With the collapse of Enron and fallout in the US Energy industry, the efficacy of risk management systems has received much attention. To avoid similar mishaps a new approach to implementing energy trading and risk management systems is needed.
Liberalization and increased competition have driven energy companies to create trading and risk management capabilities to trade power and gas. A key investment for these companies has been in Energy Trading and Risk Management (ETRM) systems to support these capabilities. Given the speed with which deregulation has occurred and the cost and risk of developing custom systems, energy companies have generally opted to invest in package-based ETRM solutions.
Figure 1. An example of ETRM Web services architecture
While ETRM systems initially enabled organizations to participate in the deregulated markets, organizations are now faced with a number of challenges. Firstly, those trading packages that were originally built for the financial markets are not designed to measure the asset risk profile, such as for generation, storage or a retail portfolio, resulting in some instances of substantial losses.
These problems are further compounded by the fact that the packages tend to be point solutions, giving rise to long and costly implementation projects to achieve end-to-end process integration. An inability to interact effectively with other trading and risk management systems across the enterprise results in sub-optimal decisions being taken on an enterprise-wide risk management level. These integration issues then tend to re-emerge as the energy companies reorganize, become involved in mergers and acquisitions or are impacted by further regulatory/deregulatory activity.
Consequently, energy companies need to undertake a number of initiatives to sustain competitive advantage. To improve usability and maximize the potential of the traders in the new markets, their desktops needs to be designed around them. User Centered Design (UCD) techniques need to be used when creating the trader’s desktop environment. UCD of trading desks helps traders understand their books at a glance, see trends more quickly, execute decisions faster and make fewer mistakes. Better decision-making in turn supports increased profit and lowered risk. At Sapient, through its application of UCD in recent projects, it has enabled traders to achieve a five-fold increase in productivity.
Because understanding real user work processes, work practices and information requirements can be complex, it is imperative that specialized techniques and methods are applied to all aspects of evaluation and design. Sapient employs a team of experienced and qualified specialists to do this comprising psychologists, ergonomists and anthropologists. Its user research teams are trained in ethnographic research and behavioural analytic techniques. Using methods such as contextual enquiry, video analysis, target audience description, cognitive task analysis and experience modelling they create deep and detailed understandings of the information architecture required in an application to deliver trading systems that maximally support trader efficiency.
Energy companies also need to examine the benefits and potential of emerging open technologies, such as web services, as well as Enterprise Application Integration (EAI), to reduce integration costs and obviate future integration problems. Web services enable key components to be available àƒ la carte, reducing upfront investments. They facilitate plug-and-play for services, reduce integration costs, provide greater flexibility in products and services and eliminate value-added costs from implementing systems with costly but superfluous features. The results are greater efficiency, with reduced costs and timescales for implementation.
The key to improving profitability for energy companies, while reducing associated risk, is that the systems provide information to enable efficient assessment of overall asset risk profile in the context of dynamic market prices. The assets need to be modelled in the system and the results integrated into the portfolio. This means that the ETRM systems need to be linked to real-time generation and load positions driven by the efficient operation of their assets. Crucially, this approach needs to be extended throughout the forward curve and not just for the scheduling activity, as this is where the foundations of a robust, high performance portfolio are built.
As a direct result of Enron, shareholders, credit rating agencies and analysts are placing greater pressure on energy companies to have sound credit risk management principles and processes in place. It took some energy companies days to calculate their exposure to Enron. Due to its fundamental price drivers, measuring risk in energy is different to measuring risk in the money markets and many ex-utilities have little experience of credit risk management. Credit risk management has simply not been a part of an energy company’s core competence.
As credit risk management in power and gas is relatively new, the techniques and technologies for managing risk are constantly evolving. Within many energy companies, a number of largely unintegrated systems, tools, databases and processes have been implemented to trade and manage their risks. Currently, no one system can comprehensively capture the trades and measure the risks across all instruments and assets.
Figure 2. The ‘internal market’ illustration
Key to achieving an enterprise view of credit risk is integrating the credit exposures across the organization. Thus a method is required to integrate these disparate systems together into a scalable, homogeneous, enterprise-wide information architecture. A framework needs to be designed to get the best out of existing IT systems, and deliver timely and consistent information across all levels of the enterprise. This uses UCD techniques together with web services to integrate the information across the organization.
A variety of cost reduction benefits arise from such an approach. Automated communication between tightly integrated systems eliminates loss of revenue caused by manual error. Systems designed to effectively support business needs require less ongoing maintenance, less enhancements, and reduced training overhead as users do not have to relearn the interface when systems are replaced. Clearly, less disparate systems to maintain result in lower ongoing IT costs.
Robust, fault-tolerant architecture provides 24/7 availability, removing trading losses due to downtime. Moreover, an efficient enterprise-wide architecture supports seamless replacement of system components without affecting user experience, or best business process. Internationalization and localization components built into the framework allow business applications to be rolled out to new geographies rapidly and inexpensively.
There are also benefits that give rise to revenue enhancement opportunities. Consistent enterprise level information enables an accurate assessment of enterprise opportunity cost and risk. The platform, provided by this portal, provides the scalability to rapidly move into new markets, developing new products and more efficient hedging strategies. Data can be accessed quickly through a single system, allowing the business to respond quicker, and hence trade more efficiently. Operators have fewer spreadsheets to maintain, freeing up their time for added-value activities. Finally, personalization features could allow users faster and more flexible access to the information they need, thereby enhancing their ability to operate effectively.
Vertically integrated energy companies can also introduce an ‘internal market’ that enables business units to interact effectively across the organization. This organizational structure will encourage business units to take more market-oriented decisions. The internal market upgrades rigid transfer pricing structures with dynamic, market price based arrangements.
The creation of an internal market enables business units to realize higher profitability through more market aware decision making while reducing risks through the ability to react more quickly and accurately to major market shocks. Units can avoid giving the bid/offer spread away to the external market. This also allows business units and traders to operate in local currency and for currency risk to be simply consolidated centrally.
In addition, it enables the enterprise as a whole to undertake the investment/divestment cycle more effectively. Ultimately, the energy company then has the opportunity to leverage this capability by making it available to other companies. Technology to support the internal market can be provided by online exchange software such as that developed by Sapient for HoustonStreet.
Energy companies have implemented their first generation ETRM systems in the deregulating markets. Due to shortcomings in the available packages, architectures and subsequent changes in the business environment, these systems are no longer adequate to the needs of these companies. In order to maintain their competitive position in the marketplace, they need to review these systems against their current and future business requirements and create a plan for ensuring their systems can support their business goals and objectives.
To address all of these issues in a structured way, it is necessary to conduct a blueprint study to create a vision and a roadmap for achieving it. Sapient has recently completed such an exercise for the IT architecture and systems of a major European energy company.
The objective of the blueprint was consensus across the company on the following:
- A programme plan to define the way forward
- Agreed business selection criteria relating to business strategy and objectives
- Prioritized requirements in line with business criteria and processes
- A future state model
- Programme costs
The company’s IT systems were not adequately supporting their business needs, or perceived future requirements. For example, the VAR calculation engine in the power trading system was deemed to be inadequate; front office personnel had difficulty accessing and working with the information they needed to support decision-making and mid-office reporting is inadequately supported.
The outcomes of the blueprint included:
- Alignment of key stakeholders
- Prioritization of requirements according to business criteria and processes
- Clear and agreed costs
- Understanding of business impact
- Focus on technical areas critical to business
- An innovative portal-based solution that can be leveraged elsewhere within the energy company.