Hidden Opportunities for Trading European Power Futures and Agri Futures
15 June, 2015
category: Commodities, Food
Dan Gramza gives his insights on trading European Power Futures on the first day of their trade and comments on trading spreads between them and agri futures.
What is your opinion on the connection between agricultural and energy futures? Is there any?
– Yes, they are connected for the following reason: to produce a crop energy is involved in entire process, and it actually begins with fertilizers. Fertilizers come from petroleum derivatives, so fertilizers, then energy is needed to run equipment to plant a crop, to harvest a crop and to transport a crop. Apart from petroleum on all these stages natural gas is also involved. If you take corn, for example, natural gas is used to dry corn, to regulate moisture content which is very important for that product. Energy is literally applied in every part of the cycle, though the amount varies from crop to crop, but agriculture is an energy intensive industry.
Which are the most energy consuming agricultural commodities?
– As far as the life cycle for the grains and raw crops, like corn, wheat and the grasses, soybeans, from fertilizer to transportation issues are about the same, the one that is a bit different though is corn, because you need to dry it, you need to maintain moisture content at the certain level, dryers that do that are typically run on natural gas, as oppose to electricity. So I would say corn consumes more energy than any other agricultural commodity.
Could you please, tell us about the eight new European Power Futures Contracts that CME Group start trading June 15, 2015.
– There are a few things interesting about these contracts and the way the CME Group approaches them. First, they get four European countries Germany, France, Spain and Italy. If you look at the joint GDP of those countries it represents 77% of the GDP of the whole European zone. They are definitely the major components of Eurozone. The logical place to begin in this respect is Germany, the largest electricity consumer. Also their approach to the design of these futures contracts is very interesting as well: the CME Group used indexes references of those particular regions, which I think is very smart. Financial industry tends to make things very broad, but the problem with that is you do not get institutional buyers, like Banks and other organizations. And especially the financial industry itself . Because the industry would say that what they have designed does not apply to me. While in the case with European power futures contracts, the CME Group by breaking it down, provided contracts with high chances to have a buyer as well as producers and users from different countries to say that this product makes sense. The other reason I think that this is a clever product is that CME Group made the difference between the base load and the pick load. They have contracts for base loads in those four countries and also contracts for pick loads there. Base load – the amount of electricity that is generated continuously, usually the sources for that type of electricity are coal and nuclear power. Such facilities require longer time – up to several days- to be brought up to speed, but once they do operate they are fairly efficient. Let us talk about peak load contracts. Those are facilities that can start operating fairly quickly. Two examples of these contracts. First natural gas. Now there are power plants that operate with natural gas. By the way, in USA more and more people are turning to natural gas, because it is cheap here, and for obvious reasons not as much in Europe. But they run with 60% less emission than with a coal fire, so it is efficient, it is friendly in terms of carbon emission and can be turned on fairly quickly. In Europe it is fairly expensive to run them though. Second type of this contract is so called stored power, or what people call, pumped power. This is when during the off peak hours a lake, or any reservoir holds water. When it is time for peak demand you turn that on, and you have hydro load electricity that can be generated very quickly, so you need that time requirement for peak loads. We mean something like summer when people need air conditioners, fans on and etc. So CME Group made a distinction between base loads and peak loads, which I think is a good idea. Speaking of trading point of view I presume that many institutional traders would trade the spread between the base and peak loads. And then since there are multiple countries contracts you could trade the spread between the countries. You could go base load to base load in France, peak load to peak load in Italy. Spread traders would like this type of products, as it can provide potentially interesting trading opportunities.
Would wind and solar power be part of these contracts or not yet?
– Not yet, my understanding is they are not included, but here is what you do want to keep in mind, is that they do make an impact, depending on the country. For example in England, it can have an impact, or another country where they have a lot of wind power, solar energy not as much, but wind power can have an impact. For the spread trader it can take the amount of spread between base and peak load. Well, the impact that does provide supplemental energy is conditional because any alternative, renewable energies depend on wind and sun. It is important to point out here that so far inability to store that power is also a problem.It is interesting how it fits in, but there are some challenges that are still to be met, that are viable part. If you look at 30 years projections for energy, what some organizations are projecting is that the alternative energy will amount to 10-15% of our total consumption. It is something that is a great idea, but reality of solving the problem of energy needs just is not there yet and it would not be there for a while.
Can agri and energy commodities be used as hedging couples/trios for each other? Or this is not how things work in the industry?
– The challenge is the amount of the impact. Does energy impact farming – yes, so we would have to ask what is the amount of the impact? If you look at farm prices for commodities, is it 10%, 15% right? What percentage does it represent? What you have to look at – is there a relationship, and getting back to spreads, the answer is yes, yes there is and so it can be trading opportunities between those products. It depends who you are as a spreader. In other words some people want to be totally balanced between two markets. One moves the other one is going to move equally, to do that in this case for such trader would have to calculate a beta for that relationship so that if corn moves 10%, energy moves 10%, it has equal impact on both and that beta between them will determine how many contracts you will buy of one , how many you would sell of another, so that it is part of this dynamic. I do think there are opportunities today and in the future that are coming out. So we have natural gas consumption, coal, can look at electricity as well as actual underlying crop.
Dan Gramza one of the most prominent traders in the world, with 30 years of extensive trading life, he speaks to pickingalpha.com about Gold Futures and Gold Mining Stocks. Dan is President of Gramza Capital Management, Inc. and DMG Advisors, LLC. He is a trader, consultant to domestic and international clients, an advisor to hedge funds and is a developer of ETF securities.
Dan has published works in Australia, Europe, Japan, Singapore and the United States and is completing “Trading in the Eye of the Storm” and “The Handbook of Japanese Candle Trading Strategies”. He has appeared on CNN’s “Moneyline” program, Reuters TV, Bloomberg TV, ROB TV Canada, TVN 24 Poland, Intereconomial TV Spain, WCIU-TV Chicago and as a market analyst for CME Group and has been quoted in The Wall Street Journal, Chicago Tribune, SFO Magazine, Futures Magazine, Stocks & Commodities Magazine, Traders Edge Magazine, Traders’ Magazine, Traders Journal and other numerous media outlets around the world.
Dan is known to be as one of the most dedicated teachers of the technical analysis and commodities.
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