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Dr. Ken Rietz |
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This month’s commentary will be a bit different. We will introduce you to three closely-knit spreads which are also tightly connected to the spark spread that I covered in a previous commentary. If you remember, the spark spread is the difference in price between the cost of electricity and the cost of the natural gas it would take to generate it. The first spread I cover is called the dark spread, and it represents the difference in the cost of electricity and the cost of the coal needed to generate it. (The intention is that spark and dark rhyme. There are two other spreads which are the quark spread for nuclear-powered generation and the bark spread for biomass generated electricity. Those are more whimsical than useful; we do not cover them here.) There is, however, an immediate hesitation regarding coal-generated electricity, and that is coal’s reputation for being highly polluting. However, especially in the EU, is possible to purchase offsets for carbon pollution. This can be incorporated into the dark spread, giving what is called the clean dark spread (or sometimes the dark green spread) by incorporating the cost of its carbon emissions. But natural gas also produces carbon dioxide, and it is only fair to require offsetting its carbon also, giving what is called the clean spark spread. So, this month we will cover both the dark spread and the clean spark spread. There are factors dealing with the dark spread that make it more complicated than the spark spread. Coal for electricity is usually purchased in long-term contracts, and therefore is somewhat cheaper than what is available to retail customers. Coal- fired generators operate most efficiently when running continuously, and thus make good baseload generators. But this means that they generate electricity at peak load prices as well as off-peak prices. Additionally, the transportation cost of coal needs to be factored in. There are also some factors that affect equally coal and natural gas that have not been brought up, such as finance charges, operational and maintenance costs, and taxes. These make comparisons between coal and natural gas general rather than precise until you get down to the very details of such costs. Other factors arise such as currency valuations only complicate calculations further. The formula for clean spreads is similar in all cases. Clean spread = Pelectricity − [Pfuel/TEfuel + PCO2 × EMCO2 ]
where Pelectricity is the price of 1 MWh i(megawatt hour) of electricity, Pfuel is the price of the fuel (natural gas or coal), TEfuel is the thermal efficiency of the fuel, PCOs is the price of the offset for 1 ton of CO2, and EMCO2 is the emission of CO2 per MWh of electricity produced. The cost of the offset varies a lot. In the US, there is no government-imposed charge, much to the frustration of environmentalists. In the EU, however, this is a quantity that is set but changes a lot. Here is a graph of the cost of the EU’s carbon permits. |
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Figure 1: EU carbon permit prices in euros per metric ton The degree of variation here serves as another stumbling block for long-term investors. Now when you run the numbers, you find these facts emerge: • Natural gas has a higher cost per MWh than coal. • Natural gas has a higher thermal efficiency than coal. • Natural gas produces half the amount of CO2 than coal. • Natural gas is used more often when a reliable source of electricity is needed.
The result is that it is sometimes cheaper to use natural gas and sometimes cheaper to use coal, even with its higher pollution. This analysis is specifically for analyzing the relative efficiencies of various electric generation systems. While it can be used to inform specific trading or investing decisions, each situation is different and requires the incorporation of the values of several variables for that specific power plant. |