Notices

Spark spread

From Traderpedia

Definition:
In the energy markets, a long position in electrical power and short position in fuel (typically natural gas) that simulates the profit from operating a power plant (e.g., a gas turbine generator). The heat rate (q.v.) determines the size of the short position in fuel.


Example: Long one megawatt of forward power and short 10 million Btus of forward natural gas, indicating a heat rate of 10 MBtu/MwH. If the price of power went from $30 to $33 per MwH and the price of gas from $2.50 to $2.75 per MBtu, then the profit from the position would be $0.50 = $3.00 - 10 x $0.25 per MwH.

Application: A speculator might want to bet that operating a power plant with a specific heat rate during some period would be more profitable than others anticipate, so he might put on the spark spread in the futures markets.

Pricing: In the futures markets the initial value of a spark spread is zero, and one's daily profit is the change in the the obvious linear combination of futures prices over the trading day. In the forward markets the value of the spark spread is the present value of the linear combination of current forward prices, minus the present value of the linear combination of the forward prices at the time the trade went on.

Risk Management: The spark spread could be a tool for managing the risk of owning a power plant.