Speculative trade suspected to be driving German power curve volume

Changes in speculative trading strategies could be the reason behind a recent surge in German electricity far-curve volume and a decline in shorter-term liquidity, market sources said.

Curve volume on the German wholesale over-the-counter market had been falling until stabilising in 2015, while prompt volume has been growing until this year. In the first seven months of this year, traded volume of German prompt and monthly products has fallen while the volume of annual contracts is up sharply compared to the same time in 2015.

Similar volume changes have this year taken place at EEX, the main exchange where German power futures are traded. On EPEX SPOT, the main exchange for trading short-term German products, German Day-ahead volume has taken a downward turn in recent months.

Locational spreads

Changes in profit opportunities from trading certain locational spreads – price differences between Germany and other electricity markets – might have caused volume trends to change, some market sources said.

“I think the reduction of short-term trading is due to market coupling,” an energy broker at an international brokerage company said. Market coupling has reduced locational spreads and has made them more predictable, he said.

Day-ahead markets in Europe are increasingly coupled. With coupling, cross-border transmission capacities are allocated implicitly at day-ahead auctions where electricity, rather than capacity separately, is bought and sold. This usually results in more efficient allocation of cross-border capacities and lower price spreads between markets.

A more advanced coupling method was introduced in the region that Germany is part of in May 2015. The new method, flow-based market coupling (FBMC), has increased the efficiency of cross-border capacity allocation further and reduced price spreads in the region.

The FBMC region consists of German, French, Dutch and Belgian markets. On all the four FBMC markets, the volume of annual contracts was up from January to July compared to 2015 while the volume of prompt products was down. On other large European over-the-counter markets, volume changes have generally been more mixed. Similar volume trends in the FBMC region indicate that the introduction of the new coupling method might have had an impact on liquidity.

Price volatility

An improvement in forecasting renewable energy generation might also have led to lower German prompt volume, the broker said. This has reduced the need to adjust positions on the short-term market due to changes in wind and solar power forecasts.

The success some hedge funds had a few years ago with short-term trading seemed to have fuelled interest in speculative trading on the prompt, especially because curve prices were rather stable, the broker said. This interest might have cooled down because the expansion of wind and solar power in Germany has not resulted in high short-term price volatility as some had expected and because recent curve price volatility opened up more opportunities to benefit from speculative trading there.

Technical trading

Increased popularity of trading based on technical indicators might have also boosted the volume of annual contracts, a trader at a German energy management company said. Some traders have also said in recent months they look more at technical indicators.

Technical trading mostly takes place on the far curve because prices closer in are too closely linked to fundamentals. The movements of German monthly contracts depends strongly on changes of power plant availability forecasts, which are unpredictable. It is almost impossible to profit by taking a short or long position on a German monthly product, the trader said.

Financial funds often trade based on technical indicators, he said. They have become more active in European electricity trading recently, according to market sources.

Outlook

Aside from changes in the number and type of market participants, price volatility tends to be the main driver of volume changes. German short-term price volatility is not expected to pick up in the next few years because market participants continue to adjust to the volatility of wind and solar power, aided by the new power market legislation passed in June. This might mean quick prompt volume growth will not return at least in the medium term and market participants will focus on trying to identify profit opportunities on the far curve, supporting its liquidity. laura.raus@icis.com