A.3

Financial stability risks from energy derivatives markets

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Saturday, November 26, 2022
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= Financial stability risks from energy derivatives markets =

Key Points: 
  • = Financial stability risks from energy derivatives markets =
    Published as part of the Financial Stability Review, November 2022.
  • Energy sector firms use energy derivatives under different strategies, depending on their main area of activity, business model and exposure to risk in physical markets.
  • The significant volatility and a surge in prices seen in energy markets since March 2022 have resulted in large margin calls, generating liquidity risks for derivatives users.
  • European energy prices and stylised representation of players active in the physical energy market

    Sources: Bloomberg Finance L.P. and ECB staff calculations.

  • The extreme price movements over recent months highlight the importance of energy derivatives markets for hedging risks in the energy sector, as well as some of the pressures that can arise in these markets.
  • This special feature provides an overview of the European energy derivatives market, with a focus on natural gas and power.
  • It analyses the impact of extreme energy prices on the structure of energy markets, the liquidity stress faced by entities with the largest exposures to market risk and the risks that their vulnerabilities may pose to their counterparties in derivatives and credit markets.
  • Energy sector companies are key users of energy derivatives, and the number of firms active in the market has increased in 2022.
  • Of the 1,700 firms active in the euro area energy derivatives market between September 2021 and October 2022, a quarter belong to the energy production chain, meaning they are extracting oil and gas or distributing energy.
  • On average, the number of firms active in energy derivatives increased by 30% between January and September 2022.
  • Most positions belong to a few large utilities or energy companies which use derivatives to hedge their operations against market risk.
  • [5] Such a high concentration of positions might raise financial stability concerns, as it increases the risk of disorderly market functioning.
  • [6] In general, energy derivatives require relatively high margining, reflecting the generally large volatility of energy prices.
  • Overview of direct and indirect risks from increased volatility in energy markets and gross exposures in energy derivatives per market segment

    Sources: EMIR data and authors calculations.

  • Commodity swaps traded in OTC markets can partially mitigate energy firms liquidity needs as margins are lower for bilaterally cleared trades.
  • A more significant shift by utilities and energy firms towards the OTC space would imply greater risks for counterparties and the financial system.
  • Some firms trading energy derivatives are relying on bank credit to deal with the consequences of rising energy costs.
  • Overall, this evidence might signal energy firms needs to finance inflated working capital, precautionary inventories and high liquidity demand on energy spot and derivatives markets ( Chart A.7, panel a).
  • A quarter of energy firms deal with the same set of banks for obtaining credit and client-clearing services for derivatives.