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Anna Kolesnichenko

Energy prices are a matter of security and should be handled accordingly

These days the topic of energy prices has become a matter of national security in many countries. In the UK it is threatening to become a full-blown crisis, with inflation projected to reach up to 18% by the end of 2022 and about half of households being forced to freeze in the winter or starve, as they will not have enough money to pay both for food and energy. Hopefully the UK government will come up with an adequate response. In continental Europe, governments responded with price caps, direct pay-outs to households and energy-saving measures, but the situation remains tense.


We are clearly in the midst of a major energy security threat. And it is not just the availability of supply, but also of the level of prices. If the price rises prohibitively high, do you still have an option to buy?


That is why I decided to explore a bit what happened to energy prices. My main impression from reading news these days is that there is this unstoppable natural phenomenon called “wholesale energy prices”, and that no one can do anything about it, and the only thing left to governments is to cope with its consequences, for example, by distributing cash to households. I do not claim to be an energy sector expert, but even a quick glimpse at the situation suggests some obvious things that one can do to tackle the problem and not just its consequences.


The situation with gas prices is especially dire, so let´s look at it. Gas prices started rising already in 2021, for a range of supply-demand reasons plus deliberate policies of Gazprom not to increase supplies when needed. Energy Transitions Commission has a good summary of these reasons - here. This analysis, however, shows only a partial picture, they totally omit the role of financial markets and energy companies in exacerbating the volatility of the price of gas (and other commodities).


In his article Jeffrey Frankel argues that the prices of commodities are defined not only by natural factors (like GDP dynamics), but by monetary policy - real interest rates and money injections by the central banks. Quote:


Two episodes illustrate that the effect of real interest rates on commodity prices operates independently of the GDP effect. Neither the spike in dollar commodity prices in the first half of2008 nor the decline in 2014-15 can be explained by fluctuations in economic activity. They can instead be interpreted as the result, respectively, of loose US monetary policy (quantitative easing) and a tightening of US monetary policy with the end of QE.


One of the channels through which this works is a switch between commodities and Treasury bills. “For “financialized” commodities, an increase in the interest rate encourages institutional investors to shift out of the commodities asset class and into Treasury bills”, Frankel says. Clearly, this works in reverse as well: loose monetary policy with low interest rates induces investors out of bonds and into commodities. This is probably what happened this time, with a wall of cash, injected by central banks through quantitative easing, chasing attractive assets. The mere volume of this money makes any change in sentiment translate into large market swings.


In the charts for gas and oil futures prices below we see the largest spikes at around financial crisis in 2008 and now.

























In the wake of 2008 financial crisis, US and European regulators did introduce some measures to restrict speculation in commodities. In particular, they prohibited banks proprietary trading in commodity futures. However, there still remain many loopholes and unregulated areas in these markets. For a good overview of the problems and what needs to be corrected see the article by Jayati Ghosh.


Furthermore, it became apparent this spring that business model of energy trading companies is not very stable. They run a “high risk – high return” business model, of the kind Bear Stearns did. As energy prices surged in early March after Russian invasion of Ukraine, many energy traders found themselves deprived of funding. The European Federation of Energy Traders, has called on governments and regulators to provide emergency assistance to energy trading companies to avert a cash crunch.


The thing is that commodity traders have a high leverage and finance their speculations and commodity purchases with short-term debt. For example, let’s look at Trafigura´s (the key player on the oil market) latest report (for 6 months ending on 31.03.2022). The first thing we read:

Trafigura Group registered its highest ever first half year profit in the six-month period ending 31 March 2022, as volatile commodity markets put a premium on our ability to move commodities…


This is nothing new, traders do profit from volatility. The question is who is on the other side of this trade, i.e. the one who has to pay the higher final price.


Reading further: Trafigura´s net profit increased 27% yoy. Revenue rose 73% yoy to $170,6 bn. Of total revenue the Energy segment contributed $112,9 bn (66%), which is 93% increase yoy. I made a small table with financials for convenience.


Trafigura financials, 6M to March 2022, USD bn









Profitability is strong – ROE is 21%. One of the helping factors here is high leverage - at 7,3 (debt to equity ratio). Notably, of the total debt, short-term borrowings and trade payables are 64%.


On this background of high returns and massive improvement in income, calls for the government to inject cash into such companies to help them meet their margin calls look unconvincing. What they signal, however, is that its high time for regulators to have bigger scrutiny over sustainability of business models of such companies and their effects on the markets. To that end, there is already some movement, with the head of the Financial Stability Board (FSB) Klaas Knot saying at G20 meeting in July 2022:


"The volatility in commodity markets following Russia’s invasion of Ukraine has highlighted the risk of financial strains in these markets – through large margin calls, undetected leverage and concentrated exposures"


FSB said it was beginning to scrutinise commodity markets to identify vulnerabilities.


Another segment that has most likely contributed to energy price volatility are Exchange Traded Funds (ETFs). See, for example, European Systemic Risk Board report on how ETFs can influence their underlying securities and systemic risk. In the wake of the Russian attack on Ukraine, investors rushed into commodity ETFs. Bloomberg reported on 7 March 2022:


Commodity ETFs Pull In $4.5 Billion. Investors are flooding commodity exchange-traded funds with cash on signs that shortages for energy, metals and grains will spark hefty returns.


This is when Brent oil futures reached the peak of 124 USD/Bbl and EU Natural Gas Dutch TTF jumped to 227 EUR/MWh.


I will end my sketch here. The topic of energy prices is huge indeed. But what I have seen even with such a sketchy analysis is enough to conclude that wholesale energy prices and their recent inflation/volatility are not a natural phenomenon, but rather the result of play of some idiosyncratic circumstances and different actors. Of course, Russian disruption plays a major role, especially for the gas market. However, it is not enough to explain the volatility and the size of price jumps we observe. Given the huge security and welfare implications, it seems obvious that governments need to take more control of wholesale energy prices.

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