Chicken or Egg? Can Energy Traders Build Supply Chains If Even Buyers Can’t Agree on What They Want?

The timeless chicken-or-egg conundrum aptly parallels the challenges faced by energy traders in today’s volatile market. In a sector that’s rapidly changing with evolving consumer demands, the success of trading hinges largely on understanding and predicting these demands.  

However, when consumer demand is inconsistent, how can traders establish effective mechanisms? Should the formation of a robust supply chain precede clear demand, or should the latter determine the former? This article explores the dilemma. 

The Challenges of Ambiguous Demand

Diverse Demand Profiles

Supplying for multiple distinct demand profiles poses a significant challenge in terms of establishing efficient and responsive supply chains. 

With the push for green initiatives, some buyers are emphasising renewable sources, while others remain tethered to traditional sources for various reasons. 

Public sentiment is increasingly leaning towards green and sustainable practices which influences buyer decisions, sometimes rapidly. Geopolitical situations also heavily influence the preference of one energy source over the other, and traders can be caught off guard by sudden policy shifts.

Storage Challenges

Renewable energy generation can be intermittent and may not align with demand patterns, which complicates storage, as opposed to traditional energy sources that have well-established storage methods. 

During periods of low demand, excess generated power may be wasted, leading to losses. To meet sudden spikes in demand, utilities may need to activate peaker plants (plants can be turned on or off quickly, in contrast to baseload plants that run all the time). Peaker plants usually operate at a higher cost-per-unit of electricity as they use more expensive fuels. 

Infrastructure Investment Decisions

Energy – especially renewable sources – requires a complex infrastructure for storage and distribution. Long-term decisions must be made about infrastructure investments, and unclear demand complicates this process. 

Without a consensus among buyers about their preferred energy sources, traders are left to speculate which infrastructures to invest in, a risky and capital-intensive endeavour.

What Do These Challenges Mean for Energy Traders? 

The above challenges have significant implications for energy traders, as outlined below. 

Handling Price Volatility 

The price volatility caused by demand fluctuation can be both an opportunity and a risk. Predicting long-term demand can be especially challenging, making it risky to commit to long-term contracts. 

Without proper risk management strategies and tools in place, unpredictable demand can lead to frequent buying or selling on the spot market, often at less favourable prices. 

What’s more, too many sudden and extreme fluctuations in demand impact the liquidity of certain energy contracts, making it harder to trade with minimal risk – and demand will only fluctuate more as we see more extreme weather events due to our changing climate. 

To navigate the challenges of fluctuating demand, traders need to invest more in monitoring tools and analytical capabilities. The use of real-time analytics and advanced forecasting tools helps in quickly gauging shifts in buyer preferences; traders can then adjust their strategies proactively and at short notice. 

Machine learning and AI can be particularly useful here, identifying patterns and trends that might not be immediately obvious. 

Hedging Strategies

The combined unpredictability and volatility in the energy markets requires sophisticated hedging strategies. While these strategies can help mitigate potential losses, they can also be costly and complex to manage. (Our renewable fuel ETRM helps you streamline hedging, credit, inventory, cash flows, and much more.)  

Counterparty Risks

If a supplier or buyer faces financial difficulties due to the challenges of fluctuating demand, they might default on their obligations, introducing counterparty risks for traders. 

The Future: An Adaptive Approach

The way forward is not in creating rigid supply chains based on speculative demand but in developing flexible, adaptive systems that are more agile and sustainable than our current options. 

Alternatives to Peaker Plants

The end is nigh for peaker plants – they are fossil-fuel intensive and many are due to be retired soon. While they are still necessary for the time being, newer and more sustainable alternatives will need to be adopted. 

Virtual power plants (VPPs) are one option. VPPs are networks of distributed resources such as solar parks, wind farms and so on, which are coordinated by a central control system. The objective of VPPs is to track, forecast, and trade their power, stabilising the grid. 

One study showed that VPPs can produce the same resource adequacy as gas peaker plants and utility-scale batteries at only 40-60% of the cost. 

Demand response solutions can also reduce reliance on peaker plants, incentivising end-users to reduce their electricity consumption during peak demand times or when the grid is under stress. 

Due to the expense of operating peaker plants, reducing their run time can result in substantial cost savings for utilities, which can be passed on to consumers, making participation in demand response programs appealing. 

Energy Analytics 

Beyond the infrastructure itself, traders can use advanced energy analytics including AI-based solutions. Despite market volatility, such solutions provide a head start and equip traders with insights that would otherwise not be available. Looking beyond day-to-day decisions, such insights may guide the development of adaptive supply chains by revealing patterns in buyer behaviours. –

Relationships with Producers and Consumers 

Maintaining open channels of communication with both ends of the supply chain allows traders to get early insights into shifting preferences or potential supply disruptions, which aids in quick decision-making and in forging long-term partnerships.

CCP Clearing

It’s becoming more common for futures contracts to be traded on exchanges where trades are cleared through central counterparties (CCPs) instead of through OTC markets. This may provide more protection in today’s increasingly-volatile energy markets.  

Conclusion 

Inconsistent energy demands transform the trading landscape, introducing new layers of complexity and risk. However, with these challenges also come opportunities. Agile traders, equipped with the right tools and insights, can leverage these market dynamics to their advantage.

Inatech provides best-in-class ETRM software, founded on deep industry expertise. We supply a range of solutions for trading everything from oil to carbon emissions, and our renewable fuel ETRM is equipped with the finest risk analytics tools to arm traders with decision support. Contact us today to book a demo.