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Join Jerry and Eszter as they discuss the factors that drive complexity in the energy industry, advice to market entrants, and more.
By
Eszter Pontenagel
Welcome to the first episode of Time2Talk, where we talk about interesting developments in the energy industry. In today's episode, join Jerry de Leeuw and Eszter Pontenagel as they discuss the trends they've observed in recent years and give valuable advice to new market participants in the energy industry.
Jerry de Leeuw is the founder of Entrima, which has been providing learning services for 19 years. After his studies in Economics, Jerry became a trader in the financial markets – a stock options trader. Consequently, he has been trading all these kinds of products in the capital markets, like stock option bonds, currencies in the FX markets, options future swaps, and some commodities futures. He has not traded electricity and gas.
Jerry entered the energy market in 2004. At the time, he was still working by himself, whereas now, he works at the company he founded. It took two years to get on board at the start. When he started the business 19 years ago, he expected to serve parties in the financial and capital markets.
By pure coincidence, two utilities and an energy exchange contacted him first, asking about energy markets. They were interested in Entrima's services due to the liberalization of the European energy markets, as the prices had started to fluctuate. With price risk not a factor, these companies were interested in learning and education.
Jerry de Leeuw's background is very valuable from an economic and financial perspective due to his education and experience, as well as conceptually, in terms of the mechanisms in energy markets. His knowledge about price formation, how exchanges work, and how over-the-counter (OTC) trading works are all relevant aspects to the commodities markets.
What makes these factors so complex is that one needs to understand physicality, the whole supply, and value chains from production to consumption.
Nowadays, with so many changes and new products coming to the markets, it is quite uncommon for Jerry to go a day without picking up new knowledge.
Today's energy markets are different from what they were five to seven years ago, which has to do with the energy transition and the fact that we now talk about hydrogen, ammonia, and battery storage of electricity.
Let's consider energy markets as complex social systems. The most significant change is that the complexity has increased, which can be a deterring factor for some, while for others, it's made energy more attractive and appealing as a commodity.
Complexity brings about numerous characteristics. Information cannot be derived in one place anymore. Market participants now need to consult multiple sources.
Furthermore, it brings uncertainty. All complex social systems are characterized by uncertainty. While risk can be quantified, uncertainty cannot.
Political factors also play a massive role in driving these changes. There are many unpredictable fireplaces these days, which we can not control as market participants.
Of course, we have to discuss the energy transition and influx of renewables. Bio-energy in terms of biomass, bio-fuels, bio-gas, and the carbon markets, for instance, trading carbon emissions rights, are all products that have recently evolved in European markets. Voluntary carbon markets have also expanded globally.
Considering all of these factors, flexibility has become a crucial concept in the energy markets. For instance, renewables are considered intermittent capacities: If the weather isn't windy or sunny, production is much lower.
The production levels in renewable capacities are incredibly volatile, meaning market participants must have an established backup facility. For instance, gas-fired power plants and hydro plants help participants cope with volatility. That flexibility is required.
For instance, electricity can be stored in a battery in case of surplus. In a deficit of production, stored electricity can be utilized. That is a form of flexibility, which is very important.
Another form of flexibility can be using overproduced electricity for electrolysis, using electricity to split water and create hydrogen, which can be stored. It can also be stored in the form of ammonia.
For Jerry, indicating flexibility is the most significant change in the current energy markets.
Increased market flexibility brings new risk measurements, which need to be considered. But risk has a flip side: Risk brings opportunity. The more opportunity there is in a market, the bigger the chances for traders are. If one wants to grab the opportunity, they need to expose themselves. This is where risk management comes in.
Market risk signifies the fact that prices can move adversely. There's counterparty risk and liquidity risk in financial markets. You need working capital to finance your trading activities. Market or asset liquidity discusses that specific properties are traded on the market very actively, while others hardly. There are also operational risk and weather risks. Each type of risk needs to be managed differently.
Suppose we focus on the fact that there is market risk and, therefore, an opportunity for prices to fluctuate in the preferred direction. In that case, there are market players that make use of these movements.
Many market players may not be asset-backed and act as pure trading houses, either energy trading firms or companies from the industry's commodity trading side. We see an influx of players from other commodities and take up energy trading as part of their portfolio.
There are so many factors that come into play here. But to keep it simple, some of these players have a background in the financial markets and come from either capital or FX markets. When those players come into energy, which are first and foremost physical markets, they need to be aware that they need to be able to make delivery when it comes to settlement of contracts or delivery vs. payment. That means they need a position that allows them to do that or involve other parties, which can help them fulfill their obligations.
In terms of compliance and regulations nowadays, market abuse regulations are immense. While in financial markets, market abuse regulations focus on protecting the investor, in energy markets, these regulations primarily focus on protecting the end consumer.
The awareness of the focus of regulations is already beneficial as a new entrant in power and gas trading.
The recent developments in the last one to two years have shown that compliance measures, both from a regulatory and a market player perspective, have become more and more stringent.
Time2Market provides market access services and opens the doors for new jurisdictions and new markets. We see the regulations that apply to each case. In case of non-compliance, a company can be sanctioned. However, in the case of market abuse, a criminal activity, and a financial crime, individuals, the company's employees, can end up in prison. This is taken to the extreme, but the awareness of the possibility is extremely valuable.
We advise new market players to refrain from applying their current strategies to energy one-to-one, as the markets are so conceptually different. Considering the regulatory perspective before taking on physical power and gas trading is crucial. A viable business case that combines the business functions with the control and support functions ensures that all bases are covered.
Control functions can include risk management, but they also include trade compliance, surveillance, and audit.
Focusing on your value proposition is excellent, but pay attention to the rest of your business case.
Looking into the crystal ball, we sense that the focus on processing data and using those data for decision-making is of utmost importance. The application of algorithmic trading is present and on the rise in the energy markets. While AI is quite a broad topic, applying algo-strategies has to make sense for the businesses that use them.
Furthermore, we see the energy transition continuing. However, we do not expect that the role of fossil fuels has come to an end. They're still present and are badly needed. The energy transition will gradually happen over a period of decades.
As a market participant, you must play chess and combine all aspects. This is where flexibility comes into play again.
Electricity can be produced in many ways and stored more than ever. In time, we can store even more.
There is a considerable need for intelligence and clever solutions carried out by people. We can talk about AI a lot, but people are a crucial piece of the puzzle for now. Their roles might shift somehow, but they cannot be replaced.
We at Time2Market are incredibly thankful to Jerry for his guest appearance on Time2Talk. Visit entrima.org to learn about the educational solutions they provide to market participants within and outside the energy industry.
If you would like to be a guest on Time2Talk or would like to recommend an expert for us to invite, please get in touch with us at communications@time2market.dk.
We deliver. You excel.
Disclaimer: Time2Market ApS is not responsible for the completeness, accuracy, and actuality of the information provided. This article is intended for informational purposes only and should not be considered business or legal advice.
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