Natural gas markets suffered an unprecedented crisis in 2022 and 2023 when Russia’s full-scale invasion of Ukraine was followed by a steep decline of piped gas deliveries to the European Union. The supply shock drove natural gas prices to all-time highs – necessitating painful readjustments in demand and leading to a profound reconfiguration of global flows of liquefied natural gas (LNG), which became a new baseload source of supply to Europe.

Global gas markets have moved towards a gradual rebalancing since the 2022/23 supply shock. However, while market tensions have moderated, the volatility of gas prices remains well above historical levels in both Europe and Asia.

Each time commodity prices surge or price volatility spikes, a debate emerges about whether the main driver is market fundamentals or sentiment and speculation. In recent years, it has been no different. Higher energy prices, together with heightened volatility, have put a spotlight on the financial players that play an increasingly important role in energy derivatives trading and supporting liquidity.

This commentary seeks to add context to the discussion. Speculation in derivatives markets is often seen by the broader public as a key driver of increased price variability. However, derivatives trading in gas markets today is dominated by players with physical involvement in the energy industry, such as companies producing, distributing or consuming gas. There are numerous structural factors that have contributed to higher gas price volatility in recent years. This analysis explores some of them and looks at options for managing volatility, which has repercussions for energy security and affordability.

Natural gas trading has expanded strongly in Europe, requiring more sophisticated risk management

Market reforms initiated by the European Commission in the early 2000s supported the development of active energy trading in Europe. Natural gas trading rose by more than tenfold in the last 20 years, with traded volumes reaching a record high of 7 300 billion cubic metres (bcm) in 2024, around 15 times higher than overall European gas demand. This strong growth was primarily supported by the surge in derivatives trading across a few mature hubs (primarily the Dutch TTF and the British NBP).

A derivative is essentially a financial contract whose price is based on the value of an underlying asset or commodity. The most common types of derivatives include futures, forwards, swaps and options. There is liquid trade of derivatives for energy commodities such as crude oil, natural gas, coal and electricity.

Derivatives are used for different purposes by different players. Physical players (such as producers, large end-consumers and midstreamers) typically use derivatives for risk management by hedging their physical positions. Meanwhile, trading houses and midstreamers aim to benefit from arbitrage opportunities across time and space, as well through cross-commodity spreads. Hedge funds, investment banks and other financial institutions generally use sophisticated trading strategies to benefit from short-term price movements.

Financial players often support stronger market liquidity, making it easier to buy and sell various assets. And they can serve as a counterparty for traditional actors with physical positions, making it easier for them to hedge their positions. Derivatives also enable price discovery, providing clear and frequent signals on how market participants are assessing current and future conditions.

Structural changes have fostered stronger natural gas price volatility

Natural gas price volatility in Europe rose to an all-time high in 2022 amid the supply shock induced by the steep decline in Russian piped gas deliveries. And while price volatility has moderated from its 2022 and 2023 highs, it remains elevated. In 2024, it was 50% above the average seen between 2010 and 2019. Similarly, in Asia, the volatility of spot LNG prices in 2024 remained 90% above the average between 2010 and 2019.

Several structural drivers have underpinned higher price volatility. They include:

• Closer links between gas and electricity markets: Across Europe, countries have committed to phasing out coal, though their timelines vary. Since nuclear power usually runs at full capacity (or close to it), and wind and solar output can vary according to weather conditions, this leaves gas as a key source of electricity generation for balancing supply and demand in many markets1 – creating a strong link between gas and electricity markets. Gas-fired power generators often meet marginal electricity demand while setting day-ahead wholesale power prices in competitive markets. Additionally, as the share of weather-dependent electricity sources in Europe’s electricity mix rises rapidly, there is greater sensitivity to events such as droughts and periods of low wind, during which higher gas generation often offsets lower power supply. These variations increase the overall volatility of gas-to-power demand. In the United Kingdom, for instance, the volatility of gas-fired power generation rose from just over 400% in 2017 to more than 800% in 2024. This variability has translated to higher short-term volatility in natural gas prices. At the same, the relationship between gas and electricity markets is of course two way: high volatility in natural gas markets often carries over into electricity markets, as was seen in 2022 and 2023 following Russia’s sharp curtailment of gas supplies to Europe.
• The globalisation of natural gas markets: Regional natural gas markets around the world are becoming increasingly interlinked through LNG, which unlike pipeline gas can be shipped to a range of destinations. This means the supply and demand dynamics (and resulting price volatility) of one region can influence gas prices in other, more distant markets as they compete for LNG supply. This is well demonstrated by the evolving correlation between benchmark TTF prices in Europe and JKM prices in Asia, which rose from an average of 60% between 2013 and 2018 to over 90% since 2019, reaching an all-time high of 95% in 2024. This strengthening correlation coincides with the rapid ramp-up of US LNG production, which is underpinned by destination-flexible contracts and today accounts for just over 20% of global LNG trade

Geopolitical complexity: Geopolitical tensions can have profound implications for commodity markets, potentially augmenting volatility. This has been particularly visible in natural gas markets in recent years. Before its full-scale invasion of Ukraine, Russia was the world’s largest natural gas exporter, with most flows heading to Europe. The steep decline in Russian piped gas deliveries to the European Union after the invasion had a major impact on import-dependent markets in both Europe and Asia. Today, these regions remain dependent on imports of natural gas, though increasingly in the form of LNG.

The growing complexity of gas trading: Another potential driver of volatility is algorithmic trading, or the process by which computer algorithms determine trading parameters such as price, quantity and whether to initiate orders with limited or no human intervention. The automation of certain trading processes through algorithms could be contributing to stronger volatility patterns and can amplify market movements in both natural gas and electricity markets. The use of algorithms is expected to expand further in the coming years. The practice allows for the rapid balancing of positions, which is increasingly necessary as the share of variable renewables in power

The growing volatility of European gas markets is naturally attracting financial players who wish to benefit from short-term price movements and often act as counterparties for market participants with physical positions. However, financial players still accounted for less than 40% of the total TTF volumes traded in 2024. While these players can contribute to volatility, they are distinct from the structural drivers identified above.

There are tools to mitigate gas price volatility, protecting both buyers and sellers

Generally speaking, producers and consumers prefer greater price stability in markets than we see today, since it allows them to better plan for the future. Should volatility persist, however, there a variety of strategies and tools available to manage the associated risks. Diversification across portfolios is a fundamental pillar. Indeed, there are a variety of derivatives that can hedge expectations for future production or consumption. Risk-aware market players can also mitigate the prevailing gas price volatility through the conclusion of long-term contracts. Additionally, pricing formulae in natural gas sales contracts can ease short-term price variability through mechanisms such as reference periods, damping, price corridors and hybrid indexations.

Long-term contracts, together with domestic gas production, typically accounted for 80-90% of the European Union’s natural gas consumption before the 2022 crisis. In the past two years, that share has dropped to around 50%. If no new contracts are signed and existing ones are not renewed, the share of spot gas and flexible LNG in total EU gas supply could increase to around two-thirds by 2030, which could increase exposure to short-term price volatility.

Against this backdrop, it is necessary to strike a fine balance between long-term contracts and spot procurements. Strengthening transatlantic LNG partnerships, including through long-term contracts, could also reduce Europe’s exposure to price fluctuations and deliver benefits to economies on both sides of the Atlantic.
Source: IEA