5 min read
Energy trading firms play a crucial role in the energy ecosystem. By efficiently connecting global energy demand and supply, they ensure that countries, companies and consumers have access to a broad range of energy sources. The major energy trading businesses have always been working capital-intensive. However, as energy markets remain vulnerable to shocks and disruptions, and global supplies diversify to lower carbon sources, trading firms are facing increased pressures when it comes to risk mitigation. We explore some of the key strategies that energy traders can adopt to help ensure they have sufficient working capital in a market that is best described as VUCA: volatile, uncertain, complex and ambiguous.
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Russia’s invasion of Ukraine in February 2022 sent gas prices soaring and impacted energy markets worldwide. Although gas prices had stabilized in Europe by mid-2023 due to an influx of liquid natural gas (LNG), they remain vulnerable to further shocks, such as an especially cold winter, or supply shocks such as strike action at LNG producers in Australia.
In such an environment, trading firms must guard their access to liquidity to ensure they can meet large margin calls and take advantage of trading opportunities brought about by market dislocations. The key is to view working capital as an integrated resource across both cash and trade finance. We suggest trading firms ensure they fully utilize their own cash as a primary financing option, whilst simultaneously maintaining additional access to appropriate capital as a secondary option through borrowing in the
Trade and Working Capital Market. The first step is to make sure their cash resources are visible, accessible and easy to move. Trading firms also require appropriate lending facilities to be available. Treasury solutions such as global, real-time cash concentration can be useful, as they allow firms to automatically mobilize and centralize funds from across different accounts and countries, giving them access to intraday liquidity.
Being able to move money rapidly, often across borders, is also a vital aspect of supply chain finance. If a hedging broker makes a margin call, then it is important that the trading firm makes the cash available as quickly as possible with no settlement delays. One way of doing this is by using efficient and fast payments systems based on blockchain technology. JPM Coin System is a permissioned-blockchain system that allows near real time payments with finality, 24/7, between J.P. Morgan accounts in USD.1 With JPM Coin System, a trading firm can send funds within seconds, as opposed to T+1 or T+2 for more traditional rails. The speed and certainty of funds transfer also allows the trading firm to centralize all of its cash in a single location in order to optimize returns as opposed to having to leave cash in pockets as a security buffer.
As the world transitions to net-zero, a swathe of new energy sources is coming onstream, from renewables like solar and wind, to biofuels. As a result, energy trading firms are becoming increasingly multi-product and are creating new desks or entities that specialize in these areas. This adds complexity from a treasury perspective. Afterall, more products means more counterparties. Treasury teams will require tools that enable highly accurate reconciliation, as well real-time visibility into different parts of the business. It will also be important for them to be able to segment their data by business unit or desk, rather than just looking at the macro account position. What is the business doing in crude oil versus electricity? What is it doing at the crude oil trading desk in London versus what it’s doing in Singapore? These are the type of questions they will need to answer.
One way to do achieve this is through virtual account structures, where each client or off-taker gets a virtual account to pay into, allowing funds to be virtually segregated. This makes it easier to reconcile transactions while allowing greater transparency across different corporate or third-party entities. The virtual accounts can also be segmented by business line or geography making it easier to monitor profitability and or working capital consumption per business line.
In addition, commodity trading tools like cash flow intelligence will be useful, as the business becomes more complex and harder to forecast. The most advanced solutions use artificial intelligence to predict cash flows based on historical performance and other factors.
As the number of counterparties grows, each with numerous separate entities, this will also create challenges with verifying accounts for payments. Often energy trading firms may just receive an invoice with a series of account numbers with no further information. Being able to make sure that payments are going to verified accounts is essential to prevent fraud. One product developed by J.P. Morgan is Confirm, which allows financial institutions to securely share account information details with each other via a blockchain network. With Confirm, companies can validate account information before a payment is sent, ensuring that the money is going to the right place.
Another growing trend is that energy majors are focussing on trading rather than optimizing equity oil and gas production. Typically, this involves contracting third-party barrels from an independent producer. To do this, they need pre-payment facilities that enable them to lock in supply contracts, amidst competition from other energy firms. By partnering with a bank, they can create payment facilities where they are able to pre-pay for up to a proportion of the future value of a cargo. Importantly the financial institution does not just provide funding but shares the performance risk.
Whether it’s building virtual account structures, providing access to funding or pre-payment facilities, or ensuring fast, reliable payments, J.P. Morgan allows energy trading firms to optimize every aspect of their working capital operations.
Transfers on the system are completed on a 24/7/365 and on a same day basis. Moving funds between systems – i.e., to and from JPM Coin System and traditional DDA on legacy systems has a three hours downtime over the weekend (3-6 PM EST every Saturday, enhancement under development).
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