Don’t blame the speculators: complexity behind Europe’s gas volatility

I’ve had several discussions with friends and colleagues about what could be behind a spike in volatility on Europe’s benchmark Dutch TTF front-month gas contract in recent months. 

And it isn’t just me. Traders, portfolio managers and anyone following these markets have probably been having similar conversations to try and work it out. Let’s dive into some theories here.

News-driven trading

In the middle of February, the TTF front-month price fell after US president Donald Trump announced he had called his Russian counterpart Vladimir Putin to discuss a possible ceasefire in Ukraine. No details were provided, yet in a few days the market reversed at least half of a massive bull-run that had been building since the middle of December. 

It was another sign that commodity markets are driven more by news and sentiment than fundamentals. The narrative dominating energy markets lately reflects this, despite the old saying in trading: “Markets can stay irrational a lot longer than you and I can remain solvent.” 

Irrationality is a word frequently mentioned in relation to extreme volatility in gas and power markets – which emerged after the 2022 energy crisis – and the growing role of financial investors or speculators. Can anything be done to calm the markets? Some have argued for regulatory intervention, such as limiting position sizes. Others called for a review of the EU’s 90% mandatory storage filling target, which may have helped fuel the rally. Last week, the European Parliament agreed to lower the target to 83% of capacity.

More regulation or deregulation? 

Regulation on market behaviour seldom, if ever, has a positive impact. Two negative examples that stand out for me are: 

EUA market

Pricing carbon emissions is necessary for a greener future, but wouldn’t a simple tax have been more effective? Instead, regulators tried to control both supply and demand while economic and technological changes outpaced legislation. 

The EU ETS market became insignificant after the 2007-08 financial crisis, with prices near zero due to dwindling demand. “Backloading” was introduced in 2014 to reduce supplies with postponed auctions – followed by the market stability reserve to control supply and demand dynamically. Speculation surged, leading to the same concerns now seen in the gas market. Today, gas has taken the spotlight from EUAs, but this could change when the carbon border adjustment mechanism (CBAM) comes into effect in January.

Slow, asymmetric regulation attracts traders by distorting risk/reward balances – like the EU’s mandatory gas storage targets creating artificial demand.

Hungary's fuel price cap

A personal one, as this is my home country. The Hungarian government introduced a fuel price cap during the energy crisis – yet another failed price control. The result? Fuel shortages and long queues at petrol pumps. Eventually, in December 2022, the government had to abolish the cap at Hungarian energy company Mol’s recommendation.  

The lesson: regulation leads to more distortion, increased volatility and at worst threatens market function. 

Banking on success 

One factor often overlooked is how risk appetite on the demand side of the European gas and power markets has shifted since 2010, particularly in industrial energy supply contracts.  

After market liberalisation, most industrial consumers favoured fixed-price contracts for budget stability. In Hungary, fixed-price electricity contracts covered more than 90% of the market, compared with 70-80% in western Europe. Nordic countries historically had more spot-indexed contracts.

In 2013-2015, indexed contracts gained traction as spot prices remained below futures for years following the 2011 Fukushima disaster. Some industrials sought cheaper prices, while others adapted to competition. 

Before the 2022 energy crisis, fixed-price contracts had reduced but still dominated. Gas contracts have followed similar trends. 

The energy crisis changed everything. Futures gas and power prices surged 10-fold, making customers hesitant to lock in costs initially. Later, energy suppliers withdrew fixed-price offers or priced them at massive premiums to cover rising credit costs and default risks. By 2022-2023, indexed contracts soared to 60-70%. 

There has been some return to fixed-price contracts but indexed contracts still dominate at 55-60% in central and eastern Europe. 

This has implications for wholesale markets. With the share of indexed-price contracts having nearly doubled since 2010, long-term futures are now less frequently used for hedging. This has shifted more buying activity into the short-term markets, driving up volatility and amplifying price swings. 

A sizeable portion of these hedges are financial contracts arranged through banks, while the physical gas is purchased via separate channels. 

Yet no one is calling for regulation of indexed contracts for industrial consumers – and rightly so, as this would distort market dynamics and undermine demand-side flexibility.

Energy market speculation 

Blaming speculators or irrationality for today’s volatile energy markets is popular, but it’s an oversimplification – and not a constructive one. While new players and financial derivatives have certainly amplified price movements, claiming these shifts are entirely disconnected from fundamentals would be a bold assertion. 

If price signals are essential to drive investment in renewables and flexibility, then the liquidity provided by financial players is equally vital. Markets need participants on both sides – sellers and buyers willing to take on risk. Overregulation could upset that balance and bring unintended consequences. 

Finally, risk management is more important than ever. It is especially true for industrial customers as some of them have been testing new waters in recent years. Every stakeholder should evaluate what level of price risk their company is willing to run, which also matches their adaptability and budget flexibility on the consumption side.

This article originally appeared as a column on www.montelnews.com