Europe fights Putin’s energy war with cash

European governments are patching together emergency measures to support utilities amid fears that companies will buckle under the weight of growing margin calls, worsening an energy crisis that's sent prices soaring and left the continent short of gas.

Recent days have seen a flurry of news – from Sweden to Switzerland to the UK – as companies and governments try to get to grips with the situation. Norway's Equinor ASA has said that European energy trading risks collapsing under the weight of margin calls amounting to at least $1.5 trillion.

The euro zone is almost certainly entering a recession, with business activity contracting for a second month in August.

On Tuesday morning, Finnish utility Fortum Oyj got 2.35 billion euros ($2.3 billion) of bridge funding to ensure adequate liquidity. Switzerland granted Axpo a credit line of up to 4 billion francs ($4.1 billion). The company, which produces and trades renewable energy, asked for the credit line but hasn't used it yet.

Other European Union governments are set to roll out at least 376 billion euros to support households, with gas prices now 400% more than a year ago.

Incoming British Prime Minister Liz Truss is finalising plans for a £40 billion ($46 billion) support package to lower energy bills for UK businesses, as well as a $130 billion scheme to freeze prices at current levels for the next 18 months.

Along with such actions have come dire warnings as wild price moves increase the amount of collateral companies need to maintain hedges. Finland is warning of an "energy-industry Lehman Brothers" moment, with companies facing sudden cash shortages. It and Sweden announced a $33 billion emergency liquidity facility Sunday to backstop utilities through loans and credit guarantees.

In the UK, Centrica Plc is in talks with banks on the potential extension of credit lines, according to a person familiar with the matter. Centrica declined to comment.

The aid effort is a response to what is a rapidly worsening situation, particularly after Russia cut off gas supplies through the key Nord Stream pipeline. Power providers and energy traders faced huge margin calls last winter when gas prices jumped to what were then record highs. Now as those levels are dwarfed after months of price surges, governments are beginning to heed industry warnings that policy support may be needed with prices expected to stay higher for longer.

The hit to the euro zone economy and its currency from would likely be so severe that more aggressive monetary tightening from the European Central Bank will do little to stop the euro's slide.

"Companies have been bleeding cash for a long time because of the margin calls and collateral requirements," said Kristian Ruby, secretary general of power industry group Eurelectric. "This triggers the question – 'What if things get worse?' Governments need to be ready to handle such a situation and back up companies with direct credit, otherwise there's a risk of one falling and dragging down others."

The European Commission is also examining measures to help with liquidity. These could include credit lines from the European Central Bank, new products as margin collateral, and temporary suspensions of derivatives markets, according to a policy background paper seen by Bloomberg News. 

"We now have to do everything we can to secure our power supply," Swiss Energy Minister Simonetta Sommaruga said Tuesday. "We need to avoid that because of a temporary liquidity bottleneck a company gets into a tailspin and pulls others with it."

As wholesale buyers of power and energy, utilities tend to hold majority short hedging positions against their physical contracts, leaving them vulnerable if prices rise sharply and turn those positions loss making. When this happens, a company's broker, bank or exchange may request cash to act as collateral against the position. 

Late last month, Fortum said its collateral requirement rose by 1 billion euros to 5 billion euros in the space of a week. Analysts at Citigroup Inc said last week that soaring power and gas prices forced utilities to put up more than 100 billion euros of additional collateral to cover margin calls.

"This is just capital that is dead and tied up in margin calls," Helge Haugane, Equinor's senior vice president for gas and power, said in an interview. "If the companies need to put up that much money, that means liquidity in the market dries up."

One measure popular among lobby groups is to allow utility companies, but not financial participants in derivatives markets, to post products other than cash as collateral against trades, such as bank guarantees or carbon credits. That would free up utility balance sheets to use capital for other "meaningful purposes," Eurelectric's Ruby said.

As for credit, so far Germany has introduced Europe's biggest scheme to backstop companies affected by the fallout of the war in Ukraine, setting aside 7 billion euros in loans to be made available to companies facing liquidity issues on top of a 100 billion-euro aid package. German energy giant Uniper SE last week sought an extra 4 billion euros after fully using a 9 billion-euro existing facility.

Vienna's municipal power utility also secured 2 billion euros from the Austrian government to cover trading positions.

"European governments need someone to take the price and commodity risk right now," said Steven Kelly, Senior Research Associate at the Yale Program on Financial Stability. "And if the banks aren't able to play the intermediary role you're going to have to go to the source and see sovereigns pick it up if they don't want a liquidity crisis to turn into a balance-sheet crisis." 

Disclaimer: This article first appeared on Bloomberg, and is published by special syndication arrangement.