2005 proved to be a volatile year. Volatility in June broke all barriers with the single largest fall in a lqiuid product of £17/MWh in a day. This volatility has been caused by a general feeling of uncertaintity within the market. Fundamentally players are not sure whether demand will be met by supply. Gas market prices have drifted up in the latter half of the year with a squeeze caused by cold weather and European supply problems. Gas and power have become more correlated there are two key reasons for this one is the growth in the emissions markets which tend to drive correlation between gas and power.

The dependency on which fuel to burn is now primarily dominated by the cost of emissions. Therefore a rise in emissions prices drives the market to push gas prices up. The other key driver is the risk associated with holding one position in one product is so great even for a trading house with such high volatilities that position are being hedged against each other. This means that power traders are being asked to trade the spread where the volatility is less and the risk of the market moving against a position is decreased. The theory being that a rise in gas prices will see a rise in power prices, and so if you are short power in the spark spread you will be long the gas and so lose on one leg but gain on the other.

This year saw the growth of independent power producers, with Drax Group and British Energy both refloating on the stock exchange. The world of falling prices close to fuel parity which originally drove these companies into their financial difficulties, reversed and it was the suppliers who were under duress. Some of the small ones sold out or went bust, but others have had to raise cash quickly to make the margin calls required. Large vertical players have had some hits on their supply balance sheets, with consistent price rises throughout the year and more to come in 2006.

Perhaps the biggest lesson learnt is that players have started to understand that risk management is key to development of the market and growth of power purchasing. Flexible products are becoming the norm and whilst some recognise that this is the way forward, others also see that it can have its downsides when risk is not fully accounted for.