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Trends in Trader Compensation: No "Magic Bullet"

When it comes to pay levels, knowledge is power.

Fortnightly Magazine - December 2006

objective is to pay dividends to their shareholders. As such, they are very risk-averse and interested only in balancing load obligations with reliable supply. Trading generally is short-term or limited to long-term supply acquisition. Trading talent is required but is of a very different nature than for those more interested in optimizing their assets or in discretionary trading.

To see this more clearly, examine hedge funds. Their objective is to make a sufficient rate of return to maintain their investor base and attract new capital. Unlike a utility trading operation, hedge funds usually don’t have physical assets to maintain or customers to serve. The traders are involved in large-size discretionary trading and are expected to take risks accordingly.

Obviously, this type of trading is different from what a utility would require, and involves considerably different skills. For a utility to compete for that hedge-fund-caliber talent is, in most cases, unnecessary because the market for talent goes in cycles. Don’t get caught up in bidding wars for talent you might not need or can’t afford.

2. Know what reward structures your competitors are offering, and know what you can offer that they can’t. In other words, figure out what is really motivating your traders to stay or go. The answers may surprise you.

Trader compensation schemes are almost as varied as the number of participants in the market. In theory, salaries and bonuses are inversely proportional, with bonuses calculated either as a percentage of trading profits or expressed as a percentage of salary. As the risk tolerance of the organization increases, bonuses tend to become uncapped and could involve several multiples of salary levels. In recent years, as retention issues have become more pressing, the use of retention payments or restricted shares have become more prevalent.

Contrary to popular belief, most traders are not all about money. Of course, compensation is one of the most important factors in a trader’s decision to leave. 1 According to Towers Perrin’s 2006 Compensation Survey of Energy Trading and Marketing Positions , the highest bonus paid to an individual energy trader was well in excess of $5 million, but money certainly is not the only factor. Location, internal career-advancement opportunities, and general working conditions also are important and should not be underestimated. If senior management actively involves the traders in the management of the business and treats them fairly, retention will be less of an issue.

3. Review your compensation scheme to make sure it’s fair and equitable and doesn’t contain any incentives that are not in the best interests of the company.

No incentive program is perfect, especially when physical assets are included in the mix. In general, as management tries to make incentive plans more equitable, they grow increasingly complex. The level of complexity in optimizing a large portfolio of physical assets is equal to or greater than simply engaging in speculative trading.

Utilities often presume, mistakenly, that “trading around the assets” requires a less qualified front-office staff. With potentially billions of dollars at risk, nothing could be further from the truth.

Designing an incentive