Spark Spread - Clean Spread

Clean Spread

In countries that are covered by the European Union Emissions Trading Scheme, generators have to consider also the cost of carbon dioxide emission allowances that will be under a cap and trade regime. Emission trading has started in the EU in January 2005.

The Clean Spark Spread is calculated using a gas emissions intensity factor of 0.411 tCO2/MWh. Therefore the clean spark spread is calculated by subtracting the carbon price per tonne (multiplied by 0.411) from the ‘dirty’ spark spread, i.e. Clean Spark Spread = Spark Spread – (Carbon Price*0.411).

Clean spark spread or "spark green spread" represents the net revenue a generator makes from selling power, having bought gas and the required number of carbon allowances. This spread is calculated by adjusting the cost of natural gas in MMBtu for the efficiency of the generation and subsequently applying the market cost of procuring or opportunity cost of setting aside an emissions allowance such as a European Union Allowance (EUA) in the European Union Emissions Trading Scheme (EU ETS).

Let S: spark spread, E: electricity price, G: gas cost, Ng: number of carbon credits necessary to cover gas operation, Pcc: price of a carbon credit.

Then, Clean spark spread = E - G - Ng*Pcc = S - Ng*Pcc

Clean dark spread or "dark green spread" refers to an analogous indicator for coal-fired generation of electricity. The spark green spread and the dark green spread are especially important in areas where coal-fired electricity generation is prevalent as the convergence of the spreads will lead to an important decision point.

Let D: dark spread, E: electricity price, C: coal cost, Nc: number of carbon credits necessary to cover coal operation (2–2.5x that of gas), Pcc: price of a carbon credit.

Then, Clean dark spread = E - C - Nc*Pcc = D - Nc*Pcc

Climate spread: The difference between the dark green spread and the spark green spread is known as the "Climate Spread".

Climate spread = Clean dark spread - Clean spark spread = (D - Nc*Pcc) - (S - Ng*Pcc) = (D - S) - (Nc - Ng)*Pcc.

Note: (D - S) and (Nc - Ng) are positive numbers.

In a carbon constrained economy a power producer in a geographic area where coal is currently the preferred method by which electricity is generated may eventually encounter a negative climate spread if carbon credit prices rise. This would mean that when taking into consideration the cost to produce plus the cost of compliance with a cap and trade (coal is on average 2.5 times as polluting as natural gas for the same MWh of electricity), natural gas would be a better decision. This would begin to cause more internal abatement via power generation fuel switching and less reliance on flexible mechanisms. This is important due to concerns regarding supplementarity.

Climate spread is also interesting in that it is the fundamental driver for the price of carbon credits. Since the ETS cap-and-trade system covers the major polluting industries, power generation by coal- and gas-fired power plants, by far the largest power sources, create the most carbon credit demand within the ETS. To cover emissions on an ever tightening ration of free EUA allowances, a coal-fired powered power plant will either have to abate internally or buy credits. If the price of marginal internal abatement is lower than the price of carbon credits, the firm will choose internal abatement. However marginal abatement becomes more and more expensive, at some point forcing the plant to buy credits – thus the carbon credit price is equal to the marginal cost of abatement to the extent that European power plants have chosen to abate.

Clean Dark Spreads are a reflection of the cost of generating power from coal after taking into account fuel (coal) and carbon allowance costs. A positive spread effectively means that it is profitable to generate electricity on a Baseload basis for the period in question, while a negative spread means that generation would be a loss-making activity. However, it is important to note that the Clean Spark Spreads do not take into account additional generating charges (beyond fuel and carbon), such as operational costs.

Both the UK and German Dark Spread tables use a fuel efficiency factor of 35% for the coal conversion, and an energy conversion factor of 7.1 for converting tonnes/coal into MWh/electricity. In reality, each type of coal has a different energy value and each coal-fired plant has a different fuel efficiency, but 35% is accepted as a broad standard. At the time of writing (March 2007) there is no liquid Dark Spread traded market in either the UK or Germany. The Dark Spread value is the power price minus the coal price divided by 0.35, i.e. Dark Spread = Power price – (Coal price/0.35).

The Clean Dark Spread is calculated using a coal emissions intensity factor of 0.971 tCO2/MWh. Therefore the Clean Dark Spread is calculated by subtracting the carbon price (multiplied by 0.971) from the ‘dirty’ spark spread, i.e. Clean Dark Spread = Dark Spread – (Carbon Price*0.971).