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How to assess the counterparty risk of your energy supplier(s)

By Kathleen Peters

By Kathleen Peters on 7/09/2022

We’re over halfway through 2022, a year to which future history books will add the word energy crisis. The likelihood of a shortage of natural gas supplies this winter has increased now that Russian supplies have been cut further and Germany has upped its alert status one step closer to the emergency level. On top of this, buying natural gas and electricity in Europe continues to cost many times more than anything we’ve seen before. This also has an upward pull on many other markets across the globe. Our consultants are busier than ever helping their clients deal with the consequences of this crisis. But they’re still willing to give us a bit of time to share their views on the issues large energy buyers have to deal with.

This series includes:

  1. How to tackle the high prices
  2. Understanding the security of supply risks
  3. How to assess the counterparty risk of your energy supplier(s)

In this interview, we bring some insight in dealing with the counterparty risk of your energy supplier(s). This includes the risk that you lose the prices you hedged at lower levels if your supplier disappears because of damages that they suffer when retailing energy in these inflated, extremely volatile markets. We speak to Kathleen Peters, one of our Consultants and a specialist in supplier sourcing and analysis, and our expert on European energy suppliers, to unravel the counterparty risks.

Why are suppliers getting into trouble?

The volatile market and security of supply events we have been witness to this year have uncovered certain supplier behaviours that have increased their risks of getting into trouble. Those that have had to balance portfolios at such inflated spot market prices have also faced higher costs. Such practices as ´over´-generous contract conditions, however, have added to the risk. This includes volume flexibility and hedge execution, where the high prices make them lose money. Compounding this is opportunistic trading desk behaviour resulting in unhedged positions, leaving suppliers unnecessarily open to spot prices. Of course, these issues have come to ahead after a series of unfortunate events during the past two years:

  • Before 2021: Occasional issues with suppliers disappearing due to bad hedging practices
  • Lockdown 2020: some issues with suppliers being overhedged or suffering from volume flex with clients consuming much less
  • Run up in 2021: problems for small suppliers that are short
  • Peaks: issues with many suppliers due to the many issues making the retailing of electricity so difficult at the moment

How can large energy users determine the likelihood of energy suppliers getting into trouble?

There are couple of points that can be assessed here regarding the supplier. One would be whether and which power production plants a supplier might own. Any power production plant that is not entirely based on gas should make a significant amount of money with today´s prices. Another point would be whether the supplier has a transportation or distribution branch, meaning a regular flow of profits. Next to that, their global versus local presence can be reviewed where profit and losses might be balanced at a group level. Putting this all together; large, diversified energy companies might be protected better against current events.

What suppliers are impacted by the current geopolitical situation?

I can’t imagine that there is any supplier that is not affected at all by the current situation. However, there are for sure some affected more than others. To our knowledge, two suppliers are leaving the supply market and only keeping existing customers. They are no longer offering new contracts. One of these have suggested increasing fees, which they would need to do in order to be break even. They have clearly seen losses in the supply, probably due to the high balancing cost. The other supplier had very sharp add-ons in the past and always full-flex, which might explain their difficulties now.

What steps can large energy users take to protect themselves from counterparty risk now?

Either way, the contract should not be terminated in panic. The first step would be to get an idea of the counterparty risk and to make an inventory of the potential impact. This can be assessed by looking into the previously mentioned points. Also, it would be valuable to have an open talk with the supplier to get an understanding of what measures they might have taken in the past to reduce the risk. Check the supplier’s hedging practices. If the supplier is at risk, it should be checked whether hedges could be taken over in case the supplier might disappear. Third party hedging can be reviewed for any further hedges to spread the risk for the future. During upcoming contract negotiations, closer scrutiny should be paid regarding risk assessment, including low add-ons, something E&C can help with.

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