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Glossary · Energy industry & energy transition

Counterparty Risk (Gegenparteirisiko)

Counterparty risk counterparty risk Energy Trading PPA Clearing electricity market risk

Counterparty risk, in German Gegenparteirisiko, is the risk that a contracting party fails to fulfil its obligations, in whole or in part. In the electricity market this means, for example: a supplier does not deliver, a buyer does not pay, a trader cannot make a financial compensation payment, a balance responsible party defaults, or the partner to a long-term power supply contract becomes insolvent. It is therefore not about whether electricity prices rise or fall. It is about whether the other side of a specific contract remains solvent, able to deliver and willing to perform. In finance, a closely related concept is often called credit risk.

Counterparty risk arises wherever market participants commit to something for the future. In electricity this matters particularly because many transactions are concluded long before delivery. A utility buys electricity for the next quarter. An industrial company secures electricity from a wind or solar plant for many years through a PPA. A trader enters forward market positions. A balancing group causes balancing energy that is settled only later. Time passes between contract conclusion, delivery and payment, and during that time the prices, creditworthiness and liquidity of the parties can change.

Distinction from price risk, liquidity risk and performance risk

Counterparty risk is often confused with market risk. Market risk is the uncertainty about price movements. Anyone who has bought electricity at a fixed price bears no price risk for that volume as long as the contract is performed. Counterparty risk remains, however: if the seller defaults, the buyer may have to procure the electricity again on the market. If the market price is then higher, a replacement loss arises. How high the loss is depends on the price level at the time of default. It is triggered, however, by the fact that the other side does not perform.

A simplified calculation example: a buyer has agreed a baseload delivery of 10 MW at €80/MWh for one year. With 8,760 hours, that is 87,600 MWh. If the market price for the remaining term rises to €120/MWh and the seller defaults right at the start, replacement procurement costs €40/MWh more, in total around €3.5 million. In the opposite case the seller loses money: if prices have fallen and the buyer defaults, the seller can only resell the volumes at a lower price. Which side is affected at any given time can therefore reverse during the term.

The concept must also be distinguished from liquidity risk. Liquidity risk means that a market participant does not have enough liquid funds in the short term to meet payments, collateral or a margin call. This can become counterparty risk if the inability to pay leads to contracts not being performed. The levels are nevertheless different: liquidity concerns one's own ability to pay or the tradability of positions. Counterparty risk concerns the reliability of the other contracting party.

Counterparty risk also differs from operational performance risk. If a plant generates less electricity than planned because of a technical defect, this is initially a technical or volume-related risk. It becomes counterparty risk only when the contracting party therefore fails to meet its obligations even though it would have to supply replacement, for example. In practice these risks overlap. Contracts therefore regulate precisely what applies in the case of force majeure, replacement delivery, compensation payments, termination and collateral.

Why counterparty risk is particularly relevant in the electricity market

In the electricity market, physical delivery, financial settlement and regulatory responsibility are interlinked. Anyone who supplies or takes electricity is not only in a contract with a single counterparty. Deliveries must be allocated to balancing groups, schedules must be notified, balancing groups must be balanced, and settlements with exchanges, grid operators, suppliers or customers must be fulfilled. If one participant defaults, this can therefore have effects beyond the individual contract.

One example is the default of an electricity supplier. For end customers in Germany, what applies then depends on the grid level. Anyone who draws electricity from the low-voltage grid of general supply without the consumption being attributable to a supply contract is deemed under § 38 EnWG to be supplied by the local default supplier (Grundversorger). The law calls this Ersatzversorgung (substitute supply). It applies to all such final consumers, not only households. It ends with a new supply contract, but at the latest after three months. The default supplier may adjust prices on the 1st and 15th of a month without notice period. Substitute supply is something different from the open-ended basic supply (Grundversorgung).

For customers on medium voltage there is no such obligation. Since the EnWG amendment at the end of 2025, however, § 38a EnWG allows a voluntary transitional supply (Übergangsversorgung): distribution system operators and default suppliers can agree on it, including for customers at the transformation from low to medium voltage. Whether it exists therefore depends on the respective grid area. For the market, costs and open questions remain in any case: open procurement positions must be closed, balancing group deviations settled and, if necessary, claims filed in insolvency proceedings. Safety-net mechanisms thus do not make counterparty risk disappear. They distribute it, limit it or shift it in time.

In long-term contracts the risk is particularly visible (see also PPA risk). A PPA over ten or fifteen years can be the basis of financing for a plant operator and give the electricity customer price stability. The financing bank then looks not only at the contract price and expected generation but also at the creditworthiness of the offtaker. A high contract price helps little if the offtaker cannot pay in a crisis. Conversely, the buyer checks whether the plant operator is technically, organisationally and financially able to meet its delivery or compensation obligations over the entire term.

Measuring and limiting the risk

Counterparty risk is not assessed merely by gut feeling. Energy traders, utilities and larger electricity customers set credit limits, check creditworthiness, require collateral and continuously value open positions on a mark-to-market basis. What matters is the current replacement value of a contract, that is, the amount that, as in the calculation example above, would be lost today in the event of a default. Because electricity prices fluctuate strongly, this amount can grow quickly. Besides today's value, one therefore also considers how high it could become by the end of the contract.

To limit the risk there is collateral (collateral) such as bank guarantees, sureties, cash collateral or parent company guarantees. In addition there are thresholds, rating requirements, termination rights and obligations to post additional collateral. The EFET framework agreement for electricity, widely used across Europe, the General Agreement, expressly provides in § 16 that the parties can agree on such collateral. In addition there is a standardised annex for collateral (Credit Support Annex).

Netting plays a major role here. Two forms are distinguished. With payment netting (§ 13.3 of the EFET agreement), payments of both sides that fall due at the same time are offset, and only the balance is paid. With close-out netting, in the event of default or termination all individual transactions are terminated, valued and consolidated into a single net claim. This can greatly reduce the amount actually outstanding. Whether close-out netting holds in insolvency, however, depends on the insolvency law of the state in which the contracting party is based. It must therefore be examined individually for each legal system.

Another way to limit risk is clearing. Here a central counterparty (CCP) steps between the trading parties and becomes the buyer to every seller and the seller to every buyer. Its main task is to manage the risk that a party fails to make a payment when due. In the EU, Regulation (EU) No 648/2012 (EMIR) governs the requirements for central counterparties and for OTC derivatives. Participants then no longer directly bear the default risk of their original trading partner. Instead the risk is absorbed through margin systems, collateral and the rules of the clearing house.

Clearing does not eliminate the risk completely, however. It is shifted to the central counterparty, its clearing members and their collateral. If prices rise sharply, high margin requirements can themselves create liquidity pressure. Clearing thus exchanges part of the counterparty risk for higher liquidity needs.

Typical misinterpretations

  • "This is only a topic for lawyers": counterparty risk affects prices, contract terms, financeability and market access. Anyone with weak creditworthiness often pays indirectly: they must post more collateral, get smaller credit lines or are excluded from some transactions. Creditworthiness thus becomes a competitive factor.

  • "A fixed price protects against everything": a fixed price reduces price uncertainty only as long as the contract is performed. The further the market price moves away from the contract price, the greater the incentive or pressure on the losing side to renegotiate the contract or no longer perform it. Besides price formulas, contracts therefore need robust rules on default, collateralisation and replacement.

  • "With financial contracts there is no delivery risk, so no counterparty risk either": counterparty risk exists with both physical and financial settlement. With financial contracts it concerns the payment obligation. With physical supply contracts there is the additional question of whether the other side can procure volumes, adhere to schedules and organise its balancing group responsibility.

Link to market design and system costs

Counterparty risk is not a purely private problem between two companies. How an electricity market is organised determines where risks arise and who can bear them. Exchange trading with clearing reduces default risks between trading partners but requires standardised products and sufficient liquidity. Bilateral contracts in OTC trading allow tailor-made terms, volume profiles and price formulas. In return they require more due diligence, negotiation and collateral management. Long-term procurement can secure investments but ties both sides to each other for many years.

This distribution of risks affects system costs. Collateral costs money: capital tied up as collateral is missing for investments, working capital or other hedges. High creditworthiness requirements hit small providers, new project companies or electricity-intensive mid-sized companies harder than established, well-capitalised players. Requirements that are too low, by contrast, shift default costs onto contracting parties, clearing structures or, in extreme cases, onto state or statutory safety-net mechanisms.

With progressing electrification and more weather-dependent generation, load profiles, generation profiles and hedging strategies become more complex. Companies no longer buy just an annual volume of electricity. They hedge specific periods, profiles or guarantees of origin. This creates new dependencies on contracting parties. A PPA with solar power has different risk characteristics than a baseload supply contract. A flexible consumer can reduce price risks but remains dependent on reliable settlement, balancing and supply relationships.

Counterparty risk thus describes the vulnerability that arises when actors in the electricity market share the work through contracts. The concept shows that an electricity contract is determined not only by price, volume and term. How good it is also depends on whether the parties remain solvent over the entire term, can provide collateral and are able, within the market structure, to fulfil their obligations.

Sources

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Edited by eCMS on 11.11.2026 18:09

© 2026 Erik Schmidt. All rights reserved. Quotations with a link to the source are welcome.