Nordic energy market: hedging challenges and opportunities

The Nordic energy market is undergoing significant changes, making effective hedging strategies essential for managing risks. This article examines the evolving dynamics of hedging in the Nordic energy market, focusing on regulatory shifts, market fragmentation, and the role of exchanges. It highlights key figures and trends that shape the current landscape and offers insights into future considerations for market participants.

Evolving regulatory landscape

Regulatory changes in the Nordic energy market have a direct impact on hedging possibilities. The development of the underlying energy system and derivatives regulation has created both opportunities and constraints for stakeholders. These frameworks can either enhance or limit hedging strategies, making it critical for participants to stay informed about regulatory updates to manage risks effectively.

Since the early 2010s, regulations have tightened significantly. Norway was divided into three price areas around 2010, followed by further divisions in other regions. The global financial crisis prompted stricter market oversight, and subsequent events, including the ongoing energy crisis, have added layers of complexity. These changes have raised questions about the effectiveness of traditional hedging approaches in the Nordic markets.

Declining exchange-traded derivatives volumes

Exchange-traded derivatives volumes in the Nordic markets have declined sharply over the past decade. In the early 2010s, Nordic prices were closely correlated, leading to high liquidity in exchange-traded markets. However, this correlation has weakened, contributing to a steep drop in trading volumes. In 2022, Nasdaq commodity exchange traded volumes reached 409 terawatt-hours (TWh), reflecting a significant reduction compared to historical levels.

This decline has prompted a reevaluation of hedging strategies. The shift away from exchange-traded derivatives suggests that market participants are exploring alternatives, such as bilateral trading, to meet their hedging needs. The reasons for this shift include mismatches between available exchange products and underlying hedging requirements, as well as high costs associated with exchange trading.

Fragmentation of the physical electricity market

The physical electricity market in the Nordic region has also changed considerably. In 2006, weekly average prices across four price areas showed low volatility and high correlation. By 2024, the market has fragmented into 12 distinct price areas, with correlations between system prices and area prices diminishing significantly. This fragmentation, driven by regulatory changes, the rise of renewable energy sources, and new interconnections, has reduced liquidity in exchange-traded markets.

The move from a tightly coupled system to a more fragmented one has made it challenging to use system prices as a proxy for area-specific hedging. Data from 2012 to 2024 shows a clear trend toward lower correlations between system and area prices. This shift underscores the need for tailored hedging strategies that account for local price dynamics.

Persistent need for hedging

Despite these challenges, hedging remains a critical tool for managing risks in the Nordic energy market. Data from public sources indicates that utilities have maintained steady hedge ratios over the past five years. However, the decline in exchange-traded volumes suggests that hedging activity has shifted to bilateral agreements or other venues. One utility reported revising its hedging strategy due to discrepancies between system and local prices, highlighting the need for more flexible approaches.

The question of whether system prices can still serve as a proxy for area prices is central to this discussion. The diminishing correlation between system and area prices indicates that system prices are less reliable for hedging local production needs. To address this, market participants must consider alternative strategies that align with the realities of a fragmented market.

Future considerations for hedging

Looking ahead, several factors could help restore the effectiveness of hedging in the Nordic markets. Matching electricity demand with production in specific price areas is essential for stabilising prices and improving correlations. Investments in grid infrastructure and potential regulatory changes, such as new bidding zones, could also support more effective hedging.

Another emerging idea is geographically differentiated grid connections, which could steer resources to areas with high demand. These developments would require coordinated efforts from regulators, market participants, and infrastructure providers to ensure alignment with market needs.

Exchange competition and market access

The Nordic power market features two main exchanges: EEX and Euronext Nord Pool. EEX offers products tailored to Nordic price areas, while Euronext Nord Pool relies on more familiar derivatives. Both exchanges operate membership models through general clearing members (GCMs), which provide access to market participants.

From a customer perspective, price transparency, suitable hedging tools, liquidity, and easy market access are critical. Competition between exchanges is expected to drive improvements in product offerings and liquidity. For example, EEX recently launched a Nordic liquidity programme aimed at enhancing market activity. Such initiatives could help address the decline in exchange-traded volumes and support more effective hedging.

Challenges and opportunities of exchange membership

The GCM model, while facilitating market access, presents challenges for smaller participants. The costs associated with GCM membership can be prohibitive, potentially

pushing smaller players toward bilateral trading. Additionally, access to markets through GCMs can be complex, as the number of Nordic service providers is limited.

However, opportunities exist to streamline access. For instance, a single GCM could potentially provide access to both EEX and Euronext Nord Pool, reducing costs and complexity for participants. As exchanges continue to develop their offerings, the availability of physical and financial clearing options is expected to expand, benefiting a broader range of market participants.

Key takeaways for market participants

To succeed in the evolving Nordic energy market, participants must carefully select products and trading venues that align with their needs. The ongoing decline in system price correlations with area prices requires a shift toward more localised hedging strategies. Choosing a GCM that enables trading across multiple venues can provide flexibility and cost efficiency.

Competition between exchanges is likely to enhance product development and liquidity, offering new opportunities for hedging. However, participants must remain vigilant about regulatory changes and market trends to adapt their strategies effectively. By staying informed and flexible, market participants can manage risks and capitalise on opportunities in the Nordic energy market.

The Nordic energy market is at a crossroads, with regulatory changes, market fragmentation, and declining exchange-traded volumes reshaping hedging dynamics. While challenges persist, opportunities exist to develop more effective strategies through tailored products, improved market access, and infrastructure investments. By understanding these trends and adapting to new realities, market participants can navigate the complexities of the Nordic energy market with confidence.

Guest post by Suvi Paaso - Managing Director, Power Deriva