Volatility pulls speculators back to UK power market

Financial institutions such as hedge funds are regaining interest in the UK power market due to the recent surge in volatility and liquidity.

Multiple sources have said that increased activity on the market has piqued the interest of non-asset-backed participants looking for opportunities to profit from speculative trading.

Volume traded over-the-counter (OTC) on the market increased substantially in September amid high levels of supply-led volatility (see EDEM 4 October 2016).

According to market participants this volatility has attracted some financial participants such as funds back to the market after a tightening of regulations and lower prices in recent years led to a sharp drop in speculative activity.

“I’ve had people call me up who wouldn’t have gone near UK power previously,” said one consultant specialising in both the short-and long-term markets, in reference to funds. “And now, all of a sudden, they want me to help them out.”

This observation has been echoed by a number of market participants amid the heightened activity of recent weeks.

A trader at a continental utility also said he had lately been encountering more financial counterparties in the market.

“We’re certainly seeing more involvement from funds,” he said. “And it makes sense as conditions are ripe on the market at the moment.”

Comeback

Banks and hedge funds largely withdrew from commodities markets following the financial crisis in 2008.

Tighter regulation and a long-term drop in prices and volatility meant that financial participants, and banks in particular, moved away from the UK power market. This cut liquidity which created a vicious circle as more companies turned away from the market. Because, while liquidity breeds liquidity, the reverse is also true

But many of these institutions – including Citigroup, Macquarie and JP Morgan – remain licenced to trade, and have continued to do so to an extent, having acceded the balancing and settlement code (BSC).

Now, higher volatility means there are greater opportunities for speculative traders to profit from quick, sharp fluctuations in the value of contracts.

Despite this, a spokeswoman from the Futures Industry Association (FIA) – the trade organisation that the UK power Trading Committee is a part of – said that stringent regulation meant it was unlikely that banks and funds would be returning for good.

“A volatile market may be tempting to trade in, but I can’t see them rushing back in to rebuild their power trading departments just yet,” she said. “Regulatory uncertainty, the threat of higher capital requirements in the US and uncertainty with Brexit mean that they’ll be quite wary of getting more stuck in.”

Outlook

Sources have said that liquidity on the market is expected to remain high throughout the winter amid strained supply margins.

Participants are expecting that price spikes seen in September will become more common during what is widely expected to be a risk-laden season.

Further volatility could arise as a result of concerns surrounding nuclear supply in France. Strong movement on the French market as a result of ongoing disruption to the country’s nuclear fleet has filtered through to the UK in recent weeks.

With the UK facing the winter with greatly reduced coal generation capacity, electricity imports from France via the 2GW IFA interconnector are expected to strongly influence prices. The UK market is therefore likely to be highly reactive to supply-led volatility in France as it must remain higher priced to attract the vital import volume.

The source at the continental utility said that interest from speculators would persist if the market remained volatile.

“It [speculative trading] will carry on as long as the market remains lively,” he said. christopher.somers@icis.com