EEX: Nordic electricity market is not working as it should. Yet the Commission wants to copy it

Low liquidity in futures contracts is a problem for the Nordic wholesale electricity market. This can mean higher costs for market participants seeking to hedge against the risk of price fluctuations. According to Tim Greenwood of EEX, the market should move away from its existing products. The European Commission is considering introducing this structure elsewhere in Europe.

“[If the Nordic market were being established now:] We would not introduce a system price. The level of correlation simply isn’t high enough for that to be considered at all,” said Tim Greenwood, chief commercial officer at EEX.

In the rest of Europe, it is common practice to trade futures contracts in individual zones for hedging and, when liquidity is low, to use futures from more liquid trading zones (known as proxy hedging). To hedge price risk when using proxy hedging, participants then use either long-term transmission rights (LTTRs) on the price difference between individual zones, issued by transmission system operators, or exchange-traded products (known at EEX as power future spreads).

Scandinavia introduced futures products tied to the so-called system price, primarily because its market is divided into smaller trading zones. This product sets an electricity price for the entire Scandinavian region that reflects the price that would have prevailed if there had been no transmission capacity constraints.

The aim is to concentrate liquidity, giving market participants in less liquid trading zones the opportunity to hedge. Special contracts for differences (CfDs), known as EPADs, are then used to hedge price risk between local trading zones and the system price.

Liquidity in products tied to the system price has been falling steadily over the past 10–15 years. Reasons cited include various factors, among them stricter regulation, the removal of bank guarantees for so-called collateral, and increased price differences between trading zones in the region, along with their weaker correlation with the system price.

The market has evolved; we need to look ahead

Proposed solutions from various market participants in the region to boost liquidity often look back to the conditions of 2005–2015, when liquidity was high. These include bank guarantees, fewer trading zones, and retaining a common system price combined with the EPADs mentioned above.

“While I think it is entirely natural to look back at a time when things worked well and now don’t work as well as they used to, the problem is that you have to look ahead,” Greenwood said in an interview.

“A lot of discussion about the past doesn’t help the situation, because things have moved on over the past 10–15 years,” Greenwood added.

Greenwood said that calls for transmission system operators and governments to intervene in order to improve market liquidity or compensate market participants for risk are also typical of the region.

“We are always quite surprised by that, because we never discuss these types of solutions in other markets,” Greenwood said.

Most trading in the region is cleared through Nasdaq Commodities, which acquired the Nord Pool financial market in 2010. In March, Nord Pool—owned by Euronext—postponed the launch of products for individual zones until March 2026.

An opportunity for EEX

EEX entered the Scandinavian market with the aim of introducing the trading model used elsewhere in Europe. In June, it launched a package of measures that includes, among other things, removing trading fees to attract traders to its platform. Nord Pool’s delay in introducing products for individual trading zones therefore presents EEX with an opportunity to attract traders.

EEX aims to achieve regular daily trading in Nordic system-price contracts and the most liquid zonal contracts by next spring, Greenwood said.

“That level of trading would allow us to start building the market and bring in financial players who trade other products. We would be very happy with that,” Greenwood said.

He said regular trading could be achieved by attracting around 25 companies currently active in the Nordic electricity market and then bringing a further 15 companies back to the market.

This year, the exchange recorded monthly trading volumes in Nordic energy futures ranging from 43–730 GWh, while monthly trading and cleared transaction volumes on Nasdaq ranged from 40.2–48.9 TWh.

The Commission plans to introduce the Scandinavian model elsewhere in Europe

While EEX wants to introduce in Scandinavia the product structure used elsewhere in Europe, the European Commission is taking the opposite approach. Its proposed reform of the energy market includes the introduction of a so-called virtual hub, a trading system similar to the one currently used in Scandinavia.

The main idea behind a hub, or virtual trading point, is that it would pool supply and demand from less liquid trading zones, allowing traders in those zones to trade in a market with greater liquidity than their own. This is intended to prepare Europe for the possible division of its current trading zones.

At present, the liquid German market is used primarily for trading long-term electricity contracts in Europe. According to ACER, it is also the only sufficiently liquid market in continental Europe. However, a review of trading zones in Europe proposes splitting the German trading zone. Depending on how it is divided, this would also affect the liquidity of long-term contracts; according to the Commission, introducing a virtual hub is the solution.

The creation of a virtual hub has been criticised by the European Federation of Energy Traders (EFET), the lobbying group for major electricity producers Eurelectric, and the Association of European Energy Exchanges (Europex). The liquidity problems with this solution in Scandinavia suggest that introducing a hub for the rest of Europe could be a step backwards.

The question, of course, is how to determine the price of hub-linked products; there are alternatives to the Scandinavian approach. A stronger correlation between the price of hub products and products in individual zones could help prevent the problem of low liquidity.