The energy industry was a little late to the dot-com party but was not damaged by the market crash of last spring. While slow to embrace electronic commerce, the energy industry is very information-intensive and very conducive to internet applications.
Electronic energy trade will firmly take hold for oil, gas, and power trading over the next 2 years. Other internet applications will include e-billing, advanced supervisory control and data acquisition applications, and automation of the procurement and tendering process.
The oil and gas industry has been gradually using more energy risk-management tools to manage its financial risks over the past 2 decades. The unprecedented price volatility in oil and gas markets experienced over the past 2 years is accelerating industry adoption of both financial instruments and internet energy trading.
While liquidity on the internet today remains low, the movement to internet trading will create its own liquidity and force the over-the-counter (OTC) paper markets for oil, gas, and power to migrate to the web. Moreover, other industry trends of consolidation, market liberalization, and privatization are creating a tsunami of risk that must be managed more proactively, and the internet will be the medium for that trade.
Global Change Associates' Electronic Energy Trading report has identified over 60 platforms of energy e-commerce in the energy patch. While the number of platforms continues to ramp up, some of these platforms are in dire financial straits and have not built trading liquidity. Ultimately, most of these trading platforms will fail, but what appears inevitable is that several will dominate the internet trading space while others will perform well in niche market functions. This pattern is true of major changes in any new market.
Why now?
Energy trading began after the end of the official selling price programs by the major oil companies and Organization of Petroleum Exporting Countries after the 1973 oil embargo and coincided with the development of spot markets for crude oil and petroleum products. In 1978, the changing structure and nature of the physical spot market for oil presaged the development of energy futures with the successful launch of the New York Mercantile Exchange (NYMEX) No. 2 heating oil futures contract, which was tied to physical delivery in New York Harbor. Successive oil futures contracts for crude and products in New York and London and the development of an active OTC market for oil trading during the 1980s brought structural changes to the international oil industry. In effect, price transparency accelerated both the physical and financial trading of crude and products globally. On Apr. 4, 1990, NYMEX launched the successful Henry Hub natural gas futures contract, which simultaneously coincided with the development of an active OTC natural gas market.
Electricity trading followed a different path to market maturity in the US, with the emergence of an OTC price swaps market in late 1993 prior to the launch of futures contracts, which were launched on Mar. 29, 1996, by NYMEX and followed by a total of 10 failed electricity futures contract launches by NYMEX, Chicago Board of Trade (CBOT), and Minneapolis Grain Exchange. Something had radically changed in energy trading markets, and that was the age of electronic trading coupled with the OTC market flexibility, which usurped exchange-traded futures contracts. The exchanges have been slow to react to this phenomenon.
Other critical changes have occurred over the past 20 years, including that of price assessment panels and index trading-which had failed in the late 1980s but succeeded in the 1990s. Energy trading has changed forever. Electronic index construction coupled with screen trading has now catalyzed the global energy industry into the internet age. The proliferation of electronic brokering and trading platforms that are emerging today will continue to change the face of energy trading. While energy markets have traditionally followed financial markets in terms of application of trading methodology and instruments, the commoditization of the energy complex is now in full swing, and the pace is quickening.
The following analysis of some trading platforms does not pretend to be comprehensive, but it is indicative of the state of the energy electronic trading space. These platforms are all focused on the paper trading of oil, gas, and power, and will extend into coal, bandwidth, and emissions trading. They are dominated by the OTC markets.
Intercontinental Exchange
Today, one clear electronic trading winner has emerged, and that is the Intercontinental Exchange, also known as ICE. Backed by the major energy companies, gas and electric utilities, and investment banks, ICE launched all its energy trading platforms, or verticals, by October 2000. These include crude oil, petroleum products, natural gas, and electricity.
The major players behind this electronic trade are active in oil, gas, and power markets on both the physical and financial sides. The backers include American Electric Power Co. Inc., BP, RoyalDutch/Shell, Duke Energy Corp., Aquila Energy, Morgan Stanley Dean Witter & Co., Goldman Sachs & Co., El Paso Corp., Reliant Energy Inc., Mirant (formerly Southern Energy), Deutsche Bank AG, TotalFinaElf SA, and SG Investment Banking, a unit of Société Générale Group.
The only piece missing for total oil, gas, and power dominance by ICE is the participation of the major European gas and electric utilities, such as Electricité de France, Germany's RWE AG, Italy's Enel SPA, and Spain's Endesa SA. Market liquidity is growing rapidly even in niche markets, such as jet fuel hedging.
E-NYMEX
NYMEX's attempt at electronic trading with an internet-based platform seems destined for failure due to its announced plans to launch in the OTC energy derivatives market for oil and gas, where it has no expertise.
While NYMEX has had an after-hours trading system for its energy futures contracts for the past 8 years called ACCESS, exchange members do not want to cannibalize their existing trading floor business and its highly liquid and successful oil and natural gas futures contracts, which continue to grow each year. Thus, they have decided to launch an ill-conceived OTC trading platform, which puts it in direct competition with ICE and other OTC internet trading platforms.
A more sanguine strategy would have been for NYMEX to become the global internet oil and gas futures exchange, and for NYMEX to clear for all internet energy platforms with its very successful clearinghouse function. Accenture, formerly Andersen Consulting, and software vendor Kiodex Inc. are readying the NYMEX internet trading platform for launch during NYMEX Energy Week in early May 2001.
Ultimately, e-NYMEX will fail but not for a lack of resources. NYMEX will load its seven illiquid electricity contracts in a vain attempt to bring liquidity to these moribund contracts. E-NYMEX will not be allowed to penetrate NYMEX's core oil and gas futures business and will suffer liquidity problems accordingly.
HoustonStreet, RedMeteor.com
Other listless trading platforms will fall by the wayside. The two most noisy in this space during the past year have been HoustonStreet Exchange Inc. and RedMeteor.com Inc. Each failed to gain sufficient liquidity and will not survive the year.
HoustonStreet has had the most visible public relations campaign in memory but has not gained the legs to create any liquidity in its oil, gas, and power verticals.
Redmeteor.com has changed its business model three times in the past year. It also bought TCT Crude Inc., an OTC energy broker. However, the TCT voice brokers never migrated the business over to the web and still use the telephone for most of their business. The movement of both HoustonStreet and RedMeteor into European markets will not create any value for either company, as they are working on unfamiliar turf.
EnronOnline
EnronOnline is another kettle of fish and not a true exchange, but it is the most liquid internet energy platform. Enron acts as market-maker to all transactions on both the buy and sell side. It is making markets in oil, gas, and power and has extended its platform into bandwidth, emissions credits, pulp and paper, steel, petrochemicals, plastics, commercial credit, weather, and metals.
In bandwidth, the company is complementing its internet rollout with the building of a 15,000-mile fiber optic network similar to its earlier oil and pipeline networks. In fact, many observers feel that network industries may be the most ideal candidates for web-based trading.
EnronOnline went live on Nov. 29, 1999, and has wildly exceeded all expectations, gaining over $300 billion in commodity trading. EnronOnline has captured over 60% of Enron's transaction business and is an unbelievably successful market model.
Moreover, EnronOnline has spawned offspring, including Click-Paper.com, Commodity Logic, DealBench, EnronCredit.com, and Enron Metals.com, which are market-making moves into other verticals besides energy. These offerings are moving Enron's business model into the commoditization of all markets, while also reducing its marketing costs as it shifts more trading activity from the floor to the internet. EnronOnline is active throughout both Asia and Europe.
Dynegydirect.com
Enron's highly successful business model has been emulated by Dynegy Inc.'s dynegydirect, which is offering over 150 products in North American gas, power, and natural gas liquids markets.
Dynegy wants to aggregate multiple transactions of its site and then execute them on TradeSpark.
Dynegyconnect has recently been launched as a means to offer increased connectivity to expand networks and add internet access to their service portfolios.
Altra Energy Technologies
Altra Energy Technologies is the granddaddy of all electronic trading platforms, with the launch of Chalkboard for oil trading over 8 years ago. Altra Energy Technologies Inc.'s acquisition of TransEnergy Management, Quicktrade, and Energy Imperium during the past few years added significant overhead and systems integration problems. While still a very liquid gas trading system, its effort to create more verticals has been suspect. Moreover, while it reduces its headcount, the company has been described as a charity as it continues to lose money every month. The salvation of an initial public offering not being viable at the present time makes Altra ripe for acquisition by an existing platform or a new competitor.
TradeSpark
TradeSpark has a mix of partners different from ICE's.
Williams, Dynegy, Coral Energy, Dominion Resources Inc., Koch Industries Inc., TXU Corp., Entergy Corp., and broker Cantor Fitzgerald's eSpeed may have a chance at some liquidity.
These well-capitalized partners may offer another alternative to the dominance of ICE.
European market developments
European internet platforms are just as poorly defined as those in the US. The need for separate power exchanges for almost each country in the European Union does not demonstrate a willingness to move away from nationalism. The internet is borderless. The many platforms are highly parochial.
There are the Amsterdam Power Exchange, the Leipzig Power Exchange, the European Energy Exchange (which is actually German), the Polish Power Exchange, the Austrian Power Exchange, and up to six electricity verticals in the UK. The flawed thinking in moving Altra, RedMeteor, and HoustonStreet into Europe has not created any significant liquidity.
The only successful platform in Scandinavia has been Nord Pool, which has worked successfully since 1993 due to the nature of the hydropower and nuclear power markets in Norway, Sweden, and Finland. It is a small, successful niche market.
Turning to European oil and gas platforms besides ICE, the International Petroleum Exchange (IPE) seems to be in the midst of confusion. It identified almost 50 technology platforms to unveil its electronic internet strategy but seems to have very little energy in sorting out the best-of-breed technology. Also, since now it is a public company due to its demutualization, it is in play to be acquired. Suitors include OM group, ICE, and possibly NYMEX. IPE trades the highly liquid Brent crude oil contract as well as gas oil and natural gas futures contracts. It seems inevitable that IPE will be resurrected as the European oil and gas futures electronic platform.
Asian markets
The Asian internet markets seem to be in a phase of arrested development, as its oil futures platform has withered and died. The Singapore Exchange will now launch only electronic energy contracts in the future, as its oil futures contracts for Brent mutual offset and fuel oil have fallen by the wayside. While Platts Global 190 trades oil electronically, it seems to be there by default and by a lack of trade interest.
There is an interesting play in open-spec naphtha (e-OSN.com) in the East Asian markets that will probably work, because it has had an active and liquid forward OTC market for over a decade. E-Osn.com acts as broker to all market participants; however, the site is a niche market play. It does, however, demonstrate the potential viability of niche market segments for energy trading on the web. SwapNet, based in Singapore, has been slow to change Asian oil trading onto the internet. The illiquid gasoline contracts on the Tokyo Commodity Exchange are not very viable.
One of the obstacles in Asia market development has been that Asian internet growth lags worldwide usage but should accelerate over the next several years. China and India will undergo rapid growth, as currently under 1% of their populations use the internet. India has the world's largest electronic exchange (for equity trading). Both countries may embrace internet energy trading in a big way by leapfrogging technology.
Vision for the future
To use a baseball analogy, we are at the top of the second inning in bringing electronic trading to the energy industry. The hype is gone, and the reality is that internet trading applications are very conducive for the energy industry. The death of the internet is greatly exaggerated, just as its entrance was. The key barriers today are not technological but changing human behavior to use the internet as opposed to human relationships, which are still a strong part of the energy trading complex.
No one doubts there is a need to attract more liquidity, create methods for more price discovery, and create adequate controls and systems to handle credit risk, clearing, and settlement.
The bogus issue of secure encryption is not an active barrier to entry. Interbank transfers of funds have high degrees of security and have been going on for over 2 decades. Business-to-business (B2B) exchanges will not only survive but also thrive in the next 2 years, as the need accelerates for digital markets to centralize information, create communities, and trade energy.
The fragmented markets of today will lead to the consolidated trading markets of tomorrow with several dominant global players and regional and niche players relegated to the sidelines. Parsing and weaving in the best of platforms for other commodities related to energy, such as emissions and bandwidth, will create a multicommodity warehouse that will have clearing and settlement taken care of by the major banks that are already part of a global consortium. The platforms will have better functionality as the technologies improve. Buying customers and technology, the front, middle, and back office will be web-enabled so that the exchanges can provide seamless trading opportunities on an around-the-clock, borderless basis. Pricing will become more transparent, and liquidity will grow exponentially.
The energy industry is the nexus for the application of the internet for not only energy trading but also procurement and electronic retailing. A global business packed with information would seem to be the place to catalyze internet applications. That business is called energy.
The author-
Peter C. Fusaro, president of Global Change Associates, has over 25 years experience in the global energy business. Former employers include ABB, Petroleos de Venezuela SA, and the US Department of Energy. Global Change Associates advises on energy electronic commerce and energy risk management and has been active with energy trading and electronic energy commerce for the past 7 years. He is the author of Energy Derivatives: Trading Emerging Markets (2000) and Energy Risk Management (McGraw-Hill, 1998). E-mail: [email protected]