MEMORANDUM
To:
From:
Re:
Michelle Michot Foss, Ph.D.
Chairman & CEO of Energy Inc.
Challenge Partners (Rex Coppock, Larry Jones, Raj Mehta, Kiran Parthasarathy
Alison Stringer, Nancy Tjiawa,)
The Role of IT & the Internet for the Energy Trading & Marketing Industry
Energy Trading and Marketing functions are playing a more dominant role in many energy
companies as markets begin to deregulate domestically and internationally. With improvements
in technology and maturing markets (e.g. oil and natural gas trading), this segment is
experiencing high growth and competition. This is leading to narrowing margins. With the advent
of the Internet and the “go e-commerce” trend, many industries are forming electronic
exchanges to make business processes more efficient and cost effective. The energy industry
is no different. Just recently, there have been announcements on the formation of Internet
based trading exchanges by a number of major industry players and their financial counterparts.
The use of the Internet for carrying out energy trading and marketing (“T&M”) activities is
becoming a norm.
While T&M activities are moving towards the Internet, there are a number of issues to be
addressed. Traditionally, T&M activities have been based on relationships and networking.
Traders and brokers negotiate and transact most energy commodity deals over the telephone.
This traditional approach can serve as a gateway to Internet based trading. In addition, the
nature of commodities being traded is expanding. Certain commodities, such as electricity, are
immature due to the limited liquidity of contracts in the markets.
An effective electronic marketplace can help foster creativity, innovation, and higher revenues.
In today's wholesale energy market it's crucial that operations are made efficient to reduce
overhead and to boost profitability. With the increases in trading volume, traditional tools of the
job (i.e., the telephone and fax machine) cannot keep pace with this vast and rapidly changing
market.
Furthermore, Internet based technology can lead to more liquidity as it offers consumers not
only the ability to easily compare multiple prices on the basis of many factors but also to
compare and understand arbitrage opportunities on product variations as well. Being able to
view all offers available and to have the ability to compare them is what many would say the
Internet is perfectly designed for and there may be no better application of such than to the
energy industry.
However, according to the Forrester report, online trading models are geared towards shortterm deals, which are more volatile in terms of pricing. These kinds of deals also tend to be last
minute, arising from a situation such as a natural disaster or a power outage. Longer-term
deals are not suitable because they require longer, more complex contract terms and a more
service-oriented approach16. As the trust and experience in electronic based trading grows over
time, we believe many types of deals will transact via the Internet.
Some other potential benefits that electronic forums provide is a standardized process for newer
traders to follow and the ability for smaller players to have equal buying and selling power
through anonymity. This improves price discovery, reduces the per-unit cost of a trade, and
speeds overall trade execution. Additionally, through computer technology, electronic trading
systems can improve the process of tracking positions, pre-approve and manage counter
Page 1
parties and real-time credit limits, maintain high data integrity, monitor and control traders, and
reduce the risk of human error and personnel administration costs.
Thus, migration to an Internet based trading platform (in some form) seems to be the path that
Energy, Inc. will need to take. In order to understand the issues and applicability of Internet
based technology for the Challenge Partner segment of Energy, Inc., we will: 1) analyze the
major trends in the industry; 2) identify and evaluate the major players; and 3) identify the
potential opportunities and challenges. In order to stay competitive, it will be beneficial for
energy companies to identify and develop a clear strategy related to trading information
systems.
I.
MAJOR TRENDS IN THE ENERGY TRADING
A. Industry Trends:
The following are examples of some current trends within the electronic energy trading
industry:
 On March 21, 2000, seven leading banking and energy companies announced that
they would work together to launch an online electronic market for over-the-counter
(OTC) trading in energy, metals, and other commodities. The new exchange will be
called the Intercontinental Exchange14. Currently, the bulk of trading in the
wholesale OTC energy and metals markets is conducted on the telephone. Beyond
the benefits of electronic links, the exchange will create a “paperless back office”.
 Another example of a major strategic alliance is Altra Energy’s alliance with major
market makers – American Electric Power (AEP), BP Amoco, and Koch Industries.
The goal of the alliance is to increase the volume and liquidity of energy products
and to strengthen its position as the leading independent online trading exchange for
the energy industry.
 On April 13, 2000, six of the largest gas and electricity marketers in the U.S.
announced they have formed a new independent energy trading consortium, which
will own and operate an Internet-based, business-to-business, over-the-counter
energy trading platform. The new trading platform is expected to be in operation by
the end of the year and will be open to all wholesale energy industry participants.
The consortium’s members are American Electric Power, Aquila Energy, (a
subsidiary of UtiliCorp United) Duke Energy, El Paso Energy, Reliant Energy and
Southern Company Energy Marketing (a unit of Southern Company). Each of these
companies is among the top 10 U.S. marketers in either gas, electricity, or both.
“This Internet platform initially will offer an over-the-counter market place for natural
gas and electricity in North America," said Paul Addis, President of AEP Energy
Services, Inc. "But we expect to expand our business to include natural gas liquids,
coal, weather derivatives, crude oil and other energy-related commodities and
instruments as those markets develop." The platform is expected to deliver a number
of benefits to users compared to the smaller platforms, single dealer systems, and
phone brokers currently used for energy trading.
 During 1998, the industry experienced losses in the power market due to lack of
understanding and quantification of various risks involved in energy trading.
Subsequently, the industry has studied various risk management systems used in
other sectors (such as banking) and realigned them for use in the energy markets.
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Examples of these are VAR modeling and calculation of credit risk models. Due to
the volatile nature of the energy industry, electronic trading systems should be fully
integrated with a robust risk and transaction management system so real-time data
flow can be seamlessly intertwined through the company’s front-, mid- and backoffice functions.
Other trends in the industry are the growth of trading volumes and expansion of energy
trading and marketing operations into international markets, especially European
markets. An Internet based system will efficiently handle such increases in growth of
trading volumes, especially in the power market given the recent restructuring of the
industry. Additionally, Internet technology, which is already global in nature, can
effectively facilitate the international expansion of energy trading.
B. Technology Trends
Throughout the 1990’s, corporate America built up multiple stovepipe communication
networks and protocols and ventured into the wide area network (WAN) to increase
internal communication between various business segments, domestically and
internationally. EDI became accepted for standard billing and invoice processes.
Enterprise wide planning was a thought instead of a realized goal. Efficiencies from
streamlining operations and eliminating redundancies came and went with the “STRIVE
FOR QUALITY” initiative.
Leading us into the promise land of e-commerce is the Next Generation Network (NGN)
with its promised cost efficiency and redundancy elimination. People will work smarter
not harder as they incorporate the new technologies into their everyday work life. The
NGN is a combination of strategic alignments between IT and business units. It is
designed to optimize business design processes and establish a competitive edge in the
marketplace. It will eliminate the problems of legacy systems by standardizing desktops,
incorporating Internet Protocol (IP) to network systems that aid in the decision process. It
combines voice, video, and data in a single integrated package that can be transmitted
over a common network. The term “ubiquitous connectivity” can be used to describe the
reach of the NGN as it provides information from the wellhead to the retail gasoline
pump.
What the acceptance of IP offers is a common language that can be used to speed
decision processes and deploy enterprise wide solutions quickly and efficiently. It aids in
the enforcement of corporate security enforcement and aligns IT with business. It forces
the company to optimize the entire value chain from exploration and production to
marketing and distribution. The NGN pushes forward the concept of flexibility,
nimbleness, and agility. Speed is essential in this process where first mover typically has
an advantage. In addition, IP based instrumentation, SCADA, and knowledge based
platforms will be used and is currently being used to transmit information real time.
How does this apply to Challenge Partners? Key to any successful trading organization
is the quality and quantity of information that can be gathered and disseminated into
useful trading data. The ubiquitous connectivity mentioned above would give the traders
and scheduler’s real time information of supply and demand issues before competition
has a chance to react. The company can be proactive when it comes to leveraging its
assets in face of new information. The typical trading and supply organization interfaces
with upstream, midstream, and downstream business units. Information is exchanged to
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manage price risk for the producer in case prices fall, and for the refiner is case prices
rise on the input side of the refinery and fall on the output side. The opportunities do not
arise so much from the fact that the business units need to buy and sell products, but
instead the opportunities arise when the business units can optimize their strategy when
they know what the alternatives are. By knowing inventory levels and demand forecast,
a NGN aligned organization could conceivably optimize wellhead production, divert
truckers, increase or decrease peak or non-peak pumping on pipeline stations, increase
or decrease product delivery based on contract tolerances (standard international +/5%), while the trader adjusts hedges reflecting the changes with the NYMEX exchange
or an online partner. The integration of the entire business process is just the beginning
of the trade cycle.
The cycle continues with the outfitting of an organization for trading, especially online
trading. Trading online replaces the traditional phone trading with OTC brokers and
replaces these traditional liquidity providers with a new breed of broker, a cybermediary.
Standard plain vanilla financial settled instruments can be traded online without much
effort. Standardized contracts for most any product can conceivably be traded online.
Online trading is much more efficient then traditional methods because it saves people
time as it eliminates the need to shop for the lowest bid-ask spread, or specific quality, or
specific quantity, and it saves on broker commissions. The trading department assumes
the risk in these trades and therefore must have systems to measure the various types
of exposure. The basic types of exposures are outright price exposure and spreads
exposure (inter-period, inter-commodity). Most financial institutions have systems that
measure, interpret, and report these parameters fairly well. Online trading should pose
no threat to these measurements. The other type of error frequently incurred is
operational risk. Operational risk includes modeling error, keypunch error, data entry
error, or security issues. All are heightened with the volume transacted online and will
therefore require additional resources to manage exposure.
C. Extend Online Trading to Online Scheduling?
Today, most schedulers in an office use phones and faxes to schedule the flow of gas or
electricity through pipelines, grids etc. We think that the next step for the major industry
players would be to provide online scheduling services as well. This is likely to have a
significant impact on lowering processing time (reduction of time used on phones and
faxes), increasing accuracy, and lowering the number of staff required to process trades.
It would also present traders with more price arbitrage opportunities between trading,
storage, and transportation, as the underlying constraints become more transparent.
This forecast is be confirmed by the Altra press release that is discussed later in the
paper. However, this system would still require companies to hire some schedulers who
would use online web based systems to schedule the flow of gas or electricity.
The next possible step would be to provide companies the option to outsource the entire
scheduling activity to the energy online provider, such as EnronOnline, for a fee or a
charge built into the bid offer spread. This would help companies to concentrate their
resources on the trading activity, analyze exposures and develop tools to track markets,
positions, strategies and focus on high profit based structured products. For the online
energy providers who also provide scheduling services, the operation would have higher
economies of scale that would provide higher profitability.
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II.
MAJOR PLAYERS
This section of the paper will primarily focus on the major players in online energy trading, the
key features of their systems, and the software they use.
A. Altra Technologies17
History
Altra was formed on January 1, 1996, by PanEnergy and Williams of Tulsa (PanEnergy
later became part of Duke Energy). The sophisticated electronic trading systems of
Willams and the support systems of PanEnergy were combined to form Altra. On
December 5, 1997, technology venture capital firms Battery Ventures and Austin
Ventures purchased 100% of the partnership interests in Altra. In 1999, Altra bought
Quicktrade and merged the platforms into the new Altrade product. The company also
merged with another ‘electronic risk management’ company to form its risk management
service division based in Atlanta.
Key features of the real time systems offered by Altra
 The natural gas liquids system that is offered by Altra is a brokerage system for
trading of crude oil and Natural Gas Liquids.
 Buyers and sellers exchange bids and offers anonymously. After the deal is
finalized, confirmations to both companies involved in the trade are carried out
through the regular process.
 The Altra Gas Suite has three components to it: Electronic trading (which has been
explained in the first two points above), Scheduling and Delivery, which has three
sub components (explained next) and Altra Risk.
 Altra’s Scheduling and Delivery consists of Altra Gas, Altra Pipeline and Altra Web
that allows Altra users to schedule gas, view purchases and sales, track energy
positions and generate remittance and invoice statements. The system helps run the
business process of scheduling and delivery at a more efficient and profitable rate.
 The Altra risk system is an enhancement to the Altra Suite that helps the traders
understand the various risks of their portfolio with the help of tools such as
sophisticated graphs and charts.
 The Altra Suite for trading Power is identical to the gas suite with three major
components: Electronic Trading, Scheduling and Delivery and the Altra Risk system.
All major power hubs in the country are covered in the Altra trading system. The
major ones being Palo Verde, Mid Columbia, PJM, Entergy, California Oregon
Border, Comed, Entergy. Altra’s system also covers some emerging trading points
like ERCOT, NEEPOOL and Florida Georgia Border.
Some recent milestones for the Altra system
In a recent press release, Altra has claimed that more than 340 traders representing
electric utilities, power marketers, municipalities and independent power producers have
installed Altra Power. For its power trading system, Altra reached a daily trading volume
of more than 2.1 million-megawatt hours of power which it claims is a record. Also, in
February 2000 more than $400 million worth of power deals were traded on the Altra
system, which according to them represents a 328% increase since November 1999.
On April 12, 2000, Altra announced an alliance with PROS Revenue Management to
integrate PROS’ revenue management tools into the trading software provided by Altra.
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The product is scheduled to be launched in the third quarter of this year. This could be a
significant source of sophistication for the Altra system and could help Altra secure a
niche market of clients who are interested in advance management of their trading
revenues. Further, this product would consist of a system that routes gas from supply to
market with minimized transportation and fuel costs and maximized buy/sell
opportunities at pools and interconnections. According to the press release, the system
has been measured to provide 7% to 25% increases in related revenue.
However, it has to be noted that Altra’s system is not accessible through the Internet.
The Altra software is installed for a fee in the various companies who register for the
software. It is believed in industry circles that the recently introduced EnronOnline is a
more powerful and flexible system. Its Internet platform combined with the fact that it is
not fee based like Altra makes it a very serious contender for the number one position in
the online energy trading industry. Here are some more details on the EnronOnline
system.
B. EnronOnline18
EnronOnline was introduced in October 1999 by Enron North America and was
positioned as a business to business online trading system with ‘web-based commodity
transaction capability’, free of charge. EnronOnline covers traditional commodities such
as gas, power and crude oil as well as new areas such as weather derivatives.
Some of the major features of EnronOnline
 Competitive pricing in real time
 EnronOnline provides coverage around the globe including Asia, Europe, Americas
and plans to serve other markets as well.
 As discussed earlier, EnronOnline is a provider of access in energy markets as well
a variety of other commodities such as pulp &paper, plastics, emission allowances
and weather derivatives.
 EnronOnline provides these services in various currencies.
Technical features of EnronOnline
 EnronOnline uses Security Socket layer (SSL) protocol to maintain high level
security and encryption of data. This protocol also provides server authentication,
message integrity and client authentication. The SSL protocol scrambles and
unscrambles the data to maintain data integrity (technically referred to as
‘encryption’).
 Traders who use EnronOnline consider it a high-speed system that can keep up with
moving markets.
 A master user account authorizing one user in every authorized company is given.
Then that master user can validate other traders to use the system.
 A user ID and password is required to login into the system and transact business.
As EnronOnline is a web based application, it has very simple system requirements
which are:
-Internet connection
-A Web browser (Internet Explorer 4.0, Netscape Navigator 4.0 or newer versions)
and a Macromedia shockwave which is commonly available with the browser.
 EnronOnline also has the advantage of being a 24 hour system that facilitates
trading at any time to take advantage of market opportunities.
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Some statistics on the performance of EnronOnline
 According to a news report in Gas Daily, EnronOnline saw 70,000 transactions
executed since its launch late last year, representing a US$ 27 billion gross revenue.
 In the first quarter of 2000, 39% of Enron’s wholesale transactions and 27% of the
volumes were executed through EnronOnline.
 It is believed that the 31% increase of Earnings Before Interest and Tax (EBIT) for
the first quarter for the Wholesale Energy group was mainly attributed to
EnronOnline.
C. New York Mercantile Exchange (NYMEX)20
The NYMEX is a Futures Exchange that facilitates online trading for standardized
contracts, standardized amounts, and maturities. The positioning of NYMEX is different
compared to EnronOnline and Altra and the likes of Houstonstreet.com in that NYMEX
has standardized terms and requires members to post margins when the contracts are
out of the money. The other energy online providers deal with over-the-counter products
and this is the main distinction. The volume of contracts is the highest at NYMEX in the
entire energy industry. A wide variety of swaps and options amounting to several billion
dollars are traded on the exchange everyday.
Although Altra, EnronOnline and NYMEX are the major players in the industry, there are
also a few newer players who are following the industry leaders in the market and trying
to establish a presence and gain market share. One example is Houstonstreet.com.
D. Houstonstreet.com19
Houstonstreet.com is an online trading exchange that has been formed recently with a
$6 million investment by Equiva Trading Company, the trading arm of the US Alliance of
Shell Oil for downstream products, Texaco Inc. and Saudi Aramco. It is a majorityowned subsidiary of Baycorp Holdings, Ltd. and headquartered in New Hampshire. The
chief features of Houstonstreet.com are that it is a web based exchange and can be
easily integrated with back office and support systems in companies that use the
platform for trading. It is not anticipated that Houstonstreet.com will gain a majority
share in this nascent market as the industry leaders EnronOnline and Altra have already
established a lead in the marketplace. However, unlike the other major players in the
energy online arena, Houstonstreet.com does specialize in the area of refined products
and may be able to capitalize on the fact that other dot coms do not focus on this
particular segment. By offering all grades of gasoline (regular, midgrade, and premium
unleaded) and distillates (high and low sulfur diesel, resid, and jet fuel), a niche market
may be available for Houstonstreet.com to capture.
E. Intercontinental Exchange
As discussed earlier in the industry trends section, seven large players in the energy
industry will create this exchange and commodity markets to provide an online electronic
market for over the counter products. This exchange is expected to generate significant
liquidity in the market because these companies will be funneling their own captive
business through the exchange.
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III.
IDENTIFICATION OF POTENTIAL PROBLEMS AND CHALLENGES
A. Efficiency
Spreadsheets and telephone conversations are currently utilized as the primary tools in
energy trading and marketing companies. It is believed that online systems, on the other
hand, create opportunities to realize market efficiencies by concentrating on market
dynamics rather than relying on conventional trading systems such as telephones and
spreadsheets to maintain and track data internally.
Some have asked whether these efficiencies can be realized or whether online trading
will simply create the need for more traders and more tracking of data. There seem to
be differing views of this question from people close to the industry. For example, Leigh
Spangler, President of Latitude Technologies in Houston, agrees that online trading will
create “more efficiency, more deals, more data – smaller margins – but possibly fewer
traders”1. Sue Dietrich of Baltimore Gas & Electric (BG&E) has an opposing view as she
responds to this same question as it relates to imbalance trading of natural gas. She
believes that instead of gaining efficiencies, more work would actually be created and
“even if the trading process is completely automated, there will be a certain level of
administration that will be required”2. BG&E has looked at this issue and found that “the
last time they approached the subject of imbalance trading, the cost of automating the
process exceeded the cost of having one or two employees maintaining phone calls and
spreadsheets”2.
One can look around the marketplace, however, and see a lot of movement and support
for online trading that suggests that people within the energy industry believe online
trading is valuable and here to stay. One can also infer that because the industry sees
online trading as valuable, they must also see that there are indeed efficiencies to be
gained by embracing online trading. BP Amoco Group Chief Executive John Browne
announced in March of this year that his company would only “refine about 60-70% of its
daily requirements for refined oil products and would trade for the remaining balance on
the online market”4. Browne went on to suggest that online trading will grow rapidly and
predicted that approximately 20% of the market will participate in online trading within a
year. BP Amoco has recently announced its affiliation with the Intercontinental Exchange
in Atlanta4. Additionally, a recent survey by Energy Argus found that the use of
electronic trading platforms for execution of wholesale power trades has increased and
now makes up about 26% of the total market. The increase in popularity was attributed
to efficiency-related factors such as instant credit screening, anonymity, and speed of
execution. Another factor was the ability to visually rather than aurally witness and
execute trades (i.e. witnessing and executing trades via the telephone such that one can
only hear rather than see what is
Exhibit 1
happening)5.
1
5
£26.95
In summary, it appears that online
trading is increasing in popularity and
at least part of that popularity may be
attributable to the opportunities that
online trading creates to realize
market efficiencies. For example, as
seen in diagram (Exhibit 1), tab {5}, if
on-line trading is integrated with the
Contract Administration
Trading
(Deal Capture)
System
Internet
Based
Trading
Exchange
4
2
Traders
Credit
Management
System
Credit Management
Group
3
Risk
Management
System
Risk Management
Accounting
(G/L, A/P,
A/R)
Accounting
6
Page 8
Other
T&M
Companies
trading and back-office function, efficiencies could be gained as there will be limited
human intervention compared to tab {6} and tab {2} where a trader has to manually enter
the trade into the trading system.
B. Price Transparency
One of the problems facing the energy-trading environment today is that there is no price
transparency in the OTC market. Online trading creates opportunities to be a market
maker and to gain market share in a more perfect market environment. To elucidate, if
transactions are processed online, energy marketers can act on information in a more
timely manner.
Support of the creation of price-transparency in today’s energy market can be seen in
many areas. BG&E’s Sue Dietrich suggests that “marketers can definitely act on
information in a more timely manner”. Through BG&E’s delivery service system, reports
and information is provided to marketers and customers several times throughout the
day. Ms. Dietrich suggests that by having these updated reports available, “marketers
are able to more closely monitor their customers’ usage and react appropriately” 2.
Having information available online also decreases the possibility of penalty situations.
The earlier a marketer can respond to an imbalance the better”2. Mr. Spangler of
Latitude Technologies believes that “at a minimum online trading creates a widely
viewed ‘benchmark’ price that is more current than waiting for tomorrow’s Gas Daily” 1.
BP Amoco’s Chief John Browne suggests that online trading will make markets more
transparent and competitive by bringing in more bids4. In a recent venture among seven
banking and energy companies to launch an online electronic market for OTC trading in
energy, metals, and other commodities, the venture suggests that it will offer OTC
participants “increased market transparency, liquidity and efficiency while preserving the
anonymity most market participants require”5.
The online trading environment is a
perfect place to bring buyers and sellers Exhibit 2 (Source: Whitepaper from Nexus Software Homepage)
together and to allow them to collect
information and compare prices. This
concept is proliferating throughout all
industries and segments of the economy.
Online
Trading
Increasingly we see retailers of book,
Exchange
clothes, CDs, cars, and many more taking
their products to the online marketplace
and the energy industry is no exception.
In summary, it seems that price
transparency could certainly result from increased online trading as information is made
more readily available via the online environment, as more deals are brought to the
table, and as it becomes easier to bring buyers and sellers together. As seen in Exhibit
2, online trading can facilitate price transparency as buyers and sellers are allowed to
interact in one central place rather than being forced to contact each energy company.
C. Segmented Markets
The end user segments of energy markets are very fragmented. Retail markets are
priced very differently than wholesale markets. Energy, Inc. is faced with the challenge
of expanding into various market segments and online trading can facilitate such
Page 9
expansion. It will be important for Energy, Inc. to face this challenge as competitors in
this industry are already making inroads into online trading.
While much of the discussion and evolution in the electronic marketplace has taken
place so far on the wholesale side, it is believed that electronic markets will begin to play
an important role in the retail energy marketplace as well. This segment of the market is
still very new because thus far customer choice in states that have deregulated has
moved at a very slow pace, slower than many market observers expected. Much of this
sluggishness can be attributed to consumers’ lack of understanding of what is happening
in the deregulated industries and what their options are. It is argued that an electronic
marketplace could be a “fix” to this problem. It is believed that the electronic marketplace
could be a key component to a company’s retail marketing and customer acquisition
strategy. Several reasons can be identified in support of this theory. These include the
suggestion that the Internet is a more appropriate medium (as opposed to TV, print or
radio) to explain the new retail energy market to consumers. It is also more likely to
reach the informed and educated consumer, and therefore, the Internet can be used to
more effectively target certain consumer groups7.
Internet-based electronic marketplaces are beginning to emerge for the retail side of the
energy business. These include “listing” websites very similar to those used in the real
estate or travel industries. These sites provide a place for consumers to view lists of
energy suppliers and offers. One such service is ENERGYguide.com operated by
Nexus Energy Software. ENERGYguide.com was the first electronic market in the retail
electricity market. It currently operates in all states where markets have been opened up
including California, Pennsylvania, New York, Massachusetts, and Rhode Island. There
has also been an auction-based approach used on the wholesale energy side that might
also be applied to the retail side someday. Energymarketplace.com, which is operated
by Southern California Gas, offers a service that allows companies to post electronic
RFPs for suppliers. It is currently aimed at larger commercial and industrial companies,
but could eventually be used in some form for the retail energy marketplace. Many
suppliers are hesitant to participate in a marketplace that is shared with competitors, but
there are several reasons that this type of participation is beneficial to suppliers. One, it
has been demonstrated that electronic markets “yield tangible benefits to sellers,
including lower overall transaction costs and wider distribution of information” 7. It is also
thought that electronic markets could play a vital role in ensuring the success of
deregulation. Finally, energy suppliers need to be comfortable with differentiating
themselves from their competitors. They need to be able to sell their “brand”, which is
important in almost every industry7.
It is clear that there will continue to be progress and change both, on the wholesale and
retail side, of the energy business. Currently, there are opportunities for suppliers on the
retail side to take an active role in shaping and developing the retail electronic markets.
Specifically, suppliers who become first movers and early adopters of this technology
can “learn how to best take advantage of these markets, more quickly adjust their
marketing strategies, and ensure that they can influence these markets to develop in a
manner beneficial to the industry in general and themselves in particular”7.
D. Structured and Exotic Transactions
Internet transactions can be broken down into two categories: low touch and high touch.
Low touch is synonymous with books, compact disks, calendars, crude swaps, and
Page 10
spread options. These are items or transactions that can be easily managed and serve
as the foundation of Internet business. These are typically low risk and low rewards
transactions, but serve as an entry point to acquire and cultivate customers. High touch
items are shoes, cars, shirts, swaptions, and collars. There is a myriad of OTC derivative
instruments, butterflies, condors, strangles, straddles, strip, straps, and fences that can
all be purchased or sold on the NYMEX exchange. The advantage of transacting these
instruments over the Internet is that you can customize the deal to a particular location,
for a non-standard pricing period, and for various quantities. Typically these are
European option structures (OTC) as opposed to American option structures (NYMEX).
Yet it is this customization that makes it difficult to apply the transactions over the
Internet. It is not the calculation of risk measurements or valuing the instruments that
make these difficult, it is structuring of the deal that makes it difficult to automate the
process. Finding a counterparty willing to take the opposite side of the trade may be
difficult if not impossible as will the associated credit risk. The alternative may be that the
online exchange will house the basis risk and will manage that risk within their portfolio
parameters thus allowing the trade to take place.
E. Return on Investment
If Energy, Inc.’s T&M operations will be Internet based, it (as in any IT initiative) will
require significant financial resources. What is going to be the Return on Investment
(ROI)? Though our findings on ROI for energy e-commerce turned out to be fruitless,
there are many generalities that can be inferred from general e-commerce and that can
provide insight to “would be” energy online sites. Also, there are new technologies on the
horizon that ROI information was not available for, but that we believe are worth
mentioning because they will be the up and coming e-commerce drivers.
Everybody realizes that e-commerce is growing quickly and that it is considered wise to
be a “player”. The business-to-business (B2B) transactions account for about eighty
percent of e-commerce because they offer tremendous transaction cost savings and
distinct advantages such as customized billing, reduced inventory costs, lower carrying
costs, extended reach, richness, and affiliation9. By streamlining the purchasing process,
reducing unnecessary buying, aligning strategic suppliers and distributors, business
process cycle times can be reduced by 50%10. Eighty percent of B2B in 1999 accounted
for revenue exceeding $150 billion and it is believed that this revenue may approach $3
trillion by 2003. Recent quarterly reporting has shown that e-commerce does indeed
generate business, but that this business comes at lower margins8.
Most benefits come from economies of scale, cutting costs and intermediaries, and from
cheaper distribution. There is also a lower working capital requirement because online
retailers typically get paid immediately and usually pay the distributors later. Since
Internet sites are scalable, they can be easily adapted to new product lines and easily
expanded to reach global markets thereby reducing the marginal cost of adding one
extra item or customer.
On the negative side, maintaining a web site to 99.999% reliability is very expensive.
With so many online sites adding physical markets to their offerings, logistics and
distribution become a critical component and thus receives a heavy amount of funding to
insure customer satisfaction. To relate how important these factors are, one needs to
remember the debacle in order fulfillment during the Christmas 1999 season, specifically
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TOYS “R” US and Wal-Mart . Both were unable to deliver online items and have since
retooled their distribution systems (at great additional costs). Two key factors played a
critical role in the failure of these retailers, wrong type of distribution system and shipping
costs. Both Wal-Mart and TOY “R” US are geared to wholesale distribution whereas
online retailing is geared to individuals. Secondly, the shipping costs proved to be a
deterrent. Another factor that leads to a site’s success is the amount of marketing
employed to attract customers to their site. Termed acquisition costs, these have proven
to consume a major portion of the overall marketing pie due to what is known as the
“network effect”. Network effect allows e-tailers to warehouse data in an effort to
customize offerings. Therefore, the more use the site achieves, the more useful the site
becomes to the e-tailer.
Related to new technology, a few items worth noting are discussed These will again
prove challenging for energy e-commerce. For instance, investment returns in security
technologies such as SMART cards or DIGICASH may not be realized instantaneously
as consumers overcome security fears of credit card use over the web (or at the pump).
Business-to-Consumer e-commerce is finding it difficult to assure credit card payment
given the media reports of hackers breaking through security firewalls. Two new
technologies that will receive great attention in the coming months are Internet
Telephony and Voice Recognition Software. These two items are surely to make a great
impact on B2B as it currently exists due to the broadband trading efforts being put forth.
F. Managing Security
One of the biggest concerns for doing business on the Internet is security. Online
trading will involve significant investment of resources for management of IT security in
online transactions as well as deal capture and internal processing of transactions in the
middle office and back office. Therefore, the entry strategy for online trading has to be
carefully planned out and implemented such that there is no IT breakdown leading to the
collapse of the trading organization.
The implementation of an interactive system on the Internet will require additional capital
expenditures on equipment such as servers and software. In addition, twenty-four hour
seven day a week third party security monitoring should be employed to effectively
combat any hacker attacks. Also, it will be important to bring in an Internet security
auditor during the conception and design phases of the project.
Security is not just an external issue but an internal one also. It must be remembered
that most of the large losses in the trading industry occurred because a lapse or total
lack of security, monitoring, and control of internal processes. Electronic trading has
made rouge trading easier for the technically gifted and so a more concentrated effort
must be made in establishing a thorough internal security model.
Another issue related to Internet security is positive identification of parties in order to
avoid repudiation of any trade transaction deals. Traditional methods of identification
through use of ID and password are not very effective as passwords can be guessed.
Digital certificate based authentication is the future for addressing repudiation issues in
doing business on the Internet. Implementation of PKI (Public Key Infrastructure) should
be considered for Digital Certificate based authentication of parties.
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G. Maintaining State of the Art of IT systems
The energy industry as well as the IT industry is changing and evolving rapidly. It will be
a challenge to ensure that the technology infrastructure built today by Energy Inc. will
support the future business environment as new players start building more
sophisticated systems in the future.
Commitment to market leadership in today’s new economy is a commitment to
technology leadership. In today’s market a company’s market share can be quickly
eroded by competitors that have faster and better technology. This fact coupled with the
staggering pace of technological advancement means that Energy Inc. will have to be
committed to a never-ending cycle of capital expenditures for software and hardware
upgrades. As an example, Enron capitalized over $240 million in software costs alone in
fiscal year 1999.
In building the technological infrastructure a fine line between tried and true technology
and cutting edge technology must be walked. The use of cutting edge technology can
push out the time to replacement as much as a year to a year and a half but can have
serious pitfalls in reliability. While the use of tried and true technology reduces or even
eliminates the reliability issues, it can expose the company to more advanced
competitors and will have a shorter life span.
H. Customer Service
Companies will need to consider how customer service will be impacted by online
trading systems. While it will create opportunities for customers to transact twenty-four
hours a day and seven days a week, online systems could also create frustrations for
customers when they are not able to interface directly with a “live” person.
We are still a long way from online trading by true “end-users” (e.g. small industrials, dry
cleaners, etc.). Most users of online trading will be traders and sophisticated buyers, for
whom a “live” person is not as important as the transaction itself. In addition, as every
day of the new economy dawns, the consumer is becoming more and more comfortable
with transactions that don’t involve that “live” person. By the time most end-users are
trading online they will never have experienced the “live” person transaction in this
industry. This is not to say that there will not be any customer support and customer
service offered because there will be, but it will be as automated as possible.
IV.
CONCLUSION AND RECOMMENDATIONS
As in many industries, the Internet is revolutionizing most of the business processes to take
advantage of efficiencies, whether it is in reducing costs (such as e-procurement, administrative
costs, etc.) and/or increasing market reach. According to Forrester Research, barely 2% of
natural gas and 0.2% of electricity was traded online in 1999. The expectation is that these
percentages will go up in the next few years (natural gas -25% by 2004). However, Enron’s
experience with 45% of its trading via the Internet during March 2000 indicates that this
migration may be faster.
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According to Leigh Spangler, President of Latitude Technologies, Internet trading in the gas
industry for both daily transactional needs as well as longer term activities has been increasing
steadily, but not quickly enough.1 However, the forced implementation of Interactive Web Sites
by interstate pipelines on June 1, 2000, will move many players to the Internet that have not
been there (at least on a daily basis) previously.
Thus, due to competitive reasons and other issues discussed earlier (i.e., efficiency, price
transparency, segmented markets, etc.), Energy, Inc., and especially the Energy Trading and
Marketing sector needs to embrace the Internet as the next key business initiative. To
accomplish this, there are three alternatives for Energy, Inc. to consider:
1. Form an alliance with other key players to form an independent energy trading consortium
2. Use services of other Internet based bulletin boards such as Houstonstreet.com or Altrade,
Altra's independent online energy exchange
3. Create our own Internet based online trading system like EnronOnline.com
Alternative 1
Advantages:

Implementation cost of
this initiative will be
lower as it would be a
joint effort with other
companies (sharing of
cost).

Potential for better
technological solution
as diverse experiences
can be drawn from to
create/design this
technology and
process.

By bringing the trading
power of all the
business partners, the
electronic exchange will
be more visible – draw
more business, thereby
increasing throughput
and liquidity in the
market.

This would give us the
opportunity to
customize (to an extent)
the technology that
would fit our needs
(e.g.: integration with
mid-office and backoffice technology)
Alternative 2
Advantages:
 Least costly of all the
choices.
 We should be able to
calculate the ROI more
easily as out of pocket
expenses are known.
 The exchange chosen
would be a proven
vehicle.
Alternative 3
Advantages:
 Would be custom
developed to address
our needs. Potential for
integration with all the
other supporting
business processes.
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
Though there has been
talks about forming
exchange alliances
between a number of
energy companies,
nobody has yet
Alternative 1
Alternative 2
Alternative 3
Disadvantages:
Disadvantages:
Implemented it. If acted
upon quickly, we can be
a first mover.

Potential for having a
shared system of credit
and contracts
management and
billing.
Disadvantages:

Development will be
more costly than using
an existing exchange.

The potential alliance
partners may not agree
to the technology
design.

The ROI will be
unknown

There will be no
integration with mid and
back office. Thus, not
much efficiency will be
gained.

Most costly to develop
and implement. Also,
benefit of other
company experiences
will not be available.

There is no competitive
advantage.

May not have the same
attractiveness as a
consortium due to the
limited volumes.

By the time we
implement it, other
companies may have
formed their online
exchanges.

The ROI will be
unknown
Based on the above comparison, Alternative 1 appears to be the best choice. The keys to
success for implementing this strategy include:

Forming an alliance with the right partners:
Forming an alliance to develop an exchange provides benefits such as the use of combined
experience and volume to make the site attractive and thus to increase throughput and
liquidity. Therefore, having an alliance with energy players such as PG&E, Duke, etc. would
be needed.

Dealing with cultural impact on traders:
Creating Internet based online trading operations could result in a reduction of traders.
Thus, there could be resistance in the industry with the implementation of this strategy. In
Page 15
addition, trading is still a relationship business. Traders leaving the company tend to take
away business, and new traders bring in new business. It’s not clear how this part of the
equation will be addressed. Maybe having a hybrid operation will be the key. As mentioned
earlier, the relationship and phone conversations could be a gateway to the Internet based
exchange.

Integration with back-office and assets:
According to Leigh Spangler at Latitude Technologies, online trading will increase the
number of deals (volume). The processing of these deals will have to keep up– credit,
delivery, billing, and collections. If the back-office is not updated or not integrated, the
(increasing smaller) deal margins will be eaten up by higher administration costs. Thus,
implementation of the NGN infrastructure (as discussed earlier) will be important. Proper
internal controls and checkpoints for the manual and automated part of the operations will
also be important.
In addition, it will be key to integrate the assets (generation plants owned by Energy, Inc.)
with the trading operations to optimize production and marketing.

Participation of multi-functional group in development of the exchange:
Besides having the expertise of all the business partners, the composition of the team will
be important. Expertise of all the following disciplines will be needed: senior management,
technology, audit, external consultants, and industry experts.
Page 16
REFERENCES
INTERVIEWS
1. Interview with Leigh Spangler, President of Latitude Technologies, Houston, Texas.
April 10, 2000.
2. Interview with Sue Dietrich, Delivery Service Project Administrator, Baltimore Gas & Electric.
April 7, 2000.
3. Interview with Steve Heinen, Director of Technology, Reliant Energy Services.
April 17, 2000.
PUBLICATIONS
4. Mercandetti, Tony. “BP Amoco to Refine Only 60-70% of Its Oil Product Needs.” Bridge
Information Systems, Inc. via NewsEdge Corporation. March 28, 2000.
5. Reuters. “OTC Online Venture Formed.” March 21, 2000.
6. Survey by Energy Argus. April 3, 2000.
7. Flushberg, Martin & Ross, Warner. “The Role of Internet – Based Electronic Markets in
Retail Energy.”
8. Enron 2000 First Quarter, SEC.
9. “Reach is size of audience, richness is the intricacy and customization of services offered,
and affiliation is the extend to which you are seen to respond to customer’s interest”.
Economist. February, 2000.
10. World Energy, Vol. 2, No. 2. 1999
11. Sherman, Lee. “Power Brokers.” Knowledge Management. January 2000.
12. Fisher, Daniel. “Web Powerhouse.” Forbes. November 15, 1999.
13. King, Julia. “Online Business Trades Ramp up at Frantic Pace.” Computerworld. October
11, 1999.
14. McKay, Peter A. “Banks, Energy Firms will Form Online Market.” Wall Street Journal.
March 21, 2000.
15. Ward, Judy. “Power Outlet.” Executive Edge. December 1999 – January 2000.
INTERNET RESOURCES
16. Enermetrix.com Home Page -- www.enermetrix.com
17. Altra Home Page -- www.Altra.com
18. EnronOnline Home Page -- www.EnronOnline.com
19. Houstonstreet Home Page -- www.Houstonstreet.com
20. NYMEX Home Page -- www.NYMEX.com
21. The Power Marketing Association Home Page -- www.powermarketers.com
22. Nexus Energy Software Home Page -- www.nexusenergy.com
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