Commodity markets are often described in simple terms: prices are determined by supply and demand. But in reality, especially in energy markets like electricity and natural gas, the forces behind pricing are far more intricate. Prices are not set by a single entity or even a single group. Instead, they emerge from a dynamic interaction between physical infrastructure, financial incentives, and strategic decision-making by a diverse set of participants.
Few people understand this interplay as deeply as Neel Somani of Eclipse, a former Citadel quantitative researcher who specialized in power markets. His perspective highlights a critical truth: commodity prices are not just abstract numbers; they are the result of real-world decisions made by businesses operating within physical constraints.
The Core Players in Commodity Markets
At the center of energy markets are several key participants, each playing a distinct role in shaping prices:
Each of these groups both reacts to and influences price signals. But perhaps the most important—and often misunderstood—participant is the producer, particularly in electricity markets.
The Dual Role of Power Producers
Power plant operators occupy a unique position in commodity markets because they are both buyers and sellers.
Take a natural gas power plant as an example:
This dual role means that power producers are constantly balancing two interconnected commodity markets:
Their profitability depends on the spread between the two.
The Spark Spread
This relationship is often captured by a concept known as the spark spread, which represents the margin between the price of electricity and the cost of fuel required to generate it. If electricity prices rise while natural gas prices remain stable, the plant becomes more profitable. If gas prices spike or electricity prices fall, margins compress.
From Neel Somani’s perspective, this is where commodity markets become deeply interconnected. A change in natural gas pricing doesn’t just affect gas producers; it directly impacts electricity pricing because it changes which power plants are economically viable to run.
How Prices Are Actually Set
In electricity markets, prices are determined through a process known as economic dispatch.
Grid operators rank available generators from lowest to highest cost and dispatch them in order to meet demand:
The price of electricity is then set by the marginal generator, the last (and most expensive) unit needed to meet demand.
This is a critical insight: Even if most electricity is generated cheaply, the price is often set by the most expensive plant running at that moment. Neel Somani explains that this mechanism means that power producers, especially those operating marginal plants, play a direct role in setting market prices.
Natural Gas: The Hidden Driver
In many regions, natural gas is the marginal fuel, meaning gas-fired power plants frequently set the price of electricity.
As a result:
But the relationship is not one-way. Electricity demand can also influence gas demand, particularly during periods of high power consumption, such as heatwaves.
This creates a feedback loop between the two markets, where:
The Role of Traders and Financial Participants
While producers and consumers operate in the physical world, traders operate in both physical and financial markets.
Their roles include:
For example, a trader might:
Neel Somani’s background at Citadel involved building models that could simulate thousands of market scenarios, allowing traders to understand not just expected outcomes, but also the range of possible risks.
Importantly, traders don’t just react to prices, they help shape them by:
Utilities and Load-Serving Entities
Utilities and other load-serving entities (LSEs) are responsible for ensuring that electricity demand is met reliably.
They:
Unlike traders, utilities are less focused on profit maximization and more on:
However, their purchasing behavior still influences prices. Large-scale procurement decisions, especially long-term contracts, can shift demand patterns and impact market dynamics.
Industrial Consumers and Data Centers
Neel Somani of Eclipse explains that large industrial users are increasingly important players in energy markets.
These include:
In recent years, AI-driven data centers have emerged as a major new source of demand. Their energy consumption is:
This has begun to reshape pricing dynamics in certain regions, as demand growth outpaces infrastructure expansion.
From Somani’s perspective, this shift is one of the most important developments in modern energy markets. When large buyers are willing to pay a premium for reliable power, it can:
The Interaction That Sets Prices
Ultimately, commodity prices are not set by any single participant. They emerge from the interaction of all these players:
These interactions occur within a framework defined by:
The result is a system where prices are constantly evolving in response to both predictable patterns and unexpected shocks.
A System Governed by Both Physics and Finance
One of Neel Somani’s key insights is that energy markets sit at the intersection of physics and finance.
Unlike purely financial markets:
At the same time:
Understanding commodity pricing, therefore, requires thinking in both domains simultaneously.
Final Thought
So who really sets commodity prices?
The answer is not a single company, trader, or regulator. It is the collective outcome of decisions made by producers, consumers, and intermediaries, each operating within a system shaped by both physical realities and financial logic.
As Neel Somani’s work illustrates, the key to understanding these markets is not just knowing who the players are, but how their incentives align, and collide, in real time.
In an era where energy demand is being reshaped by technologies like AI, that understanding is becoming more important than ever.
