Blockchain, the distributed ledger technology which was possibly the hottest tech topic in the energy sector in 2017, has still to prove itself as more than hype in the oil sector.
While electricity companies and grid operators see huge potential in digitalization in general and blockchain in particular to make power stations and grids more efficient, for example, the oil sector is keeping an open mind.
“We are not abandoning technology efficiencies we’re developing on current platforms,” BP’s head of strategy for IST, Mike Leonard, told the S&P Global Platts Digital Commodities Summit in London in November.
“We’re seeing this as complementary…We don’t have all our eggs in blockchain, but nor do we want to avoid the topic or not take part in it,” he said. “But the more we [talk about blockchain within the company, the more] we’re finding new opportunities to explore different areas of our current technology, which is also exciting, so we may find this emerges for BP specifically in different ways than we expect.”
BP is testing the blockchain concept. It signed up in November to a consortium with fellow oil and gas companies Shell and Statoil, trading houses Gunvor, Koch Supply & Trading and Mercuria, plus banks ABN Amro, ING and Societe Generale, to co-develop a blockchain-based digital platform for trading energy commodities. The platform is to be designed and stress-tested by its investors, but run independently.
“This is about reliability and reducing costs. Many of our back office functions appear not to have changed since 1985. We’re after bottom line savings, but also how this can free up resource elsewhere in the business,” Leonard told the summit. The aim is to move away from cumbersome paper contracts to the authenticated transfer of electronic smart documents.
Leonard declined to speculate on when the first cargo of Forties crude was likely to be cleared through this platform, which is planned to be up and running by end-2018.
The consortium’s long-term aim is to migrate all forms of energy transaction data to the blockchain platform. The next step is to address inefficiencies in cash flow, as faster cash and clearing cycles mean more opportunities to do business.
How Blockchain Works
Blockchain emerged in 2008 as the distributed, decentralized digital ledger underpinning cryptocurrency Bitcoin, recording transactions in an immutable way.
In reality it works like this: an individual (or a machine) registers as a member of a blockchain, which can be public, like Bitcoin, or private, for example like a street of householders or a group of traders. The individual/machine receives an online wallet that can be charged up with a digital currency. The individual/machine can then transact with other members registered to the blockchain.
The blockchain’s network of registered computers continually validates the transactions, building blocks of transactions that are then permanently entered in the ledger. Nobody can change the ledger, it is immutable. It is shared with all members at all times – it is not stored in one place, there is full transparency and, if the blockchain is public, anyone on the internet can view it.
Since transactions are cleared instantaneously using the chosen digital currency, there is no settlement risk. Nor is there any paperwork or middleman fees beyond set up and running costs associated with relatively simple computing.
In a key development step for energy, automated code-based processes, known as smart contracts, can interact with and update the database. This application can be used to provide an automated transaction model with no or limited third-party intermediaries, compared with the traditional transaction model involving a provider, network operator and consumer.
Blockchain’s ability to track the flow of electrons on a distributed grid, for example, enables their secure and transparent trade between consumers (or machines) directly. A practical example of this is European utility Innogy and startup Slock.it’s prototype electric vehicle charging system, Share&Charge, which enables registered users to make micropayments via a smartphone app.
The shipping industry has also started finding ways to make use of the technology to simplify its processes. Container line Maersk, one of the world’s largest shipping companies, is in the process of developing a blockchain initiative with IBM to allow a better flow of information through its systems.
In research from 2014 the companies identified more than 30 personnel and companies— and more than 200 interactions between them—involved in a typical shipment of avocados from Kenya to the Netherlands. Maersk and IBM’s system is designed to guarantee the validity of each transaction while maintaining their privacy.
In short, for energy, for shipping, for agriculture, for all transactional proceedings that lend themselves to digitalization, the technology offers huge potential to cut costs, reduce security risk and eliminate error. And, in the energy sector, the first prototypes are underway—in decentralized networks and in commodity trading.
Three of BP’s blockchain consortium partners, ING, Societe Generale and Mercuria, carried out a test of a live oil trade between parties with Mercuria at the start of 2017. The successful experiment involved a shipment of African crude, which was sold three times on its way to China, and included traders, banks as well as an agent and an inspector, all performing their role in the transaction directly on the prototype Easy Trading Connect blockchain platform, Mercuria said in February.
And in March, banking group Natixis, IBM and Trafigura pioneered the first blockchain trade for US crude oil. They used a distributed ledger platform, built on the Linux Foundation open source Hyperledger Fabric, which they said was designed to be adopted at scale across the entire crude oil trading industry.
European electricity and gas companies have also tested pilot blockchain trading projects. In June, BP and Italy’s Eni completed a pilot program for processing European gas trades using blockchain technology developed by Canada’s BTL Group. This focused on gas trade confirmations, and the plan is to look at expanding it to other back office processes, including netting and generating invoices.
In May, over 20 European energy trading firms joined forces to develop peer-to-peer blockchain-based trading using Hamburg-based IT company Ponton’s Enerchain framework. In October, E.ON and Enel completed a first power trade using the system.
Agriculture had an even earlier pilot, with a wheat trade in Australia settled through blockchain back in December 2016. The deal was “auto-executed” by a smart contract run by commodity management platform AgriDigital, which also has high hopes of expanding into other commodities.
Critical Mass Challenge
Achieving critical mass is a common theme in all the pilot platform developers, including the energy commodity trading consortium involving BP, Shell and Statoil, which plans to open its platform to all commodities eventually, pending approvals. “It only works if there is widespread adoption,” consortium spokeswoman Carolien van der Giessen told S&P Global Platts in November.
Hugh Halford-Thompson, CIO of the BTL Group working with BP, Eni and others on the platform to automate gas trading processes, agrees. “The challenge is getting a large enough synchronized group to shift volume onto a new settlement standard,” he told the Platts summit. “You need that critical mass to…drive the rest of the industry to move across.”
If commodities traders do move en masse to decentralized blockchain platforms, that could reduce liquidity on established, traditional platforms – like exchanges.
European energy exchange trade body Europex has warned that decentralized platforms are “dangerous” for wholesale electricity and gas markets, for example, arguing that lots of small set-ups could fragment and distort price signals. This would go against the prevailing EU policy to promote strong wholesale price signals, for example.
For now, though, regulators are more interested than concerned.
Blockchain’s impact on traded markets is still too small to need specific rules, according to EU financial authority ESMA, for example. Regulators are following developments, and the approach is pragmatic. “If you see a problem with the regulatory framework, tell your local regulator,” Clemens Wagner-Bruschek from Austrian energy regulator E-Control told the Platts summit.
Regulators are also interested in how blockchain can streamline regulatory requirements, such as post-trade reporting, but data standards would have to be harmonized first to get real benefits. Meanwhile, the EU’s executive body, the European Commission, is spending €500,000 to set up an EU Blockchain Observatory and Forum to monitor and assess blockchain developments across the economy, and whether any EU-level response is needed.
All of which means blockchain will continue to be high profile in 2018, but the critical mass needed for it to transform energy trading, and potentially regulation, is likely to take several years more—if it comes at all.