Risk Management in Energy Trading Market: Top 3 Challenges

Jan 9, 2024

Security, Speed, Reliability

How do systems address those and what are the areas for improvement?

As stated in McKinsey’s article The Future of Commodity Trading, “recent market developments include increased price transparency, greater access to structured and unstructured data […], contract standardization, new exchanges and platforms, and regulations“ resulting in “higher market participation, transaction volumes and costs, and speed to market”.

This results in increased volatility of the traded financial and physical products, and demands a more flexible response to the constantly changing market conditions. Given this, commodity traders and risk managers are facing new challenges and demanding more and more support for technologies. In this article we are going to focus on the top three of them, how systems address those and the room for improvement.

Security

In the energy industry we operate, the risk of hacker attacks has increased due to recent geopolitical events. Data is the core of every trading business and analysis nowadays. Predictions and strategies based on this data are proprietary goods and key to financial success. The main challenge for every company is security. This becomes even more important given the regulations in the energy sector and the requirements for anonymization encryption and disclosure/reporting of transactions to the supervising authorities.

Volumes of digital, online and algorithmic trading are increasing and are supported by tools, systems or AI. The online exchange of sensitive data, as well as investments in IT security also escalate. The setup of proper encryptions, proxies, gateways, VPN tunnels and procedures to protect your data and trading systems becomes a must for every key player in the industry. With that, the area becomes more attractive for software engineers too.

As systems evolve, so do encryption algorithms. Hackers’ creativity grows and the IT security teams must follow. With the increased usage of nearshoring and consultancy services outside of a particular trading company, teams become more global. Data protection and the usage of proper authorization and authentication mechanisms are inevitable. Therefore, step number one in developing any new product, component or whole architecture is setting up the proper structures for granting functional and data permissions and securing the data transfer protocols.

This is an area where IT companies can provide expertise to trading companies, either by ways to customize the usage of already known systems and tools or by helping with the development of in-house systems to ensure the protection of this precious data.

Speed

Given the increasing data flows, speed becomes a significant challenge across the whole cycle: accessing, transforming, synchronizing, processing, storing, querying, and exchanging data. The companies that manage to implement the aforementioned process-cycle the fastest, would usually unlock trade potentials and arbitrages inaccessible to the ones who are slower. By using tools, systems and AI-based, self-learning and training programs, it is no longer a matter of minutes or even seconds – but milliseconds. The maximum response times become a key non-functional requirement in every new development. This is the area where an IT specialist can provide significant value not only for traders but for risk managers as well.

Position management in highly volatile market environments requires not only real-time monitoring and very frequent updates of data. It also requires quick reactions to new market trends. Full excellence and high efficiency can only be achieved by optimizing the whole chain of data flows to ensure maximum speed of data handling and decision making – and respectively, taking the appropriate actions. It is possible to improve in the following areas:

  • Optimizing access to data by caching or querying. This can be done either directly on a database level or via the usage of web-based services;
  • Acceleration of data transformation or processing via standardized ETL tools or own programs/algorithms;
  • Ensuring proper visualization of data to drive informed decisions using proper monitoring and BI tools;
  • Optimization of data exchange protocols and interfaces;
  • Applying proper data storage procedures provides maximum efficiency when trying to extract a particular data set;
  • Last but not least: ensure a proper orchestration of all components driving the data flows

The maximum speed in the above areas often results in maximizing profits and minimizing risks (sticking to the predefined limits) by quickly reacting to market changes, one-off events or reversing trends. This is where investments in IT can provide value and returns.

Reliability

Speed, of course, means nothing, if you cannot rely on the data and the systems. This data should be of the desired quality and without errors or gaps. The systems should be constantly available. With that said, the next challenge is reliability. Without proper validations or constant and continuous/uninterrupted access to it, even the best data becomes worthless.

With the rise of cloud-based technologies, it is possible to deploy services to new services, restart or restore not running machines, and increase computational power remotely within a couple of minutes to avoid long-lasting disruptions or outages. IT specialists can help design the cloud architecture in the best and most reliable way, increase availability and minimize infrastructure/system costs. If traders or risk managers base their decisions on outdated or faulty data, there is a high chance that the decisions are wrong as well, sometimes with significant financial implications.

That is why energy (trading) companies increasingly invest in cloud-based architectures, while still keeping the above requirements on security and speed in mind in addition to reliability and availability. Minimum availabilities are becoming part of almost every contract for IT infrastructure or components. The need for 24/7 incident management and monitoring services increases as well, as trading happens in different locations and markets around the clock.

In summary, with the increased flows and availabilities of data, the volatile market conditions and the ever-increasing online trading, investments in proper IT infrastructure become very important. To maximize returns and minimize risks supported by the proper software and experts, companies need to tackle the challenges related to those continuously and with diligence. IT systems are a powerful weapon – however, if misused, their usage may lead to self-destruction.

Author: Konstantin Grigorov

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