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Yves here. Again, as in 2007 and 2008, we are seeing that market time moves faster than both real economy and political time, and that has consequences. Remember that European leaders knew in late July that a serious energy crisis was in the cards, to the degree that they deemed an immediate 15% reduction as a necessary measure. Yet all they decided to do was agree to voluntary national restrictions, starting August 1…which in relation to the July end decision date, meant there was not even a credible pretense that anything was being done.
So now that summer is over, Russia shutting off Nord Stream 1 indefinitely (while increasing the deliveries on the pipeline through Ukraine as a partial offset, and maintaining flow on TurkStream) has focused a few minds.
Businesses, consumers, and politicians have gotten the message, via skyrocketing energy prices, that there may not be enough energy to meet ordinary demand, which means either new sources need to be found or big cuts are in store. But Alexander Mercouris yesterday gave the history of Europe’s search for cheap energy after coal. The short version is nuclear looked like an important part of the mix until Fukushima, when public pressure rose for a phaseout. And lacking other options, Europe turned even more to Russian gas.
As an aside, the press is continuing to amplify misleading reassurances, like “gas storage is nearly 80% full”. That level bears no relationship to real world needs. Gas storage was meant as a backup to regular supply, and not a substitute for it. Total gas storage capacity is about 100 billon cubic meters. The total supply of Russian gas to the Europe was 140 to 155 billion cubic meters a year. Some commentators think the amount might even be higher, that some purportedly North Sea gas was actually Russian due to the desire not to appear too dependent on Russian gas.
Regardless, 80% of the storage is not enough to substitute for even a year of Russian gas. And the name of the game is not just to get through the winter. Europe needs gas on an ongoing basis, and has no adequate substitute for Russian gas in sight.
Even though design flaws in the electricity market pricing have arguably driven prices even higher than this bad situation warrants, it’s still clear that the energy shortage will be severe, far worse than the West suffered in the 1970s oil shock. Yet the Europe is setting out to make the shortfall worse by trying to impose a price cap on gas, which means Russia will simply stop delivering entirely. And the G7 is hell-bent to do the same for Russian oil. That means Russia will stop selling oil to the price-control-wannabes, so oil prices, at least in the EU and US, also look set to go higher.
Now to the energy company derivatives mess. As an OilPrice story below explains, European companies are facing a ton of margin calls on energy bets gone bad. It will be some time before the press can ferret out how much of this was sensible hedges gone bad, stupid hedges gone bad, and speculation gone bad. Sadly, officially sanctioned speculation, also called “Treasury as a profit center” is common in large companies.
Now that headline $1.5 trillion in margin calls is not simply attention-getting. It also will take priority. Governments will not allow energy companies to fail in the middle of energy shortages. They will also not allow large-scale defaults on derivatives contracts because, as we saw in the financial crisis, banks are often the losers. In 2007 and 2008, they were directly the losers by too often holding CDOs whose market value went to zero. With the energy company trades gone bad, the chain might be longer (the bank could have ordinary loans to the sick energy company, could have loans to a rich investor or hedge fund that has an energy company default on a trade, or the bank could have a commodities trading operation and have its books blow up because some positions it thought were hedged suddenly aren’t due to counterparty failures).
The point of this discussion is that the energy derivatives blowup has the potential to be a systemic crisis. It’s also the energy-related crisis that will hit first. Therefore it will also be first in line to get rescue money. It will compete with and take precedence over funding of real economy bailouts.
And yes, the risk of yet another financial system meltdown is real. We’ve pointed out for some time that the European banking system remains wobbly, particularly Italians banks and Deutsche Bank….and Germany and Italy are also the two economies most dependent on Russian gas. As Colonel Smithers pointed out yesterday:
You are right to wonder. I do, too, and, working in the City, wonder about the impact of defaults and contagion in the banking system.
Having worked on the post 2008 banking and related reforms, as a bankster lobbyist, I thought that the new rules were compromises and there’s not enough bank capital to absorb losses, leverage is too high and circuit breakers like bank structural reform too weak to prevent a repeat of 2008.
When the Basel Committee on Banking Supervision (part of the Basel based Bank of International Settlements) addressed these issues a dozen years ago, two camps soon emerged, the hawks (UK, USA, Netherlands and Sweden) and doves (France, Germany, Italy and Spain). The latter saw no need for reform at first and then sought to delay until 2025, knowing how true state of the Eurozone and their banks.
I often wonder when and how the missed opportunity would come to bite us.
We’ll know more about specific proposals for rationing and subsidies after an emergency EU meeting set for September 9. This chart gives an approximation of which countries are getting squeezed most now:
How do consumers’ energy bills compare across Europe? UK consumers hardest hit: pic.twitter.com/slK0rj3ccG
— Anne-Sylvaine Chassany (@ChassNews) September 7, 2022
By Josh Owens, the Content Director at Oilprice. Originally published at OilPrice
- Europe is facing a potential “Lehman Brothers” event as energy companies face $1.5 trillion in margin calls.
- Some countries in the EU have already decided to set up funds to avoid a collapse of their energy derivatives markets.
- The crisis deepened after Russia said on Friday that the Nord Stream gas pipeline to Germany would remain closed indefinitely.
European energy companies are facing margin calls of a total of $1.5 trillion in the derivatives market and many would need policy support to cover them amid wild swings and skyrocketing gas and power prices, an executive at Norway’s energy major Equinor told Bloomberg on Tuesday. According to Helge Haugane, Equinor’s senior vice president for gas and power, the $1.5-trillion estimate is even “conservative”.
Liquidity at energy firms is drying up as many companies have started to struggle to meet their margin calls on the energy derivatives market.
“If the companies need to put up that much money, that means liquidity in the market dries up and this is not good for this part of the gas markets,” Equinor’s Haugane told Bloomberg.
Some countries in the EU have already decided to set up funds to avoid a collapse of their energy derivatives markets. Finland and Sweden put out plans this weekend to support their energy companies trading in the electricity derivatives markets, looking to avoid a “Lehman Brothers” event in their respective energy industries and financial systems.
“This has had the ingredients for a kind of a Lehman Brothers of energy industry,” Finland’s Minister of Economic Affairs, Mika Lintila, said on Sunday, as carried by Reuters, commenting on the energy crisis in Europe.
The crisis deepened after Russia said on Friday that the Nord Stream gas pipeline to Germany would remain closed indefinitely, and blamed on Monday the Western sanctions for this situation.
Finland discussed stabilization measures required in the electricity derivatives market, and a proposed central government scheme “is a last-resort financing option for companies that would otherwise be at risk of insolvency,” the Finnish government said in a statement on Sunday.
Finland will look to set up a loan and guarantee scheme of up to $9.92 billion (10 billion euro), under which the State may grant loans or guarantees to companies engaged in electricity production in Finland.
In neighboring Sweden, the government proposed state credit guarantees to mainly electricity producers trading in the market for electricity derivatives. The total amount of required collateral in the market has since June increased from about $6.5 billion (70 billion Swedish crowns) up to about $16.6 billion (180 billion crowns), the government said.
“The purpose of the measure is to prevent that the lack of liquidity could create risks for contagion to other parts of the financial system,” Sweden’s Finance Ministry said.
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So, deja vu all over again.
Let’s see… use of leverage, check, opaque derivatives, check, poor disclosures, check, what could go wrong, check, a black swan event never happens, check.
Will Main Street be protected, not a chance.
Will anyone lose their jobs, not a chance.
Alas, lots of people will lose their jobs; just not anyone who is responsible for this mess
… until, maybe and if, Europe ever holds elections again.
This has been an interesting chart service to follow over the past few weeks, showing real-time and historical electricity production in the EU.
https://www.energymonitor.ai/sectors/power/live-eu-electricity-generation-map
So far production, or the energy mix, doesn’t seem to have substantially changed since the crisis started, but I’m just basing that on a gut feeling visual evaluation. The differences by country in how reliant they are on fossil fuels is also striking.
Deutsche Bank. Well I have no particular bone to pick with individuals, that is a crooked institution and from the outside has appeared that way for a long time. It used to be, my recall to be clear, one could pencil in “Nomura” anytime that a market bet or market timing was gone awry.
Twenty years after Enron. See how far we have come (not in a good way).
Thank you, Griffen.
DB and Standard Chartered recruited from Enron. The ones at DB were terrible and eventually fired.
Thank you Colonel, your endless personnel insights are invaluable! They put a Democratic motto on much more substantive grounds: All politics are personal. (And we ain’t in the club.)
This article makes sense of what Alex Christoforou was talking about in one of yesterday’s videos. He mentioned that some countries were bailing out their energy companies and where this article talks about Finland and Sweden, you can add Austria to that mix. Here is a rough transcription of what he had to say about Austria-
‘…and in Austria they are bailing out energy companies on Wednesday, Austria which announced it would bail out the country’s main energy supplier with a 2 billion Euro loan, the AFP reported Chancellor Karl Nehammer said the loan to Wien energy was an extraordinary rescue measure to ensure its 2 million customers mainly Vienna households continue to receive electricity it will run until next April. Wien energy asked for bailout this weekend after suffering financial trouble amid soaring energy prices and speculation the company mismanaged their funds. Nehammer said Wien energy which is owned by Vienna could have to answer questions as to how they got into trouble.’
https://www.youtube.com/watch?v=g8O0HNcbI98 (17:44 mins in)
Yesterday, the Swiss government also bailed out via an emergency decree one of Switzerland’s largest electric power companies, Axpo, with a credit line of up to CHF 4 B. In addition, a budget for further credit lines has been set up, totalling CHF 10 B.
Somehow Axpo, which is making money hand over fist with the increasing prices at which it sells electricity to its corporate clients, could not find the necessary liquidity to advance as a caution in the electricity exchange (caution whose amount increases in function of energy resell prices).
A funny detail: Axpo is entirely owned by Cantons, i.e. the equivalent of States in the USA, or Länder in Germany and Austria, as Switzerland is also a federal state.
Cracks everywhere. And Switzerland is comparatively in a good situation with all its hydroelectric power…
Ok, replace “caution” with “security deposit” — Kaution, caution are the German, resp. French terms.
All the Wien energy entries in a Google search are in German and I need to turn in. However, I am pretty sure, and even the quick pass seems to show, that the trouble dates back to at least Sept 2021, so way before the gas/electricity crisis.
Also, merely saying the energy companies need rescues, which is what the Christaforu remarks seem to suggest, has two misleading effects. First, it suggests that they might be in trouble for virtuous behavior, as in having big cost increases that they haven’t yet or are somehow not allowed to fully pass on, as opposed to hedges or actual bets gone bad, which is what this article indicated will be the biggest driver. Second, by not putting the focus on the derivatives, it may also obscure for a while how big the holes are.
I certainly think we have a financial market failure which could cause wider contagion to banks, but I am not sure the mechanics are outlined correctly here. My understanding is that the players in the market are suppliers of oil and gas, energy producers, refiners, energy retailers, hedging providers and speculators. Anecdotal rumours suggest that no market players can get hedging provision beyond 6 months and even the large companies that trade derivatives to provide their own hedging are out of the long range market. In the UK energy retailers with inadequate hedging and too many yearly or more customer contracts are failing with knock on impacts to banks, customers, and other energy retailers (industry insurance provisions and customer transfer costs).
On January 27th 2022 we know that natural gas prices jumped 46% on the Nymex exchange with a suggestion that a failed delivery into the Louisiana Henry Hub caused the problem. The result of this issue seems to be an increase in the margin requirements for natural gas futures. This seems to have reduced contract future volumes beyond six months on both ICE and NYMEX exchanges and speculators are disappearing as margin requirements continue to rise. Further maintenance work to gas pipelines in the US this Summer seems to have had a larger effect on world gas contract prices than normal.
I would be guessing that energy firm loan financing from banks gets more expensive if solvency is more questionable or would risk bank solvency. I also see no reason why higher margin requirements for futures could not be spreading to food and mortgage hedging markets as well. Not being an expert all I can go on is known facts and anecdotal evidence which are flagging warning signs as many news outlets have tunnel vision of blaming the war in Ukraine entirely for everything. I just wish I understood the liquidity problem better.
The misapprension you have is in assuming only energy players use these markets. Even retail investors participate. There are energy and ag commodity ETFs and mutual funds. As we discussed at length in 2008, financial firms are big in commodity futures, forwards, and options, so big that there’s an established practice by Goldman called “date rape”.
Moreover, if an energy firm fails, aside from contagion in the markets (the exchange having to go into its reserves if a margin fail is big enough; recall how NASDAQ a couple years back had one big trader fail and blow through 2/3 the exchange’s reserves), the energy firm might have been writing OTC contracts. Thus whoever was on the other side , like a big Wall Street firm or Eurobank or hedge fund which almost certainly has other leveraged positions, would take the loss and could default on bank loans or other trading agreements. And an energy firm that fails will default on loans, leases…..those can create cascading failures too.
Oh, and exchanges do fail. The CME nearly did in 1987 and if it had, John Phelan, head of the NYSE, said the NYSE would not have opened and might never have reopened again.
Norwegian companies are losing money too, including the state owned Statkraft. Hedging and derivative trading.
From Klassekampen, referencing articles in Minerva:
https://klassekampen.no/utgave/2022-09-07/leder
——————-
Hedge fund
LEADER Bjørgulv Braanen
…..The explanation lies in the fact that the companies have entered into financial contracts at fixed prices. When prices rise, as now, the companies lose money through increased ground rent tax and book losses because the market price is higher than the fixed price contract. But the losses are not just accounting technical. In several of the contracts entered into on the Nasdaq exchange, ongoing settlement is required as market prices rise. For the owner municipalities in the power companies, this could develop into a Terra scandal. There is a certain rationality in the fact that the companies have wanted to stabilize earnings through fixed price agreements, but companies such as Statkraft have also engaged in regular financial speculation, including through so-called derivatives trading. “If the company has gambled that they will be able to buy electricity in the market at a lower price than what they have sold it for,
“What Statkraft is doing is in practice no different to what a hedge fund is doing,” says Warren, who believes that the Norwegian state through Statkraft is now probably running Norway’s largest hedge fund, where people become involuntary investors without the opportunity to follow what happens. As during the financial crisis in 2008, European authorities are putting up thousands of billions to save the energy companies, while industry and households are bleeding. The energy crisis, which is about to develop into a comprehensive industrial and financial crisis, must lead to a clean-up and fundamental change of the market system for power. Today’s system has failed.
The infuriating part is that the government is the sole owner of Statkraft, yet by their own rules can’t interfere in how the company operates.
This in stark contrast to how the banking crisis in the 90s was resolved, where the government bailed out the banks by buying a controlling share. And from there put management on a tight leash.
But when the time came to privatize the phone network, creating Telenor, they solemnly swore to be hands off even as they retained the majority share. And since then Telenor as burned billions of money on questionable partnerships and contract in eastern Europe and Asia. They even lost their operating license in India during the scandal there.
At this point it has gone way beyond any semblance of naivety…
Thank you for the shout out, Yves.
I am away this month, in Burgundy at the moment and at Amsterdam HQ in late September, so will update this community from both locations.
“…a last resort financing option.” Sounds like the first resort financing option to me. Let them enter receivership. Nationalize the remains. Public utilities are they not? Pay chump change in their bad bets. If a utility has a variety of energy sources, use marginal pricing (it finally has utility value!) to help sort out the real costs and explain the options to the people. Invest appropriately. I know…way too simplified. Get a template for saving the population rather than the bespoke suits and pound on it. It’s like everything is Brexit.
an aside: The last 12+ minutes of Alexander Mercouris’s recent video is instructive, imo. I don’t expect politicians to understand the deep details of how infrastuctures work, but I’d hope they’d take decisions only after asking experts in the field how things work. I’d hope they’d do that before, in effect, deciding over drinks at the club that something sounds like a good idea because “what could go wrong”. My 2 cents.
Ukraine Disaster Troops Surrounded on Ingulets River; Europe Disaster Gazprom Suspends Nord Stream 1
https://www.youtube.com/watch?v=sBucXLjxUOc&t=2274s
In her article yesterday Yves wrote this common-sense sentences: “ultimately the end for higher energy prices is that they do kill demand. But to kill demand enough to lower energy use to available supply will kill most of these economies stone cold dead.”
Our german secretary of Economy and climate protection, Robert Habeck, begged to differ in a hilarious TV-interview yesterday evening. The talkshow host, Mrs. Maischberger, asked Habeck whether it will be the case that a lot of businesses which can´t afford their energy costs will go bust; not necessarily so, said Habeck, “I can imagine that some industrial sectors stop producing in time for a little while…” Afterwards he tried to explain what will be won for the companies waiting for better times and cheap energy and how to manage that but failed to do that.
Habeck is a complete failure and out of his depth: Neither does he have some knowledge of economics nor did he ever work in a private company; he studied philosophy and wrote third-rate books for children.
The so-called political and administrative “elite” in Berlin, Frankfurt and Brusseles is going to try what they did with extraordinary success within the last two decades: kicking the can down the road with “silly money” from Madame Lagarde (in earlier days Trichet and Draghi) so that in the end the Euro will go bust.
>>> he studied philosophy
Just how well did he do in philosophy? I mean philosophy besides the large dollop of nonsense as well as thinking about the big questions or an examined life is supposed to teach you how to think and it does; of course, it does not make you wise especially if you don’t use the knowledge.
Thanks for this post. On the US side, the US is in a recession – or at least inflation is running high – and yet the dollar is rising in value compared to where it was a year ago and compared to the Euro. (During high inflation the value of the dollar typically falls, I think.) It looks like the dollar is a flight to safety from the EU for the moment. (Think Greece in an earlier crisis). That doesn’t mean the US will escape market contagion from what’s happening across the EU countries. Think of how intertwined our markets and stock markets have become. The City and Wall St are deeply linked. (Never mind the derivative trades…. ) My 2 cents.
adding: in the year of a US national election – midterms or presidential – energy prices are kept as low as possible starting in the summer, often artificially low, because all the incumbents want to be re-elected, and rising gas prices endanger their re-election chances. (The current lower US gas prices are in part a result of tapping the US strategic petroleum reserves.) Doesn’t matter which team is up, happens with either team in control of the WH or Congress. So, after the US midterms I think US energy prices will rise. Just a guess.
Funny how gas has become the modern day bread (as in bread and circus, with MMA being the circus most likely).
Plus ca change as the French put it, i think…
Indeed.
Plus ça change, plus c’est la même chose.
The more things change the more they remain the same.
this is the guy who set the bar so low for the western left, that today the dim wit left thinks the robber baron era was progressive.
the so called left today are feverish believers in all things milton friedman.
https://listverse.com/2014/02/05/10-reasons-bill-clinton-was-secretly-a-terrible-president/
“The financial crash of 2008 was the result of so many complex, compounding factors that people still can’t agree on who, if anyone, was responsible. However, there’s one name that keeps cropping up again and again: Bill Clinton.
Although he ran on a ticket of reeling in the excesses of big business, Clinton quickly became the financial district’s best friend. During his years in office he completely failed to act on regulating derivatives, a central cause of the crash. In 1999, he repealed the Glass-Steagall Act, a nifty bit of legislation that effectively blocked the creation of today’s dangerously unstable super-banks. As The Guardian noted in 2009, sub-prime loans before the repeal accounted for only 5 percent of all mortgage-lending. By the time of the crash, they’d hit 30.”
Because the “left” these days only think in social terms, while in the past their focus was economics.
Much of it thanks to their rank and file having grown up in a time of plenty, and thus their “needs” has shifted far up the pyramid.
None other than Maurice ‘Hank’ Greenberg was circulating memos to the AIG employees to write to .gov to repeal the ‘antiquated’ Glass-Steagal in the late ‘90s.
Well, all’s well that ends well on Bailout Street!
They’re all bought and on the same team, just wearing different uniforms.
So western countries are setting up funds to guarantee derivative margin calls? To prevent a crash. So that’s clever. Nationalize derivatives. Let energy fluctuate as necessary. I do wonder what determines “necessary.” Nationalizing energy derivatives is in my mind the same as nationalizing energy – it just has the added benefit of guaranteeing the TBTF financial system based on energy. If these price fluctuations are determined by “the market” then we might have a wee problem – or maybe it is all part of the cornerstone of fighting inflation with inflation. Whatever works at this point. Except for the fact that fossil fuel energy is dangerously abundant for a finite resource; and the climate is on fire. What authority will step in and inform the nationalized neoliberal world that the use of energy is restricted to a certain amount? This is gonna be interesting.
So, fer instance, if the government which set up the fund to back energy derivatives decides it is time for some severe rationing of oil and gas (because not just the derivatives market but the real market is once again out of control), and then proceeds to impose rationing, will that be considered inside-trading? And etc.
How many crashes will it take before governments pass and enforce laws to prevent the practices which lead to these crashes? Many hard lessons were learned from the Great Depression, lessons that lead to laws and regulations which provided a modicum of stability to the economy. How and when might the Populace regain some of the control over the government, or at least some concern by government for Public Welfare, at even such modest levels as once enjoyed after the Great Depression and the Second Great War? As Climate Chaos, resource depletion, and growing numbers other dark Horsemen gather, Humankind’s prospects for the future are grim. Why and for how long will such complete misrule, adding to the speed and misery of collapse, continue to be tolerated with so little complaint?
Not sure about the EU, but most of the laws that did this in America came out of the Depression, and were removed when Freidman/Greenspan/Rubin/Summers got rolling.
European countries better wise up. The physical assets are important. The workers and factories that make those assets and maintain them are important. The knowledge for all that is important. The rest? It’s churn and parasites. Act accordingly.
Remember the lessons from 2008. America bailed out banks. China kept building, even empty cities. Real industry is hard, do it or lose it.
I’ve been a dedicated NC follower for nigh-on 15 years now and learned much as a result – usually sadly. But, alas, there are still articles like this one that describe a jargon-filled world that is utterly incomprehensible to me. Derivatives in the energy markets? Energy companies making money hand-over-fist and obscene profits but unable to pay their debts? Debts that, it seems to me, relate purely to some kind of obscure and totally unnecessary gambling game conducted as a unforced sideline like some gambling addict forsaking wife and children to stake his wages on the turn of a card in some smoke-filled back room.
I’ve no doubt it’s all very grown-up and necessary to the proper running of civil society. I just wish I understood.
Yves Smith wrote a book you might want to obtain a copy of, that answers your questions: “ECONned: How Unenlightened Self Interest Undermined Democracy and Corrupted Capitalism” – October 11, 2011. “ECONned” explains the way the Financial Sector undermined the world economy in 2008.
I will attempt an inexact ‘hand-wavey’ explanation of sorts: The post above describes how many of the same financial “innovations” have been used to engineer another collapse like that in 2008 — except instead of the housing market, the Finance Sector went to work on the energy sector building a bubble of 1.5 trillion dollars of speculative debt with little collateral to back it. Now the value of that collateral is plummeting and lenders are demanding additional colaterial — margin calls — to cover the debt. If this sounds like “some kind of obscure and totally unnecessary gambling game” you got that right, except you might want to add a little larceny to that characterization. Perhaps you wonder, as I do, how world markets could have suffered near catastrophic economic collapse in 2008, with rampant criminal behavior, and gross malfeasance, but no one was prosecuted, the perpetrators of the scheme were bailed out using trillions of u.s. government money, 10 million home owners lost their homes, and nothing was done to pass laws against the outrageous financial ‘innovations’ that fashioned the collapse — Thank Obama and thank Geithner. Now it looks as if it could be happening all over again. I do not believe there is anything about this that is grown-up or necessary to the proper running of civil society. Futures markets can serve to hedge risks, but when the trading is heavily juiced with borrowed money backed by very little hard collateral, futures markets deteriorate into high stakes gambling casinos.
Only this time, it is in energy and everything depends on fuel of some kind even if it is just wood or physical labor. I get that much of the problem is probably having the flow of money going, but it’s more than that. It really beyond stupid or folly. If people start to actually die from the cold, or have no power when they know they didn’t do anything to cause it, and the To Big to Fail are made whole, can we say revolution? This is as easy to see as the Sun and yet the elites are ignoring this.
One part of your question I left hanging is how is money made from engineering a colossal financial collapse. Fees, commissions, bonuses, and of course most of the gamblers are using someone else’s money. If they win, they can win big, and if they lose, someone else takes the loss — like retirement funds or small investors holding mutual funds, or bigger investors in hedge funds, or banks holding the funds of many. Again, this is an inexact ‘hand-wavey’ explanation … get your hands on Yves’s book. It is a real eye-opener.