The Next Generation of Energy Trading

Investments in energy trading, curtailed in the wake of the turbulent years
following 2000, have begun to swing back, and agile companies are identifying
new models to improve their results and establish competitive advantages. This
new generation of energy trading will require risk-centric and control-oriented
processes and technologies. Companies must increase the maturity of their internal
capabilities in order to differentiate and position themselves in the evolving
marketplace. The movement of financial institutions into the vacated energy
trading market signals growing opportunity, and utilities will be required to
work harder to achieve credible and competitive energy trading and risk management

Evolving Imperatives of Energy Trading

Corporate interest in energy trading in the U.S. has begun to recover from
recent hibernation; the emerging models, however, have fundamental differences
from their predecessors. In addition to the traditional operationsbased companies
starting to test the waters, financial institutions have begun to fill the energy
trading and services void as they identify new opportunities and space in the
market. This market recovery is creating requirements on energy companies to
focus on better management of the risks and regulation in their core businesses,
as well as respond to growing competition in their markets.

Given the evolution of the industry and competition, companies are facing several
strategic imperatives as they reassess their as-is and needto- be capabilities
in the market and seek to define the scope of their trading activities and capabilities.

Energy trading has evolved to be risk-centric, as opposed to profitcentric,
mandating a new level of systems and data integration and transparency. As financial
institutions explore new roles in the energy market, utilities must recognize
the importance of meeting the challenges head on. Energy companies that wish
to be successful in trading must develop their capabilities to better analyze
the risks and opportunities present in their trading books on both an aggregated
and disaggregated basis and make decisions based on this information in accordance
with the firm’s strategic direction. According to recent META Group research,
“Accountability is now more important than trading volume,” and this is leading
companies to focus on improving data management, extraction and reporting capabilities.[1]

Energy trading operations must raise their capabilities to enable rapid response
to changes in regulation and competition. Corporations that have invested in
clarification of processes and ensuring oversight in response to regulatory
mandates must now work harder to confront an evolving market and increased competition.
Strategic corporate priorities and the corresponding internal resource capabilities
need to be weighed against the potential risks of failure to comprehensively
manage market and regulatory risks.

Consistent gaps in process, information management and reporting must be corrected.
In addition to trading and risk management, decision makers, executive management,
corporate boards, regulators and stakeholders will continue to require an auditable,
safeguarded base of information to support business continuity of trading operations.
The drive for operational excellence and improved financial performance will
force companies to integrate and optimize business processes across functional
areas while using existing legacy applications.[2]

Evolution of technology is increasing the speed of information integration
and derivatives calculations, opening new opportunities and raising regulatory
expectations. As information integration software enables the combination of
information previously housed in disparate legacy systems, it creates both the
ability and responsibility to consider potential revenue generation opportunities
within an acceptable risk-reward curve. Enterprise risk management is breaking
traditional product silos, integrating risk analysis with customer, geographic
and product analyses.[3]

Critical Success Factors

These strategic imperatives are creating the need for companies wanting to
participate in energy trading to re-evaluate certain critical success factors
and develop plans for improving their abilities to meet increased competition
and evolve quickly to meet new challenges. These factors are presented in Figure
1. Although each area is important to increasing competencies and creating competitive
advantages in energy trading, three aspects are particularly important at this


The ability to continue to identify efficiencies in operating models continues
to be an important focus for energy companies. As energy trading activity increases,
prior cutbacks in organizational capabilities must be reconsidered. Examine
consistency and alignment between roles, processes and incentive plans, to verify
that all areas of the organization are working to contribute to the same strategic
goals. Increased focus on business performance management (BPM) via executive
dashboards is enabling business leaders to measure efficiencies, establish goals
and achieve quantifiable progress.

Risk Control

Regulation at federal, state and local levels will continue to require focus
on operational controls, accountability and reporting. Companies should verify
that reporting requirements are automated to reduce costly manual data consolidation
or analysis. In addition, energy trading companies need to elevate their ability
to quickly and accurately quantify and analyze risk (market, credit, operational)
to a level that paces them astride their new financial institution competitors.

Integrated IT Systems

IT systems are crucial to all phases of energy trading, from acquisition of
market information, analytics and trade processing to portfolio optimization
and sophisticated scenario analysis, as well as the obvious reporting and back-office
processing. So critical to effective energy trading are improved IT capabilities
that, according to META Group, 70 percent of companies are increasing spending
in energy trading support systems. Competitive advantage will be gained by companies
that also use technology to gain visibility to enterprise risk and market opportunities.[4]

Toward a Higher Level of Maturity

Important components and levels of competency in energy trading can be evaluated
along a maturity curve. Particularly important is the realization that although
an integrated technology platform is a critical step in attaining high levels
of maturity, it alone is not capable of generating value without strong underlying
processes, roles and incentive systems.

Level 1 maturity has been attained by the vast majority of utilities as a fundamental
part of operations resulting from focus on regulatory issues and risk controls
implemented over the past several years (see Figure 2). How consistently companies
build upon these underlying policies and processes and generate true business
value will determine their success moving forward.

Most utilities are currently operating at a Level 2 maturity, and many are
working to verify that roles, responsibilities and reward structures are consistent
with corporate policy. Reductions (or elimination) of skilled professionals
in trading, research, analytics, control and processing functions have resulted
in increased workloads and multiple roles for some trading staff. Incentive
payment structures need to be aligned with measures of corporate value, and
leaders require accurate information to correctly recognize and reward desired

At Level 3, an integrated technology base becomes a strategic imperative, enabling
integration of information sources, reducing manual efforts required and providing
a flexible basis for developing new products. Although some utilities have invested
heavily (and not always successfully) in new systems implementations, the majority
of companies are assessing their capabilities to quickly integrate existing
systems via data warehouses, middleware or integrated energy trading applications.

Level 4 maturity is attained only by firms with integrated organizational structures,
processes, analytics and straight-through processing which is designed to enable
seamless end-to-end trade processing and control, from market research to regulatory
reporting. Once at this level, companies have the flexibility to rapidly respond
to market changes and opportunities and have established processes of continuous
improvement to support adjustments as market conditions change.

Next-Generation Platforms

The next generation of energy trading platforms will respond to the imperatives
of regulatory oversight, increased competition from traditional and nontraditional
segments, sector convergence, mergers and consolidations and continuous change
in the business environment. Mature energy traders require new business and
technological capabilities based on new systems architecture requirements. Trading
organizations will require prompt access to various components integrated into
a consolidated trading platform with underlying data warehouses and interfaces
for access to market information and back-office systems. Speed to market, flexibility
and integrated services will be paramount.

Legacy System Transformation

Energy trading organizations that lack the appetite for investments in new
trading systems are adopting strategies to transform their existing systems
so they can introduce flexibility and portability not currently present. Utilizing
new technologies to unlock the value resident in legacy systems, companies are
leveraging enterprise architecture solutions and portals to reduce laborious
systems integration efforts, to reduce the need to modernize interfaces and
to solve data synchronization issues. Established methodologies focused on application
consolidation, renovation and Web enablement are bringing results at reduced
costs and reduced risk to ongoing operations.

Service-Oriented Architecture and Web Services

The goal of service-oriented architecture (SOA) is to “componentize” key business
processes so that they can be more easily changed to meet new business conditions
while also lowering the cost needed to manage and change the application. Componentization
of business processes and application functions create opportunities for collaborative
development and permits integration of established business rules with new applications.
Energy traders will have the ability to graft new functionality to the existing
suite of applications and diverse databases. Energy trading organizations have
invested heavily in legacy applications that often have achieved neither the
desired capabilities nor ROI. Web services allow true plug-and-play capabilities,
giving the energy trader the ability to implement new components or functionality
quickly and cost effectively as the business environment evolves. In addition,
SOA gives the energy trading organization the ability to achieve true BPM functionality;
more than real-time position management, it is proactively managing the portfolio
to a set of enterprise performance measures (as opposed to reacting to stale
indicators). Energy traders utilizing BPM concepts do not wait until the end
of closing periods to know their integrated key performance measures. BPM is
designed to provide nearreal- time access to the performance measures and the
ability to assess the impact of potential decisions on these measures.

Data Warehouse Integration

The importance of seamless data access (both transactional and market information)
to energy trading cannot be overstated. In the past, much of the data created
or acquired was simply dumped into discrete databases. Because of regulatory
pressure, more data integrity control has been introduced; however, many organizations
have yet to realize the full benefits of having a componentized data service
capability, enabling and controlling access to all corporate data. Next-generation
architectures must provide tools that will expedite the flow of business information
to the critical decision-making processes and support enterprise value optimization.
These tools are becoming a necessity to identify and evaluate potential trades
and their impact on the trading book and on the enterprise portfolio. The capability
to quickly and accurately assess the impact to credit risk, liquidity and market
risk enables comprehensive scenario-building to support risk management and
enterprise value optimization.

The next-generation energy trading platform offers companies the ability to
perform in the new risk-focused environment. The ability to integrate information
from trading platforms with information from other corporate systems will be
a critical factor in determining which energy traders will be key players and
which will cede space to more capable competitors.