Energy transition = volatility (part 2)

The EU pioneered energy market liberalisation in the belief that free market competition delivers efficiencies that drive down the cost to consumers. The experiment with market-based pricing for natural gas paid off: EU retailers and heavy industry saved billions of euros on gas import bills over the past decade – but will these savings endure? As the winter energy crunch morphs into a full-blown energy crisis, the pitfalls of liberalised energy trading are coming to the fore.

In the 1990s, most gas consumed in the UK and Europe was bought and sold under long-term contracts that calculated prices as a percentage of the crude oil price. Oil indexation meant gas prices followed crude market movements and did not reflect gas supply and demand fundamentals. Use of trailing averages (average crude prices over the last three or six months) resulted in relatively smooth price patterns that shielded consumers from wild price swings.

This has been replaced with real-time market pricing for gas that reflects supplies from domestic and international sources, as well as daily, weekly and seasonal variations in gas demand. Liberalisation gave rise to deep and liquid gas trading hubs with futures contracts and financial derivatives allowing market participants to hedge their exposure to gas market fundamentals, and profit from price swings.