Electricity. You trade what?
As I open my trading screen in the morning, am I a gambling opportunist? Can I be personified as the testosterone-fueled cliché, full of keyboard smashing rage, expletive-filled outbursts of raw emotion, pointing and incessantly yelling at ‘those guys’ represented by the bids to buy and offers to sell on my screen? Or, am I an operator who attempts to synthesize almost limitless quantities of data into transactional stories that can represent the fundamentals of the grid and human behaviour, adding intelligence to the market and driving down system costs? The former, not really (but not never). The latter, I like to think so.
Most individuals have lost touch with the connection between the light switch and generating station. Aside from the recent climate tail events in California and Texas, reliable power just magically happens without an appreciation for all of the actors involved in the production.
We don’t have to choose between running the dishwasher, charging our phone, or brewing our coffee. Modern society has the option to productively work in illuminated environments when the sun is set. It all just works. The delivery of power from the wind turbine hidden far from view in the countryside to the internet browser on your laptop requires the contribution and coordination of generation, transmission, system reliability coordinators and markets. Electricity is a commodity, just like oil or natural gas. When you see the price of a barrel of oil quoted in the newspaper (RIP) or CNBC (life support), the same markets exist for various other commodities, ranging from natural gas, coal, copper and gold. Energy marketing broadly describes all of the layers of commercial activities that span the sale of electricity from generators to your utility bill.
The deregulation of electricity markets is a modern invention. It requires a far more intricate and considerate market design than typical commodities because of its most unique feature: you cannot store it. Markets are designed to prioritize grid reliability while minimizing the total system production cost. Grid operators are given the tools and information to dispatch units up and down, carefully monitor load and model transmission flows to maintain grid reliability. Dynamic prices send signals to energy suppliers on how much energy to produce and how long according to their energy production cost and the operational limitations of the generation source.
The human and machine-led coordination of transmission limitations, generation characteristics and ever-changing weather is one of humanity’s most outstanding achievements in controlling and harnessing the physical world to democratize the availability of inexpensive and reliable energy.
Poorly designed energy markets create counterproductive incentives, have inconsistent and opaque reward mechanisms, are short-sighted, lack climate resilience, and can contribute to power outages. Well-designed energy markets enable the fair and transparent flow of information to allow thousands of inquisitive minds to compete with each other to squeeze every last bit of inefficiency from the system. Just as you don’t want the invisible hand writing the tax code, you don’t want the Receiver General¹ leading a startup.
Energy traders feature a significant role in the optimization exercise that seeks balance between reliability and low cost. Sometimes you don’t know if you have a poorly designed market until you have a reliability failure. These events usually lead to several news headlines that feature firms with spectacular losses, and spectacular gains. When we sometimes don’t know what we don’t know about the ideal market design, it is easy to place blame while wearing hindsight glasses². Progress is built upon learning from these mistakes, looping back with constant iterations and improvements.
Primary energy describes energy sources as they exist in nature. The sun, wind, oil, coal, uranium and wood are primary energy sources. Secondary energy, also described as energy carriers, describes the energy that has been transformed from its natural state. Electricity, gasoline, natural gas and hydrogen are secondary energy sources. The trading of oil and gas, coal and electricity can broadly be described as energy trading³.
Because it cannot be stored, once electricity has been produced by prime movers⁴ such as fossil fuel generation stations, wind turbines, hydroelectric turbines or solar panels, it flows freely on the grid and requires several coordination layers to manage. Supply and demand need to be in constant balance, or transmission lines and transformers can exceed operational limits, causing localized outages or even widespread blackouts. This leads to pricing that can be extremely volatile, changing every hour of the day, every day of the year, responding to the dynamic fundamental conditions of the grid.
Fundamentally, humans do not like to live close to large machines that do useful work. They typically don’t look very nice, make a lot of noise and can emit a lot of unhealthy toxins into the air. The modern electricity grid (well semi-modern, given that it is somewhat crumbling in many regions of North America) is one of the most novel inventions of the 20th century. Giving open access to a shared piece of infrastructure in which we are all connected was an astounding regulatory achievement, largely due to the work of Samuel Insull⁵.
We take it for granted now, but the electricity delivery was originally comprised of private decentralized grids of varying characterics, access and geography. Pearl Street Station, the first commercial power plant in the United States, served just 85 customers. Electricity was expensive to produce and deliver. Insull marketed power to different customer bases at different prices in order to create reliable revenue streams to fund the fixed cost of building generation and infrastructure. The most novel of these offerings was offering price discounts to large industrial customers during non-peak times, particularly overnight, so that large generators could run with higher capacity factors. This allowed for increased revenues and reduced wear and tear on the machines that would create a virtuous cycle of reducing the cost of production to the end user. This insight enabled for production with common quantitative and qualitative characteristics for a shared grid, making electricity far more accessible to customers. Once a luxury good available to only elites, the cost of electricity would plummet, increasing access to all of society and making way for the electrification of society as a whole.
Agreeing on a set of frequency and voltage protocols allowed for a centralized grid that enabled power generation to be built away from demand, and produced with economies of scale that allowed for its wide adoption. The original grids were built to provide cleaner and higher quality light to the wealthy. As costs plummeted, access was increased and standards were implemented, the electrification of modern society would begin.
Different regions in North America have different energy mixes depending on the access and abundance of resources. British Columbia, Manitoba and Quebec are rich in hydro resources. Alberta and West Virginia in coal, although getting rapidly decommissioned. California in solar. Iowa in wind. Pennsylvania and Texas in natural gas. Energy transitions throughout time move to alternatives that are cheaper, more abundant, more convenient and cleaner than historical alternatives. The transition to modern micro grids are no different in this respect. In order for their more widespread adoption, the cost of solar panels (and less talked about, the cost of installation, which can be half of the cost of the system) and energy storage must plummet in order for there to be widespread adoption. A significant challenge for these renewable technology choices is they work with varying degrees of effectiveness according to their environment.
Jumping ahead a century, innovation in energy economics had matured to the point where the deregulation of electricity markets began in the 1990s. Well designed markets promote competition, drive down total production cost of energy and promote desired attributes for generation and transmission. Some of these attributes include capacity, flexibility, climate resilience, and human led dispatchability (instead of mother nature led).
What drives the volatility in electricity prices? Because we fundamentally don’t like generation to exist in our backyards, we built web of high voltage transmission lines. However, these lines aren’t able to deliver unlimited quantities of power. The lowest cost generating sources live far away from load, and more expensive forms live closer to load to meet demand imbalances when the main transmission lines reach the limits of their allowable capacity. The grid is very similar to a highway system. There are limits to how many lanes, which limits the number of cars. When highways get congested, cars naturally move to secondary roads and side streets to get to their destination. Where the metaphor breaks down a bit, is if transmission lines reach their operating limits, they can collapse grids. In order to maintain reliability, generation closer to load must be dispatched to relieve congestion. Regulated grids are able to manage all of this complexity, but I believe well designed markets are best equipped to synthesize the vast quantities of information flows to pull excess costs out of the system.
A highly incented team of 20,000 outperforms a marginally incented team of 2,000.
There are different types of energy traders in this web of interactions. There are traders that schedule power from regions of low demand and low prices to regions of higher demand and higher prices. There are traders that market excess generation to the market. There are traders that link up long term contracts for physical supply and demand. There are traders that make forecasts on how much power is going to flow across transmission lines and in which direction. Then there is me. I learned the grid by scheduling power between regions, but evolved to trading electricity futures contracts and on an electronic trading platform. These contracts allow generation, load, hedge funds and commodity trading houses to hedge physical exposures and speculate on future prices. It takes a lot of work to build an accurate price forecast that is never correct, but at least best combines all of the available information in the market.
I developed a career finding the signal from the infinite noise of information available to analyze. I have spent hours in front of the screen, staring at graphs, deep in manuals, predicting the path and intensity of storm clouds, diving into dead-ends of data fundamentals, trying to find the hidden correlations between price action and the physical world. As an athlete, I was drawn to trading as a profession because I felt it combined the competitiveness of sport with a high degree of analytical skill. Like sport, you always know the score, and have direct feedback on if you have done a good job or not. I believe so many athletes make good traders because they are used to losing. A profitable trader is right 65% of the time with consistent volume, a great one closer to 80%, winning percentages that mirror the very best in sport. You have to get used to being completely wrong 20-35% of the time, and it takes resilience to live that kind of existence. Every loss is a piece of tuition paid that has to be properly internalized in order to prevent the same mistake from happening in the future. Anyone can be a hindsight trader, they exist everywhere, from talking head media, to the barber shop, to energy Twitter. Foresight traders create and capture value. They are the ones making calculated bets on risk and reward fundamentals before conventional wisdom has reached its consensus. Adding intelligence and liquidity to a market as complex as electricity requires some abstract gymnastics to jump from the conventional zero-sum view to that of positive sum contribution to society. When I trade electricity, I exchange stress, disagreeability, information signaling, and contrarianism for a series of uncertain financial rewards. In a small way, I contribute to the base of knowledge to uphold a modern version of Insull’s vision of free and open access. It’s less sexy than Billy Ray Valentine, but also far less nefarious than Jordan Beauford.
Receiver General: Canada’s version of the Commission of Internal Revenue
Before piling on the market design of Texas for failing to prepare itself for extreme cold events, it is probably the grid in North America that is best prepared to handle the upcoming tsunami of electric mobility demand.
Coincidentally, wood has successfully categorized itself out of energy trading, and into the broader category of commodity trading. Wood has been a material that humanity has used for thousands of years for energy, light, tool making and architecture. We don’t refer to wood as energy, even though it was our first energy source. In our minds, wood is wood. As an aside, my personal belief is that oil and gas must work harder to transition in this way, offering society a more compelling vision of the commodity in the creation of innovative materials and potentially hydrogen, instead of its continued embrace of combustion culture. A lot of oil feeds into wind turbines and electric cars.
Prime mover: The engine, turbine, water wheel, or similar machine that drives an electric generator; or, for reporting purposes, a device that converts energy to electricity directly (e.g., photovoltaic solar and fuel cells).
This story is well told in The Grid: Electrical Infrastructure for a New Era.
