- Europe’s total risk is $1.5 trillion – Equinor
- ECB source says liquidity problem is exaggerated
- Energy Market Players Stuck in Margin Calls
- Commodity market is opaque, without a trade register
LONDON, Sept 21 (Reuters) – Europe’s oil and gas supply woes this winter, following a dispute with Russia, could be exacerbated by a new crisis in a market where prices are already red-hot: a liquidity crunch could push prices further higher.
But European governments have only belatedly offered financial support to power suppliers on the verge of collapse in an attempt to ease pressure on a market that is vital to keeping people warm.
“We have a dysfunctional futures market, which then creates problems for the physical market and leads to higher prices and inflation,” a senior trading source told Reuters.
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The problem first surfaced in March, when an association of top traders, utilities, major oil companies and bankers sent a letter to regulators urging them to develop contingency plans. read more
This was due to the fact that market participants hastened to cover their financial risks from a sharp rise in gas prices with the help of derivatives, insuring against future price spikes in the physical market where the product is supplied by opening a “short” position.
Market participants usually take loans to open short positions in the futures market, with banks accounting for 85-90%. About 10-15% of the value of a short position, known as the minimum margin, is covered by traders’ own funds and deposited in the broker’s account.
But if the account equity falls below the minimum margin requirement, in this case 10-15%, this causes a “margin call”.
As electricity, gas and coal prices have risen over the past year, so have the prices of short positions, with the result that margin requirements have forced major oil and gas companies, trading firms and energy companies to invest more capital.
Some, especially smaller firms, have been hit so hard that they have been forced to stop trading entirely as energy prices soared after Russia’s invasion of Ukraine in February, exacerbating the overall global deficit.
Any such reduction in the number of players reduces the liquidity of the market, which in turn can lead to even more volatility and sharper price spikes, which can hurt even the big players.
Since the end of August, European Union governments have stepped in to help utilities such as Germany’s Uniper. read more
However, given the upcoming winter price spikes, there is no indication whether governments and the EU will be able to support banks or other utilities that need to hedge their trade, and if so, how quickly.
Exchanges, clearing houses and brokers have raised initial margin requirements to 100-150% of the contract value from 10-15%, according to senior bankers and traders, making hedging too expensive for many.
The ICE exchange, for example, charges margin rates up to 79% on Dutch TTF gas futures. https://www.theice.com/products/27996665/Dutch-TTF-Gas-Futures/margin-rates
While market participants say the rapid disappearance of liquidity could severely cut trade in fuels such as oil, gas and coal and lead to supply disruptions and bankruptcies, regulators still say the risk is low. read more
Norwegian state company Equinor, Europe’s largest gas trader, said this month that European energy companies, excluding UK ones, need at least 1.5 trillion euros ($1.5 trillion) to cover costs associated with rising gas prices. gas. 1N30D0XO
This compares to the $1.3 trillion value of US subprime mortgages in 2007, which triggered the global financial crisis.
However, a European Central Bank (ECB) politician told Reuters that the worst-case loss would be 25-30 billion euros ($25-30 billion), adding that the risk lay with speculators, not the real market.
However, some traders and banks have turned to regulators such as the ECB and the Bank of England (BoE) to provide guarantees or credit insurance to brokers and clearing houses to lower initial margin levels before the crisis.
According to sources familiar with the negotiations, this will help bring participants back into the market and increase liquidity.
The ECB and the Bank of England have met with several major trading houses and banks since April, four trading, regulatory and banking sources said, but the consultations resulted in no specific action that was not previously reported.
“This is too big a risk point for the bank. Banks have reached or are close to reaching their levels of liquidity risk and counterparty risk,” said a senior commodity finance source at the bank.
Banks have a certain level of capital that they can tie to a particular industry or a particular player, and price spikes and shrinking players are currently testing those levels.
The ECB has repeatedly stated that it sees no systemic risks that could destabilize the banking sector. The ECB declined to comment further.
ECB President Christine Lagarde said this month that she would support fiscal measures to provide liquidity to solvent energy market participants, including utilities, while the ECB stood ready to provide liquidity to banks if needed.
Meanwhile, the UK Treasury and the Bank of England announced this month a £40bn ($46bn) funding scheme for “emergency liquidity requirements” and short-term support for wholesale energy companies. read more
A finance ministry spokesman said the measures come at an opportune moment after observing the market for some time and in line with European counterparts.
However, energy and commodity markets remain opaque and physical transactions are hedged with financial instruments depending on internal rules set by the various participating companies.
And because no single regulator or exchange maintains a central register of transactions, it’s impossible to see the full picture, sources at several major commodity houses told Reuters.
However, for some, the signals are obvious.
“Open interest and volumes have dropped significantly as a result of what’s happening on the margin front,” Saad Rahim, chief economist at Trafigura, told a conference call last week.
“Ultimately this will affect the physical volumes traded because physical traders need to hedge.”
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Reporting by Dmitry Zhdannikov and Julia Payne; Additional report by Francesco Canepa in Frankfurt; Editing by Alexander Smith
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