Discussions about a potential reform of the European power market's design are becoming more concrete, as prices continue soaring to record highs and show unprecedented volatility. In an interview with Argus, the European Energy Exchange's (EEX's) chief executive, Peter Reitz, details the role and challenges of the exchange in these uncertain times for market participants.
Power market liquidity has dropped significantly since last year. Are you seeing any signs of this reversing? In terms of market participants that are active on the exchange, are you seeing a notable decrease recently?
We have seen a major drop in liquidity in the over-the-counter (OTC) market, but not on the exchange. Our August volumes are up compared with the previous month, and it is above the average of the past couple of years of a typical August. There is a concentration of liquidity on the exchange in an overall shrinking market. In these times of high volatility, market participants are aware of the counterparty risk and the service of clearing is of much value to everyone engaged in the energy markets.
And in terms of participants, these days we are seeing more of them on the exchange than ever. Some of them were trading only in the OTC before and have joined the exchange because it is where they will find [the most] liquid markets.
Speaking of volatility, it is now difficult for trading companies to operate in these times of high prices, particularly regarding daily margin payments. What has the EEX done to amend its methodologies and processes in response to the current market environment?
We have not changed it significantly. Our major measure in terms of margin calls has been to advise our customers on how they can optimise their margins. The biggest effect we have seen is that many of them have moved OTC gas positions into the clearing house, which looks at the overall net risk position. So many of them were able to reduce their margin requirements for their power position by putting their gas position into the same clearing house. This has been a trend since volatility started to rise last year.
Friday, 26 August, was a day of unprecedented volatility on the German year-ahead, trading in close to a €400/MWh range intra-day and reaching nearly €1,000/MWh. What caused this level of volatility?
These days, each market message or announcement can have an immediate impact on prices and there were a couple of news items announced on this day — for example, the announcement that additional nuclear power plants in France were going to be taken out of the market. All market participants have their own models and come to different expectations when news comes out.
How do you feel the EU market reform, currently being discussed, could affect trade in the forward market, and what changes are you considering to adapt to this? What do you see as the most effective stage of the market in which to intervene, and using what methods?
It is not clear what the actual European decision will look like, so it is difficult to judge what the impact will be. The current proposals on the table are probably not affecting the market design as such. The merit order is the most efficient mechanism by which to allocate which sources of electricity will be used.
Another question is how to allocate the profits and costs once the price has been determined. One way of doing this could be a windfall tax on those who benefit from high prices, although having lower costs […] and now there are proposals to take that [money] from other power producers. We think this sounds good on paper but the devil is in the details. If you are running a wind farm with a cost of producing electricity of €50/MWh and you are seeing a market price at €500/MWh, you will not necessarily get that price. A lot of the capacity that produces electricity is hedged years in advance, so this power may have been sold at €80/MWh. Determining who to tax and how is important in this discussion. When policy decision makers talk about changing the market design, they often mean the redistribution of wealth after the market has determined the price.
In March, exchange trade was suspended in the nickel market because of an extreme rise in prices. How do you avoid a similar position, and what would be your reaction if the power trading sector is at risk of failure?
Price spikes lead to increased margin requirements. Considering a scenario in which the whole market may become unstable because of defaults, we have pushed for a 'lender of last resort' credit facility, because those higher-margin requirements also affect companies that are perfectly hedged but can have shortages of immediate cash. Ideally, we would have a European solution for this, which would prevent such a scenario.
But the situation is very different in the energy market than what we have seen in the nickel market. You cannot create such a short squeeze, as it is a real-time market that always needs to be balanced due to there being few storage facilities.
Under what circumstances would the EEX consider it necessary to suspend power trading? Are there any other volatility control mechanisms or circuit breakers that you are planning to implement or that are already in place, and what would be the triggers for them?
We have, and have always had, such volatility interruption instruments in place, in case there is an intra-day big movement. In this case, we go to an auction phase, giving market participants some time to reconsider their positions. We are using this instrument from time to time for individual contracts if there is high volatility.
We could also take the decision to temporarily close the market if we see a complete imbalance in which there is no fair and orderly trading. This has not happened so far. Our regulators could also advise us to do this. But it would be the wrong thing to do, as we do not have a market problem, rather a supply problem that the market is just showing. You cannot shut down the market, [but] you can shut down a marketplace. If people need to buy power, they will find a way to do it and it will be completely untransparent.
