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, such as metals, agriculture and ‘even cotton. The differences lie in the scope of traded commodities.
Who uses ETRM system?
ETRM systems are 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 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.
As depicted in the table below, ETRM systems link each step of the trading cycle, connecting business processes conducted across the front, middle and back offices.
Is there an ETRM for renewables?
Renewables nowadays no longer operate exclusively under fixed long-term price guarantees backed by the government, such as Feed-in-Tariffs (FiTs). Business models have evolved, and there’s greater routes-to-market optionality. Energy sales management is now embedded to the DNA of the renewables industry, and players are learning to treat the electrons from clean energy projects as commodities.
To this end, some renewables players may explore how an ETRM system can help them with their sales decisions, and the ongoing management of their hedges. However, there is no ETRM system exclusively suited for portfolios only comprising renewable energy assets.
The concept of traditional ETRM systems was developed and advanced putting to the epicentre the needs and use cases of trading houses and utilities. These players have been managing an entirely different portfolio, out of which renewables are only a share, and have significantly different needs. Many ETRMs are engineered to manage equities, bonds and currency positions which have very different risk characteristics compared to renewable energy.
Shortcomings of ETRM systems for renewables business models
That being said, there is an intense conversation about the need for an enterprise software tailored to renewables. However, 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.
The Holy Trinity of renewables risk are price, capture and volume. Capture risk – the effect of the cannibalization phenomenon in the captured price of the asset depending on when it’s produced – and volume risk – since standalone renewables are inherently dependent on weather – are almost exclusively connoted with wind and solar assets. These risk will come into play in many phases of the investment cycle.
- Traditional ETRMs provide many features surplus to renewables business models. Therefore, there’s a significant risk of paying excessively for features that are not adding value (such as managing the physical dispatch or the time-sensitive intraday trading nuances). This is the number one deal breaker.
- Revenue logics for renewables have become significantly complicated and are not straight forward to understand from an ETRM system. PPAs are heavily customised contracts and revenue monitoring requires advanced data integration, valuation models and calculation logics. If an ETRM is tailor-made to understand a specific PPA, costly customisation would be required when a new deal is added. The same applies to revenue from subsidised assets, as support schemes no longer have the simplicity of a Feed-in Tariffs (FiT), and have higher merchant exposure and more complicated rules.
- A clear data-driven support system is needed to optimise investment decision processes. An emerging trend we are seeing is the need to quantify if a new project acquisition with existing commercial arrangements will be supporting the organisation’s risk-adjusted returns expectations and its impact on the overall portfolio risk exposure. This use case would need advanced quantitative metrics that traditional ETRMs lack, as they were never meant to be used for investment decisions.
- In order to benefit from diversification effects, investors are looking to adopt a portfolio view and understand how risks correlate – i.e., measure the degree to which one risk moves with respect to another. Correlation benefits could provide natural risk hedging and increase revenue certainty without onboarding more risk. But only if such hidden value is identified.
- To manage market risks, renewable players seek targeted deal valuation tools to execute risk-adjusted PPAs and hedges. Particular hedges, such as Baseload PPAs, need significant post-deal management, but a lot of forethought can be conducted in the pre-deal phase through ‘What if’ scenarios to stress-test different conditions and be prepared of the required actions if volume, price or capture risks exceed limits.
The PexaOS
Pexapark’s Operating System for Renewables is a plug & play software suite which has been designed to manage exclusively 100% renewables portfolios straight from the beginning, without the need for time-consuming customisation.
Our enterprise-wide offering meets all the crucial day-to-day needs of renewables operators, covering multiple phases of the overall journey including the pre-investment phase when acquiring new assets, pre-deal support when strategising a hedge, and post-deal management of revenue and risks of the overall portfolio.
Pexapark’s ultimate software-driven renewables investment and portfolio management process, using the PexaOS
Step 1 – Showcase the right infrastructure for ample fundraising
Renewables are a sizing game. To provide the required funds to execute near-term growth strategies, investors are increasingly asking to see that the right risk management is in place. Nowadays, renewables investors crave returns higher than a bond yield, and archaic revenue models are unable to provide that. High revenue strategies need innovation, agility and adaptability to market conditions.
Because of their inherent risk-adverse mindset, limited partners prefer entities with a well-managed end-to-end approach comprising elements such as risk-adjusted hedging strategy, monitoring of energy risks, ability to react fast to short-term opportunities, and software-driven revenue and risk reporting replacing old fashioned tools such as Excel.
Step 2 – Build a strategic portfolio
Once the necessary capital is in place, the expectation is to deploy it. M&A activity needs to be strategic, and not merely opportunistic. Evaluating potential acquisitions through credible tools and insights easily understood by key stakeholders (i.e., credit committee, board and lenders) can be a game changer for identifying the risks and benefits of a new project addition.
Modelling assets up for sale can reveal which projects can add the most value to a portfolio, and inform the bidding approach. Respectively, it can be of help for developers who are looking to understand what assets to retain based on their portfolio risk DNA.
Every portfolio holds unique and evolving risks based on technology, location, asset performance, marketing agreements, and sales contracts. Risk awareness will allow the adoption of a portfolio view, which will reveal the hidden value behind risk diversification effects and correlations in a way that can inform significant decisions around hedging and financing of the assets.
Don’t forget what risk really means: drivers that will impact the uncertainty of revenue. New acquisitions need to be stress-tested to allow for a smooth portfolio ecosystem even when market conditions for a specific asset change unexpectedly.
Step 3 – Optimise portfolio cashflows through a risk-adjusted hedging strategy
The main goal of a comprehensive hedging strategy is to balance risks and desired revenue targets, based on the defined risk capacity, which determines the minimum revenue to stay afloat and risk policy depending on the appetite.
Once the foundations have been set, the risk and revenue profile of each hedging decision needs to be clearly understood and tested against set limits. To adhere to the portfolio view principles, a ‘What if analysis’ is needed to stress-test the impact of the deal in the overall portfolio and have a preliminary view of how the deal will hold up against different scenarios, such as price shocks or repressed volume production.
The final decision needs to be based on the use of the right quantitative tools to assess the best deal and the optimal PPA volume structure and hedging ratio. This way, the selection will be backed by data-driven analysis to know that at that time, the decision maker opted for the best possible solution.
Step 4 – Actively manage revenue and risk exposure
Renewables portfolios nowadays comprise assets operated under a dazzling array of different revenue models, most of the times with one common element: exposure to price, volume, and capture risk. Monitoring asset revenue performance and risk becomes more complex, as each PPA or subsidy scheme is governed by different sets of rules.
Frequent (contrary to merely quarterly) portfolio and asset-specific reality checks of both short-term and long-term positions will ensure that revenue targets will be met. Professionalisation of revenue and risk reports through access to all-in-one-place data updated in real time, where all the hedges are monitored at any time, will allow for timely trigger correction actions when risk limits are breached.
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The PexaOS provides enterprise software solutions to manage portfolio risk and revenue and allow for portfolio-based quantitative analysis and deal stress testing.
Our solution is used by leading pure-play renewables IPPs, Funds and Asset Managers across Europe such as Encavis, Ardian and CEE Group, Low Carbon, Octopus Energy Generation, EuroWind, AIP Management, Taaleri, Glennmont Partners and Galileo Green Energy.
Depending on individual needs, the PexaOS can be used in a complementary manner through integration with an ETRM software, if such a system is needed.
If you’d like to learn more about the PexaOS, book a coffee chat with Tom Forrest (tomforrest@pexapark.com) and Carlotta Carboni (carlottacarboni@pexapark.com).
