Energy Trading: Why We Need Those Big Swinging Dicks

Our host asked me to pen this piece - and even came up with the title ... [BSD is © Nick Leeson - Ed.]

He'd seen reference to how Nicola Sturgeon was being disingenuous when she announced her new publicly-owned Scottish energy company saying it would have the advantage of not needing to pay "corporate bonuses":  but that her careful choice of words meant she knew full well there would need to be the customary big bonuses on offer to the energy traders involved.  How so? - couldn't energy trading be automated?  Might I be able to explain ..?

Well, many commodity markets are indeed already characterised by a lot of algorithmic trading.   But the gas and electricity markets are different (and also, for idiosyncratic reasons of market design, Brent crude oil at the 'spot' end of the market - though not in the longer dated, more liquid forwards).  It was once considered by some academics that gas, and still more electricity, was a paradigm case of a commodity that couldn't be traded (for "reasons" I won't bore you with, because they were fallacious). 

Turns out though, it's not impossible to trade them: this was proved triumphantly by *ahem* Enron, as a pure act of intellectual conviction and commercial will.  But it is more difficult - and in the case of electricity, much more difficult. The primary reason is that in most electricity markets there is virtually no inventory to act as a buffer in the market, so that relatively slight physical events (which happen all the time, with major events not uncommon) within and around the extensive infrastructure can have a rapid and profound impact on the supply / demand balance. In those few electricity markets where there is an effective buffer - which mostly means those such as Norway that are dominated by hydro-electricity, where the buffer is represented by water stored in dams and 'ponds' at the top of the mountain - trading is concomitantly easier.  Gas suffers from a similar, though less pronounced problem of limited inventory.

A secondary (and related) reason is the 'granularity'.   Copper, for example, trades in units of one month: gas is traded by the day; and electricity by the hour, or even the half-hour.  The gas grid needs to be balanced daily; and the power grid requires balancing in real time.  There are many, many other related contributory factors besides, making gas and electricity highly dependent on more than just the usual financial principles.  In consequence, gas and electricity prices (wholesale / traded markets) are hugely more volatile than has ever been encountered elsewhere - an order of magnitude more volatile in the case of gas, and often two orders more in electricity.  Phenomena like the growing amount of intermittent wind power in the 'fleet' only serve to make this more extreme.

Until, then, the advent of that Holy Grail - an effective and efficient form of electricity storage on a large scale(1)  - successful trading in these markets requires a unique blend of classical 'financial' trading skills, plus deep understanding of the very extensive physical / infrastructure aspects and their complex dynamics.   As a rule, financial traders hate getting their hands dirty with the physical stuff; and physical specialists don't understand the financial stuff (which can be deeply counter-intuitive to the novice, even the highly numerate novice, as most engineers are). 

So the winners - who really clean up - are those who can be arsed to acquire both sets of skills.   The amateurs get destroyed.  Some household-name big companies have really screwed this up over the years.  Many companies actually outsource their trading requirements to specialists - and pay a nice mark-up, but can then say "we don't need those nasty traders(2) & we don't pay those immoral bonuses".  But of course they do, really - like retaining an overseas 'agent' to do the dirty business with the backhanders. 

I wonder which route the pious Sturgeon is going down?   Sadiq Khan had promised to set up a municipal energy company for London, but seems to have thought better of it which, in my view, is wise.  Keep those big swinging dicks out of sight of the innocent Scottish politician ...

ND
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(1) Mr Musk has a very, very long way to go yet.  He's a great BS-merchant, though.

(2) The traders' culture is abhorrent to the engineering culture that quite naturally dominates the energy co.s.   There are many points of conflict.  When an energy co eventually realises it needs a trading floor (and be willing to pay serious bonuses), it can cause truly dreadful frictions.  Traders and the like have been heard to call the old-timers "Dougs" - dumb old utility guys ...  and since this is a family blog (is that right, Sackers?), I won't relate what the engineers call the traders.

Send the office cleaners into the City

Cleaning up the trading rooms physically could be the way to amend the traders' behaviour (htp: Overcoming Bias)

People are unconsciously fairer and more generous when they are in clean-smelling environments, according to a soon-to-be published study...

... The first experiment evaluated fairness. As a test of whether clean scents would enhance reciprocity, participants played a classic "trust game." Subjects received $12 of real money (allegedly sent by an anonymous partner in another room). They had to decide how much of it to either keep or return to their partners who had trusted them to divide it fairly. Subjects in clean-scented rooms were less likely to exploit the trust of their partners, returning a significantly higher share of the money...

$700 billion: cui bono?

Hunter in the Daily Kos (HTP: my brother) says that the $700 billion rescue plan has no relation to the (much smaller) likely amount of mortgage defaults; instead, it's designed to prop up the derivatives scam that banks have been running for years.

I've thought recently that the bankers and traders are, in effect, being offered absolution without confession (1), restitution (2), doing penance (3) or a "firm purpose of amendment" (4).

1. Full disclosure of all liabilities and "assets"; admission of each person's part in the debacle. This should be Watergate Plus: there's a lot more than four burglars and the damage to third parties is incalculable.
2. Preferably, repayment of past bonuses awarded at a time when the recipient knew, or ought to have known, that the game was destabilising his own firm and the national economy.
3. Ideally, jail time, for some; at least, loss of office for those responsible.
4. Adoption of regulations designed to maintain the value of the currency and prevent future speculative bubbles.

From time to time we hear the defence that the consumer was at fault, too. Perhaps, if you're thinking about home equity withdrawals; but even the boll weevil is "just looking for a home" as Leadbelly sang, and when banks opened the money sluices house prices doubled. The buyer had no option to purchase a home at 2002 prices in 2007 (and I'm not sure what happened to the cost of rent in that time). The lenders should have known what they were doing; the poorest borrowers were not their equals in expertise. There was a duty of care.

What would houses cost, if it had always been illegal to use them as collateral for debt? What would the US and UK economies look like, if the vast sums sunk into housing had gone into small business enterprises? How much wealthier would we be?

I'll stay on the outside, thanks

Actually, I hope all the top bankers and star traders keep their huge bonuses (one year's worth of which would keep people like us for life), and I hope none of them gets jailed for their corruption/criminal incompetence.

Because otherwise, I might have to believe in Big Brother, and love Him.