Financial innovation and energy trading have regularly gone hand-in-hand, as utilities and other firms constantly seek to hedge their exposure to price volatility or take bets on the perennially volatile energy business.
Open interest, or the number of positions open in existing contracts, hit the landmark one billion megawatt-hours level on the CME Group’s trading platforms this week. CME Group owns NYMEX, a formerly independent exchange that hosts trading in the benchmark West Texas Intermediate crude oil contract. The firm has made a concerted push in building out its energy business across a range of financial products, from floor-traded futures contracts to options and other products across a range of energy commodities.
Power trading has been an uneven business over the past decade following the collapse of Enron; the industry’s deregulation remained patchy and although demand remained strong for tools to diminish risk and even out returns in a business exposed to the vagaries of weather and the broader economy, electricity has been a difficult commodity to trade outside of several high-profile hubs.
The billion-megawatt mark in part represents the exchange group’s launch of swaptions, or options contracts stretching over several months, and calendar spread options. CME recently announced the launch of commodity swap futures, which it says are “unique contracts that allow market participants to hedge for the maximum amount of power that could be used at any point of time, rather than for the consumption that is used over a period of time.”
Innovation To Meet Unique Challenges
“As the power industry continues to evolve and seeks new types of hedging products that match the unique needs of the electricity markets, we have worked with producers, marketers and other market participants to launch innovative new contracts,” CME Group Chief Operating Officer and Managing Director, Products and Services, said in announcing the new open interest record this week.
Among the unique challenges the electricity market faces, one of the most unusual is storage. Large-scale storage of electricity remains challenging, although in some cases stored fuel, quick-cycling reserve generation capacity and even water behind hydroelectric dams has been described as a form of energy storage. Without large-scale physical storage that can offset trading, acquiring a position in the underlying fuel commodity, like coal or natural gas, has become a de facto way for power companies to limit their exposure to price swings.
The deeper and more actively-traded power markets become, the more quickly price signals can potentially result in deployment of stored electricity from renewable sources, a longstanding issue in the construction of new renewable energy generation and the transmission required to move it to demand loads.
Photo Caption: Traders in the oil and natural gas options pit at NYMEX.