What is the spot market in energy trading?

What is the spot market in energy trading? 

Taking risks can pay off - a technique that can work well for energy procurers. One trading method that takes into account risk tolerance and strategy is the spot market, which is an action that sells energy very close to the time it’s consumed, for example, the day on or before it’s used. This is different from future or long-term markets, which often use spot markets to set prices for energy sold further into the future. A marginal cost pricing system is used in spot markets. Propane, gas and oil are common energy products traded in the spot market. Day-ahead markets trade energy the day before it's generated, whereas real-time assets are traded to be used immediately.  

Why spot market prices matter for energy cost management 

Spot markets can help businesses manage costs in the short term in relation to procurement and benchmark pricing in the future.  

Direct impact on short-term procurement costs 

While future markets may be a better fit for companies seeking longer-term stability or trends in relation to the energy market, spot markets may be a good option for businesses looking to impact short-term purchasing costs. This is because more competitive pricing may be possible with such short-term procurement.  

Use in benchmarking retail or contract offers 

Contract offers often utilise spot markets influenced by business demand and supply behaviour. This is also sometimes known as the benchmark rate, which goes up or down depending on supply and demand, and is used to ‘benchmark’ future rates, or ‘forward’ rates.  

Role in budget planning and variance analysis 

These benchmarked rates can be used to help with a business’ forward planning in energy procurement, allowing them to forecast the cost of energy based on the current spot rate. While this is a useful tool to forecast how much energy might cost in the future loosely, it’s important to consider the factors that might impact pricing in the future and allow cost margins for this movement to occur.  

Factors influencing spot energy prices 

Spot market pricing is a volatile market, and many factors can cause it to drop or increase. We examine some of the key factors influencing spot market price movement.  

Supply and demand imbalances 

Energy pricing can experience volatility when supply and demand imbalances happen, and the spot market is no different. In some instances, energy pricing can even influence inflationary periods. This is often due to global energy supply decreasing, making it more scarce and increasing current prices. This can be due to factors such as weather, the affects of climate change, damage to infrastructure, the cost of running plants, grid issues and geopolitical tensions.   

Weather and seasonal demand patterns 

Weather can have a huge impact on energy pricing in the spot market, usually in the case of renewable energy. Renewable energy can fluctuate in price depending on how much energy is generated. Because the weather generates many types of renewable energy, for example, wind and solar, when these conditions aren’t present, plants don’t generate energy. Spot pricing can help integrate renewable energy into the marketplace as the pricing can be adjusted close to the time it is actually used, making room for pricing adjustments to be made.  

Grid constraints and outages 

As we move towards a more modern network, the grid in its current state is not overly fit for purpose when considering the integration of enabling energy. Its volatility makes it unsuitable for the current grid and as a result can cause grid constraints and outages as our network upgrades as part of the global energy transformation process. The spot market can help to price energy as part of this volatility, as it can apply real-time pricing during supply constraints.  

Geopolitical tensions and policy shifts 

Energy is traded in international markets, which involves trading between countries with volatile political tensions or corruption. When these tensions affect procuring countries - for example, an energy producing country may restrict the amount of energy or increase the cost of energy to a country it has specific political tensions with - these factors can impact the price of energy as it becomes bottlenecked, disrupted or damage infrastructure. Spot pricing can become skewed, resulting in higher spot prices as usual. 

Data sources for spot price analysis 

Data can be a key source of information for businesses procuring energy via spot pricing as they can provide accurate analysis of the energy market, focusing on the real-time element of spot pricing. Specific market operators, such as EEX, have been developed for spot pricing, with area prices calculated for all market bidding areas. Nord Pool, for example, offer day-ahead pricing and more regular intraday statistics, with data as close as one-hourly. From a certification perspective, ISO websites can monitor and analyse the volatile prices of certification services.  

Public APIs can also help keep the public informed about the spot market. Organisations like the U.S. Energy Information Administration publish open data through their API concerning commodities such as electricity, natural gas, petroleum, and coal, along with some green energy data, such as biomass. Regulatory bodies such as Ofgem also provide data on energy prices, retail and wholesale prices, and price caps.  

Spot markets offer cost-saving potential and agility for businesses, but success depends on smart analysis, risk awareness, and real-time market data.