Michael Lewis’s 1999 book, The New New Thing, hit the shelves just as the technology mania and the crazy valuations of entities with net-zero revenues (to ape current phraseology) frenzied the investment world (best represented in the mid 1990’s by the launch of Netscape on public markets – where the stock traded to 3x offer price on day one)!
The tech boom of the late 1990’s heralded a mania where otherwise cautious and intelligent investors seemingly took leave of their senses as they jumped aboard.
It was this “New New Thing”, that led the world into a” new normal ” (to employ another currently popular, if somewhat irritating phrase), and to a life dominated by the internet and the ready flow of information to the handsets of the general public.
While there were some big losers at the time, there were many more big winners, for this was not tulip bulbs nor groundnuts or voyages to Darien, rather this was a mania which changed the way of the world. There were those whose fame lasted for a New York minute, as well as the likes of Microsoft, Intel and other big names. And scores of newbies found fortune in their particular niches, whether tech savvy salesmen, bankers, financiers or manufacturers.
In many ways, the Renewables revolution that is currently underway, in response to the global climate crisis and the essential need for rapid decarbonisation, mirrors the experiences of the tech revolution of the mid to late 90’s. As we attempt to drink from the proverbial firehose that is flooding us with new renewable technologies, broad reaching targets and bold visions, what will this “New New Thing” mean for the business of transporting and trading energy? What will be the” sustainable” energy trading model of the 2020’s and beyond, will it be any different from the strategy currently employed by energy traders, and who will be the winners as change accelerates and the way of the world again changes?
There are plenty of opinion pieces available from the consultancy sector, along with investment bank research pieces, newspaper articles and learned academic papers that offer predictions and aspirations across the considerable breadth of the topic (if not specifically on the markets and trading angle). Ans so, how to parse this excitement, filter out the false news and vacuous hyperbole and uncover where this all takes us, is no small task.
Recalling both the tech revolution of the 1990’s and the ab initio development of trading in energy, there are many parallels that might inform what the “New New” energy trading model might look like, what might be traded and by whom and who might lose and who could win? History is not, as described by Henry Ford, “bunk” and there is always much to learn from the lessons of the past.
Markets
For those who watched from the floor as Enron self destructed, a key lesson to be learned was that markets “emerge” to service a clear need rather than their being the creation of a supply push. The “forcing” of markets in, for example, Bandwidth and, to a lesser extent, Weather as promulgated largely by Enron, was proven to be a fruitless exercise. Indeed, the pressure exerted by the investor community on the group of companies (that could be categorised as Enron lookalikes) to emulate Enron, led to many a collateral downfall.
Looking back to the energy markets (and they were primarily in oil) that developed in the mid 1980’s, one finds that the needs for matched volume hedging, for managing geographical basis risk and for separating supply and pricing decisions were serviced by the development, firstly, of liquid physical markets, followed by forward, futures and derivative markets as participants became more numerous, firms became educated in risk management techniques and products to offset price risk became both more applicable and sophisticated. The market maturing process was slow-arguably 10 years plus- in advancing from early markets through the greater maturity of derivatives markets to the asset backed market interface businesses that now represent the most effective, widespread and profitable energy trading model.
The process from inception to maturity will undoubtedly move more quickly as and when the underlying need for new renewables-based markets fully emerges. Indeed, the long history of liquid traded markets in Electricity across most jurisdictions in the USA (since the late 1990’s), in Europe (centred around Germany) and in EU Carbon already offers a significant base for expansion.
It is likely to be in asset-based optimisation activities that the greatest prospects lie as is the case in oil markets where assets allied to a portfolio of supply commitments (so-called “shorts”), represents the preferred mode of operation. The seduction of clients is already well underway, with offerings to manage the power supply, carbon profile and price exposure of large consumers from entities ranging from HETCO Solutions to Shell already commonplace. As liquidity in underlying markets further develops, expect an explosion of activity in this area.
Yet for all that is out there today, the breadth of these markets is limited when compared with the canvas of markets in the oil sector- Crude oil and Oil Products across many different geographies, with widely differing quality characteristics and with extended temporal dimensions. Cross regional arbitrage, time spreads, relative value trading and more, represent a tradeable complex attractive to the speculator (the crucial, yet undervalued, liquidity provider) and of beneficial use to the hedger and risk manager.
Power and Carbon markets are, at this point (perhaps aside for US power markets), much less multi-dimensional than oils. If they can be characterised as being two- dimensional (temporal and outright), then in scope they compare less favourably (opportunity wise) with the four- dimensional markets in Oils (outright plus temporal, geographical and quality are all basis tradeable). As the horserace betting fan will recognise, the reward for landing two winners on a Yankee is very different from the reward for landing all four!
It is also clear that while oil markets derive much of their volatility from geopolitical events, power markets are less globally interconnected and tend to respond more, in price terms, to local or national demand and supply events, often on a shorter dated time frame than oil (for example a plant outage or a short-term weather event). And respond they certainly do, making the business of risk management in Power a more expensive exercise given the tendency to extreme short-term volatility from time to time. The need to employ experts in the range of different jurisdictions with differing regulations and underlying’s, results in further expense in operating in these markets.
There is still plenty time for markets to further develop in “new” Renewables. Markets may develop in Hydrogen and as an ab initio market, there should be ample opportunity to create a market structure that addresses the needs of risk managers and is attractive to liquidity providers. There will likely be enhanced opportunity to trade in Biofuels as products such as Bio-Methane expands their reach. Perhaps the Climate Conference of 2021 in Glasgow will bring forward more Carbon cap and trade initiatives. Already, ICE have announced that they will trade UK Emissions on their exchange from 2022 and a further notable markets initiative in Voluntary Sector credits is being led by former B of E Governor, Mark Carney.
Players
Certainly, the energy trading community is readying itself. Existing markets in fossil fuels have come to be dominated by five large independent trading houses- Vitol, Trafigura, Glencore, Mercuria and Gunvor – along with the trading arms of large “majors” such as BP, Shell, Total and Equinor.
These entities are serial succeeders in markets, survivors through crises of war, financial market collapse, regulatory reach and extreme volatility. They are populated by some of the sharpest entrepreneurial and commercial minds-people who understand how to mine the opportunities presented by production, infrastructure, transportation and trading in energy. They understand how to trade “naked” (without asset backing) and ” covered” (with asset or contractual backing), can turn on a sixpence when conditions change through having a system of delegated authorities within tightly risk controlled limits, set and evaluated by a management imbued in the psyche of markets.
It is unlikely that they will be daunted when presented with the renewables play book. Indeed, they are already tooled up. There have been plenty announcements about the projects in renewables that they are establishing, whether in wind, biofuels or hydrogen (“Traders rush to invest billions into Renewables”- FT 10/01/20) and they are already well established in Power and Carbon trading.
There is little reason to believe that these same entities will not be the success story in the markets of the future where there is rent to be collected from utilising their core competencies of exploring for and uncovering inefficiencies and acting as re-equilibrators on both physical and financial markets.
If the outlook is good for those already in the know to be able to retain the level of market interface activity revenue previously obtained from fossil fuel markets (and the public markets valuations of these companies attaching to this), then what of the core renewables companies and what of new entrants?
Orsted, Iberdrola, Centrica and SSE have been companies (amongst others) at the forefront of the renewables wave in the UK and Europe. How will they fare in the traded markets? Some already participate and have done for quite some time. Those entering anew will need to ensure that they have Board level commitment to operating at the market interface, that they understand their objectives (risk management and/or risk assumption), that they have the right levels of delegation in place and the right people with the right reward incentives, amongst other things, to be able to compete with the old hands. These are the critical, yet complex, success factors which Energex has direct experiencing in developing operationally for a range of our clients.
Power and Fuel markets (which will be the crux of renewables trading) have seen a number of new entrants over recent years. Companies such as Danske Energy and NEAS have brought young minds and new ideas to bear, yet, have not lasted long as independent entities, having been snapped up by Equinor and Centrica respectively. Perhaps they came to reason that they would forever struggle to challenge the large incumbent energy traders and that scale would be impossible to grow organically. Or perhaps their core reason for setting up was the desire to build to a point and be acquired, a strategy again harking back to the days of the tech boom.
In addition, there appears to be a trend towards groupings being created to develop the renewables agendas of existing entities, possibly in order to spread the risk and cost associated with production and infrastructure in new areas. These combinations may turn out to be powerful forces in markets. In one example, Trafigura and IFM have formed a Renewables JV to invest in Wind, Solar and Power Storage and the recent creation of the so called “Airbus for Hydrogen ” group is another case in point. They intend to increase their combined Green Hydrogen output to 25GW’s by 2026 and to bring costs down to $2 /kg by the same date, making Hydrogen competitive with Diesel. This grouping consists of not only some big hitting firms, but also some big hitting individuals in these firms with significant markets experience- Mark Crandall of AWP was a founder of Trafigura and Marco Alvera of SNAM created the markets arm of ENI, for example. And yet, JV’S and groupings are difficult to run. Objectives become mis-aligned, different company cultures demand different strategies, operational practices differ and getting decisions made in good time becomes an impossibility. Perhaps then the impact of “groupings” and “JV’s” on market development and liquidity will be less than at first promised.
The most likely scenario then, is that those with the fossil fuel trading backgrounds will be in poll position to continue to neatly shift their focus towards also becoming dominant in Power, Carbon and whichever other markets develop to serve the risk transference needs of the Renewables industry (while at the same time retaining their existing fuel trading businesses, as Oil and Oil Products remain significant in powering the world and reality outstays aspiration, despite the heavy external pressures to green -up and desist).
Fuels – Old and New
What then of Gas and Nuclear and the place they might have as, respectively, a pathway to Net Zero Carbon, and as a stable baseload product for grid systems. There is an especially active gas market in the U.S. dating back to the deregulation of the industry in the mid 1980’s. The market in Europe is smaller but time served and reasonably liquid, while connecting the global dots is the, as yet embryonic market in LNG, a fuel which some, at least, hope will provide the fossil fuel “lite” pathway to a Net Zero Carbon future.
If Gas is already well established from a markets perspective, regional and national attitudes vary tremendously when considering the place of nuclear. The German reaction to the Fukushima nuclear disaster of 2011 has been extreme, yet next door, the French rely on their reactors. In the UK, the industry was historically disliked and mistrusted by the public until a publicity campaign to support part privatisation in 1996, changed perceptions and enabled a successful public sale. The Nuclear Electric company’s output auctions had been a regular part of traded electricity markets at the time of the Electricity Pool (whose demise is much mourned by some).Yet the public image of the industry (probably not helped by luke -warm support from successive governments), has regressed since then and once more seems to be in the semi doghouse, not helped by the ongoing perception of safety as an issue, cost overruns and delays on construction of plant in Finland, the US and elsewhere, and difficulties experienced by those attempting to finance and build new plant in the UK.
However, in the UK, it seems unavoidable that either Gas or Nuclear or both will have a significant role to play in the drive to a Net Zero Carbon position both from an output perspective and from a market trading angle. As a clear example, recent research by experienced grid system expert and consultant at Sentri Ltd, Trevor Turner, sets out the clear need for a baseload product to ensure grid stability in the case where the much-vaunted scenario of 40 GW supply of wind power to the UK grid comes to pass. The conclusion is that the volatility ensuing from the irregular supply profile of wind in this market will result in a split of the traded markets into firstly, a capacity market which will secure availability and secondly, an energy market which will pay for actual production.
Although neither Gas nor Nuclear neatly fit the agenda of the “New New Thing” they are, nonetheless, bound to be of greater consequence than is being acknowledged in the present debate on the future fuel mix and thus in the portfolio of the integrated trading firms.
Give the current level of excitement, it is to be hoped that Hydrogen can overcome concerns around infrastructure and storage and deliver a scalable green power resource, but as yet the case seems to be not proven.
Carbon Capture and Storage has, at this point, something of a spotty track record, yet must up its game as an essential component of the transition. Biomass and biofuels may struggle on scalability even if, from a traded markets perspective, they are already off and running. Wind and Solar present stability issues, well-rehearsed by commentators, although seemingly such difficulties are of less consequence in the minds of Government.
While the politics and economics of the future fuel mix are for others to much more fully contemplate, it will be important for incumbents and new entrants to follow closely how the fuel mix develops going forward, how that will play into the development of traded markets and how to successfully adjust or create business models to be effective at that “new normal” market interface. Much will depend upon global and regional efforts to put an effective (and most likely higher) price on Carbon. Whether by fiscal action or market discovery, it is this that will determine the value interrelationships across the slate of fuels, old and new.
Even more critical however for markets will be the question of infrastructure. Without distribution and storage infrastructure there can be no transport and no trading. This is potentially a massive constraint to the development of a matrix of tradeable markets. Both Hydrogen and CCS are currently compromised in this context. The requirement and the cost of this needs to be planted firmly in the priority mindset of decision makers in order that both public and private infrastructure initiatives can be fast tracked with confidence.
And So…
There is a sense that if one is not an evangelist, then one is automatically a denier. For some, the climatology debate carries on, as summarised well by Ronald Bailey in his article “What climate science tells us about temperature trends”. However, most are entirely convinced that we are dealing here with evolutionary reality executed at a revolutionary pace (albeit with all the broad brush, big hair, “to the moon and back” statements of grand intent that go with it)! A modest degree of caution, even healthy scepticism, is hardly surprising and must not be mistaken for denial. There is a verbal similarity between” getting carried away” and “getting carried out” that suggests that both maxims of “behold ” and “beware” might be equally appropriate in the ongoing mania that is the push to the critically important Renewables future.
At Energex we believe that calm, reasoned, seasoned and grounded consideration which takes account of the lessons to be learned from the history of development of traded energy markets, will be essential to incubating success and handing-off the pitfalls of the current mania. There will also be ample need for a not inconsiderable input from both experts and scientists, however unpopular those labelled as such have become in some quarters!
As yet, the consumer has not been tested on the level of commitment to the cause and, as eloquently pointed out by Dominic Lawson in an article in the Sunday Times of 10th January 2021, will we all still be “on heat” when we have to pay up to cover the, undoubtedly, colossal and likely significantly underestimated costs of change? Will Utilitarianism hold sway, or will selflessness be trumped by selfishness? Happily, high costs have (and will further) breed innovation and costs will continue to fall. Yet, none of us should be in any doubt about the need to pay, whatever the price becomes, as the alternative global climate nightmare cannot be contemplated.
The eminently quotable WS Gilbert coined the phrase “If you go in, you’re sure to win”. In the same libretto, he also wrote “On fire that glows with heat intense, I turn the hose of common sense”. They need not be mutually exclusive sentiments. At Energex, we can help those who want to “get in” to navigate the way to so do with the right focus, objectives, operational structure and common sense.