Slightly worn, but dignified, and not too old for sex.
I confess, I used the title to get your attention. I wanted to write about the liquidity in the Nordic power market and for some reason, those lines from that old ABBA song, "When all is said and done", came up.
The Nordic power market started in Norway already 1993 but really took off 1996 when Sweden joined. Further boosts in liquidity came with Finland (1998) and Denmark (2000).
The Nordic financial power market immediately became a success. The simplistic construction with one credible day-ahead spot price and a stable clearing house increased liquidity. It wasn’t perfect for everyone but good enough for most. Germany, on the other hand, with peak and off-peak products and a more complex market with bilateral contracts had a slower start.
Engineers from the control rooms became traders and had to learn the difference between mine and yours. But slowly the lusekofte cardigans and the Birkenstock sandals were outcompeted by suits and hand sewed English leather shoes. (Fortunately we have relaxed the dress codes again.) Traders of other commodities and FX-traders shifted to the exciting new market. After some years, we suddenly had a market on drugs – American drugs. Enron, TXU, Aquila, Entergy-Koch and several others created an amazing environment with hundreds of megawatts in single deals flying over the broker desks. The money and risk taking were crazy. FX-traders learned the hard way about direction dependent volatility. Oil traders learned about snow depths and blocking highs. Fortunes were made and lost. Legends were created.
Then came the Enron crash and the Americans left. Most of the hedge fund investors withdraw their capital. The Goldmans, the Morgans, and the Lehmans had to focus on other things. Like surviving.
Financial regulation and tougher rules on collaterals forced several smaller players out of the market. A quite cynical development as it was the banks who caused the financial crash that now benefited from the regulation.
European power prices and volatility fell. Eventually, the banks also lost interest. UBS, Deutsche Bank, Barclays, Citigroup; they all either had other troubles or just didn’t see the business anymore with all the added cost of regulation and lower liquidity and volatility.
After these obvious blows to liquidity and market interest, there came a number of subtle challenges. Retail customers moved from fixed to variable price contracts. That removed the one-year-ahead hedge interest from wholesale companies. An increasing share of intermittent renewables pushed, and are still pushing out coal or gas fired power and the need to hedge further out on the curve.
And there are more potential challenges on the horizon. Demand side flexibility from a new breed of end users and grid sized battery storage has the potential to push the activity to the short end and intra-day trading. I used to believe that was the inevitable future a few years ago. I am not so sure anymore. I see a near future where automated trading and distributed intelligence manages the short term optimization with very few human short term traders.
The Nordic power market has been through some rough times – but it is still there and it still works. Although with lower liquidity. The traded volumes are less than half of the 3232 TWhs in the glory days of 2002 but still 4-5 times the underlying physical market. Institutions, hedgefunds, producers and portfolio managers are all there – despite a thin market further out on the curve.
There are some hurdles. Have we gone too far in pleasing everyone with too small bidding areas, making the system price a lousy hedge? Is it “only working under normal circumstances” – not when it is really needed? Should we aim for more fixes or go the other way to go back to simplicity? Is there a holy grail or is it a combination of smaller actions?
We have learned and found ways to manage the challenges. Is lower liquidity being the cause or the effect? We continue to discuss what ways to improve. A market is never “everyone else”. I believe our market is dignified enough to break the negative liquidity trend. Sometimes a compromise is for the better – sometimes, when it only makes things worse for everyone, not.
and not too old for…
Trading is a game of psychology. At least until the machines take over. You have to master both your own head and the mass psychology that is the sum of all the other trader’s heads. The decreasing liquidity has been a topic of many conference dinners and boat trips, broker parties and the annual customer meetings of the exchanges. Don’t let your minds see a half empty glass when it really is half full.
Maybe we did more of it in the younger years, but now we are much better at it and know what we were doing. "it can still be a fantastic market with a lot of fun and opportunities." – as one of our most experienced traders recently said at a conference.
The volatility is there, you can’t wait for major trends all the time. Use the market volatility, use options, be active in trading spreads between locations and periods. A market cannot only exist of price takers.
All is not said
Now I know why that song came up in my head. It is the ending rows I have always connected to: "It’s so strange when you’re down and lying on the floor. How you rise, shake your head, get up and ask for more."
Do not miss the opportunity to join and continue the discussion at the NAET autumn meeting in Oslo on the 28th of September. There is a Nordic tradition to contribute to the discussion process to move it forward towards the best possible solution. Even if our proposal is criticized and voted down, we help the process.
All is not said and done yet.
Fredrik Bodecker, Bodecker Partners