How energy players are reaching the limits of hedging

The energy hedging market is in constant flux: end-users and producers enter and leave depending on their financial limits, estimates of future market conditions and management beliefs and strategies; banks and speculative financial players swarm or recoil as price curves change shape. However, in 2018, a couple of developments in the energy business promise to produce more lasting changes.

Smart meters are finally becoming commonplace in major electricity markets. A majority of households in the US already have them, while the UK has targeted 2020 for virtually complete household coverage. Other major economies around the world have similar plans. And while it has taken US utilities a while to work out exactly what to do with the torrent of user data these meters provide, time-of-use rates are now poised to roll out in some of the largest markets in the US. The result could be less volatility, lower margins and a significant drop in the demand for power hedging.

Time-of-use rates are now poised to roll out in some of the largest markets in the US. The result could be less volatility, lower margins and a significant drop in the demand for power hedging

Much of this rests on assumptions about the degree to which consumers will alter their behaviour in response to the introduction of TOU rates – something that remains unclear, especially for the retail market. Introducing smart appliances could help here, but that assumes smart meters will operate on a single open standard that appliances could effortlessly and seamlessly use as an interface – which looks like an optimistic belief, to say the least. Hopes of behavioural change might be better founded in the commercial and industrial sectors.

Hedging is also dwindling at the long end of the oil market – in part because of backwardation, but also because of fundamental changes in the hedging market. Bank withdrawals from the commodity hedging market have left little liquidity at the far end of the curve, and an influx of speculative money at the near end is making market movements difficult to forecast. Many of the changes may reverse when the price curve changes, but the banks will not return any time soon – their regulators have made their feelings clear on the issue. This, more than any other factor, means the oil hedging business has changed significantly and permanently.