Affection and firmness are the solution to the energy derivatives crisis

Affection and firmness is the best solution for the European energy derivatives crisis. The utilities and the traders Energy companies are facing a $1.5 trillion increase in collateral demands due to fluctuations in gas futures. The solution could be bailouts or the suspension of the rules of trading and guarantees. The least bad option seems to be state support, at an appropriate price.

The last Lehman moment of Europe has its origin in the rules that seek to make the system more secure. Futures are used by power producers or distributors to hedge the price at which they sell power to customers. But they also have to post collateral to protect their partners from trading against the risk that they fail and owe money on the contract.

The increase in natural gas prices by almost 10 times in the last year, caused by Vladimir Putin’s invasion of Ukraine, means that traders they have had to provide more and more guarantees, with needs that exceed 1.5 billion euros, according to Equinor.

A year ago, the margin of the Dutch trading point TTF futures contracts for the first month was 8.44 euros per megawatt hour. On Tuesday it had shot up to 78.63 euros, according to ICE data. The risk that the contraction becomes a self-fulfilling prophecy: companies worried about not being able to cope with liquidity demands may exit the market, making prices more volatile. In the worst case, it can cause a cascade of bankruptcies. That’s why Finland and Sweden rushed to provide state support on Sunday, and it’s one of the reasons Germany’s Uniper turned to Berlin for help.

There are other options apart from governments providing liquidity or even injecting capital, as happened with Uniper. European leaders could consider relaxing collateral rules, enshrined in EU law. That could mean, for example, using lower-quality assets, such as letters of credit, or setting margin levels. The danger of this measure is that it increases the risk when a counterparty fails. A more worrying suggestion is to completely cancel the trading. This could make it difficult to close existing contracts and make prices even more erratic.

The least bad option is government support, with a counterpart. The risk is that bailouts leave taxpayers at great risk, while traders of energy benefit. However, if the aid comes at high interest rates, such as the 14.2% bridging loan from Finnish energy company Fortum, the state should be largely covered. Blocking dividends and bonuses will also curb moral hazard. Exceptional times call for exceptional measures.