My last two jobs have been at retail energy startups. One is headquartered in Copenhagen, and the other is in Manhattan. Both are working at the cutting-edge intersection of energy grid deregulation and climate change. And both are being held back in their success by some of the most antiquated tooling from some of the least technologically proficient software vendors I have seen in a decade of software engineering. I don’t want to rant for too long, so today I am going to focus on forward curves.
What’s the big deal with forward curves?
I explained in a previous blog post that forward curves are an important tool for forecasting energy costs. But if you haven’t read that one let me quickly explain that retail energy providers (REPs) typically buy forward curves from specialist vendors. These vendors have access to valuable market data and synthesize that data into forward curves, which REPs use to forecast their costs.
These vendors typically provide daily updated forward curves across various energy cost components. These forward curves must be updated every day because electricity markets can change very quickly. These forward curves are used to generate prices that customers can accept. If the forward curves are inaccurate, a REP can lose a customer by offering too high of a price, or win a negative value customer by offering too low of a price.
Shooting in the dark
If you aren’t convinced that the accuracy of forward curves is important for REPs to control their costs, then you really should go read the previous blog post I already mentioned. Since accuracy is important, I would expect that the vendors who sell forward curves would also publish metrics on the accuracy of those curves. None do. NONE. I know because I have looked (but let me know if you find one). They all deliver a product for which they provide no guarantees of quality.
Instead, REPs typically assume that the curves they buy are accurate. They generate prices using these curves. Then, when they try to transact in futures markets..they realize the price they can get in those markets is quite different from the price that the forward curves suggested!
This is quite solvable. If the REP tells the vendor that the forward curves are inaccurate, then this whole confusion can be easily resolved. Right?
The dirty truth
There is a hidden assumption in the product model of the incumbent forward curve vendors. They sell the same forward curves to every REP who contracts their services. This implies that all REPs can transact in forward markets equally. Do you think that is true?
Let us put ourselves in the shoes of a counterparty selling year-long futures contracts. Two REPs approach us requesting identically sized contracts. However, one REP is large and established. The other is a recent startup. Should they get the same price? No! The startup could easily default before the contract term is complete!
I have seen that credit rating and transaction size both impact the price that a REP can transact in futures markets. This completely invalidates the model of the incumbent forward curve vendors. And this explains why some REPs will never receive accurate forward curves from their vendor, no matter how much they complain.
It can’t be!
You may protest – “but Max, anyone can transact on the open exchanges and get a fair market price regardless of their size or credit rating”. Yes, you are right, you particularly clever and attractive member of my blog audience. But there are downsides to transacting on the open exchange.
The minimum transaction sizes on the open exchanges are quite large. And I have seen that in general, prices are lower when purchasing from counterparties instead of on the open exchanges. So normally, REPs transact in futures markets through counterparties who have the latitude to provide different prices to different customers.
But I am sure the customer service is good…right?
In addition to the fundamentally flawed products they provide, I have seen some interesting behavior from these vendors.
After a company I worked at complained of inaccurate data (even more inaccurate than expected) the vendor denied it repeatedly and refused to provide any justification.
One forward curve vendor provided data many days late because “the analyst was on vacation and couldn’t upload the spreadsheet.”
One forward curve vendor repeatedly failed to provide data until we prompted them via email. We became the monitoring system that told them when their product was unavailable.
What do we do about it?
This is why I am starting Willard Energy Software. We rely so much on the energy industry, and it needs to be better. Check out our offerings at willard.energy.
.svg)
Comments