What Drives Energy Prices

What Drives Energy Prices

During normal market conditions, market cycle transitions are gradual. There may be peaks and valleys, but prices typically remain within an anticipated range. In addition to these cycles, a broad variety of factors affect the market. Changes in one or more of the following can intensify volatility and cause dramatic price changes within a compressed period of time:

Weather: Weather is one of the most influential variables of market pricing because it can be unpredictable and directly affects energy consumption. Of course, weather is predictable to some degree, giving rise to the seasonal market cycles mentioned previously. However, within those seasonal expectations, weather can change unexpectedly and cause unforeseen variances in demand.

Extreme Weather: Analysts closely monitor weather forecasts for catastrophic weather events such as hurricanes, floods and blizzards. These events can create periods of extreme price volatility, particularly if natural gas production or electricity transmission facilities are damaged. These natural gas facilities provide source fuel for electricity generation (limited supply) or to the electricity transmission and distribution infrastructure (reducing demand and limiting the flow of electricity). When forecasters anticipate extreme weather, market prices typically take the probability of such events into account. Prices are also subject to change in the aftermath of extreme weather when actual damage and impact are clear.

Government Regulations: When regulatory agencies propose or introduce changes, the wholesale market may respond with changes in pricing. In addition, regulations affecting process fuel industries may also resonate on the electricity and natural gas market.

Outages: Power plants periodically shut down or slow production to complete facility maintenance. Offshore natural gas wells and inland shale rigs sometimes need to close or slow production due to inclement weather like hurricanes, floods or freezing temperatures. Either scheduled outages or unexpected closures can impact prices.

Source Fuels: The electricity and natural gas markets are swayed by one another and by the supply, demand and pricing in other source fuel markets, including crude oil and coal. The interdependency of these fuel markets is complex and can vary by region. To control costs, many companies seek the cheapest source of fuel to power their business's operations, switching sources based on the cheapest market cost at the time. As a result, a price change for one type of fuel often affects the price of the others. Additionally, because source fuels are used in electricity generation as well as in heating and cooling, dramatic movement in any of these markets also impacts the electricity and natural gas markets.

Geopolitical Events: In regions that import or export natural resources, events such as political unrest, war, and hostage crises, can affect the energy market. Typically, these events impact the market immediately, which can affect short-term prices. Protracted events produce prolonged uncertainty, causing wholesale market prices to escalate long term. Conversely, trade agreements that open a new stream of fuel supply to the global market can create advantageous prices.

Electricity prices can also be driven by regional weather and environmental conditions. In each region of the United States, electricity is generated with a different mix of source fuels. For example, 2005 data shows that more than 40 percent of the electricity produced in Pacific state-controlled waters was generated by hydroelectric power plants on the region's rivers.1 By monitoring indicators such as snow pack (which will eventually melt and flow into rivers) and salmon spawning (which can limit generator output), analysts can determine a plant's ability to offer electric supply to the market at specific points in time.