Energy Crisis In Europe Could Worsen Due To Impending Liquidity Crisis: Reuters

After a dispute with Russia, Europe may have trouble obtaining oil and gas this winter. However, a new market crisis—a liquidity crunch—could make things worse by driving up prices even further.

But in an effort to relieve pressure on a market whose smooth operation is essential to keeping people warm, European governments have only recently banded together to offer financial support to power providers on the verge of collapsing.

“We have a dysfunctional futures market, which then creates problems for the physical market and leads to higher prices, higher inflation,” a senior trading source told Reuters.

When a group of top traders, utilities, oil companies, and bankers wrote to regulators in March to request contingency plans, the issue was first brought to light. 

This was brought on by market participants scrambling to hedge against future price spikes in the physical market, where a product is delivered, by taking a “short” position. They were trying to cover their financial exposure to skyrocketing gas prices.

Banks typically provide 85–90 per cent of the borrowing used by market participants to develop short positions in the futures market. The traders’ own funds are used to fund the minimum margin, which is between 10% and 15% of the short’s value. This money is deposited into the broker’s account.

However, a “margin call” is initiated if the account’s funds fall below the minimum margin requirement, in this case 10-15%.

Over the past year, as power, gas, and coal prices have increased, so have shorts’ costs. As a result of the ensuing margin calls, oil and gas majors, trading companies, and power utilities have been forced to increase their capital commitments.

Energy prices increased after Russia’s invasion of Ukraine in February, worsening a general global shortage. Some businesses, especially smaller ones, were hit so hard they were forced to stop trading entirely.

Any such decrease in players reduces market liquidity, which can result in increased volatility and sharper price spikes that can harm even major players.

Governments in the European Union have intervened since late August to support utilities like Germany’s Uniper.

There is no indication, however, of whether or how quickly governments and the EU will support banks or other utilities that must hedge their trades in the face of impending winter price spikes.

According to senior bankers and traders, initial margin requirements have increased from 10-15 per cent to 100 per cent-150 per cent of contract value by exchanges, clearing houses, and brokers, making hedging prohibitively expensive for many.

For instance, Dutch TTF gas futures are subject to margin rates as high as 79 per cent at the ICE exchange.

Regulators maintain that the risk is low despite market participants’ claims that rapidly vanishing liquidity could significantly reduce trading in fuels like oil, gas, and coal and cause disruptions in the supply and bankruptcies.

European energy companies, excluding those in Britain, need at least 1.5 trillion euros ($1.5 trillion) to cover the cost of exposure to skyrocketing gas prices, according to state-owned Equinor, the top gas trader in Europe.

In 2007, the value of U.S. subprime mortgages was $1.3 trillion, which led to a global financial crisis.

In contrast, one policymaker for the European Central Bank (ECB) told Reuters that losses in the worst case scenario would total 25–30 billion euros ($25–30 billion), adding that the risk lay with speculators rather than the market itself.

However, a few traders and banks have requested that regulators like the ECB and the Bank of England (BoE) offer guarantees or credit insurance to brokers and clearing houses in order to reduce initial margining levels to levels prior to the financial crisis.

According to sources familiar with the discussions, doing this would aid in increasing liquidity and bringing participants back to the market.

Four trading, regulatory, and banking sources said the ECB and BoE have met with numerous significant trading houses and banks since April, but the consultations, which have not previously been reported, have not resulted in any concrete actions.

“It’s too big a single point of risk for a bank. The banks have hit or are close to hitting their liquidity risk and counterparty risk levels,” a senior banking source involved in commodities finance said.

The price spikes and the decline in players are currently testing the banks’ ability to tie up a certain amount of capital to a specific industry or player.

The ECB has repeatedly stated that it does not perceive a systemic risk that could cause the banking industry to become unstable. The ECB declined to make any additional comments.

This month, ECB President Christine Lagarde stated that the central bank was prepared to support fiscal measures that would provide liquidity to solvent energy market participants, including utility companies.

In the meantime, the Bank of England and the British Treasury this month unveiled a 40 billion pound ($46 billion) financing plan for “extraordinary liquidity requirements” and short-term assistance to wholesale energy companies.

According to a Treasury spokesman, the actions are being taken at the right time after carefully monitoring the market and in line with European peers.

But the energy and commodity markets continue to be opaque, with physical trades hedged with financial instruments in accordance with guidelines established internally by the various companies involved.

Additionally, no exchange or regulator keeps a central register of trades, making it impossible to get a complete picture, according to sources at several major commodities houses, who spoke with the media.

However, the signals are obvious to some people.

“Open interest and volumes have come down significantly as a result of what is happening on the margining front,” Saad Rahim, chief economist at Trafigura, told a conference last week.

“It will ultimately have an impact on the physical volumes that are being traded because physical traders need to hedge.”

(Adapted from Reuters.com)



Categories: Economy & Finance, Geopolitics, Strategy, Sustainability, Uncategorized

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