Physical Foundations of Energy Commodities

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Energy trading isn't like equities or currencies - you can't just settle positions in cash when things go wrong. When you trade gas or power, someone must physically deliver it through a pipe or a wire. Understanding the physical infrastructure and operational constraints beneath energy markets is what separates energy traders from other commodity traders.

This guide starts with electricity's most extreme constraint: instant balance. The UK grid operates at 50 Hz, and supply must match demand within milliseconds - not minutes, not hours. You'll learn why this non-negotiable requirement drives everything else in power markets: the role of system operators like NESO, the Balancing Mechanism, and why imbalance charges during system stress can wipe out a week's profits from a single bad forecast.

You'll see how gas markets work differently - shippers manage their own portfolios because gas storage provides a buffer measured in hours or days, not milliseconds.

The guide then builds the merit order dispatch stack: how NESO ranks every generator from cheapest (wind at £0/MW) to most expensive (peaker plants) and dispatches them in order until demand is met.

You'll understand why the marginal plant sets the clearing price everyone receives, why demand follows predictable 24-hour patterns (overnight troughs, morning ramps, evening peaks), and how seasonal variation creates 10-15 GW swings between summer and winter.

Most importantly, you'll learn why gas-fired plants are usually marginal price-setters in the UK. Wind and nuclear sit at the bottom of the stack (low or zero fuel costs), but their combined capacity rarely meets peak demand. Modern CCGTs fill the gap, and when demand pushes into the upper reaches of the stack - old, less efficient CCGTs or open-cycle peakers - prices spike. This is the foundation for understanding spark spreads: the economics of when gas plants are profitable to run.

You'll also see how physical constraints create trading opportunities. Interconnector capacity limits prevent arbitrage between connected markets. Pipeline constraints trap gas in the wrong location. Grid frequency violations trigger automatic disconnections. Scottish wind farms get paid to turn off because transmission lines can't carry all their output south. These aren't software bugs - they're physics.

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How This Fits the Curriculum

This guide is the foundation. Every subsequent topic - gas shipping, storage arbitrage, spark spreads, position management - builds on the concepts introduced here. You'll return to merit order pricing when learning spark spreads (which plants run, and why), to system operators when understanding imbalance risk, and to physical constraints when trading cross-border flows. Without this foundation, later material becomes a collection of formulas without context.

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Prerequisites

No prior energy market knowledge required. Basic understanding of supply/demand economics helpful but not essential.

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Mastery Tip

Revisit sections 3 and 5 after completing the Spark Spread guide. Merit order dispatch and marginal pricing will make more intuitive sense once you've worked through real spark spread calculations and seen how generation economics determine which plants set the clearing price.

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