The Integrator’s Guide to ETRM

Unraveling the Knots of Energy Trading Systems

Stitching a new energy trading and risk management (ETRM) system into a modern systems environment is a substantial and risky undertaking. ETRM as a business function is notably complicated and the challenges an integrator faces are legion.

An ETRM Project Kicks Off

This week I provided a systems integrator with some industrial insights into the oil and gas industry’s trading business. The integrator had been retained by an oil company on a contract to interface a new energy trading system with the client’s cloud-based SAP backend system and several operational systems, and they wanted a view on the challenges of such an endeavor.

The backend systems aren’t really the problem here. SAP is well understood, and there are ample professionals with depth in ERP who can assist. SAP is built with interface protocols, and interconnections are a core part of its design. The operational systems most likely will not be directly connected because they are mission critical and real time. At best, the trading system will likely interact with data historians, or perhaps some kind of data repository.

Even the trading system is being deployed directly by the publisher. To a degree it’s a black box. However, the integrator still needs enough understanding about the processes in the black box to identify critical data — both inputs and outputs — that are needed for a seamless solution.

The challenging bit, it turns out, is going to be the integration effort. I’ve been through a few similar projects in the past, and as usual, have a point of view that I was only too willing to share

.

Why Trading Is So Fraught

Energy trading is perhaps the most complicated of all of the various functional areas one encounters in the oil and gas industry.

Fungible products

To start, energy commodities are often purely fungible, which creates near infinite possibilities for buying and selling. There are exceptions — high sulphur crude oils can only be processed by refineries equipped with the right configuration of sulphur removing units. But gasoline and diesel are truly fungible given their universally accepted specifications.

Volatile Prices

The unit prices of energy products such as oil and gas are very volatile. The average price of a Brent barrel of oil in 2020 was $41, and $101 in 2022.  The price of US liquefied natural gas was $16.72 for 1000 cubic feet in September of 2022, but only $6.56 in February of 2024.

Non-standard Measurements

Speaking of barrels, there are no truly universal ways to measure energy products. Oil is measured in barrels in the US, but metric tons and cubic meters elsewhere. Refiners and processors work with mass, not volume. Natural gas products are denominated in cubic feet, cubic meters, tons, British thermal units, and gigajoules. Gasoline is in gallons or liters, and is temperature corrected.

Huge Volumes

The mega volumes that traders deal with are hard to fathom. A very large crude carrier (VLCC) holds over two million barrels of oil, whose value varied from $81m to $202m per the unit price variance above. A theoretical large tidal refinery of 300,000 barrels daily capacity has to purchase and receive two million barrels of crude every 6.5 days.

Long Timelines

The cycle times involved in moving energy vary between nearly instant (as with electricity) and weeks (with oil). The sailing time between Ras Tanura (a big Saudi Aramco terminal) and the east coast of North America is up to 45 days depending on the route.

To keep my theoretical 300k barrel refinery supplied exclusively from Aramco using only VLCCs requires a half dozen of these behemoths on the water, representing 12 million barrels of oil in total, for a value of $1.2 billion.

And while these cargos are on the tides, their value can swing up or down dramatically.

Counterparty Risk

Trading partners are inevitably international, exposing the traders to the international banking system, which adds its own delays, fees, and sovereign risks. And while most deals are done in US dollars, there’s an increasing movement to settle using other currencies, such as Renminbi or Rubles.

Trading in commodities is carried out by many different parties and under a range of strategies. Some are part of big energy companies who have real inventory needs to address, while others are  trading houses, brokers, agents or marketers, taking positions in the market for the margin possibilities. Even governments get into the market, as when the US government transacts for its Strategic Petroleum Reserve.

The sums involved, over the time lines required, in currencies that are themselves volatile, create credit risk, or the concern that the counterparty will be unable or unwilling to satisfy the contract.

Infrastructure Limitations

The purchase and sale of energy products is tightly coupled to physical infrastructure capacity. Traders need to know these factors for trades to work. For example, ocean tankers fall into general classes, such as those able to pass through the canals (Panamax, New Panamax, Suezmax) or fit into smaller ports (Aframax). Pipelines have only so much throughput and capacity. Storage tanks range in size.

Contract Complexity

The contracts entered into between traders are necessarily very complex because of these factors, and traders are exceptionally creative in coming up with new solutions to challenges in the market. This makes for a demanding role to keep on top of contracts so as to avoid non-compliance, failed deals, and losses.

Financial Market Dependencies

Finally, thanks to the sophistication of the market, energy trading is tightly linked to financial instruments whose purpose is to create hedges and protections against price movements in the underlying commodities.

Putting it all together, and we have a high risk, high stakes, high cost, highly dynamic, complex function with relatively few actual transactions, carried out by very few people who have deep industrial insight, and with strong ties into operations and finance. What could go wrong?

The Implications for An Integrator

The integrator dealing with energy trading has to deal with both the general challenges typical of integration work as well as with specific energy trading challenges.

The General Issues

The integrator, whose role is to see that data moves seamlessly, quickly, and correctly relies on a data model, but there is no common data model in this setting. Each of the systems at play (SAP, the ETRM, the operational systems) will have their own data model, none of which will line up.

The involved systems (ETRM, ERP, operational) will all feature their own respective architectures and modules. These won’t line up either, and there will be ample duplication. The typical ETRM system has the ability to manage inventory, as does SAP. SAP even includes its own commodity trading module set.

The range of data required is substantial. Counterparties, product specifications, prices, volumes, dates, times, infrastructure. And the data flows bi-directionally peer to peer, not just in the usual parent-child relationship.

The range of stakeholders is equally broad. Traders operate in their own department, distinct from Finance, accounting, and operations. Each department has its own performance metrics, responsibilities and risks. These are dissimilar and frequently at cross purposes.

Traders are naturally concerned about secrecy because their ability do certain kinds of deals is contingent of being the first mover. Security and protections for data are very important because of the sensitivity of the data involved in trading.

The Specific Challenges

The integrator will have to contend with a set of hard-to-solve challenges that are very specific to the world of ETRM.

Traders need timely access to ample exterior systems (weather data, market pricing), the provision of which can create problems. These systems are often provided by third parties, and can create security vulnerabilities.

I’ve already hinted at the complexity of commodity markets, with their commodity specific measures, pricing models, sources, trading nuances, and infrastructure specifics. Contracts for purchase and sale agreements may be hard to systematize.

Energy trading is the only type of business transaction that I know of which has a financial market operating in parallel to provide for hedging and loss protection. The financial market devoted to hedging in energy is said to be an order of magnitude bigger than the energy market itself.

Energy companies routinely locate their trading organizations in one unit, so that the traders don’t end up competing with each other. That unit, however, can often have multiple operations located around the world in a follow-the-sun model, with offices in Houston, Singapore, and London. Those offices may have specific regulatory or business practices that inform the integration effort, and complicate the effort to deliver the integration.

Conclusions

Successfully deploying and integrating an ETRM system into a running business is a substantial task. The successful integrator will promote an open and collaborative environment for the multiple technology and business teams to address the many integration challenges. While the stakes are high, the benefits of a well-designed and executed integration are well worth the investment.