The Financial Crisis—A New ETRM Dislocation Event in the Making? by Gary M. Vasey

For those of us that started out working with natural gas marketing software in the early 1990s, the TRM software category has come a long way. The history of the category is one marked with periods of rapid growth followed by “dislocation” events as the industry went through significant changes under an air of uncertainty. The CommodityPoint ETRM dislocation model is explained in some detail in our book, “Trends in Energy Trading, Transaction and Risk Management Software - A Primer” (Booksurge Publishing 2006) but the concept is worthwhile revisiting under current market circumstances.

The CommodityPoint Dislocation Model

The model was developed from our experiences working in the ETRM software space for almost two decades. Essentially, most software markets evolve following a traditional technology adoption curve (Figure 1). The category is both created and pioneered by early adopters and, if it succeeds, is brought into the mainstream by the early majority from where it becomes a mature software category.

The problem with this model for ETRM software is that industry events, such as de-regulation, the collapse of the merchants and others, occur periodically disrupting the adoption curve. These events disrupt the curve as follows:

• Changes in business practices, rules, regulations and so on impact the requirements for the software. For example, after the de-regulation of power markets in North America, the requirements changed from natural gas marketing to gas and power marketing and price risk management.
• These disruption events can last for an extended period as players assess their response to the change. During these periods of disruption new license sales dry up as decisions are postponed or delayed starving vendors of license revenues. As an example, the collapse of the merchants resulted in many companies reviewing their strategies at that time causing a delay in procurement decisions that impacted the software vendors.

It is true to say that each dislocation event so far has resulted in a bigger market for the evolved ETRM software market attracting new entrants on the vendor side. Indeed, the onset of a dislocation event results in three potential impacts on the ETRM software market as follows:

• Well funded vendors are able to make the requirement changes either through software development and/or acquisition and survive the event.
• Less well funded vendors are unable to evolve and either fail, are acquired or become “stranded” vendors serving a niche market for the remainder f their lives.
• The new market looks bigger and more attractive bringing in other vendors from peripheral software markets through acquisition or new build and,
• New vendors emerge in the form of start-ups who see the dislocation event as an opportunity to enter the market with a new offering built on more modern technology and concepts.

In fact, as described in the book, the earlier technology adoption curve is truncated and becomes replaced by a new technology adoption curve in the process (Figure 2). Indeed, the book chapter goes into considerably more detail on the mechanics of the model providing examples of vendors impacted in the process through time.

What is useful about the model is how it can be used to “predict” something about each vendor's software offering and to gain an understanding of the different vendor's positioning and strategy from both the analysts and buyers perspective. It also uniquely demonstrates that the ETRM software market is not a traditional 'packaged software market' at all. However, since the book was published, much has occurred. It is time to revisit and update the history of ETRM software using the CommodityPoint model as a framework.

Updating the Model

The last several years essentially saw a prolonged period of growth for ETRM software which emerged from the Merchant collapse with a fewer number of vendors. As financial players entered the market and European markets slowly de-regulated, ETRM software morphed into CTRM software serving a larger number of different participants trading a broader array of commodities using many more exchanges and instruments.

But as the market evolved and grew, functional requirements barely changed. Yes, new commodities, instruments and so forth had to be added but most solutions were configurable and could handle these evolutions without significant development. In fact, growth was so robust and steady that the emphasis on development really switched to architecture as vendors migrated to more flexible and powerful SOA architectures, addressed reporting and user interface design and generally improved their products. Yes, there were acquisitions periodically but these were more oriented to expanding product coverage across commodities, across the trading business environment and up and downstream of trading.

CommodityPoint's research began to suggest that the category was maturing rapidly as the number of mainstream vendors gradually whittled down to just three to five vendors (depending on geography) while still keeping several ten's of other vendors in business serving different market niches especially in the area of logistics. Looking back, it has been a golden era for ETRM software over the last five years or so.

The Financial Crisis of 2008/9

The current financial crisis is having considerable impacts on commodity markets as exemplified by our landmark study “Changes in Commodity Markets: Impacts on Traders and Software.” Reduced liquidity, tight credit, counterparty concerns, volatility and many more symptoms of the current financial crisis are impacting traders and, based on our ongoing assessment of activity levels in the sector, we may be beginning to see the commencement of a new “dislocation” event. At this stage, it is too early to be sure as most vendors have an order book backlog and there is tremendous interest around risk management, which our study identified as clearly being the issue of 2009. The chances are good that this will be another dislocation event however and it will eventually impact the ETRM software arena.

But what will the impact be?

Most likely, it will be as in previous dislocation events where a period of market uncertainty decreases software procurement while market changes—both structural, regulatory and requirements—will change what products and functionality are procured in the next cycle. It will result in mergers & acquisitions, new entries and in the demise of some vendors. As we have discussed in other IssueAlerts, it will also stress the existing solutions in place at trading firms and drive requirements around more holistic risk management (including credit, regulatory and operational risk management), pre-trade assessments, better integration, better access to information and speed of processing.

Early Adopters?

Over the last five years or so, the ETRM software market has become characterized by the buying habits of the majority and one or two laggards! New start ups in the space have had a hard time finding those early adopters willing to take a risk and support a new flavor or variety of ETRM software. Despite that, there are a number of start-up vendors who have emerged in recent years with new visions of what ETRM software should look like and who have employed from the ground up new technologies, concepts and developments to address issues with current ETRM software solutions. Those vendors would include Hyper Rig, Contigo and Abacus Solutions. It is to be hoped that these vendors get increased attention under the current business environment as they represent the new ideas and new approaches that might offer the solution to the integration and speed of processing limitations of many current offerings in the space.

If indeed this is the commencement of another dislocation period, then it is also the beginning of a new technology adoption curve with its early adopters willing to take a technology or platform risk in an attempt to redefine ETRM software. If so, these vendors may well benefit by being in the right place at the right time?

Existing Vendors

Some of the existing vendors also look well positioned to evolve with the industry. Others do not. As in the past, some will fall by the wayside as stranded vendors, some will be acquired and some will fail altogether. Waiting in the wings might be a major software name or two as well. SAP has partnered with Triple Point, for example, to enter the TRM world. What about SAP's major rivals? Isn't it time for an Oracle or similar to enter the TRM market? We will see.