Record power prices driven by the soaring cost of gas as Russia chokes supply to Europe are presenting European utilities with an existential problem: despite selling electricity at record prices, they are running out of cash because of spiralling collateral requirements.
Finland has warned that the energy sector faces a potential “Lehman Brothers” moment if governments do not step in to provide emergency funding. Others are calling for a complete overhaul of the way power is traded.
Why are electricity generators short of cash?
Electricity generators use futures markets to help guarantee the price they will receive. The markets are crucial to managing the provision of power and electricity to millions of homes.
The companies like to de-risk their power sales to households and businesses by taking short positions in futures markets before selling the physical electricity. That way if power prices fall, any losses on the contract will be mitigated by gains from the short position, and if prices rise the additional profit made on the physical delivery should cover the cost of the short.
Under current market rules, anyone taking a short position in futures markets is required to post additional collateral — or margin — to the exchange if the price of the underlying asset rises. In normal times, this is accepted trading practice but in recent months the soaring price of electricity has meant the collateral requirements for utilities that have hedged their power sales — often months or years in advance — have ballooned.
As prices have soared their future positions have often fallen deep into the red, prompting exchanges to request more and more collateral, with larger generators at times facing calls to provide hundreds of millions of pounds or euros overnight. The positions will normally be profitable once the physical energy is sold but some will not mature for months or years, leaving the companies at risk of exhausting their existing credit lines.
Centrica, the owner of British Gas, is seeking billions of pounds in extra credit in case of a further spike in collateral demands, the Financial Times reported on Monday.
Finnish utility Fortum, which also owns Germany’s Uniper, said 10 days ago that the collateral it had tied up on the Nasdaq power exchange had increased by €1bn within a week, to approximately €5bn.
While companies such as Centrica and Fortum are likely to make a profit when the related power is eventually sold, the collateral requirements are resulting in a huge liquidity squeeze across the sector that officials and industry officials warn could mean profitable utilities collapse.
“Here were all the ingredients for the energy sector’s version of Lehman Brothers,” Finnish economy minister Mika Lintilä said on Sunday, referring to the Wall Street bank that collapsed during the 2008 global financial crisis.
Where do these trades take place?
Politicians’ criticisms that the markets are malfunctioning have put the spotlight on the main market operators for energy futures in Europe — Nasdaq in Sweden for electricity, ICE Futures Europe in London for oil and in Amsterdam for gas, and Germany’s EEX for electricity. They also run the clearing houses that manage the risks and exposure on open derivatives contracts, calculating payments every day that determine how much margin customers put down.
Regulations require most margin payments to be made in cash so that the funds are immediately available in the event of a problem. Some exchanges and clearing houses that mainly trade energy, particularly Spain, Sweden, Norway and Poland, accept bank guarantees from end users such as energy companies because the latter do not have a lot of cash or other collateral available compared with banks.
However, even those bank guarantees are only accepted if they are fully covered by cash.
Who provides the collateral?
To meet the exchanges’ collateral requirements, large utilities typically rely on established revolving credit facilities with their banks. In the past 12 months, as prices for gas and power have soared, many utilities have put in place additional liquidity facilities with the same lenders but there are signs that some are reaching the limits of their commercial credit lines.
RBC Capital Markets on Monday said that even “the strongest utilities” were facing “huge pressure in terms of collateral payments”. Sweden on Sunday said it would provide up to $23bn in credit guarantees to Nordic utilities to help them avoid technical defaults, while Finland has proposed a €10bn package.
Deepa Venkateswaran, European utilities analyst at Bernstein, said the intervention by the Swedish and Finnish governments suggested commercial credit lines had been tapped out. “Because the numbers are increasing quite significantly, maybe the banking system can’t bear it,” she said.
Which groups are most exposed?
Most electricity generators hedge their power contracts to some extent, meaning many power producers in Europe risk being exposed to the liquidity squeeze. Eurelectric, which represents more than 3,500 European utilities, warned on Monday that the ballooning payments were of “grave concern” to its members.
Even before August’s further price surge, several big utilities including Germany’s Uniper and France’s EDF had already run into severe difficulties. Both companies struggled to cover margin requirements when gas and power prices first started to rise in October last year. Since then, Uniper has been required to buy gas at record prices as deliveries from Russia have dried up, while EDF has had to import power to cover outages.
Venkateswaran said utilities with a high proportion of hydropower and nuclear energy, such as in Sweden and Finland, tended to hedge more than those reliant on other forms of power generation and were likely to be particularly exposed to the increased collateral requirements.
What can be done?
EU energy ministers will consider taking bloc-wide steps at an emergency meeting on Friday, according to officials briefed on the discussions. Power market players say governments have two main options: prepare to provide utilities with billions of euros of state-backed credit or modify the rules around margining.
At present, the EU’s European Market Infrastructure Regulation, which sets the legal framework for margin requirements, does not distinguish between power generators and pure financial counterparties. By reducing or removing the collateral that exchanges require from electricity producers, analysts argue regulators could ease the liquidity squeeze on utilities with limited risk to their counterparties. “These are companies with power generation assets, so they are not running away anywhere,” said Venkateswaran at Bernstein. “It’s different from someone who’s just speculating on power prices.”
John Musk, a European utilities and infrastructure analyst at RBC Capital Markets, also said “structural reforms” were likely to be required. “Supporting energy companies by moving collateral payments from their books on to the financial system/government books is perhaps not the ideal solution,” he said in a note on Monday.
One solution authorities may explore is to tweak the type of bank guarantees that electricity generators can post as collateral.
“Alleviating liquidity pressure on non-financial market participants by allowing fully committed on-demand bank guarantees should not be that far away,” said Rafael Plata, secretary-general of Each, the European clearing house association. “If implemented through a fast-track procedure, we could see producers and consumers benefiting from it shortly, as they do in other jurisdictions like the US or Canada.”