OTC power trade recovers against exchange

Author: William Peck

2020/02/03

LONDON (ICIS)--European power trade migrated from exchanges to over-the-counter (OTC) venues in the fourth quarter of 2019, as participants opted to reduce transaction costs amid declining recession and therefore counterparty risk.

Since the summer, central banks have cut interest rates and the US and China signed a trade deal, calming global markets.

This saw OTC deals rise 6% compared with third-quarter transactions, and exchange trade fall by the same amount.

Exchanges are more expensive but offer better protection against the losing trading partner declaring bankruptcy and failing to settle its debt. This is likelier to happen during a recession than when global economies are growing.

With the energy complex stuck in a sideways trend, OTC trade still fell 22% compared with the fourth quarter of 2018. Exchange trade fell 4% over the same period.

OUTLOOK

The emergence of the coronavirus as a serious threat to global economic growth could stifle OTC trade in the current quarter, with counterparty risk potentially driving participants to the safer haven of shorter-dated transactions and exchanges.

If the threat of a recession passes though, the OTC share of European power transactions could rise back above 68% this year, rejoining its 2014-2018 range. ICIS began tracking this data in 2014.

It would likely take another energy complex bull run to attract financial players to OTC venues and really raise traded volume and the OTC share though. The LNG glut is set to persist into 2021 and potentially beyond though, a key bearish pricing driver.

MARKET BREAKDOWN

Both exchange and over-the-counter liquidity declined year on year in Europe’s four largest power markets Germany, the UK, France and Italy.

Patterns in smaller markets varied more.

• Surging near-curve volumes brought up Dutch OTC trade year on year

• Polish OTC liquidity has evaporated due to foreign companies leaving the market and legislation limiting where power producers can sell their volumes

• Belgium recorded a steep decline in exchange trade in particular. Nuclear uncertainty supported liquidity in the country in 2018

• Abundant hydropower availability prompted re-hedging and unwinding in Switzerland, supporting exchange and OTC trade

• The post-2017 pattern continued in Czech Republic and Hungary, with exchanges gaining at the expense of OTC venues