Many renewable energy players are new to the concept of an ETRM. In this article we will provide a few quick answers to the most frequently asked questions around the topic, some of which may surprise you!
What is ETRM?
Energy trading risk management (ETRM) is an enterprise software solution that enables the management of energy commodities’ physical and financial trading. You may have heard of CTRM as well. The difference with Commodity Trading and Risk Management (CTRM) software is that the latter includes all kinds of commodities, not limited to energy-related ones. For example, metals, agriculture and ‘softs’ such as cotton. Therefore, the differences lies in the scope of traded commodities.
Who uses ETRM system?
ETRM systems have been traditionally used by large trading houses and utilities managing a plethora of energy commodities, primarily natural gas, LNG, oil, crude oil, refined products and electricity. They have been so popular in that sector because they facilitate hundreds of transactions and deals daily, which is in line with the primary business model of trading houses, for example.
This is due to their ability to link the different steps of the trading cycle, connecting business processes conducted across the front, middle and back offices, which has proven very useful for traders and utilities.
Traders & Utilities Typical Set-Up
Execution of physical or financial contracts
What are ETRM consultants?
ETRM consultants perform two functions. First, they help identify which ETRM solution best fits their client’s needs. Typically, a consultant helps the client launch a tender with what services they need and manages the request for proposals (RfP). Not all ETRM solutions offer the same functionality. The elements included in the ‘packaging’ are subject to many factors, such as the size of a portfolio, the variety of commodities included in the portfolio, and the level of sophistication the client needs.
Second, they can help with the implementation of the solution. ETRM systems are not out-of-the-box solutions, and need an integration consultant whose’ services can cost substantial multiples of the software solution itself.
The implementation phase will also require substantial internal resources. Key people need to be heavily involved, and the process will require extensive time investment on their side.
Is there an ETRM for renewables?
There is no ETRM system exclusively suited for portfolios only comprising renewable energy assets. The concept of traditional ETRM systems was developed and advanced considering the needs of trading housing and utilities. These players have been managing an entirely different portfolio, out of which renewables are only a share, and have significantly different needs.
Added complexity derives from the fact that many ETRMs are based on systems developed to manage equities, bonds and currency positions which have very different risk characteristics compared to energy. Thus, every time a renewables business evolves and requirements change, there’s the risk of starting a new development cycle almost from scratch, with substantial additional cost.
That being said, there is an intense conversation across the ETRM and energy sales world about the need for an enterprise software tailored to renewables. For renewables players that do not need to manage the physical dispatch of power or navigate the time-sensitive intraday trading technicalities (which is performed by other systems, but position management comes from the ETRM), traditional ETRMs provide many features surplus to their requirements. Therefore, there’s a significant risk of paying excessively for features that would never be required by a pure renewables portfolio owner. This is the number one deal breaker.
More importantly, pure-play Independent Power Producers (IPPs) and renewable funds have particular requirements unique to their operating models, which cannot be met by traditional ETRM systems alone.
For example, it is practically impossible to have a growth strategy without the ability to quantify if a new project acquisition will be supporting the organisation’s revenue goals and if the new project will adhere to the set risk limits. This would need advanced quantitative metrics that traditional ETRMs lack.
In addition, to construct high-performing portfolios and take full advantage of diversification benefits, investors need to adopt a portfolio view and understand how the unique risks of renewables correlate – as in, measure the degree to which one risk moves with respect to another. Correlation benefits could provide natural risk hedging and increase secure revenues without increasing the risks. But only if an investor is able to identify the hidden value their portfolio has.
Likewise, renewable players need access to targeted pricing data and deal valuation tools to execute the more secure and revenue-driving PPAs. And when they do, they need to be able to run ‘What If’ scenarios to see how a new deal will impact their portfolio view and revenues.
Very importantly, as renewable investors are new to the realities of the merchant markets, they often require end-to-end guidance on building rock solid risk management processes. Similarly to how ETRM consultants offer guidance with ETRM integration processes, expert renewable risk managers can help businesses in setting up an energy risk policy, establishing best practice procedures to manage the unpredictability and volatility of electricity markets.
Pexapark’s Operating System for Renewables has been designed to specifically support the unique challenges of managing 100% renewables portfolios. Our enterprise-wide offering meets all the crucial day-to-day needs of renewables operators: from trading decisions, position keeping, portfolio optimisation, risk management and deal execution through to financial reporting and revenue management. It is an end-to-end solution for market players with ambitious growth strategies.
It is particularly suitable for funds and asset managers turning into Independent Power Producers (IPPs) that want to employ utility grade risk management due to their increasing exposure to market prices and associated risks.
Pexapark’s ultimate renewables portfolio management process, using the PexaOS
Step 1 – Identify Risks
As a first step, you need to identify the risk drivers of your portfolio. Every portfolio holds unique and evolving risks based on: technology, location, asset performance, marketing agreements, and sales contracts. Don’t forget what risk really means: drivers that will impact the uncertainty of your revenue.
Step 2 – Develop Strategy
The main goal of a strategy is to balance risks and desired revenue targets. A comprehensive strategy needs to incorporate some key elements:
- Risk capacity & appetite: determining minimum revenue to stay afloat (for example OpEx and debt repayments)
- Risk policy: The framework that will govern your risk strategy, including expected revenue analysed by a probabilistic approach and confidence level for each scenario. Other considerations are: risk mandate to onboard and offboard risk, evaluation criteria for hedging options and overall risk management process. For example, frequency of exposure review.
Risk management needs to be systematically defined. From setting the floor and the ceiling of the hedging ratio, to reviewing the horizon of how far forward you want to optimise. In this step, it’s very important to set target levels that trigger a review. For example, market conditions, production levels or breached risk limits. And then, you lay out hedging instruments that are approved and well understood to choose from.
Step 3 – Quantify Solutions
Once you know what hedging options are suited for your target results, the next step would be to conduct an optimisation analysis and test different expected outcomes to evaluate hedging options. You’d need to use the right quantitative tools to assess the best deal and the optimal PPA volume structure and hedging ratio. This way your selection will be backed by data-driven analysis to know that at that time, you genuinely opted for the best possible solution. In addition, you’d need to pursue a ‘What if analysis’ to stress-test the impact of the deal in your portfolio.
Step 4 – Execute Hedges
Once a decision is made on the best hedging instrument, you need to employ an optimal and cost-effective execution strategy. For example, if you have opted for a 10-year pay-as-produced PPA, you must sign the best price possible, and ensure that the contract terms and conditions do not affect the price. To this end, access to first-class PPA pricing data for the volume structure and tenor of choice and country insights will give you significant power in the negotiation room.
The same PPA pricing granularity applies to short-term hedges which can be significantly higher in value depending on the market conditions. For example, an EEG revenue optimisation PPA in Germany. Or, a short-term PPA to underpin the financing of a new plant instead of a long-term one. Yes, we have seen this happening already.
Step 5 – Actively Manage
Revenues and risks need to be actively monitored. Frequent reality checks of both short-term and long-term positions will ensure that revenue targets will be met. How? Through access to readily available data to trigger correction actions when limits are breached.
The Pexa OS provide enterprise software solutions to manage portfolio risk and revenue, guidance on risk management, quantitative analysis to compare hedging options, and data transparency to get the right price. Our solution is used by leading pure-play renewables IPPSs, funds and asset managers across Europe such as Encavis, Ardian and CEE Group.
Depending on individual needs, the PexaOS can be used as a substitute to ETRM, or in a complementary manner through integration with an ETRM software.
If you’d like to learn more about the PexaOS, reach out to Kashif Javaid at email@example.com to book your chat. Kash has more than 10 years’ experience in traditional ETRM systems, as well as enterprise solutions exclusively suited for renewables. He will be happy to answer more of your questions!
P.S He also thoroughly enjoys sharing tips for biking adventures in the UK, so feel free to surprise him with your enquiries!