timing, location and competition: the state of wholesale power management and trading solutions in 2005

Amid the early-2003 malaise in the energy trading sector, I found myself traveling frequently outside of Houston to visit clients, so my wife and I decided to sell our house to move closer to our families on the East Coast. Our real estate agent in Houston had a twist on the proverbial “location, location, location” mantra. She called hers “TLC.” The house sat on the market for 18 months before I sold it for a 25 percent net loss, and that’s when I found out that TLC is not about “tender lovin’ care.” Our agent was referring to “timing, location and competition.”

It seemed I had struck out on all three. My timing was bad: The market was soft as a result of events like the Enron scandal, the 9/11 tragedy and its impact on Continental, and the HP/Compaq merger. My location wasn’t desirable. I was way too far from downtown, and I was facing competition from several new subdivisions similar to mine that were under construction just down the street.

My travel schedule had changed in response to my company’s shift from providing consulting services and software solutions primarily to energy merchant and trading shops to selling more projects to regulated utilities. We went from an environment where everyone wanted to trade everything to one where clients didn’t trade at all-they just wanted to “optimize assets.” Requests for proposals (RFPs) for energy trading solutions at the time reflected the same abrupt change in philosophy. Prior to 2003, most RFPs in the sector focused heavily on multi-commodity trading and risk management functionality, and included commodity-specific optimization, logistics, settlements and data management only as an afterthought.

But fall 2002 changed all of that. With decreased liquidity in power markets, reduced debt ratings and the associated increased cost of capital for participants, and increased regulatory scrutiny of speculative trading and profit-making, utilities and energy merchants alike retreated to largely asset-backed, physical transaction management functions. Accordingly, wholesale power market solution procurement retreated to take on a decidedly physical bent.

SMD and the emergence of WPMM solutions

While the market was beginning to emphasize physical transaction management, wholesale power markets in North America were becoming a lot more complex. FERC’s Standard Market Design (SMD) vision was moving forward, and, in particular, utilities in the Northeast, Midwest and mid-Atlantic were introduced to a new kind of market where day-ahead and real-time spot prices were based on timing, location and competition. This example of TLC was known as Locational Marginal Pricing (LMP).

More than any single event, the opening of and maturation of LMP-based power markets drove the wholesale power software and services market of the last two years. In one of my client’s quantitative analysis groups, they had a special interpretation for the SMD moniker attributed to the large SMD-readiness project that saved the team from organizational realignment: “Saved My Department.” And it was true for many wholesale power market solution providers as well. SMD breathed new life and new opportunity into companies and offerings and created a whole new class of vendors: Wholesale Power Market Management (WPMM). In one Midwest ISO-sponsored vendor solutions fair in late 2003, more than 40 vendors were selling SMD-focused products.

Through attrition and combination, the market for commodity-specific solutions for optimization, logistics, settlements and data management for power has been rationalized some since 2003. However, a number of software vendors continue to focus offerings on the vagaries and constant change present in wholesale power markets. Examples include Global Energy Decisions, OATI, PCI, Siemens New Energy and The Structure Group. Software offerings across this sector vary widely from those that are focused on asset optimization to those more focused on transaction management, but the differences are beginning to be arbitraged out by client demands for more integrated solutions that combine front-office focused analytics and optimization with mid and back-office focused transaction management and settlements.

ETRM vendors shifting focus as well

During this same period, the fortunes of many energy trading and risk management (ETRM) software vendors have been driven by sales to regulated utilities. Many of the recent competitive RFPs increasingly emphasize physical transaction management needs. The recent actions of several vendors highlight the shift of focus from serving partial ETRM needs across multiple commodities to providing end-to-end ETRM needs for specific commodities. Examples include:

“- Allegro Development’s recent sales to power and gas utility organizations;

“- Openlink Financial’s development of the pMotion, gMotion, and now cMotion products for logistics and settlements for power, gas, and crude respectively;

“- Sungard Energy’s selection of the Nucleus platform as the foundation for its Entegrate product strategy in North America, and

“- TriplePoint Technology’s development of the XL-product lines for power and gas management to complement its flagship Tempest XL product for crude.

big oil, utilities, re-un-distressed energy merchants, banks and hedge funds

The catalyst for much of the growth and change in the ETRM and WPMM software sectors is increased capital spending by wholesale power market participants. And the capital, it seems, is beginning to flow from all directions.

Oil and gas majors, flush with cash from $60-plus crude, are investing in solutions for multiple commodities, including a substantial number of projects around power trading and market management. Electric utilities, concerned about Sarbanes-Oxley compliance, continue to invest in new software and integration services. Energy merchants, after two years of significantly curtailed capital expenditures, are beginning to invest heavily to shore up operations and re-position solutions built for a dramatically larger business. “Solution rationalization” and “ETRM re-implementation” are current buzzwords in many energy merchant shops.

Several banks, recognizing the dearth of credit-worthy or risk-tolerant wholesale power participants, have stepped in to provide necessary liquidity for wholesale power markets and to profit from arbitrage and risk-absorption opportunities. And, lastly, what article on today’s wholesale energy sector is complete without mention of the explosion in energy hedge funds. One facet of energy hedge funds that has not been covered extensively, however, is the number of funds that appear to be organizing around arbitrage opportunities in physical power markets. Over the last three weeks, I’ve met with several funds separately that are focusing heavily on physical power markets, looking to profit from arbitrage opportunities in ISO/RTO virtual markets, locational swaps, and forward vs. spot markets.

cooperation, competition and consolidation in the ETRM and WPMM space

For wholesale market participants, vendor focus on meeting end-to-end, commodity-specific needs is a welcome trend. It likely portends an increased ability for “one-stop shopping.” For many years, in most cases, it’s taken at least two stops: one for an ETRM solution and a second for a WPMM solution. The independent complexity of the ETRM requirements and the WPMM requirements made it challenging to be all things to all people. And lest we forget, ETRM vendors still have other commodity- specific needs to address across crude, natural gas, emissions, etc. Power was just one place they could invest. Given that dynamic, there has been considerably more cooperation than competition between ETRM and WPMM vendors.

But that may be changing. July’s announcement of Global Energy Decisions’ acquisition of KWI appears to be an attempt to create a one-stop shop focused uniquely on the needs of the wholesale power sector. NEA’s acquisition of Woodland’s Technologies in late 2003 appears to be aimed at a similar objective. It seems likely that with SMD-driven changes slowing down, ETRM opportunities getting more complex, and capital spending spurring vendor investments, there will continue to be pressures to build scale and be more things to more people.

The reawakening of the Houston energy trading sector, it seems, has begun.

back to Houston

Nine months after selling my house, I find I’m spending a lot more time in Houston. On a whim last week, I decided to drive out to my old neighborhood. The new Fort Bend Tollway had opened, making it a relatively short commute from downtown. As I drove into the neighborhood, it came as no surprise that the new neighborhoods nearby were virtually all built and sold out. Naturally, there was a “For Sale” sign on my house and an “Under Contract” sign just below it. Turns out, it’s contracted for 25 percent more than what we sold it for. Timing. Location. Competition. Hopefully, I get these three right more often in my business endeavors.

David Shepheard is a principal with The Structure Group, a leading provider of energy trading business solutions and consulting services to market participants in North America and Europe. For more information about The Structure Group, visit www.thestructuregroup.com or contact us directly at media@scgo.com.

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