Crude prices have plunged, Russia is in recession, experts are declaring shale investments dead in the water (too soon in my view) and government policies favouring renewables are under new scrutiny, as economics suddenly favour dirtier coal and gas.
Whether you blame technology, politics, softening demand or a mix of all three, these ructions are testament to the dynamic nature of energy markets and the huge risks that emerge in a period of profound volatility. The most important question for energy market participants however, is how can we minimise our exposure?
A quick recap of recent events
Technology in the form of hydraulic fracturing (fracking) and horizontal drilling has arguably made America the world’s pre-eminent oil producer, pulling up to 4m barrels a day from sources that were once called “unconventional”. So much oil is sloshing around that Congress has taken its first tentative steps toward removal of the crude export ban by allowing exports of certain condensates. Full-on exports of crude oil or natural gas haven’t happened yet, but exports of liquefied natural gas (LNG) will start this year. Increased trade in LNG will create a more global gas market, undermining Russia’s pipeline monopoly in Europe.
Softening demand for oil, especially from China, Japan and the euro area is another factor -- along with unexpected resilience in supply from countries in the midst of conflict like Libya and Iraq.
Following OPEC’s decision to not decrease supply, the imbalance between oversupply and under-demand has driven crude to sub $50 a barrel. While consumers may see these developments as superficially positive, so much rapid, unforeseeable change always creates worry in the markets. There is justifiable concern about how volatility will impact the flow of goods across supply chains, weaken certain shale investments and irritate commodity prices.
To a trader grappling with the practical complexities these changes create, macro analysis is only of general interest. What really matters is profitability, position visibility and the extent to which they have the freedom to make trading decisions quickly, with the most recent information.
How is transformation impacting energy traders?
Companies transacting in crude oil, liquid natural gas and refined products are just beginning to understand how the current period of transformation will affect how they source, supply and move assets. Some of the variables are known and ongoing, but the last six months have shown that there are always ‘unknown unknowns’ which can dramatically re-shape the market.
Generally speaking, the major risks impacting traders’ position visibility in 2015 can be grouped around three key concerns:
1. Price volatility (how can I predict where the market will go and how do I best hedge my position?)
2. Optimisation (what is the fastest and cheapest way to procure, market and move my product?)
3. Production (for producers: how do I match output to the peaks and valleys in price and demand?)
Price volatility is obviously the first concern – which in turn makes supply chain optimisation absolutely crucial. The ability to control the costs around physical transport allows liquids traders to protect their margins against changing regulation, shifts in supply and demand, seasonal pricing fluctuations and other factors.
That’s because wherever there is a choice of route or carrier, potential savings can be identified amongst the myriad of event-based fees, gathering fees, quality fees, pipeline tariffs, storage, detention and demurrage costs that affect the price of moving assets physically from A to B.
As supply lines stretch from partner to partner across international boundaries however, the flood of data from various sources, in different formats, over multiple platforms, presents a whole new set of management challenges.
Volatility: how to re-claim control
Being able to track the full commodity lifecycle for crude, LNG and refined products is absolutely essential if traders are going to profit in a period of market transformation. Too much information however can actually fog-up position visibility and slow down buy/sell decisions.
Given the accelerating pace of change we are seeing across refined products, crude oil, petrochemicals and LNG, the legacy systems traders have relied on for years are creaking under the strain of data overload, making them unreliable for providing insight and control – especially when assets are increasingly exposed to risks across an expanding global value chain.
At minimum, traders need to automate manual processes and data feeds with these capabilities:
- Manage scheduling and logistical data by visualising movement capture and actualisation of assets. This would ideally include real-time integration to a risk management engine that takes into account exposure, price and cost changes based on delivery, events, delays etc.
- Use Big Data to forecast price using historical trades and real-time price information. This will simplify estimation and
measurement of price, volume and cost for better trading decisions and reporting.
- Reduce market risks with more reliable insights. The technology exists to give traders a holistic portfolio view, with risk reporting and "what-if" scenario forecasting
Knowing exactly where the money is coming from – by region, state, field, basin or well – is essential to making smart plays in a fast-moving liquids marketplace. It requires industry-specific software with robust computing capability. This is now a baseline requirement for accurately projecting profit and loss across numerous lines of business.
The days of manual spreadsheets are over and traders will need to match the transformation in the market with their own transformation on the IT front.
According to Citi’s "Energy 2020 Out of America" report, U.S. production surpluses are expected to continue for at least two generations, despite declining crude prices. The impact of so fundamental a change to world oil production and consumption will continue to be felt for decades.
By contrast, EU imports of primary energy way exceed exports because of the shortfall between production and consumption. This continues to cause dependency on countries outside the EU.
Man will continue to endeavour to find ways to extract oil and gas however, the concept of “peak oil” may indeed disappear and “peak technology” also seems to be a long way off. Investing in automation and in a robust trading and risk management software today will enable energy market participants to confidently navigate market turmoil in the future.
Case study: Australia’s Caltex finds millions in savings
Caltex is a Global energy company which produces and markets refined products, gasoline and diesel across a network of terminals and retail outlets in Australia.
In 2013 the company implemented a commodity trading and risk management (CTRM) system and integrated it with its existing logistics software and risk management processes. The project was initiated to improve the way Caltex operated its supply chain and minimise operational risks.
Leveraging Allegro’s trading and risk management tools, coupled with IBM’s iLog for optimisation, Caltex was able to identify both operational efficiencies and financial alternatives during the marketing and scheduling process.
With better access to real-time data and market analysis, Caltex increased the profitability of its energy positions, creating supply chain efficiencies that led to total savings of $40 million.
David Bernal is Senior Solutions Consultant for Allegro Development. Prior to Allegro David received his MBA from University of Texas at Dallas and Bachelor of Science in computer science at Texas State University.
Allegro Development Corporation is a developer of software tools for energy trading and risk management.