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Are We Making Any Money Yet?

Measures of generator unit performance are uncertain.

Fortnightly Magazine - February 2006

This affects spot-market electricity prices. While a high electricity price is always good if you are selling output of a wind project, it is not necessarily good (or as good) if you have a natural gas-fired generator. If natural gas prices are high, then the marginal natural gas-fired generator will not experience improved profitability from the commensurately higher spot-market electricity prices.

Global Energy forecasts spark spreads for all market areas. Figure 2 shows forecast monthly spark spreads for Entergy under Global Energy’s Fall 2005 forecast. For comparison, we also show spark spreads based on a 10,000 Btu/kWh heat rate.

Higher natural-gas prices generally result in higher spark spreads. This rule of thumb derives from the fact that in heavy load hours generators with lower efficiency in converting natural gas to electricity are dispatched. For example, in heavy load hours a simple-cycle gas turbine with a heat rate of 10,000 Btu/kWh could be called to meet load. As a result, spot-market prices during these hours will need to be high enough to cover the operating cost of the 10,000 Btu/kWh unit. So, if gas prices increase by $1/MMBTU, then spot-market prices during heavy load hours should increase by $10/MWh to cover the increased cost of the 10,000 Btu/kWh unit. However, the cost for a more efficient (7,000 Btu/kWh) combined- cycle gas plant only will increase by $7/MWh. Therefore, the spark spread for the 7,000 Btu/kWh heat rate combined-cycle unit will increase by $3/MWh under this scenario.

Forecast vs. Traded Spark Spreads

Spark spreads indicated by traders occasionally are higher than those developed from fundamentals-based energy price forecasts. Trader data allegedly is based on actual deals being made in power markets. Global Energy has attempted to verify the existence of actual trades behind trader-quoted numbers, but it often is difficult to get information that can validate that actual deals being made at these high spark-spread levels. It is possible that some small quantities are being bought and sold at these levels. However, there often does not appear to be a significant amount of volume in power transactions to make for reliable decision making.

It also is possible that long-dated trader spark-spread data are the mid-level of a “buy-sell” spread. The “buy-sell” spread is likely to be large in these outer years, and the asking (sell) price may be at a level to cover the full cost of a new generator (fixed and variable). If “asking” prices are at this level, the mid-level of a “buy-sell” spread may be artificially high. We believe the most reliable forecast is a fundamentals-based forecast assuming normal conditions, which might differ from what certain buyers and sellers are willing to trade at as a result of their respective concerns about future uncertainties.

Any number of factors can lead to differences between fundamental forecasts and forward prices. In particular, there may not be a liquid market for forward contracts between creditworthy parties. Where illiquidity exists, forward prices can be biased by relatively small-value transactions. Forward markets also reflect a perceived “risk premium” that is absent from our deterministic spot-price forecast.