Fitch Ratings analysts believe clearing services in the wholesale natural gas and power markets could help restore the health of the energy trading business. But some significant hurdles remain and there probably will be limited progress this year.

Trading volume in gas and power has suffered substantially over the last year as concerns have grown about counterparty risk, rising interest costs and rising capital requirements. The negative impact has been compounded by admissions of sham transactions, false price reporting to index publishers and overstatement of income and assets in long-term modeling. As a result, many energy companies have closed up their trading shops entirely.

“Against this pervasively negative backdrop it is no surprise that the remaining industry participants seek a quick way to restore the viability of the wholesale energy markets” Fitch said in its report titled “Clearing Natural Gas and Power: Silver Bullet or Silver Lining?” The question is will clearing be the solution that will help “reinvigorate wholesale power and gas trading.”

Fitch analysts believe there are some clear benefits to clearing. It can reduce overall collateral requirements and counterparty risk, foster increased price transparency, and level the playing field. In contract clearing service, the counterparties to a particular transaction are replaced by a clearinghouse that then takes on the risk and responsibility of those original counterparties.

“While Fitch expects progress toward clearing natural gas and some power products in a few U.S. regions by the end of this year, widespread application of clearing for physically delivered power contracts will take several years due to numerous hurdles,” said Denise Furey, senior director at Fitch.

“Hurdles to the effective clearing of natural gas and in particular power products include a lack of uniformity in products, too much competition among clearing houses, fragmenting an already thin marketplace, and difficulty in replacing a counterparty in a deal gone awry, as there are a limited number of entities that can physically deliver power due a number of items including transmission constraints and the need to have a FERC power marketing license.”

Fitch said there are power providers both under traditional and competitive regulation plans that are naturally long and short power and gas. These entities need access to the risk management tools offered by wholesale trading markets. Well designed wholesale markets which include a financially sound clearing system should be able to offer a variety of supply options and hedging products for market participants.

Fitch believes an effective clearing house that avoids putting the collateral of all participants at risk, must have clear rules and capitalization appropriate to the products traded. “An imprudent clearing system could result in more concentrated counterparty risk than currently exists in the bilateral market,” said Furey.

For more information on the Fitch report, go to https://www.fitchratings.com.

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