The UK’s Cryptic £40 Billion Bailout for Energy Traders

The £40 billion ($43 billion) plan announced in the first days of Liz Truss’s government to bolster energy traders remains a black box. Who benefits, at what cost and under what conditions is a mystery the Treasury and the Bank of England have yet to explain — with three weeks to go until the fund is formally launched.

The Energy Markets Financing Scheme isn’t getting much attention because it’s been overshadowed by the energy bailouts for households and businesses, which may end costing as much as £160 billion over the next two years. It’s also far more technical than the easily understood freeze on energy bills for families, further discouraging attention.

But it deserves close scrutiny. Properly designed, it’s the right policy, and may end costing a fraction of the £40 billion headline amount. But if badly implemented, it could end channeling billions of taxpayer money to speculators.

To understand the scheme devised by Chancellor of the Exchequer Kwasi Kwarteng, one has to delve into the bowels of the energy market. There, utilities hedge, or lock in, the price of the electricity they charge. By selling forward, they can have taken a position that loses money if prices rise. When that occurs, exchanges such as the Intercontinental Exchange and the European Energy Exchange, demand payments – or margin calls – to cover potential losses. Ultimately when the forward contracts mature, the utilities are fine: losses in financial markets are matched by equal gains from their actual sales. But as they wait for the contracts to mature — as long as several months, or even two years — they need cash to face the margin calls. Lots of cash.

With gas and electricity prices in Europe gyrating wildly, at times as much as 25% in a single day, the margin calls can be brutal. For example, when Wien Energie, a municipal utility in Vienna, asked the Austrian government for a bailout, it disclosed it had faced a margin call of 1.75 billion euros ($1.7 billion) in a single day.

Ultimately, the size of the margin calls may overwhelm a company. The new scheme is “a backstop source of additional liquidity to energy firms in otherwise sound financial health to meet extraordinary variation margin calls,” the UK Treasury said.

Who are those energy companies? That’s the key question the UK Treasury hasn’t answered. When the scheme was announced in early September, it said it would help companies that “have a UK presence” and “play a significant role in UK electricity and gas markets.” On Friday, it tweaked its aim, saying it will help “those making a material contribution to the liquidity of UK energy markets.” Pressed on the matter, the Treasury said it was still working on “the eligibility criteria.”

The key word in the new statement is “liquidity.” Because the biggest liquidity providers in British and continental European energy markets aren’t the utilities that sell electricity to households and businesses, but big banks, commodity traders and hedge funds.

Until now, most European governments have focused on providing liquidity for margin calls to utilities. The British scheme, however, could open the public wallet to many others, including banks in the City of London like Goldman Sachs Group Inc. and Morgan Stanley, hedge fund speculators in Mayfair and commodity traders like Vitol Group and Glencore Plc.

London should follow the Europeans’ narrow focus: limit help to firms that produce – or consume – electricity and natural gas. The support should be tied to physical flows of energy and actual fixed assets, like gas-fired plants, wind farms or nuclear power stations located in the UK, rather than simply to liquidity provision. It should focus on companies that pay most of their taxes in the UK, too, leaving to others to help outfits incorporated in low-tax jurisdictions or tax havens.