The influence of hedge funds has become so great that they may even detonate the European energy market.
Hedge funds, attracted by dramatic price swings, flooded the European gas market in the wake of the energy crisis. Their influence has become so great that they may now even trigger a market crash.
Several funds, including Izzy Englander’s Millennium Management, Ken Griffin’s Citadel and Balyasny Asset Management, have stepped up their recruitment in recent years and collectively made billions of dollars. Overall, the industry will end 2024 with a record number of long positions – effectively a bet that natural gas prices will rise.
But with market liquidity drying up as participants begin to settle their books for the end of the year, the huge bets are now dominating, potentially creating more volatility in a fragile market. Several traders said privately they were concerned that the concentration of positions could lead to a sell-off.
Arne Lohmann Rasmussen, chief analyst at Global Risk Management in Copenhagen, said, “A high concentration of positions puts pressure on the market to reach the limit where it will eventually collapse. When everyone wants to pull out at the same time, it becomes a real risk.”
Hedge funds themselves don’t hurt the functioning of the market; they even provide additional liquidity and create more buying and selling opportunities. But they can also amplify volatility and market shocks, according to an ECB paper on the role of hedge funds in government bond markets. For electricity and natural gas markets, dramatic price swings are serious because they immediately affect consumers and bring the entire industry to a standstill.
While these players are not new faces to the gas market, the scale of their participation has grown significantly since the European energy crisis. While the Eurozone is no longer dependent on Russian gas, its exposure to international markets means that events occurring thousands of miles away can trigger dramatic price fluctuations.
Volatility imposes significant costs on the industry and consumers, with many cutting back on consumption to keep bills under control. Against a backdrop of uncertainty over energy costs and a slow economic recovery in Europe, more stable prices – high or low – would allow businesses and households to plan spending programs.
Moutaz Altaghlibi, senior energy economist at ABN AMRO, said, “Volatility doesn’t help anyone, it makes it difficult for both producers and consumers to plan ahead and make investment decisions.”
Meanwhile, Millennium Management earned about $600 million in 2023 from commodity investments, thanks in part to natural gas and electricity trading. Castle Investments’ commodities business generated about $4 billion in profits this year. Its founder, Griffin, said in a November interview that slashed energy demand in Europe “creates a degree of stability in the market.”
Castle Investments said it doesn’t comment on its positions. Millennium Management and Balyasny also declined to comment.
The heart of the problem is that hedge funds’ money chases speculative bets. They are not the same as traditional power companies, which buy gas or sell the associated output on behalf of their customers.
Some of the trading algorithms used by hedge funds have led to a significant increase in liquidity, which benefits all market participants, the European Union’s energy regulator, the Co-operation Directorate, said in an emailed response. But the increase in trading intensity requires greater market transparency and stronger surveillance systems.
Meanwhile, a representative of the European Securities and Markets Authority said the agency does not have specific guidelines on hedge fund activity in the energy markets.
More turbulence ahead
Expectations of a cold winter and delays in liquefied natural gas (LNG) projects have undermined confidence that 2025 will see more adequate supplies and ease volatility in Europe. Rapidly dwindling natural gas stocks and the impending end of Russian gas supplies through Ukraine have fueled concerns.
However, market pessimism has begun to ease in recent weeks due to mild temperatures and enhanced LNG flows. Since speculators have taken a large share of the market, prices could change quickly when conditions change.
For example, if Russia continues to supply gas after the expiration of the transportation agreement between Moscow and Kiev at the end of the year, which is Citigroup’s base-case scenario assumption, says Maggie Xueting Lin, Citi’s energy research strategist, “European gas will sell off as the market removes the risk premium that has been factored in. ”
Volatility will eventually subside once a new wave of LNG supplies enters the market. But until then, it has the potential to leave a deep mark on the region’s economy.
For now, “the market is pretty bullish,” said George Cultraro, head of global commodities at Bank of America. “But the biggest pain isn’t going up, it’s going down, and I don’t think anyone is ready to give up on the bullish story yet.”
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