No liquidity, no stability?

Have you ever been to the Toyosu Fish Market in Tokyo?

It’s one of the busiest marketplaces you can imagine: Sellers are shouting prices, buyers are scanning auctions for the best deals, and fish are changing hands in rapid succession. There’s next to no hesitation because traders know they can always find a counterparty. Prices fluctuate within a predictable range, and even as the market moves fast, it remains stable. If one supplier runs out of tuna, another one has it. If a buyer drops out, someone else steps in.

Now picture the polar opposite: a Soviet-era department store.

The shelves are mostly empty, and when new stock arrives, no one knows what it will be or when it will come. Customers queue for hours, hoping to get their hands on basic goods. Some days, the store is overflowing with products nobody wants, while on others, essential items disappear in minutes. Prices are disconnected from supply and demand.

A small shift in availability can cause chaos, and people hoard what little they can get because they have no idea when the next shipment will arrive. Yet it’s not scarcity per se, but rather the unpredictability that throws sand in the market gears. This is what happens in a market with low liquidity - unpredictability, inefficiency, and a complete breakdown of stable pricing and risk management.

The latter scenario is, in principle, also what happens when liquidity dries up in forward energy markets. Without enough participants trading actively, price signals become distorted, hedging becomes unreliable, and market efficiency collapses, as illustrated in the great policy paper on “Further development of the EU electricity forward market” by ACER.

Forward markets exist to provide stability. They allow energy traders to hedge against future price fluctuations, ensuring that utilities, businesses, and industries can secure electricity at predictable costs. However, the level of liquidity is not uniform across Europe. The churn factor - the proportion of the trading volume to physical demand - shows stark differences across regions.

Germany remains the benchmark for liquidity, with its churn factor rising from 7.1 in 2012 to around 12 today. This is an indicator of a highly active market where trading volumes support efficient price discovery and risk management. In contrast, several European markets struggle with illiquidity, making it difficult for participants to hedge effectively.

Ireland and Greece, for example, have churn factors close to 1, indicating extremely limited trading activity and weak price formation. This restricts the ability of market participants to manage long-term risks, leading to greater exposure to sudden price swings. Poland, while having a large electricity market, also experiences structural liquidity issues, as nearly all forward market volumes are confined to power exchanges.

Without sufficient liquidity, hedging becomes expensive, price volatility increases, and market confidence erodes. The consequences of poor liquidity were painfully evident during the 2022 energy crisis. German wholesale electricity prices surged from €50 per MWh in late 2020 to over €600 per MWh in August 2022, triggering extreme variation margin calls, which averaged over €1 billion per day and peaked at €3.4 billion daily. Market participants struggled to maintain collateral, forcing them to withdraw from trading and exacerbating the liquidity crunch. These conditions made an already volatile market even more unpredictable.

The structural hurdles for forward market liquidity

One of the primary factors limiting liquidity is market fragmentation. While short-term electricity markets have benefited from centralized coordination and integration, forward markets remain heavily segmented along national lines. Each country operates under its own regulatory framework and uses different financial instruments, making cross-border transactions complex and costly. Traders seeking to hedge positions across multiple bidding zones often encounter inconsistent rules, additional fees, and operational inefficiencies. 

As ACER states: "EU’s electricity forward markets in different bidding zones and venues operate largely isolated from each other without much arbitration and integration between them," which leads to a situation where liquidity remains weak in many regions.

Compounding this issue is the lack of standardized long-term hedging instruments. To effectively manage price risks beyond the day-ahead and intraday markets, traders require accessible and reliable financial tools. However, the availability of such instruments varies widely across Europe. Some markets rely on Financial Transmission Rights (FTRs), while others use Contracts for Differences (CfDs) or alternative hedging mechanisms. Without a uniform approach, cross-border trading becomes cumbersome, and market participants face higher costs. 

Due to their structural limitations, "Long-Term Transmission Rights are currently not able to combine the liquidity of small zones and large zones into one single integrated market." - ACER

Another significant barrier to liquidity is market concentration. A small number of dominant players exert control over large portions of the market, limiting competition and restricting access for smaller participants. When liquidity is concentrated among a handful of actors, price discovery becomes inefficient, bid-ask spreads widen, and market resilience weakens. CEER highlights that the depth of forward market liquidity is directly influenced by the size of bidding zones and the degree of market integration, with fragmentation preventing the realization of liquidity benefits across Europe.

Policy and market-based solutions

Addressing these challenges requires both regulatory and market-driven solutions. One of the most urgent reforms is improving long-term cross-zonal capacity allocation. Increasing the availability and efficiency of cross-border hedging instruments would allow traders to manage risk across multiple bidding zones without unnecessary financial or regulatory barriers. Expanding access to long-term capacity auctions and making their outcomes more transparent would also enhance forward market liquidity. 

"A fully integrated internal electricity market is of utmost importance to secure affordable prices to EU citizens" - ACER

Another way to increase liquidity is regulatory harmonization. By aligning national rules and ensuring consistent access to hedging tools, market participants would have a clearer and more predictable trading environment. This would encourage greater participation, enhance competition, and ultimately improve liquidity.

Beyond regulatory changes, market-based innovations offer opportunities to enhance liquidity. Advances in digital trading platforms, automation, and real-time market analytics can streamline trading processes, lower transaction costs, and expand access to hedging instruments. Algorithmic trading, in particular, can help optimize trade execution and improve liquidity.

Strengthening forward market liquidity

A well-functioning forward market ensures price stability, reduces risk, and supports investment in the energy transition. Market participants need access to deep liquidity, efficient execution, and reliable regulatory frameworks to hedge risk effectively and operate with confidence. To achieve this, traders require advanced access to the following:

• - Advanced market data analytics to support informed trading decisions and identify hedging opportunities.
• - Automated execution tools that streamline trading processes and enhance efficiency in fragmented markets.
• - Regulatory compliance monitoring to ensure smooth adaptation to changing European market rules.

Europe moves toward an integrated energy future, and improving liquidity is a prerequisite for success, and we are committed to equipping our clients with the tools they need to stay ahead.

At e*star, we provide the technology solutions to make it possible. Our platform empowers traders by delivering all capabilities needed to thrive in modern energy markets.