At a time when energy prices are ripping into end-consumers, bringing forth recession and burning holes in household savings, worrying about market downside risks might seem counterintuitive. Nevertheless, the EU has, since 2021 been under geopolitically linked energy market pressure, with the last few months making it plain to see that Russia is using mainly its market position in European gas markets to blackmail EU countries ahead of winter.
Repeated gas export reductions and re-starts, have injected a maximum of uncertainty into markets and forced market actors to engage in storage and price hedging at prohibitive costs. Recently Russia completely halted North Stream 1 deliveries, initially blaming faulty equipment but later menacingly reminding Europe that a lifting of sanctions could resolve the issue.
Dramatically reduced Russian exports have already forced the EU to underwrite energy companies’ costly inventory build, as well as to recently guarantee power companies’ liquidity strains amid risks of exorbitant margin calls. The focus is, rightly so, on making sure Europe gets through peak demand winter season with as little gas and power shortages as possible to diminish end-consumer suffering, corporate defaults, rising unemployment and what seems like an almost inevitable recession.
At the same time, the large inventory build, at record price levels, makes companies exposed to large risks in itself. As ELS Analysis warned already last month, the prospect of Russia suddenly opening the taps, if only for a time, to either split EU political unity, maximise market uncertainty, increase export revenues, or all of the above, should not be ruled out. In such a scenario highly leveraged and expensively hedged inventories would lose in value, exposing many companies to imminent risk of survival and potentially throwing markets, as well as physical supply, into disorder.
The fast actions of German and Nordic governments in the past weeks with regards to putting up liquidity guarantees to head of margin call shocks raises hopes the edge would be take off such a development, but it needs to be followed by more than the UK which is now preparing a similar scheme. Care needs also to be taken that such schemes are extended to cover also other types of liquidity strains than those caused by margin calls only.
Market manipulation can be made in upward as well as downward movements and a sharp loss of value in leveraged assets risks setting off mechanical reactions in exposed financial institutions – many of which might even be mandated. Maintaining readiness for all eventualities, will be key for many more months, it seems.