How to manage price volatility in energy markets

Identifying the Causes of Energy Price Volatility

As renewable energy is a relatively new method of energy generation compared to traditional sources like fossil fuels, the market remains subject to price volatility. Various factors, including the variable input of energy into the market—such as in the case of solar and wind power—can impact price stability within the renewable energy sector. In this article, we explore how these factors contribute to price volatility and examine other key influences at play.

The Impact of Weather on Energy Prices

One of the most significant factors affecting renewable energy prices is weather. Key renewable energy sources like solar, wind, and hydro rely heavily on weather conditions to generate energy. These energy sources are often situated in areas with extreme weather to maximise energy production. However, when these extreme conditions are absent—for instance, a drop in wind due to a lack of storms or a decrease in water levels due to insufficient rainfall—renewable energy production can falter. This reduction in energy generation can lead to increased prices as demand for renewable energy outpaces supply.

The Impact of Infrastructure Failure on Energy Prices

Extreme weather conditions can also lead to infrastructure failure, as equipment in harsh environments tends to degrade more quickly. For example, transmission line failures during periods of intense heat can disrupt solar energy generation, directly affecting pricing. When infrastructure fails, leading to power outages, market price volatility can increase. The temporary halt in energy production due to infrastructure issues reduces supply, potentially driving up the cost of renewable energy.

The Impact of Renewable Energy Transition on Energy Prices

As businesses increasingly prioritise carbon emissions reduction, there has been a shift towards procuring renewable energy over fossil fuels. However, the current energy grid was originally designed with fossil fuels in mind, which typically offer a more stable and consistent input into the grid. Renewable energy, on the other hand, is less predictable, which can disrupt the grid and cause renewable energy prices to fluctuate.

The Importance of Building Resilience and Strategic Energy Procurement

Energy pricing significantly affects consumers, investors, and the environment. Ensuring market resilience through robust strategies is crucial to mitigate the impact on the following factors:

Environmental Factors

Market volatility can make renewable energy less competitive compared to fossil fuels. Fossil fuels offer a steadier, more predictable energy output, making it easier to set fixed prices. In contrast, renewable energy's unpredictability can cause price fluctuations, making it a less appealing option for consumers who need to budget effectively. This unpredictability may hinder the growth of the renewable energy sector.

Geopolitical Factors

Countries that do not produce their own energy rely on imports from other nations. When a supplying country restricts energy exports, it can drive up energy prices in the importing country. The same applies to renewable energy technology or components—if a supplier country restricts the export of these technologies, it can impede the development of renewable energy in the importing nation.

Consumer Factors

Fluctuating energy prices can negatively impact consumers, making it harder to manage budgets. Price spikes particularly affect utilities on the renewable energy side. When prices reach all-time highs, consumers find it challenging to switch providers and secure better deals.

Investor Factors

Price volatility in the renewable energy market can erode investor confidence. Investors may be reluctant to invest in renewable technologies if returns are uncertain. To mitigate this risk, investors might opt for Power Purchase Agreements (PPAs) with more flexible terms, such as a mix of renewable and fossil fuels, which could reduce overall investment in renewable energy.

Monitoring and Response Techniques to Price Fluctuations and Hedging Strategies

Increasing Production

To counter periods of low energy generation, power plants can monitor these times and opt to increase production to compensate—such as ramping up output during cloudy periods in solar farms or during lulls in wind farms. However, placing additional stress on power plant technology can lead to higher maintenance costs, ultimately increasing renewable energy prices.

Energy Storage

Energy storage offers a solution to balance high and low energy production periods. As more batteries are integrated into energy networks, excess energy produced during high-generation periods can be stored and used during times of low production.

Hydroelectric Energy Simulating Battery Storage

Hydroelectric plants can mimic the storage functions of batteries by adjusting water flow to conserve energy for use during droughts or periods of low rainfall. By managing water storage boundaries, these plants can increase energy generation during low-production periods.

Financial Instruments

Businesses can protect themselves against price fluctuations through hedging strategies, such as purchasing energy at a fixed price for a specified period. This ensures price stability and guards against potential increases. Additional hedging tools include future swaps and options.

Diversification and Risk Assessment Tools for Energy Portfolios

Diversifying an energy portfolio is one of the best ways to manage risk and "hedge" against market volatility. This can be achieved by investing in various types of energy sources, such as a mix of renewable energies with different generation requirements (e.g., wind and solar) or a combination of renewable and fossil fuels.

One effective method is through Power Purchase Agreements (PPAs). PPAs involve investing in a renewable energy producer for a predetermined period while receiving energy at a fixed price. There are many PPA variations, with options ranging from fixed to flexible pricing.

A bundled PPA may be an excellent choice for those looking to diversify their energy portfolio. This type of PPA allows the inclusion of both renewable energy and fossil fuels, offering the benefits of stable pricing through fossil fuels and the potential for lower costs from renewable energy.

Effectively managing price volatility in energy markets is crucial for maintaining stability, fostering investor confidence, and encouraging the adoption of renewable energy. By implementing strategies such as diversification, energy storage, and hedging, stakeholders can mitigate risks, ensuring a more resilient and sustainable energy future.