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As the U.S. government inches forward on Federal climate change information, the more apparent it is that corporations must start looking seriously at their IT budgets to measure, track and monitor their carbon (and other emissions) footprints. A compliance driven environmental market will sustain the need for more environmental software applications. Indeed, the software industry is already creating new software applications in anticipation of these impending changes.
Measuring the Carbon Footprint
Outside of the energy industry, which has had to comply with environmental laws since 1993 in Southern California and 1995 under the Federal acid rain program, most companies have not been required to report their emissions footprint. Because of this lack of data sets, there is a huge market opportunity for software applications and consultants to offer services to Fortune 1000 companies in the United States. Large consulting firms like CH2M Hill and ICF consulting, as well as many software companies have stepped into this void. These software companies include IHS, Locus Technology, Zero Footprint, Vision Monitor, Sungard Energy Solutions and Navita to name a few.
Green Trading Takes Off
Trading software application markets can only occur when those markets have reached a level of maturity where trading is active. That is about to occur in the United States and has already occurred in the EU Emissions Trading Scheme. The European Union (EU) market is a fairly simple power market compared to the larger scale U.S. market and its massive carbon footprint of six billion tons. A U.S. cap and trade program will be industry-wide and regulatory coverage is expected to be 80 percent of U.S. business. That means moving beyond the energy patch, and looking at industrial processes, transportation, buildings and possibly agriculture. This means Fortune 1000 companies must comply with emerging environmental laws across their supply chain.
The present environmental financial markets are being expanded from their existing infrastructure of 38 markets presently traded to a deeper economy wide program that will create many more markets in coming year. The U.S. carbon footprint is six billion tonnes, and if you add in Canada with its 1.3 billion tonnes, the North American carbon market is over 25 percent of global greenhouse emissions. There will also be North American linkages to the EU Emissions Trading Scheme and other regions active in emissions trading in Asia and Latin America. This trend indicates that the resulting software systems will need to be both robust and modular. Since many of these applications will reside with the energy trading desk, we see environmental trading as an extension of energy trading to a large degree.
A Clash of Two Software Markets?
In our book on ETRM software1, we discussed the coming clash of two software markets as vendors that produce emissions monitoring software and those that produce ETRM software both attempt to respond to these requirements. The environmental compliance software market is still a relatively immature category with numerous small vendors. Additionally, while many offer the ability to measure, monitor, forecast and report emissions, in reality they lack the true trading and risk management capabilities that are needed in today's commodity markets. More importantly, they lack the ability and the experience of integrating with other systems such as generation dispatch, generation optimization and energy commodities trading, scheduling and risk management systems. On the other hand, while the ETRM vendors may often lack emissions trading or tracking and risk management-specific functionality, they have both the framework and configurability to add this functionality in a relatively short timeframe. However, they fall very short when it comes to measuring, monitoring, forecasting and reporting emissions. Given the potential short fall of functionality of both groups of vendors, one can expect alliances and partnerships to develop initially between the players in both software markets.
A further issue to consider with these software vendors is whether their software is targeted at the physical or financial side of the energy business. This is a key consideration for a utility with generation assets. Many ETRM vendors originated in serving the financial markets. As a result already lack the ability to truly model the complex behavior of generation facilities (such as mixed fuels, variable efficiency rates, etc.) or retail customers correctly. This behavior is made more complex by the addition of emissions. What utilities dealing with EU ETS and similar schemes require is a trading and risk system that was designed to cater for the physical specifics and complexity of their business. Despite that, the experience of many utilities and trading firms in Europe has been to utilize their existing ETRM software to trade emissions.
Our recent “commodities study”2 also highlights just how widespread the trading of emissions is today—and it isn't simply a European phenomena either. Emissions were the third most actively traded group of commodities amongst the North American respondents to the study with just over a quarter of all respondents actively trading emissions there as compared to 60 percent of all European respondents. What this demonstrates is that either the existing ETRM software solution employed is actively being used to support emissions trading already today or, spreadsheets or other solutions are being utilized. What remains unclear from any past UtiliPoint study is how widespread the use of emissions monitoring software is and what the nature of the linkage between the monitoring and trading side actually is. Indeed, this will be an area of investigation in our new study (see below).
Physical Commodities Traded by the Commodities Study Respondents
Summary
As the United States now appears set to gear up for further regulations around emissions, it seems that trading firms are a step ahead in some respects in seeing the opportunity to profit from emissions trading. But we expect emissions trading to grow and as they do so so will the need for emissions trading software. However, the consequences do not stop there as many businesses need to monitor and report their emissions and to utilize emissions credits to manage their footprint effectively. This set of business imperatives should drive the emissions software markets and two types of software vendors (trading and monitoring) will start to potentially morph and merge. Our new study is designed to analyze the implications of this and to review the emissions software market and solution landscape generally to help utilities and energy companies better understand the lay of the land.
1
Trend in Energy Trading, Transaction & Risk Management Software—A Primer, Booksurge, 2006 by Dr. GM Vasey and Andrew Bruce
2 Changes in Commodity Markets—Impacts on Traders and Software, UtiliPoint Report, 2009
UtiliPoint International, Inc. and Global Change Associates have undertaken a sponsored environmental software study called “Emissions Trading and Monitoring Software Study.” The research will be conducted during the next three months with delivery of the report in May 2009. For further information contact with Gary M. Vasey, Ph.D. (gvasey@utilipoint.com">gvasey@utilipoint.com) or Peter C. Fusaro (peterfusaro@global-change.com).
What is now happening is that the spread between WTI and Brent has widened to over $10 per barrel last month when it Brent usually trades $1.50 to $2.50 per barrel premium over WTI. Today that spread is over $7 dollars per barrel.
Basically, WTI becomes detached from world oil markets and becomes an ineffective marker for hedging world oil futures. Brent has become more internationalized in oil production pricing outside the US. Rising crude oil stocks, which are stored in tanks at Cushing,are oversupplied depressing WTI prices in both the physical and paper markets. NYMEX needs to fix the problem but looks at open interest, which is strong, and ignores the reality of the world oil market. The fix is not difficult it involves delivery of WTI like crudes, like LLS, into the Guld Coast. That fix would bring in the spread with Brent. That probably won't happen but oil traders at banks and hedge funds are grumbling.
Peter Fusaro
The US “recession” is also spreading to impact various European countries most notably the UK. It will continue to spread into various European economies in my view. At the core of the issue though is the US Dollar and while the European Central Bank remains focused on inflationary fears and the US Federal Reserve on economic growth, it would seem that the US Dollar will continue its downward spiral thus impacting commodity prices.
Many commentators see danger in the high price of commodities right now. Hot money has come in to the markets in a large way and to many, prices are unsustainable against the economic backdrop. And yet a lot of the money in commodities is a hedge against inflation and a switch from equities to commodities. As we have said many times in these pages – things have changed in commodity markets and that’s what makes it so difficult to assess now.
In truth, if one considers the fundamentals, nothing much has yet changed. In a situation of supply/demand tightness one can certainly expect volatility and an upward pressure on prices. As the US Dollar declines there is a further impetus for rising prices. On the other hand rising commodity prices are now beginning to raise the inflation fear and sooner or later, one must expect a demand response?
In considering all the sides of this complex argument, my view, for what it is worth, is that commodities are still, on balance, the best place to be invested. Given that and an expectation of volatility, commodities, at least in the short-term, ought to continue to perform. But there is increasing risk and that risk is that the consensus view will shift to the idea that commodities are overpriced and in that event there is room for a significant correction or corrections.
"Integration of the myriad of applications used to support energy trading activities is a well known problem for all firms that trade energy," reports Dr. Gary M. Vasey, General Manager, UtiliPoint Europe. "This study sought to benchmark how European energy traders tackle this issue and it consequently provides a great deal of new data and insights into the issue."
"UtiliPoint has learned that primary research crossing country boundaries in Europe is a powerful tool for utilities and service providers alike," said Jon T. Brock, President & COO of UtiliPoint International. "This research is no exception as it provides insight into how integration efforts are succeeding or failing in Europe for utilities and companies that trade energy," added Brock.
The major conclusion of the study is that ETRM related software markets appear to be quite immature with a high number of custom solutions being used as opposed to vendor-based solutions and indications of some confusion in the marketplace as to what software is available. While not all respondents replied to all questions, meaning that there is only limited data for some application areas, the data suggests that European energy traders appear unaware of many of the mainstream vendor-based applications that are available to them.
The research study was kindly sponsored by SunGard Energy Solutions.
"This study confirms our belief that many energy companies prefer custom built models and best of breed applications to address their energy transaction needs," says Roger Donovan, Managing Director - Europe, SunGard Energy Solutions. "SunGard's product strategy provides an integrated suite of solutions and also supports customer preference by enabling heterogeneous systems to interoperate. This helps our customers to flexibly address business requirements across their energy value chains today and for the future."
The report is available for purchase from UtiliPoint at http://www.utilipoint.com/rci/details.asp?ProductID=1164
About UtiliPoint International, Inc.
UtiliPoint is a leader in providing analysis and consulting services to the energy and utility industry. Our 75-year history and over 500 clients worldwide have led us to currently operate as an energy and utility consulting and issues analysis firm. Our staff is comprised of leading utility and energy experts with diverse backgrounds in utility generation, transmission & distribution, retail markets, mergers and acquisitions, new technologies, investment capital, information technology, outsourcing, renewable energy, regulatory affairs, and international issues.
"Blogs are having an increasing impact on information gathering and corporate communications," reports Dr. Gary M. Vasey, General Manager, UtiliPoint Europe. "This study sought to see what influence blogs are having on the energy and utilities space and it conclusively demonstrates that blogs have a growing importance there."
UtiliPoint maintains its own blog sites including the UtiliPoint Europe blog (http://www.utilipointeuropeblog.com/) and the ETRM Community (www.etrmcommunity.com/site/modules/wordpress/) which have seen tremendous growth in visitors over the last few months.
UtiliPoint can also offer services relating to blog creation and blog marketing in energy and utilities.
The report is available for purchase from UtiliPoint at http://www.utilipoint.com/rci/details.asp?ProductID=1165.
About UtiliPoint International, Inc.
UtiliPoint is a leader in providing research and consulting services to the utility and energy industries. Our 75-year history and over 100 clients worldwide have led us to currently operate as a utility and energy consulting and issues analysis firm. Our staff is comprised of leading experts with diverse backgrounds in utility generation, transmission & distribution, retail markets, mergers and acquisitions, new technologies, venture capital, information technology, outsourcing, customer service, advanced metering, meter data management, renewable energy, regulatory affairs, and international issues. Learn more at http://www.utilipoint.com/.
“The popularity of our first book on ETRM software has convinced us that a book on implementing ETRM software was both long overdue and demanded by the marketplace,“ said Dr. Vasey. “The new book draws upon UtiliPoint’s extensive research and expertise in this area to deliver an experiential guide to selecting and implementing ETRM software.“
The new book focuses in on selecting and implementing ETRM software and includes UtiliPoint’s research in this area as well as the combined expertise of its two principal authors. Additionally, it draws upon the expertise of the book‘s sponsors, reputable and leading consulting and sevices firms, to present a compehensive primer on the topic.
"Given the costs and risks inherant with deploying a new ETRM system, its difficult to overestate the importance of understanding the acquisition and implemention process," according to Mr. Reames. "We believe this book will be a valuable tool for the staff and stakeholders of any company seeking to improve its ability to compete in the wholesale energy trading marketplace through the acquisistion and implementation of a modern ETRM system."
"We are very pleased to have had the support and input of our sponsors on this project, Deloitte & Touche LLP, Sapient and The Structure Group," continued Mr. Reames. "As organizations that involved daily in helping companies on-board new ETRM systems, their insights and experiences offered in this book will prove invaluable for the reader." Specific contributions by these sponsors include "Implementation Key Success Factors" provided by Mr. Randall Orbon, VP of Trading and Risk Management for Sapient; "The Importance of Testing" by Mr. Roger Schaffland, Energy & Resources Director of Deloitte & Touche LLP; and "Managing Upgrades – Mitigating the Risks of Upgrading Your ETRM Systems" by Angela Ryan, Director and Baris Ertan, Senior Manager of The Structure Group.
About UtiliPoint® International, Inc.
UtiliPoint is a leader in providing analysis and consulting services to the energy and utility industry. Our 75-year history and over 500 clients worldwide have led us to currently operate as an energy and utility consulting and issues analysis firm. Our staff is comprised of leading utility and energy experts with diverse backgrounds in utility generation, transmission & distribution, retail markets, mergers and acquisitions, new technologies, investment capital, information technology, outsourcing, renewable energy, regulatory affairs, and international issues.
On the fundamental side the first thing to consider is supply/demand tightness. On the one hand OPEC suggests that markets are well supplied but others believe that it is not. In fact, oil markets are very tight. According to the BP World Energy Review global production in 2006 was 81,663 thousand bpd and global consumption was 83,719 thousand bpd but global crude stocks were well above their five-year average. According to the EIA, in the first and second quarters of 2007, global oil supply and demand was as follows – Q1: supply 84.15mbpd, demand 85.58mbpd, Q2 – supply 84.47mbpd, demand 84.47mbpd. Currently, the IEA says that OPEC members are not pumping their full quotas. It identified 2.5 million barrels a day of spare capacity among 10 OPEC nations; roughly half of it is in Saudi Arabia. So looking at the numbers, the supply/demand picture is extremely tight although robust oil stocks are easing the situation. But, and this is a big big but, all oil isn’t the same and there are various types of crude oil that have to be factored in to this picture too. Light sweet crude supply is declining and gradually being replaced by heavy sour crude. All this seems to suggest that we have a real problem with supply and demand.
Let’s add in to that then refining capacity. With increasing amounts of heavy sour crude coming to market, looking simply at refining capacity isn’t really sufficient but to keep it quite simple let us simply understand that according to BP, refining capacity globally grew in 2006 for the first time since 2001 and, according to Lehman Brothers analysis, it is set to expand further such that by the beginning of the next decade, there will be overcapacity. On the other hand, almost all of that new capacity will be built outside of the USA and North American refinery utilization is also very high. In fact, refiners have been putting off unnecessary maintenance because it is so profitable to refine crude oil right now. The big picture is that refinery capacity is stretched at the moment and utilization rates are very high.
Under such a scenario, any event that appears to threaten supply or demand is bound to have an over exaggerated impact on price formation and there are plenty to consider including Iraq, Iran, events in Venezuela, Mexico, Nigeria and so on. Then there is the weather. Weather events can impact supply by knocking out production as in a Hurricane in the Gulf. Then there are unforeseen events, and with refineries delaying unnecessary maintenance the risk factors are simply increasing.
Who can do anything about any of this right now? Only OPEC but OPEC seems somewhat unwilling to officially increase quotas pointing fingers at other factors instead. One has to ask then if, in fact, OPEC is able to increase supply at all but according to the IEA they are. Nonetheless, and at the risk of running counter to my own past stance, it does appear a bit suspicious.
Let’s also just revisit the majors – another pet topic of mine these days. The majors continue to spend insufficient capital on E&P and instead, return money to shareholders and buy back stock. Again, one can take two views on this – either its good business to reward shareholders when profits are high and the cost to find has risen so much (and cynically, that this keeps the prospects of more oil coming to market lower and hence company profits higher) or there simply isn’t anything much left to find and so the majors are busy diversifying themselves for a non-oil future? Of course, the reality is that it is the smaller E&P and national oil companies that are doing the heavy lifting at the moment and spending the money to find new reserves. And they are finding new reserves and more importantly – new plays. A case in point is the new mega field discovery offshore Brazil which s both a new find and a new play with lots of promise.
The US Dollar factors in strongly too. As the Dollar has declined in value then the oil price has risen. At the time of writing here in the Czech Republic $5000 which just two-months ago was worth just slightly more than 100,000 Czech Crowns is now fetching only 89,000 Czech Crowns.
Higher prices have a demand response. That demand response has been slow coming but it appears that there is a consensus view developing that it is there as the IEA reduce their demand projections. When one looks at the global macro economics, there is a real danger arising of recession – especially in the US – and that ill impact future demand southwards too.
Finally, and there isn’t the space to cover everything here, there is the policy of China and India who are somewhat aggressively investing in energy including oil across the globe – even Canada’s oil sands. In effect, China and India are removing supply from the market through their activities.
Which leads us to the next set of factors – that of ‘speculation.’ Over the last 2-3 years not only has much more money entered markets but and more importantly, the cost and difficulty of trading energy markets has fallen dramatically. There are all kinds of new, liquid, exchange-based instruments to trade that simply were not there 5-years ago. Anyone can trade oil now through ETF’s and other vehicles. All of the banks and around 170 commodity hedge funds and an unknown number of proprietary trading firms are now involved in energy markets on an intra-day basis. And why shouldn’t they be?
What seems to get forgotten about these new traders however is that (at least in theory) they don’t care which way prices are moving because they can make money on up or down markets. The fact is of course is that many are actually ‘long bias’. What impact do they have on price formation? Well, opinions differ wildly which is why this last two weeks has been interesting.
A week or so ago, Lehman Brother’s pointed to the large open interest in oil markets suggesting that hot money was betting on $100 oil by the end of the month (effectively anyway). The interest was in options with an expiration date of last Friday. At the time, prices were moving inexorably towards the magic $100/bbl. However, a few days later, the IEA released its World Oil Outlook in which it stated that high prices had prompted it to cut its demand projections. Prices fell on the news. Certainly, the price moved back upwards again but $100 oil was not reached by Friday. Of course, there were other price signals during the period too. Fundamentals beat speculation last week and it always eventually will. Speculators speculate in both directions and are often simply playing the volatility. They are good for markets and increase liquidity and the number of trading counterparties available. They most certainly are not all powerful when it comes to directing price but admittedly they can help shape market sentiment and at any point in time, help to build a momentum and premium in prices (in either direction).
Meanwhile, Goldman Sachs stated last week that oil prices had traded in a range bound around $95/bbl in the past two weeks with a few short-lived attempts to rise to the $100/bbl mark and to fall below $90/bbl. Despite the limited change in levels, price volatility has been extremely high with average daily price moves of over $2.00/bbl, they said. They also said that “they are currently maintaining a $70/bbl assumption on 5-year forward WTI prices, but there is mounting evidence that the required levels could be higher.” They also pointed out that long-dated oil prices have increased considerably in recent weeks driving the rally in spot prices.
So what am I driving at here? Well, I didn’t suddenly become a peak oil fan and I have dealt with that fairy story on several other occasions. While it might be true to say that oil supply momentarily peaked, it was due to a lack of investment, an unreal sense of well being and a demand side surprise. Now, after 2-3 years of extra spending on E&P, there is at least one announcement of a new discovery everyday and some of them are very sizable. No, what I am suggesting is that we are stuck right now in a finite period of supply/demand tightness that means that prices will continue to be volatile and oil will continue to attract ‘speculators’ – though I prefer to call them ‘investors’.
In reality, as one polls the various views, analyses and opinions there is a rising consensus that prices are now too high and, at some point, there will be a correction. But that correction will take us to a price somewhere in the $75/bbl arena. This level will continue to support the marginal cost of alternative sources of oil and the increased finding cost of conventional oil and that will help insure that new supplies continue to come to market. But, this is only the start of high energy prices for there is yet no fossil fuel replacement and looking at the IEA forecasts, the future looks like supply tightness on and off for the rest of my – and your, life.
Article published as a European IssueAlert from UtiliPoint International, Inc. This newsletter is free and you can subscribe at http://www.utilipoint.com/european/subscribe.asp
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“Energy Hedge has proven to be a popular addition to our product suite,” reports Dr. Gary M. Vasey, Co-Principal, EHFC. “However, we see an increasing trend to making information freely available via the internet and have decided to follow that trend. Given the large numbers of people who request a free sample every issue, we believe this will benefit both EHFC LLC and our growing community.”
“ The New York Times online went free this month and so do we. The Internet has proven to be an advertiser supported medium rather than subscription based. We feel with a freely available newsletter the subscriber base will grow exponentially,” said Peter Fusaro, co-principal of the EHFC.
In January 2008, Energy Hedge will now become a monthly publication with increased content in its free subscription guise. Additionally, it will feature a greater variety of third-party content along with its already popular standing features such as Fusaro’s Focus and Vasey’s Vista. The site also offers the EHFC Directory of Energy Hedge Funds is available by subscription only at the Energy Hedge Fund Center (www.energyhedgefunds.com). Peter C. Fusaro and Dr. Gary M. Vasey are also the co-authors of ‘Energy and Environmental Hedge Funds – The New Investment Paradigm’ published by John Wiley (2006).
About the Energy Hedge Fund Center LLC
The Energy Hedge Fund Center LLC offers analysis and consulting services in energy and environment. It also provides the only online community tracking alternative investments in energy and environment at www.energyhedgefunds.com which offers the directory of energy hedge funds as a subscription service and the popular online newsletter Energy Hedge. For more details contact Dr. Vasey at 420774302950 or gary@energyhedgefunds.com.
About Energy Hedge
Energy Hedge is the official newsletter of the Energy Hedge Fund Center, LLC and is edited by Mr. Peter C. Fusaro and Dr. Gary M. Vasey. Energy Hedge is issued monthly electronically and contains commentary and insights on energy and alternative energy investing and trading including a number of standard columns and features.
