Spreading Value, Part 2: How Market Fundamentals Change the Calculation
This column previously summarized industry terms that could be used to describe electricity industry economics ...
by Tanya Bodell, Energyzt
This column previously summarized industry terms that could be used to describe electricity industry economics under then-anticipated environmental policy (Electric Light & Power Volume 87, Issue 4). Spark spreads made way for clean spark spreads, and dark spreads became dark green spreads in a carbon-constrained world. Changing market fundamentals have created the need for new definitions.
Spark spreads are the difference between the price of electricity and the price of gas converted to electricity price units using an assumed heat rate (e.g., 7,000 British thermal units (Btu) per kilowatt-hour (kWh)) and represent natural gas-fired generation energy margins.
Dark spreads are to coal plants as spark spreads are to natural gas-fired power plants, representing the difference between the price of electricity and the price of coal converted to electricity price units using an assumed heat rate (e.g., 10,000 Btu/kWh).
Bed spreads represent the dark spread minus the spark spread, equivalent to the price of gas converted to electricity prices using a baseload combined-cycle heat rate and the price of coal converted to electricity price units. Until recently, the marginal cost for coal-fired power generation was lower than the marginal cost of gas-fired generation, resulting in positive bed spreads. Bed spreads have declined in most markets and are negative in some. Negative bed spreads indicate that coal plants no longer can operate profitably as 24/7 baseload generation. Their mid-merit position increasingly is setting the price for power during on-peak hours.
The difference between on-peak and off-peak power prices is the head spread. Seasonal periods of high power demand increase the head spread as more expensive units dispatch to meet load. Shoulder months generally have lower head spreads. Declining gas prices further compress the head spread, which has been mitigated by price-setting coal units.
Bed Head Spreads
As natural gas prices continue to fall, natural gas-fired peaker plants become less expensive to operate than coal-fired units. This situation is reflected in bed head spreads, the difference between the price of natural gas converted to electricity units using a peaker heat rate (e.g., 11,000 Btu/kWh) and the price of coal converted into electricity. If bed head spreads are low enough, gas-fired peaker plants could become the next baseload generation resource.
Negative bed spreads and bed head spreads stress the economics and operations of coal plants. Given the new peaker position of coal plants and multi-day dispatch decision due to operational inflexibility of coal-fired boilers, a new term is required to describe the economic decision of whether a coal plant should operate.
A deadhead spread is the weighted average of the dark spread during on-peak hours plus the dark spread during off-peak hours over a specified time. If a coal plant operates at a loss during off-peak hours but can cover those negative margins by producing during consecutive on-peak hours, the deadhead spread is positive and the plant should operate. Anticipation of a negative deadhead spread implies the coal plant should shut down. If the deadhead spread is positive but insufficient to cover anticipated fixed costs over the long run, it might be time to mothball or retire the plant.
Whether you want to think of this new definition as 1) a nod to fans of the Grateful Dead; 2) reference to deadheading (a term used when airline employees travel free of charge but are not working; or 3) allusion to when trains hauled cattle (and were paid for carrying the live stock and not the “dead heads”), deadhead spreads are the new dispatch decision.
Energy markets have challenged the traditional merit order of power generation, changing the nature of power plant operating decisions. Impacts are particularly dramatic for coal plants, which have lost the security of their inframarginal position and associated energy margins. Although this transition in market fundamentals eventually will work itself out as coal plants exit the supply curve and natural gas prices recover, it pays to understand the new economic realities of dispatch decisions.
Mathematical Definitions ($/MWh)
Spark spread = Pelectricity – Pgas * HRCC
Dark spread = Pelectricity – Pcoal * HRST
Bed spread = Pgas * HRCC - Pcoal * HRST
Head spread = Ppeak – P off-peak
Bed head spread = Pgas * HRCT – Pcoal * HRST
Deadhead spread = (Tpeak /Ttotal) * Ppeak + (Toff-peak /Ttotal) * Poff-peak – Pcoal * HRST
Pcommodity = Price of the identified commodity
HRunit = Heat rate of the referenced generating unit
Tperiod = Number of hours in time period of interest
Tanya Bodell is executive director of Energyzt, a collaboration of energy experts intent on understanding the impacts of energy integration. Reach her at 617-416-0651 or email@example.com.
“Lately it occurs to me what a long, strange trip it’s been.” —“Truckin’” by the Grateful Dead