Credit risk in energy contracts

A possible outcome of this economic crisis is a credit crisis. The energy sector needs to be given consideration here because of the huge impact of credit risk on its business and the large proportion of energy business on global GDP. Confronted with credit risk negotiations with a supplier, a buyer should be aware of the specific character of credit risk in this sector due to the logistics of energy supply making it difficult for a supplier to just cut supply when a client defaults on payment(s); cascade billing due to which suppliers pre-finance non-commodity parts of the energy bills; the erosion of margins that we’ve seen; pre-financing of collateral in wholesale market operations; and the lower profitability of the energy business.

Unfortunately, the COVID-19 crisis has further impacted the energy markets: overall, energy demand has dropped, causing a decrease in energy prices. Since many suppliers have fixed capacity bands and full volume flexibility contracts, if those clients now consume less, suppliers need to sell that excess energy at those lower prices, but can´t pass on those losses to the client.

Short on cash themselves and apprehensive of what might happen to their customers, suppliers are taking to clauses in their contracts to reduce their credit risk exposure. Most energy contracts include clauses that allow them to take measures in case of a deterioration of the client’s credit rating. These include pre-payments, bank and parent guarantees. Many of those are now being exercised. And in the negotiations of new contracts, it’s much harder to get good credit conditions from energy suppliers.

In case you are confronted with a supplier claiming a bank guarantee in the framework of a general condition, we can give you some tips on how to treat this situation, including verifying the suppliers’ claims, checking the wording in your contract, and being transparent with the supplier. Nobody wins if cracking down on credit risk pushes your company towards bankruptcy, so give your account manager – your ambassador within the suppliers’ organization –  arguments to beget an exception for your company. And the current experience should teach us lessons for the future. That starts with learning more details about credit risk in energy contracts, which is exactly what you can find in this whitepaper.