Energy companies that produce and distribute electricity use the open market to trade power and hedge risk. In addition, many institutional investors seek exposure to energy commodities (oil, gas, electricity, coal and emissions) through managed commodity accounts and single commodity ETFs and ETNs. Hedgers and speculators alike need hybrid solutions to achieve maximum efficiency and transparency in their operations.

Two years ago, energy commodity prices, especially crude oil, were extremely volatile. While moderate volatility tends to spark interest, too much volatility is bad for the market. Market participants, who would typically trade 1,000 units of a commodity to gain the exposure on their book, were only trading 50 units.

"It got to the point where we just had too many shell-shocked traders sitting on the sidelines," says Michael Cosgrove, GFI's managing director and head of its Energy  and Commodities Brokerage in North America. "That hit our businesses pretty hard across the board."

Since then energy market volatility has declined - in fact, implied volatility in natural gas and power has been extremely low, which has had a dampening effect on the market. Still, 2010 has been a better year than 2009 and interest in energy commodities is visible. If the market is to continue to grow, however, participants will need good trading and risk technology to support their business.

Many energy companies still manage their internal order flow on spreadsheets, and the dual key-in increases the risk of errors. Trades are often executed through voice communications and pricing systems are not live.

"There's no real control over what people are entering and no validation," says Richard Everett, product manager, Trading Gateway and Internal Markets at Trayport. "By putting this on an electronic platform that's also real time, all of these risks can be either reduced or removed."

In order to optimise their external market activity, energy producers need to understand the risk profiles of the operating units within their enterprise. To meet this need, Trayport developed its Internal Marketplace platform, which is part of GlobalVision, a configurable transaction and data routing platform. Internal Marketplace enables users to optimise their internal liquidity by tapping into their own inventory and consolidating order flow within their organisations before undertaking the necessary external balancing transactions.

Trayport claims to be the leading platform in the European energy market. The company works closely with major utilities, which have grown their trading floors substantially in the last few years, to develop solutions to meet industry needs. Trayport also has a significant presence in the US.

"Within Europe we have pre-built connectivity to all of the marketplaces, which allows us to enter algorithms to automatically fulfil orders from the internal market externally," says Everett. "In the US, we're still building out that connectivity, but the platform still offers the same risk benefits before the external optimisation."

Trayport also offers Automated Trading, a platform designed for executing sophisticated and high frequency trading strategies. The system connects to all the major exchanges, and traders can choose whether they want to be filled on an exchange, in the OTC market, or go with the best price.

Automated Trading is targeted towards the European market. Like Internal Marketplace, it streamlines workflows and allows traders to automate strategies instead of executing them manually, thus improving productivity.

Traders can create complex spreads within the system that none of the brokers or exchanges offer. Let's say a trader creates a spark spread (the difference between the market price of electricity and its cost of production) for a UK power station. When the target price for the spread is entered in the system, the order is sent to the market and is either filled, or held for execution when the market conditions are right.

All the major energy commodities except oil are actively traded by voice and electronically on Trayport. Yet according to Paul Newman, managing director of ICAP Energy, oil makes up about 35% of the activity in the energy complex. ICAP launched TrueQuote to fill that gap.

TrueQuote is a combined voice-electronic broking service for OTC crude, fuel oil and Middle Distillate swaps. The service offers OTC oil swap customers a screen-supported voice hybrid service with execution and STP to clearing. ICAP TrueQuote is powered by IntercontinentalExchange and is distributed on WebICE, the front-end to ICE's trading platform.

It is the interdealer brokers' job to provide price discovery and transparency, as well as execution. Newman maintains brokers can be most effective by offering a hybrid platform comprising electronic and voice solutions.

"We might do 1,000 deals a day in short date electricity and natural gas. With these high-velocity, low-value transactions, it isn't worth exposing ourselves to human error, so it is better to enable clients to execute electronically," says Newman. "In coal derivatives, where we might only do 100 deals a day, the volumes do not justify an electronic-only market."

Screens are useful for posting prices, even if they are only indications, because it saves time for market participants. But with some transactions, the clients want the broker to provide some "colour" or perspective on the market. These deals lend themselves to hybrid trading.

Similarly, GFI has a proprietary screen trading system on which about 250,000 prices a day are posted. Many institutional customers are logged on to it throughout the trading day, and the prices are live, tradable and fully transparent. Analysts say commodities could be among the first markets to recover from the economic slump. The fact that several governments are planning to invest in infrastructure and energy projects bodes well for the market. Growth will depend on participants' ability to use technology to balance transparency, efficiency, cost savings and liquidity with the practicalities of the market.

Sidebar: The UK, right on the spot

About four years ago, UK power market participants and the Futures and Options Association created the Forward Traders Forum as a framework for discussing ways to increase liquidity. The UK had a natural gas market, but the spot and forward markets were too small to fulfil trading and hedging needs. In addition, the regulators were pushing the industry to increase liquidity and price transparency and boost the market's credibility.

To this end, the European commodities exchanges were asked to submit a proposal for organising a UK power spot market, financial futures market, and a natural gas market. Nasdaq OMX, together with Nord Pool Spot, won the competitive bid and set up N2EX.

N2EX currently has 14 members including the big six power producers, some smaller producers, a couple of Nordic players, and some banks who are trading for their proprietary account or on behalf of customers.

Market participants can connect to N2EX via Nasdaq OMX's Condico platform. Purpose-built for energy and commodities trading, Condico integrates trading and clearing and supports both bilateral and cleared business models. They can also connect via Click, an integrated platform for electronic trading of securities, derivatives, commodities and electricity contracts. The clearing platform supports clearing administration tasks such as amendments, allocations, give-ups, commissions, exercises, transfers, margins, positions and settlement.