2 KUL 2022 Commodity Markets Eric Bosman (Engie: Retired)

COMMODITY MARKETS
WITH FOCUS ON ENERGY
ERIC BOSMAN
© Esofin Economic, Social & Financial Research 1

 Commodities
 Interrelations
 Earning models power
 Implications share analysis

WIN A BOOK
iShares Diversified Commodity Swap UCITS ETF (EUR) | EXXY
 On the 5th of October 2021 the iShares EXXY were at 22.50 euro
 How much will they be on the 15th of March 2022?

 Mail your answer before the 27th of February to eric.bosman@telenet.be and give a
short comment on the why of your prediction

COMMODITY RISK MANAGEMENT
Trading
Proprietary, origination, giants, …
Sales
Gas Supply
gas
Request
Forecasting Costing Pricing Offering
For Quote
Central Portfolio Sales
Contract
Portfolio Management
Sourcing
Sales
Forecasting Delivering Metering Billing

Signature
Balancing
Sales
Generation
power

ASSET & LIABILITY MANAGEMENT (ALM)
Market
Assets Liabilities
(loans) (deposits)
•Investment loans •Savings and certificates

•Mortgages •Margin management •Term deposits =< 1 year
•Short term loans •Maturity risk management •Term deposits > 1 year
•Other •Current accounts
Transfer price Transfer price •Savings accounts
Gross margin •Other
– Costs
= net margin

OPTIMIZATION & HEDGING IN OTHER
INDUSTRIES: OIL
Hedging and optimization
Exploration &
Refining Marketing
Production
• Highly transparent global market • Multiple refined products, with arbitrage opportunities
• High diversity on crude qualities • Multiple channels, with arbitrage opportunities
Markets
• Liquid but more regional markets
• Exploration: locations Capacity utilization Price realization

• Production: effective extraction Low operating costs Retail: location & services
drivers
Value
operations & planning Crude optimization Industrial clients: size

Inventory optimization
INDUSTRIES: ALUMINIUM (AND CUPPER)
Bauxite Alumina Primary
Processing Manufacturing
Extraction Refining Smelting
Secondary
Smelting
Scrap
Products
Semi-finished
Bauxite Alumina Aluminum
products
Major volume flows kept Major volume flows kept Major volume flows kept Market dominated by
Early 90s
internal internal internal long-term contracts at

market
• Market trade existed, fixed price

yet market price volatility
avoided
Major bauxite volume Globally traded, yet 95% Standardized commodity Largely commoditized
flows kept internal through contracts Highly liquid LME trade markets
Current
• Some LT contracts for • Price follows aluminium

market
external flows price (chemically related)

market Some high-margin niche
• Price mechanism less Trend towards LME markets
transparent
trade
INDUSTRIES: ALUMINIUM (AND CUPPER)
From cost-based transfers to Current market-based transfers
Bauxite Cost+ Cost+ Bauxite Market Market

extraction price price LT fixed extraction price price
& Smelting Processing price & Smelting Processing
Alumina contracts Alumina
refining refining
INDUSTRIES: CHEMICALS
Advanced
Chemical
chemicals
applications
Basic • Industrial players
Basic plastics • Consumer market
chemicals
Plastics
Advanced
processing
plastics
• Fairly transparent • Less liquid
• No true spot exchanges
Markets
available, yet industry

reference prices published
• Plants typically very asset

intensive
drivers
Value
 Commodities
 Interrelations

GLOBAL ENERGY MARKETS
biofuels
crude
gas pipe
crack spread
capacity
freight
oil products
(gas oil, fuel oil, jet fuel,
naphtha)
emission allowances
natural gas
LNG
spark spread cross border

coal FX dark spread capacity
QUICK QUIZ
1. The announcement of the Israel being engaged in a war with Iran → Oil up / down / stable
2. Expected Chinese GDP revised down from 8 % to 2 % → Coal up / down / stable
3. Decommissioning of 2 low efficiency gas turbines from 1960’s → Power up / down / stable
4. Coming winter expected as the coldest in the last 50 years → Gas up / down / stable
5. Big player forced to divest 20% of its assets to competitors → Power up / down / stable
6. Gas price decreasing by 20 % while coal price remains stable → CO2 up / down / stable
7. Heavy rains falling without interruption in Indonesia → Coal up / down / stable
8. The merge of ENGIE Electrabel with EdF → Power up / down / stable

Reference commodity

MAIN TYPES OF CONTRACTS TO TRADE ENERGY
 An agreement for immediate delivery

Spot contract (typically within 48 hours) of a commodity at a
specific price
 An agreement for delivery of a commodity at a

Forward contract or specific time in the future, at a specific price
future contract
* A third contract type is an option contract

LINKING SPOT AND FORWARD
 With storage (gas)

 Without storage (power)

SPREAD DEFINITIONS
 Clean Spark Spread

 Power – 2 * gas – 0.4 * EUA
→ 50% efficiency
 Clean Dark Spread
 Power – 0.377 * coal – 0.9 * EUA
→ 38% efficiency
 With 47% efficiency, the formula becomes:

 Clean Dark Spread = Power – 0.305 * coal – 0.7 * EUA
Power in EUR/MWh Gas in EUR/MWh EUA in EUR/ton Coal in EUR/ton

DAY AHEAD PRICES

MARKET PRICES COMMODITIES
Gas and Oil Power
Coal CO2

Oil Gas
Power CO2


 Commodities
 Interrelations

WAVE OF ELECTRICITY SUPPLIER BANKRUPTCIES

ELECTRICITY PRICES HAVE SKYROCKET, BOTH
SPOT AND FORWARD

SHORT HISTORY
 After World War II (*), the energy sector knew 3 periods:

 A fully regulated environment (or state owned companies)
 Liberalization with a split between market participants and regulated grid operators
(ca. 2000-2016)
 The prosumer era, where generation is becoming more decentralized, with new tasks
for both the commercial utilities and the grid companies
(*) it all started with stand-alone power plants serving mining and steel industry,
and in a next phase interconnection and scale effects

SHORT HISTORY
Procurement Gas, Coal, Biomass, Freight
Pool Calories
Green Certificates, Certificates of Origin, EUA, CERs
Markets, Exchanges, Auctions, VPP

Trading
Origination Development
Coordination
Production
Transport
Portfolio Management New Sales Products, Portfolio Services
Hedging
Optimization
Sales forecasting, nominations, costing, …
Independant System
Operator
Back Office Deal Confirmation, Margin Calls
Risk VaR, Earnings at Risk, Risk Committee, Credit Risk
Legal & Regulatory Master Agreements, Clearing, MIFID, Market Abuse, REMIT
HR Multi-culture, trader market
IT ETRM, Electronic Trading Platforms
EUA: European Emission Allowances VPP: Virtual Power Plant CER: Certified Emission Reduction ETRM: Energy Trading and Risk Management
REGULATED BUSINESS MODEL
 Permission to charge all operational costs, investment costs and a reasonable

return on this investment, in what is called a rate-of-return regulation.
 Such approach caused two additional attention points to regulators
 How to avoid the risk in overinvestment (Averch-Johnson)
 How to allocate the costs towards different customer segments (Ramsey-
Boiteux)

TECHNOLOGICAL RAPIDS
 Liberalization triggered by end of

scale effect in generation
 Technological breakthrough
(CCGT)
→ Leading to a mature trading market

→ Models based on merit order
→ Leading to a centralised risk model

MAXIMIZING THE S-P MARGIN OF THE ASSETS
• Power plant with 50% efficiency: • Power plant with 50% efficiency:
input of 2 units of gas to produce 1 unit of input of 2 units of gas to produce 1 unit of
power power
• Strategy “hedge and walk away” • Strategy “option value”
o T1: forward gas 22 €/MWh; power 50 €/MWh o T1: forward gas 22 €/MWh; power 50 €/MWh
• Plant margin: 6 €/MWh => plant will run • Plant margin: 6 €/MWh => plant will run
• Sell power, buy gas, gain 6 €/MWh • Sell power, buy gas, gain 6 €/MWh
• Plant margin: -3 €/MWh, but already hedged at • Plant margin: -3 €/MWh => plant will not run
6 €/MWh • Sell gas, buy power, gain an additional 3 €/MWh
• Plant margin: 2 €/MWh, but already hedged at • Plant margin: 2 €/MWh => plant will run
6 €/MWh • Sell power, buy gas, gain an additional 2 €/MWh
o Bottom line: 6 €/MWh o Bottom line: 11 €/MWh

CHURN
Churn observed: 0.1 20
E.g.:
 Germany power: 10
 TTF gas: 14
 NBP gas: 20
Churn rate: Trading Volumes / Physical Consumption

PRICE SETTING CWE
€/MWh Demand curve
Market price
Offer curve
MWh
Conventional
Wind, Solar, Hydro Nuclear Coal CCGT Peaking units
© Esofin Economic, Social & Financial Research Gas 56
PRICE SETTING CWE
EdF, RWE, E.ON, Vattenfall, Engie
€/MWh
Market price
MWh
Conventional
PRICE SETTING CWE
Belgium, Luxemburg, Netherlands, Germany, France
€/MWh
Market price
MWh
Conventional
CENTRALISED RISK MODEL
Trading
Proprietary, origination, giants, …
Sales
Gas Supply
gas
Request
Forecasting Costing Pricing Offering
For Quote
Central Portfolio Sales
Contract
Portfolio Management
Sourcing
Sales
Forecasting Delivering Metering Billing

Signature
Balancing
Sales
Generation
power

REGULATION
 The introduction of markets shifted the attention of regulators to competition

issues and the transfer between the still regulated transmission part and the
market players (e.g. ancillaries).
 The financial character of trading brought this activity in the perimeter of
financial regulation with compliance issues on REMIT(*) and MiFID (*).
(*) REMIT: Regulation on wholesale Energy Market Integrity and Transparency

MiFID: Markets in Financial Instruments Directive

IMPACT ON WHOLESALE PRICES IS BIGGER
THAN EXPECTED
 Merit order effect:

high wind & solar → low wholesale
price
BUT
price for end-customer increases due
to remuneration RES via subsidy
 RES pushes conventional power plants out of the merit order
Classical units only remunerated

through wholesale markets
Investment decision also impacted,
resulting in :
• Mothballing, decommissioning
• Or modification to more flexibility
CAPACITY REMUNERATION MECHANISM
 Missing money leading to capacity renumeration mechanisms

ENERGY ONLY MARKETS AND MISSING MONEY
Wholesale electricity prices adjust to equilibrate demand and supply. In scarcity situations
however, demand and supply may not intersect, and this requires regulatory intervention:
Theory: price caps, should be set at “VOLL” to be economic efficient.
If the cap is lower than the VOLL, then market revenues (inframarginal and
scarcity rents) are not sufficient to invest in the socially optimal capacity level
(= missing money).
ENERGY ONLY MARKETS AND MISSING MONEY
INEFFICIENT PRICE CAPS AND SUBOPTIMAL INVESTMENT
Chart from:Economic,
© Esofin Joskow (2006),
Social & Financial Research 73
The Price responsive demand is added to the original graph .
JOSKOW EXAMPLE CALCULATED

REGULATION
 A main shift in regulation is required (and will occur) in distribution.

 Towards a zero marginal cost society?
 Correct economic signals are needed in order to guide generation and storage
investments between centralized and decentralized ones and in order to boost
the elasticity of short term demand.

RENEWABLE PRODUCTION VS. DEMAND
 Two components in the wholesale market

 Renewable production exceeds demand: negative prices
 Renewable production lower than demand: CCGT price
 Impacted by elasticity of demand, storage potential

DISTRIBUTION
 Rate of return? (Benelux)

 RAB (Regulated Asset Base)
 Building extra Transfo
 Versus Generation (local generation) or
 Versus Savings or Demand Side Management

Wholesale
Centralized generation
Interconnection
DSO + ?
OR
emergency
Customer generator load
shedding
Prosumer
implication ?
PV + battery

EARNINGS MODEL
 Bringing together producers and consumers in a sharing economy

business model via
 blockchain technology
 decentralized production
 microgrids
 Energy as a service

EARNINGS MODEL IN A TRIPLE ZERO WORLD
 Level playing field for all new technologies, be it central or local

(renewables, demand response, …)
 Large need for structuring services
 Smart objects need to communicate and exchange power through proper

price signals

EARNINGS MODEL IN A TRIPLE ZERO WORLD
 Proven business model

 Energy market solutions for Renewables
 Demand Response (load increase / curtailment / shifting)
 Price responsive model: client holds the option (service fee)
 Virtual power plant: client sells the option (option value or profit split)
 Business model under design

 Smart Grid and Local Optimization Solutions
 E-mobility energy market solutions
 Blockchain certification and transactions

SMART GRIDS AND LOCAL OPTIMIZATION
 Some trends in Power Systems….

 Increasing renewable production capacity connected at the DSO level
 Increasing number of electrical vehicles
 Increasing Demand Side Management capacity at the DSO level
 Increasing Peak demand more quickly than global consumption
 …Need to limit grid reinforcement cost at DSO and TSO level
 Organize and operate micro-grids efficiently

 Develop local flexibility services for the DSO/TSO by optimizing and controlling both local
production and consumption
 Develop local markets which allow energy exchange

SCALING & SHARING
PV/wind
Battery/storage
home
Transport/mobility district/site
city
region
national grid/
Demand CWE market
management

SCALING & SHARING

EFFECT ON TRADING AND RISK MANAGEMENT
 Leading to short term trading

 Leading to demand side modelling
 Leading to decentralized risk management

FROM …… TO
 From hedging and year ahead trading  … to short term and volatility trading
 From focus on limited number of  … to focus on residential demand
suppliers (big data)
 From inelastic demand  … to elastic demand
 From stable offer curve  … to intermittent supply
 From non-storable  … to battery optimization
 From economic forecast models  … to weather forecast models

BUSINESS MODELS / EARNING MODELS

Grid Generation Sales
Scale effects
Regulated
Off the shelf

STEGs
Central Risk Management &
Markets
Photovoltaics,
wind, batteries
Comfort
as a service

 Commodities
 Interrelations

SOME EXAMPLES ON THE STOCK EXCHANGE
Asset Liability
Regulated Services
Management
Elia X
Fluxys X
Engie X X X
ENI X X
EON X
RWE X
EDF X X X

EARNING MODELS
 ELIA, Fluxys, Fluvius
 Engie, Eneco, Luminus
 Nanogrid,Yuso, Stroohm, Eazy, Eoluz

ELIA - FLUXYS

ENGIE - ENI

E.ON – RWE
(verleden E.ON is ongeveer RWE – toekomst RWE is productie / E.ON is netten + leveringen)

SCHNEIDER ELECTRIC – ALFEN

7C SOLARPARKEN - SEO

EDF - ENGIE

2 KUL 2022 Commodity Markets Eric Bosman (Engie: Retired)

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COMMODITY MARKETS

WITH FOCUS ON ENERGY

© Esofin Economic, Social & Financial Research 1

© Esofin Economic, Social & Financial Research 2

 How much will they be on the 15th of March 2022?

© Esofin Economic, Social & Financial Research 4

Central Portfolio Sales

Forecasting Delivering Metering Billing

© Esofin Economic, Social & Financial Research 8

•Investment loans •Savings and certificates

© Esofin Economic, Social & Financial Research 9

• Liquid but more regional markets

• Exploration: locations Capacity utilization Price realization

operations & planning Crude optimization Industrial clients: size

internal internal internal long-term contracts at

• Market trade existed, fixed price

• Some LT contracts for • Price follows aluminium

external flows price (chemically related)

From cost-based transfers to Current market-based transfers

Bauxite Cost+ Cost+ Bauxite Market Market

available, yet industry

• Plants typically very asset

© Esofin Economic, Social & Financial Research 14

spark spread cross border

© Esofin Economic, Social & Financial Research 18

© Esofin Economic, Social & Financial Research 19

 An agreement for immediate delivery

 An agreement for delivery of a commodity at a

* A third contract type is an option contract

© Esofin Economic, Social & Financial Research 28

 With storage (gas)

© Esofin Economic, Social & Financial Research 29

 Clean Spark Spread

 With 47% efficiency, the formula becomes:

Power in EUR/MWh Gas in EUR/MWh EUA in EUR/ton Coal in EUR/ton

© Esofin Economic, Social & Financial Research 35

© Esofin Economic, Social & Financial Research 36

© Esofin Economic, Social & Financial Research 37

© Esofin Economic, Social & Financial Research 38

© Esofin Economic, Social & Financial Research 39

© Esofin Economic, Social & Financial Research 40

© Esofin Economic, Social & Financial Research 41

© Esofin Economic, Social & Financial Research 42

 After World War II (*), the energy sector knew 3 periods:

© Esofin Economic, Social & Financial Research 44

Markets, Exchanges, Auctions, VPP

Back Office Deal Confirmation, Margin Calls

Risk VaR, Earnings at Risk, Risk Committee, Credit Risk

HR Multi-culture, trader market

IT ETRM, Electronic Trading Platforms

 Permission to charge all operational costs, investment costs and a reasonable

© Esofin Economic, Social & Financial Research 48

 Liberalization triggered by end of

→ Leading to a mature trading market

© Esofin Economic, Social & Financial Research 50

o Bottom line: 6 €/MWh o Bottom line: 11 €/MWh

© Esofin Economic, Social & Financial Research 53

Churn observed: 0.1 20

Churn rate: Trading Volumes / Physical Consumption

© Esofin Economic, Social & Financial Research 54

Central Portfolio Sales

Forecasting Delivering Metering Billing

© Esofin Economic, Social & Financial Research 60