Energy trading and risk management technology in the oil and gas industry

“The benefits of getting an ETRM infrastructure ‘right» are significant. The tasks of implementing this infrastructure can be one of the most daunting challenges an organization will face.”—Tom Lochbichler, Deloitte & Touche LLP

The Big Bang approach can look very attractive on paper. In theory, it seems to deliver all required functionality within a certain, acceptable time horizon, and offers economies of scale. Instead of running multiple small, sometimes overlapping efforts, the entire benefit is being delivered in one, coordinated, effort.

However, the reality is often very different. The Big Bang approach often takes longer, costs more, and delivers less than originally planned. One reason for this is that ETRM systems implementations are large, complex projects, especially if there is an existing infrastructure that must be enhanced and partially replaced.

Such projects are difficult to plan from end to end with a high degree of accuracy. As the business changes over time, so will the associated functional requirements, effectively changing the scope of the project and redefining the success criteria. Also, implementing an ETRM solution is not something most businesses and their IT organizations have prior experience in, so there is a learning process involved. Finally, the promised timelines are often unrealistic since they represent what is acceptable to the business, rather than what is actually achievable.

Single ETRM system vs ‘best of breed’

An organization must take into account the current business and technical environment when making a decision about future direction. Starting out with a premise of consolidating all trading activity to a single system may not be the right approach, especially when dealing with large-scale, geographically spread-out trading organizations that already have existing infrastructure in place.

There have been a number of attempts by large oil companies in recent years to standardize their global trading organizations on a single ETRM application. A recent ETRM IT benchmark survey conducted by Deloitte showed that in the oil industry, such efforts have often failed to deliver on their initial promise. In contrast, investment banks have been more successful in standardizing on a single ETRM application for their energy trading activities, although many have recently added a second application to their trading architecture.

One needs to be careful though, when trying to draw too many parallels between investment banks and oil companies. While they may trade similar products, the scale and complexity managed by oil companies, in particular around physical logistics, is far greater.

Organizations whose operations are geographically dispersed, with different systems supporting functions in different regions, or organizations that have different functions or lines of business supported by different systems, may find it very difficult to move the entire business to a single platform in a single effort.

At the same time, a best of breed approach, where each region, or function or line of business chooses, or is allowed to keep, their own system has its own set of challenges. First, maintenance costs will be much higher than with a single application, both in terms of maintenance fees paid to the vendors, and in the erosion of economies of scale because of the need to support many different applications and technologies. Finally, this approach will require a very large investment in systems and data integration, as all of these applications will require the ability to communicate with one another.

Practically, there should not be a binary decision between two extremes: either a single system that covers every function, or a separate system for each function.

Not the entire solution

There are really two dangers inherent in looking at an ETRM application as the entire solution.

First, it pre-supposes that the solution lies in technology alone. This is not the case of course. Technology merely exists to support a business activity. It enables the business; automates tasks; creates transparency into risks, exposures, and P&L; and provides tools that support activities such as forecasting, pricing, valuation, and complex risk analytics. As such, the business process being supported must be well understood prior to embarking on a project to support it. Many trading organizations find that their business processes are in a similar state to their technology infrastructure – varied, inconsistent, non-standard, and fragmented. It is therefore important to not only understand the current business environment, but to also redesign broken processes and strive to standardize processes where possible. IT can be used effectively to automate standard processes and make them more efficient and scalable. It is less practical to automate non-standard processes because it increases the complexity and cost of the solution and raises execution risk (the risk of having a failed or only partially successful project). Yet many systems projects set out, by not considering this, to implement systems to enable broken processes and automate non-standard processes.

Second, an ETRM application, though vitally important, is only a single element of an overall ETRM technology solution. There are other major elements that need to be considered as part of the solution architecture, such as data architecture, reporting, and supporting systems. The data architecture should chart out the global flow of data through the organization, and should provide a plan of how this flow will be supported by the ETRM infrastructure, including taking into consideration integration technologies. This flow should include all information relevant to the trading business, and not just that contained within the ETRM application.

Reporting is another key element of an ETRM infrastructure and is often not considered until the end of the implementation project, once the overall solution is in place. However, failing to consider how the organization needs to look at its information during the solution design and implementation phase can lead to a “black hole” of information. Data is entered and functions are performed in the system, but the results can’t be reported out in the way that is useful to the organization.

Additionally, there are a number of supporting systems that need to be considered, or, if already a part of the infrastructure, integrated into the new solution. These include systems for pricing, forecasting, freight and logistics, inspection, terminal, and plant management systems, among others.

Facing the challenges: A holistic approach

Organizations can benefit from taking a long-term, program view of their ETRM infrastructure. A program should be forward looking and clearly define benefits and functionality that is planned to be delivered, but also needs to be flexible enough to deal with changes in scope over its lifetime.

A program may have a three- or five-year defined time horizon, but it needs to deliver in incremental packets, via defined projects and initiatives with a short time-horizon. The majority of the program’s component projects should have durations of around three to six months, with fewer, larger initiatives of longer durations. These are, of course, general guidelines only. In the end, projects need to be structured in a way that makes sense given the current environment, needs, and priorities of the organization.

In the case of an ETRM infrastructure implementation, the program needs to take into account the current state of the technology infrastructure and prioritize according to defined pain points. Organizations should resist the temptation to structure the program around a single ETRM application at the onset, attempting to replace the entire existing infrastructure in one big effort. While the final result may well be a single ETRM application at some defined point in the future, the program should be structured to deliver a series of intermediate stepping-stones of self-contained functionality prior to that point. Legacy application should be phased out over a period of time in a way that makes sense to the organization, whether it is by region, line of business, or function.

This means that parts of the new solution will be integrated into the existing environment over time, as they become implemented. The organization will need to become comfortable with the idea of planned obsolescence, as this approach will lead to the implementing some stopgap solutions with the intent of replacing them within a year or two.

Although a difficult sell in many organizations, this approach represents a disciplined and pragmatic approach to ETRM systems implementation. It helps mitigate implementation risk by delivering in smaller, more easily scoped and delivered projects that deliver incremental value to the organization.

A successful program also puts business process ahead of a technology solution. For this reason, a successful program will start with business process documentation and redesign, and drive to a standardized set of processes where possible. No tools or systems should be implemented before the processes they are intended to support are understood and, if necessary, redesigned or improved.

The program also needs to consider reporting in the initial business process redesign. How the organization plans to report on its data needs to be clearly understood and has to be included as a foundational element of the new solution. For instance, the way the organization plans to report market risk, position, credit, P&L, financials, and regulatory information should be clearly documented a the outset. The structures that will be used to organize this information, such as book structure, strategy, and region have to be understood and documented. The reporting thread runs from front to back through the entire program and forms the basis of how information is presented to the organization.

None of the above steps, of course, guarantees success. However, they are all demonstrated methods that, if properly employed, can decrease delivery risk of large ETRM systems projects and enhance both the chances and benefits of success.

While implementing a front-to-back ETRM infrastructure is filled with many challenges, the benefits of doing it right will have a transformational impact on the organization. Management will have better visibility into the business with better information sooner, and a more efficient organization, measured through increased volumes of business per employee, as well as lower per-transaction costs.

About the author

Tom Lochbichler is a principal with Deloitte & Touche LLP’s Energy & Resources practice. He is primarily focused in the energy trading industry, assisting his clients to develop and implement transformational strategies around business process, operations and information technology.