Spark Spreads
The spark spread represents the theoretical margin for a power plant. If a spark spread is a positive number, then the price of the power is higher than that of the fuel and the spread is profitable. If the spread is a negative number, the power is priced at less than the cost of fuel and is not profitable. The spread can be determined using the natural gas, coal, or heating oil futures contracts with the Exchange's cleared over-the-counter electricity contracts which are 400 Mwh each.
Because the natural gas, coal, and heating oil futures contracts and the OTC electricity contracts differ in size, the appropriate hedge ratio of electricity to fuel must be determined to capture the margin successfully.
Hedge Ratio
The heat rate of the generating plant is the number of Btus needed to generate one kilowatt hour of electricity. A heat rate of 8,000, for example, means it requires 8,000 Btus to generate one kilowatt hour. The heat rate in this example can be simplified
by multiplying the per million Btu price of fuel by eight to equate one million Btus of fuel to one Mwh.
Once the hedge ratio is determined, the spark spread can be calculated:
Spark Spread
| (400 Mwh x peak days in a month) | |
| X | Price per megawatt hour |
| minus | (Fuel price per mmBtus x mmBtus per contract ) |
| X | Hedge Ratio |
| divided by | (400 Mwh x peak days in a month) |
| Calculate | |
| = | Spark spread $ /Mwh |
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