Energy market liquidity faces threat from regulation

After the US, the European Union has some of the most liquid and transparent energy markets found anywhere in the world. That is a valuable thing. It makes for greater competition and efficiency, allows producers and consumers to benefit from lower transaction costs and lets them more easily hedge their risks.

But despite the efforts of EU institutions to bring the continent's energy markets closer together through initiatives such as market coupling, they are not monoliths. In power and natural gas, the ‘churn rate' – or the level of trading compared with actual physical deliveries – is high in a few countries, before dropping off dramatically elsewhere.

The goal of full market liberalisation has certainly not been achieved by some western European countries. And in some, progress is being reversed by top-down policies aimed at greening the generation mix and ensuring national security of supply. But the situation is quite different in EU countries of the former eastern bloc.

Bulgaria is one example. I travelled to Sofia for Energy Risk Balkans in April, where speakers criticised the way the government has sought to open up its power market under the EU's Third Energy Package. Participants faced a lack of information on trading activity, they complained, as well as onerous taxes on exports and a planned exchange run by the state-owned company that also happens to be the country's largest generator.

Despite the very real challenge of bringing the country's government around to the idea of true competition, market participants in Sofia were upbeat. The goal of a liquid and transparent market there is perhaps closer than it has ever been, and they needed no reminding of the benefits this could bring.

How different this is to the attitude of financial regulators, which have ploughed ahead with numerous reforms that impinge on the liquidity of energy markets. Under Mifid II, a package of financial law whose main provisions go into effect in 2017, many energy companies are likely to get entangled in rules primarily designed for financial services firms. Industry groups argue this will irreparably harm the existing liquidity in EU energy markets, which has taken some 15 years to build. Let's hope that Europe's emerging energy markets, such as that of Bulgaria, are not strangled at birth.

Politicians and financial regulators must recognise the critical difference between energy and financial markets. Liquid power and gas markets are not created by accident, but by years of hard work between governments, regulators and industry. Energy is the lifeblood of the modern economy. If the EU is serious about having markets to allocate energy resources, they must be allowed to function properly.