European gas traders are increasingly looking to algorithmic trading methods to gain a competitive edge in the fast-moving energy markets, following the technology’s proliferation across equities, foreign exchange and other commodities.
Precise definitions are contested, but algorithmic trading generally refers to a kind of automated trading in which complex mathematical models identify and execute trades with limited or no human intervention, all at split-second speeds.
In the US, automated trading accounted for 53% of all trade of natural gas futures from 2014-16, up from 44% in 2012-14, according to the Commodity Futures Trading Commission (CFTC).
In Europe, the technology has been gaining dominance mostly in power markets. But in June, pan-European exchange PEGAS authorised its first vendor of fully automated algo-trading software, potentially opening the door to its expansion in natural gas.
Power vs gas
“If you look at algorithmic trading today, it’s basically coming from intraday power, because you have half-hourly or quarter-hourly trading requirements there,” Frank van Doorn, head of trading at Vattenfall, told ICIS.
While in power algorithms are often used to execute lighting-fast trades, “with other commodities it will be more about machine learning to find trading strategies,” he said. “Clearly that’s somewhere that we see growth. We’re not active with algo trading in gas yet, but that will be a matter of time.”
Other traders spoke on condition of anonymity, while some declined to comment due to the sensitivity of these tools in their trading strategies.
One gas trader at another German energy major said automation had already become an everyday part of his work. “We use one [algorithm] for within-day activities, linked to the TSO [transmission system operator] buying and selling for balancing purposes,” he said. “The TSO enters a volume order and then it is up to the robots to react to it.”
But not all market participants see increased automation as a positive thing. “The [gas] market is going in that direction. The oil market is already there,” said an Italian energy trader, who bemoaned that his firm lacked the technology to do more.
The managing director of a Dutch capital investment firm active on the gas market agreed. “Those bots are pretty annoying,” he complained. “They basically try to put you in a corner, like a boxer with your back against the wall. If you bid .60, the bot comes with a .625 bid or joins the bid with size.”
Exchange vs OTC
Traders interviewed by ICIS said automation had flourished on exchanges rather than in over-the-counter trading because that is where liquidity is concentrated on the intraday power markets.
Algorithms work best in high-liquidity environments where they can scrape masses of data on prices and volumes and react in increments of milliseconds.
“OTC power intraday is not as liquid,” said Jurgen Mayerhofer, managing director of VisoTech, the software company working with PEGAS. “But we’re discussing with some clients about within-day gas.”
The German trader added that exchanges offer the benefit of anonymity. “Do you want a broker to see that you go up and down like crazy?”
On Europe’s benchmark gas market, the Dutch TTF, OTC trade dwarfs exchange platforms with 78% of all traded volumes, according to the latest ICIS data, and continues to increase its dominance. But exchanges’ lead with automation may prove hard to break as the technology becomes increasingly embedded.
Wherever trade takes place, automation is reshaping the industry. Vattenfall has created a dedicated algorithm development team, while Russia’s Gazprom is building its own algo trading platform.
“It’s slowly affecting the structure of the organisation, and we are likely to see fewer [manual] traders,” admits Vattenfall’s van Doorn.
For Mayerhofer of VisoTech, that represents an opportunity. “I would think, especially for the power intraday market, that in future most trading will be algorithmic. There will be no place for a manual trader there because they will be focused on improving the algorithms. For gas, I think it will take a bit longer.” ICIS
Article written by Patrick Sykes and published in ICIS on July 20, 2018. © 2018 ICIS
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