Energy Price Volitility
What is energy price volatility?
Price volatility is a description of how drastically and frequently the price of a commodity changes. Energy price volatility refers specifically to how often the price, or rates, of services that supply energy such as electricity or natural gas fluctuate. Energy prices are typically much more volatile than that of other commodities, meaning that they tend to change on a very frequent basis and in more drastic amounts than prices in other markets.
Why do energy rates to change so much?
In general, prices are dictated by how much there is of something and how much people desire to buy it, or supply and demand. The fluctuation of prices is also a result of supply and demand, as well. When the demand for energy increases, prices go up, and when the demand decreases, prices go down. If there is a shortage in the supply, prices will go up, or if there is a surplus, prices go down. The more dynamic the supply and demand for something, the more volatile the price for that item will be.
One reason that the price for energy commodities tend to be very volatile is the fact that comsumers are very limited in their ability to use a substitution. For example, a business that utilizes electricity for all their energy needs cannot just switch to using natural gas very easily. A switch would require replacing heating and cooling units, stoves, ovens, and all other appliances that are currently used for new ones, and that simply is not a practical solution. Whereas, while purchasing food items, the consumer could find that a specific item was priced too high for their budget and in response select a different substitution fairly easily without much disruption or further action being required.
What factors impact supply and demand causing price volatility?
Many factors can influence supply and demand and subsequently prices in our economy. For instance we have seen many commodities undergo a drastic price increase after an increase in demand caused major supply shortages of items such as toliet paper, processed meat products, and hand sanitizer during the recent pandemic. Some common influcing factors to energy price volatility are...
Extreme Weather Conditions
Acts of nature such as tornados, hurricanes, and floods can causes damage and disruptions to the supply of the commodity and drive up prices. Price rates can also be influenced by an increase in demand due to extreme hot or cold weather conditions. Weather conditions that are more mild than usual can similarly result in a decrease in demand reducing the price rates.
The majority of the energy used today is generated from fossil fuels which provide the most inexpensive method of energy generation. When the market experiences a shortage of fossil fuels the decrease in the supply results in higher prices, and if there is a surplus in the supply it results in lower prices.
Economic growth leads to increased infrastructure and a higher demand for energy to power that infrastructure, and with that increased demand comes higher rates. Likewise, a poorly performing economy may experience a decrease in demand thus resulting in lower rates.