Only a few firms in the commodity specialist hedge fund community have weathered the volatility of power and energy markets for more than a few years. But e360 Power has been a stalwart in those markets – which has helped earn the Austin, Texas-based firm the title of Best Performing Fund in 2020 as well as over the past 2 and 3 years ending in December 2020 in the discretionary energy trader category. The awards, part of The Hedge Fund Journal’s CTA Awards for 2021, are based on risk-adjusted returns and are powered by Preqin data.1
e360 Power’s co-founders, James Shrewsbury and Juan Penelas, met in the early 2000s at the merchant operations of the utility American Electric Power (AEP). The two were among the earliest participants to trade electricity derivatives as US power markets were deregulated. As commodity specialists for their entire careers, with Shrewsbury trading agricultural commodities at Continental Grain and Penelas working in the metals and energy industries in South America, their transition to the power space was a natural progression.
After managing merchant and proprietary exposures at AEP, the pair moved to Griffon Energy Capital LLC in the mid aughts where they continued to generate great returns and develop a working relationship that would later evolve into a partnership.
Whenever fundamentals are evolving at a rapid pace, opportunity is out there if you know where to look.
James Shrewsbury, co-Founder, e360 Power
In 2009, the pair launched e360 Power with capital from a specialist commodity fund of funds, which remains an investor to this day. The firm’s flagship strategy has produced annualized gross returns greater than 30% over the last 12 years while managing external capital for a mix of family offices, funds of funds, and institutional investors.
For offshore investors, e360 Power offers access via a Cayman domiciled offshore fund. Investors can scale the strategy across a range of average portfolio volatility and margin to equity. A Sharpe ratio near one is a testament to their team’s ability to deliver long term, strong risk adjusted returns in highly volatile markets.
As a discretionary strategy employing fundamental analysis to build and manage a portfolio of best ideas, the e360 Power team is confident that the next decade will present extremely attractive trade themes as global energy systems rapidly evolve. “The accelerating global transition to a low-carbon economy will continue to have a meaningful impact on the way energy is produced and consumed, upending long standing physical relationships that drive price formation in commodity markets, which the firm views as highly actionable,” says Spencer Schredder, the firm’s Head of Research. “The pursuit of electrification will be essential if we are to achieve a less emissions intensive economy, which makes the e360 Power strategy the ideal vehicle to gain exposure to the ‘green transition’. Our domain expertise coupled with our proprietary research process enables us to develop views on how fundamental changes will influence price formation as systems evolve,” says Schredder, who expects the incoming transformational changes frequently referenced by both the public and private sectors will introduce a myriad of new risk drivers.
Shrewsbury, who has successfully managed exposures through multiple fundamental cycles, argues that “whenever fundamentals are evolving at a rapid pace, opportunity is out there if you know where to look”.
The 2010s were a defining time for power markets in the U.S. as the shale revolution upended power dispatch dynamics, with new combined cycle power plants fueled by cheap natural gas pushing coal out of the supply stack. But renewables and energy storage will define the next chapter of change as most countries and regions move aggressively in the direction of electrification-led decarbonization.
“Ambitious clean energy targets will support trillions of dollars of investment in clean energy infrastructure by 2030,” says Schredder, adding that it could “structurally change the supply and demand relationships that we seek to identify”.
Risks to the implementation of the green theme remain very high, which is why the firm maintains a technology-agnostic view of the future. The transition away from fossil fuels will push the transportation sector onto the power grid and make it more challenging to produce hydrocarbon fuels. This could create a situation where electricity demand will grow in tandem with an increasing reliance on non-dispatchable resources like wind and solar, which face the problem of intermittency that has become apparent in many European countries in 2021.
The firm’s flagship strategy has produced annualized gross returns greater than 30% over the last 12 years
“This will present major challenges for system operators until utility-scale energy storage solutions are commercially scalable,” says Schredder. “Regulatory reform focused on streamlining the permitting process and evolving market structures to accommodate new technologies will be essential.”
In addition to the technology risks, Schredder says that “highly concentrated supply chains for metals and rare earths – dominated by China both on their mainland and abroad – will introduce a new macro element to what have long been isolated domestic markets”.
Many of these risks were highlighted in a research note released by e360 Power in the wake of Winter Storm Uri in February, 2021. To access the paper, titled The Hidden Risks of Decarbonization, you can find the firm’s contact information at www.e360power.com.
Energy markets are notoriously volatile, but the e360 Power strategy tends to thrive in fast moving markets.
“The resurgence of volatility provides opportunities for our strategy and the fundamental backdrop of our markets is presenting a compelling case that we are witnessing a volatility regime shift – not simply a one-off event,” says Penelas, who oversees much of the firm’s options exposure.
In order to create an exposure profile that can adequately capitalize on the firm’s key fundamental themes while minimizing risk, views are expressed using a combination of both futures and options.
Penelas, describing the portfolio construction process, says that “options are used not only to express views on implied volatility, but also to manage price gapping risks, to create controlled exposure ranges, and also to manifest outright directional views, as power options on the underlying futures can be very liquid.”
To avoid risks associated with temporary phenomena, the e360 Power portfolio is focused on deferred tenors as far as five years into the future. These tenors are far less volatile than the headline-grabbing negative prices and hundreds-fold surges seen in the cash markets in recent years, which are heavily influenced by current weather conditions and short-term physical constraints. According to Penelas, by establishing positions further out the curve, the strategy is “better able to capture the true fundamental trends that underpin our market views”.
Ambitious clean energy targets will support trillions of dollars of investment in clean energy infrastructure by 2030
Spencer Schredder, Head of Research, e360 Power
While there is typically a watchlist of about 30 themes at any time, between five to eight of them will make it into the portfolio. Trades can be trend driven or contrarian, with underlying fundamentals serving as the ultimate impetus to action. The trending nature of commodity markets can provide occasional overlap with trend flowing strategies that trade energy markets, such as CTAs, but the low correlation of the firm’s returns to the various CTA benchmarks highlights the role of fundamental analysis in portfolio management.
“Trends are important because supply and demand phenomena are typically slow moving,” Shrewsbury says. “Fundamental conditions drive price action, which then underpins the elasticities that force physical participant responses that ultimately keep markets in balance.” By following fundamental cues, Shrewsbury says that the e360 Power strategy is able to “maintain the flexibility to enter and exit trends before turning points”.
The e360 Power portfolio solely consists of financially-settled, exchange cleared futures and options on futures. For electricity, the firm focuses primarily on regional US markets that are mostly within the Eastern Interconnection. The bulk of the firm’s power trading is concentrated in the PJM footprint, which is a regional transmission organization that serves electricity demand across 13 states in the Mid-Atlantic and is the most liquid power market in the US. The firm also expresses fundamental opinions across other power markets opportunistically, including NYISO (NY), MISO (Midcontinent), and ERCOT (TX). e360 Power’s presence in natural gas markets is more global in nature, with exposures spread across dozens of locations in the US in addition to the European benchmark TTF.
Beyond the opportunities that the ‘green transition’ will present in the core markets of the company’s strategy, a crackdown on emissions – spurred by governments’, companies’, and institutional investors’ decarbonization targets – has created new markets for carbon emissions. So far, the company has participated in a variety of carbon markets, having traded EUAs in Europe, CCAs in California, and the Regional Greenhouse Gas Initiative (RGGI) in the Mid-Atlantic US.
As performance continues to demonstrate the ability of e360 Power’s team to identify key fundamental themes to generate returns, the future appears bright for the firm. Historically, capacity for the firm’s strategy peaked at around $500m, but as open interest has climbed in existing markets and the opportunity set has expanded to include a broader swathe of products, they now see capacity as high as $1bn.
1. e360 Power is registered as a CPO, and does not hold out to be a CTA