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Glossary · Energy industry & energy transition

Credit Risk

Credit risk credit risk counterparty risk electricity market Energy Trading PPA risk

In the electricity market, credit risk refers to the risk that a contracting party does not fulfil its financial or delivery-related obligations in full, on time, or at all. In German it is usually called Kreditrisiko or counterparty risk. This does not only mean the classic case of a company failing to pay an invoice. It also includes the economic consequence of a default: if the market price has changed in the meantime, the remaining party must replace the missing delivery, offtake or hedge on less favourable terms.

Where credit risk arises

In energy trading, credit risk arises wherever delivery, payment and time diverge. Electricity is delivered at a specific point in time, but the contracts are often concluded long beforehand. Invoices are paid later, collateral is continuously revalued, and price risks can persist for months or years. A supplier procures electricity before the customer pays. An industrial customer concludes a long-term PPA whose value fluctuates with electricity prices. A trader holds positions on the futures market where daily price movements require additional collateral. In all cases, the performance of a contract depends on the counterparty remaining solvent and faithful to the contract.

What is measured: exposure rather than the outstanding invoice

For risk management, what counts is not only the outstanding invoice amount but the possible loss at the time of a default, known as exposure. It is made up of receivables that have already arisen, i.e. energy that has been delivered but not yet paid for, and the replacement value of the contract volumes still outstanding. In practice, this replacement value is determined by valuation at current market prices (mark-to-market). In addition, there is an estimate of how much the exposure could still grow until the end of the contract (potential future exposure). In credit risk analysis, the expected loss is, in simplified terms, derived from the probability of default, the exposure at the time of default and the loss rate after realisation of collateral.

A simplified calculation example shows the difference: A municipal utility (Stadtwerk) has bought 10 GWh of baseload electricity for the coming year from a trader at €80/MWh. The trader defaults when the same annual contract costs €130/MWh on the market. Replacement procurement then causes additional costs of €50/MWh × 10,000 MWh = €500,000, even though not a single invoice is outstanding yet. If, on the other hand, the price falls below the contract price, the risk lies, mirror-image, with the trader: if the municipal utility defaults, the trader must resell the volume at a lower price. Because exposure moves with the price, credit risk in energy trading is usually considered together with market price movements.

Distinction from market risk and liquidity risk

Market risk describes the possibility that prices, interest rates, exchange rates or other market variables develop unfavourably. Credit risk describes the possibility that a counterparty does not fulfil its obligation. The two risks can reinforce each other: a contract may be worth a lot economically, but this value can only be realised if the counterparty remains solvent. It is particularly unfavourable if the probability of default of a counterparty rises precisely when the exposure to it also grows. This is then called wrong-way risk.

Liquidity risk is also not the same as credit risk. It arises when a company cannot raise enough cash or collateral at short notice, even though it might be solvent in the long term. In energy trading this boundary easily blurs in practice, because high margin calls after strong price movements can consume a company's liquidity very quickly. An operationally sound counterparty can thus fail because of short-term collateral requirements. For the other contracting side the result is similar: performance becomes uncertain, and replacement procurement becomes necessary.

特 Characteristics of the electricity system

In the electricity system, credit risk carries particular weight because electricity can hardly be stored on a large scale and many contractual relationships rely on ongoing performance. Suppliers, generators, direct marketers, municipal utilities, industry, traders, balance responsible parties and grid operators are interconnected through payments, schedules, balancing energy, collateral and settlements. Physically, electricity flows according to the laws of the grid, not according to payment flows. The economic settlement, however, runs through contracts and the balancing group. If a party defaults, the physical demand does not disappear: other participants must step in, close positions or bear costs.

In Germany this becomes apparent, for example, when an electricity supplier defaults and its withdrawal points can no longer be assigned to a supply contract, for instance after termination of the balancing group contract or the grid use contract. For final consumers on low voltage, the electricity is then deemed under § 38 EnWG to have been supplied by the local default supplier (Ersatzversorgung, i.e. replacement supply). This ends with a new supply contract, but at the latest after three months. The default supplier may charge separate prices for it. For household customers, the procurement costs included are limited to what short-term procurement via exchange products would cost. The supply of customers is thus secured, but the additional costs of short-term replacement procurement nevertheless arise and are passed on through these prices. This rule does not apply to customers on medium or high voltage.

PPAs and project finance

Credit risk becomes particularly visible in long-term supply contracts and PPAs. A PPA can secure the financing of a wind or solar park because it creates predictable revenues. For the offtaker it offers price stability and often guarantees of origin. The credit quality of both sides thus becomes part of the project economics. A financing bank examines not only yield assessments, technical availability and expected generation, but also the creditworthiness of the offtaker and whether the contract is enforceable. A long contract with a weak offtaker can be worth less for financing than a shorter one with a very resilient counterparty. That is why bank guarantees, parent company guarantees or rating thresholds are often agreed in PPAs.

Instruments for limiting risk

  • Credit assessment and limits: internal ratings, caps on exposure per counterparty and group, regular monitoring and escalation rules.

  • Collateral: cash deposits, bank guarantees, parent company guarantees and deposited collateral. They reduce the loss only if they are provided in time, are sufficient and are legally enforceable in the event of default.

  • Margining: ongoing settlement of changes in value (variation margin) and advance protection for possible future movements (initial margin).

  • Netting: mutual claims are offset against each other, and with close-out netting also all open transactions in the event of default. This reduces exposure, provided the agreement is also effective in insolvency.

  • Contract clauses: termination rights, rating triggers, obligations to provide additional collateral and short settlement cycles.

However, collateral shifts liquidity needs onto the counterparty. With strongly fluctuating electricity prices, this collateral logic can itself become a stress test.

Clearing and bilateral trading

A clearing house (central counterparty, CCP) steps in between buyer and seller and thus becomes the buyer to every seller and the seller to every buyer. According to EU law, its main task is to manage the risk that a counterparty fails to make payments when due. In the EU, the market infrastructure regulation EMIR (Regulation (EU) No 648/2012) sets strict requirements for CCPs. For derivatives traded over the counter (OTC trading) that are not centrally cleared, it prescribes risk mitigation procedures, such as the daily valuation of open contracts. In clearing, the individual trader is not exposed to the default of each trading partner, but to the rulebook and resources of the clearing house. For this, the CCP requires daily valuation, initial margin and variation margin. The risk does not disappear as a result: it is standardised and pooled, and the requirements for liquidity, risk models and collateral management increase. Bilateral contracts allow more freedom of design, but require their own credit assessment, their own contract clauses and their own monitoring.

Lessons from the energy crisis

The 2022 energy crisis showed how strongly credit risk and liquidity depend on price fluctuations. According to ESMA, the sharp increases in prices and volatility on the energy derivatives markets caused the margin requirements of CCPs to rise considerably. As a result, some participants came under liquidity pressure, including energy producers that had hedged their future generation. The EU subsequently adjusted, among other things, the rules on which collateral CCPs may accept. According to an ECB analysis, a large part of the additional bank loans to energy companies came from Germany, where state-guaranteed credit lines were made available to finance margin calls. At the same time, suppliers with fixed-price contracts and insufficiently hedged procurement got into difficulties. If prices fall later, the incentive may grow not to perform expensive contracts any more.

Common misconceptions

Credit risk is not merely a problem of poor creditworthiness. Even a company with good creditworthiness can create high counterparty risk under a particular contract structure if term, volume, price formula and collateral interact unfavourably. Conversely, a weaker counterparty can be acceptable if delivery periods are short, receivables are limited and collateral is sufficient. Moreover, a payment default is a single event. Credit risk, by contrast, is the possibility of a loss resulting from it that can be measured and managed in advance. It combines probability, loss amount, term, collateral and legal enforceability. Good risk management therefore does not begin only at the default, but already with contract design, limit allocation and price calculation.

Significance for market design and corporate governance

Companies need credit limits, counterparty checks, risk reports and clear responsibilities between trading, sales, treasury, legal and risk management. Market rules must specify when collateral has to be provided, how defaults are handled and what consequences they have for balance responsible parties and suppliers. Requirements that are too low can shift default costs onto the general public. Requirements that are too high make market access harder and can push out smaller players. Credit risk thus shows that contracts only stabilise if their performance is economically secured: a fixed price or a long-term delivery is only worth as much as the counterparty can actually bear, even under changed market conditions.

Sources

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Edited by eCMS on 11.11.2026 18:15

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