Wholesale Market Volatility: Hedging, Risk, and Opportunity

Introduction

The GB energy market has always been exposed to the ebb and flow of global commodity prices, but the volatility seen in 2021–2022 has been unprecedented. Wholesale price spikes have tested the resilience of suppliers, exposed weaknesses in risk management, and forced a re-examination of hedging strategies. Yet, volatility also brings opportunity—for those able to manage risk, innovate, and adapt. In this article, I’ll explore the causes and consequences of wholesale market volatility, the tools and strategies used to hedge risk, and the new opportunities emerging in a more dynamic market.

The Nature of Wholesale Market Volatility

What Drives Volatility?

Global Gas Prices: The UK’s reliance on gas-fired generation means that global gas market shocks—such as those seen in 2021—directly impact electricity prices.
Weather and Renewables: Variability in wind and solar output can cause rapid swings in supply, especially as renewables’ share grows.
Interconnector Flows: Cross-border trading with Europe can buffer or amplify price movements, depending on market conditions.
Policy and Regulation: Changes in carbon pricing, capacity market rules, or network charges can all affect wholesale prices.

For a real-time view, see Elexon: System Prices and National Grid ESO: Energy Data.

The Impact on Suppliers

Cost Exposure

Suppliers buy energy in the wholesale market and sell to consumers at fixed or variable tariffs. When wholesale prices rise sharply, suppliers who have not hedged their purchases in advance may be forced to sell at a loss—sometimes a catastrophic one.

The 2021–22 Crisis

The surge in wholesale prices during 2021–22 led to the collapse of over 25 suppliers, many of whom lacked robust hedging strategies (Ofgem: Supplier Exits). The price cap, while protecting consumers, limited suppliers’ ability to pass on costs, compounding the risk.

Hedging: Tools and Strategies

What is Hedging?

Hedging is the practice of locking in future prices to protect against adverse market movements. In the energy sector, this typically involves buying forward contracts, futures, or options.

Common Hedging Instruments

Bilateral Contracts: Direct agreements between generators and suppliers for future delivery at a fixed price.
Power Purchase Agreements (PPAs): Long-term contracts, often used for renewables, providing price certainty for both parties.
Exchange-Traded Futures: Standardised contracts traded on exchanges like ICE Endex or EEX.
Options: Contracts that give the right, but not the obligation, to buy or sell at a set price.

Hedging Horizons

Short-Term: Days to months ahead, often used for balancing and fine-tuning positions.
Long-Term: Years ahead, providing stability for investment and tariff setting.

Risk Management Practices

Portfolio Diversification: Spreading risk across different contract types, time horizons, and counterparties.
Stress Testing: Modelling the impact of extreme price movements on financial health.
Credit Risk Management: Assessing the risk of counterparty default, especially in volatile markets.

For more, see Ofgem: Wholesale Market Risk Management.

Opportunities in a Volatile Market

Flexible Generation and Storage

Volatility creates opportunities for flexible assets—such as gas peakers, batteries, and demand-side response—to capture value by responding to price signals. The Balancing Mechanism and ancillary service markets reward those able to ramp up or down quickly (National Grid ESO: Balancing Services).

Innovative Tariffs

Suppliers like Octopus Energy and OVO have launched time-of-use and dynamic tariffs, passing wholesale price signals through to consumers. This encourages demand shifting and can reduce costs for flexible customers (Octopus Energy: Agile Tariff).

Corporate PPAs

Large energy users are increasingly signing direct PPAs with renewable generators, locking in long-term prices and supporting new investment (RE-Source Platform: Corporate PPAs).

Case Study: The Role of Hedging in Supplier Survival

During the 2021–22 crisis, suppliers with robust hedging strategies—such as the “Big Six” and well-capitalised independents—were able to weather the storm, while those with limited or speculative positions failed. This has prompted Ofgem to tighten financial resilience and risk management requirements for all suppliers (Ofgem: Supplier Licensing Review).

Challenges and Risks

Market Liquidity

Periods of extreme volatility can reduce market liquidity, making it harder to execute hedges at reasonable prices. Smaller suppliers may face higher costs or be unable to access certain products.

Regulatory Uncertainty

Frequent changes to market rules, price caps, or support schemes can complicate risk management and deter investment.

Counterparty Risk

As more participants enter the market, the risk of counterparty default increases—especially during periods of stress.

The Future: Digitalisation and Advanced Risk Management

Data and Analytics

Advanced analytics, real-time data, and digital trading platforms are transforming risk management. Suppliers and traders can now model scenarios, optimise portfolios, and respond to market signals faster than ever.

Blockchain and Smart Contracts

Emerging technologies like blockchain are being piloted for peer-to-peer trading and automated settlement, potentially reducing transaction costs and increasing transparency (Elexon: Innovation).

Regulatory Evolution

Ofgem and BEIS are reviewing market design to ensure that risk is allocated efficiently and that the system remains resilient as volatility increases (BEIS: Review of Electricity Market Arrangements).

Lessons Learned

Hedging is Essential: Robust risk management is non-negotiable in a volatile market.
Flexibility is Valuable: Assets and business models that can respond to price signals are well-positioned to thrive.
Innovation is Accelerating: New products, services, and technologies are emerging to help manage risk and capture opportunity.

Conclusion

Wholesale market volatility is both a challenge and an opportunity for the GB energy sector. Suppliers, generators, and consumers must adapt to a more dynamic environment, embracing robust risk management and innovative solutions. As the market evolves, those able to hedge effectively, respond flexibly, and innovate will be best placed to succeed.

References: