Hedging energy purchases: How two Brazilian firms are developing derivatives

Bnamericas Published: Wednesday, September 21, 2022
Hedging energy purchases: How two Brazilian firms are developing derivatives

Urca Trading, part of Brazilian group Urca Energia, and local firm XP have just closed the biggest purchase of an electric energy option via derivatives in the local market. 

The deal involves around 50mn reais (US$9.7mn) to contract 40MWa. The objective is to offer hedges to investors with exposure to the sector that want to protect themselves from variations in energy prices.

The expectation is that the financial product will increase the liquidity of electric power purchases and sales and attract new investor profiles, including various types of funds. 

The asset was registered on the B3 São Paulo stock exchange, therefore waiving registration with the electric power trading chamber CCEE, which is responsible for transactions in the physical energy market.

In July, XP closed the first deal of this type in the country, with Gold Energia, in a transaction for around 7.5mn reais. The strong demand for the asset encouraged the offer of new products of the same type.

BNamericas talks about the hedging option with Pedro Assumpção (pictured, left), partner of Urca Energia and executive director of Urca Trading, and Marcelo Leitão (right), responsible for the commercial area of XP Comercializadora de Energia.

BNamericas: Why did Urca Trading decide to carry out the transaction for the power purchase option? What are the expected benefits?

Assumpção: This operation has an avant-garde nature, since the derivatives market is still in its infancy in the Brazilian energy sector. Last week, by coincidence, the minister [of mines and energy, Adolfo Sachsida] himself made a statement to this effect; that we need to promote financial products backed by energy. 

In our case, it was a hedge operation we offered to one of our clients, a generator that wanted to reduce its exposure to the volatility of energy prices. This year has seen relatively low spot prices, but over a longer window, things can be different. Last year, with the water crisis, we saw spot prices rise sharply. 

BNamericas: Where will the 40MWa come from? 

Assumpção: This energy comes from a third party, a generator outside Urca group's portfolio. Urca Trading is a subsidiary of Urca Energia that is focused on carrying out these transactions with a more financial connotation in the sector. 

BNamericas: What are the perspectives regarding power purchase operations in the Brazilian market? 

Leitão: From XP's point of view, we must first say that this product [the energy purchase option] is the result of something we’ve been doing for a long time with a very experienced team, using the synergy of XP's finances. We already do other products in the derivative area. Here, in this case, we’re specifically talking about energy purchase options. So, we use the financial market know-how with that of a trading company. 

This is an experience that is already very strong in other countries. The potential for this product is huge. We’re developing business with other counterparts, not just with derivatives. But we see derivatives via options as a priority operation for the Brazilian market in order to mitigate risks. 

This tool can even serve other counterparts outside the energy market that wish to have exposure in this market, and can be used by financial players, such as asset managers, other banks, etc. In the same way that they can be 'long or short' in dollars, they can be 'long or short' in derivatives. 

We want to bring in new players. This is just the beginning.

BNamericas: What actually is an 'energy purchase option'?

Leitão: It means having the option of a purchase or sale, paying a premium for it. If you want to buy the product ‘year 2023’, but you’re not sure that you will do so, I can give you an option on this purchase at a future date, such as December 2022, at a strike price of X. 

If the market goes up or down, you have that option in your hand. If the market exploded, that is, went up, in December, you’ll trigger that option. If the market goes way down, and the price falls below the strike value of your option, you’ll let that option expire. So it’s a tool that acts very well as an insurance, or hedge, as it’s called. Several different structures can be set up using this options tool besides the simplest ones, which are the call and put options. 

In the world of commodities and currencies, options are already widely used for exporters to hedge their costs. We’re bringing this to the world of electricity. 

BNamericas: What are the products offered by XP? Can this portfolio be expanded?

Leitão: We’ve offered NDFs [non deliverable forwards] for more than a year. But this product is also within the range of derivatives. The novelty now refers to the option. 

We want to enhance the use of options and, in a second stage, start with swaps using derivatives. Our goal is to be a vehicle for our clients with a focus on electricity to serve and leave counterparts with tools to protect themselves against fluctuations in energy prices. 

BNamericas: What are the main impacts of the increased synergy of the energy market with the capital market?

Assumpção: In the next 10 years there will be a gigantic disruption in the energy sector, as we saw back in the day in the telecommunications sector and, more recently, in the financial sector itself. 

Last week, for example, we carried out a very innovative operation involving the energy and bitcoin markets, with the sale of energy tokens to more than a thousand individuals. It’s yet another product that enters the range of energy-backed financial products for the general public. 

And, with the arrival of 5G, we’re also going to see a lot in the retail world with the distributors. 

With climate change, the world has experienced extreme events very frequently. The water crisis provoked an emergency auction in Brazil, so having financial devices that can provide protection for the agents in the sector in this context is something essential for the development of the sector. 

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