Similar to the Crack and Frac spreads, the spark spread has developed in the electricity markets.
In the United States there are two organization responsible for electricity markets, regional transmission organization (RTO) and independent system operator (ISO). RTO covers a larger area than ISO while ISO usually operates within a single state.
Major ISOs within North America:
Electric reliability council of Texas (ERCOT),
California independent system operator (CAISO),
New York independent system operator (NYISO),
Midwest independent system operator (MISO)
ISO New England (ISO-NE)
Some well-known RTOs are:
Pennsylvania-New Jersey-Maryland (PJM)
Midwest independent transmission system operator (MISO)
Southwest Power Pool (SPP)
ISO New England (ISONE)
Electricity spot market prices are very volatile due to non-storability entailing the necessary balancing of demand and supply. Demand is an inelastic function of price, supply may also change abruptly causing volatility on the market.
Electricity can be generated by fuels such as heating oil, gas and coal and is driven by the price of these commodities.
Natural gas has been the fuel for electric power generation in the past years due to low gas prices.
The spark spread is the simultaneous purchase and sale of electricity and natural gas futures contracts. In other words, it is the difference between the price received for electricity produced and the cost of natural gas used to produce the electricity.
The profitability of a power plant is estimated by spark spread. In case if the spark spread is positive the price of the electricity is higher than the gas used so the spread is profitable. Negative spread means that the cost of gas higher than the price of electricity and therefore it is not profitable to operate the plant.
There are three major types of spark spread ($/MWh):
1. US spark = Electricity price($/MWh) – Natural Gas($/mmBtu) * Heat Rate(mmBtu/MWh)
2. Dirty Spark (EU) = Electricity price($/MWh) – Coal ($/MWh)/ Efficiency (%)
Dirty spark spread is also known as the dark spread. A dark spread is the difference between the price received for electricity produced and the cost of coal needed to produce the electricity.
3. Clean Spark = Dirty Spark($/MWh) – (emission rate(tCO2/MWh)*emission price ($/tCO2))
There are other variable costs as operation and maintenance (O&M) that are not included in the formulas above.
As can be seen, the cost of gas and coal and emission prices indicates when it is economically to switch from coal to natural gas or vice versa.
There is also one more vital component in the formula above, namely Heat Rate. Heat rate is a thermal efficiency of a power plant to convert gas into electricity, i.e. how many KWh of electricity is received from a given amount of natural gas. It accounts for all the electricity a power plant consumes to operate the generators and other equipment.
This rate is used in order to determine a quantity of forward contracts to purchase gas in order to capture the margin successfully. Usually a benchmark heat rate is 7 000, 8500, 10 000 and 12 000 Btu/KWh. The efficiency of a generator can be determined by dividing 3 412 Btu (which is equal to 1 KWh) by the heat rate. For example, if the heat rate is 7 000 Btu/KWh the efficiency is 3 412 / 7 000 = 49%.
Electricity price is divided into two different categories, on-peak and off-peak. On-peak characterized by high electricity demand, off-peak demand is low thus the lowest price per KWh is set.
The chart below represents NYISO Zone J monthly based peak swap futures with contract size of 400 MWh. As it follows from contract specification, the Floating Price will be equal to the arithmetic average of the hourly day ahead Locational Based Marginal Prices (LBMP) for Zone J published by the New York Independent System Operator (NYISO) for all peak hours in the contract month.
Spark spread quotes are available in the Excel file.
Tolling agreement is the practice of operating a power generation plant for a fee under a contract to another party who provides the gas input and sells output electricity. The tolling fee can be in a form of a fixed monthly payment or as a tolling charge for each MWh. The agreement itself shell include Minimum/Maximum available capacity, heat rate and tolling fee as well.