Energy Markets and Price Fundamentals
Market fundamentals
Energy prices are built from marginal cost and scarcity, not average cost. In electricity, the merit order stacks generators by variable cost; the clearing price is set by the marginal unit, so a small demand or supply shift can move prices sharply. Natural gas and fuels trade on their own supply-demand balances, storage, weather, LNG flows, and pipeline constraints, and they feed power prices through the heat rate. Understand units: gas in $/MMBtu, power in $/MWh, capacity in $/kW-day or $/kW-month, and heat rate in Btu/kWh. A common trap is mixing energy and capacity: a capacity payment reserves availability, while an energy payment compensates delivered MWh. Another trap is reversing a heat-rate conversion. Remember 1 MMBtu/MWh equals 1,000 Btu/kWh.
Worked example: a gas unit has a heat rate of 8,000 Btu/kWh, gas costs $3.00/MMBtu, variable O&M is $5/MWh, and carbon cost is $0. Fuel cost is 8 MMBtu/MWh × $3.00 = $24/MWh; add O&M to get $29/MWh. If gas rises to $4.00, fuel cost becomes $32/MWh and the unit's offer rises by $8/MWh. The spark spread is power price minus fuel cost, and in practice minus variable O&M and carbon. Basis-the difference between a local delivery point and a benchmark hub-can dominate the price at constrained locations. Seasonality, weather, outage schedules, storage levels, and transmission congestion are recurring drivers. Questions often confuse cause and effect: cold weather raises gas demand for heating and can raise power demand, but the price effect depends on supply, storage, and infrastructure. Rule of thumb: build the marginal cost stack first, then add basis, capacity, and policy costs; never compare a hub price with a delivered price without adjusting for basis and losses.