UK energy markets face volatility risk as banks retreat

The UK’s energy markets face the risk of unpredictable price volatility and lower liquidity following the steady retreat of financial players from gas and power trade, market sources have warned.

On Tuesday Barclays Capital became the latest financial player to back away from UK energy trade with the announcement it will exit commodities markets, including energy, to refocus on more profitable areas for the group.

The move away from energy commodities follows similar withdrawal from JP Morgan, Deutsche Bank, Bank of America Merrill Lynch and Morgan Stanley, all of which have reduced or closed their European power and gas trading units over recent months.

Although unsurprising, the loss of yet another financial player from the energy trading space has sparked renewed concern over the health of the UK’s gas and power markets at a time when energy regulator Ofgem continues to push forward with plans to boost liquidity and market participation.

Not only will fewer financial participants decrease liquidity overall, traders warned, but the reduced variety of market player could threaten the stability of the market.

“The main issue is more than losing a section of the market that provided liquidity – this could provide opportunity for those still left,” a UK power trader said, “But it may make it easier for more dominant parties to bully the market.”

Clive Furness, MD of market consultancy Contango Markets, explained that active participation of financial institutions is a stabilizing factor in the market because banks will have inherently different drivers compared to those with generating portfolios.

“You need a mixture of participants to have a fully functional, balanced market,” Furness said.

“In a market dominated by a few large participants there is a risk of sharp, unexpected price moves [because] the risk of there not being enough participants available to ‘soak up’ volume is higher,” Furness added.

UK power traders told Utility Week that one of the key reasons behind the exodus of financial players is increased regulation surrounding derivatives trade, specifically European Market Infrastructure Regulation (Emir), combined with reduced profit potential in energy markets.

“There are significant capital costs involved with the introduction of Emir and Remit[Regulation on Wholesale Energy Market Integrity] so banks will look very carefully on the return on that capital and where it doesn’t make sense they will exit,” Furness said, adding that tighter available funds would be allocated to markets with greater potential for profit.

“If you don’t make enough money from a market it won’t be considered part of the ‘core’ business,” Furness said.

Reduced market participation from the financial space comes as Ofgem continues to drive forward policy seeking to encourage new entrants into the market. In April, its ‘Secure and Promote’ rules came into effect forcing the UK’s largest suppliers to place bids and offers on forward-curve products within designated time windows, to boost liquidity on the wholesale electricity market.

Traders say that although the regime has increased pricing visibility it is still too soon to tell whether it will support the inclusion of new entrants.