European energy companies anticipate at least the partial automation of trading by the end of the decade as the arrival of new technology is likely to disrupt current models and usher in greater transparency and market volatility, according to research carried out by ICIS.
A survey of companies across European and Turkish electricity and gas markets assessed by ICIS found that some companies have already taken steps to use computer programs that create orders and submit them to a market centre or exchange.
Most of the automation happens on intra-day markets where companies have started to use self-developed systems that could take positions on the market. However, automation could expand to spot and curve products traded both on the over-the-counter (OTC) market and exchanges.
Traditional trading environments could see a radical makeup as traders and brokers could be replaced by automated systems.
Although still in its infancy, automated trading is becoming increasingly popular in Germany, which has the most liquid power market in Europe and where high-profile companies such as RWE or STEAG are reported to be using the technology for taking positions on exchange intra-day markets hosted by EPEX Spot and Nord Pool.
In the UK, one of the six big utilities said automated trading was not part of their current strategy, but added that it was closely monitoring the technology.
Automation in the energy sector is expected to be principally driven by banks and hedge funds, which have already gained experience in using automated software in financial markets. Nevertheless, smaller energy companies are also contemplating investing in automated systems.
For example, a medium-sized company active on the Dutch gas market said it may introduce partial automation by 2020, a view that was reflected by similar entities active in the Italian energy sector.
The survey found that interest in automation is not solely concentrated in the more liquid western European power and gas markets, which already benefit greatly from the experience of highly-developed financial markets where automation has already been underway for the last five years.
Companies active in central and eastern Europe as well as Turkey are equally looking at automation as a means to minimise costs and reduce human error.
However, given the lack of market liquidity in the region, companies interviewed by ICIS said they anticipated automation to happen first in data scraping and analysis rather than trading.
“I think for central and eastern Europe, the automation will take place in the data scraping and analysis rather than trade execution until market conditions improve and cleared trading becomes the norm,” a source active in the Romanian power market said.
A large Turkish generator with a long tradition in the sector was even more optimistic noting: “Depending on market liquidity and the value that could be created out of trading, our company will lean towards the full automation of trading, complete with all mid-, back-office integration as well as commercial asset optimisation and risk management platforms and tools.”
Automation could usher in multiple advantages ranging from investment opportunities, increased liquidity, cost-minimisation, transparency and a radical new approach to regulation, the survey has found.
Although the value of automated trading derived from cost-cutting and profit generated from the introduction of the technology has not been gauged yet, the level of investment in blockchain technology, for example, points to an area of important growth, particularly in terms of start-ups that are likely to develop the technology that would be used for energy companies.
For example, a report by consultants Deloitte found that the technology which introduces a data-management system that is shared, validated and updated collectively by participants on a network, attracted investments of $500m in 2016 alone, bringing the total investment in blockchain technology start-ups across multiple sectors, including finance and energy to $1.5bn at the end of last year.
Vijay Michalik, industry analyst at consultants Frost & Sullivan told ICIS the energy sector was still on average three years behind the financial sector in terms of start-ups, noting that for each technology start-up in the energy sector, there were 10 in the financial sector.
Nevertheless, energy companies are braced for radical changes in the sector.
A source active in the Turkish market that the technology including automated trading and blockchain could entrench itself in the sector within the next three-five years.
“We’re about three years away from automation in western Europe and about five in Turkey,” he said.
Although optimistic, some companies interviewed for the survey suggested that automation could not take off unless markets were fully developed.
“Trading liquidity might increase, since the emotional aspect of trading would be missing,” a source active on the Italian gas market said. “But we should always consider that we’re still talking about commodities whose prices are still strictly related to physical contingencies rather than others.”
Other companies active in the central and eastern European gas markets said automation might breed liquidity as software programmes would remove error risks, which would incentivise trading. This would further lead to increased volatility, which would generate more liquidity.
Nevertheless, a Romanian company was sceptical about the potential increase in liquidity:
“As we operate mostly in central and eastern Europe, markets are rather illiquid and trading is not cleared (so the counterparty list is rather unpredictable), I have doubts the conditions would allow the automated trading execution in this area,” he explained.
Nevertheless, the parallel introduction of blockchain technology that could give multiple participants secure access to fundamental data aggregated on a central ledger could help to boost transparency.
One participant noted that the radical changes that might happen on the trading floor would have to be mirrored by changes in market regulation as watchdogs need to adapt to the new reality.
A source active in the Italian gas market noted that requirements for greater transparency made under regulations such as REMIT, EMIR, and MiFID were putting a big burden on industry participants.
This means, that regulation ought to be simplified and streamlined to respond flexibly to the challenges presented by technology.
Nevertheless a Turkish company warned that regulators should first ensure that markets guarantee the reliable formation of prices.
“As long as there are imperfections in the market, […] full automation could not be sponsored by trading companies.” ICIS staff