1/19/ Me and my girlfriend were wondering why energy prices went up.
The obvious answer is: it's because of the war. But that's a total curiosity stopper isn't it?
How does it work, mechanically?
2/ If Russia stopped exporting gas, the effects would be easy to understand (less supply). Similarly, if Russia decided to sell at a higher price, things are easy (less supply at previous price). But that's not what happened.
3/ What is even "the price" of, say, natural gas (natgas)? My expectation is that not everybody pays the same price, depending on negotiated contracts.
That's as much as I knew, besides that I expected futures to be involved.
4/ So anyway, let's google it. en.wikipedia.org/wiki/Natural_gas_prices is pretty helpful.
Turns out that in the US, the index price in the "physical market" is determined by averaging the price of all transactions (which are concluded in advance) on the next day.
5/ Natgas futures are contracts for the delivery of gas at a certain place, date and price. In the US, the locations for these contracts is Henry Hub in Louisiana. The "spot price" underlying these futures is thus the physical market price at Henry Hub.
6/ These futures are almost always settled in cash, but you can choose to actually deliver / take delivery of gas in Louisiana.
7/ All of that ... doesn't tell us much? Like how is the price of the transactions arrived at in the first place?
8/ Surely the physical market index price feeds back into the price paid for transactions somehow? You wouldn't keep paying over market rate unless contractually obligated. It would also make the index price less meaningful.
9/ Anyway, how does this works in Europe?
ec.europa.eu/energy/sites/default/files/quarterly_report_on_european_gas_markets_q1_2021_final.pdf
10/ This at least confirms that not everyone pays the same for natgas, mostly where pipelines are concerned.
11/ Natgas is transported either under gas form via pipelines (which are often subterrean or submarine), or under its (much more compact) liquid form (LNG - liquefied natural gas), which is typically ferried by boat.
12/ The LNG market is much more liquid (pun completely intended), probably because boats can go pretty much everywhere, whereas pipelines have to be built. As a result, the price paid for LNG tends to be fairly identical, whereas the price for pipelined gas varies a lot.
13/ And it can vary *A LOT* — at time more than 3x between different pipelines.
14/ In any case, all of this hinges on how natgas supply contracts are defined and how spot price and futures price feed back into it.
This is surprisingly difficult to search for, I didn't find anything.
15/ But the fact is that despite the war, gas is mostly still flowing as freely as ever. Therefore the price hike must hinge on the fear that gas might not trade so freely in the future, meaning it will more expensive (less supply).
16/ Turning information into price is the purview of the market, but since I (a home customer) am paying more for gas, this means that somehow my gas provider is affected. Which implies their contract-specified price is influenced by the financial index. Would be nice to be sure.
17/ Also, what if gas might be more expensive in the future? The thing is, gas is pretty hard to store, so it's hard to stockpile gas now to profit from a price hike in the future.
18/ Is the effect of increasing stocks at the margin sufficient to move the price though? It's a bit like the fact that on a given day, only a tiny fraction of all Apple shares changes hand, but the supply/demand imabalance on that day can have a big price impact.
19/ Anyway, I think I spent enough time on this. Hope you learned something, I certainly did!
Happy Norswap 🤠🏴☠️✨
@norswap
Perpetual soldier of fortune, occasional internet slacker. Cooking @happychaindevs, I mostly talk about blockchain tech.
