Supply and demand determinants of natural gas price volatility in the U.K.: A vector autoregression approach

Abstract

Since 2008, the U.K. natural gas market has witnessed a marked drop in volatility. This fall has coincided with specific events in oil and gas sector such as the onset of the U.S. "shale gas revolution" and the subsequent rerouting of liquefied natural gas (LNG) shipments from the U.S. to other markets such as Asia and Europe. LNG cargoes, along with other sources of flexibility such as underground storages and interconnector import, can potentially reduce volatility. On the other hand, demand shocks can increase volatility. To examine the dynamics relationship between daily shocks in U.K. gas demand and supply, and the gas spot price volatility, we use a vector autoregressive (VAR) model. While we find evidence that daily deviations in aggregated gas demand significantly impacts volatility, we are unable to find direct evidence for an impact from shocks in disaggregated demand or supply. In fact, one important contribution of the paper is to suggest that flexible sources of supply such as LNG, storage and interconnector flows react to shocks in retail demand, dampening their potential effects on volatility.

Price and Volatility Spillovers Between Crude Oil and Natural Gas Markets in Europe and Japan-Korea

“…Our results comply with Dahl et al (2011) who suggest that there is no causal relationship between Brent and NBP prices. Further, the results give support to Misund and Oglend's (2016) view that the UK gas system is endowed with interconnections, which mitigate potential deviations. The market design additionally enhances the hard equipment of the market.…”

“…Geng et al (2016b) add that both West Texas Intermediate and Brent prices heavily influenced Henry hub and NBP prices respectively, but this kind of condition altered due to the shale gas revolution when European gas markets remain coupled to oil volatility. Misund and Oglend (2016) suggest that the UK gas system has mitigating mechanisms like flexible assets such as interconnection and storages which smooth effects from deviations in a single demand or supply variable. They also add that spot contracts influence volatility more than long-term ones, while the UK gas volatility's decrease can be attributed to the decreased gas demand.…”

An assessment of OPEC's strategy and market factors on crude oil pricing

“…We agree with Dahl et al (2011) who suggest that there are no spillovers between Brent and NBP prices. Our results strengthen Misund and Oglend's (2016) suggestion that the UK gas system is endowed with interconnections which mute causal relationships. The efficient market design supplements the hard infrastructure of the market.…”

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“…Sims [53] introduced a popular VAR model to econometrics in 1980, and the VAR model has been widely used since then [54,55]. In the VAR model, endogenous variables were used to regress the lag value of each variable in the system for studying the dynamic relationship between these system variables and the endogenous variables.…”