 MW one day and 20 MW the next day, the value 30 MW has no meaning you can meaningfully add two values in Megawatt hours at different times If I drive 10 miles in the first ten minutes, then 6 miles in the next five minutes, then I have driven 16 miles in total If I flow 240 MWh one day and 480 MWh the next day, then I have flowed 720 MWh over the two days you can't normally price something in Megawatts - a toll road makes you pay per mile, it doesn't matter how fast you went For clarity: 1 Watt = 1 joule per second; 1 W = 1 j/s 1 kilowatt = 1,000 Watts; 1 kW = 1,000 W 1 Megawatt = 1,000 kilowatts; 1 MW = 1,000 kW 1 Gigawatt = 1,000 Megawatts; 1 GW = 1,000 MW 1 Terawatt = 1,000 Gigawatts; 1 TW = 1,000 GW | ||
Megawatt hour | ||
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A measure of energy - abbreviated to MWh Equivalent to one Megawatt of power flowing for one hour Detail In physics Power = Energy per unit time, e.g. joules per second this can be thought of as an energy flow rate it follows that Energy = Power * time think of energy (MWh) as the equivalent of distance (miles or kilometres), and power (MW) as the equivalent of speed (mph or kph) Electricity (confusingly also normally called power) and gas trades are often described in terms of a rate of energy, e.g. Megawatts, or therms per hour However energy trades are priced in terms of energy (e.g. €45.3/MWh) so we need to be able to calculate the number of MWh of the trade or delivery period This is easy if we use the equation: 1 MWh = 1 MW flowing for one hour and simply remember this Megawatt.hours = Megawatts x hours or MWh = MW x hours Just like the speed of a car: you can't meaningfully add two values in Megawatts at different times - what does it mean to add two speeds together at different points on the Motorway? If I drive 60 mph for 10 minutes, then 72 mph for the next 5 minutes, does the number 132 mph mean anything? (No!) If I flow 10 MW one day and 20 MW the next day, the value 30 MW has no meaning you can meaningfully add two values in Megawatt hours at different times If I drive 10 miles in the first ten minutes, then 6 miles in the next five minutes, then I have driven 16 miles in total If I flow 240 MWh one day and 480 MWh the next day, then I have flowed 720 MWh over the two days you can't normally price something in Megawatts - a toll road makes you pay per mile, it doesn't matter how fast you went | ||
Quark spread | ||
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Exchange for Physical | ||
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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
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Delta | ||
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At its simplest the delta of a trade or position is the ratio of its change in value to the change in value of its underlier Detail More accurately the delta is the ratio or sensitivity of the change in trade trade value to any variable, market value or observable For example a simple Physical Forward trade has a sensitivity to:
So the delta is the ratio of the change in value of the trade per unit volume (e.g. €/MWh) to the change in value of a market value or underlier (e.g. the underlier power price quoted in €/MWh) to give a dimensionless ratio You may come across a use of Delta as the ratio of the change in total value of the trade (e.g. €) to the change in price of the underlier (e.g. €/MWh) to give a value with units of volume, in this case MWh. This definition of delta is usually referred to as the Exposure, and may also be thought of as the delta above multiplied by the volume The delta of fixed price Forwards and Futures is about one The delta of options varies between 0 and 1 (or -1 to +1) Exposures are additive - they can be summed across a set of trades or portfolios Deltas are not additive - because they are dimensionless ratios Delta is one of the Greeks - usually the most important Greek for trades with no optionality | ||
Underlier | ||
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Something physical or tangible that may be referenced by a contract or trade Detail Financial derivatives are completely cash-based and usually have no physical underliers Energy derivatives usually have at least one physical underlier, which may be a commodity, e.g. coal or a something related to a commodity e.g. storage The underlier acts as a bridge to the physical world - and usually as a set of reference prices for price-setting and valuation We need to emphasize that nearly all energy trades have at least one physical underlier - few of them actually involve the delivery of energy commodities
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Terminal | ||
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Usually used in the context of Natural Gas - an entry or exit point into a regional gas network or National Transmission System Detail In the UK natural gas is mostly extracted from gas fields in the North and Irish Seas and pumped through an offshore network of pipelines to a series of Terminals At the Terminals the gas is metered and then enters the National Transmission System LNG may be discharged from LNG vessels in an LNG plant, and then regasified into a Terminal located in or close to the port Interconnectors connect to Terminals at both ends, allowing gas to be flowed out of, and into, the NTS The UK Terminals are mostly located on or near to the coastline, and are therefore sometimes collectively referred to as the "Beach", or individually as Beach Terminals | ||
Margining | ||
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Margining is a form of Settlement, whereby exposure to Credit Risk between two parties is limited by keeping the overall Credit Exposure below a certain threshold by means of Margin payments between the parties whenever the threshold is breached Detail Let's take a simple example
If you go out of business or default on the deal I won't lose out
But if I default then you will lose $200
I need to arrange for that $200 available to you in case I do default
On day three we both note that the price has risen to $62 per tonne - that's good for me, bad for you Now if I default you won't need to deliver $12,400 worth of coal in exchange for $12,000 cash
But if you default then I'll be $400 worse off
You need to arrange for $400 to be available to me in case of default
Let's say on day eight the price rises to $66 per tonne
You now need to arrange for $1,200 to be available to me in case of default
We talked about making the cash available in case of default - how does that work?
There are actually a few different schemes:
Clearingin a clearing arrangement each if us has a margining account with a central clearing house
Before we even start trading we need to deposit some money into the account, and each time we execute a trade we need to make sure there is sufficient in the account to cover a certain amount of loss
Let's say we both deposit $1,500 initially and then an additional $1,000 as a result of doing the single trade - we can see that on typical price movement, for the volume of the trade this, then it would take quite a large movement in the price to change the value of the trade by $1,000
We both now have $2,500 deposited
The initial $1,000 deposit against this specific trade is called the Initial Margin
At the end of day two the clearing house would remove $200 from my account and put it into your account - this is the Daily Variation Margin
I now have $2,300 and you have $2,700
At the end of day three the clearing house would remove $600 from your account and put it into my account - this is the Variation Margin
I now have $2,900 and you have $2,100
At the end of day eight I would have $3,700 and you have $1,300
At this stage you would need to make a payment into your account to top it back up to a minimum level - this may be $200, or it might be more depending on the agreement
CollateralWe might agree to post $2,000 collateral with each other to cover any initial movement either way
We agree to margin limits of a minimum of $1,500 and a maximum of $2,500, if the margin falls below $1,500 we will post a minimum of $500 to get the collateral back up to $1,500, and likewise, if the collateral goes above $2,500 we will be able to withdraw cash to bring it below $2,500
At the end of day two my collateral stands at $1,800 - the cash in the collateral account minus the $200 current liability on the deal at that point - we're both OK, I have more than the minimum $1,500
At the end of day three I have $2,400 collateral and you have $1,600 (your original $2,000 less your current liability of $400 on the deal)
At the end of day eight I have $3,200 collateral, and you have just $800 (your original $2,000 less your current liability of $1,200 on the deal)
A requirement to top up a clearing account or collateral account is known as a margin call
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LNG | ||
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Liquefied Natural Gas Natural Gas is difficult to liquefy by compression alone, it is usually liquefied, stored and transported at very low temperature LNG acts like oil and coal for transportation, like natural gas once it is returned to its gaseous form Detail Unlike propane gas it is not practical to liquefy natural gas (which is mostly methane gas) by compression alone, and it is normally liquefied by refrigeration to -160 oC and stored and transported at moderate pressures LNG needs to be transported in specialist ships (LNG vessels) that can maintain the low temperature required, so are quite different to other commodity carriers On arrival at a destination port the LNG needs to be returned to its gaseous state in a plant which is attached to a gas terminal Other than the ships themselves the logistics of LNG transport involve the same complexities as oil and coal LNG is big business for two main reasons: A vast quantity of natural gas is already available from oil rich countries - but there are no pipelines to flow it long distances (Russian gas into Europe being the main exception) The process of extracting natural gas from unconventional sources (typically shale) by hydraulic fracturing ("fracking") is likely to yield even more gas - but usually not where it's needed
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Arbitrage | ||
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The difference in cost of achieving the same outcome through different means Detail This is easiest explained as an example: To buy a particular new car in the UK costs £27,000 The identical UK-spec car costs £22,000 in Belgium It will cost you about £1,000 to have it shipped to the UK, plus another £1,000 costs for delivery, any inspections, your time to manage all this etc. Cost of buying the car in the UK = £27,000 Total cost of buying the car in Belgium and having it delivered to your home = £24,000 There is an arbitrage opportunity of £3,000 In general, in a liquid market, with minimal market constraints, traders will exploit any arbitrage, and the arbitrage values should all tend to zero In our example if everyone chose to buy the car in Belgium: the price would probably go up in Belgium because of the higher demand the cost of shipping might go up (because of demand and the realization it's valuable) the price of the car in the UK would probably fall (because they weren't selling any) When the market acts to reduce arbitrage to insignificant values then we describe this as arbitrage-free Arbitrage-free is a powerful method in many valuation tools: it implies we can value an Instrument or trade by looking at alternative ways of achieving the same outcome For example the value of an oil forward contract in six months time, should not be significantly different to the spot price of oil, plus all of the costs of storing that oil for six months | ||