Lec. 05: Energy Trading Flashcards
(43 cards)
1
Q
What is energy trading?
- “…” is buying and selling, i.e. exchanging commodities.
- A “…” is a homogeneous product - uniform and standardised.
- Examples of commodities: agricultural (wheat, coffee), metals (gold, steel) etc.
- Examples of energy commodities: electricity, natural gas, crude oil, LNG, coal.
- Related markets: freight, CO2 emission allowances.
- Distinguish between underlying commodity and “…” (e.g. futures, forwards, options, swaps) that derive their value from the underlying assets.
- Energy trading has parallels to financial markets (shares, bonds and other financial instruments) – even with its particularities due to the physical nature of electricity (gas/oil/coal etc.) as underlying.
A
“Trading”
“commodity”
“derivatives”
2
Q
Energy vs. financial markets
What are similarities?
A
- Future prices cannot be predicted based on historical prices
- The best prediction of tomorrow’s price p_t+1 is today’s price p_t
- Transparency (availability of information to all market participants) is a crucial prerequisite for an efficient market
3
Q
Trading forms
What is the difference between exchange and OTC?
A
Mediated trading: pool or exchange
- Organised auction resulting in uniform
pricing - Standardized products
- Regulated
- Clearing and colateral costs
- Transparency
Bilateral trading: over-the-counter (OTC)
- Individual prices agreed between pairs of buyers and sellers (∼ pay-as-bid principle)
- Standard framework agreements:
EFET/GTMA; ISDA; DRV etc. - Unregulated
- Intermediation cost (opportunity cost or broker fee)
4
Q
A trading product is combination of transaction features.
1) Name the transaction features and provide examples in case electricity is traded.
2) Provide the characteristics of bids (offer to buy) and asks (offer to sell).
A
1) Transaction feature
- Underlying asset
–> E.g. electricity - Delivery point
–> E.g. TSO control area - Delivery period
–> E.g. start date / end date - Delivery amount
–> E.g. contract capacity [MW] / contract quantity [MWh]
2) Characteristics of bids and offers
- Product
–> E.g. base - Price
–> E.g. 50 €/MWh - Trading day and time
–> E.g. 05.02.25, 8-9 am
5
Q
Product types
1) What is the difference between physical and financial products?
2) What is the difference between fixed-prices and (index-based) floating prices?
A
1) Physical vs. financial products
- Physical product implies physical delivery of the underlying asset (i.e. electricity)
- Financial product implies exchange of cash without physical delivery
–> No set-up with TSO required –> Swap
–> At expiration the amount of cash exchanged depends on the difference between the contract price and the spot market price
2) Fixed-prices vs. (index-based) floating prices
- A fixed price is stated as an amount of money per unit of underlying asset (e.g. MWh electricity)
- A floating price is determined by reference to a price index at a specific point in time after the deal closed.
6
Q
What energy sub-markets do you know?
A
Energy sub-markets
- Compare slide 7
Future / Forward / Term
- Years, quarters, months ahead of the delivery
Spot / Short term / Cash
- Day ahead
–> A day ahead of delivery - Intraday
–> Up to 5 min before of delivery
7
Q
What electricity wholesale sub-markets do you know?
–> Category: exchanges
A
Electricity wholesale sub-markets
–> Category: exchanges
Spot markets (mostly physical, delivery <= 2 days)
- E.g. EXAA, EPEX Spot
- Sub-markets
–> Day-ahead
–> Infraday - Products
–> 1/4h, 1h, base block (12:00 am to 11:59 pm), peak block (8 am to 8 pm)
Future markets (mostly financial, delivery > 2 days)
- E.g. EEX Futures
- Products
–> Base/peak/offpeak/etc.-futures with different durations (e.g. day, week, month, quarter, year) and different due dates (years, quarters, months, weeks, weekends, days)
–> Options on futures
(Can be traded, but are not traded in practice)
8
Q
What electricity wholesale sub-markets do you know?
–> Category: bilateral trade
A
Electricity wholesale sub-markets
–> Category: bilateral trade (e.g. between generator and retailer)
OTC trading
Spot markets (mostly physical, delivery <= 2d)
- Sub-markets
–> Day-ahead
–> Infraday - Products
–> 1/4h, 1h, base block (12 am to 11:59 pm), peak block (8 am to 8 pm)
Forward markets (physical and financial, delivery > 2d)
- Products
–> Base/peak/offpeak/etc.-forwards with different durations (e.g. day, week, month, quarter, year) and different due dates (years, quarters, months, weeks, weekends, days)
–> Options on electricity forwards
(Can be traded, but are not traded in practice)
Individual supply according to schedule with and without flexibility (physical)
9
Q
What electricity wholesale sub-markets do you know?
–> Category: control power markets
Who buys balancing power from whom?
A
Electricity wholesale sub-markets
–> Category: Control power markets
Different types of control power / control power markets
- Primary reserve (FCR: Frequency Containment Reserve)
–> Automatic activation within 30 sec
–> Duration per failure: 0 < t < 15 min
- Secondary reserve (aFRR: Frequency Restoration Reserve with automatic activation)
–> Complete automatic activation within max. 5 min
- Tertiary/minute reserve (mFRR: Frequency Restoration Reserve with manual activation)
–> Complete semi-automatic activation within max. 15 min
–> Duration per failure: 15 < t < 60 min or up to several hours for several failures
Who buys balancing power from whom?
- TSOs procure balancing power from Balance Service Providers (BSP) in balancing markets
- Energy cost is charged to balance group
- Balance Service Providers (BSP): generators, demand response, storage
10
Q
Draw a sample power purchase portfolio for a given load curve.
A
–> Compare slide 10 + 12
- Standardised futures do not match with typical load schedules.
11
Q
True or false?
Trading volumes for base are much higher than peak.
A
True!
–> Compare slide 13
12
Q
Name and explain the main characteristics of the following electricity wholesale sub-market:
EPEX Spot Day-ahead auction
A
EPEX Spot Day-ahead auction
- Double-sided auction with order book trading
–> Bids and offers are collected over a period and executed at a single clearing price based on the resulting supply and demand curve - Uniform price auction
–> Single market clearing price for each product (hour or block) - Products
–> 1h, base block (12:00 am to 11:59 pm), peak block (8 am to 8 pm) other blocks (e.g. off-peak block) - Trading period before delivery date D
–> Order book opens on D-45
–> Order book closes at 12 pm on D-1 - Price publication time
–> Asap; Usually 12:50 to 1:00 pm - Min order amount/amount increment: 0.1 MWh
- Min price: -500 €/MWh; Max price: 4000 €/MWh
13
Q
How much of the consumed electricity in Germany is traded on the day-ahead spot market?
A
~1/3
The rest is traded over the counter (OTC) or on the intraday market.
14
Q
Name and explain the main characteristics of the following electricity wholesale sub-market:
Intraday market
A
Intraday market
-
Uniform price auction for 15-min products
–> 3 pm and 10 pm on D-1 for all delivery periods of delivery day D
–> 10 am on D for delivery periods between 12-11:59 pm of delivery day D -
Continuous trading for 1h and 15-min products
–> 3 pm on D-1 and up to delivery on D
–> Continuous: as soon as two entered bid and ask orders match, the trade is executed
15
Q
What role does the intraday market have in an increasingly renewable electricity system?
A
Intraday market
- Intraday market volumes are steadily increasing
- This reflects a growing need for short-term flexibility due to uncertain forecasts of demand and flucuating renewables
- It is used to adjust trading positions based on corrected forecasts close to the delivery date
16
Q
What is a balancing group?
What is the balance responsible party (BRP)?
A
Balancing group
- Is a virtual energy volume account associated with one or more grid users within a specific control area
- Every grid connection point is allocated to one balancing group
–> E.g. electricity supplier for a group of customers, or power plant
Balance responsible party (BRP)
- Is responsible for balancing the saldo of the BG (feed-in and consumption) for each 15 min; balancing includes trading on spot markets
- Transmits the schedules (load schedules + power plant dispatch)) of his BG to the balancing group coordinator (TSO)
- If transmitted schedules deviate from the actual feed-in/consumption, the balancing group coordinator (TSO) must use control energy
- The costs of the control energy used (=”Ausgleichsenergiekosten”) are charged by the TSO to the balance responsible party (BRP)
- To calculate the control energy costs, the cross-control area balancing energy price (“reBAP”) and the balancing group deviations (= control energy requirement) are determined by the TSO
17
Q
Name reasons for imbalances in balancing groups?
A
- Unplanned outage of generation units or activation of large loads
- Inaccurate forecast of fluctuating RES generation or demand
18
Q
What trader types do you know?
A
Trader types
- Asset-backed
–> Trade to optimise assets and/or hedge price risk - Merchant / proprietary
–> Trade to speculate / gamble
19
Q
What is the difference between a long and a short position?
A
Long position
- An entity is long on a commodity if it benefits from a price increase.
- E.g.: A generator is long on electricity, since they hope electricity prices will rise
Short position
- An entity is short on a commodity if it benefits from a price decrease.
- E.g.: A consumer is short on electricity, since they hope prices with drop
(A marketer who buys and resells power can be either long or short. If they have bought fixed-price power before finding a market for that power they are long; if they have sold fixed-price power before securing supply they are short.)
20
Q
Long vs. short positions.
What position do generators, final consumers and traders naturally have?
A
Generators
- Have a natural net long position: their value increases with rising prices
Final consumers
- Have a natural net short position: they benefit from falling prices
Traders
- Who buy and resell power can be long or short.
- If they have bought fixed-price power before finding a market for that power they are long; if they have sold fixed-price power before securing supply they are short.
21
Q
Explain the fundamental tradeoff between risk and return.
A
The fundamental tradeoff between risk and return
- For a higher risks we expect a higher return to offset the possibility of loss in the expected value
22
Q
What is hedging?
What do final consumers, traders and generators typically hedge?
A
Hedging
- Is reducing the overall risk (i.e. uncertainty) by offsetting the risk of the current position through a new opposite and equal position
- Hedging reduces potential losses and potential profits
Final consumers (industrial and commercial)
- Typically hedge price risks using fixed-price contracts to achieve better cost planning due to a lack in trading capability and market insights
Traders
- Hedge positions that they are not able or willing to close
- E.g. long-term supply contract at a fixed price)
Generators (e.g. wind and solar projects)
- May hedge price risks using long-term fixed-price power purchase agreements (PPA) to facilitate financing
23
Q
What is a forward contract?
On what sub-market is it closed?
A
Forward contract
- Is a non-standardized contract between two parties to buy or to sell an asset at a specified future time at a price agreed upon today
- They are closed on the OTC market and are not exchange-traded
24
Q
What is a future contract?
On what sub-market is it closed?
How can a future be closed?
A
Future contract
- Is a standardized contract between two parties to buy or sell a standardized asset (quantity and quality) at a future time for a price agreed upon today
- It is traded on exchanges
- It is physically settled, offset, closed via a rollover or cascaded
25
What role do futures and forwards play in the context of hedging?
Forwards and futures allow market participants to manage or hedge price risks in advance
26
Electricity markets:
What percentage of the power needs of retailers and other consumers is secured through futures, forwards and the spot market?
Power needs of retailers and other consumers are covered with futures, forwards and the spot market.
- Futures and forwards: 80-90%
- Spot market products: 10-20%
27
What elements influence the price of future contracts?
The price of a futures contract is a function of:
- the current underlying asset’s spot price
- interest rates
- storage costs
- expectations of future supply and demand conditions
(- Most important is the current price of the underlying cash commodity.
- Even though actual delivery is quite rare, the possibility of delivery provides the critical link between spot and futures markets, enabling arbitragers to profit when prices get too far out of line.)
28
How electricity generators and consumers generally use futures to hedge?
Provide one example for each.
- An entity with a long position in the electricity market (e.g. generator) can hedge by selling a future.
- Example
--> If a generator has a marginal cost of 15 €/MWh
--> They sell a future for next month with a price of 20 €/MWh and as a result they lock-in a profit now
--> By avoiding a loss, they also forgo ("verzichten auf") potential profit if the spot price is higher than 20 €/MWh.
--> The generator now has a short futures position, i.e. they profit from the future when prices decline below 20 €/MWh.
- An entity with a short position (e.g. consumer) can hedge by buying a future.
- Example
--> If a consumer has a marginal benefit of 100 e/MWh, they may choose to buy a future with a price of 20 €/MWh to lock in the benefit.
--> They forgo benefit if the spot price is lower than 20 €/MWh.
--> The consumer now has a long futures position, i.e. they profit from the future when prices go above 20 €/MWh.
29
How electricity generators and consumers use futures to hedge?
Describe how a **consumer of electricity** can hedge his risk using futures?
- **Market participants hedge risk by taking opposite positions in the physical and futures markets.**
- **With a perfect hedge the magnitude of the corresponding gains and losses in the physical and futures positions will be exactly the same.**
Commodity: electricity
Market participant: consumer
**Without future**
- Cash position
--> Short the physical commodity electricity in the future
- Risk from cash position
--> If spot market prices increase: profits decrease
--> If spot market prices decrease: profits increase
**With future**
- Future position / hedge
--> Long electricity future (bought future)
- Risk from future position
--> If spot market prices increase: profits increase
--> If spot market prices decrease: profits decrease
30
How electricity generators and consumers use futures to hedge?
Describe how a **generators of electricity** can hedge his risk using futures?
- **Market participants can hedge risk by taking opposite positions in the physical and futures markets.**
- **With a perfect hedge the magnitude of the corresponding gains and losses in the physical and futures positions will be exactly the same.**
Commodity: electricity
Market participant: generator
**Without future**
- Cash position
--> Long the physical commodity electricity in the future
- Risk from cash position
--> If spot market prices increase: profits increase
--> If spot market prices decrease: profits decrease
**With future**
- Future position / hedge
--> Short electricity future (sold future)
- Risk from future position
--> If spot market prices increase: profits decrease
--> If spot market prices decrease: profits increase
31
Explain why futures in the case of **generators** allow to hedge without distorting real-time incentives.
Generator
**Without future**
- Compare slide 38
- Profit [€] over price [€/MWh]
--> If P < MC it doesn’t run Q=0
--> If P > MC it runs at max capacity Q = Y
- For the sale of its generation, it has a long position (i.e. benefits from high P).
**With future**
- Compare slide 39
- Profit [€] over price [€/MWh]
--> If P < MC it doesn’t run Q=0
--> If P > MC it runs at max capacity Q = Y
(Futures don't distort real-time incentives!)
- For the future it has a short position (i.e. benefits from low P).
32
Explain why futures in the case of **consumers** allow to hedge without distorting real-time incentives.
Consumer
**Without future**
- Compare slide 40
- Profit [€] over price [€/MWh]
--> If P > MB it doesn’t consume Q=0
--> If P < MB it consums at max capacity Q = Y
- For energy consumption, it is short.
**With future**
- Compare slide 41
- Profit [€] over price [€/MWh]
--> If P > MB it doesn’t consume Q = 0
--> If P < MB it consums at max capacity Q = Y
(Futures don't distort real-time incentives!)
- For the future it has a long position (i.e.
benefits from high P).
33
What three options do you have if a future contract ends?
When a futures contract ends you have three options
- **Settle** the contract by providing the underlying service (physical settlement, e.g. electricity) or cash (financial settlement)
- **Offset position** by taking out opposite and equal transaction
--> E.g. if you sold 2 futures for September, need to buy 2 futures for September. The difference in price between initial and offset position is the profit/loss on trade.
- **Rollover**, i.e. offset existing position, buy future for next period
--> When rolling forward, a trader will simultaneously offset their current position and establish a new position in the next month
--> This maintains the same risk position beyond the initial expiration of the contract
- Electricity futures can also **cascade** ("umgewandelt werden") into shorter-term products the closer the delivery date gets
--> E.g. a future for year 2022 will cascade in December 2021 into futures for months Jan, Feb, Mar in 2022 and into futures for quarter 2, 3, 4 in 2022
34
Explain the price development patterns on futures markets.
- Contango
--> Futures price exceeds the spot price.
- Backwardation
--> Spot price exceeds the futures price.
- Market participants are driving the futures price up/down in line with their expectations.
--> Compare slide 45
- Since producers are less diversified than consumers, they have a higher risk and would tolerate lower futures prices, so we expect backwardation to be the norm.
35
What are options?
An option is the right to
- to buy (call option) or sell (put option)
- a specified quantity of an underlying ("Basiswert")
- at a specific time (European option) or during a specified period (American option)
- at a certain price (strike/base price)
- The option premium is a fixed amount paid by the holder (option buyer) to the writer (option seller) upon concluding an option
36
True of false?
An option fee occurs regardless of whether the call/put is activated or not!
(Call; 300 MWh; Strike price 20€/MWh; Option fee = 1 €/MWh; **not activated**; Expenses = 300€)
True!
Option fee = Option price
37
Put Option Payoff/Profit
Draw the diagram from the perspective of the
a) holder (option buyer)
- Put Option Payoff
- Put Option Profit
b) writer (option seller)
- Put Option Payoff
- Put Option Profit
**[Payoff = "Auszahlung"]**
Put Option Profit
a) Perspective: **holder (option buyer)**
--> Payoff: compare slide 48
--> Profit: compare slide 49 (slide 48 - add option premium)
- Linear falling curve than constant in second quadrant
- Break-point at exercise/strike price
- Constant in second quadrant; profit = option premium
- Difference between y-axis intercept and option premium = exercise price
b) Perspective: **writer (option seller)**
--> Payoff: compare slide 50
--> Profit: compare slide 50 + add option premium
**[Payoff = "Auszahlung"]**
38
Call Option Profit
Draw the diagram from the perspective of the
a) Holder (option buyer)
- Call Option Payoff
- Call Option Profit
b) Writer (option seller)
- Call Option Payoff
- Call Option Profit
**[Payoff = "Auszahlung"]**
Call Option Profit
a) Perspective: **holder (option buyer)**
--> Payoff: compare slide 51
--> Profit: compare slide 52 (slide 51 - add option premium)
b) Perspective: **writer (option seller)**
--> Payoff: compare slide 53
--> Profit: compare slide 53 + add option premium
**[Payoff = "Auszahlung"]**
39
Further Option Terminology
What is missing?
"...": positive payoff in case of option excercise.
"...": zero payoff in case of option excercise.
"...": negative payoff in case of option excercise.
A call option is in-the-money if "...".
A put option is in-the-money if "...".
NB: Options allow you to keep choices "..".
NB: Options have an "..." payoff (unlike perfect hedging with "...").
"In-the-money"
"At-the-money"
"Out-of-the-money"
call: "strike price < spot price"
put: "strike price > spot price"
"open"
"asymmetric" ; "futures"
40
What is missing?
**Generators hedge with "..." options**
A power generator uses "..." to "...". Suppose the electricity futures contract price is $25/MWh. The power generator wishes to receive at least $25/MWh for the physical sale of power. To accomplish this, the power generator purchases a put option for a premium of $1/MWh.
**If the price of electricity increases**, the power generator can sell electricity into the **spot market** and receive the higher spot price.
**If the price of electricity decreases**, the power generator can **exercise his put option** by selling electricity at its strike price of 25$/MWh on or before expiry.
"put"
"put options"
"guarantee a minimum selling price for its generated electricity"
41
What is missing?
**Consumer hedging with "..." options**
A power consumer can hedge price risks using a "..." option by "...". Suppose the electricity futures contract price is $25/MWh. The end user wishes to pay no more than $25/MWh. To accomplish this, the end user purchases a call option for a premium of $0.75/MWh.
**If the price of electricity increases**, the consumer can **exercise his call** option by buying electricity at its strike price of 25$/MWh on or before expiry.
**If the price of electricity decreases**, the consumer can buy power in the **spot market**.
"call"
"gurarnteeing a maximum price and avoiding high prices"
42
What is an electricity swap?
Electricity swap
- Traded on OTC-market (bilateral)
- Financial, not physical product
- Duration: multiple periods (e.g. months, quarters, years)
- Examples for Swaps: CfDs and VPPAs
- Fixed-for-Floating Price Exchange
--> One party pays a fixed price for electricity
--> The other party pays or receives the difference between the fixed and a floating price linked to a market index (e.g., day-ahead spot price)
- Example CfD
--> Retailer buys electricity from a generator over a period of time for a fixed strike price using a CfD
--> If spot price > strike price, the retailer pays price difference to generator
--> If spot price < strike price, the generator pays price difference to retailer
43
What are Contracts for Difference (CfDs) and Virtual Power Purchase Agreements (VPPAs)?
Contracts for Difference (CfDs) + Virtual Power Purchase Agreements (VPPAs)
- Financial swap
- Common ways of financing renewable energy
--> The generator receives a fixed price per MWh for their electricity (= the strike price) from the buyer
--> If the market price < the strike price, the generators receives the difference from the buyer
--> If the market price > the strike price, the generators pays the difference to the buyer
--> Price risk is transferred from the generator to the purchaser ("swaped")
