How We Trade
Energy trading and pricing is a complicated business, which is why Government Procurement Service has developed a level of expertise and scale you are unlikely to have in your own organisation.
It is a full-time task to continuously monitor the markets and to react quickly and appropriately to any significant event that might impact prices.
Here we explain some of the complexities and the way that trading is conducted.
Determining Price
All energy prices, from your own domestic supply to that for your organisation, are determined by the wholesale market based on forward contracts and interpretations of trends, ranging from political factors to weather effects.
Even with a traditional fixed term, fixed price approach, the significant energy element of your price will be calculated using forward wholesale prices for your contract period on the day of either quote or award, added to the supplier’s view of your consumption. This price is likely to include a large risk premium, reflecting the possibility of markets rising after your price is offered and ultimately fixed.
You may not be big enough to have sufficient energy usage to buy flexibly through multiple purchases. Even if you have double or treble the volumes required for a single trade this may mean only a couple of purchases, giving negligible flexibility.
Market Trading in Action
Major energy buyers like Government Procurement Service have a range of options for purchasing electricity and gas. Currently, we trade on the wholesale market (both prompt and forward) using over-the-counter (OTC) platforms. (See definitions of these terms below)
Trading can take place on exchanges, which allow parties to anonymously buy and sell commodities, derivatives and other financial instruments. Exchanges trade standardised contracts, on standard terms and conditions, and provide clearing services to help eliminate counterparty risk for traders. Exchanges also publish pricing information, which is often used as a reference for both OTC and structured contracts.
The majority of electricity and gas trading occurs in the OTC market. It is used for bilateral trading between parties and may be voice- or electronically-brokered.
Another mechanism for trading energy is through structured contracts, where energy is purchased directly from generators or producers using contracts that are arranged bilaterally, often on a long-term basis.
With electricity, we are taking active steps to adopt a strategy of sourcing a proportion of our volumes directly with the generators, commonly known as Power Purchase Agreements (PPAs).
Trading can be for spot delivery (on the same day as the trade), prompt delivery (within the next month) or forward delivery (after the next month).
Spot and prompt prices are largely determined by the interaction of demand and supply fundamentals, such as unplanned generation outages and change in the weather.
Forward prices largely reflect expectations of price in the future and are mainly influenced by factors such as forward prices of fuels such as coal, oil and gas.
Other important participants in the wholesale energy markets are price reporters who provide price information on energy markets (generally based on surveys of market participants).
They can promote liquidity by providing indices, which may be used by traders to benchmark for trades and clear forward trades.