Electricity trading and risk … February 2015 Current trading market in Japan 2 Electricity trading and risk management in liberalised market • Latest trends and experiences from

Electricity trading andrisk management inliberalised market

February 2015 PricewaterhouseCoopers

www.pwc.com/jp

Agenda

1 Current electricity trading in Japan 1

2 Evolution of trading in a deregulated market 5

3 Fundamentals of trading 16

4 Operating model considerations for a tradingfunction

24

5 Comparison of trading systems 32

6 Case studies: Approach to trading 54

Page

PwCFebruary 2015

Current electricity trading in Japan

1

Electricity trading and risk management in liberalised market • Latest trends and experiences from European markets

PwCFebruary 2015

Current trading market in Japan

2Electricity trading and risk management in liberalised market • Latest trends and experiences from European markets

Section 1 – Current electricity trading in Japan

JEPX • Established in 2003, JEPX is the onlyelectricity trading market in Japan

• Accounts for less than 1% of the totalelectricity sold

Spottrading

• Accounts for approx. 99% of JEPX trading• 48 products in 30-min blocks• Blind single-price auction• Minimum volume: 1MW

Forwardtrading

• Accounts for about 1% of JEPX trading• Both bilateral and spot-based• 1 year ahead products by weekly or monthly

blocks• Continuous pricing• Minimum volume: 500kW

Intradaytrading

• Accounts for less than 1% of JEPX trading• 4-hour ahead products for 8h or 32h supply• Blind single-price auction• Minimum volume: 1MW

Other(99.5%)

Spottrade

(98.6%) Forwardtrade

(79.9%)

Intradaytrade

(20.1%)

JEPX(0.5%)

Others(1.4%)

JapanTotal

(874 BkWh)

JEPXTotal(4.7 BkWh)

JEPXnon-spot

(60 MkWh)

* As of FY2010

■ Trading volume breakdown*■ Overview of Japan Electric Power Exchange (JEPX)

PwCFebruary 2015

Changes anticipated in the trading market due toliberalisation



• Plan to introduce 1-hour ahead trading with 24/7 transactionsavailability in 2016

• Plan to reduce the transaction fee to 1/3Products

Liquidity expected to increase as a result of liberalization.Currently, IPP/wholesalers (8.2%*) are obliged to sell toEPCs. From 2016, they can choose to sell to other parties,including JEPX.

Liquidity

• JEPX expected to facilitate wide-range merit order afterNational Transmission Operator (TSO) is established in 2015

• Price in JEPX expected to provide an indicator priceUse of data

* As of FY2010

PwCFebruary 2015

By contrast, trading in the UK electricity sector is muchlarger



• 317 TWh annual demand• ~57.5 GW peak demand• ~77.5 GW installed capacity (including wind)• Capacity margin ~7%

UK MarketOverview

*1 Spot market and prompt market combinedNote) The above figures are 2013 data

APX

OverviewTrading profile by market types

Day-ahead auction Intraday*1

• 14.1TWh

N2EX• 42 members • 139.4 TWh

• Maximum daily volume over500 GWh

• 3.4 TWh

• 66 members• 675,000 trades

• 8.6TWh• Maximum monthly volume

~974GWh

Total 148TWh (89.5%) 17.5TWh (10.5%)

<Overview of UK trading market >

PwCFebruary 2015

Evolution of trading in a deregulatedmarket

5


PwCFebruary 2015

What changes as an electricity market deregulates? (1/4)


Section 2 – Evolution of trading in a deregulated market

Customers have choice

They choose different typesof tariff

They choose a differentretailer

PwCFebruary 2015




Customers have choice

They must forecast theircustomer demand: In-area and

out-of-area

They must develop tariffs toattract and keep customers

Retailers no longer have astable customer base

They need access to data tomanage price and volume risks

They must manage theirelectricity purchase costs to

support their tariffs

PwCFebruary 2015




They must understand plantreliability and start to allocate

the cost base across plant

They must develop demandforecasts to determine how their

generation plant will run

Generators no longer have aguaranteed market for their

production

They must understand the costbase and reliability

of competitors

They must manage their fuelpurchase costs to support their

operating plans

Customers have choiceRetailers no longer have a stable

customer base

PwCFebruary 2015




All market participants becomeexposed to risk

Trading becomes a fundamentalpart of operations for all market

participants

Generators no longer have aguaranteed market for their

production

Customers have choiceRetailers no longer have a stable

customer base

PwCFebruary 2015

What does trading mean for market participants?



Trading helps generators and retailers manage risk

• Delivers electricity to end consumers

• Manage transmission constraints

• Manage outages

• Manage short term changes in demand

Physical trading

• Manage exposure to wholesale prices

• Protects margin within retail tariffs

• Seeks to protect against uncertainty inwholesale and retail prices

Financial trading

PwCFebruary 2015

How do market participants trade physically?



1. Long term offtake agreements betweenan IPP and a retailer

500MW of power for every hour for15 years, with the price indexed to the costof LNG and inflation

2. Bilateral contracts between generatorsand retailers

1000MW of power for every hour in theyear at the wholesale price in the market

3. Trading exchange 100MW of power for 1700–2100 on thenext day

4. System support contracts with theSystem Operator

Fast reserve or load reduction

Examples

PwCFebruary 2015

How do market participants trade financially?



1. Include price trigger within a contract(an embedded derivative)

2. Via an exchange or financialcounterparty using afinancial derivative

3. Contract between 2 counterparties

Offer an industrial customer the option tofix its contract price for the month based onthe average baseload price in the first week

Examples

Contracts for Difference, which enableboth generator and retailer to have pricecertainty for the contract duration andvolume

See hedging example (Section 3)

PwCFebruary 2015

What does this mean for a market participant?



Generation Retail

Generators focus on:

• Operation of powerstations

• Managing cost base tomaintain margins atcontracted levels

Retailers focus on:

• Management ofcustomers

• Tariff developmentbased on contractedcosts

Traders focus on:

• Acting as the interface between the company and the market

• Implementing company strategy in the light of market conditions

Trading

WholesaleMarket

Tradingexchanges

PwCFebruary 2015

Example of a European EPC structure



Market

Generationbusiness

Fuel business(eg gas, coal)

Retailbusiness

T & D business (own) T&D business (others)

DispatchTradingDivision

Transmission management

PwCFebruary 2015

Management of risk requires additional governance andoversight



Data

• Technical andoperating data forpower plant

• Demand data

• Existing contracts

• Counterparty details

Processes andcontrols

• Manage exposure limits

• Trade size

• Approval processes

• HR training

• IT systems

Reporting

• Risk management

• Performancemanagementinformation

• Regulatory

• Market analysis

PwCFebruary 2015

Fundamentals of trading

16


PwCFebruary 2015

A standard trading operating model includes a front,middle and back office


Section 3 – Fundamentals of trading

• Networks

• Banks

• Exchanges (Monetary)

• Governments

• Joint ventures

• 3rd partyexchangese.g. ICE

• Bloomberg

• Reuters

• Banks

• Brokers

• Suppliers

• Customers

• Governments

• Exchanges

Externalpartners

Trading andmarketing

Risk managementteam

Operations Finance

Frontoffice

Backoffice

Middleoffice

Counter-parties

Logisticsproviders

Financialpartners

Governanceand

compliance

Deal captureand positionmanagementTrading

decisionsupport and

analysis

Markettracking and

analysis

Financialexecution andmanagement

Accounting/Reconciliation

Enterprisereporting and

analysis

Paper tradeand risk

management

Logisticsoperations

management

Physical trademanagement

PwCFebruary 2015

Each function has specific business processes thatsupport trading operations



Middle Office

Back Office

Settlement & Invoicing

Risk Management

Mark to market & Position Reporting

Governance & Compliance

Contract & Cash Management

Financial Reporting & Control

Front Office Trade Analysis

Trading

Position Management

PwCFebruary 2015

3 Trading Models



FuelProcure-

ment

SellPhysical

GeneratePower

1 SPOT

Lower Risk –Managing

physical flow

Higher Risk –Trading

for profit

FuelProcure-

ment

SellPhysical

GeneratePower

BuyFinancialDerivative

(hedge)

2 HEDGE

SellPhysical


3 ARBITRAGEBuy

Physical

SellFinancialDerivative

PwCFebruary 2015

FuelProcure-

ment

SellPhysical

GeneratePower

1 SPOT

Spot



Spot = Forward sale of power for specified period of time usually 1 month to 5 years

Generation profile

Power sale profile

Generation GenerationRamp

UpPlannedOutage

1 year sale – Purchase Price Agreement (PPA) @ Floating price – Power index

1 month@ Fixed

Price

1 month@ Fixed

Price

1 month@ Fixed

Price

1 month@ Fixed

Price

1 month@ Fixed

Price

1 month@ Fixed

Price

Short term sale@ fixed price

Long term sale @floating price

Time 6 months 1 year3 months

PwCFebruary 2015

FuelProcure-

ment

SellPhysical

GeneratePower


(hedge)

2 HEDGE

Hedge

21


Financial Hedge – Future Power Sales (Exposure)


Illustrative example

Generator

Retailer

Physical power$/MWh @future marketprice

$0

$30

$70P

rice

of

po

wer

$/M

Wh $45

Historic Market Prices

Potential Profit

Potential Loss

Now 1 yr

Cost of power generation

Current Market Price

PwCFebruary 2015

FuelProcure-

ment

SellPhysical

GeneratePower


(hedge)

2 HEDGE

Hedge

22


Financial Hedge – Future Power Sales (Exposure)


Purchase a financial hedge to guarantee a margin

Generator Bank

Retailer

Physical power$25/MWh

$25/MWh

$45/MWh

$0

$30

$70

Pri

ceo

fp

ow

er$

/MW

h $45

Now 1 yr

$25

Market Price at date ofsettlement (sales price)

Physical Contract Loss$25 – sales price$30 – cost to generate

$5

Financial Contract Gain$25 – Pay to Bank$45 – Bank pays Generator

Guarantee Margin of $15

$20

PwCFebruary 2015

3 ARBITRAGE

Arbitrage



UK energy prices: Jan 2006 – Feb 2015

Source: http://energyserve.co.uk/daily-update

Current price$45/MWh

Own view of forwardmarket prices

Forward market prices

Outturn market price of$43/MWh:loss of $2/MWh

Outturn market price of$51/MWh: profit of $6/MWh

Buying a forward financial contract on a speculative basis

PwCFebruary 2015

Operating model considerations for atrading function

24


PwCFebruary 2015

Case for change: What drives organisations totransform their operating model?


Section 4 – Operating model considerations for a trading function

Change catalysts

Increased trading volumesMore complex trading

strategies

Market volatilityInternal/external

reporting requirements

PwCFebruary 2015

Effective trading operations depends on many factors



Implementationand change

Trading operations

Service deliveryand process

Operationalefficiency andeffectiveness

Systems to supportbusiness needs

Trading Strategy

Market position

Governance andcontrol

Risk mitigation

People andcapability

Right people

PwCFebruary 2015

Impact on trading function based on complexity oftrading strategy

27



Spot Hedging Arbitrage

• One Trading Desk

• Small OperationsTeam

• Additional personnel torisk manage hedgingactivities

• + 1 Risk personnel

• Split trading desk betweenhedging and arbitrage

• +1 Trader – Arbitrage

• +1 Risk personnel(depending on volume)

• Policies and controlsto manage physicaltrading

• Additional policies andcontrols for hedging(financial derivatives)

• Increased oversight tomanage financial risk e.g.trade strategy approvalprocess

• Simple trading bookstructure

• P/L and positionexposure reporting

• Trading book structureincreases to managehedging strategies

• What- if scenario andhedging analysis

• Trading book structuregrows larger to manageboth hedging andarbitrage strategies

• Enhanced risk reporting tomanage trading strategies

• Specialist system • Specialist system • Enhanced risk analyticsImplemen-tation &change

Service delivery &process

Governance &control

Trading Strategy

People & capability

PwCFebruary 2015

How can a trading system support managingoperations and trade activity?



Business benefits

• Standardise business processes

• Single system to manage transactionlife cycle

• Greater position and P/L visibilityacross multiple business units

• Streamlined forecasting, scheduling,settlement and operations activities

• Data Security

Trading activity benefits

• Load forecasting tools enablingscenario and historical analysis

• Better visibility of trading position(trade, forecast, plan, loss, schedule,actual)

• Ability to capture financial tradeinstruments, including futures, swapsand options

• Real-time analytics and what-ifanalysis

• Real-time P&Ls, volumes, value at risk(VaR) and other portfolio metrics

1 2

PwCFebruary 2015

Why invest in a new IT system to support trading?



Business case

• Project objectives

• Business requirements for front,middle and back office

• IT infrastructure and interfaces

• Data management strategy

• Project risks

Outputs

• Benefits to the business

• Costs

• Resource requirements

• Project timeline and plan

• Procurement requirements

PwCFebruary 2015

Trading systems are at the centre of your ITarchitecture



ETRM systems link external data feeds and Enterprise Resource Planning (ERP) systems

Customerrelationshipmanagement

Energy Trading & RiskManagement (ETRM)

Brokers

ExchangesERP (Finance & Back

Office)

Marketsources

Contractmanagement

Planning and consolidation

Performance reporting

Banks

Market datarepository

Exchangeintegration

platform

Brokerplatform

PwCFebruary 2015

Comparison of trading systems

32


PwCFebruary 2015

Energy Trading and Risk Management (ETRM) systems


Section 5 – Comparison of trading systems

Used to trade physical and financial energy commodities

Source: IDC Energy Insights

• Trader’s tools

• Simulations

• Scheduling

• Nominations to systemoperator

• Credit risk analytics

• Market risk analytics

• Price forecasting

• Simulations

• Stress testing

• Balancing

• Settlement

• Invoicing

• Contract management

• Hedge accounting

Deal capture

Reporting

Front office Middle office Back office

PwCFebruary 2015

Major ETRM vendors in the Power & Gas Trading market

34


Source: Chartis RiskTech Quadrant for Energy Trading Risk Management Systems 2013

Low High

Ma

rket

Po

ten

tia

l

High

Best of Breed Category Leaders

Point Solutions Enterprise Solutions

ETRM Software Landscape


Completeness of Offering

TriplePoint

SunGardBrady

AllegroMurex

OpenLink

PwCFebruary 2015

Comparison of ETRM Software Vendors

35




Vendor Commodities Covered

Crude &RefinedOil

Natural Gas& Liquids

LNG Coal &Freight

Power &Carbon

Metals,Chemicals,andAgriculture

OpenLink

TriplePoint

Allegro

SunGard

Brady (no freight)

Murex

PwCFebruary 2015

Comparison of ETRM Software Vendors

36



Vendor Main Energy Customers

OpenLink • GMR Energy (Singapore)• Hess (US)• Scottish Power (UK)• Dong (Denmark)• Petronas (Malaysia)

TriplePoint • Iberdrola (Spain)• ConocoPhillips (US)• SK Energy (Korea)

Allegro • National Grid (UK)• Saudi Aramco (Saudi Arabia)• DTEK (Ukraine)• BKW (Germany)

SunGard • Iberdrola renewables (Spain)• San Miguel Power (Asia)• CFE (Mexico)• Fortum (Finland)


PwCFebruary 2015

OpenLink



• Front to Back Office solution for Power, Generation, Transmission,and Distribution

• Focus on risk management and optimisation

• ‘Cube Logic’ to support data management

• Treasury & Commodity Management

• Endur – Power & Gas Trading

• Findur – Treasury & Cash Management

• Cube – Data Management

Overview

Software Platform

• Comprehensive risk analytics framework

• Sophisticated analytical & reporting capabilities

• Strong capability for financial & reporting modelling

• Standard valuation models & simulation capability

• Scheduling capabilities to handle daily and hourly nominations

Strength

PwCFebruary 2015

TriplePoint



• Multi commodity platform

• Focus on enterprise risk management (market, operational,counterparty credit, regulatory)

• Integrates seamlessly with personal productivity tools (e.g. Excel),enterprise systems, and market feeds

• Commodity XL – Commodity Risk Management

• Softmar – Chartering & Vessel operations

Overview

Software Platform

• Supports full transaction lifecycle including procurement(Commodity XL)

• Strong logistics and shipping capability (Softmar)

• Business Intelligence to model load and generation availability

• Hedge accounting capability to support hedge trading

• Regulatory functionality to support external reporting

Strength

PwCFebruary 2015

SunGard



• Cross Platform Technology with software solutions across multipleasset classes

• Aligne platform focuses on energy and risk management

• Large professional services team

• Aligne – Energy Trading & Risk management

• Avantgard – Treasury & Cash management

• MarketMap – Data management

Overview

Software Platform

• Focus on commodity and asset management in power and gastrading including procurement (Aligne)

• Offers supporting solutions across regulation / compliance andmarket data (Aligne/MarketMap)

• Strong Treasury functionality (Avantgard)

Strength

PwCFebruary 2015

Allegro



• Focus on Power, Generation, Transmission, Capacity, andDistribution and Ancillary services

• Strong power and gas trading functionality

• Hosting & managed service offerings

• Allegro v 8.0

Overview

Software Platform

• Component approach offers flexible architecture & features

• Intuitive user interface

• Ease of rollout and integration

• Real time scenario analysis functionality

• Integration with ISO’s to streamline scheduling

Strength

PwCFebruary 2015

Case studies: Approach to trading

54


PwCFebruary 2015

Agenda


Section 6 – Case studies: Approach to trading

Background Client need How did PwChelp?

IT systembenefits

Overall clientbenefits

1 2 3

4 5

PwCFebruary 2015

Increased information reporting requirements

Additional operational procedures required

Increase in risk management and need for newtrading strategies

Background



• Deregulation led to increased competition• Pricing changed from regulated pricing to market-based pricing• Independent System Operator (ISO) and trading exchanges established• Regulatory changes to wholesale and retail energy sector

Registration with ISO

New trading exchanges

Regulatory reporting

Impact on our client

Market change

PwCFebruary 2015

Client Need



To adapt its regulated business model to successfullyoperate in a liberalised trading market

Perform a strategic and operational assessment of its front, middle,and back office for its marketing and trading functions

Objective

Areas of focus

1

2

3

4

5

Governance & oversight

Organisation & staffing

Information systems

Front/middle/back office processes

Risk and performance reporting

PwCFebruary 2015

How did PwC help?



Reviewed current business model and developed a road mapto implement recommendations across each area

1

2

3

4

5

Governance & oversight

Organisation & staffing

Information systems

Front/middle/back office processes

Risk and performance reporting

Revised governance and controlsframework

Modified business model for themarketing and trading functions

Selected and implemented new ITsystem

Updated business processesincluding defined roles andresponsibilities

Enhanced risk and managementreporting

Areas of focus PwC Support

PwCFebruary 2015

IT System Benefits (1/5)



Facilitated management of business activities acrossscheduling, trading, risk management and trade processing inone system

Our client used different systems to manage activities across the powerand gas transaction lifecycle

Its systems were not well integrated and different sources of informationrequired manual consolidation

High risk of errors occurring when data was transferred between systems

Issues & business needs

Integrated solution with one source of the truth Real time information across the business to support more informed

decision making (procurement and trading)

Trading system solution

PwCFebruary 2015




Enhanced the portfolio management capability to managephysical load, generation and trading activities

Our client sought improved: Understanding of its generation position (forecast & management) Communication of data to comply with ISO requirements

Enabled our client to: Model demand load and generation and simulate its underlying power

position Automate communications with ISO via the new IT system thus reducing

resource effort and eliminating manual processes



PwCFebruary 2015




Supported facilitation of new trading strategies to optimisefinancial hedging of generation and arbitrage

Our client wished to develop its financial trading capabilities: Position (volume) Risk exposure to that position (market value) Trading or hedging strategy (trade strategy)

Our client was able to: Capture physical and financial positions in one system Support consolidated risk management activities Model trade simulations



PwCFebruary 2015




Provided simplified compliance with external ISO schedulingrequirements for power nominations

Resulted in a simplified scheduling process using a single system tomanage nominations across multiple ISOs



Our client needed to generate day-ahead nominations to send to each ISO The ISO interfaces varied by location requiring different nomination

reports to be generated Our client wanted to minimise the risks of potential error using manual

systems to manage data across different ISO platforms

PwCFebruary 2015




Enabled our client to manage its regulatory reporting onimbalances across multiple control areas

Our solution enabled our client to monitor imbalances in each ISO area ona single screen

The new system enabled our client to see both balanced and unbalancedpositions at any time



Our client was responsible for its balance position within each controlareas

It needed to keep track of its balance position in each control area in realtime

Its existing capabilities were time consuming and used multiple systems

PwCFebruary 2015

Overall Client Benefits



The new trading system enabled our client to reduceoperational and market risk through creating a new businessmodel to compete effectively

Information flow from long term tradedesks to day-ahead trade desks

Enhanced data flow fordecision making

Improved organisational and taskalignment

Optimised operationalprocesses

Higher efficiency achieved across businessprocesses (front, middle, and back)

Reduced manual effort

Automation of ISO operationalrequirements and ease of compliance withregulatory reporting requirements

Improved IT system

Electricity trading and risk … February 2015 Current trading market in Japan 2 Electricity trading and risk management in liberalised market • Latest trends and experiences from

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