Question

Suppose you are the CFO of a small Independent Power Producer in western PA (which is part of the PJM Electricity Grid (PA Jersey Maryland)). Your main business is to purchase natural gas and convert it to electricity for sale on the grid. You recently looked into PJM Western Hub futures contracts and natural gas futures that trade on the CMEGroup exchange.

Assumptions:

Natural Gas Input 60,000,000    MMBtu's / Six Months

Megawatt Hours Generated    9,000,000    MWh / Six Months

Price of Power Futures (N9) Sold    $19.00    $/MWh

Price of NG Futures Purchased    $2.00    $/MMBtu

a) What is the heat rate of your power plant in MMBtu/MWh?

b) If the spot price of NG is also $2.00, what is the minimum spot rate for electricity at which the plant should generate electricity?

c) What is the spark spread implied by the futures market contracts in $/MWh?

d) Ignoring the basis, how much profit can you "lock in" given current future prices (in $/MWh)?

Answer 1

(a)	Heat Rate=	Natural Gas input/Mega whatt hours generated
		=60000000/9000000
		6.666667	MMBtu/MWh
(b)	Spot rate of NG =$2
	Natural Gas input Required for Mwh=6.666667
	Cost of Elecricity =		Spot rate of NG * Heat Rate
		=	2*6.66667
		=	13.33334
	spot rate for Electricity is $13.33334/MWh
(c)	Spark spread =		Power price -(Narural gasprice *Heat Rate)
		=	19-(2*6.666667)
		=	$5.66666/MWh
(d)	Current Given future prices are
	Price of power futures			$19
	Price of NG futures			$2
	cost of NG for MWh of Electricity =				$2*6.666667
				=	13.33334
	Lock in profit while using Futures=				$19-13.33334
				=	$5.66666/MWh