The energy options market’s development is hindered by a lack of option pricing standards and tools. To deal with this, GFI launched Fenics Energy, an option pricing system for the European energy markets, in October. Using GFI’s market data, the system produces benchmark pricing and risk measures for OTC electricity and natural gas options. Fenics – purchased in 2000 by GFI – has already signed up 30 users.
“Compared with some financial markets, energy option volumes are low, but we believe this market is set for strong growth,” says Francesco Cicero, a product manager at GFI Energy in London. “The introduction of a benchmark pricing tool, such as Fenics Energy, will improve standardisation, thereby helping to fuel this growth.” GFI plans to update Fenics Energy early this year, and to introduce a version for the US market.
“It is sometimes difficult to see the emerging liquidity in energy options, but it is interesting from a risk management point of view because these markets are quite volatile,” Cicero adds. “We are helping the market get into the idea of managing and trading risk instead of just prices. The market needs a better understanding of risk parameters, primarily volatility.”
GFI also boosted its trading volumes in both the North American and European electricity markets. Cicero claims a 40% market share in UK electricity trading and roughly 60% in the German market. In France and Denmark, it has a 70% share, he says.
Although independent confirmation of these figures is hard to find, client feedback supports GFI’s claims. “GFI is the number-one broker for German power,” says Manfred Knabl, head of trading at APT, the trading arm of Verbund, Austria’s largest energy firm. “We trade about 70% of our volumes electronically with GFI, because the system is easy to handle, but we also have a good relationship with their voice brokers and tend to use them for the more complex, larger volume trades.”
Knabl says the Fenics software would benefit from more data feeds, which GFI says it will add when it updates the system.
GFI included online trading for European coal in 2001. Traders can now transact electricity, natural gas and coal on a single trading screen. Up to 50% of German electricity and 35% of UK electricity production relies on coal, and this exposure, along with Germany’s plan to phase out nuclear power generation, has increased the need to offset related energy risks. “Hedging future price movements is a key problem for coal market participants, and requires a liquid market with reliable reference prices,” says John Rose, a trader at Duke Energy Merchants in Houston. GFI now claims to handle between 40% and 50% of European coal trading volumes.
GFI has made particularly strong headway in online trading. Michael Gooch, its founder and chief executive, strongly believes in the hybrid model of voice and electronic broking. The firm is hiring voice brokers to keep up with growth in energy trading volumes. “Higher value contracts will always require a voice broker, and options are still essentially a voice broker market,” Ron Levi, managing director of GFI’s London operations, says. “But the spot market for electricity and gas could conceivably become wholly interactive – although the broker market would have to establish a suitable clearing mechanism before this can happen.”
APT’s Knabl agrees that the next big challenge for energy brokers is to arrange an OTC derivatives clearing house. In Germany, at least, this is already in the works. At the end of December, Clearing Bank Hanover announced that it will offer a clearing service for the German electricity forward market beginning this spring, both for clients of GFI and the Hamburg-based energy brokers, powerITS. Other brokers have been invited to sign up.