Central bank support for energy markets unlikely

Central banks have stepped up talks with energy trading firms to ease market tensions sparked by the war in Ukraine, but are unlikely to immediately provide additional support, according to people familiar with the talks.

Energy market leaders spoke with the Bank of England and the European Central Bank this week to express concern over the sharp rise in commodity futures prices, which is hampering risk management and threatening the smooth flow of physical assets around the world.

Senior BoE officials want to know how tensions in futures markets can be eased and are aware of the potential risks to global trade, according to people familiar with the matter. However, the central bank believes that the facilities in place already provide a cushion against a possible deterioration in market conditions.

"I think there's been a pretty active debate between regulators, central banks and banks about how we can solve the problem," said Jeremy Weir, chief executive officer of commodities trader Trafigura. "We're doing our part by talking to the various institutions and regulators to at least say that those are the market conditions... We need some form of liquidity to get back into the market," he said on Tuesday at the FT Commodities Global Summit in Switzerland.

Russell Hardy, chief executive officer of Vitol, another of the world's largest commodity traders, said participation in the gas spot market has declined due to trading costs.

To transport a load equivalent to a megawatt-hour of LPG priced at €97, traders must set aside €80 in cash, which exceeds their capital needs, Hardy said.

"The depth and liquidity of the gas markets would normally prevent something like that - the price doubling in a day," he said.

Traders rely on networks of terminals, storage facilities and shipping fleets to move key commodities around the world. But they also depend on the financial markets to help them set floor prices for future dates and to hedge the risk that prices move against them until the goods are delivered. This is typically done through contracts linked to commodity prices from exchanges such as ICE Futures Europe and CME Group in Chicago. Most European energy contracts are risk-monitored in London under the supervision of the BoE.

The BoE and the ECB declined to comment. The British regulator, the Financial Conduct Authority, says it is in "close contact with financial companies that are active in the energy markets".

Russia's invasion has pushed up the cost of the commodities it produces, like oil and gas, and Ukrainian exports, including wheat. This means that traders' hedging against falling prices has become very loss-making, leading to calls for more margin.

These margins are returned to traders when the goods are delivered, but in the meantime, traders may struggle with liquidity constraints. This is especially a problem for smaller companies that don't have access to large lines of credit.

An industry group representing Europe's biggest energy traders - including Shell and BP, as well as major German utilities - wrote in a letter this month asking for help. Many traders would like central banks to support clearing houses and banks so that they, in turn, are less forced to increase margins for traders.

Eurozone officials have ruled out direct support for extractive industries, arguing that any explicit support or guarantees should come from governments or development banks.

Last week, Rostin Behnam, chairman of the Commodity Futures Trading Commission, the main US derivatives regulator, said there was plenty of collateral remaining in the global financial system after volatility in March 2020 when markets collapsed on Covid worries.

"I think this has acted as a nice buffer as we've had to deal with the shock over the past two weeks. Neither the CFTC nor I personally have come across anything that is overtly worrying," he said.

However, he urged market participants to share their concerns. "It's helpful that we're talking about this so we can work together to mitigate the risks that may arise.