Why are European electricity producers running out of cash?

Record electricity prices driven by soaring gas prices as Russia chokes off supply to Europe pose an existential problem for European utilities: despite selling electricity at record prices, they lack liquidity due to increasing 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 call for a complete overhaul of how energy is traded.

Why are electricity producers short of money?

Electricity producers like to reduce the risks associated with their electricity sales to households and businesses by taking short positions in the futures markets before selling the physical electricity. This way, if electricity prices fall, any loss on the contract will be mitigated by gains from the short position, and if prices rise, the additional profit made on physical delivery should cover the cost of the short position. .

Under current market rules, anyone taking a short position in the futures markets is required to post additional collateral – or margin – on the exchange if the price of the underlying asset rises. Normally this is an accepted business practice, but in recent months soaring electricity prices have led to increased security requirements for utilities that have hedged their electricity sales – often months or years in advance.

Centrica, the owner of British Gas, is asking for billions of pounds in extra credit if there is another surge 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 risen by 1 billion euros in a week, to reach around 5 billion euros.

While companies such as Centrica and Fortum are likely to make a profit when the corresponding power is eventually sold, collateral requirements are causing a huge squeeze on cash in the sector which officials and industry officials say could lead to the collapse of profitable public services.

“Here were all the ingredients for the version of Lehman Brothers for the energy sector,” Finnish Economy Minister Mika Lintilä said on Sunday, referring to the collapsed Wall Street bank. during the global financial crisis of 2008.

Where do these exchanges take place?

Politicians’ criticism of dysfunctional markets has shone a spotlight on Europe’s major energy futures market operators – Nasdaq in Sweden for electricity, ICE Futures Europe in London for oil and Amsterdam for gas , and the German EEX for electricity. They also manage clearinghouses that manage risk and exposure on open derivative contracts, calculating payouts every day that determine the margin clients deposit.

Regulations require that most margin payments be made in cash so that funds are immediately available if something goes wrong. Some exchanges and clearinghouses that primarily trade energy, in particular Spain, Sweden, Norway and Poland, accept bank guarantees from end-users such as energy companies, as the latter do not have much cash or other collateral available from banks.

However, even these bank guarantees are only accepted if fully backed by cash.

Who provides the warranty?

To meet stock exchange collateral requirements, large utilities typically rely on revolving credit facilities established with their banks. Over the past 12 months, as gas and electricity prices have soared, many utilities have set up additional liquidity facilities with the same lenders, but there are signs that some are reaching limits. of their commercial lines of credit.

RBC Capital Markets said on Monday that even “the strongest utilities” faced “tremendous pressure in terms of guarantee payments.” Sweden announced on Sunday it would provide up to $23 billion in credit guarantees to Nordic utilities to help them avoid technical failures, while Finland offered a €10 billion package.

Deepa Venkateswaran, European utilities analyst at Bernstein, said the Swedish and Finnish government intervention suggested commercial credit lines had been tapped. “Because the numbers are going up quite significantly, maybe the banking system can’t handle it,” she said.

Which groups are most at risk?

Most power producers hedge their electricity contracts to some extent, which means that many power producers in Europe are likely to be exposed to the liquidity shortage. Eurelectric, which represents more than 3,500 European utilities, warned on Monday that rising payments were a “serious concern” for its members.

Even before the new price spike in August, several major utilities, including Germany’s Uniper and France’s EDF, had already run into serious trouble. Both companies struggled to cover margin requirements when gas and electricity prices started to rise in October last year. Since then, Uniper has been forced to buy gas at record prices as deliveries from Russia have dried up, while EDF has had to import electricity to cover blackouts.

Venkateswaran said utilities with a high proportion of hydroelectric and nuclear power, such as in Sweden and Finland, tended to hedge more than those dependent on other forms of electricity generation and were likely to be particularly exposed to increased collateral requirements.

What can be done?

EU energy ministers will consider taking bloc-wide action at an emergency meeting on Friday, according to officials briefed on the talks. Electricity market players say governments have two main options: prepare to provide utilities with billions of euros in state-guaranteed credit or change margin rules.

Currently, the EU 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 exchanges require from power producers, analysts say regulators could ease pressure on utility liquidity with limited risk to their counterparties. “These are companies with power generation assets, so they’re not running away anywhere,” Bernstein’s Venkateswaran said. “It’s different from someone who just speculates on electricity prices.”

John Musk, European utilities and infrastructure analyst at RBC Capital Markets, also said “structural reforms” would likely be needed. “Supporting energy companies by moving guarantee payments off their books to the books of the financial/government system may not be the ideal solution,” he said in a note Monday.

One solution that authorities can explore is to change the type of bank guarantees that power producers 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 off,” said Rafael Plata, secretary general of Each, the European clearinghouse association. “If implemented through a fast-track process, we could see producers and consumers benefiting from it shortly, as they are doing in other jurisdictions like the United States or Canada.”

Mary I. Bruner