While wild swings in gas and electricity prices are forcing European utilities to tap governments for emergency cash, trading houses are weathering the storm.
The region’s energy crisis is driving prices higher — gas futures rose as much as 35% on Sept. 5 alone — and putting utilities at risk as at least $1.5 trillion in margin calls ejected cash from the sector pulled. Similar price spikes earlier this year and into 2021 weighed on liquidity at leading commodity traders including Mercuria Energy Group Ltd., Gunvor Group Ltd, Vitol Group, Trafigura Group and Glencore Plc.
As utilities buckle under margin calls and raise concerns of Lehman Brothers-style contagion across Europe’s energy sector, large trading houses are in a better position this time. Since previous stresses, they’ve reduced trading volumes and moved more trades off exchanges — relieving pressure on margins — while increasing credit line buffers and equity to secure more credit when needed.
The shift has kept the clutch of largely private trading houses at the heart of what are now hugely lucrative businesses, while allowing them to continue to supply much-needed gas and electricity to buyers, often at staggering profits.
“I didn’t see any liquidity problem with any of the big trading houses, they all managed to find lines of credit and bank facilities,” Charif Souki, chairman of US LNG company Tellurian Inc., said in an interview. “And they’re all making more money than ever before.”
Soaring prices over the past year have resulted in massive liquidity constraints for producers, utilities and traders, raising concerns about the impact on the financial world in general. Officials at places like the Federal Reserve, the European Central Bank and the International Monetary Fund have urged regulators to take a closer look at commodity trading or warned of the risks involved.
A major change in trader behavior over the past year has been smaller trading volumes of derivative and physical gas and power.
The overall market is hedging less, and some trading houses are not hedging certain physical positions, instead offsetting price risk through fixed-price deals with producers and end buyers, according to several executives who declined to be named. Physical gas volumes have also fallen because funding lines have not grown as fast as prices, they said.
Some also buy out-of-the-money call options, which pay off on extreme price movements and reduce margin requirements when prices rise, traders say. Also, trading houses don’t face the same type of margin calls for commodities like oil, metals, and grains.
The shift from more over-the-counter trades to over-the-counter deals with banks is another way for traders to secure margin call credit and hold positions when prices fluctuate. That’s becoming increasingly important as gas margins skyrocket and benchmark futures have tripled over the past year.
At the same time, large independent traders have grown, pumping record profits from volatile commodity markets into equity to secure larger bank loans. For example, Gunvor and Trafigura’s equity rose at least 19% in the first half.
While retailers’ balance sheets remain heavily indebted, billions of dollars in additional loans from banks provide a buffer in case prices rise. Some traders have resorted heavily to facilities in recent weeks, according to people familiar with the matter.
Although high prices mean traders don’t have the credit lines to trade the same amount of electricity and gas as they did before Russia invaded Ukraine, it’s still enough to make huge profits.
“The margins that LNG cargoes are generating these days are significant,” Muqsit Ashraf, chief strategy officer at consultancy Accenture, said in July. “In 2020, an LNG shipment generated less than $1 million. Right now we are talking about margins in excess of $100 million for each LNG cargo.”
–Assisted by Andrew Reierson and Jack Farchy.