The volatility for natural gas has increased substantially with the overall decline in the price level. The change in volatility is related to the strong structural changes in the natural gas market. The shale gas development from fracking as pushed significant new supply into the market which has lowered prices, but the cause of the increase in volatility is associated with the demand side of the equation.
As the price of natural gas has fallen, it has become more of a close substitute for coal. The elasticity of demand has increased because the price for switching between energy sources has become more operational. Lowering of gas prices will increase gas demand and switch off coal usage. An increase in price will lead to switching back to coal. Hence, if there is a demand shock that will increase power usage small changes in price will lead to larger changes in demand.
We expect that coal - gas switching prices will con tune to cause high volatility in gas prices for the foreseeable future. Volatility may decline but the overall level will stay higher than what was seen in past periods and the volatility of volatility will stay high with spikes in volatility associated with demand or weather shocks.
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