Enel is one of 70 energy companies in Italy that could end up needing a state-guaranteed credit line, as derivative hedges blow out. Which is likely to place even further pressure on the finances of Europe’s most indebted large economy.
One thing former European Central Bank Chairman Mario Draghi did before resigning as Italian Premier was to devise a credit scheme to shield Italian energy companies, their lenders and counterparties, from the economic fallout of the proxy war in Ukraine and Europe’s backfiring sanctions against Russia. Under the plan, the country’s trade-credit insurer Sace would provide guarantees for around 70% of the total amount of fresh debt extended.
That plan is now very much in the implementation phase. Italy’s biggest lenders, UniCredit SpA and Intesa Sanpaolo SpA, are expected to contribute €5 billion a piece to a €16 billion emergency credit line for Italy’s largest utility, Enel. State-backed Cassa Depositi e Prestiti SpA and two other banks, Banco BPM SpA and BPER Banca SpA, are likely to throw in an additional €2 billion each. This is an 18-month “revolving credit” line, meaning the money will be withdrawn as needed. Much of that money, like the emergency business loans disbursed during the coronavirus crisis, will be guaranteed by the Italian government.
Enel apparently needs the credit line to cover derivative risks linked to hugely spiking energy prices, although gas and electricity prices in Europe have fallen quite significantly in recent weeks. Just as we recently saw in the UK’s gilt market, derivatives are doing exactly what they did in the GFC: magnifying risk and extending contagion.
An EU-Wide Problem
Significant sums of state-guaranteed credit have already been extended by European governments to energy companies, in order to prevent them from defaulting on their derivatives contracts. As NC reported in early September, this could cause a Lehman-like unravelling of the derivatives markets, with companies facing as much as €1.5 trillion in margin calls. To keep that from happening, Sweden and Finland have already provided guarantees worth €33 billion.
In July, Germany gave the national energy giant Uniper, owned by the Finnish company Fortum, a €15 billion loan, only for the firm to hit the rails once again in September. In the end, Berlin took over 99% of the company, at an additional cost of €29 billion. As Germany’s biggest importer of gas, Uniper was hit particularly hard by the vastly reduced flows of gas arriving from Russia. But its problems actually began before Russia’s invasion of Ukraine, with souring derivatives hedges largely to blame. In January this year Uniper was forced to borrow €10 billion from its Finnish parent group, Fortum, to meet margin calls following a surge in European gas and electricity prices in 2021.
Now, it’s Rome’s turn to help out Italian energy companies. As Yves has previously noted, it will take time before we know whether the liquidity problems at these companies are the result of sensible hedges gone bad, stupid hedges gone bad, and speculation gone bad. That said, it is quite normal for electricity producers like Enel to place shorts on the energy market as a hedge, as the FT explains:
The companies like to de-risk their power sales to households and businesses by taking short positions in futures markets before selling the physical electricity. That way if power prices fall, any losses on the contract will be mitigated by gains from the short position, and if prices rise the additional profit made on the physical delivery should cover the cost of the short.
Under current market rules, anyone taking a short position in futures markets is required to post additional collateral — or margin — to the exchange if the price of the underlying asset rises. In normal times, this is accepted trading practice but in recent months the soaring price of electricity has meant the collateral requirements for utilities that have hedged their power sales — often months or years in advance — have ballooned.
“A Simple Tool… To Manage Financial Risk and Support.”
Interestingly, Enel’s derivative plays appear to have extended far beyond the energy futures markets. In 2021, it partnered with French lender Credit Agricole to establish the first sustainability-linked forex derivative program. As a 2017 piece in ISDA Quarterly lays out, the company uses derivatives for a number of reasons, across a variety of asset classes, including interest rates, FX and commodities.
“We remain substantially stable in terms of our derivatives use. Derivatives are a sufficiently elastic product to keep us aligned with underlying risks, despite the challenges in the market,” said Fabio Casinelli, Enel’s head of treasury and capital markets. “Derivatives are a real support, a simple tool that absolutely helps us to manage financial risk and support.”
Five years later, Enel’s use of that “simple tool” has created a €16 billion liquidity shortfall that Italian banks, with the government’s help, must now fill…
Read the full article on Naked Capitalism
Nick Corbishley 