After a conflict with Russia, Europe may have trouble obtaining gas and oil this winter. However, a new financial crisis—a liquidity crunch—could make things worse by driving up prices even further.
But to relieve pressure on a market whose efficient operation is essential to keeping people warm, European governments have only recently banded together to offer financial assistance to power companies on the verge of collapsing.
According to a top trade source, the futures market is broken, which causes issues for the physical market and raises prices and inflation.
When a group of leading traders, utilities, oil companies, and bankers wrote to authorities 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 fluctuations in the physical market, where an item is delivered, by taking a “short” position. They were trying to cover their potential losses to skyrocketing gas costs.
Banks often provide 85–90% of the borrowing used by market participants to develop margin calls 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 transferred into the broker’s account.
However, a “margin call” is initiated if the account’s funds fall below the required margin requirement, in this example 10-15%.
Over the past year, as the prices of power, gas, and coal have increased, so have the prices of short positions.
As a result, margin calls have forced gas and oil majors, trading companies, and power utilities to increase their capital commitments.
Energy prices increased after Russia’s assault on Ukraine in February, worsening a widespread global shortage. Some businesses, especially smaller ones, were hit so hard that they were compelled to stop trade entirely.
Any such decrease in participants lessens market liquidity, which can result in increased volatility and 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 little indication, however, of whether or how soon governments and the EU will support banks or any other utilities that must hedge their trading in the face of impending winter price surges.
Senior bankers and traders claim initial margin requirements have increased from 10-15% to 100%-150% of the value of the contract by exchanges, clearing houses, and brokers, making hedging prohibitively expensive for many.
Dutch TTF gas futures are subject to margin fees as high as 79% in the ICE market.
Regulators maintain that the danger is low despite market participants’ claims that rapidly vanishing liquidity could significantly restrict trading in fuels like oil, gas, and coal and cause disruptions in supply and bankruptcy.
European energy businesses, excluding those in Britain, require at least 1.5 trillion euros (about $1.5 trillion) to cover the costs of exposure to skyrocketing gas prices, according to state-owned Equinor, the leading gas trader in Europe.
In 2007, the worth of U.S. subprime mortgages was $1.3 trillion, which led to a global financial crisis.
However, one policymaker for the European Central Bank (ECB) said losses in the worst-case scenario would total 25–30 billion euros ($25–30 billion), noting that speculators bore the risk rather than the market itself.