German electricity insider trading and 'informational theft': a Matt Levine-esque take
Matt Levine, god of finance journalism, loves to interrogate the limits of insider trading[1], often saying its illegality rests on theft of information rather than unfairness. When I read Montel News’ headline about an insider trading scandal in the German power markets, all I could hear was Levine’s deep, sultry voice - “theft or unfair?”
“Whistleblowers sound insider trading alarm on German power”
Companies permitted to help balance Germany’s electricity grid are abusing this privilege to trade in the electricity market with inside information worth perhaps tens of millions of euros, whistleblowers have told Montel.
Managing insider trading is a governance issue. It is not unique to energy markets, though they have been particularly susceptible. Oil cartels have been fixing prices since the days of Rockefeller over 100 years ago, and the energy industry is constantly accused of manipulating prices.
Liberalised electricity markets work, broadly speaking, by power plants placing bids to provide electricity at a certain price[2], at a specified time in the future. Depending on the market design, this is done hours, days, weeks or even years in advance, and there is usually a real-time market[3] to account for imbalances, like if a power plant has an unplanned outage or there is an unexpected surge in demand.
In less liberalised markets, electricity utilities are often “integrated”, meaning they own the electricity generators, poles and wires, and the relationship with a customer. They are a monopoly; there is no competition.
Liberalisation increases competition, and (in theory) makes markets more efficient and benefits consumers with lower prices. Each piece of the electricity system is separated (“unbundled”) and sells services independently. Power generators can operate as standalone entities, as can retailers and networks. Under this system, a power generator is now selling their product into a publicly traded market (“power pool”).
To ensure that the market truly remains competitive, some regulators explicitly prohibit companies from spanning multiple parts of the electricity system (e.g. banning networks from owning generation). The large energy conglomerates, though, often own companies that do everything, even if they technically need to treat their inter-company relationships at arm’s length.
Liberalisation also has the by-product of commoditising and financialising the power markets. As with so many other commodities, traders with no skin in the game (i.e. they are not producing power nor are they supplying it to customers) can place their bets alongside other market participants.
Here is where Germany’s power market comes in. The accusation is that some market participants (those who provide “balancing energy” to resolve last-minute supply/demand problems) receive information sooner than others and can trade on it.
Grid operators’ signals to activate balancing energy are not publicly disclosed in real-time in Germany. Nor is the state of imbalance on the grid. Yet this information provides a lucrative insight into the imminent direction of the intraday market – where electricity for delivery the same day is traded.
Those aware their company is requested to provide balancing energy know the system faces a shortage. They have a head start of sometimes 30 minutes to buy up electricity before everyone else in the intraday market.
…. The signals are not just useful on the way up. They are just as useful on the way down because they also reveal when scarcity will subside.
~30 companies who provide large, fast-responding electricity receive information on when the grid is going to experience a shortage, so that they can provide the electricity to deal with it (“balancing energy”). Separately, electricity generators and traders can keep buying and selling electricity on the intra-day market in blocks as small as 15 minutes and up to five minutes before delivery.
Suppliers in the balancing energy market essentially receive private information from the grid operator ahead of time (“hey we’re experiencing a power shortage, please help us out”) that could be used to place bets on the larger intraday market (“ooh there’s going to be a power shortage in an hour, let’s buy before everyone else knows”). The accusation of insider trading is because these two markets - “balancing energy” and “intraday” - are different, even if they are sometimes served by the same suppliers. The traders who work at the subset of companies who provide balancing energy will have information up to 30 minutes sooner than the rest of the intraday market traders.
Under Matt Levine’s framing of insider trading, this advantage does seem unfair to the downtrodden speculators. But are they information thieves?
If a company is trading its own energy units for balancing, it doesn’t seem so. The market operator gives them this information willingly and does not require its disclosure. Even if they trade their own units on the intraday market, it seems like they should be able to make use of this information to decide how they bid their own assets.
Where this may drift into the realm of insider trading is if a company received this information and then speculated on the intraday market generally, beyond their own assets. Even then, they have hardly stolen information that should have been private, but I can see why traders are upset at the informational disadvantage. More obvious still would be telling a third-party trader and sharing the profits, given the outsider has no entitlement to the information about the balancing needs of the system.
While this insider trading complaint charitably has consumer’s interests in mind, parts of the article read like the grumblings of a trader on the losing side of a bet with a large utility. It also seems the market operator deliberately withholds real-time information to reduce speculation to reasonable limits, in order to maintain energy security. By disclosing the grid’s balancing needs only to those participants who can actually do something about it, they prevent the rest of the market from panicking and may reduce the risk of wild short-term price swings.
The European regulators and traders mentioned in the article seem largely untroubled by the concerns raised by Montel, though the German regulator said “in certain situations, the balancing activation signals may constitute inside information.” They leave it up to companies to sort out their information flows, it seems. New regulation, introduced in May of this year, may change that, but I’m doubtful given their blasé responses to the reporters.
Though some may see this as lazy regulation, or entrenching the interests of big power companies, I’m somewhat sympathetic to the regulators. They seem happy with clipping the wings of cowboy traders, at the risk of a few extra millions of euros going to the companies that ensure Germany avoids power cuts in real-time. If the choice is between a fairer, more transparent market for speculators and a more reliable, secure power system, I can understand why they are being so obtuse.
[1] He talks about it so much that he invented the Laws of Insider trading.
[2] Electricity units are usually sold in kilowatt-hours, a measure of energy delivered. Some markets also tender the delivery of capacity, kilowatts, which is the availability of the unit of power to create energy, rather than the dispatch of the energy itself.
[3] If 5 minutes could be considered “real-time”