There is often tension between the short-term motivations of CEOs and politicians and the extended, strategic perspectives that energy traders and other industry stakeholders often need to adopt. But how can we think long-term in this situation – when decision makers often don’t?
This article reviews the risks that result from these conflicting stances and how energy traders can manage those risks.
The Current State of Renewable Energy Adoption
The adoption of renewable energy sources has been growing steadily over the last decade or so, but progress is not fast enough. According to data from the International Renewable Energy Agency (IRENA), the renewable share of electricity generation in 2021 was 27.8%, an increase of 0.2 percentage points compared to in 2020. This was the smallest annual increase during the last decade.
In the UK, Q2 of 2023 saw a 12% increase in solar power generation compared to 2022, reaching a record-breaking 5.5 TWh. However, total renewable generation decreased by 11%, falling to 27.2%. Meanwhile, in the US, it’s forecast that natural gas supply will drop by 1% in 2024 due to an increase in the share of renewable generation this year from 22% to 25%.
2023’s Breakthrough Agenda Report, a collaboration among IRENA, the International Energy Agency (IEA), and the United Nations Climate Change High-Level Champions, does not bring promising news.
The report reviews the progress made and actions needed in order to achieve the Breakthrough Agenda, a clean technology plan signed by 48 countries in 2021. It states that current efforts, in terms of investment and deployment, are not enough to meet international climate goals.
The Problem with Short Term Focus
To achieve the goal of a sustainable future, it’s essential to think long-term, yet politicians often focus on short-term policies that will appeal to their constituents and ensure their re-election, as well as policies that will yield noticeable results within their term – rather than long-term strategies that might be beneficial in the distant future but less immediately popular or visible.
UK Prime Minister Rishi Sunak has been criticized for delaying key targets without clearly setting out the consequences, and setting goals without forming long-term plans to achieve them. Frequent policy changes are also making it difficult to meet targets, and some governments are heavily relying on private investment to reach net zero in 2050.
Investing in new renewable energy infrastructure requires significant upfront costs, which not all decision makers are prepared to allocate when facing budgetary pressures, or if they’re more concerned about the immediate fiscal year. With that said, delaying action may ultimately increase the cost of meeting targets.
CEOs, particularly those of publicly traded companies, find themselves in an intricate dance between the long-term imperatives of renewable energy adoption and the relentless demands of quarterly financial performance. The energy transition requires substantial capital investments, forward-thinking strategies, and patience to realize returns on investments. However, the emphasis on quarterly results often pressures CEOs to produce immediate profitability.
The Risks for Energy Traders
These short-term perspectives introduce yet another layer of unpredictability in the energy markets; traders, whose success often hinges on their ability to anticipate market shifts, find their forecasting models and strategies challenged by sudden changes, increasing the risks they face.
At the mercy of others’ short-term thinking, traders face abrupt changes in regulation and sudden price fluctuations. In addition, investing in long-term solutions such as infrastructure, new technologies or long-term contracts becomes risky when a nation’s plans may change in the near future.
What Changes Are Needed for Long-Term Results?
To achieve renewable energy targets, governments need to ensure policy consistency and, according to the Breakthrough Agenda Report, they must strengthen their collaboration in terms of standards and regulation, financial and technical assistance, and market creation. A few important areas to watch include:
- Continuing to phase out subsidies for fossil fuels.
- Implementing carbon pricing mechanisms.
- Policing counterfeit green fuels. Fake green fuels can produce more carbon dioxide than fossil fuels, so their unchecked production and distribution needs to come to an end. It’s also important to ensure that other purported solutions are not creating more problems than they’re solving, such as unsustainable electric vehicle battery production.
- Investing in infrastructure and potential renewable sources such as hydrogen.
- Improving climate performance in hard-to-decarbonize industries through executive incentives.
How Does ETRM Software Manage Risk?
Energy Trading Risk Management software plays a critical role in managing a plethora of risks (especially if it incorporates energy analytics), as well as boosting operational efficiency.
Below are a few ways that these systems can help your organization navigate the markets and elevate your risk management operations – even when politicians aren’t thinking far ahead.
Risk Management Features in ETRM Systems
Comprehensive Data Integration
ETRM systems centralize data from various sources, including market data, trading data, and external factors like weather patterns that can influence energy prices. This provides clarity in terms of market dynamics and potential risks.
Modern, cloud based ETRM software provides real-time monitoring of positions and daily profit and loss, enabling traders to quickly identify and respond to potential threats or opportunities. Of course, this is especially important for natural gas trading where market movements change continuously.
Energy trading software can model potential market events, from minor disruptions to major crises, assessing how such events would impact portfolios. Users can run what-if scenarios, Monte-Carlo simulations and other tools for getting a better idea of how different contingencies may affect their positions.
ETRM systems can compute Value at Risk (VaR), a measure of the potential loss in value of a portfolio over a defined period for a given confidence interval, helping traders understand the potential downside of their current portfolio under typical market conditions. Our ETRM analytics software also calculates market to market (MtM), cash flow, and cash flow at risk (CFaR).
Hedge Effectiveness Testing
For those using hedging strategies, energy trading software can test the effectiveness of these hedges under various conditions, ensuring they provide the desired protection.
With the ever-increasing urgency to adopt renewable energy, it’s paramount for stakeholders in the industry to adopt a long-term perspective. Not only does short-term thinking hold back change, but it gives traders a hard time, adding another layer of uncertainty to an already-volatile market.
Thankfully, an ETRM system makes the markets much easier to navigate. At Inatech, we provide complete front, mid and back-office solutions, helping to manage, automate and optimize every facet of your operations. To see our software in action, contact us to book a demo.