An introduction to the energy markets

During the early ‘90s, the UK’s electricity and natural gas industry changed from a Government controlled monopoly to a competitive market, meaning that businesses now have the freedom to choose their energy supplier. During this process a commodity market for wholesale electricity transactions and natural gas delivery was established. Electricity and natural gas is traded in large volumes, mostly between generators/ transporters and energy suppliers.

Just like other commodities such as oil, coffee and gold, wholesale gas and electricity prices are driven by traders’ perceptions of the relationship between supply (how much is readily available and at what cost) and demand (how much is required now and in the future). Traders’ perceptions are based on their analysis of the many factors which influence supply and demand. These factors include: the current economic climate; changes to prices of related commodities such as oil and carbon; short and long term weather forecasts; and the impact of international events such as natural disasters and politics.

The constantly changing relationship between these factors leads to volatility in wholesale energy prices. In fact the wholesale electricity price is considerably more volatile than stocks and shares on the FTSE. The graph below compares the electricity market against the FTSE 100 index , showing just how volatile the electricity market is.

Energy Costs