Facts about the energy markets

The most active energy markets trade in electricity, gas, coal, oil and CO2 emission certificates. Energy trading takes place at exchanges, but also outside of them on a bilateral basis.

In Europe there are more than twenty different energy exchanges. The most liquid exchanges are the European Energy Exchange (EEX) in Leipzig and the Nord Pool Spot / Nasdaq Omx Commodities in Oslo.

The main markets within an energy exchange are the spot market, for short-term trading, and the forward market, where the physical delivery of, for example, electricity or gas takes place at a future date.

The significance of energy trading has grown rapidly in Europe as a result of increased energy consumption as well as market integration. Almost no country can cover its energy needs from its own sources today. Energy trading offers the possibility to ensure the needed supply of energy and protects from supply shortages and price fluctuations.

Electricity

The power exchange is the hub of the electricity market, and the market price for electricity is determined on the power exchange's spot market. The actors on the spot market are producers, retailers and traders as well as large end users.

The majority of producers sell their electricity on the spot market, where short-term trade in electrical power is done via day-ahead auctions. During the trading process, electricity producers who want to sell power to the spot market must send their sale offers (for the amount of electricity they are prepared to deliver at various prices during the 24 hours of the following day) to the power exchange by 12 noon on the day before the power is delivered to the grid.

Electricity retailers must send their purchase orders (corresponding to the amount of electricity they believe customers will consume during the 24 hours of the following day), and the amount they are willing to pay. The market price is then used by electricity retail companies to set the price of electricity for end consumers (the "electricity retail price").

The market price may vary somewhat between different market regions, depending on physical transmission limitations that sometimes occur and the generation mix within each region.

The market price is determined by supply and demand, corresponding to the marginal cost of the last production unit that is required to meet demand in each hour. In Europe, this is normally on a par with the cost of producing electricity with coal or natural gas.

Unlike most other commodities, electricity cannot be stored. It is produced at the exact moment of demand. Therefore all the factors that influence supply and demand have an immediate impact on the price on the spot market.

Some factors that influence the price of electricity

  • Fuel prices – for coal, gas, biomass and oil – and the prices for CO2 emission certificates.
  • Wind and weather, as they determine how much electricity is generated by wind turbines and hydroelectric stations. The weather also influences consumer behaviour.
  • The capacities of power plants, their current technical condition and planned overhauls or unplanned outages.
  • The state of the general economy influences demand.
  • Holidays.

For an end user (household or business), the price of electricity is comprised of three parts:

  • Price for power production
  • Grid price
  • Taxes and fees (renewable energy surcharge, energy tax, VAT, etc.)

Gas

The price of gas is determined in much the same way as the price of electricity: by supply and demand. Companies purchase the gas as it flows from the well and pay a "wellhead price". At this stage, the gas has not been processed or transported. The most important gas hubs in Europe are the National Balancing Point (UK), Title Transfer Facility (Netherlands), Zeebrugge (Belgium), Gaspool and NCG (Germany). 

Consumers, on the other hand, pay for processed gas delivered directly to their homes through an extensive distribution system. The consumer price is determined by the cost of processing and delivery, metering, billing, distribution system maintenance and other factors.

As with electricity, different gas operators own different parts of the chain. While extraction companies are responsible for the raw material, trading and retail companies are responsible for delivery to end users. The price of gas is determined with free competition and, under the Natural Gas Act, grid and network fees must be fair, non-discriminatory and cost reflective. Network companies are monitored by authorities to ensure compliance.

Although the consumer price of gas is set with free competition on a spot market, many gas suppliers often have long-term contracts with major gas producers which index the price of gas to oil prices. With the spot market gaining more importance, this kind of pricing has decreased.

Fuel

The price of electricity is influenced by the prices of commodities used as fuel in power plants, such as coal, oil and biomass, and the prices for CO2 allowances.

Coal

Coal is mined commercially in a large number of countries all over the world. It is available from a wide variety of sources in a well-supplied worldwide market. The price of coal is set at commodity exchanges, such as ICE and CME.

Oil

Oil is a very important commodity in the global society. Supply and demand is an indicator of the performance of the global economy and oil price usually affects prices for all other commodities. The price of oil is set at global commodity Exchanges like ICE and NYMEX.

Biomass

International trade in biomass for power generation is still limited. Imports into Europe from other parts of the world are, however, expected to increase as biomass increases its share of the European energy mix. This will require that a standardised global system for trade and certification is established.

CO2 emissions certificates

Emission trading is a market-based approach to control emissions of CO2 and other pollutants. The EU Emission Trading System sets a limit on the amount that may be emitted. The limit is allocated or sold to firms in the form of permits to emit a specific volume. These permits or units can be sold in the international market at the prevailing market price.

Trading exchanges have been established to provide a market in permits. Trade in carbon credits takes place at a number of exchanges, such as European Climate Exchange, NASDAQ OMX Commodities Europe, PowerNext and the European Energy Exchange.

Last updated: 2013-10-08 16:51