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Managing Risk at CME Group - How it All Works
A great and yet very simple introduction to the vital role CME Group plays in helping people manage their risk on a daily basis....
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Spark Spreads
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.
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
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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