UK gas prices hold lessons for all commodities

UK power markets are in a particularly volatile state right now due to the soaring cost of gas. The collapse of several energy firms and risk of further issues has left consumers worried, regulators and government stepping in, and increased pressure on the providers still in business to source the power they need.

The immediate effects are already being felt in electricity markets and other energy commodities, but are also beginning to impact on energy-intensive industries such as steel, food and fertiliser production. Although the power markets that are making the news are in some respects less mature than other commodities, the current challenges in this space provide lessons for all commodity operations.

What’s happening in UK energy?

Energy prices have been high across Europe in recent weeks and have hit the UK particularly hard. On 14^th September, People’s Energy and Utility Point ceased trading, impacting over 500,000 households, and following the closures of two other small energy providers only the week prior. And over the weekend, the UK’s sixth largest energy company announced it was looking for a bailout to stay afloat. The market has proven challenging for all utilities, with most large providers announcing they will be raising prices to the regulator Ofgem’s annual price cap from October.

These larger providers are being forced to absorb the higher input costs, including day-ahead power prices that tripled to record levels last week, and month-ahead gas prices 420% higher than the previous year. However, smaller providers are finding themselves exposed as they are less likely to have the capital to run a comprehensive hedging strategy and manage the market risk.

What’s causing the problem?

As with many commodities right now, the (overly) simple answer is that the global recovery from the Covid-19 pandemic is altering the dynamics of supply and demand, an issue that could impact any producer, trader or buyer of commodities.

In the case of UK gas in particular, the Covid recovery has led to a rebound in LNG demand in Asia and South America, markets which have outbid Europe. This only compounds other factors including the difficulty of restocking after a cold end to last winter, and low levels of wind over summer forcing up demand for gas, leaving European gas storage units 67% full, compared to the 82% that is usual at this time of year.

Supply has also been affected, with the UK’s domestic gas production lower than usual due to planned maintenance and delays to some new projects. And the supply of Russian gas to western Europe has not recovered to pre-Covid levels.

Finally, on top of these issues with the gas and LNG supply, a fire at a UK electricity interconnector has taken the site offline until 25^th September, and the connector is expected to remain at half capacity until late March 2022, affecting flows of power from the continent to the UK.

And these are only some of the factors impacting pricing.

Is better hedging needed?

The worst effects of these rising natural gas prices have been felt by the organisations that were least protected by hedging. Their collapse shows the importance of having comprehensive risk management strategies for price and market risk for all commodities companies. It also shows that simply meeting regulatory requirements is not always a sufficient risk strategy, as was the case for those organisations that were not required to hedge all their positions and subsequently collapsed.

In these periods of market volatility that the energy industry is facing – and other commodities may also experience – it is more important than ever to have clear risk management structures in place, to ensure policies are understood across the business, and to provide risk managers with all the data they need to ensure your business is both protected from risk and as efficient and profitable as possible.

Your organisation may be using an E/CTRM to share trading and position data for risk management, but some legacy E/CTRM systems may not provide the detailed and timely data needed for an effective modern hedging strategy. With legacy software, reconciliation is often not in real-time, which can leave organisations exposed until reports are run at the end of the day or even month.

In a fast-moving, volatile environment like today’s, this exposure may be considered too great a risk, but it is one that can be mitigated by good commodity management software. A modern system such as Gen10’s CommOS updates reports in real-time throughout the day as traders and operators carry out their role. This means that risk managers can see open and unhedged positions at a glance throughout the day, with ongoing reconciliation.

As well as providing the data to make better decisions faster, energy commodity management systems also provide active risk management. They can help with checks and controls including managing position limits, counterparty credit limits, providing pre-approvals for traders, and minimising operational risk.

Data is key

Access to data is what makes this risk management so effective and is essential when market volatility means the situation is changing throughout the day. And volatile markets show the importance of assessing as many data sources as possible to protect against losses. With the power of hindsight, we can see how high LNG prices led to high power prices, to fertiliser plant closures, to a shortage of carbon dioxide for beverage, medical and meat suppliers, to an expected shortage of meat in the next few days.

Putting the systems in place to collate and share data is essential – both the internal data needed for an effective hedging strategy and the data from multiple sources that help you define the best business strategies and help your people make better decisions based on reliable and timely information. With the right data delivered at the right time, traders have the agility to respond to market conditions with speed and efficiency; avoiding losses and increasing profitability.

Commodity management systems provide a core part of this vital data ecosystem, and if your E/CTRM is not a strategic advantage to your business, it is time to consider finding one that is.