Steno Signals #14: What on earth is going on in European electricity markets?
European electricity markets are completely out of sync with fundamentals and we have spent most of this week understanding why - here is our take-away!
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During the week, one of the biggest stories emerging was that some of Europe's biggest banks are exposed to risks stemming from the European energy markets due to HUUUUUUUUUUUGE margin calls arising as a consequence of the mayhem in electricity futures. Having spent hours in telcos with Power trading desks in recent weeks, here is my understanding of what was and is going on:
According to Equinor the potential margin call on electricity futures totalled around a whopping 1.5 trillion EUR last week and several banks had amounts equalling 30-40% of the entire balance sheet blowing in the wind at some point on Thursday/Friday. The list of clearing banks with ultimate exposure towards these margin calls is found here - ABN, Raffheisen and a couple of the Southern European names look vulnerable to this story.
Chart 1. A massive melt-up in electricity prices until the verbal intervention began
The main culprit behind the melt up in European electricity futures was the so-called clean spark spread (an electricity equivalent of the crack-spread), which represents the net revenue a power generator makes from selling power, having bought gas and the required number of carbon allowances. The spread is usually fairly stable, but it started melting up during last week.
Power generators selling electricity forward and buying gas forward hence ended up with a net/net negative market value as electricity prices kept rising, while the gas price didn’t follow suit. When you have locked in the sales of electricity and the purchase of gas in forward terms simultaneously, this leads to net/net margin (or collateral) calls from your counterpart in the contract. On top of this Nat Gas and Electricity are trading at two different venues, which does not allow for margin netting, making matters worse when *beep* hits the fan.
Ultimately this forced power generators to buy back the electricity already sold forward, which exaggerated the issue. The clean-spark-spread briefly traded above 400 EURs per MWH, but has since retraced to levels around 100 EURs per MWH, meaning that margin calls ought to be at index 25-30 of the 1.5trn reported late last week.
Chart 2. The clean-spark-spread was the catalyst behind the electricity mayhem
This is also a CRYSTAL-CLEAR signal that electricity prices are out of sync with fundamentals, the current price levels rather reflect a liquidity risk similar to what happened to LIBOR in 2008/2009. With EU intervention on the cards, it is time to fade this story hard. Electricity prices are coming down now.
Update on Gas Flows - given the shut down of NS1
This proxy war taking place on European soil, and its consequential sanctions, are bad for business. Particularly when the opposing sides rely on each other’s resources and markets.
Now it seems, Russia has walked the talk. The indefinite shutdown of NS1, which has long posed as the worst case scenario for Europe, is a reality. While Putin has made his move halting the NS1-flows to a complete stop, the “collective West” has yet to meet his request for sanctions to be lifted - and so far nothing indicates that they/we will.
So, if the West won't capitulate and comply and Russia won’t rev up the compressors, then where does that leave us? Well, if we revisit the below chart from last week’s newsletter, it appears that we are at the mercy of mother nature.
Chart 3. Scenarios for German gas over winter
As I stated in the last ‘Steno Signals’, which i urge you to go read if you haven’t already, my calculations indicate that with an average consumption of 105 TWh per month, which wouldn’t be far off assumed we get a somewhat mild winter, then Germany will make it to the other side unscattered - low on funds maybe. Suppose we get a cold winter though, the story would be way different. With a net burn upwards of 60-70 TWh per month Germany will not get around rationing gas and energy - that is by now the sad truth.
The gas-story is multifaceted and I will be the first to acknowledge that, as much as I would like to be, I am no fortune teller. That being said, I do believe that Germany (and hence Europe) will make it through the winter in a modal outcome. The size of the bill on the other hand could very well turn into grim reading.
Chart 4. German / Russian reliance
The European reliance on Russian flows becomes evident when observing historical data.
Russia has long been Europe’s monopoly-like supplier of gas and alternative sources of energy. This reliance has now put us (the EU) in a pickle. Adding to the troubles of the distraught Europe is the fact that German nuclear plants are still being relieved of service. Putin has without a doubt timed this to a tee - and IMO there is no doubt that the Russians have funded parts of the anti-nuclear, pro-ESG movements in Europe, which allowed for a political backdrop that Putin could utilize this year.
We mustn’t forget that Russia too has benefited from the steady cash flow coming in their direction in exchange for their gas and alternative energy resources. Adding to that, immense as it might be, Russia needs access to markets outside their own borders. In 2021 Europe accounted for 52% of total Russian exports, while 43% of Russian imports came from Europe (according to UN COMTRADE). I imagine some wealthy oligarchs are not pleased with having to visit Lada dealerships rather than ‘exotic’ European ones.
As previously stated, war is bad for business - wiseguys figured that out a long time ago - and the economic incentives for reaching some kind of deal over the coming winter are there. We already see French people taking to the streets and Italians having electricity bill-bonfires. Question is; Do the geopolitical and humanitarian objectives outweigh the economic pain? It does for now at least.
Time to acknowledge the doom-prophets for their divination?
Despite the recent shut-down of NS1 and the flow having been at 20% for some time, Germany somehow managed to reach new highs in total inflows. I know that this statement goes against the common discourse on most media outlets, but before you dig out your pitchforks and pass around torches, let me clarify; The price the Germans (and the rest of Europe for that matter) pay for this stockpiling is not the topic of discussion.
I simply note that the storages are being filled. The side-effect of soaring energy prices is a different but equally important issue.
Chart 5. Record high injections of Nat Gas into storage in Germany
Doom and gloom sells, but in my opinion the narrative is saturated - if not exhausted.
Nowadays someone comes out with a new doomsday prophecy every few days, and Twitter makes the perfect forum for sharing such takes on our ‘bleak’ future. Dusting of one's rack-and-ruin-encyclopedia presents some interesting reading;
In 1987 it was the 1990s great depression, following the financial crisis of ‘08 Peter Schiff predicted the end of the world and on December 21st 2012, when The Great Cycle of the Mayan calendar ended, people expected earthquakes, floods and what not to end human civilisation on earth - they even made a blockbuster film about exactly that.
Don't get me wrong. I do not perceive the near future with newly infused optimism. I simply call for some moderation and Germany is still managing to build up natural gas storage as we speak despite Putin halting gas flows.
Recently Putin has been hailed as a strategic mastermind both on Twitter and in the media and there is a growing sentiment that Russia will win the war of sanctions and Europe will be thrown back to the middle ages. I have talked a lot about this the last week and wanted to elaborate on my thoughts here.
Before we get to the debunking of Russian Myths, I just wanted to make it crystal clear to everyone. Yes, Europe is stuck in a mess and a recession is unavoidable, but the extent of the crisis is manageable and Russia doesn’t hold all the cards.
Here are five Russian pieces of misinformation that I would like to debunk:
#1 Russia can just sell their natural gas toIndia and China
16 % of Russian gas is exported as LNG and from the huge gas fields north of Murmansk there are only pipes going towards Europe. If Russia intends to sell their natural gas to China and India it would take both pipelines and LNG terminals and, as pointed out by Oliver Alexander, building those would take a very long time. It took 12 years to build a pipeline from the Chayanda gas field in Siberia to China and that was without sanctions imposed on Russia. Wishing Russia ‘Good luck’ on setting up the required infrastructure… With a bit of good fortune they might be finished by the time we are all using fusion power. Nostrovia, Mr Putin!
#2 The RUB is strong proving Putin is winning the economic war
The reason for the strength of the RUB lies in Russian imports. They simply cannot buy anything from Europe or the US outside of absolute necessities. Major European economies have all seen their exports to Russia drop.
#3 The Russian Economy is firing on all cylinders.
Timely indicators such as a sales/registration of cars show a much less benign picture than what is being reported elsewhere. The Russians will soon be driving around in lousy Ladas without technology.
#4 German gas flows will go to zero
No, Germany and the rest of Europe will not see zero gas inflows once Russia turns the tap off. I covered this last week but in short Germany has other suppliers and zero Russian gas should lead to gas flows last seen in 2015. Of course it is bad, but it is nowhere near the zombieland scenarios I have read.
#5 Russia can re-sell gas to Europe via China
Njah... China bought 2.35mn tonnes of LNG from Russia in H1-2022. Europe bought more than 70mn tonnes of LNG in 2021.. so at the very maximum, Russian re-selling of LNG via China will make up 5% of Europes LNG imports and the actual number is probably below 1% of total import. THAT’S PEANUTS, even if it is a hilarious story, admittedly!
Sure the situation in Europe is looking more and more critical by the day, but your Russian mastermind of a leader is currently set to throw his own economy into a pretty bad recession with a drop in GDP of some 10%. This is not winning, folks!
Chart 6. Russia’s economy will take years if not decades to recover
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Nice work Andreas, I agree with you. Also - isn't it stunning that daily gas prices in Germany are now already back below the highs from March at the beginning of the year? We're back down to €225 per MWh. Fingers crossed this trend continues.