Blockchain technology offers cost-saving and process efficiencies for the energy sector that are too compelling to ignore, write Luis Colasante and Taniga Krish for Oilprice.com. But it does require a clear framework where all participants agree on the standards and rules.
Commodity and energy trading houses have proven that they can adapt their business model in an economy that imposes more capital requirements and regulations every day. These companies have invested millions of dollars in the last decade to build efficient systems for their regulatory requirements and key risks.
Today, a new technology, blockchain, is shaping the commodity market, making it more efficient with reduced transaction costs.
Blockchain is a disruptive technology that allows storing data without the need for a central authority, implying that financial transactions will no longer be stored in a central database but distributed to several other computers that store data locally. For this reason, this technology is called distributed ledger technology (DLT). Each transaction is recorded and added to the previous one, resulting in a growing chain of information.
Blockchain is a buzzword in the financial industry, and it’s slowly captivating the trading floor, as well as the power and utilities sector, which is tiptoeing to disrupt the centralized business model approach based on legacy systems.
Based on a platform and network-based approach, the DLT system can be adapted to a specific business case, with characteristics ensuring security and disintermediation at a rapid pace. It features reduced operating costs, but there are certain limitations.
The integration of renewable energy in the energy mix is a major preoccupation of every country, and blockchain would simplify the decentralized electricity network among individuals along with their platform and networking capabilities
Financial institutions already face an uphill task of confronting the threat of a fintech sector that’s trying to seduce their clients with innovative services at fewer costs, mainly bypassing the banking institutions. Fintech would squeeze the revenues and profits of the banking sector, as they target the most lucrative parts of their earnings, predominantly in the payment and wealth management services.
Agile fintech startups can move quickly, think outside the box, and rapidly develop and launch new products and services. Financial majors either finance the startups or collaborate with them to create proprietary blockchain projects.
Global banks recently started partnering with fintech firms like R3 and Finastra to develop a blockchain-based marketplace for syndicated loans. Blockchain startup Digital Asset Holdings is at the helm of providing DLT for regulated financial institutions. Created by former J.P. Morgan Chase executive Blythe Masters, Digital Asset Holdings is based on Ethereum technology.
The Enterprise Ethereum Alliance—formed in 2017 by a group of institutions from banking, insurance, IT consulting, startups and academics—is developing Ethereum blockchain code for customized and private services for the partners.
In the oil and gas sector, the use of blockchain technology is still in its nascent form, with pilot projects happening in European gas trading for faster transactions with reduced costs.
Commodity trading has embraced blockchain, with the fintech sector (particularly in Asia Pacific) making strides with the technology that will facilitate new sources of funding for cross-border trade finance in the era of strict regulations, which isn’t favorable for the small and medium-sized firms. The digital trading platform and smart contracts based on the blockchain would improve the liquidity by attracting diversified sources of funding, faster processing of transactions and reduce fraud risk—all at lower costs.
Reporting and regulatory requirements are continuously becoming more stringent (e.g., MiFID II or EMIR), increasing the finance charges of the trading floor. For this reason, it’s essential to have a clear framework to integrate blockchain technology in the sector.
Due to blockchain developments in the financial industry, power producers and the utilities sector can also embrace this technology. Some principal assumptions used in the financial sector can be applied to the energy sector, like the decentralized storage of transaction data. New decentralized business models no longer require third-party intermediaries, with payments being done via cryptocurrencies. With the transactions being governed by smart contracts, funding and automatic payments are imitated with a sequence of approvals, without requiring a letter of credit, thus eliminating the delay time.
The most relevant difference between the energy sector and the financial industry is the final product itself (in this case the electricity/electron), which must also be taken into account because it needs to be transported and distributed via the network infrastructure.
One of the exciting initiatives making headlines is Energimine, which aims to reduce global energy consumption by encouraging individuals with energy tokens to use their platform for a peer-to-peer marketplace to buy and sell energy and a reward platform
With much emphasis on climate change mitigation measures, the integration of renewable energy in the energy mix is a major preoccupation of every country, and blockchain would simplify the decentralized electricity network among individuals along with their platform and networking capabilities. One of the exciting initiatives making headlines is Energimine, which aims to reduce global energy consumption by encouraging individuals with energy tokens to use their platform for a peer-to-peer marketplace to buy and sell energy and a reward platform.
To accelerate this technology, large utilities and commodity traders are working together, like the Energy Web Foundation consortium or the Enerchain Project, where European utilities analyze and create a legal framework in the energy sector.
Blockchain technology shows great potential, and can be used not only to execute energy supply transactions, but also to create the basis for clearing processes, metering, billing, application in the documentation of ownership, the state of asset, renewable energy and white certificates, guarantees of origin and emission allowances.
For the full deployment of this technology, it’s necessary to have a clear framework where all participants agree on predefined rules based on common standards.
The potential cost-saving and process efficiencies are too compelling to ignore. Some energy companies have calculated the savings to the tune of 30 to 60 percent on their structural costs. These savings come mainly from reduced labor costs, reduced manual and semi-automated process-related efforts, reduced capital costs through faster settlements, and reduced technology costs by reducing the dependency on multiple systems.
Blockchain technology will be the accelerator of the world energy transition, helping to have a decarbonized and decentralized energy system that will be more resilient and cost-effective.
This article was first published on Oilprice.com and is republished here with permission.