How EU’s Dodd-Frank Will Reshape $940 Billion Energy Market

  • Collateral rules may deter energy traders from doing business
  • Regulator says energy needs rules like other financial markets

As if slumping prices weren’t enough -- German electricity is trading near a 12-year low -- traders and utilities in Europe’s $940 billion power and natural gas markets have another reason to be worried.

An update of the region’s version of the U.S. Dodd-Frank Act, designed to prevent another financial crisis, may impose costs that accelerate an exit of energy traders, boost operating costs for utilities and lead to higher consumer bills, according to utility executives and energy watchdogs. The region’s financial regulator says it will prevent abuses.

Like the 848-page Dodd-Frank, passed in 2010 in response to the near-collapse of the U.S. banking system, Europe’s recast of its Markets in Financial Instruments Directive will be long, technical and hard to digest when details are published later this month.

Here’s a Q&A that explains what’s at stake for the region’s utilities, traders, businesses and consumers.

What does Europe’s energy market look like?

Europe’s energy industry is both fragmented and unified. National markets persist, but there are cables and pipelines linking them together and the EU is pushing for more integration to improve market efficiency.

Utilities, banks, grids and other traders buy and sell billions of dollars worth of power and gas within and between the region’s 28 member states. They also buy and sell a range of derivative contracts including futures and options.

Why is the directive so vital for the energy industry?

The regulator says that hundreds of energy contracts from German power to carbon permits will for the first time be subject to the same regulations as stocks and bonds traded by banks, including mandatory position limits on trades and requirements for collateral to set against trades.

“The EU’s decision has the potential to shape the European energy sector for at least the next decade,” said Chris Borg, a London partner at law firm Reed Smith LLP, which advises commodity traders and oil producers. “Imagine what your energy bills will look like should your power company be regulated like a bank.”

Each energy company may from 2018 need to boost their capital by more than 1 billion euros ($1.1 billion), mainly to guarantee trading positions, according to PricewaterhouseCoopers LLP. Capital isn’t generally required today. The rules may add as much as 20 percent to operating costs, David Coulon, head of PwC’s commodity-management practice in London, said.

Why does the EU want to include energy trading?

The tougher rules are needed to prevent financial-market abuse, says the European Securities and Markets Authority, which is leading the redesign. To ensure this covers the widest possible range of financial instruments, the areas and markets covered by European Union authority need to be expanded beyond the traditional financial asset classes of stocks, bonds and currencies.

“There’s a battle going on,” says Aviv Handler, managing director of ETR Advisory in London, which provides advice to trading companies, exchanges and technology providers. “The authority’s view is that it should be regulating the commodity markets and the industry is in fear of the capital requirements.”

The bloc’s regulator argues it needs to oversee the most important traders in each financial market. If most of a company’s activity is financial, then it should be treated like a financial firm, says Reemt Seibel, a Paris-based spokesman for the authority.

“We are looking to find a good balance,” he said. “The pure energy business should not be covered.”

The authority posed almost 250 questions as part of its consultation since December on the rules, divided into nine categories, according to data compiled by Bloomberg. It received a total of 6,753 comments, with those on commodity derivatives accounting for the most at 26 percent.

What does that mean for energy traders?

The new rules will probably require companies to hold more cash for trading. That may lead to a reduction of participants in the markets, said Gertjan Lankhorst, chief executive officer of GasTerra BV, a Dutch company that sells gas from Europe’s biggest field.

Banks including Barclays Plc to Bank of America Corp. have already exited Europe’s energy markets in the past two years, citing increasing regulation and sliding prices.

“In the worst scenario all energy companies will be treated as financial institutions” leading to a “huge reduction” of participants in the market, Lankhorst said. This would not be “good for liquidity, not good for the functioning of the market.”

What does the industry say the rules will do to energy prices?

Fewer traders means a less efficient market that may boost consumer bills by billions of euros, according to Paul Dawson, head of regulatory affairs at the supply and trading unit of RWE AG, Germany’s second-biggest utility. 

The new laws might even require grids to post collateral for trades done with the sole purpose of ensuring a balance of supply and demand on their networks through the day, according to Claire Camus, a spokeswoman in Brussels for Entsoe, an industry group for Europe’s grids.

What’s next?

Proposals would exempt companies whose buying and selling account for less than 0.5 percent of the total trading of that commodity, and use less than 5 percent of a group’s capital.

Those thresholds are too low and threaten to “devastate” some markets, Stefan Dohler, head of markets at Vattenfall AB, the largest Nordic utility, said by phone from Hamburg. Starting with higher thresholds and narrowing them over time would be better, he said.

The authority is considering “major refinements,” Seibel said.

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