Energy ≠ Coffee: an assessment of blind spots on energy spotmarkets

18 November 2005

A key aspect of energy market liberalisation is to enhance competition on commodity markets. Such competition will clearly benefit from liquid, transparant and well-functioning spotmarkets. Although some liberalising markets show a gradual development of such spotmarkets, it yet remains to be seen how that development will proceed in the course of time. In other words, it is still uncertain whether, for instance in Europe, most of the natural gas trade will, in the near future, take place via a mature spotmarket.

In order to obtain a clearer picture of the future role of energy spotmarkets, it is extremely important to first analyse the energy market characteristics in detail, in terms of volumes and price formation, contracts, players, financing, etc. One aspect of that ‘picture’ is whether, and to what extent energy, spotmarkets fundamentally differ from other commodity spotmarkets, which requires a systematic spotmarket comparison.

This study is meant to be the first in a series of studies on energy spotmarkets and specifically focuses on the differences and similarities with a number of other spotmarkets. It specifically aims to frame the energy spotmarkets and their potential development into a broader perspective.

It is clear from the study that it would be unwise to simply lump spotmarkets together. First of all, contrary to markets where assets are traded (e.g., FOREX or stocks), physical commodity markets are typically characterised by transport and other logistical issues, such as storage costs of buffers.

In addition, within the category of physical commodity markets, a distinction can be made between markets where the use of the commodity is strongly linked with accompanying restricted transport services, and those commodities where transport limits are practically absent. Natural gas, for instance, clearly belongs to the former category: natural gas that cannot be transported to the end user has little value; at the same time, the grid capacity, at least on the short term (and disregarding LNG), is fixed. Other distinguishing factors are: the presence of a regulator in the linked market, who can affect market predictability; the question whether the transport system only allows transport in one direction; the presence of vertically integrated firms, etc.
In short, energy spotmarkets differ in many respects from several other physical and non-physical spotmarkets. This implies that ‘perfect’ energy spotmarkets may inherently be (much) less perfect than other spotmarkets that have approximated the stage of theoretical perfection.

This study, therefore, tries to put the energy sector in a wider spotmarket perspective by using a number of market indicators and implementing these to a set of physical and non-physical commodity spotmarkets.

The report can be viewed/downloaded here: spotmarkten-final.pdf