Energy markets need urgent debate about role of algorithmic trading in volatility

LONDON (ICIS)–Energy market stakeholders should launch a debate about the role of algorithmic trading amid concerns the automated programmes have been feeding the rising volatility of recent months, said market sources.

Gas traders interviewed by ICIS said trading had become “completely random” with companies struggling to trade or match various products.

A source said the rate of volatility for the August natural gas contract increased 157% month on month, with prices jumping up or down some €5.00/MWh – €10.00/MWh within very short intervals during some recent sessions.

“The other day I wanted to place a bid. In the time it took me to type it in, the price had jumped up €5.00/MWh,” he said.

“Traders have no idea what to do. It’s chaos generating chaos,” he said.

Another trader agreed that volatility had increased significantly in recent months and said it may be linked to the rising presence of algorithmic trading, a process for executing orders using automated and pre-programmed trading instructions.

However, he stressed algorithms were merely reacting to a flurry of market-relevant news to which traders have been exposed in recent months.

The first trader agreed that algorithms were triggered by news but added that regulators should take a closer look and intervene, considering that natural gas and electricity markets are physical markets and that the extreme volatility will ultimately harm end consumers.

“Just to give you an example during the maintenance of [the] Nord Stream 1 [pipeline] we had less gas but prices were around €160.00/MWh. Now, we are better off, there is some gas going through Nord Stream 1, but prices are €40.00/MWh higher. How do you explain that?”

The trader said exchanges should use the tools they have developed to stop markets when they heat up, allow them to cool off and restart them when traders have repositioned themselves.

ALGOS ARE NEEDED

Markus Riess, managing director and co-founder of Germany-based strategy and management consultants Forss Partners, however, disagrees.

He notes that such measures could lead to massive losses, which markets are keen to avoid.

Instead, he said, algo traders need to be responsive to such events and control computers from the cockpit.

He insisted algorithmic trading was absolutely necessary to reflect the fact that markets are maturing and becoming more sophisticated.

“Algorithmic trading has been providing a lot of liquidity to the equity market since 2002/2003 and we see similar effects in the commodities market now,” he said.

“Commodity markets are becoming 24/7 markets particularly because of renewable generation, which also triggers a lot more volatility. If you have a wind turbine you have to react throughout the day or night.

“Algorithmic trading has been picked up in power markets a while ago by many players and we see now a strong expansion to gas markets,” he added.

For Riess, algorithmic trading is the response to the challenges of a transforming market. He added that computers were best placed to manage markets that would become increasingly dominated by renewable generation.

“Companies participating need to be technically available to play that game. Markets are moving faster and in a more sophisticated manner and we see a shift to a higher level of maturity, which is a positive development,” he added.

He said the volatility was related to the level of insecurity in the market as many companies were concerned about what was happening to gas supplies since Russia started the war in Ukraine in February.

“It is true that since February we have a lot of psychological insecurity. People are nervous and insecure about what will happen to supply, which is creating volatility,” he added.