How does gas affect power prices?

Why gas still sets the price in many power markets

Most modern power market’s function using the merit order system, which dispatches generators based on their marginal costs (from lowest to highest) until demand is satisfied. Renewable sources like wind, solar, and hydro have near-zero marginal costs, so they are dispatched first. Afterwards, nuclear, lignite, and coal plants are used, followed by gas, oil, and peaking technologies.

In Europe, gas is the marginal technology in most trading hours. Even if it only supplies a part of total generation, gas-fired plants often set the clearing price in wholesale auctions because they are among the last units needed to balance supply and demand.

The share of gas in the generation mix varies by region:

• United Kingdom: gas accounts for around 35–45% of annual electricity production and typically sets the day-ahead price.

• Germany: less dependent on gas overall, but combined-cycle gas turbines (CCGTs) still define prices during renewable lulls.

• Italy: heavily reliant on gas imports, meaning power prices closely track gas market movements.

• Nordics: hydro dominates, but interconnections to continental Europe mean gas still influences cross-border pricing.

Even as coal declines and renewables expand, gas remains the benchmark for marginal pricing across interconnected European markets.

The mechanics of marginal pricing and the merit order

Electricity prices in most liberalised markets are determined through day-ahead auctions. Generators place bids based on their short-run marginal costs, primarily including fuel, carbon, and variable operational costs. The highest-cost plant required to meet demand sets the clearing price for all generators.

Gas plants often serve this role because they are flexible, can ramp up quickly, and occupy the top position in the merit order. Two key metrics help describe this relationship:

1. Spark spread: the difference between the power price and the cost of gas required to generate one megawatt-hour of electricity.

2. Clean spark spread: adjusts the spark spread by including the cost of CO₂ allowances under systems like the EU ETS.

A positive clean spark spread shows that gas-fired generation is profitable, while a negative one indicates it is not. Since power prices are often linked to this marginal cost, variations in gas and carbon markets directly affect wholesale electricity prices.

It is also important to differentiate between marginal cost and average cost. Although renewables generate the majority of electricity at nearly zero marginal cost, the market price is still set by the cost of the most expensive generator needed to satisfy demand. This is why, even with high penetration of renewables, gas plants often set the prices in most hours.

How gas price volatility flows through to electricity costs

Because gas-fired generation often determines the marginal price, fluctuations in gas markets almost directly translate to wholesale electricity prices. Historical data demonstrate a strong statistical link between benchmark gas indices such as the Dutch TTF hub and day-ahead power prices across Europe.

Gas price fluctuations can affect power prices both immediately and over time. Immediate effects include spot and day-ahead gas price spikes, which directly feed into next-day power auctions. Longer-term contracts and hedging strategies help cushion some of the impact, causing baseload futures to adjust more gradually.

Recent market crises vividly demonstrated this relationship. Between 2021 and 2023, global LNG shortages and decreased Russian pipeline flows caused TTF prices to soar above €200/MWh. Wholesale power prices mirrored this trend closely, with monthly average correlations exceeding 0.9 in several markets. Even countries with limited gas-fired capacity experienced power price rises due to cross-border trading and regional coupling.

When gas markets settle, the relationship reverses: declining gas prices swiftly lower wholesale power prices, emphasising how closely the two are still linked.

Gas supply shocks and their power market impacts

The transmission of gas price shocks into power markets depends on several structural factors - especially storage capacity, interconnectors, and substitution potential.

• Storage levels: high gas storage buffers short-term price volatility, reducing the likelihood that gas scarcity drives power prices higher. Conversely, low storage heightens vulnerability to winter price spikes.

• Interconnector capacity: the ability to import gas or electricity from neighbouring systems can dampen local price effects, though congestion can sometimes amplify them.

• Substitution effects: coal, biomass or demand-side reductions can offset some gas shortages, though usually only temporarily.

These dynamics influence both forward curves and hedging behaviour. Traders and utilities frequently modify their positions in response to storage outlooks or geopolitical risks, strengthening the close link between gas and power forwards.

During periods of severe stress, like the 2022 European energy crisis, spikes in gas prices affected not only electricity costs but also plant dispatch and demand patterns. Gas-to-coal switching briefly reappeared, emissions intensity rose, and industrial demand was reduced to maintain system stability.

The role of renewables and demand flexibility in reducing exposure

The most effective way to weaken the link between gas and power prices is to decrease the hours when gas is on the margin. Every extra megawatt of renewable or flexible capacity shifts gas higher in the merit order, reducing how often it sets the price.

Several structural trends are driving this shift:

• Higher renewable penetration: wind and solar are increasingly displacing gas during daylight and windy hours, especially in markets like Spain and the Nordics.

• Flexibility options: demand response, short-term battery storage and interconnectors are helping absorb volatility and reduce reliance on gas peakers.

• Long-term developments: hydrogen-ready gas turbines, power-to-X technologies, and capacity markets will all reshape the residual role of gas in the 2030s.

While renewables and storage cannot yet eliminate the influence of gas, their growing presence is already softening price swings. Demand-side participation, such as flexible industrial loads or smart charging, can further reduce exposure by adjusting consumption when prices spike.

Conclusion

Gas remains the key link between fuel markets and electricity prices. Its role as the marginal technology means wholesale power costs still reflect gas market movements, especially in Europe’s interconnected systems. From spark spreads to storage levels, the economics of gas generation continue to influence the daily pricing mechanisms of the power market.

However, that dominance is gradually weakening. As renewables, storage, and demand flexibility expand, fewer hours see gas priced out. Over time, this will weaken the strong link between gas and power prices, stabilising electricity costs and separating them from fossil fuel volatility.

For now, though, gas remains the linchpin of power pricing - a reminder that even in an age of rapid decarbonisation, legacy fuel dynamics still shape the cost of the clean energy transition.