What is Electricity Price Volatility & How it Impacts Businesses

Electricity price volatility (EPV) refers to the fluctuation in the prices of electricity as a commodity, over a short period of time. Also coupled with energy price volatility, it’s characterised by quick and typically unpredictable changes in prices, which can have significant impacts on consumers, businesses, and the wider economy as a whole.

Historically, unlike other commodities, electricity has had to be consumed as it is generated, making its supply and demand dynamics highly sensitive to immediate factors. This characteristic, coupled with the complex grid network infrastructure and regulations governing energy markets, contributes to this inherent volatility of energy prices.

Across Europe, energy price volatility is influenced by a variety of factors, including changes in fuel prices (such as natural gas, which is a significant source of electricity generation), renewable energy output variability, geopolitical events, regulatory changes, and market demand fluctuations. For instance, a cold snap in the fringe seasons like Spring or Autumn can lead to a sudden increase in demand for heating, thereby pushing up electricity demand and prices. Conversely, a surge in wind or solar generation can lead to an oversupply, reducing prices.

Main causes of energy price volatility

Understanding the causes of energy price volatility is important to navigate the complexities of the market. Here’s an overview of the key factors that contribute to price fluctuations in the energy sector.

Global Political & Economic Events 

Global political and economic events play a pivotal role in influencing electricity price volatility. When nations introduce new policies, become embroiled in geopolitical conflicts, or levy economic sanctions, such actions can significantly impact the international electricity supply chain. For example, regulatory changes in major electricity-producing countries, trade disputes affecting critical components for power generation, or sanctions that limit the exchange of energy technology and resources, can disrupt the flow of electricity.

Supply & Demand Dynamics 

The dynamics of supply and demand are fundamental to energy price volatility. Energy markets operate on a delicate balance where even minor shifts in energy production or consumption can lead to significant price changes. For instance, an unexpected surge in industrial activity can increase demand for electricity rapidly, outstripping supply and driving up prices.

Weather-Related Disruptions

Weather-related disruptions significantly influence energy price volatility by affecting both the supply side and demand side of the equation. On the supply side, extreme weather events like hurricanes, floods, or severe storms can damage critical electricity infrastructure such as power lines and grid networks. This damage can lead to reduced energy production capacity, thereby constraining supply and potentially driving up prices.

Transition to Renewable Energy Sources 

The integration of renewables into the energy grid, which was originally designed for stable, baseload power sources like coal and nuclear, poses challenges. During periods of high renewable output, there may be an oversupply of electricity, leading to lower prices or even negative pricing in some markets. Conversely, during periods of low renewable output, the reliance on backup power sources, often fossil fuels, can lead to sudden increases in prices.

As the energy sector continues to evolve towards a greater reliance on renewables, managing this variability using Battery Energy Storage Systems (BESS) and integrating it smoothly into the grid is crucial for mitigating price volatility.

Power Station & Infrastructure Outages 

Power station and infrastructure outages are significant factors contributing to energy price volatility. When key components of the energy infrastructure such as power plants, gas pipelines, or nuclear facilities experience unexpected shutdowns, the immediate effect is a sudden reduction in the energy supply.

Interconnectors 

Interconnectors play a crucial role in the UK’s energy landscape by linking its energy market with those of continental Europe. These high-voltage cables allow for the import and export of electricity across borders, enhancing both energy security and market efficiency. However, this interconnectedness also means that the UK’s energy prices are susceptible to fluctuations in the European energy markets. For example, if there is a surge in demand or a drop in supply in Europe, the UK might export more electricity to the continent, reducing domestic supply and potentially leading to higher prices.

Impact of electricity price volatility on businesses

Electricity price volatility poses significant challenges and uncertainties for businesses, affecting their operational costs, resource allocation, and economic outlook. Understanding the nuances between managed and unmanaged volatility, as well as the broader implications for energy suppliers, grid operators, and investment in renewables, is crucial for navigating this complex landscape.

Businesses underpaying or over-resourcing

Managed volatility v unmanaged volatility

Managed volatility involves using financial instruments, contracts, and strategic planning to hedge against price fluctuations, providing businesses with more predictable energy costs. Unmanaged volatility, on the other hand, leaves businesses exposed to market price swings, leading to potential financial instability. Companies that actively manage their energy price risk can mitigate some of the adverse effects of volatility, enhancing their competitive edge.

Hard to forecast bills = fixed price higher rate

Due to the difficulty in predicting energy prices, businesses often opt for fixed-price energy contracts to avoid uncertainty. However, these contracts typically come at a premium, reflecting the risk the supplier takes on by offering a stable rate. As a result, businesses might end up paying more over the contract period, especially if market prices remain lower than the fixed rate.

Challenges for energy suppliers and grid operators

Electricity price volatility (EPV) increases operational and financial risks for energy suppliers and grid operators. As they navigate the fluctuating wholesale energy markets, the costs incurred can be substantial, often passed onto consumers in the form of higher energy prices. This dynamic underscores the need for efficient risk management strategies within the energy supply chain to mitigate the impact.

Negative influence on renewable energy investment

Electricity price volatility has a complex relationship with the investment in renewable energy and infrastructure. While renewables are essential for transitioning to a sustainable energy future, their integration into the grid introduces new challenges.

Solar price cannibalisation

The increasing adoption of solar energy can lead to a phenomenon known as price cannibalisation, where the market price of electricity drops significantly during periods of high solar output. This effect can undermine the financial viability of solar investments, as the returns diminish when solar becomes too prevalent without corresponding demand.

Installing solar alone is no longer a no brainer

Simply installing solar panels is no longer a guaranteed path to reducing energy costs or securing a solid return on investment. The evolving energy market dynamics and the impact of price volatility necessitate a more comprehensive approach, including considerations of solar energy storage and demand management via smart energy management systems.

Without battery storage businesses are running the risk

Investing in solar energy without adequate energy storage, such as battery systems, can expose businesses to the risk of diminished returns, especially as electricity prices become increasingly volatile and even negative during periods of oversupply. The “true cost of solar” must account for the integration of storage solutions to ensure that renewable investments remain viable and contribute positively to the energy portfolio.

Mitigating the risk of electricity price volatility

Strategies to help businesses manage

Navigating the challenges of electricity price volatility requires a multifaceted approach that includes strategic planning, risk management, and leveraging available tools and policies. Businesses and policymakers alike play crucial roles in stabilising energy costs and reducing exposure to market volatility too.

Energy price cap protection

While price cap protection offers a buffer against extreme price spikes, it’s important to note that prices can still fluctuate within the cap’s limits. This mechanism provides some relief but doesn’t entirely eliminate exposure to market volatility.

Fixed price electricity deals

Opting for a fixed price deal can shield businesses from short-term market fluctuations, offering cost certainty. However, these deals often come at a premium and may result in higher costs if market prices fall below the fixed rate.

Installing an energy storage system

Investing in an energy storage solution allows businesses to store excess energy during low-price periods and use it during peak demand, effectively reducing reliance on grid electricity when prices are high. This strategy can significantly dampen the impact of price volatility.

Employing a specialist energy buyer

Hiring an energy manager to make informed purchasing decisions can be an effective, albeit expensive, strategy. An experienced manager can navigate market complexities, identify optimal buying opportunities, and implement energy-saving measures.

Corporate Power Purchasing Agreement (PPA)

Engaging in a Corporate PPA allows businesses to agree on a fixed price for energy directly with renewable energy producers, providing price stability and contributing to sustainability goals. This long-term agreement can hedge against market volatility and potentially offer cost savings compared to market rates.

The role of Government in stabilising electricity prices

Government intervention through policies and regulations plays a pivotal role in mitigating energy price volatility and protecting both consumers and businesses.

Price caps on energy tariffs

Implementing or adjusting price caps on energy tariffs can protect consumers and businesses from sudden price surges, making energy costs more predictable. While this approach can offer short-term relief, it’s essential for caps to be carefully managed to avoid discouraging investment in the energy sector, which could lead to longer-term supply issues. Balancing consumer protection with market health is critical for the effectiveness of price caps in stabilising energy prices.

Electricity Price Volatility Across Europe

While the UK has been at the forefront of addressing electricity price volatility, this phenomenon affects countries across Europe to varying degrees. Let’s examine the situations in Germany, Portugal, and other nations to illustrate the diverse landscape of price volatility in mainland Europe.

Germany: Renewable Energy Transition & Price Fluctuations

Germany’s ambitious transition to renewable energy, known as the ‘Energiewende,’ has significantly impacted its electricity pricing dynamics. A study found that a 1% increase in gas price leads to an expected increase of 0.525% in electricity prices in Germany, while a 1% increase in coal price results in a 0.495% increase.

In 2023, more than 300 hours had negative prices on the day-ahead market, with 260 hours falling under the “4-hour rule”. Despite lower overall price levels in 2023 compared to 2022, strong price peaks continued, with almost half of the spot market prices exceeding 100 €/MWh.

The Netherlands: A Case of Extraordinary Price Increases

The Netherlands recorded the largest increase year-over-year in electricity prices by a significant margin, at 953%. This extraordinary rise was due to the discontinuation of tax relief measures from 2022 and a doubling of household electricity taxes in 2023.

Italy: High Electricity Costs

Italy recorded the highest wholesale electricity prices in Europe, with the IPEX market averaging €91.98/MWh in the first quarter of 2024. The country is the EU’s leading electricity net importer, which contributes to its high prices.

Romania: Volatility in Both Electricity and Gas Prices

Romania has experienced significant increases in both electricity and gas prices, with electricity prices rising by 112% and gas prices by 134% since the energy crisis began.

Portugal: Part of a Broader European Trend

While specific data for Portugal is not readily available, we can contextualise its situation within the broader European energy landscape. Across Europe, electricity prices have generally decreased compared to the peak levels seen during the 2022 energy crisis but remain higher than pre-crisis levels in many countries.

The average household electricity price in the EU was approximately €0.285 per kWh in the second half of 2023, slightly down from €0.294 per kWh in the first half of 2023.

Current prices remain approximately 30-40% higher for electricity compared to pre-crisis levels in most European countries.

Speak to an energy price specialist

Navigating the complexities of electricity price volatility requires a proactive and informed approach. Whether it’s the unpredictable nature of the market, the impact of global events, or the transition to renewable energy sources, understanding the multifaceted causes and effects of EPV is crucial for businesses looking to mitigate its impacts.

Our team, here at Wattstor, specialises in offering comprehensive energy management solutions that address the unique needs of your business. From exploring fixed price deals and energy storage systems to considering Corporate Power Purchase Agreements, we’re here to guide you through the options that best align with your operational goals and financial objectives.