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Forward Spreads on the
German Power Market
Electricity is not just about fuel ...
By Franck Schuttelaar
A
pproximately 55% of the electricity generated in The practical verification of this theoretical principle proves
Europe comes from thermal power plants burning relatively complex. First, there is always uncertainty with
coal, gas or refined products. The cost of fossil fuels regard to the type of plant which constitutes the marginal
therefore plays a significant role in electricity price formation. resource at any given time, particularly if the generating fleet
Tosuchanextentthat–schematically–theanalysisofmarket is diversified – as in Germany for example. Second, the price
electricity prices is often reduced to a consideration of two formulas, the characteristics of the plants and the target
distinct sets of factors. margins adopted by each operator in its arbitrage decisions
On the one hand, a more or less substantial part of the remainopaquetosomeextent.Themarketreferencesareonly
electricity price can be seen as directly linked to the value of an average snapshot of the costs of fuels, an imperfect
the fuels used to generate it. Naturally, the link between fuel reflection of the diversity of situations which generators face.
and electricity prices will be all the Nevertheless, operators in the
stronger if a substantial part of the
... over the long-term the
electricity market still keep an eye on
production in the market in question
comes from thermal power plants using
market should value
these indicators of differentials between
electricityandfuelpricesandmayadopt
fuels with a market value, such as coal,
marginal generating assets
a position in the market based on the
gas or refined products. Conversely, if at their fair price level of these spreads, to such an extent
the electricity comes mostly from plants that they can be interpreted as the
whose generating costs are relatively independent of a market’s view of the future physical supply situation in the
commodity market, such as nuclear, lignite, hydro or wind electricity system. High margins on conventional thermal
plants, its price will probably show less sensitivity to the value generating resources consequently tend to mean that the
of fuels or CO
2
. system is slightly undersupplied; conversely, low margins tend
In addition to the part linked to fuels, the electricity price to indicate an oversupplied market.
should reflect the level of scarcity of electricity as a resource in Fromthisperspective,itmaybeusefultoassesstheaccuracy
the market in question. As a function of the differential of forward spread levels in the electricity market – in other
between electricity and fuel prices, generators will be able to wordstotrytodetermine,regardlessofthetrendinfuelprices,
cover a more or less significant part of their operating, whether the market is correctly anticipating the future
maintenance and investment costs, and that will tend to drive situation of the spot electricity system.
their decisions on whether to sell their production, invest in
new plants or, conversely, shut down their assets for a certain It is True That ‘The Market is Always Right’…
period of time. But only at a Given Time
Thedifferentialbetweentheelectricitypriceandthefuelcost Far be it for us to cast doubt on the famous maxim that ‘the
is known in the jargon as the ‘spread’. The spark spread is the market is always right’. A price – or spread – set freely by a
difference between the price of electricity and the cost of the supply/demandbalanceinaliquidmarketisprobablythebest
gas used to generate it. The clean spark spread is the spark reflection of the collective knowledge of all the operators at a
spreadminusthevalueoftheCO
2
emittedbythepowerplant. particular time. No one can claim, at any given time, to have
Similarly, the dark spread and the clean dark spread represent a better knowledge than the market operators as a whole of
the difference between electricity and coal, with or without the what the value of a resource should be – or what the spreads
inclusion of CO
2
. should be in the case of the electricity market.
Butthisobservation,whichisvalidatagiventime,doesnot
Margins Sometimes More Relevant Market Signals necessarily imply that the view prevailing at that particular
Than Absolute Level of Electricity Prices time is a correct anticipation of the situation that will
In fairly theoretical terms, these spreads should not deviate ultimately arise in the spot market; nor, moreover, that such
for long from a level allowing reasonable remuneration for anticipation will not subsequently change. On the contrary, it
generators with marginal power plants. In other words, over is very likely that the price will be different at each moment.
the long-term the market should value marginal generating Consequently, it is not irrational for an operator in the
assets at their fair price taking into account the trend in fuel electricity market to have an opinion on the future level of
prices. spreads, i.e. to try to gauge the way in which collective
54 worldPower 2009
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