FRANKFURT, Nov 10 (Reuters) – The European Central Bank is examining the use of derivatives by energy companies to make huge bets on future electricity and fuel prices, to see if such activity presents a broader risk to financial stability, three people familiar with the matter said.
Two of those interviewed said the investigation was sparked by Germany’s bailout of major gas importer Uniper, which like other energy companies hedged its risks with derivatives worth tens of dollars. billion euros, far exceeding the value of the energy sold.
The ECB’s decision is the first major effort in Europe to determine whether the use of derivatives by power companies poses a wider financial threat and exposes the largely unregulated trade, which totals billions of euros, to a rare exam.
One of the people said ECB officials initially worried that energy companies would act as de facto traders, but without the regulatory oversight applied to banks, which are required to hold cash reserves against potential losses.
But there was also a broader question for officials: Could energy companies’ use of such complex instruments threaten financial stability?
The ECB has therefore extended its supervision to examine the potential domino effects, including on the banks it supervises.
The ECB, the first financial authority in the euro zone and guarantor of financial stability, declined to comment. He will present some of his findings in the coming days, two of the people said.
One of the people said that derivatives posed a risk because of the regular demands for cash collateral to back up transactions, so energy company transactions could also harm banks.
ECB officials discussed Uniper’s (UN01.DE) use of derivatives, two of the interviewees said, and whether that added to its problems when Moscow cut off gas to the ECB. Germany through the company in response to Western sanctions over the Russian invasion of Ukraine.
Earlier this month, Uniper revealed a loss of 40 billion euros ($39 billion) for the first nine months of this year, the largest in German corporate history.
As gas prices soared this year, some traders and banks lobbied the ECB to help brokers and clearinghouses amid a liquidity crunch that Equinor, the first European gas trader, estimated at 1.5 trillion euros. Read more
While ECB President Christine Lagarde said the ECB was ready to provide liquidity to banks, she said she would not do the same for energy companies.
However, central banks could, indirectly, be left behind as they act as a lender of last resort, one person said, meaning they could extend credit to banks, which would then lend to energy companies to cover the transactions.
German financial regulator BaFin said the risks associated with derivatives trading by energy companies had long been under scrutiny and warned that any such company that had not applied for the relevant financial license was breaking the law.
“Energy companies pose specific risks not only to financial stability. They are often also of systemic importance to the economy as a whole,” a BaFin spokesperson said.
“We are therefore in close dialogue with energy supervisors to deal with all kinds of risks,” the spokesperson added.
Policymakers in Brussels are also concerned and circulated a document this week suggesting extending the strict rules applied to banks to energy companies that trade in derivatives.
In the document seen by Reuters, they say that the application of stricter controls would prevent “risks from spreading from the real economy to the financial sector”.
MARGIN CALLS
Energy companies are known to buy and sell oil, gas and power rather than trading derivatives, such as an option to buy or sell gas at a fixed price in the future.
They say derivatives are primarily used to hedge or protect against price fluctuations. If the market price is well below or above the price of an option, the cost of maintaining that trade can escalate for sellers and buyers.
To ensure that trades are not confused by price movements, traders post collateral, often in cash, with the clearinghouses that process the trades. With recent price spikes, demands for such “margin calls” have skyrocketed.
A Uniper spokesman said his problems stemmed from soaring gasoline prices, which determined the cost of his rescue.
But Uniper’s financial statements gave a glimpse of the scale of derivatives-related losses as prices turned.
The company said it made a series of write-downs and adjustments, including a €3 billion write-down on derivatives and a €9 billion loss on derivatives used for hedging purposes.
Uniper said there was an €11bn impact on profits from ‘remaining derivatives’, which a spokesperson told Reuters was due to accounting rules, declining to describe the overall impact drifts.
Germany’s economy ministry, which is finalizing the nationalization of Uniper, said it could not comment on its business risks.
Ratings agency Moody’s, meanwhile, said energy companies had failed to provide enough information about their derivatives.
“We’re struggling to identify precisely what is related to operational activities and what is related to speculative trading,” credit analyst Knut Slatten told Reuters in comments on companies in the sector.
In a recent report on derivatives, Moody’s addressed the case of Uniper but also criticized RWE (RWEG.DE) and E.ON (EONGn.DE).
“You rarely find information on counterparties. You can’t really find a lot of information on the duration of these hedges,” Slatten said.
E.ON said it was transparent. RWE said its rating with Moody’s was stable and it was in contact about the impact of the Ukraine crisis, declining to give details of its coverage.
Additional reporting by Huw Jones and Dmitry Zhdannikov in London and Marta Orosz in Frankfurt; Written by John O’Donnell; Editing by Alexander Smith
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