[BETA] Fortnightly

As this article goes to press, the news is full of stories about Calpine and the difficulty merchant generation players face from the uncertainty and volatility of power markets.

With that in mind, now is a good time to review key measures of performance and profitability under uncertain conditions.

Market Heat-Rate Analysis

One method of determining the gross margin (total revenue minus cost of inputs) available to generators involves using electricity and natural-gas prices to derive the market heat rate. This is calculated by dividing the forecast electricity price by the forecast natural-gas price at the burner-tip. ¹ This normalizes the electricity price forecast relative to the natural-gas price forecast and allows one to observe trends in the long-term electricity price forecast that are independent of changes in natural-gas prices.

An increasing market heat rate corresponds to an increasing gross margin for gas-fired electricity producers. A rising market heat rate provides some information on the actual heat rate of the unit on the margin, but also includes the price impact of generators bidding higher than variable costs during periods of relative supply scarcity.

Figure 1 presents the market heat rates implicit in Global Energy’s current electricity price forecast for Entergy, based on monthly on-peak and off-peak electricity prices. The monthly pattern in market heat rates illustrates the uplift in summer prices, which is due to the higher percentage of time that electricity is generated using natural gas, and the generally higher (less efficient) heat rates of the equipment setting these prices. This also reflects the premiums generators are able to capture during periods of relative scarcity. These market heat rates increase during the first 10 years because of a declining reserve margin as the overbuild subsides and the growing percentage of time that natural gas is marginal.

Spark-Spread Analysis

For those interested in natural gas-fired generation, it is customary to describe an energy price forecast in terms of a “spark spread.” Spark spread is an indication of the profit per megawatt-hour that a gas-fired generator might expect under a particular energy price forecast. This term (spark spread) is generally used for new, highly efficient natural gas-fired generation, such as combined-cycle gas-fired capacity, and in relationship to heavy load (peak load) electricity prices, rather than all hours of the year.

These new, highly efficient gas-fired generators will use approximately 7,000 Btu of natural gas to generate 1 kWh of electricity. Therefore, spark spreads often are quoted in the trade press as being the spot-market price (during heavy load hours for a month) for 1 kWh of electricity less the cost of natural gas incurred in a 7,000 Btu/kWh generator.

In the Southeast, for example, natural gas-fired generation is “on the margin” frequently.